Dealing with Risk Asymmetric Information and Incentives
The airline industry operates in a competitive environment, and efficiency is essential in beating the challenges caused by competition. Clients in the airline industry are choosy, and it takes the airline companies a lot of effort to maintain a loyal customer base. Time management, few complaints from customers, and the safety of luggage are some of the factors that determine whether or not customers will choose an airline company over another. Airline companies are also profit organizations and put all the available measures to get as much money as possible from the customers. The use of algorithms is essential in setting ticket prices to ensure that a company does not operate in losses. Southwest Airlines, however, appears to have a different way of doing business and has managed to stay profitable for a long time. The emphasis of simplicity and implementation of effective strategies has seen Southwest Airlines make huge profits and mitigate several risks and challenges that occur in the airline industry.
Risks and uncertainties are high in the airline industry, owing to huge losses associated with accidents. Southwest Airlines has not been left behind in facing severe losses, and the risks are growing higher with the growth of the business. However, the company has been putting effective measures to mitigate the risks and uncertainties that have continued to come out (GIllespie, 2017). One of the recent actions taken to mitigate risk and uncertainty is the move to inspect its fleet of aircraft to minimize the risk of future accidents. The move was taken after an accident that claimed the life of one passenger after an engine blew mid-air. An investigation into the cause of the accident showed that the accident was caused by engine fatigue, and the company had to put necessary measures to avoid similar occurrences in the future. Although the accident was not the first one, previous accidents had not led to the loss of lives, and the company learned from experience to mitigate the risk before more lives were lost. Besides, passengers can easily choose another airline company if their safety is not prioritized. Therefore, Southwest Airlines was keen to have the inspection of fleets taken seriously and that no aircraft would be allowed to take off before proper screening. Moreover, Southwest Airlines needs stronger and more effective risk management strategies to remain profitable in the market.
Risk management has been a headache for most companies, especially in the airline industry. Companies have been relying on obsolete strategies that have not been giving desirable results. Also, the lack of strictness in handling risky matters has posed significant losses to companies, especially where history has not recorded losses. For example, Southwest Airlines did not witness deaths on previous actions and therefore was reluctant to put up risk management measures. Generally, risk management should be done before a company is hit by huge losses, which may pose a challenge in attempting to recover. The first improvement in the risk management department is a move to check on technology (Froeb, McCann & Ward, 2015). The recent changes in technology have left several companies operating on obsolete technologies due to a lack of updated systems. Southwest Airlines deals with customer details and luggage and should ensure that both are safe. Lack of effective technology could expose customer information and luggage to unintended hands, spoiling the loyalty of the customers. Secondly, effective communication aided by technology can be developed to ensure that problems are reported and solved before a loss occurs. The communication could be tailored according to the various risks facing the company. Also, frequent inspections could be done on the aircraft to keep the planes in their best condition. Moreover, adverse selection has been a great challenge for Southwest Airlines, and measures are needed to solve the puzzle.
Southwest Airlines has been a choice for most travelers due to lower prices compared to their competitors. However, the lower prices come at a cost with the risk of adverse selection coming up frequently. Southwest Airlines only offers standardized cheap tickets and does not offer first-class services. Some clients, however, are willing to pay more to enjoy first-class services. Therefore, Southwest Airlines does not enjoy the advantage of customers who are willing to pay more. The situation spreads to low economic times when few customers are traveling (Feng & Tseng, 2019). The company faces low business since the customers who pay less are also not willing to travel during the low economic times. Another challenge occurs due to the choice of the aircraft type. Southwest Airlines decided to lower the cost of conducting business by choosing Boeing 737 as the only model used by the company. The main idea behind the decision was to leverage pilot training so that the company saves on the costs of training. However, the choice of aircraft model limits the company in terms of the possible destinations. Some destinations are not fit for the Boeing 737s, and passengers are forced to choose other airline companies at the expense of Southwest Airlines. Southwest Airlines, however, has a set of options that can aid in overcoming the adverse selection problem.
The adverse selection problem is caused by the limited services that Southwest Airlines is ready to offer. First, the company needs to obtain the asymmetric information held by its customers so that it can market itself as a full-service airline. A full airline company will offer more flexibility, and the company will no longer lose clients who are willing to enjoy specialized services at a higher price. Also, the marketing strategy should be changed to meet more clients. The current marketing strategy only considers clients who have heard of Southwest Airlines before since the company only markets its services through its website. The company can use outside websites for marketing to meet new clients who might have never heard about the company. The issue with aircraft can be addressed by acquiring larger aircraft so that the company can eliminate the limitations associated with destinations. Moreover, Southwest Airlines has been on the spot for issues associated with moral hazard.
