AIB-SE (USA) 2004 Annual Meeting, Knoxville, TN

SUSTAINABLE COMPETITIVE ADVANTAGE: COMPARATIVE ANALYSIS

AND LESSONS FROM THE PRACTICE OF BRITISH AIRWAYS,
LUFTHANSA AND SOUTHWEST AIRLINES

Kristian Serafimov, University of Tennessee

This paper presents an analysis of 3 Leaders in the Airline Industry and compares their competitive
advantages by determining the key factors in making them sustainable.

Introduction

Creating a sustainable competitive advantage is important for all companies, but maybe even more
important for the actors in the airline industry. The SARS virus, September 11 attacks, and the war on Iraq
are the major events that have affected the industry, but the industry had problems before as well. Business
travelers are not willing to pay the premium prices, which they had been charged in the past and still are
paying today. Customers of today demand good service for a much lower price, including business
travelers. A number of low cost carriers have evolved the last couple of years including JetBlue Airways,
AirTran Airways, and of course Southwest Airlines. These carriers offer a “no-frills” service and monitor
their costs closely and therefore made the competition stiffer in the market place. A big challenge lies
ahead for many of the traditional hub-and-spoke system airlines if they want to be able to compete with
these companies.

Sustainable Competitive Advantage

To uphold a sustainable competitive advantage a company must perform its value activities in a way
difficult to replicate or imitate by the competitors. A competitive advantage is upheld if the cumulative cost
of performing the value activities is lower then competitors. A level of value must back up the competitive
advantage to the customer that is at least compatible to the competitors. Otherwise, a lower price will have
to be charged and the net effect will be zero. A firm’s relative competitive advantage will be made up by
what composition of the value chain the firm has versus the competitors and secondly what position the
cost drivers has in each activity.

There are a number of ways to check the sustainability of a firm’s competitive advantage. Some of them
are highly obvious and are often taken for granted while some are more subtle and intangible. It is often the
more subtle ones that give a company the extra edge.

Southwest Airlines

Southwest Airlines first flight took off in June 18, 1971. The company got underway more then four
years earlier but had a number of tough lawsuits against them before they were able to get their first plane
up in the air. Southwest Airlines began serving the Texas cities of Dallas, Houston and San Antonio.

Even though the four-year legal battle, which almost left Southwest Airlines bankrupt before they could
start their service, a tough start became the foundation for Southwest Airlines well-known corporate
culture. The employees were motivated by Herb Kelleher’s tough character in the legal battles and
underdog attitude. Lamar Muse, Southwest Airlines first CEO, contributed with several legal battles
following the first couple of years after their maiden voyage. Herb Kelleher was determined and very
successful in the courtroom and in September 1979 Southwest Airlines opened up their first interstate
service between Dallas and New Orleans.

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From the very start Southwest Airlines decided that it should be a fun experience to fly with them,
without affecting the service received by the customers. Employees are encouraged to take their job serious
but not themselves. Southwest Airlines believe that if their employees are having a good time they will
offer better service and be more effective performing their job.

Southwest Airlines has maintained the same strategy and operating style as they started with in the
1970s. They concentrate on flying to airports that are located close to metropolitan areas and are under-
utilized, e.g. Love Field in Dallas, Hobby in Houston, San Jose and Oakland in the Bay Area, and Midway
in Chicago. Southwest has from the very start only operated with fuel-efficient Boeing 737s and a low fare
strategy. Today Southwest Airlines is the market leader within the low cost segment. Examples of their
success are the 32 years of consecutive quarters with positive earnings, and a cost to fly one seat one mile
that is the lowest in the industry.

