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Table of contents
1. Strategic reward systems at Southwest Airlines........................................................................................... 1
23 January 2014 ii ProQuest
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Strategic reward systems at Southwest Airlines
Author: Singh, Parbudyal

Publication info: Compensation and Benefits Review 34.2 (Mar/Apr 2002): 28-33.
ProQuest document link
Abstract: Organizations must become more strategic if they are to survive and succeed in the current business
environment. Functional and unit strategies must be aligned with overall firm strategy to enhance organizational
effectiveness. In this respect, strategic compensation systems are vital to ensuring desired employee behaviors
and enhanced firm performance. Strategic reward systems are reviewed, and rewards at Southwest Airlines are
examined. The firm's strategic compensation and recognition programs are outlined, and implications for
management discussed. One of the key aspects of the airline's strategy is to retain valued employees and
secure long-term commitment. These objectives are attained, in part, through seniority and job security clauses
in the collective-bargaining agreement. The overall effects of the airline's recognition programs and awards on
the company's bottom line is not clear. There is no universal "right" reward strategy, and every reward system
will not be equally effective.
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Full text: Headnote
Compensation
Headnote
Strategic rewards are part of Southwest Airlines' recipe for success.
With the dawn of the 21st century, technological, political, regulatory, demographic and economic forces
unleashed in the past will continue to exert pressures on organizations to change to ensure their survival and
success. Initiating and sustaining successful change require considerable thought and action on related
supportive structures and systems. Organizations and their subsystems, including critical human resource
management systems, have to become increasingly strategic to succeed in an environment that is in constant
flux. That is, functional and unit strategies must be aligned with overall firm strategy to enhance organizational
effectiveness. It is a widely held view that strategic compensation systems, an integral aspect of human
resource management, are vital in ensuring desired employee behaviors and enhanced firm performance.' This
article provides an overview of strategic rewards and a detailed discussion of rewards at Southwest Airlines
(SWA), including implications for management.
The Need for Strategic Reward Systems
Traditional rewards systems usually have a large proportion of the total package as base pay and just a small
portion tied to employee performance as reflected in a periodic performance appraisal. Such systems
emphasize Tayloristic-type management structures and systems, including functional and hierarchical
differentiation in organizational structures, rigid supervisory control and strict compliance with rules. The
traditional structures have changed considerably over the past few decades and will continue to do so as
organizations attempt to reinvent themselves. This has led to a call for the implementation of new and more
strategic rewards systems, whereby an organization's rewards systems are aligned with overall organizational
strategy. Although traditional rewards continue to be used by the majority of North American organizations,
there is some evidence that strategic reward systems are being implemented at an increasing rate.2
These strategic rewards, categorized by some researchers as the "new pay,"3 include performancebased
variable pay (individual and group based), skill-based pay (or competency- or knowledge-- based plans),
broadbanding, team-based pay and recognition programs. In general, the empirical evidence on the
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effectiveness of these reward systems suggests that the new pay strategies are related to increased employee
productivity and firm performance.4 It should be noted, however, that for some of these programs, such as
broadbanding and team-based pay, the empirical evidence on their effectiveness is sparse.
Challenges
Given the relatively strong rationale for strategic organizational rewards, why are not most, if not all, companies
implementing them? There are many reasons. First, some managers lack the political will to implement changes
in compensation systems that have been in place for decades.
Second, there are some inherent difficulties in implementing strategic rewards. For instance, employees who do
not trust management may view variable pay with suspicion. In fact, unions have generally opposed strategic
reward systems based on the perception that, by reducing the proportion of an established base pay, such
systems would place too much control in the hands of management. Finally, managers sometimes incorrectly
perceive strategic rewards to be more costly than traditional rewards. These challenges are, however, not
insurmountable. In fact, as the case study illustrates, SWA has successfully wrestled with these challenges.
With appropriate supportive systems and structures, the prospects for strategic reward systems for
organizations in North America appear bright for the next few decades. In fact, organizations may not have a
choice if they are to successfully compete in the new marketplace.
SWA's Philosophy and Strategy
SWA was launched in 1971 by Herb Kelleher, its charismatic former CEO and president and now chairman of
the Board of Directors, and Rollin King, a friend of Kelleher and later a board member. The company was based
on the simple idea that people would fly an airline that took passengers directly where they wanted to go, when
they wanted to get there, for as little money as possible, in a fun-filled environment. The airline should provide
lower cost point-to-point services delivered with more efficiency and service than any of the other major airlines.
