The Future For Southwest Airlines: The Unknown Story of Rising Costs and The Maximum Point On Profits-Revenues Curve

The Future for Southwest Airlines The Unknown Story of Rising Costs
2012 FORTUNE 500 List Rank 167

Southwest has always prided itself for having the lowest cost structures in the domestic airline industry. It consistently offers the lowest fares and has one of the best overall customer service records. Nonetheless, this detailed case study, analyzes the profits-revenues data for all forty-one (41) years, from 1971-2011, using a new methodology, based on a universal mathematical law relating profits and revenues that has been shown to describe the financial performance of many leading companies in the Fortune 500 list. It is shown that costs have been rising continuously for Southwest, going back all the way to 1974. What is this costs? Costs = (Revenues Profits), with revenues and profits being obtained from the annual reports. Addressing this cost issue, in innovative ways, based on a greater scientific understanding of the financial dynamics, will make Southwest Airlines even more profitable in the coming years. There is no contradiction between rising costs noted here and being the lowest cost domestic airliner.
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Table of Contents
No.
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.
Topic
Summary Brief version of the story Introduction Profits and Revenues over time The Profits-Revenues Linear Law The Unknown Costs-Revenues Story of Southwest Airlines Quarterly data and Total Operating Expenses Maximum Point on Profits-Revenues Graph Brief Discussion Appendix 1: Further discussion of quarterly data 2007-2012 Appendix 2: Growth of profits and revenue in a single year Appendix 3: Type II Behavior and Type I to Type II transition Appendix 4: Profits and Passengers flown Appendix 5: Profits-Revenues in Early years: Nonlinear law The entire 41 years of profits-revenues data from 1971-2011 Now a word about Air Tran Bibliography of related articles
Page No.
11 13 18 19 22 30 35 39 43 49 54 65 71 75 89 105
http://upload.wikimedia.org/wikipedia/commons/5/53/Southwest_Airl ines_Flight_1248_-1.jpg Found this interesting image of a plane landing

(doctored?) during a Google search Southwest airlines images.
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Lets Make this Easy

Although this document has grown to an amazing 108 pages (it even includes a small section on AirTran now!), there is really nothing to it. So, here are some tips about how to STUDY this (assuming you still want to study it!)
1. Ok, just go straight to page 100 of the Air Tran section! Swoosh! 2. Fun Predictions on page 10 gives the formula for revenues, R = kF. This can be deduced from the Southwest Fact Sheet on page 9. 3. The key to the whole analysis is P = hR + c, the profits-revenues relation. It is derived in 5 and requires only a knowledge of the breakeven analysis for profitability. (All of it in just one paragraph!) The P-R formula is then tested and shown to hold true using actual financial data. (It has also been tested with many other companies.) Both P and R can thus be predicted! 4. Everything else, starting with 6, is aimed at showing, through different types of calculations, that costs have indeed been going up for Southwest Airlines, actually ever since operations began. 5. Southwest today is among the major low-cost domestic airlines that has delivered a profit consistently for 39 years in a row. Both the level of profits and the profit margins can be increased if we understand how and why costs have been increasing and, more importantly, develop INNOVATIVE SOLUTIONS to control these rising costs. 6. More importantly, just look at the graphs. There is nothing mysterious about this. Just read the captions with each graph. They tell the whole story. Study the Southwest initial year graph, Figures 28 and 29, and the Air Tran initial years graph in Figures 38 and 39.
With lots of LUV in the air!

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Happy Birthday Southwest Airlines

http://www.swamedia.com/channels/Our-History/pages/our-history-sort-by
Celebrating and Living the Southwest Way

Celebrating is an important part of the Southwest Airlines Culture. Its been that way from our very first flight in 1971, and its true today. Weve always subscribed to the mantra of Work hard, play hard.
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Quite coincidentally, this report was completed on June 18, 2012, st the 41 anniversary of Southwest Airlines first flight on June 18, 1971; see History and Timeline. Wishing even more LUV in the air!
What's LUV?
Southwest has been in LUV with our Customers from the very beginning. Therefore, it's fitting that we began service to San Antonio and Houston from Love Field in Dallas on June 18, 1971. As our Company and Customers grew, our LUV grew too! With the prettiest Flight Attendants serving "Love Bites" on our planes, and determined Employees issuing tickets from our "Love Machines," we changed the face of the airline industry throughout the 1970s. Then in 1977, our stock was listed on the New York Stock Exchange under the ticker symbol "LUV." Over the ensuing years, our LUV has spread from coast to coast and border to border thanks to our hardworking Employees and their LUV for Customer Service.
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Our History Select from a Category Select By Date
1966 to 1971
1967
March 15, 1967 November 27, 1967
Air Southwest Co. is incorporated. With $500,000 in the bank, Herb files the application with the Texas Aeronautics Commission (TAC) to serve DAL, IAH, and SAT.
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1968
January 15, 1968
Hearing before TAC begins.
February 20, TAC votes unanimously to grant Air Southwest a certificate of public convenience and necessity. 1968 Braniff, Trans Texas (later Texas International), and Continental Airlines obtain February 21, a temporary restraining order from Travis County District Court prohibiting 1968 TAC from delivering our Certificate. August 06, 1968 August 06, 1968
1969
Austin State District Court rules against Air Southwest. Air Southwest files an appeal with the Third Court of Civil Appeals over the State District Court's Aug. 6 decision.
March 12, 1969 March 12, 1969

1970
Herb files appeal with the Texas Supreme Court and offers to represent the Company free of charge and pay all costs out of his own pocket. State Court of Civil Appeals rules against Air Southwest, upholding the lower court's decision.
May 13, 1970
The Texas Supreme Court unanimously votes to overturn the lower courts' findings and rules in favor of Air Southwest.
December 07, The United States Supreme Court denies appeal by Braniff and Texas International (TI) of Texas Supreme Court decision. 1970
1971
January 01, 1971 March 10, 1971 March 29, 1971 March 29, 1971 March 29, 1971
Lamar Muse joins Air Southwest as President. Lamar Muse sells promissory notes for aircraft and startup costs, raising $1.25 million. Air Southwest Co. changes its name to Southwest Airlines Co. (Southwest). Boeing offers to sell Southwest three 737-200s with Boeing carrying 90% of the financing. Lamar Muse hires Dick Elliot, Jack Vidal, Donald Ogden, and Bill Franklin. They become known as the "Over the Hill Gang."
June 08, 1971 Jun. 8, 1971 Initial Public Offering of 650,000 shares of Southwest stock at $11
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per share ($6.5 million). Thomson McKinnon Auchincloss, Inc. and Model, Roland & Co., Inc. were the Principal Underwriters. The exchange was traded over the counter, and we did not have a ticker symbol. The Civil Aeronautics Board (CAB), refusing to interfere, throws out complaints filed by Braniff and TI that Southwest's operation might violate its intrastate June 16, 1971 exclusivity. Within hours, lawyers for the two win a restraining order from an Austin judge barring Southwest from beginning service. Herb pleads case to the Texas Supreme Court. Later that day, the Texas Supreme June 17, 1971 Court overrules the State District Court's injunction preventing Southwest from commencing service. June 18, 1971 Dallas Provisioning base opens. Southwest Airlines begins service to DAL, SAT, and IAH. Our flight June 18, 1971 schedule starts with six roundtrips DAL-SAT and 12 roundtrips DAL-IAH with $20 one-way fares. June 18, 1971 September 29, 1971 October 01, 1971 November 14, 1971 November 14, 1971 November 21, 1971 November 22, 1971 First uniforms for hostesses and ticket agents introduced. The "love airline" is born. Captain Emilio Salazar flies the inaugural flight. Southwest receives fourth aircraft. Southwest implements every-hour service DAL-IAH with 14 roundtrips and every-other-hour service DAL-SAT with 7 roundtrips. Begins service between HOU-SAT - closing triangle. Southwest "revitalizes" Houston's Hobby airport (HOU) by providing air service and transfers one-half of service from IAH to HOU. Introduces $10 "night fare" between HOU-DAL. Cancels Saturday service. $3,753,000 Revenue Trips flown: 6,051 Employees: 195 at DAL, SAT, IAH, $700,000
1971 Milestones Net Loss: passengers carried: 108,554 December 31, Fleet: 4 aircrafts year end. Cities opened: 1971 HOU Advertising budget:
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Southwest Airlines Fact Sheet

http://www.southwest.com/html/about-southwest/history/fact-sheet.html#fleet
An estimate of the MAXIMUM daily and annual revenues is readily arrived at using the data compiled here.
Operates 558 Boeing 737 (as of March 30, 2012) Fleet type Number Seats 158 137 737-300 25 122 737-500 372 137 737-700 (Beginning February 2, 2012 capacity is being increased to 143). Two 737-800s began service April 11, 2012. Southwest currently flies to 73 cities in 38 states. More than 3200 flights per day. Southwest aircrafts fly an average of six flights per day (6.18/day) or an average of 11 hours and 12 minutes per day. (558 times 6 equals 3348.) The average trip length is 679 miles and the average duration is 1 hour and 58 minutes. Southwest consumed about 1.8 billion gallons of jet fuel in 2011. The average passenger fare is $141.72 one-way and average trip is approx. 939 miles.
Other related studies: http://www.thomashauck.net/pdfs/1southwest.pdf Southwest Airlines: Case Study by Garrison & Keller, 5567 Beechmont Ave, Cinncinnati, OH 45276 http://www.dtic.mil/dtic/tr/fulltext/u2/a273125.pdf
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Fun Prediction
Fun Formula for Revenues ( R = kF ) From Southwest Airlines Fact Sheet
http://www.southwest.com/html/about-southwest/history/fact-sheet.html#fleet Based on the information compiled in the Fact Sheet, the following formula for total annual revenues, lets call it R, can be easily deduced. R = kF where F is the average fare per seat and k is a numerical constant which depends on the numbers compiled in the Fact Sheet.
Annual Revenues ($, billions) R = kF = 0.14683 (Fare per seat in $)

Average fare per seat, F $ $100 $125 $150 Annual Revenue R ($, billions) $14.683 B $18.358 B $22.025 B
It is assumed that 120 seats are sold per flight and that there are 3350 flights per day, each day of the year. The change in average seats per flight will affect the total revenues in exact proportion. Now, heres the formula for predicting the profits P. It is given by P = hR + c Here h and c are constants that can be deduced from the two line items that are now being reported routinely in the annual and quarterly financial statements. This can be appreciated by studying this document carefully. HOMEWORK PROBLEM: Repeat above for Jet Blue (ok, Air Tran!) and compare it with Southwest! Also, check out the 2011 revenues for Southwest.
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1. Summary
Southwest Airlines is an amazing company which has been in service for 40 years and has been able to report a profit year-after-year for 39 years. It is focused on offering low fares with exemplary customer service in an industry that is extremely competitive and notorious for its low profitability. A recent article by Seth Stevenson, in the Slate magazine, which discusses the keep it simple philosophy of this airline, prompted this analysis of the profits and revenues behavior. The data for the twenty year period, 1992-2011 and first quarter 2012, is studied here. The revenues have increased consistently since 1992 and revenues growth actually seems to have accelerated since 2009. Unfortunately, the same cannot be said about profits. Profits increased consistently from 1992 and reached a peak in 2000 after which profits have been varying wildly, showing large fluctuations. For the period 1992-2001, a simple linear law y = hx + c = 0.123x 0.141, where x is revenues and y is profits, both in billions, can be shown to describe the data. Profits increase at a fixed and steady rate with increasing revenues, once a cut-off or breakeven revenue was exceeded (given by y = 0 and x = $1.15 billion). This has been called the Type I behavior here and signifies a period of steadily increasing profits with increasing revenues (h > 0 and c < 0). Thus, one could also conceive of a Type II behavior (h > 0, c > 0), where profits increase at a lower rate than in the Type I phase and also a Type III behavior (h < 0, c > 0), where profits actually decrease with increasing revenues. Indeed, for the post-2000 period, a careful analysis of the profits-revenues data reveals that Southwest Airlines is now in the Type III mode: profits-revenues graph actually has a negative slope for the period 2007-2011. Extrapolating from this recently established trend, it is also conceivable that Southwest Airlines will soon report an annual loss, as revenues increase further. The recently completed acquisition of Air Tran thus takes on added significance and one would be tempted to blame this acquisition if there is any historical first reporting of a loss. This impending situation has been studied carefully to understand how costs have been increasing with increasing revenues. It can be shown that costs are actually increasing faster than revenues and this also explains the low absolute level of
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profits and the rather low profit margins. The total Operating Expenses, one of the Items reported in the Consolidated Statement of Operation, and the Cost, computed from the relation Costs = Revenues Profits (where profits is the same as the item called Net income), are both studied carefully to draw some conclusions that should engage the immediate attention of Southwest Airlines management. While the unprecedented reporting of profits, year-after-year, is unprecedented and to be highly commended, focus must now be shifted to increasing the profit margins and a return to the Type I behavior of the pre-2000 era. Many issues that affect the cost structure need to be addressed in the coming years to sustain the history of profitability. It is hoped that Southwest management will benefit from these findings (especially those in the more detailed Appendices). Perhaps, the most important finding here is that Southwest Airlines, like some other companies (notably Ford Motors, Verizon Communications, Yahoo, and Kroger) shows a maximum point on its profits-revenues (P-R) graph. Air Tran, recently acquired by Southwest, also reveals a maximum point. The P-R graph is a simple x-y graph of these two items, reported routinely in the consolidated financial statements (quarterly and annual). It is truly amazing that the existence of such a maximum point has escaped attention to date. (The present author began these recent studies on May 18, 2012, following the disappointing Facebook IPO launch and the general media discussion about its potential revenues growth.) Why is there a maximum point on the profits-revenue graph? Why would a company want to continue operations if profits actually decrease with increasing revenues? The appearance of a maximum point in the radiation spectrum for a blackbody puzzled physicists in the closing years of the 19th century. Classical physics was unable to explain the existence of such a maximum point. Now, we have, in the humble opinion of the present author, a finding of far reaching significance that should engage the attention of business leaders, and the finance and economics community, both academic and day-to-day practitioners. From such an understanding, there can be no doubt, will emerge a new, as yet unimagined, view of how the financial world behaves. Perhaps, we can start building real Profits Engines. Southwest Airlines can lead the way.
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2. Brief Version of the Story

The purpose here is to make the good better and the better the best. Southwest Airlines is already widely recognized as a highly successful low-cost domestic airline. It has been in service for 40 years and has delivered profits, every single year, for 39 consecutive years. Although some quarterly losses have been reported, the company has always reported a profit for the year, taken as a whole. A somewhat unconventional approach will therefore be taken here to show that costs have actually been rising for Southwest Airlines, especially over the last decade, with the emergence of what is described here as the Type III behavior. Hence, we will first present four key findings, in the form of simple x-y graphs. The figure captions are self-explanatory. The figure numbers used later in the text are retained here. This is then followed by a more detailed presentation.
18
Revenues, x [$, billions]
16 14 12 10
8
6 4 2 0 1990 1995 2000 2005 2010 2015
Time, t [in years]

Figure 1: Revenues growth for Southwest Airlines for the last twenty years (1992-2011). The rate of increase of revenues seems to have accelerated since 2009, as seen by the increased slope.
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0.7
Profits, y [$, billions]
0.6 0.5 0.4 0.3 0.2 0.1 0 1990
1995
2000
2005
2010
2015
Time, t [in years]

Figure 2: Profits growth for Southwest airlines for the period 1992-2011. Profits increased steadily with increasing revenues until 2000. Since then profits have been varying erratically with the recent three years (2009-2011) yielding very low profits compared to the historical values, with revenues having increased to record levels.
Now let us compare the profits and revenues data for the years 2000 and 2010, obtained from the quarterly reports for each year. Specifically, we will consider how profits grow during the year, with increasing revenues, when we take a snapshot of the financial behavior of the company in 3 month, 6 month, 9 month, and 12 month intervals.
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2000 and 2010 Profits, y [$, billions] Cumulative values during the year
0.80
2000
0.60
0.40
2010
0.20
0.00
-0.20 0 2 4 6 8 10 12 14
2000 and 2010 Revenues, x [$, billions] Cumulative values during the year
Figure 19: Composite plot comparing the evolution of profits, with increasing revenues, during 2000 and 2010 (from the 3 months, 6 months, 9 months, and 12 month quarterly data for each year). A linear profits-revenues equation, y = hx + c, is implied by the classical breakeven analysis for profitability. If a is the fixed cost and b the unit variable cost, the total cost C = a + bN where N is the number of units offered. If p is unit price, the revenues generated from the sale of the N units is R = pN. Also, N = R/p. Hence, the profits P = R C = [1 (b/p)]R a which means the intercept c = - a and the slope h = 1 (b/p). The higher intercept made on the x-axis implies a higher fixed cost. The lower slope means a lower rate of conversion of additional revenues (beyond breakeven, or cut-off value) into profits. Since, h = 1 (b/p), the lower slope means a higher unit variable cost b or a lower unit price p (due to competitive pressures). The inescapable conclusion from the above is that costs have gone up for Southwest Airlines during the last decade although the company is considered a major low-cost domestic airline. Is this a contradiction? NO!
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120 100
Profits, y [$, millions]
80 60 40 20 0 -20 0 200 400 600 800 1000 1200 1400 1600 1800 2000
Revenues, x [$, millions]

Figure 26: A very clear nonlinear growth of profits with increasing revenues for Southwest Airlines for the period 1971-1992. Costs have been rising for a long time now, as is obvious from this graph which is prepared using two line items from the Annual Reports (revenues and net income or profits). There is an unmistakable deceleration in the rate of growth of profits with increasing revenues, i.e., the slope of the mathematical curve describing the profits-revenues relation is decreasing. Amazingly, this has escaped attention to date. The maximum point on the profits-revenue graph (see main text, this is OUTSIDE the range of revenues covered in this graph) is another dramatic example of this same trend. Southwest Airlines is now operating past its maximum point, in the region where profits decrease even as revenues increase! Some other examples of leading Fortune 500 companies that exhibit this maximum point are Ford Motor Company, Verizon Communications, Yahoo, and Kroger.
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http://216.139.227.101/interactive/luv2009/198/page_003.jpg
Ready for Take-off !

