The Boeing Debacle: Seven Lessons Every CEO Must Learn
Forbes - Steve Denning 1/17/13
Brake problems. A fuel leak. A cracked windshield. One electrical fire. Then another. An emergency landing in Japan. A safety investigation imposed by the FAA. Then two premier customers—Japan’s two main airlines, ANA and JAL, ground their fleet of Boeing [BA] 787s. Then the FAA grounds all 787s used by the only American carrier. Now other regulators around the world follow suit, grounding all 50 of the 787s delivered so far. The regulatory grounding of an entire fleet is unusual—the first since 1979—and relates to a key to the plane’s claimed energy-efficiency: the novel use of lithium ion batteries, which have shown a propensity to overheat and lead to fires—fires that generate oxygen and hence are difficult to put out.
And keep in mind: Boeing’s 787 project is already billions of dollars over budget. The delivery schedule has been pushed back at least seven times. The first planes were delivered over three years late. In fact, out of a total of 848 planes sold, only 6 percent have been delivered.
Yet grave as these issues seem, they are merely symptoms of a deeper disease that has been gnawing at the US economy for decades: flawed offshoring decisions by the C-suite. Offshoring is not some menial matter to be left to accountants in the backroom or high-priced consultants armed with spreadsheets, promising quick profits. It raises mission-critical issues potentially affecting the survival of entire firms, whole industries and ultimately the economy.
Not just Boeing: an economy-wide problem
Thus Boeing is hardly alone in making flawed offshoring decisions. Boeing is just the latest and most spectacular example of an economy-wide problem.
“Many companies that offshored manufacturing didn’t really do the math,” Harry Moser, an MIT-trained engineer and founder of the Reshoring Initiative told me. As many as 60 percent of the decisions were based on miscalculations.
As noted by Gary Pisano and Willy Shih in their classic article, “Restoring American Competitiveness” (Harvard Business Review, July-August 2009), offshoring has been devastating whole US industries, stunting innovation, and crippling capacity to compete long-term.
Pisano and Shih write: “The decline of manufacturing in a region sets off a chain reaction. Once manufacturing is outsourced, process-engineering expertise can’t be maintained, since it depends on daily interactions with manufacturing. Without process-engineering capabilities, companies find it increasingly difficult to conduct advanced research on next-generation process technologies. Without the ability to develop such new processes, they find they can no longer develop new products. In the long term, then, an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate.”
Pisano and Shih have a frighteningly long list of industries that are “already lost” to the USA, including: compact fluorescent lighting; LCDs for monitors, TVs and handheld devices like mobile phones; electrophoretic displays; lithium ion, lithium polymer and NiMH batteries; advanced rechargeable batteries for hybrid vehicles; crystalline and polycrystalline silicon solar cells, inverters and power semiconductors for solar panels; desktop, notebook and netbook PCs; low-end servers; hard-disk drives; consumer networking gear such as routers, access points, and home set-top boxes; advanced composite used in sporting goods and other consumer gear; advanced ceramics and integrated circuit packaging.
The list of industries “at risk” is even longer and more worrisome.
Now unless Boeing can quickly fix the technical issues afflicting the 787, its entire airline business will also be “at risk”. Manufacturing airplanes could even become an addition to the list of industries “already lost.”
These issues are a wakeup call not just to Boeing but to every CEO whose firm or whose suppliers have been or will be involved in offshoring. Every CEO must learn seven lessons.
1. Use the right metrics to evaluate offshoring
In analyzing offshoring, firms must get beyond rudimentary cost calculations focused on short-term profit,, such as the cost of labor or the ex-factory cost and incorporate the total cost and risk of extended international supply chains. This is easily done with the help of the Reshoring Initiative, whose website includes an analytical tool enabling companies to calculate the full risks and costs of offshoring. It’s called the Total Cost of Ownership Estimator[TM]. And the price is right. It doesn’t require hiring high-priced consultants: it’s free.
The Estimator poses a series of questions. What’s the price of the part from each of the destinations? How far is it away? How often are you going to travel to see the supplier? How much intellectual property risk is there? How long do you think you are going to make it? It uses the answers to calculate twenty-five different costs. When they are added up, that’s the Total Cost of Ownership.
