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TESCO PLC CASE STUDY-Financial Statement & Data Analysis

TESCO PLC. CASE STUDY-Financial Statement & Data Analysis

Table of Contents

  1. Introduction. 2
  2. Overview of Tesco PLC.. 2

III.        Literature Review.. 3

  1. a) Efficient Market Hypothesis. 4
  2. b) Types of Profit warnings. 5
  3. Results and Analysis. 6
  4. Conclusion and Recommendations. 10
  5. References. 11

Part B: Motivations behind Earnings management and creative accounting. 12

          I.            Introduction

Tesco Plc. announced two major profit warnings in the year 2014 on September 22nd and 9th December. These two announcements had an adverse effect on the stock volumes. It came out that the company had misstated its profit statements and this aspect made its stock price take a deep dive. Therefore, this report presents the abnormal returns analysis for the company for the period of the warning. The report has the following sections; introduction, overview of Tesco Plc., literature Review, results and analysis and conclusion and recommendations.

       II.            Overview of Tesco PLC

Tesco Plc. a supermarket chain made major announcements towards the last quarter of the year 2014. The company had made six profit warnings in a year. The announcement was made by the incoming CEO Dave Lewis who had only spend 100 days in the company. The CEO warned the share market the predicted profits that were expected on the year ending on February 2015 had a £500 million deficit compared to the expected markets forecasts as they didn’t exceed £1.4bn. These announcements saw the company share price halve to its lowest in 14 years’ time. The accounting scandal of overstating their profits was also a major blow to investors an aspect that saw them lose confidence with the company. In less than a year, the company had made major changes including hiring a new CEO.

These situations put the company into a major crisis that lead it to face tough economic times. The top ten shareholders sold some of their shares after that scandal and the profit warning an indicator they had sensed some danger. However, while majority were frustrated with the state of the company, others had the hope that the company was at its lowest but it could still make a turnaround and recover the market share. The shares saw a deep dive by 16% after the announcements and the company traded way below other competitors like FTSE 100.

   III.            Literature Review

Accounting information is vital in stock markets. The accounting data that is available to the public is used to explain the changes that affect the stock prices. Many authors have evaluated literature and gave varying views on the effects of financial announcements on the aspects of stock markets. Negakis (2005) noted that the earnings and book values have no effect on the stock prices. However, various authors like Hirschey et al., 2001; Liang and Yao, 2005), identified that there exist various relationships between accounting parameters and the stock prices.

Further, Fama (1970) argues that the stock prices must reflect on the financial information that is presented to the shareholders in an efficient market. He further adds that the financial information provided to the public for the publicly owned companies influence the stock prices on an efficient market and the investors would always react to such announcements. However, some research reveal that announcements made on financial markets may not be reflected by the variations of stocks (Helbok & Walker, 2003).

Over the decades, companies have made public announcements that target the investors like takeover announcements, change of company management, assets acquisitions, dividend announcements among other financial related information. It has been established in literature that these announcements have an impact on the movement of stock prices. While some investors might perceive some announcements as a warning signs, others would not do anything when such announcements are made. The reaction is quite different ranging from one company to the other as other factors like market share play a role. According to Vega (2006), there is a change of the relationships between stock prices in the markets and the several types of public announcements made. Moshirian et al., 2012 revealed that negative public announcements adversely affected the movement of the stock prices in his study of Vilnius Stock Exchange.

In their research, Eizentas et al. (2012) evaluated abnormal returns on stocks and how it was impacted by the financial information’s signals on stock market prices. Under their study that they found few categories of financial announcements that had an influence on the stock prices. Further in their study, Kiete and Uloza (2005) adopted Cumulative Abnormal Returns and identified a semi-strong form of EMH that existed in Vilnius SE where financial brokerages exploited the market inefficiencies. They further added that financial information was a crucial key on the company returns.

Alidoro and Grigalinjnienơ (2012) also evaluated the stock price reactions to the key financial information like profit warnings and found out that the reaction to positive financial information was a bit positive on the stock prices compared to the  negative financial information. He further adds that existence of some inefficiencies leads to the investors taking advantage of that to gain profits. Generally, positive public announcements lead to a positive stock price movement while a negative public announcement may generally lead to a decline is stock prices. While some events affect these movements, some might be short lied thus the investors may not react at all to the changes.

a)      Efficient Market Hypothesis

According to EMH, investors have a limited chance to buy stocks as they are always traded at their fair value on the SE (Polk, 2013). EMH has some issues of anomalies where regular patterns are noticeable for asset returns. The patterns are regular and reliable an indicator that they can be applied in forecasting of stock prices (Jackson & Madura, 2003).

