Legacy systems can cost businesses dearly. Southwest’s screw-up is just the latest example

Southwest, the IRS and Royal Bank of Scotland, what do they have in common? Well, they all serve as reminders to companies that failure to modernize internal systems can cost them dearly. Here is how:


As 2022 was inching to a close, the airline that used to be known for customer services had the biggest meltdown in the industry’s recent history. Southwest cancelled more than 15,000 flights in the past few days, making up 80%, 86% and 94% of the country’s total cancelled flights on 27th, 28th and 29th of December respectively. This catastrophe left hundreds of passengers stranded, not knowing where to go or where to pick up their luggage. All of this could have been avoided, if it were not for Southwest’s inexplicable reliance on outdated tools and baffling refusal to modernize them.

Southwest uses an in-house system called Sky Solver to assign crews. Southwest flight attendants and pilots have been calling for an overhaul of this system for years to accommodate the growing complexity of the airline’s operations. Yet, the calls fell to deaf ears. Brutal winter storms and heightened demand unfortunately exposed Sky Solver’s shortcomings to the fullest. Phone lines jammed up. Crew members didn’t know which planes they should go to. Pilots booked their own hotels while flight attendants spent the nights at crew lounges. The airline couldn’t locate even their own employees. Although planes were ready to take off, Southwest had no choice but to cancel flights because there were no crew members to operate those planes.

By no means is this an isolated incident. In 2021, cancelled flights over 4 days in Q3 cost Southwest $75 million. Because what happened this week is bigger in scale, it is going to cost Southwest a lot more than what they paid out last year. Moreover, it is part of a trend that has been coming. In the last 10 years, Southwest consistently had more cancellations than its peers as its cancellation rate jumped from 0.8% in 2013 to 2.4% in 2022. As cancelled flights piled up, only 7 out of 10 Southwest flights have arrived on time.

The story of Herb Kelleher heroically fighting the status quo at the time to found Southwest is widely cited and studied in business schools. The airline prides itself in customer services. Yet, recent management teams have prioritized familiarity and bottom lines over making tough yet necessary investments. And now, they are paying the price. Not just in terms of the financial impacts, but also regulatory scrutiny and damaged trust from passengers.

Southwest's cancellations
Source: CNN

Internal Revenue Service (IRS)

As the agency that handles taxes of millions of Americans every year, you’d think that the IRS uses state-of-the-art systems. The reality is anything but. The IRS is the poster boy of how failing to modernize systems can cause significant damages:

  • In 1985, computer issues at the IRS delayed 1.5 million individual returns. Those who filed on time were eligible for interest on delayed payments, but that also meant millions of dollars in additional expense to the government
  • In 2007, the IRS handed out $318 million in fraudulent refunds
  • In 2018, a computer glitch on the deadline day caused widespread confusion and prevented more than 5 million Americans from filing tax returns electronically
  • The government literally spent tens of thousands of dollars over the years, trying to modernize the tools that the IRS used, with nothing to show for it
Source: Bloomberg Tax

The IRS built a system called Individual Master File (IMF) in the 1960s that holds tax payer data. More than 60 years later, the same software is still what processes our tax returns. As arguably the oldest system used in the US government, IMF runs on a legacy code that few people know. As the number of developers that can handle such an archaic code dwindles every year, the software is increasingly expensive to maintain. For good measure, the IRS has to tweak the legacy code every year to reflect changes imposed by Congress, adding complexity in the process. There has been no lack of effort to modernize IMF over the years. The latest attempt is called Customer Account Data Engine 2 or CADE 2. Announced in 2013, the project has suffered multiple setbacks and is now slated to be completed by 2030. But don’t be surprised if there are further postponements.

IMF is just the core system and one of the hundreds that the agency has developed over the years to meet its needs. Unfortunately, these systems don’t necessarily talk to one another. Per National Taxpayer Advocate:

Example: When a custodial parent wishes to amend her 2019 tax return to allow the non-custodial parent to claim a child as a dependent and to claim various credits, she can file an amended return electronically, but must mail the Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, along with Form 1040-X, Amended U.S. Individual Income Tax Return. The return-processing arm of the IRS does not have the capability to accept the Form 8332 electronically, so it must scan and upload the data from a paper form received. The delay resulting from mailing and processing of a paper Form 8332 could cause complications for the taxpayer or the non-custodial parent if the audit arm of the IRS acts on the amended return based on outdated return information of either parent.

