Financial Analysis - Southwest Airlines - Case Study Example

Financial Analysis - Southwest Airlines case Introduction One of the most common challenges for firms worldwide is to keep their competitiveness at high levels without putting their financial stability under risk. The achievement of the above target can be more difficult in certain industries – where competition is stronger; an indicative example is the airline industry. Southwest Airlines is among the most powerful firms in the US Airline industry; in 2007 the firm’s profits were estimated to $9,861 (in millions) – a significant increase compared to the firm’s profits in 2003 – about $5,937 (in millions); the above increase is indicative of the effectiveness of the firm’s strategic plans; however, in the first quarter of 2008 the passengers of the firm were estimated to 9,685 (in thousands) compared to the 43,812 (in thousands) passengers in 2007 – a significant decrease within just one year. It seems that the firm’s strategic choices have to be reviewed – its culture and its leadership should be also examined – and appropriate changes need to be made. The examination of the firm’s financial performance – through the calculation of specific profitability ratios has led to contradictory assumptions; the firm has many prospects to recover soon but radical changes should be made on its culture and its governance. 2. Southwest Airlines – corporate culture, characteristics and role in the firm’s competitiveness – employee satisfaction, innovation and risk Southwest Airlines was first established in 1966; its owner, Rollin King, had a specific vision: to create a low-fare airline that would serve people in three particular cities: Houston, Dallas and San Antonio. The firm had a significant difference from other firms: in Southwest Airlines employees have been considered as the most important part of the organization – customers are at the second level of the hierarchy; in most firms internationally this is not the case: the service of customers is considered as a priority for firms in most industrial sectors. The specific characteristic of the firm’s culture has been proved to be one of its most important advantages – in fact, this policy has been considered by the firm’s managers to be a competitive advantage – it is for this reason that a rule implemented in the firm by Barrett – Southwest’s President for the years 2001 up to 2008 – the employee can use his/ her own judgment regarding the service provided to a customer; in the past though, i.e. in 1971 the dressing of the firm’s flight hostesses has been used by the firm’s managers to attract customers. Innovation in the firm’s advertising has been another characteristic of the firm’s culture; by using unconventional advertisements the firm’s managers tried to keep the attention of customers – and to increase the firm’s customer base. Innovation is also involved in other firm’s initiatives: the offer to the customers of free drinks – an offer not provided in all the firm’s flights – and the introduction of the 10-minute turn scheme – a real impressive project giving to the firm the chance to increase the number of its flights and keep the number of its planes stable. The 10-minute scheme has been one of the most important parts of the firm’s strategic planning – showing the ability of managers to develop effective HR plans – the success of this scheme requires that all tasks are appropriately distributed among the employees participating in the specific scheme. At the next level, risk has been a key characteristic of the firm’s strategic planning; this risk has been expressed in the following two sectors: a) the expansion of the firm in new markets and b) the expansion of the firms in areas which had been rejected by rivals – as destinations. The corporate culture in Southwest Airlines has been proved to be proactive and effective; the recognition of its value by the customers and the market is proved by the fact that in 2007 the firm has become the largest firm in the U.S. airline industry – referring to the number of its passengers; also in 1998 the firm has been named as the best firm to work in the U.S. – a recognition given by the magazine Fortune. It seems that corporate culture in Southwest Airlines has a key role to the firm’s performance; changes would be possibly implemented in order for the firm to face successfully the challenges of the global crisis – the influence of which on the firm’s performance can be identified in the firm’s financial results for 2008. 3. Southwest Airlines – financial performance 3.1 Profitability ratios The firm’s profitability ratios for the years 2003 up to 2007 are presented below; these ratios indicate the effectiveness of the firm’s strategies for these years; at the next level, these ratios can be used in order to understand the potentials of the firm to recover – after the losses caused under the influence of the global financial crisis. Operating profit margin Operating profit margin = Operating Income / Revenues a. 2003 379/5,937= 0.063 b. 2004 404/6,530= 0.061 c. 2005 725/7,584= 0.095 d. 2006 934/9,086= 0.102 e. 2007 791/9,861= 0.080 The firm’s operating profit margin represents the amount of money available in the beginning of its financial year for the payment of the firm’s various expenses (like wages and so on). The firm’s operating profit margin as estimated above is rather low (from 6.3% in 2003 to 8% in 2007 – and 10.2% in 2006). Net profit margin Net profit margin = Profits after taxes / Revenues a. 2003 372/5,937=0.062 b. 2004 215/6,530= 0.032 c. 2005 484/7,584= 0.063 d. 2006 499/9,086= 0.054 e. 2007 645/9,861= 0.065 The net profit margin of the firm is rather limited; this ration reflects the level of the profit that can be achieved for every $1 invested on the firm; in 2004 the firm’s net profit margin was extremely low – just 3.2% - while the other years it did not pass the limit of 7%. Return on total assets Return on total assets = Net income/ Total assets a. 2003 372/9693= 0.038 b. 2004 215/11137= 0.019 c. 2005 484/14003= 0.034 d. 2006 499/13460= 0.037 e. 2007 645/16772= 0.038 In accordance with the above ratio – which indicate the ability of the firm to turn its investment into profit – the firm’s potential to turn its funds into profit is limited – the percentage of 3.8% in 2003 remained stable in 2007 - while in 2004 it was decreased in 1.9%. Return on stockholder’s equity (ROE) Return on stockholder’s equity = Profits after taxes / Total stockholders’ equity a. 2003 372/5,029= 0.073 b. 2004 215/5,527= 0.038 c. 2005 484/6,675= 0.072 d. 2006 499/6,449= 0.077 e. 2007 645/6,941= 0.092 The return on stockholders’ equity shows the ability of the firm to generate profits using the funds invested by the shareholders; the highest ROE of Southwest Airlines has been achieved in 2007 – 9.2%; for the previous years an average of 7.4% ROE shows that the firm struggles in order to turn the investment of its shareholders to profits. 