Competitive Advantages of SWA

Southwest Airline’s Competitive Advantages can be best viewed by analyzing six major factors, their
Procedures, Infrastructure, Edge, Communication, Atmosphere and People

SWA procedures heavily rely on the strategy of keeping the airplanes in the air as much as possible.
This has required an integration of operations and procedures to gain full control and to get a tighter
organization. Means that they have used to accomplish this is quick turnarounds and one type of aircraft the
Boeing 737 Additional means are the use of under-utilized airports that cost less to operate. The lesser
known airports are usually lesser congested and that makes it easier to achieve fast turnarounds. However,
SWA has started to extend their markets to larger airports, which makes their strategy to keep the planes in
the air hard to achieve.

The less congested airports are vital to SWA and are part of what has made them less exposed to
cyclical changes in the economy. Capacity utilization is an important factor for industries that are heavily
associated with high fixed costs, such as the airline industry. Every factor that can keep costs down is
therefore vital to make the company “recession-proof”, which makes the small airports very important to
SWA since they constitute one of the foundations of their low-cost strategy. However, the policy choices
made to be low-cost relies on more than operating cheap airports. SWA was first out on the market with
their innovation and that has given them a head start of the competition. Timing has been a major part of
several of SWA procedures since they have several innovations that have been first out on the market. This
goes for all activities in their procedures. The business cycle has started to catch up with SWA in the last
couple of years with new underdogs surfacing and threatening Southwest Airline’s position as the only
innovative airline. The competition is likely to thicken further as the business life cycle matures within the
low-cost segment.

SWA infrastructure focus is on the communication process. This is why they only have four layers
between top management and ground personnel. This is a major factor to achieve a smoother running
operation and to cut costs. The importance of interrelationships between value activities will decrease the
cost per units and potentially increase scale. SWA has very “thin contracts” which means that everyone
helps out no matter what level they are on. Also, the quick turnarounds use linkages and interrelations
heavily to achieve their goal. By integrating its operations SWA has a tighter organization that has full
control over daily routines. This projects that advantages of vertical integration are high when control over
a value activity is demanded, which is the case in SWA and their quick turnarounds.

SWA has chosen to fly one type of aircraft and has therefore been able to cut costs in maintenance,
training and scheduling of staff. This shows that their economies of scale, benefits from the policy choices
made. Secondly, by only operating one type of aircraft SWA benefits in the sharing of know-how between
staff since they only have to learn one system instead of several

Quick turnarounds are a major edge for SWA. The factors leading to this edge are produced through
interrelations between activities, linkages that connects two different departments or by simply sharing,

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learning and eliminating internal rivalry. All the different parts of the company work together to achieve
this goal. Internal rivalry is non-existent, e.g. pilots helping out to load the luggage and flight attendants
cleaning the airplanes, something virtually unseen at the other major airlines.

Innovation within a company concerns the potential of creating new ideas in different activities to
improve operations and to develop an edge over the competition. This is a part of a rule-breaking company
that does not follow the industry leaders, but instead tries to shape the environment itself. The rule breaker
redefines the service to the extent that a whole industry adapts to it. By launching the no-frills air travel in
the 1970s SWA managed to create an entirely new way of traveling. They offered an innovative service
that broke the rules of price-levels, new level of customer service and a humoristic experience when
traveling with them. Several new inventions and ideas have continued to characterize all of the areas within
SWA through the years.

SWA communicates to their customers a fun, innovative, and aggressive marketing strategy that
complies with their corporate culture. They have been known as the love airline as they began marketing
themselves as that after they won the right to use the Love Field airport in Dallas during their early years in
the business. Today their ticker symbol at the New York stock exchange is LUV. SWA being a company
with a low-cost strategy often stresses their attractive prices. In 2002 SWA spent approximately $156
million on advertising, more then American and United spent together. By being innovative with their
marketing as well as using the right channels, SWA have made this a competency by serving as a model in
the use of their assets and capabilities.

The atmosphere SWA has built, perceives them as a friendly and happy airline, which brings for low
customer complaints. Having the fewest lost bags and on-time arrival has also enhanced their image.
Image, however, can be measured by using benchmarks that looks at quality and service provided,
something that SWA has outperformed most competitors at and therefore has created a favorable image to
the outside world. Through years by holding culture-building programs, picnics and other spirit enhancing
activities, SWA has managed to build up an environment that makes employees feel implicated and part of
the SWA “family”.