To be fair, the IRS’s budget has decreased over the years while their job is not any simpler. Regardless, it’s very hard to fathom that one of the richest countries on Earth, if not the richest, and the birthplace of many tech companies cannot solve this issue. Everybody’s life will be dramatically improved if the IRS can overhaul its aging systems and make filing taxes easier. It seems far-fetched, but in the spirit of a new year, let’s just wish that would happen soon.

Royal Bank of Scotland (RBS)

Despite their pivotal roles in our societies, banks are notorious for tardiness in modernizing legacy internal systems. Such a failure to invest in IT infrastructure properly can result in serious business and financial consequences; one example of which is Royal Bank of Scotland (RBS).

In June 2012, a computer glitch wrecked RBS operations and exposed its systems’ weaknesses. About 12 million consumers had their accounts frozen and couldn’t complete transactions or withdraw cash from ATMs. Some said they couldn’t even see their account details. The meltdown cost the bank 56 million pounds in fine and another 175 million to compensate affected customers. It also put a regulatory spotlight on the bank and damaged the trust among customers.

At the time, RBS’ mainframes were using codes that dated back in the 1970s. The codes were so complicated that even insiders at RBS couldn’t understand. To make matters worse, the bank dismissed experienced employees that had the technical abilities to maintain the system and outsourced those jobs to low-paying staff in India. All in the name of cost savings. Guess what? The disaster in 2012 stemmed from one of those outsourced technicians making a major error on the job. Whether outsourcing was the root cause of RBS outages remains unclear, but perhaps given what was covered after the incident, an experienced operative would have helped avoid it.

Weekly readings – 1st Feb 2020

This post is a little bit late since I have been sick the whole weekend

The decade of the very poor and the super rich

A good read on marketplace and under-utilized assets

How the Dutch Use Architecture to Feed the World. I didn’t know that Netherlands is the second biggest exporter of agricultural products in the world.

Uber tests letting drivers set their own prices. I never thought Uber would, one day, let drivers set up their own price, but apparently they seem to be experimenting on it. I wonder whether Lyft will follow suit and whether this development will pave the way for aspirational startups.

I am very disgusted and disappointed by Southwest. After all the consequences that Boeing has had to face in the aftermath of Boeing 737 Max, Southwest still doesn’t learn the lesson. I hope they will soon

Southwest pilots flew more than 17 million passengers on planes with unconfirmed maintenance records over roughly two years, and in 2019 smashed both wingtips of a jet on a runway while repeatedly trying to land amid gale-force winds, according to the Transportation Department report, reviewed by The Wall Street Journal.

Source: WSJ

An Electronic Heath Records system provider worked with a drugmaker to implicitly encourage more opioid prescriptions to patients, despite an alarming rate of deaths by overdose.

Groundwork for the deal between the companies began in 2013, according to the statement of facts agreed to by Practice Fusion under a deferred prosecution agreement. The idea was to get the opioid maker’s pain drugs to certain kinds of patients: ones who weren’t taking opioids, or those being prescribed the company’s less profitable products. It also aimed to secure longer prescriptions, according to the court papers.

Source: Bloomberg

Southwest & Airtran Merger

In this piece, I’ll talk about the merger of Southwest and Airtran. The merger took place 8 years ago. The reasons are two-fold. One is that I learned about the operating models of airlines in general while the other is that this merger is an example of how cultural and operational factors play an important role that could break deals.

Critical Facts

To remain competitive in a cut-throat industry, airlines in the US have had to turn to consolidation or merge and acquisitions (M&A) in recent years (Wharton, 2010). In 2010, Southwest bought Airtran for $1.4 billion (Esterl, 2010), to create a $3 billion airline that would be the 4thlargest carrier in the US. The acquisition of Airtran was, at the time, only the 3rdin Southwest history. It paid $134 million for Morris Air in 1993 and $60.5 million for Muse Air in 1985 (Esterl, 2010). Despite the takeover, not all Airtran’s operation was integrated into Southwest’s immediately. McCartney (2013) reported that only 28% of Airtran’s destinations were moved under Southwest’s operation and that the two continued to function separately until the end of 2014.