There are three forms of EMH and are based on the underlying assumptions of price efficiency. They include; weak-form market efficiency, semi-strong market efficiency and strong version of market efficiency. Under weak market efficiency it’s stated that the available financial information reflects the prices for the publicly traded assets as well as the future trends cannot be predicted by the past prices while the semi-strong established that stock prices react instantaneously to the public financial announcements while the strong version argues that private insider information and public knowledge reflect the asset prices.

b)     Types of Profit warnings

Profit warnings according to analysts refer to an unexpected outcome in that the earnings for a given period or quarter may not reach the current expectations. The earnings shortfall maybe due to low sales, reduced net profits, escalating expenses, earnings per share among others. The warnings are normally made for the ending year even though quarterly announcements can be made (Kasznik & Lev, 1995). Profit warnings that there will be a shortfall of profits, sends a negative message to investors and that would lead negative reactions that could lead to a decline in stock price movement. When a company publishes its financial information, a decline in sales could be a profit warning and if the decline is persistent, then the stock prices may be influenced negatively overtime. Reduced profits that maintain a trend over several quarters consecutively or even in years could send a signal to investors and the stock prices and volume would be negatively affected (Skinner, 1994).

Profit warnings will influence the stock prices differently ranging from a company to the other. Large-sized companies would be less affected by profit warnings compared to medium or small sized companies. Also, a profit warning may lead to an overreaction by the investors in that when there is a sudden drop of profits with unclear circumstances, that could be a red signal to them especially when there are accounting scandals (Tserandash & Xiaojing, 2010). An underreaction indicates less reaction by the investors after a warning has been send and this could be when the profit drop is less significant. No reaction by the investors come in when there is an expected drop but the market is promising so the company will gain. Profit warnings are quite useful as they send a signal to the investors to act for the sake of the company. The shareholders may chip in and help the company recover from pressing debts that could be leading to declining profits. The investors can as well offer decisions to help the company recover.

    IV.            Results and Analysis

This section presents the findings of the abnormal returns for Tesco for 22-9-2014 & 09-12-2014 period after a profit warning was send. It’s expected that the stock volumes and prices declined tremendously after the announcements. Also, the findings present the company returns for the period, CAPM, AR and CAR for Tesco Plc.

A ten-day (-5 & +5 days) analysis for abnormal returns was done with an average trading volume of -260 and -10 days. The results are presented in the figure below.

Figure 1: -5 & +5 DAYS AR

From the results as shown in Figure 1 above, 5 days before the announcement of 22nd September, the returns were normal but at the 5th to 6th day, there was a sharp incline indicating the abnormal returns that were because of stock sales due to the warnings. After the period of two days, the curve took a deeper curve with negative returns before assuming the normal curve again. The results are in line with Eizentas et al. (2012) who noted that financial announcements had an adverse effect on the stock prices.

Also, the researcher calculated the daily cumulative abnormal return s for the company for -5 days and +20 days for each of the profit warning using CAPM. The results are as shown below.

22ND September Profit Warning

The figure below presents the September profit warning.

Figure 2: Sep. Profit warning

From the results as shown in Figure 2 above, the abnormal returns are experiencing a declining curve that majorly operates on the negative side.

Figure 3: December Profit Warning

Results as shown in Figure 3 reveal that the abnormal returns for December are moderately operating along the zero line but with a sharp plunge on the 21st day. The cumulative abnormal returns operate on the negative side. This is an indicator that the stock was not doing well. Comparing the two profit warnings, they almost assume a similar curve even though in December there was adverse effects compared to September.

From the results presented above, they are in line with the literature in that the profit warnings issued adversely affected the stock prices of the company. The findings collaborate with Skinner (1994, 1997) and (Kasznik and Lev, 1995) who identified profit warnings having unimpressive implications on the stock markets as the case presented by the findings.

       V.            Conclusion and Recommendations

The study concludes that profit warnings have negative effects on stock markets and would influence the stock price movements. The abnormal returns because of such announcements are short lived as for the case of Tesco, it was experienced for two days then was followed by a sharp decline. Profit warnings are treated as negative announcements and would trigger investors to sell part or all their shares if the company keeps issuing profit warnings every other time like for the case of Tesco. In the study, I would recommend that Tesco to have both an external and internal accounting team that will compare the accounting figures and accounting misstatements can be avoided prior publishing the financial reports.