The airline began with only three planes servicing three cities in Texas. Thirty years later, SWA now flies more
than 64 million passengers to 58 cities in 30 states, 2,700 times a day. Over time, SWA has become the envy of
the airline industry (see Exhibit 1). In fact, other airlines have unashamedly tried to imitate SW.Ns policies and
strategies-with limited success. Furthermore, as airlines reel under the pressures of the September 11, 2001,
terrorist attacks, SWA is the only major airline that continues to be profitable.
These accomplishments take on additional meaning because they were achieved in an industry historically
regarded as one of the most turbulent, rocked by forces such as deregulation, mergers and alliances, high fuel
costs, oil embargos, labor conflicts and more recently, terrorism. SWA is one of the most heavily unionized
airlines, with approximately 81% of its 33,000 employees covered by union contracts. So what is SWAs recipe
for success? According to industry analysts and Herb Kelleher himself, it is the culture of the firm, especially its
dedication to its employees.5 As Kelleher states, "Ask anyone at Southwest for the secret of the company's
success, and you are guaranteed to get the same response: the people. It is the dedication and zeal of the
company's employees that have made it a premier customer service organization. Nothing comes ahead of your
people."6
Several aspects of its people-oriented culture are worth noting. Employees have considerable freedom and
responsibility and a high level of employee involvement in decision making. The company hires the right people-
those who match/fit the organization. It places an emphasis on training and flexibility in using the skills of its
employees, and it uses strategic compensation and reward systems.
Strategic Reward Systems
Southwest's compensation and reward systems are considered strategically oriented, even though most of the
employees are covered by collective-- bargaining contracts. As one author noted, SWPs reward systems "are
viewed as a process for supporting and reinforcing the airline's philosophy... hence ... salaries, variable
compensation, and recognition programs are part of the process of management and highly integrated with the
things leaders and people do on a day-to-day basis."7 For analytical purposes, strategic rewards may be
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classified into four groups: strategic base pay, strategic benefits, strategic incentives and strategic recognition
programs.
Strategic Base Pay
Base pay is covered largely by union contracts; however, the collective-bargaining process and end results/final
contract may be viewed as extremely strategic. One of the key aspects of SWNs strategy is to retain valued
employees and secure long-term commitment. These objectives are attained, in part, though seniority and job
security clauses in the collective-bargaining agreement. In general, negotiated agreements reflect pay levels
consistent with or slightly below market wages and salaries. This helps to keep labor costs in line with the
company's low-cost provider strategy. Nevertheless, employees can share in the company success through
various contingent compensation programs, thereby increasing their overall pay. In fact, many of SWAs
employees are millionaires, including all of those who started with the company in 1971.
The airline industry is one of the most conflict-- ridden industries, with seemingly never-ending labor disputes.
Thus, one of SWA's strategy is to reduce such conflicts. However, this can only be achieved in an environment
of trust and compromise. It is this perspective that the history-- making 10-year contract, signed in 1995 with its
pilot union, must be viewed.
In terms of executive compensation, the CEO is paid at below the median of the market for executives in
companies of similar size. Other senior managers are compensated slightly above the market, but they retain a
smaller portion of the company's stock. In this manner, company executives are relatively underpaid in cash
compensation, but they are committed to the company's long-term financial success and growth through stock
ownership. Employees and executives have the same opportunities for stock ownership.
Strategic Benefits
The list of employee benefits offered by SWA is truly impressive. It includes both traditional programs and a few
innovative initiatives. For instance, like many other companies, SWA offers medical insurance, dental insurance,
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vision coverage, life insurance, long-term disability insurance, dependent care, adoption assistance and mental
health assistance, among others. Many of these are at no cost to the employee. Furthermore, employees and
their family fly free with SWA and enjoy discounted travel with other carriers. Employees also receive thoughtful
gifts on major life achievements and a chance to celebrate often (see Exhibit 2). One of the key concepts
behind this array of benefits is the assurance that "employees matter" at SWA and that the company will do its
utmost to take care of its most important stakeholder. Benefits help to reinforce the organization's strategic
intent of valuing its employees.
Strategic Incentives
The two main contingent or variable pay systems are the corporate-wide profit-sharing program and the
employee stock purchase plan. The profit-sharing program, initiated in 1973, is strategic in that it encourages
employees to keep costs as low as possible (thus likely higher profits), a key aspect of company strategy.
Furthermore, it allows employees to share in the success of the organization. Profits are shared equally based
on employee earnings and company profits, with those who work longer hours or fly extra trips receiving a
larger portion of the profit-sharing payouts. Traditionally, the program is composed of a cash component, as well
as a deferral to retirement account; however, as a result of employee requests, beginning in 1990 the total
payout was made on a deferral basis, thereby increasing the retirement benefits of the employees. This is
important in an organization that actively promotes long-term commitment from its employees. Employees are
offered several investment options, including company stock, enabling many retirees to become quite wealthy.