The Southwest Secret
How the airline manages to turn a profit, year after year after year
By Seth Stevenson Posted Tuesday, June 12, 2012, at 11:45 AM ET e-mail: seth@sethstevenson.com http://www.slate.com/articles/business/operations/2012/06/southwest_airlines_prof itability_how_the_company_uses_operations_theory_to_fuel_its_success_.html http://216.139.227.101/interactive/luv2009/ Financial Data for 2000-2009
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3. Introduction
A recent article in the Slate magazine by Seth Stevenson, on the enviable profits http://www.slate.com/articles/business/operations/2012/06/southwest_airlines_prof itability_how_the_company_uses_operations_theory_to_fuel_its_success_.html ) record of Southwest Airlines, caught my attention and is largely responsible for the analysis being offered here. This airline, which is mostly focused on domestic routes, has reported a profit, year-after-year, for 39 consecutive years. This point has also been proudly highlighted by the company in its 2011 Annual Report (see http://southwest.investorroom.com/ ) and also in all earlier year reports (35th year, 36th year, 37th year, and so on.) This is no small achievement, especially in the airline industry. The reason for this success, as discussed nicely by Stevenson, is in the companys basic philosophy of keeping things simple. For example, 1. The airline uses only one single type of aircraft, the Boeing 737. This introduces all kinds of cost saving s and also offers operational flexibilities (even in aircraft maintenance, crew training, etc.). 2. No seat numbers are assigned. Passengers can sit wherever they choose. 3. The bags fly free policy reduces checked bags at the gate and eliminates delays and reduces wasted time. 4. There is no hub through which flights are routed, eliminating the resulting congestions, snags, breakdowns, and hence delayed flights. A plane can be readied and turned around in as little as 25 minutes after landing. After all, an airline only makes money when its planes are flying. All of this sounded too good to be true (never had a chance to fly with them). With my ongoing interest in analyzing the financial performance of companies in the 2012 Fortune 500 list (a report on 13 companies in the 2012 list may be found at http://www.scribd.com/doc/95906902/Simple-Mathematical-Laws-GovernCorporate-Financial-Behavior-A-Brief-Compilation-of-Profits-Revenues-Data ), I decided to take a closer look at this airline. Happy Customers! Consistent Profits! Here was a real Profits Engine that I have been fantasizing about since circa 1998, when I first started studying financial data of companies, big and small, in all sectors of the economy, in many parts of the
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world. The results of my study, as we will see shortly, are counterintuitive and certainly NOT what I had expected either for Southwest Airlines.
4. Profits and Revenues Over time

The profits and revenues data for the past twenty years (1992-2011) have been compiled in Table 1. This profits and revenues data can also be used arrive at the cost, using the fundamental equation Profits = Revenues Costs. This computed cost-revenue data may be found in Table 2, see also Appendix 1 where this point is discussed clearly with reference made to the consolidated statement of operations for first quarter 2012. As seen in Figure 1, revenues have been increasing steadily year-after-year. Indeed, after a small dip between 2008 and 2009, the revenue growth seems to have accelerated since 2009.
18
16
14 12 10 8 6 4 2 0 1990 1995 2000 2005 2010 2015
Time, t [in years]

Figure 1: Revenues growth for Southwest Airlines for the last twenty years (1992-2011). The rate of increase of revenues seems to have accelerated since 2009, as seen by the increased slope.
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Unfortunately, the same cannot be said about profits growth, although the airline has reported a profit for 39 consecutive years. Profits increased steadily with increasing revenues, from 1992 to 2000 but profits have been varying erratically since then, see Figure 2. Profits declined sharply after 2000 and began to increase again between 2002 and 2007, but in a much more erratic fashion. Since 2007, profits have been decreasing although revenues have increased significantly. These trends and the profits-revenues relationships can be better understood further by the various x-y graphs presented in Figures 3 to 10.
0.7
0.6 0.5 0.4 0.3 0.2 0.1 0 1990
1995
2000
2005
2010
2015
Time, t [in years]

Figure 2: Profits growth for Southwest airlines for the period 1992-2011. Profits increased steadily with increasing revenues until 2000. Since then profits have been varying erratically with the recent three years (2009-2011) yielding very low profits compared to the historical values, with revenues having increased to record levels.
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Table 1: Profits-Revenues data for Southwest Airlines for the twenty year period (1992-2011)
Revenues, Profits, y Profit % Profits Comments x ($, bil) ($, bil) Margin, y/x 100(y/x) 2011 0.0114 15.658 0.178 Type III trend 1.14 2010 0.0379 12.104 0.459 is getting 3.79 10.350 0.099 0.0096 2009 established 0.96 11.023 0.178 0.0161 2008 Between 1.61 2007 0.0654 9.861 0.645 2007 to 2011 6.54 9.086 0.499 0.0549 2006 5.49 7.584 0.548 0.0723 2005 7.23 6.530 0.313 0.0479 2004 4.79 5.937 0.442 0.0744 2003 7.44 5.522 0.241 0.0436 2002 4.36 5.555 0.511 0.0920 2001 Highest profit 9.20 5.650 0.625 0.1106 2000 margins were 11.06 4.736 0.474 0.1001 1999 between 1998 10.01 4.164 0.433 0.1040 1998 to 2001 10.40 3.817 0.318 0.0833 1997 8.33 3.406 0.207 0.0608 1996 Type I behavior 6.08 2.873 0.183 0.0637 1995 1992-2001 6.37 2.592 0.179 0.0691 1994 6.91 All data from 2.297 0.154 0.0670 1993 6.70 Annual reports 1.803 0.097 0.0538 1992 5.38 Source: http://216.139.227.101/interactive/luv2009/ ten years 2000-2009 and also http://southwest.investorroom.com/ 2011 Annual Report; 2007-2011 Year
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5. The Profits-Revenues Linear Law

Before we proceed with our analysis and discussion, let us consider the following classical breakeven analysis for the profitability of a company making and selling N units of a product (this could be airline seats in the case of Southwest). If p is the unit price, the revenues generated R = pN. Let a denote the fixed cost and b the unit variable cost. Then the total cost C = a + bN, the sum of the fixed cost and the total variable cost. Hence, the profits P = R C = (p b)N a, or eliminating N using R = N/p, we get the relation P = [(p b)/p] R a . This implies a linear law relating revenues, say x, and profits, lets call it y. Thus, y = hx + c Linear law for profits and revenues Slope h = 1 (b/p) ... determined by unit price p and unit variable cost b. Intercept c = - a ... determined by the fixed costs of the operation. The linear law y = hx + c, implied by this classical breakeven analysis, suggests three different possibilities. Type I: Positive slope, negative intercept (h > 0 and c < 0, positive intercept on revenues-axis). Type II: Positive slope and positive intercept (h > 0 and c > 0, positive intercept on profits-axis). Type III: Negative slope, positive intercept (h < 0, c > 0, positive intercepts on both the profits and revenues axes). Examples of companies obeying these three types of linear laws have been discussed in another recent study (see Refs.[1,2] cited at the end of this article). We are observing Type I behavior here with Southwest Airlines. In the first period (before the peak profits in 2000), profits increase with increasing revenues once the revenues exceed the breakeven value of $1.154 billion (intercept made on the xaxis). Beyond this revenue level, profits increase at a fixed rate with 12.3% of the additional revenues being converted into profits. 2002 2004 2006 2007 5.522 6.530 9.086 9.861 0.241 0.313 0.499 0.645 The profits-revenues figures for the four years listed in the mini-table to the left again reveals a Type I
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relation (h > 0 and c > 0), y = 0.093x 0.273 = 0.093 (x 2.934), if we consider the extreme (x, y) values for 2002 and 2006. The slope h has decreased slightly but the cut-off, or breakeven revenue to report a profit, has increased to $2.934 billion, see the dashed line in Figure 4. This also means lower profits. The transition from one Type I behavior to another Type I behavior, with a higher intercept on the x-axis (which means higher fixed costs) and a lower slope (which means additional revenues are converted at a lower rate into profits), appears to have been the first noticeable effect of the fluctuations that started after the first peak in profits in the year 2000.
0.8
0.6
0.4
0.2
Type I behavior y = 0.123x 0.141 = 0.123 (x 1.154) 2 r = 0.936

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0
-0.2

Figure 3: The profits-revenues graph for the period 1992-2000. Profits increase with increasing revenues. The equation of the best-fit line through these points is y = hx + c = 0.123x 0.141 = 0.123 (x 1.154) with the linear regression coefficient having a very high value of r2 = 0.935. Attention should also be called to the nearly PERFECT profits-revenues graph for Apple Inc., with r2 = 0.99985, reported in the articles cited in the references; see The Perfect Apple.
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1.0
0.8
0.6 0.4 0.2 0.0 -0.2 -0.4 0 2 4 6 8 10 12 14 16 18 20
Change in the Type I behavior Lower slope means higher costs due to higher intercept on the x-axis.

Figure 4a: Profits-revenues graph with added data for the period 2002-2011. This represents the profits data in Figure 2 where we see rapid fluctuations in the profits levels. A second Type I straight line (dashed line) joining the (x, y) pairs for 2002 and 2006, with the equation y = 0.093x 0.273 = 0.093 (x 2.934) captures this trend. This was established after the first peak in profits we see in Figure 2. All of the 20-year data is considered in Figures 4 and 5 to highlight this difference between the two Type I behaviors and the increase in breakeven point, which implies increase in the fixed costs for Southwest Airlines. The fundamental significance of the intercept c in the linear law y = hx + c, or positive intercept x = x0 = -c/h when y = 0 made on the x-axis and its relationship to the idea of a breakeven revenue (x = x0 when y = 0 or revenues R = R0 when Profits P = 0) can be appreciated if we consider the profits-revenues data for the first few years of operation. This has been compiled from the annual reports from 1973, 1975 and 1978 and is discussed separately in Appendix 5. It is sufficient to note here that Southwest did report a loss (on an annual basis) in 1972 before
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reporting its first year of profits in 1973. The cover page of the 1973 Annual Report says Southwest Airlines Turned the Corner in 1973. An extract of this early profits-revenues data may be found in the mini-table after the graph.
20
15
10
-5
-10
20
40
60
80
100

Figure 4b: Profits-revenues data for the first few years of operation, obtained from 1973, 1975, and 1978 Annual Reports reveals even more clearly the significance of the intercept c and its relation to the fixed costs of operation. A loss was reported in both 1971 (partial year of operations) and in 1972, the first full year of operations. The solid blue line connects the 1971 and 1973 data (y = 0.5548x 4.934). The dashed line connects the 1974 and 1978 data (y = 0.2245x 1.194). The loss means revenues did not exceed the breakeven level. The first breakeven revenue calculated from the equation of the line connecting the 1971 and 1973 data is $8.893 million (x = x0 = - c/h = -4.934/0.555 = 8.893). The revenue for 1973 was $9.209 million. Both slope h and intercept c of the graph are clearly changing as the revenues increase and profits increase.
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Revenues, x Profits, y Costs (x y) Comments $, millions $, millions $, millions 2.129 -3.753 5.882 Data from 1971 5.994 -1.591 7.585 1973, 1975 1972 9.209 0.175 9.034 and 1978 1973 14.852 2.14 12.712 Annual 1974 22.828 3.40 19.428 Reports 1975 30.92 4.939 25.981 1976 49.047 7.545 41.502 1977 81.065 17.004 64.061 1978 Operations began on June 18, 1971. The first full year of operations was 1972. This first year data indicates a loss with a small profit in 1973. Year The slope of the straight line joining the points (x1, y1) and (x2, y2) is: h = (y2 y1)/(x2 x1). Knowing h we can determine the intercept. c = (y2 hx2) since the line passes through (x2, y2). It is also given by c = (y1 hx1) since the line passes through (x1, y1). Conversely, if h is known, the future value y2 for a future value x2 can be predicted. y2 = y1 + h(x2- x1). These simple algebraic relations are very useful for our analysis. Next, a Type III behavior is very evident when we consider the most recent data for the years 2007-2011; see also Figure 5 and the numbers in Table 1. Profits are decreasing with increasing revenues. Now, extrapolating along this Type III profits-revenues (P-R) line, if the current trend continues, we can conclude that Southwest Airlines might actually report its first ever annual loss when its revenues exceed about $18 billion or about $2.3 to $2.5 billion over the 2011 level. (This revenue level could be reached in 2012 or 2013.) This precarious profits situation with Southwest Airlines is also highlighted by the rather low values, less than 2%, of the profit margins (see Table 1) reported in recent years, with the exception of 2010. This should be compared to the profit margins in the range of 8% to 11% reported in the earlier period and with much significantly lower revenue levels. Notice that both the absolute level of profits
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($625 million) and the profit margin (11.06%) were higher in 2000 than in 2011 ($178 million and 1.14%, respectively). Essentially the above brief review of the profits-revenues situation (using the rarely used but simple tool of x-y graph in financial data analysis, and aided by the classical breakeven analysis) tells us that, notwithstanding the great many cost efficiencies arising from the keeping it simple philosophy, the costs for this airline are still too high, see Table 2. Although the company has reported a profit for 39 consecutive years, the profit levels are actually quite low, especially as a percent of revenues, see both Tables 1 and 2. Regardless of the fact that the company is operating in the airline industry, where just reporting a profit has been a major issue (see discussion of Delta Airlines in Ref. [1]), this cannot be an excuse for the low levels of profits that are being reported.
1.0
0.8
Type III behavior y = - 0.081x + 1.439 Joining 2007 and 2011
0.6
0.4
0.2
0.0
10
12
14
16
18
20

Figure 5: The profits-revenues graph for the period 2000-2011 is lacking the remarkable Type I trend revealed for the earlier period. As seen in Figure 2, and also in Table 1, profits have been fluctuating wildly and decreasing (after reaching a peak in 2007)
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even as revenues have increased. This is Type III behavior and is described by the straight line with the negative slope. Using the (x, y) values for 2007 and 2011, the equation of this Type III straight line is y = - 0.081x + 1.439.
Southwest management must therefore take a careful look at the reasons for the wild fluctuations in the profits since 2000, and the cost issues implied and address them earnestly to avoid reporting a loss in the near future. It would be very easy, yes very, very easy, to blame such a uncharacteristic and historically first loss on the recently completed acquisition of AirTran, if this prediction (made on June 14, 2012) is borne out when the next annual report is filed, or in the next couple of years at most. The profits-revenues graph for the all forty-one years of operation, from 1971-2011, has also been prepared (see Appendix 5) and reveals the same unmistakable trend. Company Profile
With 40 years of service, Southwest Airlines Co. (Southwest), a low-fare major domestic airline, continues to differentiate itself from other low-fare carriers, offering a reliable product with exemplary Customer Service. Southwest was incorporated in Texas and commenced Customer Service on June 18, 1971 with three Boeing 737 aircraft serving three Texas cities - Dallas, Houston, and San Antonio. Today, Southwest is the nation's largest carrier in terms of originating domestic passengers boarded serving 73 cities in 38 states. On May 2, 2011, Southwest completed the acquisition of AirTran Holdings, Inc., and now operates AirTran Airways as a wholly owned subsidiary. Southwest has among the lowest cost structures in the domestic airline industry, consistently offers the lowest and simplest fares, and has one of the best overall Customer Service records. LUV is our stock exchange symbol, selected to represent our home at Dallas Love Field, as well as the theme of our Employee and Customer relationships. Southwest is one of the most honored airlines in the world known for its commitment to the triple bottom line of Performance, People, and Planet. To read more about how Southwest is doing its part to be a good citizen, click on the tab above to read the Southwest Airlines 2011 One Report.
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6. The Unknown Cost-Revenue Story of Southwest Airlines

The cost of producing the sales is highlighted in different ways in the financial statements of a company. Here we will use the fundament equation of the financial world, Profits = Revenues Costs, or P = (R C) with profits always being the net income that is applied to determine the earnings per share (EPS). This also ensures that all changes in tax laws are fully accounted for when we discuss the profits-revenue or the costs-revenue relations. The costs that we will discuss now therefore are the overall or the effective costs, after all obligations have been met. Or, we can all it the computed cost to make it clear that it comes from this simple computation.
7
Costs, (x y) (or C), [$, billions]
6 5 4 3 2 1 0 0 1 2 3 4 5 6 7 8
C = 0.877 R + 0.1414 With r2 = 0.9987 1992-2001 with 2000 excluded from regression
Revenues, x (or R), [$, billions]

