Unpacking Southwest’s Low Pricing

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Southwest Airlines

As the low-price carrier gets ready to enter the Atlanta market, Ram Chellappa of Goizueta's ISOM department discusses pricing. PHOTO: BriYYZ/flickr.com

In February 2012, the discount carrier Southwest Airlines plans to begin flying out of Hartsfield-Jackson Atlanta International Airport in Atlanta. The move will likely mean lower fares choice for some air travelers, but it won’t necessarily be a knockout blow to “legacy” carriers like Delta, which maintains a hub at the airport.

One reason is that despite its reputation as a low-cost carrier, Southwest doesn’t always offer the least expensive fare, according to a professor at Emory University’s Goizueta Business School that follows the industry.

“Southwest’s pricing strategy is interesting in that it doesn’t strive to be the lowest cost airline in its market,” says Ramnath Chellappa, an associate professor in the information systems and operations management area and Caldwell research fellow. “It creates the impression of low prices through the practice of everyday low pricing, or EDLP strategy.  It is so fanatical about the pursuit of this strategy to the extent that we can find it adhering to it even in markets where it enjoys a monopoly.”

Chellappa led a team that he notes wrote the first comprehensive study on the EDLP policy of Southwest, which he says is the second largest airline today in terms of domestic market share.

Pricing is a complex decision that involves the consideration of costs, product and market characteristics, as well as competition, Chellappa notes in his paper, “Strategic Implementation of ‘Everyday Low Price’ in Electronic Markets: A Study of Airline Pricing on the Internet.”

“The price image of a firm is a critical component of its overall strategy which influences the types of customers that it attracts and, ultimately, its profitability,” he says. “We engaged in a rigorous empirical examination of over a quarter-million ticket prices, which accounts for over 80 percent of the market, offered online.”

Even though Southwest may not always offer the best price, the carrier attracts customers because it creates a “uniform and permanent expectation in the mind of a consumer,” Chellappa explains. “The consistency aims to deliver the perception that the airline’s prices are in the lower end of the market spectrum,” even if in fact it’s not always the lowest.

“For obvious reasons, no airline can always offer the lowest prices in all markets; hence it can only be expected that EDLP carriers be ‘found out’ online given the relative ease of search on the Internet,” he says. “But Southwest and other EDLP carriers appear to be able to get around this by adopting some unique strategies. For one thing, they tend to shy away from so-called online travel agents like Expedia or Travelocity, effectively limiting the ability of consumers to engage in instant price comparisons.”

Further, while airlines typically target their promotions towards leisure travelers through Saturday-night fares and advance-purchase tickets — neither of which is suitable for business travelers — EDLP carriers “strategically use their cost-advantage in short-haul markets to undercut prices of non-EDLPs’ business tickets (i.e, those with no Saturday-night restriction),” he adds.

Legacy airlines have a tough time matching these low prices because of their higher-cost operating structure, Chellappa explains.

Due to the nature of their operating structure, other major carriers are not quite suited to fully enjoy the stability or low variance offered by EDLP strategy, Chellappa explains.

“Only firms that fully align their back-end operations with front-end pricing can enjoy these benefits.”

“For example, Southwest Airlines operates only Boeing 737 flights; while JetBlue Airways operate only two types of flight,” he says. “Compared to their non-EDLP counterparts which employ a myriad of aircrafts, these airlines potentially enjoy significant cost advantage and logistical efficiency in short-haul markets.”

But there’s “a place for everyone,” he says, noting that a legacy airline like Delta will still appeal to distinct consumer types.

“Business-class travelers who are willing to pay for more amenities may stay with legacy carriers,” he observes. “Also, Delta has a strong international flight coverage, which Southwest does not. These however, are all key differentiators that enable EDLP airlines like Southwest, and legacy carriers like Delta, to maintain their respective advantages by avoiding ‘head-to-head’ competition. If they do engage in such direct conflict, the risk is that the ‘golden rule’ of not undercutting each other might be violated, which could lead to a price race to the bottom that may ultimately hurt all the carriers.”

Chellappa also observes: “Interestingly my new research shows that the presence of Southwest will depress Delta prices in certain short-haul markets originating from Atlanta.”

ABOUT THE EXPERT

Chellappa (bio) joined the Goizueta Business School faculty in Fall 2005. Chellappa’s expertise is in the field of electronic markets, pricing, digital goods and economics of information security and privacy. His research in the areas of digital product piracy has been widely published in leading journals and conferences. His work on information privacy in online transactions received the Best Paper Award at INFORMS-CIST 2003. His recent works examine pricing in the US domestic airline industry and competitive dynamics in business software industries. His research methods include analytical modeling, empirical modeling and social network analysis. Chellappa has taught courses in undergraduate, MBA, PhD and Executive Education programs.

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