Most companies have tended to make their sourcing decisions based on the wage rate or the ex-works price or the landed cost, and leave out another twenty cost categories. The Estimator makes it easy for the company to calculate the other twenty costs.
“Often what firms find,” says Moser, “is that whereas the offshoring price is perhaps 30 percent less than the US price, all these other costs add up to more than 30 percent. If they are willing to recognize all of them, then they can see that it may be profitable to bring the work back.”
“For instance,” says Moser, “I took the last 27 cases where users compared China to the US. On average, the US price was 69 percent higher than the production price in China. It turned out that the US total cost of ownership was 4 percent lower. So it made a huge difference to make that calculation. That’s an indication that a substantial portion of the work that has been offshored would come back if people would use the right metrics.”
2. Review whether earlier outsourcing decisions made sense
Let’s back up a bit and note that Boeing’s problems have been visible for some time. In August 2011, my article drew attention to the perilous offshoring course on which Boeing was embarked.
In December 2012, fellow Forbes contributor Jonathan Salem Baskin wrote: “The company was convinced by one or more management consulting firms to outsource design and production of the 787’s components. While this idea might make sense for sourcing coffeemakers, it was a nonsense approach to assembling perhaps the most complicated and potentially dangerous machines shy of nuclear reactors. I’m sure blather from Harvard Business Review supported the idea that distances between factories in Seattle and Outer Mongolia were no farther than a VOIP chat, but the reality was a mess. Parts didn’t fit together with others. Some suppliers subcontracted work to their suppliers and then shrugged at problems with assembly. When one part wasn’t available, the next one that depended on it couldn’t be attached and the global supply chain all but seized up. Boeing had to spend $1 billion in 2009 to buy one of the worst offenders and bring the work back in-house.”
“The grounding — an unusual action for a new plane — focuses on one of the more risky design choices made by Boeing, namely to make extensive use of lithium ion batteries aboard its airplanes for the first time,” write Christopher Drew, Jad Mouawad and Matthew Wald in the New York Times: “The 787’s problems could jeopardize one of its major features, its ability to fly long distances at a cheaper cost… The maker of the 787’s batteries, Japan’s GS Yuasa, has declined to comment on the problems so far. “
What was Boeing thinking when they opted to embrace such extensive offshoring? Moser believes the error lay in using the wrong measure of the impact of offshoring on earnings. “Many companies that offshored manufacturing didn’t really do the math,” Harry Moser, an MIT-trained engineer and founder of the Reshoring Initiative told me. “A study the consulting company, Archstone, showed that 60 percent of offshoring decisions used only rudimentary cost calculations, maybe just price or labor costs rather than something holistic like total cost. Most of the true risks and cost of offshoring were hidden.”
For many companies, it’s time to redo the math, and then verify whether they still have the expertise to bring manufacturing back.
3. Don’t outsource mission-critical components
“Boeing has acknowledged, says Moser, “that its biggest problem was in outsourcing not only manufacturing but also a lot of the engineering. There were multiple tiers of outsourced companies who were supposed to be making their designs consistent so that the parts fit together. And they didn’t fit together. If Boeing had taken full responsibility for the engineering and then had jobbed the parts out and gotten them made to print, their problems would have been a lot less severe. It seems like they had this brilliant idea of outsourcing a lot of engineering with the manufacturing. There’s almost nothing as complicated as a Dreamliner.
“For example, an iPhone isn’t nearly as complicated. The downside risk isn’t as great. Apple has succeeded with outsourcing almost everything to Foxconn, mainly because they first completely manufacture the new product in the US. They make sure it’s right, while Foxconn is working in parallel with them, developing their tooling and whatever. So Apple has a finished product and they say to Foxconn: make it just like this! What Apple has done has worked amazingly well, because they have the capability to do the perfect prototype here, before it gets offshored to Foxconn. Most companies don’t have that.
“Thus Boeing didn’t have a finished product. So there were all kinds of risks of things not coming together. The tendency is too often for companies to try to do the engineering over here and the manufacturing over there. Eventually the innovation declines and the risk increases, as outlined by Pisano and Shih.”
