Most incumbents at the time of the entry of Southwest Airlines are showing small profits because of low consumer demand, high operation and maintenance costs. However, Southwest Airlines' introduction of a new business model significantly altered this situation.
It can be recalled that deregulation has lowered the barrier to entry in the industry as well as enhanced the competitiveness of the players which are previously receiving subsidy from the government. This, in turn, largely contributes to the cost efficiency of airline operators allowing them to charge lower prices to passengers. A low cost carrier like Southwest Airlines typically adopts a business model which offers only a single passenger class and a single type of airplane which allows the company to cut on training and servicing costs. Budget airlines also typically employ a very simple fare scheme which rewards early reservation by increasing the fare charged as the plane fills up. There is usually no reserved seating in order to allow customers to choose their own seats thereby encouraging early and quick boarding (Sorensen 2006). In order to drive down operation costs, technological innovation particularly the internet is used in order to eliminate the huge commission usually passed on to travel agencies. Budget airlines also prefer flying on secondary and simplified routes as well as having relatively shorter flights and faster turnaround times. Budget airlines, unlike larger air companies usually skip in-flight catering and other complimentary services replacing this with optional paid-for-in-flight food and drinks. In order to insulate themselves from future increases in oil prices, budget airlines often undertake aggressive fuel hedging, that is, "making advance purchases of fuel at a fixed price for future delivery" (Fuel Hedging 2006).
The operation of an airline necessitates the investment in capital which includes the planes, and ports among others. Southwest Airlines also recruited pilots, stewardess, and staff which will run the operation. The company also pays mechanic for the maintenance of its fleet. Looking the company's cost structure; it incurs both direct and indirect costs in order to keep the business running. The fixed costs associated with Southwest Airlines' operations include the monthly maintenance of the mechanic, the insurance paid for its fleet, the expenses associated with the leased properties like the airport, electricity expenses in its offices, and even the rent expense that it pays for its booking premises. These fixed costs can be seen as indirect expenses because they cannot be necessarily identified with a specific product or value (Garrison et al, 2007). These costs are incurred as the air carrier operates and are very significant to keep it in business. However, they cannot be directly linked to the specific process of product and process costs.
In its daily operations, Southwest Airlines shoulders operations cost. As opposed to business organizations which can directly identify the costs associated in creating a product which is suitable to a specific customer order or requirement, Southwest Airlin