    VI.            References

Collett, N. (2004). Reactions of the London stock exchange to company trading Statement announcements. Journal of Business Finance & Accounting, 31(1/2),

Eizentas, V., Krušinskas, R., Stankeviþienơ, J. (2012). Impact of public information signals on share prices: evidence from Lithuania. Economics and Management, 17, 879-888.

Fama, E. F. (1970). Efficient capital markets: review of theory and empirical work. The Journal of Finance, 25, 383-417.

Helbok, G., & Walker, M. (2003). On the Willingness of UK Companies to Issue Profit Warnings: Regulatory, Earnings Surprise Permanence, and Agency Cost Effects. Working Paper, University of Manchester.

Jackson, D., & Madura, J. (2003). Profit Warnings and Timing. The Financial Review, 38, 497-513.

Kasznik, R., & Lev, B. (1995). To Warn or Not to Warn: Management Disclosure in the Face of an Earnings Surprise. The Accounting Review, 70, 113-134

Kiete, K., Uloza, G. (2005). The information efficiency of the stock markets in Lithuania and Latvia. SSE Riga Working Papers, 2005:7 (75).

Laidroo, L. (2008). Public announcement induced market reaction on Baltic stock exchanges. Baltic Journal of Management, 3, 174-192.

Laidroo, L.; Grigaliuniene, Z. (2012). Testing for Asymmetries in Price Reactions to Quarterly Earnings Announcements on Tallinn, Riga and Vilnius Stock Exchanges during 2000-2009. Baltic Journal of Economics, 12, 61 – 86.

Moshirian, F., Nguyen, L. H. G., Pham, P. K. (2012). Overnight Public Information, Order Placement, and Price Discovery during the Preopening Period. Available at: http://ssrn.com/abstract=1785682

Polk D (2013) HK profit announcements: to warn or not to warn? IFLR

Skinner, D. J. (1994). Why firms Voluntary Disclose Bad News. Journal of Accounting Research, Spring, 38-60.

Tserandash T & Xiaojing W (2010) The relationship between the Profit warning and stock returns: Empirical Evidence in EU markets; Published Master Thesis, UMEA School of Business UK

Vega, C. (2006). Stock price reaction to public and private information. Journal of Financial Economics, 82, 103-133.

 Part B

Creative accounting describes a best practice in accounting and is undertaken to solve individual conflict of interest that arise in a workplace as they care more on self-interests while overlooking the ethical dimensions of accounting. Managers and accountants can manipulate their financial statements and reports as a misuse of their position in the company thus giving a false information to the shareholder. Motivations for creative accounting are known to be the stimulating behavior for creative accounting in the company. One of the key motivators for creative accounting is one reporting a decline in business income to lower the payable tax. Also, when a manager reduces the company losses to huge figures to make the company to appear having a better performance in future. Lastly, also providing a positive view on the expectations, securities valuation as well as reducing the existing risks in an anticipated capital markets to maintain the performance of the company.

Burger King Case Analysis -BBA 3210, Business Law

Strategic management: Southwest airlines case study Part 2

Strategic management: Southwest airlines case study Part 2

Strategic management: Southwest airlines case study

Current strategy (Including current use of technology)

Southwest Airlines’ dominance in the airline industry is largely attributed to its competitive fair prices, which are the lowest in the industry. Southwest Airlines operates as a Low Cost Carrier (LCC). The airline charges fares which are 30% as low compared to majority of its competitors. The company employs a number of strategies in order to achieve the low cost leadership. To start with, the airline does not offer meals but only some snacks and an assortment of drinks such as coffee, cold drinks and juices on all flights. However, customers are allowed to carry meals onboard. The airline provides passengers with only one class of ticket; hence there are no first class seats, thus passengers pick any available seats. However, the airline has introduced ‘A-List’ seating for select members (Hill, Jones, and Schilling, 2014). Southwest Airlines provides point-to-point flights thereby eliminating the need for connection flights. This saves time, eliminates delays and requires fewer employees compared to airlines that rely on hub connections. The airline has predominantly operated one type of airplane, the Boeing 737. This reduces maintenance costs, inventory costs as well as costs of training employees. Lastly, the airline has ensured high employee productivity with an employee/passenger ratio of 1:1,999 in 2012, the best employee/passenger ratio in the industry (Hill, Jones, and Schilling, 2014).