The company's employee stock purchase plan allows all employees and managers to share in the risks and
success of the company. In addition to the profit-sharing investment options, employees may purchase stock
from payroll deductions at a discount through the employee stock purchase plan. In fact, through these
purchases, employees now own about 12% of the company. The pilot contract allows for even greater
investments in the company through stock options. Employees are acutely aware that the firm's performance is
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pivotal to their pocketbooks. In fact, the stock price is displayed in each SWA facility so as to allow the
employees to keep a constant track of SWAs and their own destiny.
Strategic Recognition Programs
Strategic recognition programs abound at SWA. Many of these programs are specifically designed to encourage
and reinforce desired behaviors and, consequently, company strategy. In fact, these programs have limited the
need for more variable pay programs. Strategic recognition programs are at both the corporate and local unit
levels, and reward and celebrate exemplary service and behaviors, as well as employee's birthdays,
anniversaries and so forth. Even though many of these programs originated and are managed at the local level,
a few key characteristics emerge. They all enjoy the support of top management, with senior executives
including the CEO often gracing the reward ceremonies; they mean something to employees/winners; and they
encourage behaviors linked to firm strategy.
Some of the thought processes and effects of these programs may be gleaned from their descriptions. These
include the "Heroes of the Heart" program, the President's awards, and the "Winning Spirit" awards. The Heroes
of the Heart program was initiated by SWAs Culture Committee in 1992. The committee wanted to devise a way
to honor unsung heroes-the "behind the scenes" employees who customers rarely see. A subcommittee
representing a wide variety of departments was established to find a unique way to honor such employees,
resulting in the Heroes of the Heart recognition program. Each year, one group is selected for its outstanding
efforts in serving and supporting employees in other parts of the company. The winner of the award is kept
secret until Valentines Day, when the announcement is made with much pomp and ceremony at the company's
headquarters in Dallas. The name of the winning group is painted on one of SWA's aircraft that carries the
Heroes of the Heart insignia. An article is also run in the company's in-flight magazine, as well as its newsletter.
The President's Awards are also given annually to employees who demonstrate values and virtues embodied in
the firm's strategy: showing compassion for customers, untiring support for coworkers, leading by example,
keeping promises and following through, bringing fun to the job and embracing change." Each winner is given a
plaque written by his or her vice president, a monetary reward and a collage of photos taken during the award
ceremony. The photos of the winners are also published in the company's newsletter.
The Winning Spirit Awards are given out every month to 10 to 12 employees whose actions reflect the
company's values and strategy. These awards are given to employees, nominated by colleagues and/or by
customers, across SWAs system. A broad-based committee makes the final decision. Each winner is invited to
the company's headquarters where the CEO reads the letter of nomination and gives a Winning Spirit lapel pin
to him or her. The winner also receives a framed photo with the CEO as a follow-up gift, and an article is
published in the company's newsletter.
There are several other awards/recognition programs at SWA, including programs such as "Together We Make
It Great," "Ticket to the Future," "Walk a Mile," "Helping Hands," "Stuck on Service," and "Go See Do" and such
awards as "Joe Cool Award," "Top Wrench Award," "Superstars," "A Shining Star" and "Voice Award." These
exhibit similar characteristics as the above in that they promote behaviors pivotal in achieving the firm's goals
and strategy.
The overall effects of these recognition programs and awards on SWA's bottom line is not clear; however, as
Herb Kelleher stated, the case for these programs lies in the long-term effects. "If you were a statistician you
wouldn't [have recognition programs], because you'd say, 'well, we could save money if we didn't do it.'
Southwest Airlines has the best customer complaint record in the American airline industry and who can say
what that is worth? I could sit in my office one afternoon and cut SWAs budget substantially by cutting these
things. But that's like cutting out your heart."9 It is this attitude that keeps the company ticking all the way to the
bank.
Implications for Management
There is no universal "right" reward strategy, and every reward system will not be equally effective.
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Nevertheless, a review of the literature, including relevant case studies, reveals certain core principles that can
help to make reward strategies more effective. Many of these principles are exemplified in the SWA case
described in this article.
First, it is important that the reward is linked to what is important for the organization. That is, as the SWA case
illustrates, the reward system must be aligned with organizational philosophy and strategy. In this way, the
organization will encourage and reinforce behaviors and values that are crucial for success.
Second, the planning and delivery of these rewards must explicitly demonstrate commitment from
organizational leaders. Leaders and employees must be involved in the development of the rewards, the
process must be trusted as being fair, adequate resources must be budgeted and the final announcement and
delivery must convey a message that the reward is important. In SWAs case, the CEO and other executives
spend considerable time and effort to ensure that these conditions are met.