Figure 6: The costs C = Revenues R Profits P were deduced from the financial data compiled in Table 1 from the annual reports. Thus, Costs C = (x y). The graph of costs C versus
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revenues R is being considered here for the two time periods, before and after the peak in profits in 2000 that we see in Figure 2. Even with the wild fluctuations in profit, the costs-revenues graph is remarkably linear and seemingly unaffected by the fluctuations (this is due to low profits margins as well) and hence P as a percent of R or C is very small). Thus, the Computed Cost C = Revenues Profits = (R P) = (x y) is given in Table 2. The reason for using the twin notations C, R and P and also x and y will become obvious in a moment. Let us take a look at the data for 2011 and 2010. The revenues increased by the amount R = $3.554 billion but the profits decreased. Why? Let us determine the C for each year using C = (R P). After determining the Cs for each year, we determine the increase in the cost C = $3.835 billion. In other words C > R. This surprising trend is confirmed if we consider the (C, R) pairs for other years. Costs seem to be increasing faster than revenues and the slope of the graph of costs versus revenues, C/R, is therefore greater than unity (or 1). This is the situation with Southwest Airlines for the most recent period 2001-2011, see Figure 6. If the slope equals unity (1), then costs = revenues and there is zero profits. If the slope is less than unity, C < R, then costs do not increase as fast as revenues increase and the company will be more profitable. This was the situation with Southwest Airlines in the earlier period, 1992-2000, see Figure 7. The above calculations of the increase in costs C and the revenues R during the post-2000 and pre-2000 periods also illustrates, perhaps, the reason for the wild fluctuations in profits that we see in Figure 2. Although Southwest Airlines has reported a profit, every year, for the past 39 years, the costs are actually increases faster than revenues, especially since 2000 and this also explains the reversal in the slope of the profits-revenues graphs the change from Type I with a high slope to Type I with a slightly lower slope and then to Type III.
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Table 2: Revenues-Profits-Costs data for Southwest Airlines for the twenty year period (1992-2011)
Year Revenues, x ($, bil) 15.658 12.104 10.350 11.023 9.861 9.086 7.584 6.530 5.937 5.522 5.555 5.650 4.736 4.164 3.817 3.406 2.873 2.592 2.297 1.803 Profits, y ($, bil) 0.178 0.459 0.099 0.178 0.645 0.499 0.548 0.313 0.442 0.241 0.511 0.625 0.474 0.433 0.318 0.207 0.183 0.179 0.154 0.097 Costs, C (x y) 15.480 11.645 10.924 10.172 9.216 8.587 7.036 6.217 5.495 4.897 5.044 5.025 4.262 3.731 3.499 3.199 2.69 2.413 2.143 5.044 C Delta C (cost) 3.835 R Comments Delta R Changes are (revenue) relative 2011 3.554 C > R
2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
6.264
5.797
C > R
9.263 10.583 10.436 2.556
9.128 10.136 10.103 2.933
C > R C > R C > R C < R Between 1999 and 1992
Since y = hx + c is the profits-revenue relation, the costs-revenue relation will become C = (x y) = x hx c = (1 h)x c or C = (1- h)R + a. In other words, the slope of the C-R graph will be (1 h) where h is the slope of the P-R graph and the intercept of the C-R graph will be the negative of the intercept for the P-R graph. This is exactly what we see here. The slope is 0.877 = (1 0.123) in agreement with the slope of the graph (Type I behavior) in Figure 3. Now, we are ready to consider the 2000-2011 period in the costs-revenue space.
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1.0
Profits, y (or P), [$, billions]
0.8
0.6
0.4
0.2
A
0.0
0 2 4 6 8 10 12 14 16 18 20
Revenues, x (or R), [$, billions] Costs, (x y) (or C), [$, billions]
25
20
15
C = 1.032 R 0.698 r2 = 0.9977 C/R = 1.032 > 1
10
-5 0
B
2 4 6 8 10 12 14 16 18 20 22 24

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1.0
Profits, y (or P), [$, billions]
0.8
y = -0.032x + 0.698 Statistically significant Deduced from C-R graph
0.6
y = 0.081x + 1.439 Joining 2007-2011
0.4
0.2
C
0.0 0 2 4 6 8 10 12 14 16 18 20

Figure 7: The costs-revenues graph for the period 2000-2011. The exact same data is considered in the upper (profits-revenues) and lower parts (costs-revenues) of the graph. The profits graph reveals a large scatter(see A) but all the points line up nicely along an upward sloping straight line, see B, in the costs graph. (This is observed repeatedly in the analysis of such financial data for many companies.) The red dashed line is the costs = revenue line. Since the data fall below this line, costs are lower than revenues and the company is reporting a profit. However, and amazingly, the slope of the best-fit line is greater than 1. C = 1.0321R 0.698 with r2= 0.9977. The unmistakable conclusion is that costs are increasing at a faster than the revenues. The discussion here about the costs of Southwest Airlines also shows why although the company is reporting a profit each year, the level of profits is also going down year after year. The only trend that is obvious from profits-revenues graph is the Type III straight line for 2007-2011. The other points appear to be outliers to this striking Type III behavior. However, a statistically significant P-R
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relation can now be deduced from the extremely statistically significant C-R that we have been able to deduce (since the linear regression coefficient is r2 = 0.9977). From P = R C, we get P = R 1.0321R + 0.0698= - 0.0321R + 0.698. This means that the statistically significant P-R graph for 2001-2011 is a straight line with a negative slope h = - 0.0321 and a positive intercept of + 0.698. This is now superimposed to the profits-revenues graph (see graph C in this figure).
7. Quarterly Data and Total Operating Expenses

Let us now consider the quarterly data for years 2007-2011 (during which Type III behavior seems to been established) to see if this intriguing finding of costs increasing faster than revenues holds even if we use the quarterly time frame. Firstly, it should be noted although Southwest Airlines has reported a profit for 39 consecutive years, the same cannot be said about the quarterly profits. Southwest Airlines has reported a loss on several occasions, on a quarterly basis, but this was compensated in the other quarters to yield an overall profit for the year. In this context, we will consider both the computed cost C, as defined in the last section, and also the line item referred to as Total Operating Expenses (OE) given in the consolidated statement of operations for each quarter (and for each year). An example of this consolidated statement of operations may be found in Appendix 1. This illustrates the results reported for first quarter 2012. The OE is Item no. 2 and profits (or Net Income), which was of interest thus far, is Item no. 7. The computed cost (in Table 2) is the sum of Items 2, 4, 5, and 6 and accounts for some additional expenses not included in the Total Operating Expenses (OE). Revenues, Profits, the Total Operating Expenses and the computed Costs, for ten consecutive quarters ending March 2012, are all listed in Table 3 below. Let us first consider the overall change between the quarters ending December 2009 and March 2012. The OE increased from $2.545 billion to $3.969 billion, an increase of (OE) = $1.424 billion. Revenues, on the other hand, increased only by $1.279 billion, from $2.7 12 billion to $3.991 billion. Hence, (OE)/R > 1 and the rate of increase of the total operating expenses is greater than the rate of increase of revenues. The overall ratio (OE)/R = 1.114 > 1 from Dec 2009 to Mar 2012.
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Table 3: Quarterly Data from Southwest Airline 10-Q SEC Filings

Quarter ending Mar 2012 Dec 2011 Sep 2011 Jun 2011 Mar 2011 Dec 2010 Sep 2010 Jun 2010 Mar 2010 Dec 2009 Revenues, x $, billions 3.991 4.108 4.311 4.136 3.103 3.114 3.192 3.168 2.630 2.712 Profits, y Net Income $, billions 0.098 0.152 -0.140 0.161 0.005 0.131 0.205 0.112 0.011 0.116 Total Operating Expenses (OE) $, billions 3.969 3.961 4.086 3.929 2.989 2.898 2.837 2.805 2.576 2.545 Computed Costs (x y) 3.893 3.956 4.451 3.975 3.098 2.983 2.987 3.056 2.619 2.596
An expanded version of this Table 3 is given in Appendix 1, with all of the data from the quarters ending Sep 2006 to March 2012 We arrive at an exactly similar conclusion for C/R. Between Dec 2009 and Mar 2012, C = 1.297 and R = 1.279 and C/R = 1.297/1.279 = 1.014 > 1. The graph of increasing Total Operating Expense (OE) with increasing revenues is presented in Figure 8, along with the best-fit line deduced from linear regression. The dashed red line is the y = x line, or R = OE line, when revenues equal the Total Operating Expenses. If the data point falls below this line, the company should be reporting a profit (some Other Expenses, Item 3, see Appendix 1, still have to be accounted). If it falls above, it will most likely report a loss. However, the interesting finding here is a slope greater than unity. Both the OE-revenues and cost-revenues equations have a slope greater than unity, see Figures 8 and 9. Total Operating Expenses (y) versus Revenues x yields, y = 1.0064x -0.209 Costs (x y) versus Revenues x yields: C = 1.022 R 0.162 The costs-revenue graph has a higher slope than the OE-revenues graph and both slopes are greater t han unity if we consider the most recent period, Dec 2009 to March 2012. This confirms the rather unpleasant trend revealed of costs rising faster than revenues, from the analysis of the annual financial data.
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There is good news, however. If we consider the data for all quarters (Sep 2006 to Mar 2012, which span the years 2007-2011 over which Type III behavior was established), we find a slope less than unity. This segment of the present study is being presented in Appendix 1 for further and careful review.
Total Operating Expenses (OE) [$, billions]
7 6 5 4 3 2 1 0 -1 0 1 2 3 4 5 6 7
Quarterly Revenues, x [$, billions]
Figure 8: The quarterly values of the Total Operating Expenses (OE), our variable y, one of the line items in the consolidated statement of operations for Southwest Airlines (and all other companies as well) is plotted here as a function of the quarterly revenues, our variable x. We consider the ten consecutive quarters from Dec 2009 to Mar 2012. The best-fit line has the equation y = mx + c = 1.0064x 0.209.The slope (m = 1.0064 > 1) is greater than unity suggesting OE rising faster than revenues. The dashed red line is the graph of y = x with m = 1. Data points must fall below this line for a profit. (It can be shown, in Excel computations, that the two straight lines will indeed intersect at high x.)
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Computed Costs (x y) [$, billions]
7 6 5 4 3 2 1 0 -1 0 1 2 3 4 5 6 7
Quarterly Revenues, x [$, billions]

Figure 9: Since Profits = Revenues Costs (P = R C), we can compute a cost C = R P from the reported values of the revenues (our variable x) and the net income or profits (variable y in all earlier graphs). This cost C is now plotted versus the quarterly revenues for the quarters Dec 2009 to Mar 2012. The dashed red line is the graph of C = R. A profit is reported only when the data point falls below this dashed line. This is a firm statement, and is always true, unlike the situation with the Item called Total Operating Expenses where some Other Expenses still have to be accounted for. Again, it is of interest to note that the slope of the best-fit line is greater than unity. y = mx + c = 1.0223x 0.162. It is actually significantly greater than unity m = 1.0223 compared to the slope found for the graph of the Total Operating Expenses.
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8. Maximum point on Profits-Revenue Graph

The Type I to Type III transition (with, perhaps, an intervening Type II which we have not highlighted as being too significant) suggests that there must be a real and continuous smooth curve relating profits and revenues, with both a negative slope and a positive slope. In other words, the profits-revenues graph must have a maximum point. This is illustrated in Figure 10 by the dashed curve.
0.7 0.6
0.5
0.4 0.3 0.2 0.1 0 0 2 4 6 8 10 12 14 16 18

Figure 10: The profits-revenues data for Southwest Airlines for the 20-year period 1992-2011can be explained by invoking the Type I and the Type III behaviors, as just discussed. The dashed curve is not based on any mathematical calculations but illustrates schematically a smooth nonlinear behavior with a maximum point. Thus, the Type I, Type II, and Type III straight lines are short segments of this more general curve. Indeed, one can postulate the existence of a family of such curves, each with its own maximum point, all described by a simple mathematical equation, y = mxn [ e-ax/(1 + be-ax)]+ c.
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A parabola, described mathematically by the general equation, y = ax2 + bx + c, or (x h)2 = 2p(y k), is a familiar example of a curve with a maximum point. The trajectory of a golf ball, or a projectile, is believed to follow this ideal mathematical curve.
http://www.trajectoware.com/Screenshot.gif
Golf ball trajectories: http://www.golf-simulators.com/images/t9_1.jpg

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http://en.wikipedia.org/wiki/Laffer_curve http://www.tennessean.com/article/20120527/BUSINESS01/305270039/Economis t-Arthur-Laffer-enjoys-renewed-popularity Laffer curve: t* represents the rate of taxation at which maximum revenue is generated. This is the curve as drawn by Prof. Arthur Laffer, but in reality the curve need not be single peaked nor symmetrical at 50%. There is another famous curve, called the Laffer curve, which is believed to have led to the birth of so-called supply side economics in the late 1970s. This was embraced by President Reagan as a governing philosophy after he got elected in November 1980. This too has a maximum point, and is traditionally represented using a parabola, a symmetric curve, although this would, no doubt, be an extreme idealization for such a complex problem as the effect of tax rates on the government revenues. Then, there is the famous catenary curve. It looks like a parabola but it is not a parabola. This describes the shape taken by a heavy cable when it is suspended between two poles. Yeah, we see them hanging over our heads, every day!
A hanging chain forms a catenary. http://en.wikipedia.org/wiki/Catenary
Freely-hanging transmission lines also form catenaries.

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There is one more curve with a maximum point, Plancks blackbody radiation curve, which also describes the relics of the Big Bang radiation (see below).
http://conferences.fnal.gov/lp2003/forthepublic/cosmology/cobe_wmap.jpg http://www.learner.org/courses/physics/visual/img_lrg/CMB_spectrum.jpg
The blackbody radiation curve, or the curve for the COBE spectrum, along with the Maxwell-Boltzmann velocity distribution curve (from the kinetic theory of gases, for the distribution of molecular velocities in a gas) are the only known examples of non-symmetric theoretical curves (familiar to this author) with a maximum point. Both the Planck curve and the Maxwell-Boltzmann distribution curve can be derived using straightforward statistical arguments. Obviously, such a non-symmetric curve, with a maximum point (with some fundamental statistics based justification), should be of great interest to us now to arrive at a quantitative picture of the profits-revenue situation with Southwest Airlines and, more generally, with any company, see Figure 10.
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9. Brief Discussion
The simplest equation for a straight line is y = mx and for a curve with a changing slope it is y = mxn where n = 1 gives the straight line and n > 1 yielding a curve with increasing slope (acceleration of y) and n < 1 yield a curve with decreasing slope (deceleration of y), see Figure 11. This is called the power law and n is called the power law index. Frictional, or air, resistance (or the drag), experienced by a moving object such as a golf ball, car, truck, aircraft, or a rocket is often expressed using the power law.
3.50 3.00 2.50
y = 0.1x1.15 m = 0.1 and n = 1.15 y = 0.1x m = 0.1 and n = 1
Profits, y
2.00 1.50 1.00 0.50 0.00 0.0 5.0 10.0 15.0 20.0
y = 0.1x0.85 m = 0.1 and n = 0.85
25.0
Revenues, x
Figure 11: Simple illustration of the power-law behavior, y = mxn for the three cases, n = 1 (linear law), n >1 yielding accelerating growth of profits with increasing revenues and n <1 yielding decelerating growth of profits with increasing revenues. In all three cases, there is NO limit to the maximum revenues or profits. This situation is certainly far more desirable than the situation where a maximum point appears on the profits-revenue curve, as with the powerexponential equation. The Type I, Type II, and Type III behavior may all be thought of a small linear segment of the more general power-exponential law. The
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appearance of a maximum point and the transition to Type III behavior, are clearly not desirable. The graph of speed versus time, in road tests routinely performed to assess the performance of vehicles, can also be described by a power law. (I have confirmed this with several vehicle road test data.) The acceleration a = v/t is the slope of the graph of speed (or more correctly velocity, hence the symbol v) versus time t. Road tests show that the acceleration is not a constant but actually decreases with time (or increasing speed). This is due to the air resistance (aerodynamic drag) just mentioned and gives the nonlinear power law curve for v-t relation. Many other examples of such nonlinear laws can be cited.
8 7 6
Profits, y
5 4 3 2 1 0 0 5 10 15 20 25 30 35

