Southwest Airlines: Do free bags create problems?

Martin Lariviere

By Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

Southwest along with Walmart and Toyota have long been stock examples in Operations Management classes. They have always been reliable go to examples of firms whose success has depended in non-trivial ways on how they manage their operations. Of course, the problem with relying on a stock example is that little things like, I dunno, recalling millions of cars can dampen the persuasiveness of the example. It’s not just Toyota. Walmart too has add some issues and missteps. Now comes word that Southwest is having operational difficulties (As Southwest Airlines tries to cope with its success, problems at Midway will get team’s attention, Mar 3, Chicago Tribune).

Bags still fly for free on Southwest Airlines, but travelers are paying a price in other ways. They’re encountering more lapses in Southwest’s hallmark on-time performance as the carrier departs from what once was its core principles of avoiding congested airports and shunning hub-and-spoke complexity in favor of getting passengers to their destinations on a single aircraft.

Revenue soared as Southwest added business destinations such as New York’s LaGuardia Airport and connecting flights at Chicago’s Midway Airport. But as it struggles to cope with increasing numbers of passengers and bags, Southwest risks tarnishing the reliability it has touted since the 1970s. …

While its rivals shrank their U.S. operations following 2008′s Great Recession, Southwest added 13 million more passengers per year. The carrier also took a scalpel to its schedule, canceling flights that didn’t attract great numbers of passengers and adding more flights to peak periods.

With little room to make up for delays, Southwest’s on-time arrivals in 2010 dipped below the carrier’s historic 80 percent rate. The lapse was magnified as rivals like United Airlines posted the best on-time numbers in their history.

Part of the issue is that Southwest has tweaked its traditional business model (something we have written about before), flying to more congested airports and operating more of a hub-and-spoke system. Part of this is related to growth. At some point, Southwest was bound to run out of secondary airports in relatively populous areas. That would leave a choice of going into smaller cities (where reliably filling a 737 would be hard) or sucking it up and going to busier airports that pose operational challenges but at least have lots of traffic. That seems a pretty obvious choice. As does a hub-and-spoke system. Once Southwest began flying to cities on both coasts, it was inevitable that passengers would look to book long trips. Having five-hour layovers then costs you business and you start to have more peaked flight schedules. The next thing you know, half of Southwest’s Midway traffic is connecting passengers.

Of course, peaked schedules with tight connection times makes for challenging operations. The proof is in the data. Not only has Southwest’s on-time performance suffered, Midway’s has. It is now last in on-time departures .

And Southwest’s bags fly free policy doesn’t help.

It’s not unusual for bags and passengers on a flight landing at Midway to connect to 12 departing flights, sending workers scurrying to sort and deliver the luggage to 12 points around the airport.

“The planes are coming in with more bags, period, because people check more bags,” [Charles] Cerf[ president of TWU Local 555, which represents ground workers at Southwest] said. “They’re having to hold some of those departures because normal connecting time isn’t enough to get the bags over there. We feel we don’t have enough agents.”

This too makes sense. Ryanair claims to emphasize baggage fees in order to keep costs down. If Southwest is going to welcome check bags, they have to expect higher costs. The question is what can they do? The article says they are loathe to increase the scheduled time for flights or scheduled layover since that would dramatically decrease their productivity. That leaves adding resources (for example, they are renting more gates at Midway and adding workers) or revising the work. The latter is obviously the most desirable outcome. It will be interesting to see if they can pull it off.

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Better ways to manage waiters

Martin Lariviere

By Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

It’s been a tough couple years for restaurants. When the economy goes south, dining out is something relatively easy to cut from the family budget. Throw in rising food prices, and you gotta brutal business. Thus it is not surprising that firms are looking to save a little cash on the labor front. The Wall Street Journal had an interesting story on steps Chili’s Grill and Bar (a division of Brinker International) is taking to reduce the amount of labor it needs in its restaurants (Chili’s Feels Heat to Pare Costs, Jan 28). Some of these steps are straight out of our core Ops class in terms of reducing the amount of time resources need to spend with each unit flowing through the process:

With costs in mind, Chili’s studied how its kitchen operations could be more efficient. It determined employees were spending too much time performing solo tasks, such as hand-mashing potatoes in a skillet or minding ribs in the oven.

Now it is testing in 10 restaurants a new combination oven that replaces the skillet and the smoker. The chain wouldn’t disclose the ovens’ cost but said that they can smoke ribs and cook bacon at three times the current capacity. That, in turn, frees employees to do other things until the timer buzzes.

Other steps include experimenting with conveyor belt ovens for burgers and quesadillas and shifting food prep from line cooks to (presumably less expensive) prep cooks. All of these are fine and good and don’t necessarily affect the customer. The customer doesn’t see what happens in the kitchen and could probably care less about who dices up the onions. The more interesting part is what they are doing in the front of the house.