Third, these rewards must have meaning and value. Winning these awards must be a significant achievement,
and this must be communicated throughout the organization. Winners must feel proud about their
achievements, and the organization must glorify the effort. For instance, at SWA, the name of the winning team
in the Heroes of the Heart program is painted on one of the airline's carriers and the effort of the winning team is
communicated throughout the organization.
Fourth, there must be a supportive organizational culture for these rewards to be effective. That is, there must
be trust, a pervasive sense that related systems are fair and an unequivocal perception that effort is truly
appreciated. Furthermore, the culture must ensure friendly competition. Also, the criteria for winning and the
judging process must be clear and effectively communicated to all employees.
Finally, there must be a continuous evaluation of the effectiveness of new reward systems and strategies. This
implies that changes must be made to those not working at optimal levels, and the company must constantly
introduce new and exciting awards. Of course, the costs of these programs must be continuously evaluated to
ensure that they contribute more than what they cost the organization.
Footnote
Notes
Footnote
1. See Lawler, E. (1995). The new pay: A strategic approach. Compensation and Benefits
Footnote
Review, 27(4), 14-22; Gomez-Majia, L., &Balkin, D. (1992). Compensation, organizational strategy, and firm
performance. Cincinnati, OH: Southwestern.
2. See Gerhart, B., Minkoff, H., &Olsen, R. (1995). Employee compensation: Theory, practice, and evidence. In
G. Ferris, S. Rosen, &D. Barnum (Eds.), Handbook of human resource management. Oxford, UK: Blackwell.
3. Lawler (1995). The new pay: A strategic approach. Compensation and Benefits Review, 27(4), 14-22;
Zingheim, P, &Schuster, J. (1995). Moving one notch north: Executing the transition to the new pay.
Compensation and Benefits Review, 27(4), 33-39.
4. For a review of the empirical evidence, see Gerhart, B., Minkoff, H., &Olsen, R. (1995).
Footnote
Employee compensation; Theory, practice, and evidence. In G. Ferris, S. Rosen, &D. Barnum (Eds.), Handbook
of human resource management. Oxford, UK: Blackwell.
5. See Wilson, T. (1994). Innovative reward systems for a changing workplace. New York: McGraw-Hill.
6. Kelleher, H. (1997). A culture of commitment. Leader to Leader, September.
7. Wilson, T. (1994). Innovative rewards systems for a changing workplace. New York: McGraw-Hill, see p. 33.
8. See Frieberg, K., &Frieberg, 1. (1996). NUTS! Southwest Airlines' crazy recipe for business and personal
success. Austin, TX: Bard.
9. Gruner, S. (1998). Have fun, make money. Inc., May.
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AuthorAffiliation
Parbudyal Singh, Ph.D.
School of Business
University of New Haven
AuthorAffiliation
Parbudyal Singh is the assistant dean at the School of Business, University of New Haven. His research covers
a broad array of human resource management/industrial relations issues, including employee and executive
compensation. His work has appeared or has been accepted for publication in several top refereed journals,
including Industrial Relations (Berkeley), Journal of Labor Research, Comparative Labor Law Journal, Labor
Law Journal, Labor Studies Journal, Human Resource Management, Journal of Vocational Behavior, the
Canadian Journal of Administrative Sciences and the International Journal of Technology Management. Dr.
Singh has worked as a personnel and industrial relations manager in a large manufacturing company. He has
also been a business consultant to many organizations.
Subject: Strategic management; Incentive plans; Compensation plans; Airlines; Corporate profiles; Human
resource management;
Location: United States, US
Company / organization: Name: Southwest Airlines Co; Ticker: LUV; NAICS: 481111; DUNS: 05-532-9262;

Classification: 9190: United States; 8350: Transportation & travel industry; 6400: Employee benefits &
compensation; 2310: Planning; 9110: Company specific
Publication title: Compensation and Benefits Review
Volume: 34
Issue: 2
Pages: 28-33
Number of pages: 6
Publication year: 2002
Publication date: Mar/Apr 2002
Year: 2002
Publisher: SAGE PUBLICATIONS, INC.
Place of publication: Saranac Lake
Country of publication: United States
Publication subject: Business And Economics--Labor And Industrial Relations
ISSN: 08863687
Source type: Trade Journals
Language of publication: English
Document type: Feature
ProQuest document ID: 213690729
Document URL: http://search.proquest.com.ezproxy.library.yorku.ca/docview/213690729?accountid=15182
Copyright: Copyright SAGE PUBLICATIONS, INC. Mar/Apr 2002
23 January 2014 Page 7 of 8 ProQuest
Last updated: 2010-06-08
Database: ABI/INFORM Global
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