Figure 12: Illustration of the three special cases of y = mxne-ax, which is the simplest form of the power-exponential law: the linear law y = 0.5x (n = 1, a = 0), the power law y = 0.6x0.67 (a = 0) and the power-exponential, y = 3x0.67e-0.125x. The maximum point occurs when x = n/a = 0.67/0.125 = 5.36. For n = 0, the law
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becomes y = me-ax and this is pure exponential behavior (example, radioactive decay). However, the linear and nonlinear laws do not reveal a maximum point. As x increases y increases, indefinitely, with only the rate of increase y/x, or dy/dx according to the calculus notation, being dictated by the exact mathematical law. One would like profits to increase as revenues increase. Even better, if profits would increase at an accelerating rate. However, as we see here with Southwest Airlines, which has reported a profit for every single year for 39 years, we do not see any acceleration in the growth of profits with increasing revenues. At best we see a linear law. This is also true if we study the data for many other companies (see discussion of Apple in Refs. [1] and [2]). There is no company that I am aware of, based on many such studies of hundreds of companies since 1998, that has consistently shown an acceleration (n > 1), for a sustained period of time, in the profits-revenue space. Should we expect to see a maximum point on the profits-revenue graph? While it is easy to speculate about this point, why would one expect to see a maximum point? This is so counter-intuitive to whole idea of always trying to maximize profits, which is just another way of saying (never mind the semantics) that we want to see profits increasing indefinitely as revenues increase all the way to INFINITY!. An infinity of revenues with an infinity of profits! Wow! Alas, over this past month (since the Facebook IPO), I find that many real world companies do show a maximum point on their profits-revenues graph. Southwest Airlines is the latest example of such a company that I have found. The others are Ford Motor Company, Verizon, Yahoo, and Kroger. Each one of these companies is seemingly profitable but each one is struggling. Perhaps, there is some as yet undiscovered natural law (of behavioral economics and finance) that is responsible for the maximum point. Also, think about the indefinite increase in profits with increasing revenues. In mathematics, we can say, and we often do, as x , y . This might be true as long as we are dealing with purely conceptual mathematical entities. Now, apply it to finance or money and we are dealing with an untenable double infinity of sorts, isnt it? How can infinite revenues yield infinite profits? Unless, of course, costs go to
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zero! May be now we have stumbled upon a simple (mathematical?) explanation for the maximum point in the profits-revenues graph. So, now, going a step further, the simplest equation for a curve with a maximum point is y = mxne-ax. This is called the power-exponential law. If a = 0, the maximum point disappears and we get the power law. If a = 0 and n = 1, we get the simple linear law or straight line. But, alas, straight lines are nice but they do not always pass through the origin. Hence, we must add the nonzero constant c to our equations. As seen here, the nonzero c in the profits-revenues graph is due to the fixed costs. The general equation for a straight line is y = hx + c. However, instead of the simpler y = mxne-ax, it is more appealing (at least intellectually speaking) to consider the slightly modified power-exponential equation y = mxn [e-ax /(1 + be-ax) ] since this is nothing more than the generalized statement of the famous equation from blackbody radiation, first derived by Max Planck in December 1900. Plancks original equation can be written as u = (82/c3) U where, and, giving, U = [ e-/kT /(1 e-/kT) ] = h u = (8h/c3) 3 [ e-/kT /(1 e-/kT) ] (1)
We do not have to understand everything about equation 1 (especially all the subtleties of the physics that led to the discovery of this law) except to note that the frequency is our variable x and the radiation energy density u is our variable y. The frequency is raised to the power 3 which is to be replaced by the general power law index n. The exponential factor within the square brackets is easily recognized. In the original Planck equation a = h/kT (where T is the temperature and k is a constant, called the Boltzmann constant). The constant m which precedes all is given by (8h/c3). In Plancks theory c is the speed of light and h is now called the Planck constant. This modified form of the power-exponential equation is preferred since we can readily derive Plancks equation using the same statistical arguments that Planck
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used in 1900 and apply it instead to the problem of profits or revenues get distributed among many different products that a company produces and sells. Thus, the power-exponential equation y = mxn [e-ax/(1 + be-ax)] + c is the simplest mathematical law relating x and y which also reveals a maximum point. The significance of this law may be understood quite simply, as follows, by considering various special cases. Linear law: For n = 1, and a = b = 0, the power-exponential law reduces to the linear law y = mx + c. Power law: For a = 0 we get the simple power law, y = Mxn, where M = m/(1+b) is a new constant that replaces m and absorbs the nonzero b in the denominator. In this case, there is NO maximum point. The derivative dy/dx = n(y/x) is nonzero for all values of x. Hence, the profits y will increase indefinitely without limit, with increasing revenues x either at an accelerating rate (for n > 1) or at a decelerating rate (for n < 1) with increasing revenues (see Figure 9, also Figures 26 and 27 in Appendix 5). For n = 0, we get pure exponential behavior (e.g. radioactive decay, charging of batteries, etc.) Power-exponential law: A maximum point appears only when a > 0, however, small. This can be appreciated by considering the simpler case of b = 0 and c = 0, for which y = mxne-ax. The derivative dy/dx = (n- ax)(y/x). Hence, there is a maximum point on the graph at x = n/a. For x < n/a the derivative dy/dx > 0 and y increases with increasing x. For x > n/a, the derivative dy/dx is negative and y decreases with increasing x. This is the type of behavior that we are witnessing with Southwest Airlines (see schematic graphs in Figures 10 and 12). This simple nonlinear Planck equation, with a maximum point, may be used to explain the appearance of the maximum point on the profits-revenues graph for Southwest Airlines. Or, one might think in terms of the Maxwell-Boltzmann type of distribution in the financial and economic world. Exactly, similar observations, regarding the maximum point, have also been made (since I began this recent study after the disappointing Facebook IPO on Friday May 18, 2012) with several companies, most notably Ford Motor Company. The Ford data reveals a maximum point, like we see here, again with a lot of scatter.
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In many ways, both Ford and Southwest Airlines are similar. They are both currently profitable and appear to be doing quite well. However, they are not able to report consistently high level of profits. There are too many wild fluctuations. The reason, as we see here, lies in the fact that, for both companies, costs seem to be increasing at a higher rate than revenues. In other words, the ratio C/R > 1. This trend must be reversed. As we see from the Southwest data, for the earlier period (1992-2001), when C/R < 1, profits were increasing with increasing revenues and the profit margins were also higher. Also, the negative (Type III) relation established since 2007 between profits and revenues is a cause for some concern. This point has been discussed in more detail in Ref. [1]. Many other companies, notably Ford, Verizon, Yahoo, and Kroger, also reveal this toxic Type III behavior. This seems to be a precursor to company reporting a continued losses even as revenues increase or, as with GM, the filing of bankruptcy after a long period spent in the Type III mode, or, as with Air Tran, becoming a target for merger/acquisition, see 15, page 89. (A discussion of the old GM financial data, from 1991 to 2008, before the bankruptcy filing in June 2009 will be presented separately.) This is what both Ford and Southwest can learn from the old GM. Type III behavior is the recipe for eventual failure and should be reversed at the earliest.
http://1.bp.blogspot.com/_R2yHiPgsajA/SsFIHuETLaI/AAAAAAAAB5k/iaFISjQ 9pK8/s400/southwest+airlines+1981.bmp
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10. Appendix 1: Southwest Airlines

Consolidated Statement of Operations First Quarter 2012 Three months ending March 2012 Three months ending March 2011 3103 954 1038 199 46 201 155 17 379 2,989 114 43 (3) (3) 59 96 18 13 5 Item No. 1 2 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 Description
Total Operating Revenues 3,991 OPERATING EXPENSES Salary, Wages, and Benefits 1,141 Fuel and Oil 1.510 Maintenance materials and repairs 272 Aircraft rentals 88 Landing fees and other rentals 254 Depreciation and amortization 201 Acquisition and integration 13 Other operating expenses 490 TOTAL Operating Expenses 3,969 3 Operating Income 22 4 OTHER EXPENSES (INCOME) 4.1 Interest Expense 40 4.2 Capitalized interest (5) 4.3 Interest income (2) 4.4 Other (gains) losses, net (170) (137) TOTAL Other (income) Expenses 5 Income Before Income Taxes 159 6 Provision for Income Taxes 61 7 Net Income (Profits in this study) 98 All numerical values here are in millions of dollars.
This is an example of the consolidated statement of operations from the 10Q SEC filings. Our interest in this study has been on Revenues, x, reported as Item no. 1 and the Net income reported as Item no. 7. It is this Net Income that has been called the Profits, y. The Total Operating Expenses (Item no. 2) plus the items 4, 5 and 6 taken together would thus represent what has been referred to as Cost (or the
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computed Cost for clarity). Of these, Item no. 2, the Total Operating Expenses is the major portion of the Cost. Hence, let us now take a look at how Item 2, which will simply be referred to as the Operating Expense (Op. Exp or OE) has varied over the last ten consecutive quarters as revenues have either increased or decreased. The data that will be analyzed is given below as Table 3.
Table 3: Quarterly Data from Southwest Airline 10-Q SEC Filings

Quarter ending Profits, y Total Operating Computed Net Income Expenses (OE) Costs $, billions $, billions (x y) 3.991 0.098 3.969 3.893 Mar 2012 4.108 0.152 3.961 3.956 Dec 2011 4.311 -0.140 4.086 4.451 Sep 2011 4.136 0.161 3.929 3.975 Jun 2011 3.103 0.005 2.989 3.098 Mar 2011 3.114 0.131 2.898 2.983 Dec 2010 3.192 0.205 2.837 2.987 Sep 2010 3.168 0.112 2.805 3.056 Jun 2010 2.630 0.011 2.576 2.619 Mar 2010 2.712 0.116 2.545 2.596 Dec 2009 2.666 -0.016 2.644 2.682 Sep 2009 2.616 0.054 2.493 2.562 Jun 2009 2.357 -0.091 2.407 2.448 Mar 2009 2.734 -0.056 2.664 2.790 Dec 2008 2.891 -0.120 2.805 3.011 Sep 2008 2.869 0.321 2.664 2.548 Jun 2008 2.530 0.034 2.442 2.496 Mar 2008 2.492 0.111 2.366 2.381 Dec 2007 2.588 0.162 2.337 2.426 Sep 2007 2.583 0.278 2.255 2.305 Jun 2007 2.198 0.093 2.114 2.105 Mar 2007 2.276 0.057 2.102 2.219 Dec 2006 2.342 0.048 2.081 2.294 Sep 2006 Notice that quarterly losses (highlighted) have been reported by Southwest Airlines but this was compensated by increased profits in the other quarters for the same year. The computed cost C = (R P) = (x y) in the last column is
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Revenues, x $, billions
always greater than The Total Operating Expenses (hereafter just OE Item no. 2 in the consolidated statements) since there are still some Other Expenses, Item no. 4, which are not accounted for in the OE. For the most recent quarters, from Dec 2009 to Mar 2012, the quarterly Operating Expenses (OE) reveal the same trend that we saw with the annualized costs. The OE is increasing faster than revenues since the linear regression reveals a slope greater than unity, see Figure 8. Also, if we compute the cost again from Cost = Revenues Profits = (x y), we again find that the slope of the cost-revenue graph is also greater than unity. The quarterly costs are also increasing faster than the quarterly revenues, see Figure 9. However, if we consider all of the data in Table 3, from Sep 2006 to Mar 2012 (the period over which we saw the establishment of the Type III trend in the annualized profits-revenues graph, Figures 3 to 7) we can derive some solace from the fact that the best-fit lines for both these graphs have a slope of less than unity. The best-fit equations are given below and the graphs have been included for completeness as Figures 13 and 14. Total Operating Expenses (OE) versus Revenues: Mar 2012 and Dec 2009: y = mx + c = 1.1134x 0.474 slope m > 1 for recent quarters, which should be cause for concern and serious study by management. Mar 2007 and Sep 2011 (highest and lowest revenues): y = 0.933x + 62.67 Best-fit equation for all quarters: y = 0.972x - 0.75 with r2 = 0.97 In all the above equations x is revenues and y is the Total Operating Expenses (OE), Item No. 2 from the consolidated statements. For recent quarters the slope is greater than unity, although when Type III has been established (with annualized data), the quarterly data seems to reveal that OE is rising at a fixed rate and is lower than the revenues (which means potential for profits, providing Other Expenses, Item 4 and Taxes do not overwhelm and lead to a loss).
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Total Operating Expenses (OE) [$, billions]
6 5 4 3 2 1 0 -1 0 1 2 3 4 5 6 7
y = 0.972x 0.075, with r2 = 0.97 Quarters Sep 2006 to Mar 2012 Covers period for Type III pattern in annualized data
Quarterly revenues, x [$, billions]

Figure 13: Total Operating Expenses (hereafter just OE), Item no. 2 in the consolidated statements given earlier, increases at a remarkably fixed rate as revenues (quarterly) increase. Data for all quarters ending Sep 2006 to Mar 2012 has been plotted here. This covers the period 2007-2011 during which the Type III behavior was established in the annualize profits-revenues graph. The best-fit equation y = mx + c = 0.972x 0.075. The slope m = 0.972 < 1 which means that OE is increased at a fixed rate with increasing revenues. It also means that less 3% of revenues is available to cover Other Expenses, Item 4, taxes, Items 5 and 6, and still report a profit, item no. 7. This trend also explains the very low profit margins that we see being reported, although Southwest has consistently reported profits on an annualized basis. Computed Costs versus Revenues Next, we consider the quarterly results and compute the costs C from the basic equation Profits = Revenues Costs, or P = R C which means C = R P. These values are to be found in the last column of Table 3. The graph again reveals a
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remarkably consistent increase in costs (just as for the OE) with increasing revenues. The best-fit line has the equation C = 0.996R 0.64 with a very high value for the correlation coefficient r2 = 0.9665 (perfect correlation r2 = +1.0).
Computed Costs C = (x y) [$, billions]
6 5 4 3 2 1 0 -1 0 1 2 3 4 5 6 7
Sep 2006 to Mar 2012 C = 0.996 R 0.64 which means P = 0.004R + 0.64
Quarterly revenues, x [$, billions]

Figure 14: Since Profits = Revenues Costs, P = R C, we can deduce costs C from the revenues (Item no. 1) and the profits, or net income (Item no. 7) reported in the consolidated statement of operations. The data for all the quarters from the quarters ending Sep 2006 to Mar 2012 is plotted here. This reveals a remarkably nice and consistent upward trend. The best-fit line through the data has the equation C = 0.996R 0.64 which means the statistically significant relation for for quarterly profits is P = 0.004 R + 0.64. The slope here is like the marginal tax rate. If revenues increase by $1 million, profits only increase by $4000, or about 0.4% conversion rate for additional revenues into profits. Hence, in addition to sustaining profitability, Southwest must also focus into efforts on improving its profit margins.
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Since P = R C, we can use the C-R equation to deduce the P-R equation and it is therefore given by P = R 0.996E + 0.64 = 0.004R + 0.64. This means that only a very small amount of the additional revenues (beyond breakeven revenues) is being converted into profits. The exact numerical value is 0.4%, less than one-half percent. This should be cause for concern for a company that is proud of its profits record, of delivering profits consistently year-after-year for 39 years. Now, let the focus be on improving this profit margin. As discussed in Refs. [1-3] there are many companies with a slope h in the profits-revenues equation in excess of 0.20. The goal should be to convert at least one-third of the additional revenues into profits. In summary, the analysis here suggests that Southwest Airlines must take steps to avoid what appears to be the inevitable reporting of an annualized loss for the first time in its history. The maximum point revealed on the profit-revenues graph should be taken very, very, seriously and the underlying reasons for this maximum must be studied and understood.
11. Appendix 2
Profits-Revenues-Costs-OE growth in a single year
Consolidated Statement of Operations First Quarter 2012
We usually look at financial data on a quarterly, or annual, basis. These are found in what is known as the 10-K and 10-Q SEC filings of all companies. There are many good reasons for doing this, one of them being the seasonal nature of revenues due to what we all do (as consumers) during any given year. And, depending on the nature of the business, there is a definitely a very marked seasonality attached to both revenues and profits. This also gives us a nice way to understand how exactly profits, revenues, costs and the Total Operating Expenses (OE) grow, literally grow each year. We will consider three-month, six-month, nine-month and the annual data for a single year and study how profits and revenues evolve. We will use two approaches.
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1. Consider the data for each quarter (ending March, June, September and December). We see significant variations between the four quarters in a single year. For example, in 2009, Southwest Airlines reported losses for the quarters ending March and September and profits for the quarters ending June and December, yielding overall profit for the whole year. For 2011, the loss in the third quarter was overcome by profits in the other three. 2. Consider the data for period ending three-months, six-months, nine-months, and twelve-months. This second approach tells us about how evolution of revenues and profits occur during a year, until the cycle is then repeated for the next year. The following min-table gives the data for 2011. Although the profits-revenues graph yields a lot of scatter (as would be expected from a look at the numbers), the costs-revenues graph reveals a nice upward sloping trend with hardly any scatter. Revenues, x TOE Profits, y Costs ( x- y) millions millions millions millions Mar 2011 3,103 2,989 5 3,098 Jun 2011 4,136 3,929 161 3,975 Sep 2011 4,311 4,086 -140 4,451 Dec 2011 4,108 3,961 152 3,956 The above table has data for three-months (one quarter) ending as indicated. Cumulative Revenues, x TOE Profits, y Costs ( x- y) values millions millions millions millions Mar 2011 3,103 2,989 5 3,098 Jun 2011 7,239 6,918 166 7,073 Sep 2011 11,550 11,004 26 11,524 Dec 2011 15,658 14,965 178 15,480 The above table has data for cumulative values for 3, 6, 9, and 12 months. The profits at the end of June 2011 were $166 million, the sum of the two quarters. The cumulative profits dropped to $26 million because of the loss in third quarter, and so on. The costs-revenues equation is C = 0.986R + 37.757. The OE-revenues graph also has a similar pattern with the equation y = mx + c = 0.954x +29.101 where x is revenues and y is the OE. All values are in millions. These equations were
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obtained by simply joining the first and fourth quarter (x, y) pairs, after confirming the linearity of the graphs. Both slopes are less than unity. Converting the cost equation to the profits equation, we get P = R C = hR + c = 0.014R 37.757. The negative intercept c = -37.757 means that once revenues exceed the breakeven value (R0 = - c/h) $2740 million, about 1.4% of the additional revenues are converted into profits.
0.6
2010 Profits, y [$, billions] Cumulative values during year
0.5
0.4
0.3
0.2
0.1
0 0 2 4 6 8 10 12 14 16
2010 Revenues, x [$, billions] Cumulative values during the year