Southwest commenced services in 1971 and as of December 31, 2010, the airline operated solely Boeing 737 aircrafts in a point-to-point model to only domestic destinations in the US (Southwest, 2011). The company’s mission statement is “dedication to the highest quality of Customer Service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit” (Southwest). On the other hand, Airtran was, at the time of the acquisition, one of the largest low-cost carriers (LCC) in the country with significant presence at some of the most popular airports in the country such as New York’s LaGuardia Airport and Boston’s Logan International Airport. The airline operated Boeing B717 and B737 to domestic destinations and a few international ones such as San Juan, Puerto Rico; Cancun, Mexico; Montego Bay, Jamaica; Nassau, The Bahamas; and Orangestad, Aruba (Southwest, 2011).

There are two main types of airlines in the US: the point-to-point and hub-and-spoke (Moss, 2010). In the hub-and-spoke system, an airline concentrates its operations at a few first-rate airport locations. The point is to route traffic to ultimate destinations from these key hubs. The system is typically favored by legacy carriers, but comes at the expense of delays due to traffic congestion and other tasks such as baggage handling, gate and slot management.

On the other hand, the point-to-point system refers to the direct traffic from one point to another. It is usually deployed by LCCs for short-haul flights, but tends to be used more for longer flights. The point-to-point system typically involves secondary airports and smaller cities in order to help LCCs avoid head-to-head confrontation with bigger legacy carriers.

Southwest relies on a simple pricing strategy with only one tier and no charges on date changes or bags whereas Airtran offered multiple pricing tiers and additional fees on changes, cancellations and baggage (Wharton, 2010).

Three years after the merger was announced, the pilot issue was resolved (Yamanouchi, 2012) and the majority of Airtran employees accepted jobs at Southwest (Maxon, 2014). In 2014, the last Airtran route was integrated into Southwest’s system and Airtran operated its last flight. Furthermore, Southwest standardized the system for both domestic and international flights, using Amadeus as the technology vendor (Maxon, 2014).


Customer satisfaction, as measured by consumer com- plaints per 100,000 enplanements (Gabreski, 2013)

Southwest prefers to operate only Boeing 737s to keep the operations simple and cost down while Airtran had a fleet of Boeing 717s in addition to 737s. The two airlines adopted two different approaches when it came to distribution. Airtran sold tickets through global distribution networks such as Expedia (Esterl, 2010) while Southwest did it all internally, cutting out the middle man. Wharton (2010) reported that the most contentious issue of the whole merger was the personnel issue. Taking in so many new employees from Airtran might put Southwest at risk of not managing them well enough. Plus, pay and seniority among pilots posed another serious challenge. If the two companies merge, where in the hierarchy would each company’s crews rank?

At the time of the merger, Southwest recorded $12.1 billion in revenue and $460 million in profit (Southwest, 2010), equivalent to 4% of the top line. On the other hand, the figures by Airtran were $2.6 billion and $38.5 million respectively, equivalent to 1.5% of the turnover (Airtran, 2011). Employee-wise, Southwest had almost 35,000 staff on the books (Southwest, 2010) whereas Airtran employed 8,500 people (Airtran, 2011).

The Dallas-based company estimated that the merger would bring in $400 million a year in operating synergies by 2013, yet would cost in the beginning at least $300 in one-time integration costs. MacLennan (2015) reported that Southwest’s shares went up by 230% since the merger’s announcement, compared to a 51% gain for the S&P 500 in the same period. Southwest also noted in the 2013 annual report that the international expansion met the 15% ROIC goal.


First of all, the merger was in line with the mission statement of Southwest. It aims to deliver the highest quality of customer service to customers and obviously new routes brought over from Airtran supported that.

Porter Five Forces

Porter’s Five Forces (Porter, 1979)

If we look at Porter’s strategy framework, the merger made sense. Southwest grew by flying from point to point and using secondary airports. At some point, the strategy would hit a limit and Southwest would have to do something drastic to fuel growth. The purchase of Airtran lessened the competition by eliminating a proven LCC. Regarding the threat of entry barriers, the merger gave Southwest an added fleet of great aircrafts and valuable access to hugely important airport hubs: Atlanta and Ronald Reegan in Washington DC. The former made it more difficult for any new challenger to match the size of Southwest’s fleet while the latter prevented anybody wishing to dominate those two airport hubs. Additionally, growing in size increased the bargain power Southwest has over suppliers, especially fuel suppliers. The increased power could play a significant role in keeping the cost low.