4. Bring some manufacturing back
Moser estimates that when the total costs are included, around 25 percent of manufacturing that is currently outsourced could be profitably brought home, if the manufacturing expertise still exists. Looking ahead, changes in relative economics are likely to increase that percentage.
It is important to take into account rapid changes in relative costs. Oil prices are three times what they were in 2000. Natural gas in the US is a quarter of what it is in Asia. Chinese wages are five times what they were in 2000 and are expected to keep rising rapidly. And in any event labor is a steadily decreasing percentage of the cost of manufacturing.
Reshoring is already happening to a limited extent. Apple [AAPL] announced recently that it will resume manufacturing of one of the existing Mac lines in the US next year. GE [GE] is spending some $800 million to re-establish manufacturing in its giant facility—until recently, almost defunct—at Appliance Park, in Louisville, Kentucky. Whirlpool [WHR] is bringing mixer-making back from China to Ohio. Otis is bringing elevator production back from Mexico to South Carolina. And Wham-O Toys is bringing Frisbee-molding back from China to California. Based on the reshoring articles in the ReshoreNow Library, Moser calculates that at least 50,000 manufacturing jobs have recently been reshored in the last three years.
Where companies see that it could be profitable to bring manufacturing back, they will need to ensure that they either have or can rebuild the necessary expertise—sometimes a daunting challenge.
5. Adequately assess the risk factors of offshoring
In Boeing’s case, as Jonathan Salem Baskin notes: “It didn’t help that the outsourcing plan included skipping the detailed blueprints the company would have normally prepared, and allowing vendors to come up with their own. Delivered components arrived with instructions and notes written in Chinese, Italian, and other languages. Oh, and they decided to build the airplane out of plastic along with other novel materials and technologies, so it would have been a big experiment even if Boeing approached manufacturing like it always had.”
Clearly firms have underestimated the risk of having extended international supply chains. I asked Moser whether Total Cost of Ownership Estimator can help firms get a better handle on that risk.
“The TCO Estimator assigns no factor values apart from freight,” says Moser. “The user assigns all the factors. The user answers questions about the delivery time, and the price. That enables the Estimator’s algorithm to assess the inventory and the inventory carrying costs. There’s a section on opportunity cost. If the firm will lose orders because it can’t deliver, then put a value on that. There are sections on natural disaster risk and political risk. “
If Boeing had been using this earlier what would be the implications? If they underestimated the delay risk or the technical risk as low, the Estimator would have reflected the underestimation of the risk.
“The Estimator would have encouraged them to try to estimate each of the risks,” says Moser. “When you have twenty-five of them, you only have to put in 1 percent in each to balance the savings you might get from going offshore.
“If you are buying pencils, not much intellectual property risk; if you can’t get it from this source, you can get it from somewhere else. The margins aren’t big, so you don’t lose so much. You don’t have much image to lose. But when you are making airplanes, there’s a lot of risk. Instead of having one size fit all, the Estimator lets you adapt for each product, each market, and make a more holistic and informed decision.
“The Reshoring Initiative site also offers resources. Library contains articles about transportation industry and equipment, and firms can understand where production was reshored and why. They might conclude: ‘Looks like a lot of companies are having problems with these things. Maybe we should increase our risk levels?’
“The Initiative also has information on what other users have found on the distribution of average costs. If they look at that, they might realize that some costs and risks have been underestimated. So the Estimator can help them make better decisions.”
6. Adequately value the role of innovation
Much of the offshoring that has taken place has assumed that the outsourced items are “little do-hickeys” with low value and so didn’t really matter much in the overall scheme of things. The little do-hickeys are worth pennies or less and have next-to-no margin. While those “little do-hickeys” might seem cheap in themselves, the lessons to be learned in improving their manufacture in the end can turn out to be highly valuable. (In cost accounting and economics, which usually don’t explicitly value knowledge, this loss is invisible and so doesn’t get taken into account.)