Top management’s charisma and talent is an important ingredient to create a successful organization.
One of SWA most prominent human asset is their top management and especially its founder and
chairman, Herb Kelleher. Both he and the rest of the top managers have played a large role in building
SWA positive attitude that runs throughout the company. The management has played a major part in
spreading know-how in the firm by implementing several labor efficiency improvements and policy
choices that builds employees integrity and feeling of responsibility. Fighting spirit is something that
characterizes SWA employees that boils down to the start-up of the company when SWA was fighting to
get their first plane of the ground. Vertical integration, controlling internal communication and retaining
key employees are also means to protect and develop know-how. Sharing of learning within the company is
essential and an environment without rivalry between the employees can foster interrelationships and
exchange of knowledge.

SWA has one of the toughest selections of employees in the industry and also keeps their own university
to train and educate staff on all levels. Boundaries at SWA are almost non-existent and this makes
employees cooperate well without any type of rivalry between different positions. They have an almost
entirely vertically integrated organization where know-how about all operations stays within the company.
SWA has built up a strong team of employees through the years and their motivation is highly affected by
the leadership of the top management. Policy choices by the management have also helped build the know-
how in the company by integrating various operations and making the employees feel like they are a part of
the company by implementing profit sharing.

Lufthansa

Founded in 1926 from “Deutsche Luft Hansa Aktiengesellschaft” is today, Europe’s third largest
passenger airline after British Airways and Air France. Headquartered in Cologne, Germany, Lufthansa

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offers flight service to over 350 destinations in about 90 countries. In 2002 Lufthansa generated revenues in
the excess of sixteen billion Dollars, an increase of 1.7% from the previous year. The increase in revenues
was primarily due to the aviation group, compromising its subsidiaries, Lufthansa Technik and Lufthansa
Systems.

Competitive Advantages of Lufthansa

Lufthansa’s five major competitive advantages are Strong financial performance of individual segments,
Favorable cost structure, Innovative services, Regarded as the most punctual airline and their Strategic
Alliances.

Strong financial performance of individual segments in Lufthansa was the result of 2002’s operating
profit of 718 million Dollars, 690 million over the previous year. This has given Lufthansa the status of
being among the world’s industry leaders in air transportation. From 2001-2004 several segments of the
Lufthansa group demonstrated strength, by expanding in the MRO business as well as in the IT market.
Lufthansa Cargo retained its ranking in the world market, despite the weak global economy, illustrating the
company’s ability to sustain in uncertain operating environments.

Lufthansa’s favorable cost structure is attained by investment in tight cost management, through its D-
check efficiency improvement program. In 2002- 2004 Lufthansa was able to achieve its annual savings
plans within, half the time originally forecasted. During all the years the company was well ahead if its
projections by saving a monthly average of 76 million Dollars. Due to these savings the company has been
able to measure up to market requirements and successfully reinforce its strength in the airline business.

To distinguish itself from competitors, Lufthansa has moved forward through innovative projects with an
aim to bolster its service profile. During the 2002-2003 months a pilot broadband system was run, for
flights between Frankfort and Washington. FlyNet was introduced early 2003 as a web-based gateway for
passengers to send and receive e-mails in-flight. Lufthansa’s new service offerings, including Internet
access on all its long-range flights, have distinguished them remarkably form its competitors. Having the
one of the youngest and most environmental-friendly fleet in the industry has enabled Lufthansa to now
offer its passengers the comfort and convenience of the most modern aircraft.

Lufthansa has maintained its position as the most punctual airline, by being the best hub airline
timekeeper in Europe. This is achieved by its reappraised work process and improved timekeeping
procedures in airports and air traffic control. Results of these exceptional timekeeping processes have lead
to reliable flight schedules and enhanced customer loyalty, driven further by their Allegro system.
Lufthansa’s Allegro system, introduced the second quarter of 2002, closely monitors aircraft ground-
handling operations and facilitates quick identification of cause of delays and subsequent rectification.