 

Part 1 : Strategic Management: Southwest Airlines Case Study

Southwest Airlines has also embraced the use of modern technology in a bid to cut down operational costs. The airline was the first to introduce online booking by establishing a web site that could facilitate online selling of tickets in 1996. This significantly reduced booking costs from an average of 10 dollars per passenger to one dollar per passenger (Kumar, 2004). In 2013, the company started working on a project that would enable it enhance its customer service through use of data analysis. The project entails use of cloud services and employee optimization solutions that will enable analysis of actual recorded conversations between passengers and personnel. This will enable the airline to quickly identify problems and to improve the quality of services.

Possible strategic alternatives

Southwest Airlines can develop new and effective strategies to further increase its competitiveness in the airline industry. The airline should consider offering first class tickets or seats to customers so as to get a share of the upper class passengers. Since the airline does not offer first class tickets, majority of the high end customers who prefer travelling on first class tickets end up using rival airlines that offer first class tickets. The company should aim at attracting more business travelers so as to bolster its revenue base. Majority of the airline’s flights take less than an hour, which prompted the management to come up with the no-meals policy (Mouawas, 2010). This has also contributed to loss of customers to rival airlines which offer in-flight meals. Southwest Airlines should introduce light meals in addition to the drinks it offers in order to attract more customers.

Southwest Airlines should also consider differentiation as an alternative strategy that can help in staying ahead of the competition. The company is currently facing fierce competition from other low cost models that have adopted its low cost strategy. As a low cost carrier, Southwest Airlines cannot afford to lower prices further. In addition, price undercutting is illegal in the United States. Differentiation can enable Southwest Airlines remain ahead of competition. For instance, the airline can come up with new and exciting packages, offer a unique product mix or sell experiences.

Southwest Airlines should also strive to maintain an upscale image among consumers. This will enable the company remain relevant in the highly competitive airline industry. Thus, the company should aim at ensuring adequate advertising campaigns are carried out through the mass media. In addition, in-flight magazines, business cards and other campaigns can be used to maintain a positive image in the public.

SWOT matrix – strengths

  1. Southwest Airlines is recognized as one of the best low cost carriers in the industry.
  2. It is among the largest airlines in the U.S. based on the number of passengers it carries in a year.
  3. The airline has a strong brand presence.
  4. The airline has maintained high capacity usage owing to its point-to-point operations which lead to low turnaround time.
  5. High productivity among employees with the lowest turnover rate in the U.S airline industry.
  6. The airline has profitably operated for over 42 years.
  7. Strong financial position due to years of profitability.

Weaknesses

  1. The airline largely concentrates its operations in the domestic market (North America).
  2. Overdependence on one model of aircraft – the Boeing 737.
  3. The airline does not provide meals.
  4. The airline does not offer first class seats hence the high profile passengers prefer rival airlines.
  5. The airline records the highest number of full-time employees which directly results to high overheads.
  6. Majority if the employees are unionized.
  7. The airline records the lowest number of morning flights.

Opportunities

  1. The airline can expand into the international market with ease.
  2. The airline has the potential to partner with other international airlines and hence expand.
  3. Acquisition of AirTran holdings will enable it expand operations to Canada and Mexico.
  4. There is an increase in demand in domestic travel within the U.S.
  5. The company can employ mobile technology that enables customers to book flights through their mobile devices.

Threats

  1. The low cost market which was once a preserve for Southwest Airlines has attracted stiff competition from Allegiant Travel, JetBlue, Public Airways, among others.
  2. Fluctuations in fuel prices leading to losses.
  3. Increased government regulations leading to additional costs.
  4. High security costs due to terrorism.

 

BCG Matrix

 

 

 

Question marks
Stars
20%

 

 

The BCG matrix assumes that cash generation is hedged on the relative market share the business controls (Lewis, 2007). Thus, if the relative market share is large, cash generation will also be high. Increase in the market share of any organization indicates that it is well at par compared to its rivals, and hence a cost advantage over its rivals. The BCG matrix also assumes that high growth markets consume more cash in form of asset investments so that the firms can sustain adequate levels of production capacity (Lewis, 2007).