Though the move made sense strategically, it came with a host of risks in terms of operating philosophies, cultures and operations. Southwest had been a quirky airline before the merger. The organization had been very cautious when it came to expansion by acquisitions, a fact proven by its only two M&A moves before Airtran in its history. Southwest didn’t want to risk its closely monitored and managed culture and organization. Merging with a significant airline such as Airtran would be almost guaranteed to disrupt such a closed environment.

Southwest had been a point-to-point carrier for domestic flights with emphasis on customer satisfaction and employees’ well-beings. On the other hand, Airtran believed in the low-cost proposition and adopted the hybrid system for both domestic and international flights.

Differences in Airline Models

The merger pushed Southwest to an uncharted territory. They didn’t have experience operating international flights or the hub-and-spoke model. They didn’t have a complex pricing system or much focus on low-costs. Essentially, the table above showed a set of stark differences inherently between Southwest and Airtran. The management of the acquirer had a decision at hand: whether it should continue to operate two separate models or to take risks and choose to stick with one model?

Let’s look at this from another perspective.

Porter Generic Competitive Advantage

Porter’s Generic Competitive Strategies (Porter, 1990)

Following the diagram above, Airtran competed by being a cost leader while Southwest pursued the differentiation path. A full integration meant that Southwest had to choose one final strategy. It didn’t make sense that Southwest acquired Airtran just to eliminate a competitor. The company had had only two deals before Airtran and in the industry that requires quite a high operating capital, spending more than $1.3 billion just to remove some competition without any synergies would be too much an investment, no matter how big Southwest was at the time. Without synergies, the merger wouldn’t have helped either company strategically.

If a full integration was the right direction, the question that remains is: which direction would Southwest choose? Given that Southwest had, at the time, more than 5 times as many employees as Airtran, integrating Airtran into Southwest would be an easier task than the other way around. Plus, Southwest’s operating philosophy was more robust and sustainable than Airtran’s.

VRIO Framework

VRIO Framework to analyze the sustainability of competitive advantage (Judgev & Thomas, 2002).

Southwest created its own sustained competitive advantage through dedication to employees’ welfare and excellent customer service. It led the industry in customer satisfaction and was profitable for 38 years in a row at the time (Southwest, 2010). It had the brand name as well. The competitive advantage that Southwest built was, in my opinion, very difficult to replicate in such a fierce industry. On the other hand, Airtran’s competitive advantage in my opinion was not as sustained. It could be argued to be a temporary competitive advantage. If other LCCs or legacy airlines had engaged in a price war, I doubt that Airtran would have survived for long. Plus, the constantly rising fuel cost was one of the main drivers of consolidation in this industry in the first place. It made Airtran’s competitive advantage less sustainable.

As a result, it made sense for Southwest to keep its original philosophy and integrate Airtran in its system.

To make the integration work, Southwest had to iron out a few wrinkles as follows:

  • The fleet of Boeing 717s
  • Difference in distribution system
  • Difference in focus on employees and dedication to customer satisfaction
  • Difference in reservation systems, especially for international flights
  • Difference in pricing models and fees
  • Inexperience in handling activities at major airports
  • Pay and seniority of Airtran’s pilots and employees

The risks above were the reason why critics and doubters had lukewarm reaction to the merger. They were indeed difficult challenges. Unless handled smoothly, they could impact negatively both the integration and what Southwest originally had. However, the benefits were significant. In Airtran, Southwest found a solution to its quest for growth. It could add more resources and competencies, particularly international flights. In my opinion, the benefits at least justified the risks.


Culturally and operationally speaking, the merger posed an immense risk to Southwest. The two companies were very different and without a well-planned and smoothly-executed integration, it would negatively affect what they already had going on at the time. However, the risk was rightly justified by the potential gains economically and strategically.

In the end, it was wise for Southwest to integrate Airtran into its system due to the reasons articulated above. Years after the merger, the financial performance shown in the “Critical Facts” section was proof of how well Southwest pulled off the integration.

This case taught me the two models in airlines industry and how they differ from each other in terms of operations and culture. Indeed, such a difference highlights an important aspect that management has to consider before any merger.


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Yamanouchi, K. (2012). AirTran, Southwest pilots approve seniority deal. The Atlanta Journal-Constitution. Retrieved from: https://www.ajc.com/business/airtran-southwest-pilots-approve-seniority-deal/yyTnyonwhHRLf0BY8rDcPJ/