The ability of Lufthansa to strike strategic alliances with several renowned industry players, have brought
in both cost savings and enhanced passenger service. Some significant advantages are sharing of lounges,
ground handling and coordinated flight schedules. The four new partners, Asiana Airlines (South Korea),
LOT (Poland), Spanair (Spain) and South African Airways are expected to strengthen the alliances and
enhance synergies. Lufthansa’s alliances with cargo partners such as SAS Cargo and Singapore Airlines are
expected to reduce shipping times, harmonize service offerings and enhance the company’s performance.

British Airways

British Airways was formed on April 1st 1972, after the British government forced a merger between the
two British state airlines (BOAC and BEAC). It wasn’t until the third quarter of 1974 that two airlines
actually, merged their two completely different operations and personnel into the new state carrier. That
year the title 'British Airways' was first seen. This initially led to industrial and financial problems, however
the new airline went on to launch the world's first supersonic passenger service, in conjunction with Air
France, when Concorde was launched in January 1976.

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Act 1980 was passed to enable this to happen. Lord King, the BA chairman of the time, was charged by
the UK Secretary of State to do everything in his power to restore BA to profitability and prepare it for
privatization. In July 1979, the UK Government announced its intention to sell shares in British Airways.
Through 1981 and 1982, British Airways was suffered from an overall deficit of 544 million British
pounds. The new 'survival' plans implemented at the time included staff cuts, suspension of unprofitable
routes and the disposal of surplus assets.

In February 1987, British Airways was privatized. Over one million applications were received for
shares in the airline, offered at 125 pence, making the flotation eleven times oversubscribed. Freed from the
boundaries of Government ownership, British Airways announced a merger with British Caledonian in July
of that year.

Competitive Advantages of British Airways

British Airways has two major competitive advantages over the entire airline industry. Their strategic
alliances and providing the most direct non-stop flights to London worldwide.

By being a part of the oneworld alliance including, American Airlines, Aer Lingus, Cathay Pacific, Finnair,
Iberia, LanChile and Qantas, British Airways provides to its passengers flight service to over 570
destinations and 135 territories, that are served by the alliance. The alliances between British Airways, the
onworld global alliance members and thirteen, other airlines also provide all passengers of these airlines to
take advantage of each airline’s arrival lounges worldwide. These enable passengers to take a shower, have
their clothes pressed and eat breakfast before attending meetings.

As London is a key destination for the world market, British Airways has the advantage of providing the
fastest flights to London. Direct non-stop services are far more restful because passengers are saved the
time and hassle of connecting with other flights. Currently British Airways with the help of their strategic
alliances provides non-stop flights to London from over 100 locations worldwide. As of 2001 U.S.
passengers have been able to take advantage of the direct non-stop flights to London from 21 U.S. airports
with a total of 41 daily frequencies.

What advantages are sustainable?

To uphold a sustainable competitive advantage a company must perform its value activities in a way
difficult to replicate or imitate by the competitors. A competitive advantage is upheld if the cumulative cost
of performing the value activities is lower then competitors. A level of value must back up the competitive
advantage to the customer that is at least compatible to the competitors.

Conclusion

Even if competitors can imitate some of the advantages SWA posses, it may take them a while to reduce
the lead that SWA have in both operations and infrastructure. When it comes to marketing, SWA have an
advantage by being the first mover since the public perceives them as “the” low fare airline. This can also
change over time as the customers get more acquainted with the new competitors in the market place.
South West Airlines’ people and culture stand out when considering, the longer a resource lasts the more
valuable it will be for the company.

The sustainable advantages of Lufthansa and British Airways are very similar. Both being a part of
multinational strategic alliances keeps them above the competition. Volume and availability are the main
factors leading to an advantage through a strategic alliance, availability and volume, of destinations to
travel, as well as availability and volume of flights to that destination.

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