Organizational Pay Analysis: A Case Study of Southwest Airlines

By: Aric Hall Completed in Partial Fulfillment of the Requirements of OM 5218 Managing Compensation and Rewards Capella University Spring 2008 Name: Address: City, State, Zip: Phone: E-Mail: Instructor:

Abstract Title Organizational Pay Analysis: A Case Study of Southwest Airlines Abstract This report begins with an overview of Southwest Airlines, its strategies, and its compensation and benefit structure. The author considers how the human resources department can use a compensation strategy to strengthen the strategic and business strategy of the organization.

Hall, p. i Table of Contents Table of Contents Organization Overview Analysis of Strategy SWOT Analysis Rewards System Role of Human Resource Management Compensation and Benefits Strategy Metrics Assessing the Effectiveness of HR Conclusion References i 1 1 4 5 7 9 10 11 12

Hall, p. 1 Organization Overview Southwest Airlines is known for its fun-loving corporate culture and its 32 years of consistent profitability. The company has a unique strategy, and that strategy is implemented by upper-level and functional managers. Human Resources has a key role in recruiting, hiring, selecting, promoting, and training personnel who will be a good fit with the strategy and with the fun-loving organizational culture. Analysis of Strategy Southwest Airlines was created in response to the high price of intra-Texas flights (Freiberg, 1996). The airlines fares were originally set to compete with car and bus travel. Over time, the little upstart would withstand time, legal challenges, a growing need for additional capital, and would survive challenges with major air carriers. For the most part, Southwest is still a no-frills carrier, not providing food, movies, reserved seats, or a first class. There service strategy is based on a short-haul, point-to-point direct flights, accomplished with rapid turnaround times. Given that strategy, Southwest has a strong majority of the market share in those point-to-point markets. The mission of Southwest Airlines is dedication to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and Company Spirit (Mission, 2007). Southwest states that the customer comes second, because the employee comes first. Southwest provides stability and equal opportunity for employee growth, and employees are encouraged to be creative and innovative in solving organizational problems. Employees are treated with the same respect and support they are expected to provide to customers in return. The company has been ranked highly in employee satisfaction. As such, the organization must

Hall, p. 2 have a compensation and rewards strategy that supports this mission and customer service strategy. Southwest claims that their primary goal is to make air travel affordable to all (Freiberg, 1996). The market value of Southwest was at one point greater than all other airlines combined (Gittell, 2003), and the airline was once called the most successful in history by Fortune. When many airlines reduced routes, cut service, and laid off employees after September 11, Southwest used their cash reserves and low debt/equity ratio to expand their low-cost model to new markets. Southwests model benefits from good management-labor relations, fast turnaround times at the gate, the faster speed of operations afforded by small airports, and that model benefits from strong leadership, strategy, culture, and coordination. Southwests functional strategy is to achieve competitive advantage, by offering the lowest fares for comparable services or greater service. Strategy and operational effectiveness may be applied differently in each company (Porter, 1996). Southwest uses a marketing strategy of presenting itself as a low-cost leader, even though Southwest may not always be lowest. Efficiency is achieved by doing more with less. Business-level strategy is composes of cost leadership and service differentiation. The company is a cost leader, as they keep expenses and consumer prices relatively low. They lead in differentiation through market segmentation, such as the focus on point-to-point travel and marketing to cost-conscious business travelers. They have distinctive competencies in offering necessary services without adding the cost of extras. Corporate-level strategy can be accomplished in limited context in alliances and diversification of operations. At Southwest that only exists with vendors and perhaps with diversity of investment activities.