Figure 15: The evolution of profits and revenues during a single year (2010). The straight line joining the two extreme points reveals the overall trend nicely. One could determine the best-fit equation but such a computational accuracy is not really
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necessary to understand these basics. The profits-revenues equation, y = hx + c or P = 0.0473 R 0.113. The cut-off or breakeven revenue is obtained by setting P = 0 = -c/h = 0.113/0.0473 = $2.397 billion (see intercept where profits go to zero). The data for 2010 can also be viewed in the same fashion. Only the cumulative values are given below. The costs-revenues equation is C = 0.953R +113.37 or P = 0.0473 R 113.37, see Figure 15. The break even revenue R0 = 113.37/0.0127 = $2397 million is slightly lower than for 2011 but the slope h = 0.0473 is much higher than for 2011. In other words, costs increased between 2010 and 2011, C = 0.986R + 37.757 for 2011 versus C = 0.953R +113.37 for 2010. Both the slope and the intercept increased in 2011 compared to 2010. What is the reason for these variations from year-to-year? Cumulative values Revenues, x billions TOE billions Profits, y billions Costs ( x- y) billions
0.011 Mar 2010 2.630 2.576 2.619 Jun 2010 5.798 5.381 0.123 5.686 Sep 2010 8.990 8.218 0.328 8.785 Dec 2010 12.104 11.116 0.459 11.973 The above table has cumulative data through the month ending as indicated.
Finally, let us consider now the data for the year 2000, the year of peak profits before the wild fluctuations started, see Table below and Figure 16. Cumulative Revenues, x Profits, y Costs ( x- y) values billions billions billions Mar 2000 1.428 0.121 1.307 Jun 2000 2.982 0.297 2.685 Sep 2000 4.461 0.481 3.980 Dec 2000 5.928 0.636 5.292 The above table has cumulative data through the month ending as indicated The profits-revenues equation y = hx + c = 0.114x 0.0424, determined by joining the start and end values. The slope h = (0.636 0.121)/(5.928 1.428) = 0.114 and the intercept c is then fixed from the (x, y) values at either the start or the end (since h is known, and x and y are known, c is calculated easily).
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0.8
0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 -0.1 0 1 2 3 4 5 6 7

Figure 16: The evolution of profits and revenues during a single year (2000). The straight line joining the two extreme points again reveals the overall trend nicely. Comparing this with Figure 15 for 2010, the most noticeable difference is the healthy profit for the first quarter and the smaller intercept made on the x-axis. Perhaps, this explains why the first quarter profits were higher in 2000 compared to 2010. The higher fixed costs seem to be a factor in this difference. Obviously, the finding being reported here needs more careful study, with data for many other companies and perhaps also for Southwest Airlines. With modern computers one could analyze large volumes of data in a matter of days, or hours, if not minutes. The present author took only a week (while engaged in other important personal activities) to perform all these calculations, prepare all the graphs and finish writing this entire report.
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0.8
0.6
0.4
0.2
-0.2
10
12

Figure 17: The red dashed line P = 0.0851 R 0.042, connecting the data for Mar and Sep has a higher slope compared to the blue solid line, P = 0.0695R 0.042, connecting the Mar and Dec data. The intercepts made on the revenues-axis are thus different. The data for Jun lies practically on the line joining the Mar-Dec data. Why did the slope (or the intercept) change during the year, between the various quarters? The best-fit line has an intermediate slope. The quarterly data for 2007 (when Type III seems to be initiated) also reveal the similar pattern, see table below. The slope is lower and intercept higher than 2000. Cumulative values Mar 2007 Jun 2007 Sep 2007 Dec 2007 Revenues, x billions 2.198 4.781 7.369 9.861 Profits, y billions 0.111 0.273 0.551 0.644 Costs ( x- y) billions 2.087 4.508 6.818 9.217
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The profits-revenue graph reveals a nice linear behavior. The straight line connecting the Mar and Dec (R, P) data yields P = 0.0695 R 0.042 while the Mar and Sep (R, P) data yields a higher slope, P = 0.0851R 0.076. The bestfit line through these four points has an intermediate slope, P = 0.0735R 0.05 = 0.0735 (R 0.68). The slope is lower than for 2000 and the cut-off or breakeven revenue has also increased.
1.0
0.8
0.6
0.4
0.2
0.0
-0.2 0 2 4 6 8 10 12

Figure 18: Best-fit line through the 2007 intrayear data has the slope that falls between the high and low values of the slope indicated in Figure 17. These detailed calculations are presented to illustrate that costs are increasing although Southwest prides itself as a low-cost airline. Now we have to understand what operational factors contribute to these subtleties in cost increases.
These simple calculations based on intrayear data show that there is significant change in both the slope of profits-revenue graph over the past decade and also the
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intercept, suggesting changes in both the fixed costs and the variable costs. Recall that, according to the classical breakeven analysis for profitability, the slope of the profits-revenues equation y = hx + c, is given by h = 1 (b/p) is related to the unit price p and the unit variable cost b. The intercept c = - a related to the fixed cost. The results are summarized below for convenience. P = 0.014R 37.757 = 0.014 (R 2.740) P = 0.0473 R 113.37 = 0.0473 (R 2.397) P = 0.0734R 0.05 = 0.0734 (R 0.68) P = 0.114R 0.0424 = 0.114 (R 0.371) for 2011 for 2010 for 2007 for 2000
The decreasing value of the slope h and the increasing values of R = R0 the minimum revenue to report a profit are unmistakable and quite obvious here. The visual appearance of the first data point in the 2010 graph (just above the cut off revenue level) versus the 2000 graph, the considerably lower scatter in the graph for 2000 versus 2010, and, above all, the scale of the two graphs - revenues have more than doubled between 2000 and 2010 - should all engage our attention, see also the composite plot that follows. Yet, profits in 2010 were lower than the profits in 2000, significantly lower - $459 million in 2010 and $636 million in 2000! In summary, the simple calculations presented in this Appendix reveal the dynamic nature of the changes in the operations of a company (especially the cost structure which is of interest to us), occurring from quarter-to-quarter and also year-to-year. Such intra-year variations, and inter-year variations, must be carefully studied to more fully understand the basic laws governing financial performance of various companies.
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0.80
2000
0.60
0.40
2010
0.20
0.00
-0.20
10
12
14
Figure 19: Composite plot comparing the evolution of profits during 2000 and 2010 (from the 3 months, 6 months, 9 months, and 12 month quarterly data for each year). A linear profits-revenues equation is implied by the classical breakeven analysis for profitability. If a is the fixed cost and b the unit variable cost, the total cost C = a + bN where N is the number of units offered. If p is unit price, the revenues generated from the sale of the N units is R = pN. Also, N = R/p. Hence, the profits P = R C = [1 (b/p)]R a which means the intercept c = - a and the slope h = 1 (b/p). The higher intercept made on the x-axis implies a higher fixed cost. The lower slope means a lower rate of conversion of additional revenues (beyond breakeven) into profits. Since, h = 1 (b/p), the lower slope means a higher unit variable cost b or a lower unit price p (due to competitive pressures). The inescapable conclusion from the above is that costs have gone up for Southwest Airlines during the last decade although the company prides itself on being a major low-cost domestic airline. Is this a contradiction? NO, if one understands the meanings of costs being discussed here. The good can still become better and the better can become the best!
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Summary listing of Profits-Revenues Equations

The following table summarizes the profits-revenues equations deduced, as discussed here, from the quarterly data for a single year, by considering the growth in 3 month, 6 month, 9 month, and 12 month intervals. Year Profits-revenues equation Units of x and y are indicated y = 0.133x +157.6 in 000s y = 0.151x -39.52 in 000s y = 0.22x 826.73 in 000s y = 0.121x + 230.12 in 000s y = 0.139x 1302.5 in 000s y = 0.130x - 1.088 millions y = 0.115x - 4.222 millions y = 0.101x - 4.477 millions y = 0.096x 1.80 millions y = 0.077x 5.14 millions y = 0.079x -11.036 millions y = 0.049x 18.75 millions y = 0.085x -14.965 millions y = 0.066x + 4.487 millions y = 0.0453x -6.72 millions y = 0.034x 17.85 millions y = 0.059x 8.62 millions y = 0.058x -6.86 millions y = 0.019x 17.97 millions y = 0.0713x + 0.0046 billions y = 0.075x + 0.071 billions y = 0.114x 0.0424 billions y = 0.0734 x 0.05 billions y = 0.0473 x 113.37 billions y = 0.014 x 37.57 billions Slope h Breakeven Comment R0 = - c/h $, millions Type II 0.26 M Type I 3.76 M Type I Type II 9.33 M Type I 8.35 M Type I 36.58 M Type I 44.26 M Type I 18.74 M Type I 66.65 M Type I 138.93 M Type I 375.12 M Type I 176.59 M Type I Type II 148.22 Gulf War! Made a Profit 523.83 Type I 145.84 M Type I 1993 & 1992 118.6 M reports have diff. values 919.3 M Type I Intercept c 0 Type II 371 M Type I 680 M Type I 239.7 M Type I 274 M Type I
1974 1975 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1992 1993 1994 1995 2000 2007 2010 2011
0.133 0.151 0.22 0.121 0.139 0.130 0.115 0.101 0.096 0.077 0.079 0.049 0.085 0.066 0.045 0.034 0.059 0.058 0.019 0.0713 0.075 0.114 0.073 0.047 0.014
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First quarter 1987, first quarterly loss since first quarter of 1973. http://www.chron.com/CDA/archives/archive.mpl/1987_459421/southwest-in-thered-for-first-time-since-73.html There are frequent back-and-forth transitions from Type I to Type II behavior between years. (This is like an engine running erratically and misfiring.) We also see a general trend of decreasing slope h (less of the revenues are converted into profits) and a rising value of the breakeven revenues, i.e., intercept c, along implying higher costs and lower profits.
Southwest Airlines route network maps from key focus cities. Goegraphy Lesson: Dont be misled by this map and try to find the Pacific Ocean near Tucson, Arizona. San Diego is southernmost city here in the continental USA, on the Pacific coast. Californias southern border with Mexico (the nearly horizontal stretch, east of San Diego) then begins. The Baja peninsula, part of Mexico, sticks out of southern California into the Pacific Ocean. All the other states to the east, all the way to Texas, share a border with Mexico. Hahaha for fooling me today!
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12. Appendix 3
Type II behavior and Type I to Type II transition
The following data, obtained from the Southwest Annual Report for 1995 is of interest since it reveals an interesting example of Type II behavior when we consider the intrayear data for 1995, i.e., the growth of revenues and profits during the year, reported in quarterly reports and summarized in the annual report. The annual report for 1995 also provides the data for the years 1991-1995 which also, reveals, as we will see a Type II behavior. Revenues, x Profits, y Costs ( x- y) Billions billions billions Mar 1995 0.621 0.118 0.503 Jun 1995 0.738 0.060 0.678 Sep 1995 0.765 0.067 0.698 Dec 1995 0.749 0.043 0.706 The above table has data for three-months (one quarter) ending as indicated. Cumulative Revenues, x Profits, y Costs ( x- y) Values Billions billions billions Mar 1995 0.621 0.118 0.503 Jun 1995 1.359 0.178 1.181 Sep 1995 2.124 0.245 1.879 Dec 1995 2.873 0.288 2.585 The above table has data for cumulative values for 3, 6, 9, and 12 months. The profits at the end of June 1995 were $0.118 + $0.060 = $0.178 billion, the sum of the individual values for the two quarters, and so on. Revenues, x Profits, y Costs ( x- y) Billions billions billions 1995 2.873 0.183 2.690 1994 2.592 0.179 2.413 1993 2.297 0.169 2.128 1992 1.803 0.110 1.693 1991 1.379 0.033 1.346 The above table has annualized data for each year as indicated.
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0.40
0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0

Figure 20: The cumulative profits and costs (see table) are increasing during the year. In 1995 every quarter was profitable. The profits and revenues vary from one quarter to the next. Nonetheless, the profits-revenues graph, as we see above, and also the costs-revenues reveal a nice linear behavior. The straight line, y = hx + c = 0.0756x + 0.071, or equivalently, P = 0.0756R + 0.071, joining the Mar and Dec data points makes a small positive intercept on the profits axis. This describes the data quite well. This is Type II behavior (h > 0, c > 0), as discussed in 5 of main text before analysis of the profits-revenues data was presented. (The best-fit line will have a slightly higher slope and slightly smaller intercept, since one data point, the nine-months ending data, is above this Type II line.) The intrayear 1994 data seems to reveal the verge of Type I to Type II transition. On a similar profits-revenues graph, the best-fit line through the four data points makes a very small positive intercept (h = 0.071 and c = 0.00458 > 0).
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0.35 0.30 0.25
1995
0.20 0.15 0.10 0.05 0.00 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
1994
Figure 21: The intrayear profits-revenues data for 1994 and 1995. The diamonds are the values for 1995 and the squares the values for 1994. Profits were higher in 1995 compared to 1994 for similar revenue levels. For 1994, we get y = hx + c = 0.0713x + 0.00458 and for 1995 y = 0.0756x + 0.071. The nearly zero value of the constant c implies that the company is going through the Type I to Type II transition with c < 0 (Type I), c = 0, and c > 0 (Type II). The data for the yeas 1991-1995 also shows and interesting pattern. As we see from the table, between 1991 and 1992 there is a significant increase in profits but this rate seems to have slowed down in subsequent years. One could describe this with a Type I behavior going into a Type II behavior. However, it is preferable to consider the alternative and more conservative viewpoint of an overall Type I behavior with a smaller slope. As we know (after data is already in place, with the benefit of hindsight, as they say) from the analysis of the entire 1991-2000 period, the conclusion of a Type I behavior is a much better conclusion.
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0.30
Annual Profits, y [$, billions]
0.25
0.20
0.15 0.10 0.05 0.00 -0.05 -0.10 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Annual Revenues, x [$, billions]

Figure 22: The profits-revenues data for the period 1991-1995, obtained from the 1995 Annual Report. Profits increased rapidly, as we see here, between 1991 and 1992. This was followed by a period with a slower rate of increase of profits. This can be described mathematically as a Type I to Type II transition (or by using a smooth nonlinear curve, such as the power law y = mxn + c, with the index n < 1). However, one should seek nonlinearity (or postulate linear transitions such suggested above) only after careful consideration of the alternative viewpoint of a single linear trend to describe the same data, see Figure 23.
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0.30
Annual Profits, y [$, billions]
0.25 0.20 0.15 0.10 0.05 0.00 -0.05 -0.10 -0.15 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Annual Revenues, x [$, billions]

Figure 23: The alternative viewpoint of a single Type I linear trend is to be preferred and must be considered before accepting the transition from Type I to Type II, in other words, a permanent transition to a lower profitability mode. Nonetheless, one must look for clues about such a transition and take appropriate actions to avoid a permanent lapse into a less desirable mode. The Type I to Type III transition, that seems to have occurred between 2007-2011, and discussed more fully in this article, is a case in point. Southwest management must address this issue immediately to avoid reporting a historical first annual loss in the near future and also carefully consider and review the historical patterns pointed out here. It should be noted that the 1995 Southwest Annual Report seems to be unique in providing data for all the four quarters for year 1995 (and also for 1994). This is usually not readily available in annual reports, as seen below.
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1995 ANNUAL REPORT ITEM 6. SELECTED FINANCIAL DATA (Pages 9 and 10) YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------1995 1994 1993 1992 1991 ---------------FINANCIAL DATA: (in thousands except per share amounts) Operating revenues $2,872,751 $2,591,933 $2,296,673 $1,802,979 $1,379,286 Operating expenses 2,559,220 2,275,224 ---------------2,004,700 ---------1,609,175 ---------313,531 72,611 ---------$ 109,923 ========== ---------$ 33,148 ========== 1,306,675 ----------
Operating income . . . . . . . . . . . . . . 316,709 291,973 193,804 --------------Net income (1) $182,626 $179,331 ========== ========== ---------$ 169,543 ==========
ITEM 8 : FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (Page 11) QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) ---------------------------------------------------1995 MARCH 31 -------$620,999 23,409 20,034 11,826 .08 JUNE 30 ------$738,205 103,425 100,801 59,724 .41 SEPT. 30 -------$764,975 114,098 114,215 67,717 .45 DEC. 31 ------$748,572 72,599 70,090 43,359 .29
Operating revenues Operating income
Income before income taxes Net income Net income per common and common equivalent share
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13. Appendix 4 Profits and Passengers Flown

One would expect to find a steady increase in profits as the number of passengers flown by an airline increases. Surprisingly, the data in this regard, for Southwest Airlines, shows a good bit of scatter, see http://www.swamedia.com/channels/ByCategory/pages/yearend-summary . This is summarized in Table 4.
Table 4: Profits and Passengers flown for Southwest Airlines

Year Revenue Passengers (millions) 88.191 86.301 88.529 88.713 96.3 77.694 70.9 65.674 63.046 64.447 63.678 Net Income ($, millions) Year 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 Revenue Passengers (in 000s) 108.554 308.999 543.407 759.721 1,136.32 1,539.11 2,339.52 3,528.11 5,000.09 5,976.62 6,792.93 7,965.55 9,511.00 10,697.54 12,651.24 13,637.52 Net Income ($, millions) -3.753 -1.591 0.175 2.141 3.4 4.939 7.545 17.004 16.652 28.447 34.165 34.004 40.867 49.724 47.278 50.035
2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000
459 99 178 645 499 548 313 240.969 240.969 511.147 625.224
While the number of (revenue producing) passengers did not vary significantly in recent years (from 2007 to 2010, a low of 86.3 million to a high of 88.7 million), notice the erratic variation in profits (net income), with a low of $99 million in 2009 and a high of $645 million in 2007. Compare also the profits for 2010 with
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the profits for 2008 with nearly the same number of passengers. Not surprisingly the x-y graph in Figure 24 thus reveals a lot of scatter.
Net Income (Profits), y [$, millions]
800 700 600 500
Recent years (2000-2010) y = 7.759x 248.23 = 7.759 (x 31.99)
400
300 200 100 0 0 20 40 60 80 100 120 140
Number of passengers, x [millions]