4. Actions suggested to the firm’s managers in order to sustain/ strengthen the corporate culture As explained above, corporate culture in Southwest Airlines is heavily based on the following priorities: the employee satisfaction, the promotion of innovative practices and the risk. However, under current market conditions the key characteristics of the firm’s corporate culture would be reviewed – existing priorities would be set at different levels of the firm’s strategic priorities. More specifically, the increase of the firm’s competitiveness in the U.S. market would be set as the first priority for the firm’s managers. This means that traditional principles like the freedom of the employee to use his/ her own judgment would have to be eliminated – or at least alternated – in order to meet the demands of the market as they are developed in accordance with the practices used by the competitors – who, in their high percentage, set the customer as the most important criterion for the development of the corporate value. The attitudes of the firm’s employees towards the customers could be changed using appropriate HR techniques; an indicative example is the use of narrative as a tool for enhancing the firm’s culture (Marshall et al., 2010, p. 18). Of course, employee satisfaction would be still considered as an important part of the firm’s strategic planning but it would be appropriately categorized – taking into consideration the common market practices in the relevant field. Other elements of the firm’s culture would be also changed – emphasis is given on risk an innovation; the development of the firm in the market could be achieved by plans that will be less risky; innovation also could be reduced – aiming to reduce the firm’s expenses on innovative projects, which have uncertain results; new priorities, like the development of a strong corporate identity, could be set in the firm’s strategic plans. The specific issue is highlighted in the study of Appel-Meulenbroek et al. (2010) who note that ‘corporate identity and its six characteristics – structure, strategy, culture, communication, behaviour and design – form a useful tool to determine the proper branding strategy for an organization’ (Appel-Meulenbroek et al., 2010, p.47). Moreover, in current recession, the development of innovative – but risky – plans could lead the firm to severe losses; in fact, the reduction of the firm’s profitability in 2008 can be considered as reflecting the inability of the firm’s managers to understand the changes in customer preferences and the market potentials for profit – referring especially to the post-2008 period. At this point, the study of Prabhu (2010) could be helpful; the above researchers tried to identify the methods through which corporate culture would still support innovation in periods of recession; their study led to the assumption ‘if certain attitudes, practices and behaviours are shared by members of a firm, it is more likely to have a forward-looking, risk-taking culture’ (Prahbu, 2010, p. 5); this means that the firm’s managers could still promote innovative – and risky – schemes but only under the terms that these schemes would be equally supported by all firm’s employees; i.e. a share of risk could lead to the limitation of the risk. Furthermore, ‘the finding of common functions and risks could open the way for an analysis of common principles in corporate reputation management and corporate finance management’ (Siano et al., 2010, p.68). This means that by closely reviewing the risk involved in corporate schemes the firm’s leaders could improve the effectiveness of the corporate finance management, a fact that would lead to the increase of the firm’s profitability. 5. Leadership actions required for the implementation of the firm’s strategic decisions In the context of the issues developed above, the firm’s leaders could proceed to a series of initiatives in order to successfully implement the firm’s strategic decisions: a) development of a department that would deal exclusively with the estimation of risk involvement in various firm’s projects – cost and profits of each strategic decision would be balanced before implementing the specific decision, b) change in the existing HR strategies: employees’ skills and capabilities were set as a priority – training should be provided – where necessary – in order for the firm’s customer service to be improved; customer would be set as a priority, c) power should be given to managers at various level of the organizational hierarchy to suggest schemes that would increase the productivity in their department – the firm’s leaders would have more precise view on the firm’s performance and it would be easier for them to develop appropriate plans for the improvement of specific organizational activities and d) the geographic area in which the firm operates should be reviewed – only destinations that are actually profitable would be included in the firm’s flight schedule. 6. Conclusion The performance of Southwest Airlines has been identified as having two different aspects: in terms of its number of passengers and its profits the firm seems to be quite successful; however, the measurement of certain financial ratios – as presented in section 3 – proves another fact: the firm cannot easily convert its money to profits while it cannot even respond – at least not easily – to its expenses – its highest operating profit margin was achieved in 2006 and was estimated to 10.2%. On the other hand, the firm has an extremely low net profit margin – the highest has been near the 7% - a fact indicating the lack of effective strategic decisions – in terms of the firm’s profitability; this assumption is in accordance with the level of the firm’s ROE and return on total assets – which have been low for the years 2003 up to 2007. The above findings if compared with the decrease in the firm’s profitability in 2008 – as estimated at least in regard to the first quarter of the specific year – lead to the assumption that the firm’s strategic decisions need to be carefully reviewed – changes should be made in accordance with the issues developed above; the potentials of the firm to improve its performance are high; however, the success of the relevant initiatives is considered as closely connected with the ability of the firm’s leaders to promote radical changes on the firm’s culture and governance. References Appel-Meulenbroek, R., Havermans, D., 2010. Corporate branding: an exploration of the influence of CRE. Journal of Corporate Real Estate, Vol., 12, No. 1, pp. 47-59 Marshall, J., Adamic, M., 2010. The story is the message: shaping corporate culture. Journal of Business Strategy, Vol. 31, No. 2, pp. 18-23 Prabhu, J., 2010. The importance of building a culture of innovation in a recession. Strategic HR Review, Vol. 9, No. 2, pp. 5-11 Siano, A., Kitchen, P., Confetto, M., 2010. Financial resources and corporate reputation: Toward common management principles for managing corporate reputation. Corporate Communications: An International Journal, Vol. 15, No. 1, pp. 68-82 Read More