Hall, p. 3 Southwest does not have the luxury of manufacturers who can relocate to Mexico to reduce costs. The company must operate domestically, and as such the company must continue to provide wages and benefits commensurate with that demanded within the industry in the United States. This can be a challenge to incur those greater costs and still be a low-cost carrier. Over the years, major airlines have had to react to actions of the little airline. It would seem that Southwest has exhibited a strategy of first entrant and first mover. This was done by moving to new markets and buying up all gate space before competitors could. Creativity was seen when Southwest was first to introduce ticketless travel. They serve half of the nation, preferring to use the smaller airports to reduce costs and delays, while attracting a different consumer niche. Southwest engages in a slow-growth or slow-expansion strategy where competition is low (Company, 2004). This allows the airline to use its cash reserves and avoid high debt obligations. Rather than using the common pricing strategy of lowering fares to cause financial harm to the competitors, Southwest opted to make reasonably low fairs permanent to prove profitability and build loyalty. The little airline that could has remained profitable through airline deregulation, September 11, and through the bankruptcy of the competitors. They are now on their 33rd year of profitability. Porter (1996) wrote of positioning and needs-based positioning, and further discussed tradeoffs that have to be made. Major airlines that tried to mirror Southwest without making tradeoffs were not profitable. In addition to its slow-growth strategy, the company also does not use travel agents, and for the most part has continued to avoid costs common to full-service airlines. Southwest maintains its competitive advantage while avoiding the growth trap (Porter, 1996). But, they have held their competitive position with additional practices, such as investing

Hall, p. 4 heavily in fuel futures trading, avoiding price shocks during the summer or following terrorist attacks. In the future, Southwest could continue to use their cautious, cash-based approach to expansion to build an even larger network of service routes. It could be possible to adopt another alliance or code sharing partner, which they have done in the past, or merge or buyout other small regional carriers. To a limited extent, Southwest could encroach on larger airports and compete with major carriers, just to make more connections with the smaller airports. SWOT Analysis Southwest has several key internal strengths. It is a great climate and culture for employees. It is considered one of the greatest companies to work for based on previous surveys of employees. Employees are taught to help each other out and not get hung up on titles and positions. Employees are given avenues to address grievances. Southwest also has a consistently strong financial position, using high cash reserves for investments or emergencies. Southwest also has an image of being fun-loving that attracts and maintains their customer base. Southwest has few internal weaknesses. There may be an issue with a lack of unity in decision making. Southwest does not pay low-level employees well, which could be seen as negative in the lack of support for employees. However, that is offset by greater pay and benefits for long-term employees. Simple things have led to strive, such as using actors for advertisements rather than employees. There is a lingering fear of competition, due to the low profit earned per passenger. There are also limited opportunities for advancement within the company for the vast majority. Southwest has external opportunities. There are additional markets that the company could expand to. If a market is deemed to be expensive or would result in longer turnaround

Hall, p. 5 times, alliances could be made with other regional carriers. Regardless, there are markets that are still not served by Southwest within the United States. Southwest has long-standing external threats. There is always competitive risks, even though Southwest uses distinctive service markets. New entrants into the airline industry is an extremely low risk, due to the costs. However, mergers and takeovers of other airlines could produce low-cost challenges to Southwest by those competitors. There is also some risk to corporate raiders buying up Southwest stock to control management decisions, though employee stock options limit that risk. Rewards Systems Southwest Airlines provides standard benefits that are common to most businesses (Employee, 2007). This includes medical, dental, vision, and health coverage, with additional coverage package options for family members (Benefits, 2008). Southwest provides time-off, dependent care spending accounts, long-term care disability insurance, and a 401(k) retirement savings plan. Less common benefits are profit sharing and stock purchase plans. Unique benefits are space-available free flying privileges. Profit-sharing is one way of linking compensation strategy to business strategy. Southwests profit sharing program is designed to encourage employees to feel like they own the place. Southwest encourages creativity and innovations from employees that will save time and money. Employees are allowed to share in those profits, which encourages workers to apply themselves. Such ideas include the ticketless travel idea and a determination by employees to speed the turnaround times. Southwest calculated how much money would be wasted if a plane spent more time at an airport and less time on a flight segment. Profit sharing provides employees a motivation to increase speed of service, and therefore profitability.