Last year, the chain shifted the way tables are served. Now, waiters work in pairs in zones and table bussers have been eliminated. Chili’s said it noticed that dedicated bussers were slowing service because they held onto tubs used to remove dirty plates, making servers reliant on them to clear tables. If the busser didn’t clean fast enough, new customers couldn’t be seated. Without bussers— who now have been gone since July—servers no longer have to share tips with them and have an incentive to turn over tables faster.

“We took a big chunk out of our labor model at the front of the restaurant without compromising the guest experience,” Ms. Valade says.

So I discussed this model of waiter management with some Kellogg econ PhD students some time back. (I believe that they had actually talked to someone at Brinker. That is, many of these changes have been in the works for a while and are not all in response to the impending changes in health care regulation even though that is how Mr. Muroch’s paper pitches things.) There is an interesting trade off here. We basically have an agency problem. The restaurant manager cannot monitor everything that each server does so having them dependent on tips gives them an incentive to put in effort and treat the customer well. As soon as you pool tips, that creates a problem. If Pablo puts in a lot of effort and gets the customer to bump up the tip a couple of bucks, he now has to share that with Mallesh. That implies that Pablo should not put in as much effort as he would if the tip was all his. Or at least that is what a standard model would predict.

So what is the trade off? The trade off arises because there are aspects of the tips that are beyond the control of the waiters. For example, the waiters have no control over whether they end up with a party of teetotalers who don’t buy booze and run up their tab. Or they don’t completely control whether a given table will turn two or three times this evening. That creates variability in their earnings but that variability is dampened out as they have a slice of more tables. Less variability would mean higher utility (assuming they are risk averse) and thus the firm can pay a lower base salary. (If you doubt that servers are that dependent on tip income, check out Steve Dublanica’s recent book Keep the Change: A Clueless Tipper’s Quest to Become the Guru of the Gratuity.)

There are a couple of other points here that might tip the scales toward pooling the waiters. For one, service might actually improve even if the waiters don’t work as hard. One can think of the waiters as a queuing system with random arrival of requests for attention (e.g., foods up for table 5, need more drinks at table 12, etc.). There are economies of scale in queuing systems so doubling the number of servers and doubling the number of requests should result in faster service of requests as long as effort doesn’t drop too much.

The second point is that waiters might not be able to shirk that much. Going back to Pablo and Mallesh, if Pablo is a total slacker, Mallesh will notice even if the manager does not. This is a repeated game and Mallesh may demand a different partner or even a different shift if working with Pablo is too much hassle. Developing a reputation as a loser and consequently being left off high volume shifts is probably more than enough discipline to keep the likes of Pablo in line.

Quality Control and Printing Money, or, why Having an Helicopter is not enough

By Gad Allon and Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

Gad Allon

Martin Lariviere

CNBC had an interesting article on the problems in the production of the new $100 bills. (“The Fed Has a $110 Billion Problem with New Benjamins“, hat tip to Ian Farrington).

Several years ago in a speech that earned him the nickname “Helicopter Ben” – Federal Reserve Chairman Ben Bernanke said that the government could easily reverse a deflation, just by printing money and dropping it from helicopters. Apparently, the government is not so good in printing money:

An official familiar with the situation told CNBC that 1.1 billion of the new bills have been printed, but they are unusable because of a creasing problem in which paper folds over during production, revealing a blank unlinked portion of the bill face. A second person familiar with the situation said that at the height of the problem, as many as 30 percent of the bills rolling off the printing press included the flaw, leading to the production shut down.  The total face value of the unusable bills, $110 billion, represents more than ten percent of the entire supply of US currency on the planet, which a government source said is $930 billion in banknotes. For now, the unusable bills are stored in the vaults in “cash packs” of four bundles of 4,000 each, with each pack containing 16,000 bills.

We tend to hear about quality problems when there is a recall (see Toyota, BMW, etc… ), but in this case, the product is still in the vault.  The interesting part though is that no one knows what’s causing the problem. And because they don’t know, they cannot figure out how many contain this issue, or even how to create a mechanism to sort the good bills from the flawed ones. Without a clear system, one needs to sort them by hand (which will take between 20- 30 years). Sorting them through an automated mechanism will take “only” a year. To get a sense for the loss in shredding the defective ones:

According to a person familiar with the matter, the bills are the most costly ever produced, with a per-note cost of about 12 cents—twice the cost of a conventional bill. That means the government spent about $120 million to produce bills it can’t use. On top of that, it is not yet clear how much more it will cost to sort the existing horde of hundred dollar bills.

Interestingly, the article says that more than a decade of research and development went into the new security features on the redesigned $100. Yet, as in many cases, we see that a lot of thought is given to the design of the product, but not so much time and attention are given to the production process.

The main question I have is why we have to print a whole batch of 1.1 billion bills before we subject these to rigorous testing.  I am sure that some (or maybe even extensive) testing has been done, but it seems that only inspection by people detected these issues. Unlike many products, allowing people to use a beta version of the product is not possible, but it is quite obvious that these issues had to be detected somehow before the large scale production and before the launch date. I am not familiar with the fixed costs associated with the production of these bills, but if this is not exorbitantly high, one may hope for a small run before full production begins.

