1. Professor Jeff Dyer Strategic Management Cost Advantage

2. Professor Jeff Dyer COST ADVANTAGE AT SOUTHWEST “Airlines don’t have revenue problems, they have cost problems.” Southwest. Conventional Strategy: Meals, pre-assigned seats, membership in airline reservation system, travel agents, and hub & spoke system are key to success. Southwest Strategy: Lowest cost operations and lowest prices. Sales/MarketingOperations Human Resource Mgmt. Offer direct flights to busy cities of less than 500 miles No pre-assigned seats Little reliance on travel agents (saves 5-10%) Snacks rather than meals Prices 20-50% lower than the competition Fly only Boeing 737s (smallest, most fuel efficient craft) Train pilots & mechanics only on 737s Fly to cheaper, less congested airports (i.e. Love Field Dallas; Midway, Chicago) Don’t transfer baggage to other airlines Fast turnaround of aircraft (20 minutes vs. 50 minutes for industry) Initially non-union, now partially union labor Cross training, flexible workforce Employees receive same pay per job hour regardless of location (low turnover overall but accept high turnover in high cost areas; i.e. Calif.)

3. Professor Jeff Dyer COST ADVANTAGE AT SOUTHWEST n Airfares in Southwest markets are roughly 25 percent lower than in non-Southwest markets. n Southwest has an average 65 percent marketshare compared with less than 40 percent for other airlines in their top 100 markets. n Unit costs of other airlines are 50-60 percent higher than Southwest’s, except for America West with unit costs that are 20 percent higher. n Southwest has been the most profitable U.S. airline from 1980-1995. Source: U.S. Dept. of Transportation

4. Professor Jeff Dyer Southwest Profitability vs Industry: 1988-1996

5. Professor Jeff Dyer THE RELATIONSHIP BETWEEN PRICE AND COST EXPERIENCE CURVES (COMPANY PROFITABILITY) Different companies within an industry will have similar prices but will have accumulated different amounts of experience Predictable Unit Cost Differences Predictable Profitability Differences Cost/Unit (Constant Dollars) Accumulated Experience (units of experience) Industry Price Cost A B C

6. Professor Jeff Dyer THE IMPORTANCE OF RELATIVE MARKET SHARE Relative market share is an excellent proxy for relative accumulated experience - of leader relative to next largest follower - of all followers relative to leader Therefore, there will be a relationship between RMS and profitability Profitability Low High Low High Relative Accumulated Experience (Relative Market Share) Relative market share is a key indicator of relative long-term profitability

7. Professor Jeff Dyer PROFITABILITY VS MARKET SHARE US CONSTRUCTION COMPANIES (MEGABUILDERS) McKee Morrison-Knudsen Parsons RoytheonPullman Fluor Foster Wheeler Bechtel Brown & Root (Halliburton Relative Market Share (Revenues, 1972 - 1978) Return on Sales (Average 1972 - 1978)

8. Professor Jeff Dyer Airline Industry: Relationship between Experience and Profitability

9. Professor Jeff Dyer STRATEGIC IMPLICATIONS OF THE EXPERIENCE CURVE n First movers in a fast growing market will secure a widening cost advantage. Firm’s must grow as fast, or faster, than rivals or be at a cost disadvantage. n Understanding the behavior of costs allows for more sophisticated pricing strategies. The experience curve can be used: – As a basis for pricing a production run or contract – As a basis for market share based pricing strategy – As a basis for planning future prices n Experience curves can be plotted for a company and its competitors to assess how well each company is managing its costs. Companies with the greatest cumulative experience should have the lowest costs (if business is properly defined). n Product life cycles influence how you use the experience curve for pricing. Products with a short product life cycle (rapid development of new models) need to be priced to make money more quickly because they can’t count on a long learning curve and long productions runs.