Hall, p. 6 Southwest salaries are governed by contract, so specific and unique rewards may not be possible for most rewards to individuals. However, Southwest does try to incorporate rewards with a sense of pride and recognitions for jobs well done (Wilson, 1999). There could be a greater use of perks, cash rewards, or some other benefit or opportunity of value. The philosophy is to give top management a below-mean salary, yet to reward other managers with an above-mean salary, coupled with stock options, thus allowing managers to share in the profitability they create. It is a point of contention to have standardized salaries, since pay can no longer be used as a motivation to excel. Individual-based pay leads to competition and a loss of team-oriented behavior (Bergmann and Scarpello, 2008). On the other hand, profit-sharing rewards the group and can lead to rewarding social loafers on that team who do not contribute. Paying based upon the job rather than the individual is risky because it does not reward for skill, worth, and actual work (Lawler, 2000). Human capital is key to organizations, as organizations now consist of more professional people with greater education, experience, and skill than in years past. Companies will be better able to retain those with the greatest talent if they can pay based upon the individual and his market value. Pay needs to move from a determination based upon job descriptions to being based upon a persons professional development activities. Lawler (2000) suggests that organizations use personal descriptions, not just position descriptions. A better reward system is individualized. A more contemporary suggestion is a two-tiered pay system (Bergmann and Scarpello, 2008). This incorporates an individual-based base pay, plus additional pay for the accomplishments of the whole team. Total compensation includes pay, recognition, promotion and development opportunities, and non-monetary benefits (Williams, 1999; Bergmann and Scarpello, 2008). The companys strategy must incorporate a compensation strategy that rewards performance. This should

Hall, p. 7 include individual merit increases, spelling out what performance objectives must be met to receive them. Southwest rewards employees, but individual rewards are limited to recognitions. Total compensation must be individualized and should provide a wide array of potential benefits, such as bonuses, recognition, promotions, training, and more. Role of Human Resource Management The human resource department has a critical role in recruiting, hiring, training, and promoting individuals who fit with the strategy of Southwest Airlines. Further, the HR department should take the role in assessing, evaluating, and redesigning the compensation strategy to one that will promote business objectives. HR managers are only one voice, and it is essential to assemble a management team who can support each other in designing the new scheme. HR has greater latitude regarding its hiring procedures and in socializing new employees (Gomez-Mejia, Balkin, and Cardy, 2007), and those new hires must be compatible with the new pay structure. Employees have lost faith in the management line, take care of the company, and the company will take care of you. Through layoffs, firings, downsizing, scandals, hiring the wrong managers, and for various lesser reasons, employees have lost faith in business. Individuals are focused on developing their own career, regardless of which company or companies it will be with. Employees look for development, training, and advancement opportunities. With this in mind, HR managers must look for options in training employees, providing job rotations, or providing other services that will have a vested interest in the employee, all while strengthening the company. These factors must be considered in compensation planning.

Hall, p. 8 The best people seek out the best employers. Talented individuals know who to work for, in the interest of career potential. Job seekers will seek out an employer with the greatest potential to provide name, image, and development opportunities. Such individuals may be willing to start with lower pay, just for the potential for advancement and additional opportunities. HR planners must consider a long-term approach to career planning and compensation strategy. Employees are looking for training, job rotation, job enrichment, and training opportunities, in addition to pay and benefits (Gomez-Mejia et al., 2007). HR is also responsible for identifying great performers. Employees are interested in the best company, and the company must market itself for the best employees. As part of this talent management (Rodriguez, 2007), HR must continuously evaluate workers to see if they still fit in the organization and where they would perform best. HR is also responsible for talent retention, keeping great performers in the company. Many organizations are looking for star performers (Chambers, 1998). The war for talent, and talent retention, can be one through an aggressive compensation, benefit, and career development plan. Employees flow through an organization and through a career (Rodriguez, 2007). Compensation and opportunities helps the organization retain the talent it has invested so much in. Southwest must continue to market its culture, and should also market its jobs (Chambers, 1998). Attracting the right managers and staff will help continue the organization by building a team that reinforces corporate values. HR should keep workers interested by giving them new opportunities before employees demand them. As part of the strategy, the organization might consider the opportunities for advancement. No pay package will keep employees in a company, if seniority will bar them from advancement. Some other organization will be looking to extract that talent.