According to the matrix, the products of a firm in the ‘stars’ situation experience high growth in a quickly growing market (Shaw, 2007). Thus, products in this category are highly profitable. Nonetheless, high management costs are incurred in this category. This is because the high market growth attracts more rivals into the industry, thus existing firms must spend huge amount of money to maintain their share of the market. The ‘cash cow’ segment represent products whose market is experiencing slow growth but control a sizeable share of the total market (Shaw, 2007). These types of products generate surplus revenues for the business to reinvest. Nonetheless, they are not attractive for growth. The ‘dogs’ category represent those products whose market share and growth are both low (Shay, 2009). These products give low profits and the management often spends more time on them. ‘Question marks’ are those products that have a low market share but in a quickly growing market (Shaw, 2007).

Southwest Airlines is currently offering two types of services; domestic flights and the recently introduced international flights. In 2014, Southwest Airlines controlled 15.8% of the total domestic market share, coming second to Delta Airline with 16.3% (‘Centre for Aviation,’ 2014). Southwest Airlines have profitably operated over the last 42 years, overcoming the threat of bankruptcy even during the economic recession in 2008. Analysts have placed great optimism on the overall industry’s growth, projecting an average of 5.7% growth rate over the coming years. In terms of growth, the airline projects a 6% growth in 2015, with 1 percent of this growth coming from international flights This places Southwest Airline’s domestic segment in the ‘cash cows’ segment of the BCG matrix. The slow growth is brought about by the company have reached the maturation stage in the domestic market. The international flight segment is expected to achieve a 1% growth rate in the year 2015. Southwest Airlines control less than 1% of the international market (‘Centre for Aviation,’ 2014). This places its international business segment in the ‘question mark’ segment of the BCG matrix. The major reason for that is because the airline introduced international flights in 2014, hence relatively new in the international market.

Space Matrix

Financial advantage Score Competitive advantage Score
Stock turn over

Working capital

Flow of funds

Liquidity

Earnings per share

Leverage

Average

6

5

4

3

3

3

4

Quality of product

Market share

New technology

Customer loyalty

Product life cycle

Capacity utilization

Average

-1

-1

-1

-2

-2

-2

-1.5

 

Environmental stability Score Industry strength Score
Change of technology

Changes in demand

Entry barriers

Competitive pressure

Inflation

Price elasticity of demand

Average

-2

-4

-3

-3

-3

-3

-3

Resource utilization

Entry into the industry

Financial stability

Profitability

Potential for growth

Extent leverage

Average

5

3

4

6

5

4

4.5

 

x-axis: -1.5 + 4.5 = 3                         y-axis: 4 + -3 = 1

 

 

The SPACE matrix indicates that Southwest Airlines should employ an aggressive market strategy in order to attract more customers. Southwest Airlines holds a competitive position in the airline industry. The airline should aim at developing robust market development and market penetration strategies. These strategies may include acquisition of rivals, development of new products and expansion into new markets such as the international front. Acquisition of rivals will enable the airline to easily commence operations in new markets that were formerly dominated by the firms acquired. The airline should also aim at developing new products or services that will entice more customers. For instance, offering first class seats can increase customers who often use rival airlines.

Evaluation of current organizational structure

The organizational structure is important in the day-to-day running of the business. It helps organizations in allocation of tasks, supervision, coordination of various activities and directing employees towards achievement of set goals (Möbius& Miller, 2002). The organizational structure also helps to draw lines of authority and in establishing lines of communication. In other words, it outlines the organization’s hierarchies. The organizational structure directly influences the success of any organization (Möbius& Miller, 2002).

Southwest Airlines operates under a functional organization structure model. In a functional organizational structure, the organization is structured depending on the type of job or specific roles of individuals within the organization (Ma, 2001). The most outstanding feature of functional organizations is the presence of departments or units that are charged with delivering specific tasks or accomplishing a particular goal. For example, an organization may have a marketing department, sales department, human resource department, research department and so forth, all of which are charged with accomplishing specified goals. The functional organization structure enables employees and the various departments identify clear objectives or purpose for their existence (Ma, 2001). Functional structure enables employees to gain thorough knowledge in their respective fields or departments. Functional structure enables an organization to produce standardized services and to increases efficiency in operations especially in case where there are limited products. On the flip side, the efficiency of a functional structure may be hindered by communication problems.