Figure 24: Net income versus number of passengers flown for the period 2000-2010. Although there is a lot of scatter, a linear trend, in agreement with data for earlier period (see 1971-1986 in Figure 25) is suggested if we consider the data selectively. The straight line connecting the data for 2002 and 2006 is shown here and has the equation y = 7.759 (x 31.99). In other words, a certain minimum number of revenue producing passengers, about 32 million, must be flown before a profit can be reported. After this breakeven level, profits increase at a fixed rate of about $7.76 per passenger. This can now be compared to the earlier period. Nonetheless, a nice linear trend is revealed, if we overlook the scatter and consider the data selectively. The same linear trend is also suggested by the data for the early years (1971-1986) which can also be obtained at the same website.
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An estimate of the (additional) profits produced per (additional) passenger can be obtained from the slope of such a graph. As we see from the Table 4, in 1971 and 1972, Southwest reported a loss. It reported its first profitable year in 1973. The number of passengers increased steadily during this period. Thus, it is clear that a certain minimum number of passengers is required (to cover the fixed costs, or the breakeven revenue discussed earlier) to report a profit. Once this minimum is exceeded, profits increase at a fixed rate per passenger. For 2000-2010 period, y = 7.756x 248.23 = 7.756 (x 31.99) where x and y are both in millions. Thus, profits increase at a fixed rate of about $7.76 per passenger once the breakeven level, about 32 million passengers is reached. This can be compared to the earlier period, 1971-1986, see Figure 25.
Net Income (Profits), y [$, millions]
70 60 50 40 30 20 10
y = 0.00415 x 0.475 = 0.00415 (x 114.54)
Early years 1971-1986

0 -10 0 4,000 8,000 12,000 16,000
Number of passengers, x [thousands]

Figure 25: Net income versus number of passengers flown for the first full sixteen years of operation (1971-1986), with 1971 being only a partial year of operation.
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A nice upward trend is observed for this earlier period. The best-fit line through the data points yields a slope of $4.15 per passenger, or about one-half the current value of nearly $8 per passenger. A number of line segments, with varying slopes and intercepts, can also be conceived for this earlier period. For these local segments, an estimate as high as $9.80 per passenger (example for the 1979 and 1981 data points, dashed line) is possible. The results here thus yield a somewhat conflicting picture and should be investigated more completely. While the per-passenger profit seems to have improved in recent years, the absolute level of profits and also the profit margins have also greatly decreased. Improved statistical models must be developed to predict profitability per passenger and also profits per unit of revenue. The latter now seems to be the more predictable of the two. ******************************************************************
New Fashion Police: Southwest Airlines

A woman was booted off a Southwest Airlines flight in Reno for wearing a T-shirt with the pictures of President Bush and Vice President Dick Cheney and the F-word. Don't they have anything better to do, like look for potential hijackers? This was poor judgment and the airline should apologize for sticking their nose where it doesn't belong. Have you ever seen the ridiculous uniforms worn by most pilots and flight attendants? They are the last people on earth who should be telling people what to wear. Above found at http://www.waynebesen.com/blog/2005_10_02_archive.html
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14. Appendix 5 Profits-Revenues for Early years

The nonlinear Power law model
Revenues, x Profits, y Costs (x y) Comments $, millions $, millions $, millions 2.129 -3.753 5.882 Data from 1971 5.994 -1.591 7.585 1973, 1975 1972 9.209 0.175 9.034 and 1978 1973 14.852 2.14 12.712 Annual 1974 22.828 3.40 19.428 Reports 1975 30.92 4.939 25.981 1976 49.047 7.545 41.502 1977 81.065 17.004 64.061 1978 Operations began on June 18, 1971. The first full year of operations was 1972. This first year data indicates a loss with a small profit in 1973. Year The slope of the straight line joining the points (x1, y1) and (x2, y2) is: h = (y2 y1)/(x2 x1). Knowing h we can determine the intercept. c = (y2 hx2) since the line passes through (x2, y2). It is also given by c = (y1 hx1) since the line passes through (x1, y1). Conversely, if h is known, the future value y2 for a future value x2 can be predicted. y2 = y1 + h(x2- x1). These simple algebraic relations are very useful for our analysis. The straight line connecting 1971 and 1973 data therefore has the equation y = 0.5548x 0.00493 = 0.555(x 0.008894) where x and y are in billions. The breakeven revenue was x0 = -c/h = $8.89 million when Southwest only had 3 aircrafts and operated between 3 cities in Texas: Dallas, San Antonio, and Houston. The first slope h = 0.555 is very high and 55.5% of additional revenues, beyond breakeven, were being converted into profits.
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Pictorial depiction of the distribution of expenses for Southwest Airlines from their 1982 Annual Report. Fuel & Oil (36.3%) and Employee Salaries and Benefits (27.7%) are the top two items. Insurance and Taxes (the focus of much political debate) only accounts for 2.1% of total expenses. In this section we will first summarize certain operational features and how Southwest Airlines has grown in the early years and then consider the profits-revenues data. For 1973, the first full year of operations with a small profits, the following data was obtained from the Annual Report. There were 10,619 flights. Still there are a number of interesting issues that affect the number of flights as noted in the 197s report. The company operated three aircrafts in its first quarter of operation (in 1971) and four aircrafts in its second quarter (in 1971). The fourth aircraft was disposed off in May 1972. Saturday operations were discontinued until November 1972. According to the 1980 annual report, the fleet size (made up of Boeing 737-200s) increased from 6 in 1976, to 10 in 1977, to 13 in 1978 to 18
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in 1979 and to 23 in 1980 and aircraft utilization increased from 9 hours and 22 mins per day in 1976 to a maximum on 11 hours 37 mins in 1979. According to the 1984 annual report, the Southwest route system covered 24 cities and 25 airports in 11 states. The trips operated in 1984 was 200,124. Aircraft utilization varied from 11 hours and 16 mins per day to 11 hours and 11 hours and 46 mins between 1980 and 1984. They had 48 owned aircraft at year end, with three new and one used aircraft being added to the fleet during the year. According to the 1986 Annual Report, the airline was operating a fleet of 46 Boeing 737-200s and 17 Boeing 737-300s. Nine more Boeing 737-300s were to be delivered in 1987. The trips operated were 262,082 in 1982 and 230,227 in 1981. This means about 4000 trips per aircraft per year or about 10 to 11 trips per aircraft per day an amazingly high number of trips for one aircraft in a single day!
From the 1984 Annual Report Now you have to believe they offer Exemplary Customer Service!
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A careful examination of the overall growth in both profits and revenues, since Southwest airlines began its operations 41 years ago, almost to the date, on June 18, 1971, reveals a clear non1inear trend, especially if we consider the data for the period 1971-1992. This is indicated by the graph prepared in Figure 26 below.
120 100
80 60 40 20 0 -20 0 200 400 600 800 1000 1200 1400 1600 1800 2000

Figure 26: A very clear nonlinear growth of profits with increasing revenues for Southwest Airlines for the period 1971-1992. Profits increase with increasing revenues but at a decreasing rate as revenues increase. In other words, the slope of the profits-revenues graph is decreasing continuously. If revenues increase by an amount x (say by $10 million), profits increase by an amount y. What is the relation between x and y? Can we predict the increase in profits? This is the whole point of discovering the fundamental mathematical laws governing the profits-revenues growth. If the ratio y/x = h, a constant, profits will always grow by exactly the same fixed amount if revenues increase by a fixed amount. The law relating profits and revenues is y = hx + c and the slope h = dy/dx = y/x is a constant. However, this linear behavior is clearly not being observed when we consider the data for the entire 1971-1992
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period. Hence, we must consider the possibility of fitting the data with a nonlinear upward rising curve.
140 120
100 80 60 40 20 0 -20 0 500 1000 1500 2000

Figure 27: The profits-revenues data for the period 1971-1992 can be described using the power-law model y = mxn + c. First we fix the power law index n = 0.66 2/3. With this choice of n, it is easily shown that the curves for m = 0.7 (lower curve, blue) and m = 0.87 (upper curve, red) bracket the entire data set. The nonzero value of c = - 5 provides the best match for the reported loss in 1971 and 1972. The value of n 2/3 is picked here since such a value of n is commonly observed in many, well understood, physical process where we observe deviations from the linear law; see text. The four year with low profits are obviously exceptional cases. The simplest such law is the power law, y = mxn + c, which was discussed earlier. The nonzero constant c is included here since at very low revenue levels, Southwest did report a loss, for both the partial year of operation in 1971 and the first full year of operation in 1972. A profit was reported only in 1973 (even first
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quarter of 1973 was a loss). Choosing n = 0.66 2/3 as the power law index, it is readily shown that the entire data set is bracketed between the curves with m = 0.7 and 0.87. The nonzero constant c = - 5 and this value is the best choice to match with the reported loss in 1972. Why n 2/3? This value of n is commonly observed in many physical processes where we see deviations from a linear law. The most common example of a liner law is Ohms law for an electrical conductor, V = RI, or Newtons law of viscosity. If the voltage V applied to a conductor increases, the current I flowing through the circuit increases proportionally. The constant of proportionality is the electrical resistance R. This is mathematically the same as y = hx + c with c = 0. However, not all electrical circuits are linear. Some also show nonlinear, or non-Ohmic, behavior. The power law (or even the power exponential law) is a simple model for such nonlinear electrical circuit. When we stir a fluid like motor oil, or water, the viscous resistance we feel does not increase as the stirring rate increases. Such a fluid is called a Newtonian fluid and its behavior is described by the law y = x where x is the shearing (stirring) rate and y the shear stress (proportional to viscous resistance). The constant of proportionality is called the viscosity . It is this law that is used to fix the viscosity values of most common liquids like motor oil, machine oil, etc. But there are more complex fluids, like paint, honey, molasses, etc. which show a varying viscous resistance as the rate of shearing is increased. Fluids with small dispersed particles (what is called two-phase mixtures, or dough or pancake mix with added ingredients) are other examples. Fluids whose viscosity varies with the shearing rate lead to what is known as shear thinning or shear thickening behavior. Stirring a paint makes it seem less viscous and this actually allows us to paint a wall. If we stop the brushing (i.e., shearing of the paint), the paint stops flowing and stays on the wall! Some other fluids show the opposite behavior and become very stiff if we stir them. The more vigorously it is stirred, the stiffer it gets. Other examples are processes such as coarsening of particles in materials science. If a system is made of very small microscopic particles, it also has a lot of energy associated with the surface of the particles. Hence, given the opportunity, the system will try to become coarse (to minimize its total energy and thus
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become more stable), with the bigger particles actually trying to absorb the smaller particles. Coarsening rates often follows a fractional nonlinear law, with n 1/3. A company like Southwest and its operations may be thought of in a similar way. Although the company has a keep it simple philosophy, as fleet sizes grow, as the number of routes increase, and as the number of cities covered increase, the operations become more complex. For example, fuel costs (one of the two top cost items) vary nonlinearly depending on the distances flown by the aircraft. Short haul flights are different from longer hauls. Other processes similar to those just described interact in complex ways. Various subunits of the organization (like the many microscopically small particles in a physical system) interact with each other in unpredictable ways. This increases the operational resistance, similar to that seen in a shear thickening or shear thinning fluid, or as in the coarsening model. These analogies from the physical and engineering sciences can be quite useful and it is obvious that the choice of n 2/3 is eminently justified. Social systems, with a complex organizational structure and hierarchy can be thought of in a similar way like many particles that interact with each other. How this interaction occurs determines the value of the index n. Simple fractions such as , , , 3/2, or whole numbers like 2 (quadratic or parabolic law) are often encountered. Of course, one could also use n = 0.5, or 0.8 or 0.85 and try to fit the data. It will soon become obvious that not all values of n are appropriate to describe the overall trend. If we consider the data for a very different company (say Apple, Google, or Facebook, see Refs. [1-3] cited in bibliography), a different value of n might apply, because of its unique culture and management philosophy. Costs have been going up for a long time now, ever since operations began in 1971 and this is reason for the changing slopes [mostly decreasing implying increasing variable costs, mathematically, h = 1 (b/p) where b is unit variable cost and p the unit price in the simple breakeven analysis] and increasing values of the intercept made on the revenues-axis (implying higher fixed costs). The nonlinearity we saw for the period 1971-1992 is further evidence of the rising costs. Composite plots for the entire 40+ years of operation are presented next to call attention to this same message.
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0.8
0.6
0.4
0.2
0.0
-0.2 0 2 4 6 8 10 12 14 16 18 20

Figure 28: The profits-revenues graph for Southwest Airlines for all 41 years, 1971-2011, for which data is available. 1971 was a partial year of operation. Every straight line on this graph, with a decreased slope, implies lower rate of conversion of revenues into profits. The dashed red line with the steepest slope highlights the initial rate of conversion of revenues to profits (y = hx + c = 0.555x 0.00493, i.e., 55% of revenues beyond breakeven was converted into profits in this period). This portion of the graph is being presented using an expanded scale, separately as Figure 29. The airlines operations then settled to a lower rate of profits generation (y = 0.142x 0.16), indicated by the reduced slope of the blue line (only about 14% of the revenues beyond breakeven are now being converted into profits). The dashed blue line, joining the 2007 (x, y) pair to the origin, has an even lower slope h = 0.065 and only about 6.5% of the revenues appeared as profits. The current trend was then established (negative slope h < 0, c > 0) with profits decreasing even as revenues have increased, i.e., a Type III behavior, with the attendant appearance of a maximum point. Southwest Airlines is now actually operating past this maximum point. (A smooth curve, with a maximum point, can be envisioned on this graph, see Figure 10).
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5.0 4.0
3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 0 2 4 6 8 10 12 14 16 18 20

Figure 29: The profits-revenues graph for the first four years, 1971, 1972, 1973, and 1974 using a zoomed in scale. Notice how the first three data points line almost perfectly on the straight line y = 0.555x 4.934 = 0.555 (x 8.894). As revenues increase profits increase (or what is the same, losses decrease). Hence, a profit is reported only when the revenues exceeded the minimum of $8.894 million. Hence, no profits were reported in 1972 when revenue was only $6 million. The revenues for 1973 increased to $9.2 million and hence Southwest was able to report a small profit. The slope h = 0.555 means that 55.5% of the additional revenues (beyond breakeven) were being converted into profits. However, this high rate of conversion of revenues to profits could not be sustained, even in 1974. Although both revenues and profits increased in 1974, the profits for 1974 were lower than the prediction based upon the extrapolation of the 1971-1973 P-R line.
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20
15
10
-5
-10 0 20 40 60 80 100

Figure 30: The data plotted here for 1971-1978 were obtained from the 1975 and 1978 Annual Reports. The solid blue line has the equation y = 0.555x 4.934 = 0.555 (x 8.893) and joins the 1971 and 1973 data. The profit y = 0 when revenues x = x0 = -c/h = 4.934/0.555 = $8.893 million. The slope h = 0.555 indicates that 55% of the revenues (beyond this breakeven level) were being converted into profits between 1971 and 1973. However, this period of high revenues to profits conversion did not last very long and the slope of the profits-revenues graph has been decreasing ever since. The highest (x, y) data here is for 1978. The dashed blue line joining the (x, y) pairs for 1974 and 1978 has the equation y = 0.224x 1.194 = 0.224 (x 5.32). This means that only 22.4% of the revenues were being converted into profits in this period. The slope h deduced here is greater than the slope of h = 0.142 (solid blue line) in Figure 28 which indicates further decrease in the rate of revenues-profits conversion. Since then a Type III behavior has been established as discussed in detail. Costs have thus been increasing but have largely escaped attention because financial data are seldom analyzed using methods such as those being described here very common in the physical and engineering sciences.
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0.06
1974-1980 1971-1973 1980-1984
0.05
0.04 0.03 0.02 0.01 0.00
-0.01 0.00
0.10
0.20
0.30
0.40
0.50
0.60

Figure 31: The data re-plotted here is for the period 1971-1984 and was obtained from the various Annual Reports. The red dashed line with the highest slope is for the initial period 1971-1973. The solid blue line connecting 1974 and 1980 data has the equation y = 0.133x + 0.00017 and essentially passes through the origin. Thus, the period 1974 to 1980 represents a much lower rate of conversion of revenues to profits. The slope h = 0.133 deduced here is consistent with h = 0.123 deduced earlier for 1992-2001[see Figure 3, best-fit equation y = 0.123x 0.141 = 0.123 (x 1.154)]. However, the data for 1980 to 1984 begins to deviate from the line with slope h = 0.133, as indicated by the blue dotted line connecting the 1980 and 1984 data. (Hence, a continuous power law curve, with n < 1, can also be used to describe the data instead of these line segments of various slopes. However, care must be exercised when making predictions using nonlinear laws, which can lead to either overly bearish or bullish predictions. The linear law is more reliable when making short term extrapolations when a fixed rate seems to be observed. Nonlinear law should be used only after a thorough understanding of the systems behavior.)
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The forty-one year profits-revenue history for Southwest Airlines

The first twenty years (1971-1990)
Revenues, x Profits, y Comments $, billions $, billions 1971 0.0021 -0.0037 1972 0.006 -0.0016 1973 0.0092 0.0002 First profit 1974 0.0149 0.0021 1975 0.0228 0.0034 1976 0.0309 0.0049 1977 0.0490 0.0075 1978 0.0811 0.0170 1979 0.1361 0.0167 1980 0.2130 0.0284 1981 0.2704 0.0342 1982 0.3312 0.0340 1983 0.4482 0.0409 1984 0.5359 0.0497 1985 0.6797 0.0473 1986 0.7688 0.0500 1987 0.7783 0.0202 1988 0.8604 0.0580 1989 0.9736 0.0745 1990 1.1868 0.0471 $1 billion Revenues 1991 1.3793 0.0370 1991 1.3136 0.0269 The data for 1992-2011 (and first quarter 2012) have been presented in Table 1 of the main text. Most of the data was obtained from the annual reports. Sometimes discrepancies were noticed, especially with revenues between various reports. Both values are included in such instances. The following values were obtained from the ten-year summary in the 1993 Annual Report and show slight discrepancies with earlier reports.
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Year
From 1993 Annual Report: Ten-year Summary

Year 1984 1985 1986 1987 1988 1989 1990 1991 1991 Revenues, x $, millions 519.106 656.689 742.287 751.649 828.343 973.568 1144.421 1267.897 519.106 Profits, y $, millions 49.724 47.278 50.035 20.155 57.952 74.505 50.605 33.148 49.724 Comments
$1 billion Revenues
From the 1974 Annual Report SWA began its operations between just three Texas cities. Service to Rio Grande Valley was added on February 11, 1975. Now Southwest flies to 73 cities in 38 states.
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What a difference a decade makes (see page 77)
From the 1974 Annual Report Those were the days!!! Somewhere in the skies over Texas With lots of LUV in the air!
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15. Now, a word about AirTran!