Firms often haven’t thought through how often they are going to redesign this product. “If it’s a bracket and you’re not going to redesign it for 30 years, it doesn’t matter very much,” says Moser. These days however there are very few components that are good for another thirty years. “If it is something that you are updating every six months or every year, then that becomes a lot more important. It’s the difference between a commodity and something that’s design-driven. The result of answering those questions is an ‘innovation cost of being at a distance.’ The Reshoring Initiative has resources so that firms can develop the understanding to make better decisions.“
The opportunity cost of lost innovation can be significant. Thus when GE decided to bring manufacturing of its innovative GeoSpring water heater back from the “cheap” Chinese factory to the “expensive” Kentucky factory, the cost of production went down. “The material cost went down. The labor required to make it went down. The quality went up. Even the energy efficiency went up. GE wasn’t just able to hold the retail sticker to the ‘China price.’ It beat that price by nearly 20 percent. The China-made GeoSpring retailed for $1,599. The Louisville-made GeoSpring retails for $1,299.
GE’s water heater as originally designed for manufacture in China had a tangle of copper tubing that was difficult to weld together. In the past, GE had been shipping the design to China and telling them to “make it”. Confronted with making the water heater themselves, they discovered that “in terms of manufacturability, it was terrible.” So GE’s designers got together with the welders and redesigned the heater so that it was easier and cheaper to make. They eliminated the tangle of tubing that couldn’t be easily welded. By having those workers right at the table with the designers, the work hours necessary to assemble the water heater went from 10 hours in China to two hours in Louisville.
“For years,” Charles Fishman writes in a great article in The Atlantic, “too many American companies have treated the actual manufacturing of their products as incidental—a generic, interchangeable, relatively low-value part of their business. If you spec’d the item closely enough—if you created a good design, and your drawings had precision; if you hired a cheap factory and inspected for quality—who cared what language the factory workers spoke? … It was like writing a cookbook without ever cooking…. there is an inherent understanding that moves out when you move the manufacturing out. And you never get it back.”
What is only now dawning on the smart American companies, Lou Lenzi, head of design for GE appliances says, is that when you outsource the making of the products, “your whole business goes with the outsourcing.”
7. Get to the root of the problem: maximizing shareholder value
While several decades of outsourcing were under way, why didn’t these smart managers think about the importance of innovating and protecting intellectual property? Why didn’t these well-educated managers realize that it was important to have designers, engineers, and assembly-line workers talk to each other? Why didn’t these MBA graduates realize that outsourcing might be mortgaging the future of their firms?
“There was a herd mentality to the offshoring,” John Shook, the CEO of the Lean Enterprise Institute, in Cambridge, Massachusetts. “And there was some bullshit. But it was also the inability to see the total costs—the engineers in the U.S. and factory managers in China who can’t talk to each other; the management hours and money flying to Asia to find out why the quality they wanted wasn’t being delivered. The cost of all that is huge.”
When managers manage with a spreadsheet rather than real-world knowledge about what is actually going on in the factory and what were its possibilities, they overlook hidden costs of the erosion of skills, the loss of quality and constraints on innovation. They also missed the potential added value to customers that could be generated by designing and manufacturing things differently. They also missed the costs and risks of an international supply chain, which is increasingly out of step with the shorter, faster product cycles.
Why did all these smart, highly educated people make all these mistakes? The root cause of these errors is a focus on the dumbest idea in the world: maximizing shareholder value. Focusing on short-term shareholder value ended up destroying vast quantities of long-term shareholder value.
A focus on maximizing shareholder value leads the firm to do things that detract from maximizing long-term shareholder value, such as offshoring, favoring cost-cutting over innovation, and pursuit of “corner cutting” and “bad profits” that destroy brand equity. The net result can be seen in the disastrously declining ROA and ROIC over the last four decades in large US firms as documented by Deloitte’s Shift Index.
The errors of offshoring are thus not isolated events. They are the result of the underlying philosophy of shareholder value, rather than the true purpose of every firm: create value for customers. The resurrection of American manufacturing will require more than simply bringing back production to America. Global manufacturing is at the cusp of a massive transformation as the new economics of energy and labor plays out and a set of new technologies—robotics, artificial intelligence, 3D printing, and nanotechnology—are advancing rapidly. Together these developments will spark a radical transformation of manufacturing around the world over the next decade. The winners in the rapidly changing world of manufacturing will be those firms that have mastered the agility needed to generate rapid and continuous customer-based innovation.