At the helm of the functional structure in Southwest Airlines seats chairman of the board, who is also the president and the chief executive officer. Immediately below, there are four departments each under a vice president. These departments include administration, operations department, legal department and a commercial department. Individuals heading these departments oversee the operations of other departments below them such as marketing department, customer services department, planning department and procurement department among others. In such a structure, poor communication resulting from any of the departments may lead to conflicts and eventually customer frustration. In order to enhance satisfaction among employees under functional structure, Southwest Airlines ensures that employees observe high standardization of their operations. In addition, employees are encouraged to try out different things. This type of organization structure also ensures that employees are directly involved in decision making in their respective departments.

Recommendation changes

Structure

A matrix structure would be best alternative for Southwest Airlines compared to the current functional structure which has certain inherent limitations. The matrix structure is a combination of functional structure and divisional structure. In a matrix structure, the organization frequently appoints teams to carry out specific tasks (Hall, 2012). The teams are appointed from employees based on their qualifications and irrespective of the department they work. Matrix structure would be more appropriate since it enhances sharing of information between team members when working on specific tasks. Thus, a matrix structure overcomes the limitations which surround a functional organization, such as divisions which may arise between various departments due to conflicts or disagreements in a functional organization (Hall, 2012). A matrix structure is most appropriate to organizations covering a wide geographical area such as Southwest Airlines. A matrix structure eliminates vertical communication and instead encourages horizontal communication within an organization. This facilitates a quicker flow of information in the organization since horizontal communication is quicker to vertical communication.

Process

Southwest Airlines has predominantly operated domestic flights in North America. Analysts have flawed this move terming the airline as slow in adapting new trends and processes. The airline does not offer flights to some of most attractive destinations that Americans prefer. For example, the airline does not have scheduled flights to the Caribbean Islands, Mexico, Cancun and Baltimore. As such, the airline has lost business to rival airlines that schedule flights to these attractive leisure destinations.

Technology

In terms of technology, Southwest Airlines has lagged behind over the recent years especially in updating its reservation software. The reservation system which the company have relied on for long could not support international reservations or code sharing. Code sharing enables exchange of reservations with other carriers in international flights. This emerged as a major problem when the company started operating international flights in 2012. For the company to expand into the international market, it must conduct huge investments in new reservation software that will enable code sharing and international reservations.

Alternative strategies for Southwest Airlines

  1. Introduction of ancillary sources of revenue – ancillary sources of revenue can act as an additional source of revenue for Southwest Airlines. Currently, the airline depends on ticket sales as the only major source of revenue. Ancillary revenue or what is also known as merchandising can enable Southwest Airlines to not only earn extra revenue but also to diversify its revenue sources. For example, the airline can introduce a variety of items that passengers can purchase at will, such as meals. Other possible products may be accommodation services, car hire services, and special seat allocation, among others. The major benefit in introducing ancillary services is that majority of these services can be offered by third parties, giving the airline management time to concentrate on other issues. The major weakness is that introduction of these services may be relatively expensive to the airline.
  2. Provision of quality services – Southwest Airlines have over the recent past reduced the seat pitch of most its airlines, contrary to new trends in the airline industry. Majority of airlines currently offer an extended legroom that allows passengers to seat even more comfortably. The main advantage is that this can attract more customers in the long run. On the flip side, each airline with more legroom can only carry few passengers. This may reduce the marginal profits enjoyed.
  3. International operations – Southwest Airlines has predominantly operated in the domestic market. However, the airline cannot achieve further growth in the market as it is already in the maturity stage. This leaves the airline with investment in international market as the only viable alternative for further growth. Investment in international market will expose the airline to international competition, and require a huge capital outlay. On the other hand, it will offer great opportunities for growth.

 

References

Centre for Aviation (2014). Southwest Airlines projects 6% capacity growth in CY2015 as long-  haul from Dallas ramps up. Retrieved from        http://centreforaviation.com/analysis/southwest-airlines-projects-6-capacity-growth-in-     cy2015-as-long-haul-from-dallas-ramps-up-197468

Hall, K. (2012). Making the Matrix Work: How Matrix Managers Engage People and Cut            through Complexity. London: Nicholas Brealey Publishing.

Hill, C., Jones, G. and Schilling, M. (2014). Strategic Management: Theory: An Integrated           Approach. Cengage Learning.

Kumar, M. (2004). Operations Management at Southwest Airlines. ICFAI Knowledge Center.      Retrieved from    http://www.gibs.co.za/SiteResources/documents/NewDocuments2013/Beverley/operatio   ns%20management%20at%20southwest%20airlines.pdf

Lewis, P. S. (2007). Management: Challenges for tomorrow’s leaders. Mason, OH:           Thomson/South-Western.