Since the AirTran acquisition will play a major role in the future of Southwest Airlines, lets take a quick look at the AirTran 10-year profits-revenues data. The results are presented here without much discussion, with the x-y graphs telling the story for us. First, consider the following data from the 2010 Annual Report. Year 2010 2009 2008 2007 Revenues, x $, millions 2619.712 2341.442 2552.478 2309.983 Profits, y $, millions 38.543 134.662 -266.334 52.683 Costs (x y) $, millions 2581.169 2206.78 2818.812 2257.3
200 150
100 50 0 -50 -100 -150 -200 -250 -300 2250 2300 2350 2400 2450 2500 2550 2600 2650

Figure 32: AirTran profits-revenues graph for 2007-2010 showing an interesting criss-crossing Type III behavior (or a back and forth Air Tran swooshing). The
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horizontal red line is the x-axis. One expects profits to increase with increasing revenues. This is the normal Type I behavior (positive intercept on revenues-axis) or Type II behavior (positive intercept on the profits-axis) But, we also see the opposite behavior with several companies, at least in some situations. If profits decrease with increasing revenues, or increase with decreasing revenues (yes, it is possible!), we have Type III behavior. This is what we see here with Air Tran. We see a very interesting pattern in the time-evolution of profits and revenues. This can be described by three straight line segments all with a negative slope. For 2007 and 2008: For 2008 and 2009: For 2009 and 2010: y = -1.315x + 3092 y = -1.315x + 3092 y = -0.345x + 943.43
The revenues increased between 2007 and 2008 but the profits decreased so much that AirTran actually reported a huge loss! This is what was classified as Type III behavior and is indicated by the line with the negative slope (h < 0, c > 0). Using the formulas given earlier, for the equation of a straight line connecting any two points, we get y = -1.315x + 3092. The arrow shows the direction of time. Next, revenues decreased between 2008 and 2009 but now AirTran reported a nice profit. The dashed line, with the negative slope, indicates this and takes us to the point above the red line. This is an interesting variant of the Type III behavior, with profits increasing with decreasing revenues. (This is observed with other companies as well, see Yahoo discussed in Refs. [1-3].) The equation for the new Type III line is y = -1.315x + 3092. Next, revenues increased between 2009 and 2010 but profits decreased once again but a loss was avoided. This too is Type III behavior, similar to that observed between 2007 and 2008. The equation of this line is y = -0.345x + 943.43. If we consider the data for prior years, the ten-year period 2001-2010, and prepare a x-y graph, no real pattern is detected. The data is given in the table below. A successful company must report a profit. AirTran has reported a profit for 8 out of 10 years, with a small loss in 2001 and a much bigger loss in 2008. But look at the profits-revenues graph. It is totally chaotic. The behavior is like that of an
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engine that works erratically each time you turn it on. It does not run smoothly and misfires and so the ride is jerky! This seems to be the way some companies are behaving today. In other words, the Profits Engine is not running smoothly. Year 2006 2005 2004 2004 2002 2001
200 150
Revenues, x $, millions 1892.083 1450.544 1041.422 918.04 733.37 665.164
Profits, y $, millions 14.714 1.722 12.255 100.517 10.745 -2.757
Costs (x y) $, millions 1877.369 1448.822 1029.167 817.523 722.625 667.921
100 50 0 -50 -100 -150 -200 -250 -300 0 500 1000 1500 2000 2500 3000

Figure 33: Erratic profits-revenue graph for AirTran for the period 2001-2010. The situation is like that of the old steam engines before James Watt started studying the reasons for their erratic behavior. During his investigations, on the old Newcomen engine (which was made available to the young James Watt for study,
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by the University of Glasgow; Watt had just finished his education and was looking things to do to launch his professional career and earn a living), Watt learned about a remarkable property of steam called its latent heat (Professor Black, from what we would now call their physics department, had also been studying the properties of steam). Armed with this knowledge, Watt built a steam condenser and essentially started recycling the exhaust steam back which dramatically reduced the consumption of coal. He also reduced heat losses by improving the insulation used. These scientific studies on the steam engine led to dramatic improvements in efficiency (it was more than doubled) and led to what we now call the Industrial Revolution. Alas, many companies today seem to be behaving like the old Newcomen engine before Watt. The AirTran profits-revenues graph seems like a perfect example.
3500 3000 2500 2000 1500 1000 500 0 -500 0 500 1000 1500 2000 2500 3000 3500
Costs, (x y), [$, millions]

Figure 34: The costs-revenues graph for AirTran prepared using the profits and revenues data from the Annual Reports. The straight line connecting the 2003 and 2010 data has the equation C = 1.0364 R 133.952. The descriptive symbols are
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used here for clarity instead of x and C = (x y). But, they are retained in the axis labels to show the relationship with the profits-revenues graph.
3500
Costs, (x y), [$, millions]
3000 2500 2000 1500 1000 500 0 -500 0 500 1000 1500 2000 2500 3000 3500

Figure 35: The AirTran costs-revenues graph with the best-fit equation C = 1.10292 57.98. The linear regression coefficient r2 = 0.9834 is very high, indicating a high degree of confidence in the important conclusion here that the slope of the graph dC/dR > 1. In other words, costs are increasing faster than revenues and so the companys profits vary erratically. The situation, however, changes dramatically if we consider the costs in the last column, determined using the simple equation which is universally applicable to all companies: Profits = Revenues - Costs or C = (x y). We will also use the descriptive notation R, P and C in this context to minimize confusion. The C-R graph shows a remarkably linear relationship. As revenues increase, costs also increase, even if we find that profits are varying erratically and there is no pattern. (A nice linear P-R relation, as we saw in the early years with Southwest, Figure 3,
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To use a sports analogy, this is like keeping golf scores. A player is allowed a certain number of strokes, say y, to play a hole. This is called par for the hole. A good player may take fewer strokes (a birdie, - 1, or eagle - 2, or rarely a double eagle -3). Or, the player can take extra strokes (bogey, +1, double bogey +2, triple bogey +3, quadrupule bogey, +4). Birdies and bogeys arrive erratically and the scores kept in this way go from positive (too many bogeys) to negative (lots of birdies). But, the total cumulative strokes y will always increases as the total holes played x increases. This law cannot be violated. The law is y = hx + c. We can test this law with several world class golfers and arrive at the values of h and c for them. (Or use hypothetical scores.) We are doing the same here. Profits and losses are like keeping scores above and below par. But, costs will always go up as revenues increase, regardless of profits or losses. This too is an inviolable law.
is the ideal situation; see also P-R graphs for Apple discussed in the articles cited. Even if P-R graph is a scatter, the C-R relation is often linear, as we see here.) Notice that the slope of the straight line joining the (C, R) data for 2003 and 2010 is greater than 1. The revenues increased by R = (2619.712 918.04) = 1701.672 but C = 1763.646. Thus, C > R, as we also saw earlier with the Southwest data in the post 2007 period. This means that for AirTran, costs have been increasing faster than revenues. To test if this is a fluke, arising from the specific choice of the data points, a linear regression analysis was performed to determine the equation of the best-fit line through these 10 points. This is given below and is now included in the new graph prepared in Figure 35. C = 1.0292 57.98 with r2 = 0.9834 With the high value for the linear regression coefficient, it is clear that the statistically significant value of the slope of the graph is also greater than 1. The best-fit line does not go exactly through the points we picked but is very close to them. The slope dC/dR = 1.0292 > 1, as we learned in our elementary calculus. The following alternative view is possible if we ignore the loss in 2008.
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180 160
140
120 100 80 60 40 20 0
-20
-40
500
1000
1500
2000
2500
3000
3500

Figure 36: An alternative view of the AirTran profits-revenues graph, if we completely ignore the 2008 data. Now the profits data can be described by two straight lines. The red line, with the equation y = hx + c = 0.024x + 78.5 simply joins the 2003 and 2009 data. This is Type II behavior (h > 0, c > 0). Profits increase with increasing revenues but usually at a lower rate than a Type I behavior (h > 0, c < 0). The blue line is the best-fit line through the remaining data points, with the equation y = 0.0214x 14.48 = 0.0214 (x 676.2). This is clearly a Type I behavior. The line makes a positive intercept of x = x0 = -c/h = 14.48/0.0214 = $676.2 million on the revenues-axis. The data for 2001 confirms this cut off since AirTran had a small loss with revenues of $665.164 million. Beyond this cut-off, or breakeven, revenues, AirTran was able to report a small profits (much less than with the Type II situation, the difference being the large positive intercept). The situation we see here with AirTran is thus unusual. There is clear evidence of costs increasing faster than revenues, if we include all the profits and losses data. If
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we analyze it more selectively, AirTran seems to exhibit both Type I and Type II behavior in overlapping periods. The slope h is roughly the same for both --- the Type I and Type II lines seem to be roughly parallel in our graph. But, the situation including the huge loss, with dC/dR > 1, suggests a Type III behavior (see below).
200 150
100 50 0 -50 -100 -150 -200 -250 -300 0 500 1000 1500 2000 2500 3000

Figure 37: The profits-revenues graph for AirTran for the sixteen year (16) period 1995-2010. Air Tran reported a profit for only 2 out of the 6 additional years (in 2000 and 1995). All data are taken from the Annual Reports. The graph of costs versus revenues, where Costs = Revenues Profits = (x y), again shows a nice linearity with very little scatter. However, the slope of the best-fit line is now slightly less than one. The C-R equation is C = 0.997R+ 7.53 = kR + A, with a linear regression coefficient r2 = 0.9885. A very small positive intercept (A = 7.53) is made on the cost-axis (when R = 0, C = 7.53) and so the best-fit C-R line essentially passes through the origin. Costs increase with increasing revenues. Since the linear regression coefficient is so high, this is a statistically significant result. Using the C-R equation, we can deduce the profits-revenues equation from P = R C which yields P = 0.003R 7.53 = hR + c, with a very small positive
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slope h = 0.003. In other words, only 0.3% of the revenues can be converted into profits. Or, 99.7% of revenues are being absorbed as costs and very little appears as profits. The analogy with Einsteins work function from the photoelectric law (discussed in the references cited) is very telling in this case. Also, intriguing is the possibility of a maximum point, as suggested by the dashed curves (NOT derived from any mathematical calculations). The four points along the curve past the maximum are for 2007-2010 which led to the criss-crossing Type III behavior discussed earlier.
200 150
100 50 0 -50 -100 -150 -200 -250 -300 0 500 1000 1500 2000 2500 3000

Figure 38: Possible appearance of a maximum point on the profits-revenues graph for AirTran. Perhaps, this was precursor to the acquisition of Air Tran. A company cannot continue to operate for long in the Type III mode with profits decreasing as revenues increase, or vice versa. (In the case of General Motors, where a similar Type III mode was observed over several years, it eventually led to its historic bankruptcy filing in June 2009.) Notice how different conclusions are permitted by the 10-year data and the 16-year data. The falling part of the curve can be envisioned with the 10-year data but the rising part is only revealed if we
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consider the 16-year data. Type III behavior is always preceded by Type I and/or Type II. A rise precedes every fall. Hence, the Type III behavior usually suggests the existence of a maximum point on the profits-revenues graph. In summary, the profits-revenues and costs-revenues pattern for AirTran, in the ten-year period immediately preceding its acquisition by Southwest, reveals interesting challenges ahead for the new company. The following is from the 2011 Southwest Annual Report. The issuance of the SOC means there is only ONE company now, legally speaking, even if the rest of the integration is not complete.
Since the AirTran acquisition on May 2, 2011, we have made tremendous progress on integrating it into Southwest Airlines. Our efforts to begin optimizing the combined network have resulted in significant changes to AirTrans route network. In 2012, AirTran is closing 15 cities that proved unsustainable with todays dramatically higher fuel prices. We will serve 97 cities total between our separate networks based on our joint schedules currently published through November. On March 1, 2012, we received approval from the Federal Aviation Administration (FAA) for a Single Operating Certificate (SOC), marking a key milestone in the integration of the two airlines. AirTran can now begin transferring aircraft to be converted to the Southwest livery, and we can begin transitioning AirTran airport facilities to Southwest, beginning with Seattle in August 2012.
http://www.airtran.com/common/pdf/SpreadingLowFares_FactSheet.pdf
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http://www.getfilings.com/o0000931763-98-000779.html
Airline Stock Symbol Founded Headquarters Employees Fleet (Active, as of Sep 27, 2010)
Southwest LUV June 18,1971 Dallas, Texas 34,636 547
Air Tran AAI Oct 26, 1993 Orlando, Florida 8,083 138
For completeness, the following is a summary of the profits-revenues data for AirTran since its operations began in 1993. Revenues, x Profits, y Costs (x y) $, millions $, millions $, millions 624.094 47.436 576.658 2000 523.468 -99.394 622.862 1999 439.307 -40.738 480.045 1998 211.456 -96.663 308.119 1997 219.636 -41.469 261.105 1996 367.757 67.763 299.994 1995 133.901 20.732 113.169 1994 5.811 -0.894 6.705 1993 The data for 2001-2010 has been presented earlier. The merger with Southwest was approved overwhelmingly by shareholders on March 23, 2011. http://travel.usatoday.com/flights/post/2011/03/airtran-shareholders-ok-southwestmerger/148989/1 Year On May 11, 1996, the (predecessor) company (ValuJet Airlines) tragically lost Flight 592, from Miami to Atlanta. The plane crashed shortly after take-off after a cabin fire. http://en.wikipedia.org/wiki/ValuJet_Flight_592 . There were no survivors. The ensuing adverse media coverage (about low cost airlines), and the intense FAA scrutiny that followed, led to a total shutdown of all operations on June 17, 1996. FAA returned the companys operating certificate on Aug 29. The DOT issued a show cause order about the fitness to be an air carrier and gave its
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final approval on Sep 26, 1996. Operations then resumed on Sep 30 with flights between Atlanta and four other cities. These tragic events explain the sudden loss of revenues in 1996 and also the losses. But, this seems to have lingered (through 1999???). Profitability was finally achieved only in 2000.
600
500
400 300 200 100 0 -100 -200 -300 -400 0
Type I behavior 1993-1995 y = 0.189x 1.996 = 0.1897 (x 10.52)
500
1000
1500
2000
2500
3000