Hall, p. 9 Compensation and Benefits Strategy There must be an increased effort to reward individuals. Southwest does not technically pay based upon performance, since pay is set by union contracts (Flynn, 1995). The company motivates employees to perform through its culture and the promise of more benefits upon achieving higher positions. Even if pay contracts limit monetary increases for individuals, there are still many options as far as cash bonuses, recognition, or training opportunities (Bergmann and Scarpello, 2008). Performance bonuses may range from pay, bonuses, allowing more telecommuting work, or other opportunities that interest employees (Compensation trends, 2006). Higher level employees have shown increased interest in benefits such as flextime, time off, and more time for family matters (Davolt, 2006). Companies may spend less time and money on internal training and instead rely on a saturated applicant pool to provide specialized skills and experience (Hansen, 2001). New strategies may focus more on job redesign, or on a strategy that is based upon competitiveness. Lawler (2000) recommends individualized pay plans. Personnel must be flexible in sharing their roles, but paying for how the individual produces. That would be threatening to a team-based or profit-sharing approach. Companies may tend toward fixed pay, or position-based pay, if individualized pay leads to increased claims of discrimination or inequality. As it is, pay is largely fixed due to labor contracts. Southwest must adopt a two-tier pay system, rewarding both individuals and teams (Bergman and Scarpello, 2008). This will encourage individuals to excel, and will offset the risks of social loafers on teams. Further, team members will have the continued opportunity to complain about team members who are merely a burden. Southwest must acknowledge the trend toward a strategy of total compensation (Zingheim and Schuster, 2002). Employees are looking for more than just money. Skilled

Hall, p. 10 workers look for opportunities for advancement and growth. Further, a genuine concern for employees, which Southwest already exhibits, will produce loyalty and improved performance for years to come. Other valuable incentives may include: job security, contracts, or guarantees of term employment (Gelinas, 2005). Compensation strategy must produce the desired results and support the business strategy (Nelson, 1998). Southwest Airlines is an example of how an organization can maintain a competent workforce and a supportive culture without having a highly paid total force (Nelson, 1998). Metrics Assessing the Effectiveness of HR Southwest can conceivably verify the effectiveness of their compensation and reward efforts. HR personnel may use a combination of surveys, observations, and performance measures. The best considerations may come from retention numbers and the assessments of performance by higher-level managers. Employees may report on their satisfaction with the new plans or identify areas that need to be improved. HR should also set objective criteria to evaluate performance, retention, absenteeism, turnover, and other statistics that compare current employment trends under the new plan with those that existed previously. Each assessment or metric must show positive results and an explanation for those results (Fit-enz and Davison, 2002). The HR department, or what Southwest refers to as its People Department, will establish quantifiable metrics for its objective assessments. This should connect customer satisfaction, speed, performance, number of complaints, and other quantifiable measures to the benefits provided under the new and old schemes. The People Department will hire and reward employees based upon the most important objective measure, which is the improvement in customer satisfaction (Cook, 2007). They also identify those who are supporting other

Hall, p. 11 employees and encouraging them. Likewise, managers and personnel submit complaints against those who refuse to help other employees or who are rude to employees (Freiberg, 1996). Southwest is not crazy about paperwork. They would rather address employee issues in brief, face-to-face sessions. In all, the greater compensation, or non-monetary benefits, will go to those who increase performance measures, customer satisfaction, or an improved workplace environment.
HUMAN RESOURCES BALANCED SCORECARD Objective: Customer Satisfaction Measure/Assessment Surveys Complaints Internal Complaints System Absentee Rates Time with Company Time til Promotions No. & Type of Recognitions Given Suggestions Made Interview Employees Regarding Satisfaction with Pay and Benefits Turnaround time, changes in Load Factors / No. of Vacant Seats

Employee Satisfaction

Employee Fit

Operations

Conclusion Southwest Airlines has reached the point of being well established. Changes to the compensation strategy would likely require support of management and unions alike. However, there would be additional benefit gained by creating additional options for rewarding individual performance while still rewarding the team effort. HR managers are best suited to research the needs and desires of employees in this area, and then to design an ideal compensation scheme that is built on mutual participation.

