Students of business strategy, as well as investors curious about what drives outperforming stocks, often find themselves pondering that inscrutable distance between decently run corporations and stellar ones.
It seems reasonable that a business that fills a compelling market demand and executes unrelentingly is positioned for success. But what tangible advantages are held by companies that continually improve on operating benchmarks, even in the face of competitive adversity?
Take Alaska Air Group, Inc. (NYSE:ALK), which by now should have seen an appreciable dent in its business from Delta Airlines' (NYSE:DAL) incursion into its home base of Seattle. Delta aims to make Seattle a global hub for its Asia business, and has been adding domestic and international routes in and out of Seattle-Tacoma International Airport at a furious pace for the last two-and-a-half years. By 2017, Delta, with nary a wrinkle in its monstrously deep pockets, will feature 150 daily flights from Seattle, versus its current mark of 90-plus daily departures.
Alaska has responded to its codeshare partner's competitive threat in a number of ways. The company has branched out by heading east, adding Seattle routes to major cities, from Oklahoma City to Washington, D.C. It's increased codeshare revenue with Delta rival American Airlines Group: During 2014, American traded places with Delta as Alaska's largest revenue sharing partner.
But as a metrics-driven company, Alaska has repeatedly stated that it will focus on its own performance as the best defense against Delta's ambitions. I've selected some of Alaska Air's most prominent 2015 goals as relayed by its top executives during its recent investor day conference. There's a common theme running through these: See if you can spot it.
Curtis Kopf, Vice President, Customer Innovation:
- "Win 8th J.D. Power award for customer service" (i.e., eighth consecutive award for best customer service among major U.S. airlines)
Ben Minicucci, Chief Operating Officer:
- "Shorten the bag drop process time to improve productivity and save passengers time."
- "Maintain #1 On-Time position"
- "Productivity target of 200 pax/FTE" (200 passengers per employee)*
Brandon Pedersen, Chief Financial Officer:
- "Meet our 2015 profit budget"
- "Hit our cost plan, reduce non-fuel costs by approx. 0.5%"
Could you find the single theme that spanned customer service, throughput, timeliness, productivity, overall profitability, and non-fuel cost control?
To be fair, it's not obvious. The answer is that each of these goals can be shifted to the better by rank-and-file employees. The bullet points above aren't solely management's jurisdiction, such as, say, the stated goal of managing the company balance sheet to maintain Alaska's investment grade credit rating (as one of only two U.S. airlines to hold this coveted credit stamp of creditworthiness).
These targets, rather, are companywide objectives that, if achieved, will perpetuate results like the record fourth-quarter and full-year 2014 net income the company reported last month.
Why Alaska always seems to meet internal goals
There's another commonality running through these ambitions. Below is the right side of a slide from the investor day presentation mentioned above, which gives a broad overview of the company's incentive pay program, open to all employees:
As the graphic shows, each of these goals is correlated directly with employees' ability to increase their paychecks. The company's incentive program is based mostly (70%) on profitability, with the rest of the weights given to costs outside of fuel (since employees can't control the price of jet fuel), customer satisfaction, and safety. Consideration is also given for on-time performance. Thus, the targets are designed to fit the incentive program, and vice versa.
If you're in the habit of perusing SEC filings in which companies describe their employee bonus programs (which I hope for your sanity you're not), I think you'll agree with me that it's rare to find bonus pay that is so closely aligned with what employees can actually control and accomplish. Moreover, the specific wish lists set by the likes of the company's COO and CFO, such as improving productivity per worker, or trimming costs, directly impact the bottom line.
Alaska's bonus program not only powerfully correlates work performance to company strategy, it's also far more significant in dollar terms than that of most of its Fortune 500 peers. Now let's look at the other side of the slide isolated above:
The annual bonus to employees for successfully meeting company goals has been equal to one month's worth of compensation over the last few years. In addition to alignment, this program is notable for incentivizing participants with a truly significant reward.
Dividing the fruits of collective effort in this manner builds a sense of shared accountability and trust between employees and management. It's why the team at Alaska Air Group hasn't lost more sleep than needed over both Delta's increased presence and the company's future in general.
Which brings us to the one metric that really matters. If you're invested in Alaska Air Group, when you read each year's annual report, thumb right to the operating expense section of the income statement, and look for the line item entitled "Variable Incentive Pay." Check to see if this number has increased versus the prior year. If it has, there's a great probability that all the other numbers you review afterwards will look pretty decent as well.