Moral hazard is common for larger companies and is associated with the use of hidden information by one party to take advantage over the other. Generally, the dominant party knows that a risk exists but does not have the motivation to tackle the situation at hand, leading to the suffering of the other party. Southwest Airlines is the dominant party in this case, and the suffering party is always the customer base (Orhun & Guo, 2018). Generally, moral hazard involves the deception of a party at the expense of the other but could have detrimental impacts for both parties. For example, Southwest Airlines has promised additional routes to customers in a bid to keep them loyal. The promise has, however, been hardly kept, and the company risks losing customers for deception. However, Southwest Airlines employs a series of practices to address moral hazard and to overcome the risk of losing business. First, Southwest Airlines compensates its employees to keep them motivated so that they can, in turn, take care of the passengers and customers. Also, employee incentives can play an essential role in motivating employees to always want to work above average. Furthermore, policies are developed to provide solutions that are tailored to address the moral hazard issue. Moreover, the principal-agent problem has been a challenge to Southwest Airlines.
Southwest Airlines has, for a long time, been faced with the principal-agent problem. The issue comes up because Southwest Airlines operates differently compared with other airline companies. For example, other companies operate flights on a to-and-fro basis within short distances while Southwest Airlines engages in continuous flight across several cities (Karanki & Lim, 2020). The flight plans have appeared challenging to passengers who have been failing to understand the operation of the aircraft. Complex aircraft trips also have to consider time management and safety of customer luggage while maintaining the cost of transport as low as possible. The problem is, however, addressed by aligning incentives both to the employees and customers to increase motivation. The customers have been provided with the promised benefits, and their luggage has been handled with the required safety. Generally, Southwest Airlines has managed to beat the competition from other companies and maintain profitability at the highest possible level. The wise management of the problem has saved the company from unnecessary expenses, and thus, profitability has been maintained.
Southwest Airlines operates as an organizational structure with a well-organized decision-making system that runs from the top. Senior management is in charge of the company, and employees have clearly-defined roles. The size of Southwest Airlines makes it complex, and the organizational structure ensures stability and efficiency in the activities associated with the company (Schlesinger, 2017). The use of similar decision-making processes throughout the company ensures that the company enjoys economies of scale. However, improvements are needed for the organizational structure since it may subject the company to some challenges. For example, inter-agency conflicts are common since departments rarely interact in decision-making. Besides, decisions are made at the top, and everyone has to agree with them. Also, the need to visit several offices may discourage customers who may see the process as a tiresome one. Southwest Airlines, therefore, needs to consider making decision-making a more inclusive process. Also, the activities of the company can be expanded to cover more geographic areas so that customers can be sourced from a larger area.
In sum, the emphasis on simplicity and implementation of effective strategies has seen Southwest Airlines make huge profits and mitigate several risks and challenges that occur in the airline industry. Southwest Airlines has been putting effective measures to mitigate the risks and uncertainties that have continued to come to emerge. Generally, the company is large, and its organizational structure has been essential in overcoming the challenges faced daily. The company needs to spread to cover more parts of the country as well as neighboring countries to increase profitability.
References
Feng, Z. Y., & Tseng, Y. J. (2019). Corporate social responsibility in the tourism industry: evidence from seasoned equity offerings. Current Issues in Tourism, 22(1), 91-106.
Froeb, L. M., McCann, B. T., & Ward, M. R. (2015). Managerial economics. Cengage learning.
GIllespie, K. M. (2017). How do Airline Acquisitions Impact Customer Service? A Case Study of Southwest Airlines’ Acquisition of AirTran (Doctoral dissertation, Fielding Graduate University).
Karanki, F., & Lim, S. H. (2020). The effects of use agreements on airport efficiency. Journal of Air Transport Management, 84, 101767.
Orhun, A. Y., & Guo, T. (2018). Reaching for Gold: Frequent-Flyer Status Incentives and Moral Hazard. Available at SSRN 3289321.
Schlesinger, D. (2017). Organizational culture. In 2017 Joint Rail Conference. American Society of Mechanical Engineers Digital Collection.