Hall, p. 12 References Benefits The eight freedoms. (2008). Retrieved June 10, 2008, from: http://southwest.com/careers/benefits.html. Bergmann, T. J., & Scarpello, V. G. (2008). Compensation decision making (4th ed.). Mason, OH: South-Western. Chambers, E. G., Foulton, M., Handfield-Jones, H., Hankin, S. M., & Michaels III, E. G. (1998). The war for talent. McKinsey Quarterly, 3. Retrieved online, February 1, 2007, from Business Source Premier database. Company Profile (Nov. 2004). Southwest Airlines. New York: Datamonitor. Available in Business Source Premier database. Compensation trends to watch in 2006 (2006). HR Focus, 84(2), 12. Retrieved May 5, 2008 from Business Source Complete database. Cook, S., & Macaulay, S. (2007). How an integrated approach to performance appraisal and the reward and recognition of employees can improve your service levels. Retrieved online, February, 9, 2007, from: http://www.ecustomerserviceworld.com/earticlestore_articles.asp?type=article&id=110. Davolt, S. (2006). Total compensation. Employee Benefit News, 20(6), 32-36. Retrieved May 5, 2008, from Business Source Complete database. Employee Benefits Summary, Southwest Airlines (2007). Retrieved online, February 23, 2007, from: http://www.southwest.com/careers/benefits.html. Fitz-enz, J., & Davison, B. (2002). How to Measure Human Resources Management (3rd ed.). New York: McGraw-Hill.

Hall, p. 13 Flynn, G. (1995). Southwest Airlines wont be grounded by a strict compensation structure. Personnel Journal, 74(3). Retrieved April 18, 2008 from Business Source Complete. Freiberg, K., & Freiberg, J. (1996). Nuts! Southwest Airlines Crazy Recipe for Business and Personal Success. Austin: Bard Press. Gelinas, P. (2005). Redefining total compensation to include the value of job security. Ivey Business Journal, 70(2), 1-7. Retrieved May 5, 2008, from Business Source Complete database. Gittell, J. H. (2003). The Southwest Airlines Way: Using the Power of Relationships to Achieve High Performance. New York: McGraw-Hill. Gomez-Mejia, L. R., Balkin, D. B., & Cardy, R. L. (2007). Managing Human Resources (5th ed.). Upper Saddle River, NJ: Pearson. Hansen, F. (2001). The future of salary management. Compensation and Benefits Review, 33(4), 7. Retrieved April 15, 2008, from ProQuest database. Lawler, E. E., III. (2000). Pay strategy: New thinking for the new millennium. Compensation and Benefits Review, 32(1), 7. Retrieved April 20, 2008, from ProQuest database. Mission of Southwest Airlines (2007). Retrieved online, February 25, 2007, from: http://www.southwest.com/about_swa/mission.html. Nelson, J. E. (1998). Linking compensation to business strategy. Journal of Business Strategy (Mar. 1998). Retrieved April 15, 2008, from Business Source Complete database. Porter, M. E. (1996). What is strategy? Harvard Business Review 74(6). Rodriguez, (2007). Talent flow. Retrieved online from Capella University, February 1, 2007. Study shows employees dont understand value of total compensation. (2007). Report on Salary Surveys, 7(1), 8. Retrieved May 6, 2008 from Business Source Complete database.

Hall, p. 14 Williams, V. L., & Grimaldi, S. E. (1999). A quick breakdown of strategic pay. Workforce, 78(12). Retrieved online, February 18, 2007, from Academic Search Premier. Wilson, T. B. (1999). Rewards that drive high performance. Retrieved online February 18, 2007, from: http://www.wilsongroup.com/ecr/case/SouthwestAirlines.pdf. Zingheim, P. K., & Schuster, J. R. (2002). Pay changes going forward. Compensation and Benefits Review, 34(4), 4. Retrieved April 20, 2008, from Proquest database.