Success in this new world of manufacturing will require a radically different kind of management from the hierarchical bureaucracy focused on shareholder value that is now prevalent. It will require a different goal (adding value for customers), a different role for managers (enabling self-organizing teams), a different way of coordinating work (dynamic linking), different values (continuous improvement and radical transparency) and different communications (horizontal conversations). Merely shifting the locus of production is not enough. Companies need systemic change—a new management paradigm.
Pursuit of maximizing shareholder value at Boeing led to offshoring that has caused massive damage to shareholder value. The eventual scale of the damage can only be guessed at today. The remedy lies not in pointing fingers at Boeing’s management, but rather in treating the economy-wide disease that caused the problem.
And read also:
Why Amazon Can’t Make A Kindle In The USA
Dont’s Diss The Paradigm Shift In Management
How Manufacturing Can Learn from Software To Become Agile
The dumbest idea in the world: maximizing shareholder value
The five big surprises of radical management
What Went Wrong At Boeing?
Forbes - Steve Denning 1/21/2013
My article, The Boeing Debacle: Seven Lessons That Every CEO Must Learn, elicited spirited conversation. Several commentators noted that, in addition to the general lessons, Boeing made specific errors in the way it handled outsourcing and offshoring. Let’s take a closer look at those specifics.
Boeing enthusiastically embraced outsourcing, both locally and internationally, as a way of lowering costs and accelerating development. The approach was intended to“reduce the 787′s development time from six to four years and development cost from $10 to $6 billion.”
The end result was the opposite. The project is billions of dollars over budget and three years behind schedule. “We spent a lot more money,” Jim Albaugh, Chief of Commercial Airplanes at Boeing, explained in January 2011, “in trying to recover than we ever would have spent if we’d tried to keep the key technologies closer to home.”
The right goal: add value for customers
Let’s start with what Boeing did right. After losing market share to Airbus (owned by EADS) in the late 1990s, Boeing could have decided to focus on reducing the costs (and the selling prices) of its existing aircraft. That would have led inexorably to corporate death. Instead Boeing decided—commendably—to innovate with a new aircraft that would generate revenues by creating value for customers.
First, Boeing aimed to improve their travel experience for the ultimate customers, the passengers. As compared to the traditional material (aluminum) used in airplane manufacturing, the composite material to be used in the 787 (carbon fiber, aluminum and titanium) would allow for increased humidity and pressure to be maintained in the passenger cabin, offering substantial improvement to the flying experience. The lightweight composite materials would enable the 787 to fly nonstop between any pair of cities without layovers.
Second, Boeing aimed to improve value for its immediate customers (the airlines) by improved efficiency by using composite materials and an electrical system using lithium-ion batteries. This would result 20 percent less fuel for comparable flights and cost-per-seat mile 10 percent lower than for any other aircraft. Moreover, unlike the traditional aluminum fuselages that tend to fatigue, the 787′s fuselages based on composite materials would reduce airlines’ maintenance and replacement costs.
All good stuff, if Boeing could deliver. Boeing’s customers apparently thought they could. And the 787 became the fastest selling plane in aviation history. The stock price popped and the C-suite received their bonuses. But reality has since set in.
We have no way of knowing whether the cause of the current grounding of all 787s—lithium-ion batteries that overheat alarmingly—is a narrow, fixable manufacturing glitch or a serious design flaw that will put the whole enterprise in peril.
It’s true, as CEO James McNerny pointed out in a letter to Boeing staff on Friday, that “Since entering service 15 months ago, the 787 fleet has completed 18,000 flights and 50,000 flight hours with eight airlines, carrying more than 1,000,000 passengers safely to destinations around the world.” But all that will mean nothing unless and until Boeing can get to the root cause of those overheating Lithium-ion batteries.
What we do know is that the cost-cutting way that Boeing went about outsourcing both in the US and beyond did not include steps to mitigate or eliminate the predicted costs and risks that have already materialized.
The coordination risk
Even with proven technology, there are major risks in outsourcing that components won’t fit together when the plane is being assembled. “In order to minimize these potential problems,” wrote Dr. L. J. Hart-Smith, a Boeing aerospace engineer, in a brilliant paper presented at a 2001 conference, “it is necessary for the prime contractor to provide on-site quality, supplier-management, and sometimes technical support. If this is not done, the performance of the prime manufacturer can never exceed the capabilities of the least proficient of the suppliers. These costs do not vanish merely because the work itself is out-of-sight.”