For those worried about the prospects of our economy, the machines are still printing the old bills.

Selling restaurant reservations at a discount

Martin Lariviere

By Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

A few weeks ago I wrote about how Groupon promotions can create operational headaches for participating service providers. In short Groupon coupons drive traffic but service providers can be easily overwhelmed, making it hard for new and current customers to make appointments for service. Now the New York Times reports on VillageVines, an alternative site that provides local promotion support (Pay Full Price for a Meal? That’s So Yesterday, Sep 8).

Like Groupon, VillageVines makes deals available on-line for registered uders. However, there are important differences. First, VillageVines specializes in restaurants as opposed to covering the waterfront from apparel boutiques to salons. Second, they don’t sell coupons but reservations.

With VillageVines, registered users get a daily e-mail and pay $10 for a reservation, which they book through the site or through MenuPages.com, thanks to a new partnership. They get a discount, usually 30 percent off their bill.

The distinction between coupons and reservations may seem trivial but it actually makes a real difference. For customers, there is no need to print and remember to carry the coupon. The discount is in the firm’s reservation system and should be taken automatically. Certainly, a classier way to handle getting a discount when on a first date.

The bigger issue is how this solves problems for the restaurant. Because customers are buying reservations they have to pick a date and time before they fork over their $10. Consequently, the firm can shape the demand they get by limiting the number of reservations they give out and specifying when the discounts can be used. If the existing customer base does not fill up the house on Tuesday evening, that’s when you offer reservations on VillageVines. Further, customers know what they are buying. This scheme eliminates customers buying a discount only to find they can’t get an appointment for two months.

So this is a very clever solution to the issues that have arisen with Groupon. Of course, from the member’s perspective it doesn’t replace Groupon. Here you only get restaurants so if you are more interested in apparel shops it doesn’t do much for you. The question is whether this format can be easily carried over to other settings. I am not sure that it can. This works for restaurants because on-line reservation systems exist on a common platform and are integrated with other restaurant systems. There is no such standard approach for other local services — even those that commonly use appointments. Part of that is because people don’t generally shop around for dentists and barbers the same way. People generally like variety in eating so there is a benefit to having one site that allows access to a variety of firms. On the other hand, most  customers are happy to deal with one dentist and one barber once they identify a good alternative.  I don’t see what a hair salon gains from putting its appointment book on a common platform with other salons. Without  that common platform, this becomes a difficult system to implement.

Managing inventory via Tweets

By Gad Allon and Martin Lariviere, The Kellogg School of Management at Northwestern University. Source: The Operations Room.

Martin Lariviere

Gad Allon

How can a retailer take the pulse of demand?  Is looking at sales enough? You can’t sell what you don’t have so you may never know how many customers came into the store liked a style but couldn’t find their size. Lululemon thinks they have a found a way to do just that (Tweet to Lululemon: Smaller sizes, please, Jun 10, Globe and Mail).

Instant feedback on Facebook and Twitter is helping the chief executive officer of Lululemon Athletica Inc. to figure out what items are hot with customers, and which ones are duds. Comments through social media about the chain running out of women’s size 4s and 6s, for example, are helping her adjust her product purchasing to ensure she’s in stock of those sizes rather than forfeiting sales, as has happened in the past. Identifying the high-demand products to carry for her “guests,” as the company calls its customers, is crucial for the purveyor of premium athletic wear.

“We learn more about that on Facebook and through social media: what are the guests really screaming for and so we actually use [the feedback] to get a little bit more indication,” [CEO] Christine Day said. The running line “really shifted our guest size profile down to the smaller sizes because we’re attracting a more athletic, fit guest which is perfectly in line with our target.”

This is an interesting twist on using social media. Obviously a challenge is getting enough feedback from customers.  I have to admit that I have rarely affiliated with a brand on Twitter or Facebook (i.e., I am old) so I am not sure how many people are inclined to provide meaningful feedback to the firm.  On the other hand, these are presumably Lululemon’s hardcore clientele so they are worth listening too. A second challenge is whether the firm has the operational capability to respond. Yes, customers are looking for more size 6 gear but apparel lead times are long. Will it frustrate customers if their complaints are heard but they only see the evidence of that next season?

A final question, what if what customers want is not completely in synch with the firm’s strategy?

Still, part of Ms. Day’s strategy is something she calls a “scarcity model.” She doesn’t want the stores to carry too many size 4s and 6s, to keep customers coming back.

“If you like size 6 or 4 in one of the colourways or seasonal styles, it’s never our strategy to be fully at demand level there. So there will always be a certain amount of noise that we expect but that helps keep the product and the brand strong, which is also part of our strategy,” Ms. Day said.

Lululemon wants to be a premium brand and that doesn’t align with a fire sale clearance at the end of the season. Scarcity of is part of the plan; turning away some size 6 demand is inevitable. Is that consistent with trying to solicit feedback over Facebook?