Figure 39: Air Tran data reveals a Type I behavior between 1993 and 1995, as indicated by the solid blue line. The profits-revenue equation y = 0.1897x 1.996 = 0.1897 (x 10.52). The reader (assuming we have one!!!) is strongly urged to deduce this equation using the data presented in the tables here. Only then will its impact be truly felt! Ideally, every point we see here should fall on this Type I line.
It can be shown that the sum of all the deviations from the profits predicted by the initial Type I line equals $3.624 billion (see tables given here for 1993-2010). The sum of all the revenues equals $19.05 billion. Multiply $19 B by 20%, for a quick calculation. We get $3.8 B. Or, use the exact slope and convert 18.9% of $19.05 B. We get $3.61 B. Add that small intercept. We get $3.624 billion the sum of all the profits NOT made. Case CLOSED for this type of an analysis!
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From 1993-2010
Sum Total of Revenues $19,049.67 million $19.05 billion Profits ($6.477) millions
Nonetheless, the availability of this historical data, since Air Tran began its operations in 1993, permits us to draw an interesting, but cautionary, conclusion about the growth and evolution of companies. As with Southwest Airlines, between 1971 and 1974, we see revenues increasing between 1993 and 1995. Unlike Southwest, which reported a loss in 1972, its first full year of operation (it only turned the corner in 1973 and reported a full year of profits), Air Tran turned the corner in its first full year of operations in 1994 and reported a profit. Both profits and revenues increased in 1995. This was followed by four continuous years of losses with profits returning only in 2000. But the profits were lower: only $47.44 million versus $116.4
million obtained by extrapolation! If Air Tran had continued to follow this initial profits-revenues line, in 2003, when it reported a profit, it would have reported $172 million instead of $100 million. This shows that something went seriously wrong (was it the accident in May 1996?) with the initial very successful plans and costs started increasing after 1995 and went totally out of control. And, instead of reporting a historically high profit of about $436 million in 2007, Air Tran reported a profit of only $52.7 million. And, instead of a profit of $482 million in 2008, it reported its highest loss of about $266 million. The potential for high profits, even in the airlines business, stares us in the face here! This can also be appreciated if we consider how profits evolve with increasing revenues during a single year. The following tables summarize the data (from the various annual reports) for 3 month, 6 month, 9 month, and 12 month periods for1995, 2003, 2009 and 2010. Comparing the cumulative profits and revenues for 1995 and 2003 and also 1995 and 2010 it is quite obvious that
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1. The fixed costs have been rising from 1995 to 2003 to 2010, as indicated by the increasingly more positive values of the breakeven revenue, given by the intercept made on the revenues-axis. 2. The rate at which additional revenues (beyond the breakeven) are being converted into profits has also decreased. This is indicated by the decreasing values of the slope h of the graphs. It was 19% in 1995 (h = 0.1911), decreased to 13.8% in 2003 (h = 0.1387) and had reduced to just 2.5% in 2010 (h = 0.0251). Now all of this is water down the bridge! Yes, the potential for high profits, even in the airlines business, stares us in the right in the face here! Just imagine converting about 18% or 20%, okay lets do just 10%, of additional revenues beyond breakeven into profits! Air Tran did it in 1994 and 1995. It can be done again in 2014 and 2015. Wow!
Lets do it with a Swoosh!
Air Tran Quarterly data: Profits-revenues growth during a single year Quarter Revenues, Profits, Cum. Rev, Cum Profit, quarterly quarterly x y $, millions $, millions $, millions $, millions 605.141 -12.025 605.141 -12.025 1Q2010 700.557 12.380 1305.698 0.355 2Q2010 667.934 36.263 1973.632 36.618 3Q2010 645.540 1.925 2619.172 38.543 4Q2010 All slopes h obtained from the lowest and highest (x, y) pairs. 541.955 28.707 541.955 28.707 1Q2009 603.653 78.438 1145.608 107.145 2Q2009 597.402 10.426 1743.01 117.571 3Q2009 598.432 17.091 2341.442 134.662 4Q2009 Graphs were prepared in all cases, even if not included here. 208.002 2.036 208.002 2.036 1Q2003 233.901 57.191 441.903 59.227 2Q2003 237.311 19.613 679.214 78.84 3Q2003 238.826 21.677 918.04 100.517 4Q2003 P-R equation For growth in the year h = 0.0251 c = -27.22 y = hx + c x0 = - c/h = 1084.1 h = 0.0589 c = -3.204 y = hx + c x0 = - c/h = 54.41 h = 0.1387 c = -26.81 y = hx + c x0 = - c/h = 193.32
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Air Tran Quarterly data: Profits-revenues growth during a single year Quarter Revenues, Profits, Cum. Rev, Cum Profit, quarterly quarterly x y $, millions $, millions $, millions $, millions 60.747 9.071 60.747 9.071 1Q1995 86.913 16.860 147.66 25.931 2Q1995 109.296 22.661 256.956 48.592 3Q1995 110.801 19.171 367.757 67.763 4Q1995 Slope h from the lowest and highest (x, y) pairs P-R equation For growth in the year h = 0.1912 c = -2.542 y = hx + c x0 = - c/h = 13.298
Cumulative Profits, y [$, millions] Growth during a single year
700 600 500 400 300 200 100
y = 0.1912x 2.54 = 0.1912 (x 13.3) x0 = 13.3 in 1995 and h = 0.19
y = 0.025x 27.2 = 0.025 (x 1084) x0 = 1084 in 2010 (higher fixed cost) and h = 0.025 (lower slope means higher unit variable cost)
0
-100 0 500 1000 1500 2000 2500 3000 3500
Cumulative Revenues, x [$, millions] Growth during a single year

Figure 40: Comparison of the evolution of profits and revenues in a single year at three-month, six-month, nine-month, and 12-month intervals, using the quarterly data. The revenues for just the first quarter of 2010 was almost double the revenue for the entire year in 1995. Yet, profits were lower in 2010. Firstly, notice the large intercept made on the revenues axis in 2010 compared to 1995. This means (using
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the breakeven analysis for profitability of a company making and selling N units of a single product) that the fixed costs have gone up between 1995 and 2010. Secondly, the high slope for 1995 is higher. Nearly 20% of the revenues (beyond breakeven value) were being converted into profits in 1995 but only about 2.5% was being converted into profits in 2010. According to the breakeven model the slope h = 1 (b/p), see 5 in main text (page 22). Hence, the unit variable cost b has increased between 1995 and 2010, or more correctly, the ratio b/p, where p is the unit price, has increased. It is to be hoped that Air Tran and Southwest can still benefit from these findings! 1995 extrapolation equals $498 M profits in 2010.
0 500 1000 1500 2000 2500 3000
50 0
-50
-100 -150 -200 -250 -300 -350
y =-0.122x + 38.07 Solid line y = -0.178x + 182.01 Dashed line 2008 Evolution of revenues-losses
Figure 41: A very unique Air Tran Type III profits-revenues graph, which lies entirely in the fourth quadrant, with losses reported for every single quarter during the year, in 2008. The cumulative quarterly loss was -$273.83 million (slight discrepancy with the annual value given, -$266.33 million). The solid line joins the
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cumulative values for first and fourth quarters but the Type III dashed line begs attention. This joins the second quarter to the fourth quarter. The general trend is what is important here, not the exact numerical values. Type III behavior we see here seems to be the precursor for either a merger (if someone is interested) or a bankruptcy filing (when no suitors are available, as with General Motors. When GM publicly announced its willingness to sell off some of its money losing foundries, back in 1990s, which produce many critical automotive castings there were no buyers! The latter is based on recollection of published reports during that time.)This should be compared to the graph for 1995 when Air Tran was able to report profits with very small revenues. The annual revenue for 1995 was only $367.757 million, between 50% to 60% of the revenue for any one quarter in 2008. Still, Air Tran could not report a profit in 2008.
200
1995
100
-100
1996
-200
2008
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1997
-400 0 500 1000 1500 2000 2500 3000

Figure 42: The profitable year 1995, with Type I behavior revealed by the solid upward sloping line, is compared with the Type III behavior observed in 1996,
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1997, and 2008 with annual losses. Even with greatly increased revenues, as revealed by the fact that the data for 1995-1997 are crowded together near the origin, Air Tran was unable to report a profit in 2008. (The Type III line for 1997 is an interesting financial example of a line with a negative slope which makes a negative intercept on BOTH the profits and the revenues axes. Most Type III lines make a positive intercept on both the axes. ) Instead of profits indicated by the extrapolation of the Type I line for 1995, it reported its highest losses, revealed by the two Type III lines for 2008. In other words, the quadrant four graph is to be wholly avoided when we consider the cumulative data (from quarterly reports) in a single year. It may be the precursor to either bankruptcy filing (if no one want to take over the company) or a merger with a willing suitor.
Air Tran Quarterly data: Profits-revenues growth during a single year Quarter Revenues, Profits, Cum. Rev, Cum Profit, quarterly quarterly x y $, millions $, millions $, millions $, millions 589.115 -34.813 596.391 -34.813 1Q2008 589.115 -13.538 1289.771 -48.351 2Q2008 589.115 -107.087 1963.063 -155.438 3Q2008 589.115 -118.391 2552.178 -273.829 4Q2008 Slope h from the lowest and highest (x, y) pairs In this case the 2Q and 4Q data beg attention, h = -0.179 P-R equation For growth in the year h = -0.122 c = 38.97 y = hx + c x0 = - c/h = 311.5
How could I say all this without that a x-y graph?

If anyone is reading this, please go back now and enjoy the story told by each of these graphs!
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If anyone is reading this, please go back now and enjoy the story told by each of these graphs!
Illustration of DC-9 ValuJet, Flight 592. The plane was observed crashing. It crashed on a lovely Saturday afternoon, the day before Mothers day. The improper placement and loading of canisters with chemicals (that are used to produce Oxygen for the Emergency System), in the cargo compartment below the passenger cabin, http://en.wikipedia.org/wiki/ValuJet_Flight_592 seems to have contributed to the spark that led to the fire and the crash.
Sadly, this is, perhaps, the clearest example of incompetent and/or ignorant employees, working without proper training or supervision, doing what they think is best! They just did not know how stupid it was to do what they did! The loss of the space shuttle Challenger, on January 28 1986, seconds after launch, is another example of a similar tragedy that could have been avoided.
It is really the story of what we all do each day, as employees, to make the company we work for profitable, to enrich our own lives, and to enrich the communities we live in. Lurking behind each of our actions is that demon called the costs. And before we know it h > 0 turns into h < 0 And the day of reckoning arrives! It happened between 1993 and 2011!
http://psiresearcher.files.wordpress.com/2011/09/flighteverglades-plane-crash2_05320299.jpg?w=640 http://www.theatlantic.com/magazine/archive/1998/03/the-lessons-of-valujet592/6534/ Time to get over that fateful 1996 crash!
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16. Bibliography
Related Internet articles posted at this website Since the Facebook IPO on May 18, 2012
1. http://www.scribd.com/doc/95906902/Simple-Mathematical-Laws-GovernCorporate-Financial-Behavior-A-Brief-Compilation-of-Profits-RevenuesData Current article with all others above cited for completeness, Published June 4, 2012 with several revisions incorporating more examples. 2. http://www.scribd.com/doc/94647467/Three-Types-of-Companies-FromQuantum-Physics-to-Economics Basic discussion of three types of companies, Published May 24, 2012. Examples of Google, Facebook, ExxonMobil, Best Buy, Ford, Universal Insurance Holdings 3. http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-it-can-bedestroyed Detailed discussion of Apple Inc. data. Published June 7, 2012. 4. http://www.scribd.com/doc/95140101/Ford-Motor-Company-Data-RevealsMount-Profit Ford Motor Company graph illustrating pronounced maximum point, Published May 29, 2012. 5. http://www.scribd.com/doc/95329905/Planck-s-Blackbody-Radiation-LawRederived-for-more-General-Case Generalization of Plancks law, Published May 30, 2012. 6. http://www.scribd.com/doc/94325593/The-Future-of-Facebook-I Facebook and Google data are compared here. Published May 21, 2012. 7. http://www.scribd.com/doc/94103265/The-FaceBook-Future Published May 19, 2012 (the day after IPO launch on Friday May 18, 2012). 8. http://www.scribd.com/doc/95728457/What-is-Entropy Discussion of the meaning of entropy (using example given by Boltzmann in 1877, later also used by Planck to develop quantum physics in 1900). The example here shows the concepts of entropy S and energy U (and the derivative T = dU/dS) can be extended beyond physics with energy = money, or any property of interest. Published June 3, 2012. 9. The Future of Southwest Airlines, Completed June 14, 2012 (to be published).
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About the author V. Laxmanan, Sc. D.

The author obtained his Bachelors degree (B. E.) in Mechanical Engineering from the University of Poona and his Masters degree (M. E.), also in Mechanical Engineering, from the Indian Institute of Science, Bangalore, followed by a Masters (S. M.) and Doctoral (Sc. D.) degrees in Materials Engineering from the Massachusetts Institute of Technology, Cambridge, MA, USA. He then spent his entire professional career at leading US research institutions (MIT, Allied Chemical Corporate R & D, now part of Honeywell, NASA, Case Western Reserve University (CWRU), and General Motors Research and Development Center in Warren, MI). He holds four patents in materials processing, has co-authored two books and published several scientific papers in leading peer-reviewed international journals. His expertise includes developing simple mathematical models to explain the behavior of complex systems. While at NASA and CWRU, he was responsible for developing material processing experiments to be performed aboard the space shuttle and developed a simple mathematical model to explain the growth Christmas-tree, or snowflake, like structures (called dendrites) widely observed in many types of liquid-to-solid phase transformations (e.g., freezing of all commercial metals and alloys, freezing of water, and, yes, production of snowflakes!). This led to a simple model to explain the growth of dendritic structures in both the ground-based experiments and in the space shuttle experiments. More recently, he has been interested in the analysis of the large volumes of data from financial and economic systems and has developed what may be called the Quantum Business Model (QBM). This extends (to financial and economic systems) the mathematical arguments used by Max Planck to develop quantum physics using the analogy Energy = Money, i.e., energy in physics is like money in economics. Einstein applied Plancks ideas to describe the photoelectric effect (by treating light as being composed of particles called photons, each with the fixed quantum of energy conceived by Planck). The mathematical law deduced by Planck, referred to here as the generalized power-exponential law, might actually
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have many applications far beyond blackbody radiation studies where it was first conceived. Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.
Cover page of AirTran 2000 Annual Report
Acknowledgements
With sincere thanks to the many Internet sources that have been used to compile this document as evident by all the corporate logos and various photographs used here to make the presentation more interesting. All of them have cited and are liberally and profusely acknowledged.
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What are the Odds?

Southwest Airlines is Americas largest domestic airline, as measured by originating domestic passengers boarded (based on third quarter 2011 data from the U.S. Department of Transportation (DOT)). We remain one of the lowest cost producers among major airlines with one of the worlds largest mainline fleets. From the 2011 Annual Report Gary C Kelly Chairman of the Board, President Chief Executive Officer
In Annual Report after annual report, Southwest Airlines has proudly emphasized its status as the low-cost leader in the industry. What then are the chances of ideas and the discussion here costs getting accepted? Only time will tell. If the predictions here have any validity, we can expect Southwest Airlines to go through a period of reporting losses - with its acquisition of AirTran and rapidly changing nature of its complex operations being held at fault. But there is a different reason and it lies buried in the story here. Costs have been rising for a long long time, as evident from the nonlinear curve for 1971-1992. Even if losses are avoided, Southwest can greatly improve its profitability by studying some of the ideas outlined here. With lots of LUV in the air!
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any of these about rising

The Future For Southwest Airlines: The Unknown Story of Rising Costs and The Maximum Point On Profits-Revenues Curve

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The Future for Southwest Airlines The Unknown Story of Rising Costs

2012 FORTUNE 500 List Rank 167

http://upload.wikimedia.org/wikipedia/commons/5/53/Southwest_Airl ines_Flight_1248_-1.jpg Found this interesting image of a plane landing

Lets Make this Easy

With lots of LUV in the air!

Happy Birthday Southwest Airlines

Celebrating and Living the Southwest Way

Our History Select from a Category Select By Date

March 15, 1967 November 27, 1967

January 15, 1968

Hearing before TAC begins.

March 12, 1969 March 12, 1969

May 13, 1970

Southwest Airlines Fact Sheet

Annual Revenues ($, billions) R = kF = 0.14683 (Fare per seat in $)

2. Brief Version of the Story

Revenues, x [$, billions]

Time, t [in years]

Profits, y [$, billions]

0.6 0.5 0.4 0.3 0.2 0.1 0 1990

Time, t [in years]

Profits, y [$, millions]

Revenues, x [$, millions]

Ready for Take-off !

4. Profits and Revenues Over time

Revenues, x [$, billions]

Time, t [in years]

Profits, y [$, billions]

0.6 0.5 0.4 0.3 0.2 0.1 0 1990

Time, t [in years]

5. The Profits-Revenues Linear Law

Profits, y [$, billions]

Type I behavior y = 0.123x 0.141 = 0.123 (x 1.154) 2 r = 0.936

Revenues, x [$, billions]

Profits, y [$, billions]

0.6 0.4 0.2 0.0 -0.2 -0.4 0 2 4 6 8 10 12 14 16 18 20

Revenues, x [$, billions]

Profits, y [$, billions]

Revenues, x [$, billions]

Profits, y [$, billions]

Type III behavior y = - 0.081x + 1.439 Joining 2007 and 2011

Revenues, x [$, billions]

6. The Unknown Cost-Revenue Story of Southwest Airlines

Costs, (x y) (or C), [$, billions]

Revenues, x (or R), [$, billions]

9.263 10.583 10.436 2.556

9.128 10.136 10.103 2.933

C > R C > R C > R C < R Between 1999 and 1992

Profits, y (or P), [$, billions]

C = 1.032 R 0.698 r2 = 0.9977 C/R = 1.032 > 1

Revenues, x (or R), [$, billions]

Profits, y (or P), [$, billions]

y = -0.032x + 0.698 Statistically significant Deduced from C-R graph

y = 0.081x + 1.439 Joining 2007-2011

Revenues, x (or R), [$, billions]

7. Quarterly Data and Total Operating Expenses

Table 3: Quarterly Data from Southwest Airline 10-Q SEC Filings

Total Operating Expenses (OE) [$, billions]

Quarterly Revenues, x [$, billions]

Computed Costs (x y) [$, billions]

Quarterly Revenues, x [$, billions]

8. Maximum point on Profits-Revenue Graph

Profits, y [$, billions]