Boeing did not plan to provide for such on-site support for its suppliers. In fact, it explicitly delegated this responsibility to sub-contractors. When the subcontractors didn’t perform the necessary coordination, Boeing had to provide the support anyway. “Boeing sent hundreds of its engineers to the sites of various Tier-1, Tier-2, or Tier-3 suppliers worldwide to solve various technical problems that appeared to be the root cause of the delay in the 787′s development. Ultimately, Boeing had to redesign the entire aircraft sub-assembly process.” The result? Huge additional expense, that should have been planned for and included in the project’s costs from the outset.
The innovation risk
The 787 involved not merely the outsourcing of a known technology. It involved major technological innovations unproven in any airplane. Would the carbon fiber composite survive the rigors of international flying? Could lithium-ion batteries, which are notorious for overheating and causing fires that are difficult to put out, be safely used? No one knew for sure. The 787 also contains multiple new electrical systems, power and distribution panels. The interactions among these novel technologies, introduced simultaneously, also exponentially increased the risk of innovation.
The innovation risk implied a greater involvement by Boeing in the development and manufacture of the aircraft. Astonishingly, Boeing opted for lesser involvement, delegating much of the detailed engineering and procurement to sub-contractors. The result? Unexpected problems have kept occurring that have delayed the project and increased its cost.
The outsourcing risk
Complicated products like aircraft involve a necessary degree of outsourcing, simply because the firm lacks the necessary expertise in some areas, e.g. engines and avionics. However Boeing significantly increased the amount of outsourcing for the 787 over earlier planes. For the 737 and 747 it had been at around 35-50 percent. For the 787, Boeing planned to increase outsourcing to 70 percent.
Boeing didn’t approach outsourcing as a troublesome necessity. Instead, like many US firms, it enthusiastically embraced outsourcing in the 787 as a means of reducing costs and the time of development. “The 787′s supply chain was envisioned to keep manufacturing and assembly costs low, while spreading the financial risks of development to Boeing’s suppliers.”
In his 2001 paper, Hart-Smith had warned of the additional costs and risks of large-scale outsourcing. Outsourcing didn’t cut costs and increase profits, he wrote; instead, it drove profits and knowledge to suppliers while increasing costs for the mother company. “Not only is the work out-sourced; all of the profits associated with the work are out-sourced, too.”
Hart-Smith argued that make-buy decisions should be based on complete assessments of all of the costs: “make-buy decisions should not be made until after the product has been defined and the relative costs established.” Outsourcing requires considerable additional up-front effort in planning to avoid the situation whereby major sub-assemblies do not fit together at final assembly, increasing the cost by orders of magnitude more than was saved by designing in isolation from the work-allocation activities.
Boeing didn’t follow Hart-Smith’s advice and outsourced the engineering and construction of the plane long before the product was defined and the relative costs established. The results have been disastrous. Boeing’s 787 project is many billions of dollars over budget. The delivery schedule has been pushed back at least 7 times. The first planes were delivered over three years late.
The risk of tiered outsourcing
Boeing further aggravated these risks by adopting a new outsourcing model, along with the new technology. Unlike Boeing’s earlier aircraft, in which Boeing played the traditional role of integrating and assembling different parts and subsystems produced by its suppliers, the 787′s supply chain is based on a tiered structure that would allow Boeing to foster partnerships with around fifty Tier-1 strategic partners. These strategic partners were to serve as “integrators” who assemble different parts and subsystems produced by Tier-2 and Tier-3 suppliers.
In due course, Boeing discovered, as Hart-Smith had predicted, that some Tier-1 strategic partners did not have the know-how to develop different sections of the aircraft or the experience to manage their Tier-2 suppliers. To regain control of the development process, Boeing was forced to buy one of the key Tier-1 suppliers (Vought Aircraft Industries) and supply expertise to other suppliers. Boeing also had to pay strategic partners compensation for potential profit losses stemming from the delays in production.
The risk of partially implementing the Toyota model
Boeing’s outsourcing was modeled in part on Toyota’s supply chain, which has enabled Toyota to develop new cars with shorter development cycle times. Toyota successfully outsources around 70 percent of its vehicles to a trusted group of partner firms.