Ma, Q. (2001). Investment horizon and the structure of organizations: Essays in the theory of the             firm.

Möbius, D., & Miller, R. (2002). Organized monolayers and assemblies: Structure, processes,     and function. Amsterdam: Elsevier.

Mouawad, J. (2010, November 20). Pushing 40, Southwest is still playing the rebel. The New       York Times. Retrieved from            http://www.nytimes.com/2010/11/21/business/21south.html?_r=0

Shaw, S. (2007). Airline Marketing and Management. New York, NY: Ashgate Publishing, Ltd.

Shay, J. P. (1999). Dynamic competitive strategy: Towards a multi-perspective conceptual           framework. Long Range Planning, Vol. 32(6): pp, 559-572.

Strategic Management: Southwest Airlines Case Study

Strategic Management: Southwest Airlines Case Study Part 1

Strategic Management: Southwest Airlines Case Study

Southwest Airlines Company is a Dallas-based passenger airline that concentrates its operations in the United States, with only a few destinations in the international markets (six destinations in the international market). The company was founded in 1967. Currently, its customer base has grown to over 20 million customers a year. According to a report from Bureau of Transportation Statistics, the company is currently the second largest domestic carrier in the United States, having transported over 8.569 million customers in 2014 (Smallen, 2014). Southwest Airlines came second to Delta Airlines, which recorded 8.850 million customers in 2014. Other close competitors such as American Airlines and the United Airlines recorded 7.104 million and 6.755 million passengers respectively in the same year. These figures reveal the high level of competition in the domestic market.

Southwest Airlines dominance in the domestic market is driven by customer-focused strategic management practices. The company differentiates itself from competitors by offering top notch customer service. This has seen the company introduce a raft of promotions that are aimed at enticing more customers. For instance, the company has become the first in the U.S to offer free bags carriage. The airline also provides passengers with connectivity through satellite Wi-Fi, a mobile application that enables customers to book flights using their mobile phones and a reward program dubbed Rapid Rewards that enables customers to accumulate and later redeem points based on tickets purchased. This is in line with the company’s mission which is to provide “highest quality of customer service…..”. (Southwest, n.d). Through its vision statement, the company seeks to “become the world’s most loved, most flown and most profitable airline.” (Southwest, n.d). One of the strategies the company has applied to achieve its vision is reduction of flight charges, hence attracting more passengers.

External assessment

External Factor Evaluation matrix for Southwest Airlines

Key External Factors Weight Rating Weighted Score
Opportunities
1.       More demand for national and international travel 0.07 4 0.28
2.       Growth of cities due to population increase in the U.S. (3 million people per year) leads to high air travel demand. 0.05 2 0.10
3.       Development of new models of airplanes which are more comfortable. 0.02 3 0.06
4.       Majority of passengers prefer direct flights which the company is able to offer. 0.10 2 0.20
5.       Increased business travel in the U.S. 0.06 4 0.18
6.       New forms of advertising such as internet advertising may boost growth 0.03 2 0.14
7.       Majority of passengers prefer easy travel procedures such as mobile booking 0.04 3 0.12
Threats
1.       Threat of terrorism which may impact international flights 0.14 3 0.45
2.       Fluctuations in fuel prices which often leads to high operational costs 0.15 3 0.42
3.       Introduction of new air regulations by the government which increase operational costs 0.10 4 0.40
4.       Development of alternative means of transportation e.g. bullet trains reduces air travel demand. 0.08 3 0.24
5.       Advances in technology may make air travel unnecessary. 0.06 2 0.12
6.       Economic recession which may reduce demand for air travel 0.04 3 0.12
7.       Rising security costs due to the need to acquire new security equipments. 0.06 2 0.12
Total 1.00 2.83

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The EFE matrix indicates that increased demand for domestic and international travel will provide the next big opportunity for growth to Southwest Airlines. According to a report from the International Air Transport Association (2015), there has been a tremendous growth in demand for air travel over the years. In 2012, demand for air travel improved by 5.2%, and 5.6% for 2013. In 2014, a 5.9% growth rate was achieved. This trend is expected to continue over the next 20 years. The biggest threat faced by Southwest Airlines is fluctuation in oil prices which leads to high operational costs. According to (Nicas and Carey, 2014), this has forced the airline to discontinue shorter flights and to consider longer flights which are more fuel efficient.  Terrorism will likely drive operational costs high for the carrier. This is because there is need for more airport security than any other time.