However key elements of the Toyota outsourcing model were not implemented at Boeing. Toyota maintains tight control over the overall design and engineering of its vehicles and only outsources to suppliers who have proven their ability to deliver with the required timeliness, quality, cost reduction and continuous innovation. As Toyota works closely with its suppliers and responds to supplier concerns with integrity and mutual respect, it has established an impressive level of professional trust and an overriding preoccupation with product quality.
By contrast, Boeing adopted the superficial structure of Toyota’s tiered outsourcing model without the values and practices on which it rests. Instead, Boeing relied on poorly designed contractual arrangements, which created perverse incentives to work at the speed of the slowest supplier, by providing penalties for delay but no rewards for timely delivery.
The offshoring risk
Some degree of outsourcing in other countries—i.e. offshoring—is an inevitable aspect of manufacturing a complex product like an airplane, because some expertise exists only in foreign countries. For example, the capacity to manufacture Lithium-ion batteries lies outside the US. Boeing had no choice but to have the batteries made in another country. More than 30 percent of the 787’s components came from overseas. By contrast, just 5 percent of the parts of the 747, were foreign-made.
While there is nothing in principle wrong with necessary offshoring, the cultural and language differences and the physical distances involved in a lengthy supply chain create additional risks. Mitigating them requires substantial and continuing communications with the suppliers and on-site involvement, thereby generating additional cost. Boeing didn’t plan for such communications or involvement, and so incurred additional risk that materialized.
The risk of communications by computer
Rather than plan for face-to-face communications and on-site communcations, Boeing introduced a web-based communications tool called Exostar in which suppliers were supposed to input up-to-date information about the progress of their work. The tool was meant to provide supply chain visibility, improve control and integration of critical business processes, and reduce development time and cost. Instead of people communicating with people face-to-face, the computer itself was supposed to flag problems in real time.
Not surprisingly, the tool failed. Suppliers did not input accurate and timely information, in part due to cultural differences and lack of trust. As a result, neither Tier-1 suppliers nor Boeing became aware of problems in a timely fashion. Boeing’s reliance on computer communications contrasts sharply with Agile practices of continuous face-to-face communications to ensure that everyone is on the same page.
The labor relations risk
We do not know to what extent Boeing’s enthusiasm for outsourcing and offshoring stemmed from a desire to circumvent difficult labor relations in Seattle. We do know that instead of involving the employees in the decision-making about outsourcing and offshoring, Boeing’s management approached decision-making pre-emptively. The approach backfired, as labor relations worsened as a result of the outsourcing decisions and a costly strike ensued.
The project management skills risk
Given the extraordinary risks of the 787 project, one would have expected Boeing to assemble a leadership team with a proven record in supply chain management and diverse expertise to anticipate and mitigate wide array of risks. Amazingly, this was not the case.
“Boeing’s original leadership team for the 787 program,” write Tang and Zimmerman in an important case study, “did not include members with expertise on supply chain risk management. Without the requisite skills to manage an unconventional supply chain, Boeing was undertaking a huge managerial risk in uncharted waters.”
The risk of a disengaged C-suite
The combination of the above risks constituted an existential threat to Boeing as a going concern. Where then was the C-suite while these risks were being incurred? An interview in 2011 with Philip Condit, who was the richly compensated CEO of Boeing when the initial 787 decisions were being made, is revealing.
In 2001, under Condit’s leadership, Boeing moved its headquarters from Seattle to Chicago, a decision continued by Condit’s successor, James McNerney. The ostensible reason for the move was to be neutral among the various divisions of Boeing, which were scattered around the US. In the interview, Condit makes no secret of another factor: as CEO, he didn’t want to be bothered with tiresome “how-do-you-design-an-airplane stuff,” or boring meetings with Boeing’s key customers (airlines) who came to Seattle.
After the move, Condit says that he spent much of his time in the Chicago business community, where he “encountered CEOs frequently gathering to nail down civic goals ranging from landing new companies to building world-class parks. ‘I was surprised by how much that happened,’ Condit said. ‘A meeting in which Starbucks, Microsoft, Costco, Boeing and Weyerhaeuser and a bunch of small businesses are all in the same place — rarely happens in Seattle,” he added. ‘It happened all the time in Chicago.’”