Competitive Profile Matrix

Southwest United American
Critical success factors Weight Rating Weighted score Rating Weighted Score Rating Weighted Score
Management 0.09 4 0.36 3 0.27 3 0.27
Advertising 0.14 3 0.42 2 0.28 3 0.42
Market share 0.12 2 0.24 3 0.36 4 0.48
Customer service 0.14 4 0.56 1 0.14 2 0.28
Global expansion 0.07 1 0.07 3 0.21 3 0.21
Organizational structure 0.06 3 0.18 2 0.12 3 0.18
Security risks 0.09 3 0.27 2 0.18 3 0.27
Price competitiveness 0.09 4 0.36 3 0.27 3 0.27
Financial position 0.11 3 0.33 1 0.11 1 0.11
Customer loyalty 0.09 4 0.36 2 0.18 2 0.18
Total 1.00 3.07 2.12 2.67

 

The CPM results show that American Airlines is the closest competitor with a rating of 2.67. United Airlines also came close with a rating of 2.12. Southwest Airlines operates as a low cost model, and also maintains a no-frills policy which has enabled it to remain profitable as indicated by the high score of 3.07 in the CPM. The airline controls a large market share, owing to its low prices and loyalty from customers. In addition, the free-bag carriage policy has attracted many passengers to the airline (Nicas and Carey, 2014).

Internal assessment

IFE Matrix

Key Internal Factors Weights Rating Weighted score
1.       The airline has profitably operated for over 43 years (1972-2015). 0.10 4 0.40
2.       Effective cost leadership strategy 0.09 4 0.36
3.       High level of employee loyalty, with low employee turnover rates. 0.11 3 0.33
4.       The company has a strong brand presence. The company appears in FORTUNE’S list of top admired companies. 0.11 4 0.44
5.       Strong cash flow and financial position, with about $ 3.1 B in liquidities and $ 800 M accessible as lines of credit. 0.08 3 0.24
6.       Attractive customer incentives such as the free bag flying. 0.10 3 0.30
Internal Weaknesses
1.       The company concentrates its operations to domestic flights 0.09 2 0.27
2.       Southwest relies on only one producer of aircraft, currently using Boeing 737 and 717 series. 0.06 3 0.18
3.       High number of permanent employees hence high operational costs 0.08 2 0.16
4.       The carrier does not offer first class in its travel arrangements. 0.09 3 0.27
5.       High indirect costs such as health care and workers’ compensation 0.09 2 0.18
Total 1 3.13

 

Southwest’s internal strength is hedged on a strong brand presence in the United States. The company has managed to create a strong positive image among many individuals in the U.S. The company is known as a low cost carrier, with quality services. In addition, the company has profitably operated for over 40 years. The financial stability has persisted even when other major airlines were making losses.

Financial ratio analysis

Southwest United Airlines American
Liquidity ratios
Current ratio

Quick ratio

0.78

0.40

0.85

0.80

0.61

0.58

Profitability ratios
Gross profit margin

Operating profit

Net profit margin

58.86%

4.43%

1.14%

61%

4.19%

1.33%

67.40%

5.62%

2.44%

Growth ratios
Sales

Net income

29.63%

-61.22%

6.96%

-29.56%

10.58%

44.01

 

The above financial analysis highlights the strong financial performance of Southwest Airlines compared to its biggest competitors, American and United Airlines. The operating profit of 4.43% indicates that Southwest is still making profits even after all expenses are deducted. Sales ratio of 29.63% indicates that the company is the most preferred among the three, with United having a sales ratio of 6.53% and American having 10.58%. In order to improve its competitiveness, Southwest Airlines should introduce business class and more flights to international destinations. This will ensure that it gains more customers.

References

International Air Transport Association (2015). Strong Demand for Air Travel Rises in 2014,       Retrieved from: http://www.iata.org/pressroom/pr/Pages/2015-02-05-01.aspx, 5th feb

Nicas, J and Carey, S. (2014). Southwest Airlines, Once a Brassy Upstart, is showing its Age.      The Wall Street Journal. Retrieved from             http://www.wsj.com/articles/SB10001424052702303949704579459643375588678

Smallen, D. (2014). Pocket Guide to Transportation 2014. Bureau of Transportation Statistics.    Retrieved from http://www.rita.dot.gov/bts/press_releases/dot004_14a

Southwest (n.d). About Southwest. Retrieved from  https://www.southwest.com/html/about-        southwest/