So while Boeing’s CEO was in Chicago, strategizing about the future of Boeing and discussing civic goals with CEOs from other companies, the managers back in Seattle were making business decisions about tiresome “how-do-you-design-an-airplane stuff” that would determine whether there would be a firm to strategize about.
And read also:
The Boeing Debacle: Seven Lessons That Every CEO Must Learn
The dumbest idea in the world: maximizing shareholder value
What Went Wrong at Boeing: My Two Cents
Forbes Eamonn Fingleton 1/21/2013
My colleague Steve Denning’s commentary today on Boeing’s 787 problems is on the money in identifying a key managerial wrong turning a decade ago. Boeing decided at the outset to rely on outsourcing for 70 percent of the plane’s manufactured content. As Steve shows at length, this greatly increased the managerial complexity of the project and almost certainly helps explain why the project ended up three years late (with consequent damage not only to Boeing’s reputation but, thanks to contractual penalties, to its immediate bottom line).
Even more troubling, however, has been the long-term cost in weakening Boeing’s competitiveness. This is something I identified in “Boeing, Boeing….Gone,” a cover story for The American Conservative, as far back as 2005. The point is that among the things Boeing has outsourced have been the wings and the wing-box. These are by far the most technologically advanced elements of an airframe and they were outsourced to a Japanese consortium led by Mitsubishi Heavy Industries. Part of the deal was that much of Boeing’s secret wing-building know-how had to be transferred to Japan. The decision was highly controversial with Boeing workers who saw it as a direct threat to their jobs. Outraged at the prone position they were asked to adopt towards their information-gathering Japanese counterparts, they were quoted by author Karl Sabbagh as vulgarly referring to Boeing’s technology-transfer deal as the “open kimono” policy.
Of course, you might think that what was outsourced yesterday can be insourced today. Actually this rarely happens in the real world, at least not where seriously advanced manufacturing is concerned. In this case a key problem is that the 787′s are made of carbon fiber. The learning curve in putting this tricky new material to work has been climbed by Tokyo-based Toray and Mitsubishi, not by Boeing. Unfortunately Boeing seems to have negotiated no effective access to the industrial secrets the Japanese have acquired. In effect Boeing has been left behind by its suppliers and cannot catch up without major costs that, given the relentless pressure for short-term profits in corporate America, will never seem to be worth incurring.
As a practical matter, the Airbus subsidiary of Netherlands-based EADS, will use Japanese-made carbon-fiber for the wings of its next major plane. The net effect is that the Japanese have suddenly bootstrapped themselves to leadership in the jetliner industry. (It should be noted that Japan’s aggregate contribution to the 787 comes to 30 percent, the same as that of the United States.) All this is the more piquant because Mitsubishi seems to be planning in the long run to enter the fray as a direct competitor to Boeing and Airbus in building full-size commercial jetliners. Already Mitsubishi is working with Toyota Motor to launch a 90-seat regional jetliner in 2017.
As for the immediate problem of getting the 787 back into the air, the news this morning is that overcharging seems to have been ruled out as the cause of the battery problems at the center of the crisis. Meanwhile Securaplane, a subsidiary of Britain’s Meggitt, which makes chargers for the 787, has announced it is cooperating in the effort to find the source of the problem.
The bottom line is that CEO and executives are vastly overpaid. They don't think clearly or at all and they are only in it to enrich themselves. There is no such thing as an MBA running a company successfully. Especially a company that makes a complex system. So here we have been told for years of how hard it is to find a qualified CEO without paying them absurd compensation and it turns out they were always worthless (HP anyone). Just as I suspected all along. CEO pay should be tied to 20-40 times the average pay of a person that actually does the work period. No extra perks because they are such a genius which the PR generated by the CEO hype-sters wants you to believe. Over the last 40 years the CEO pay has run up to astronomical numbers and now this article from a pimp CEO magazine tells us that, no CEOs were not worth a dime of the money they were paid. Sure wall street loved them because those parasites that produce nothing love to make money from "investing" in stocks they have convinced CEO's to perform massive layoffs and outsource work so the share price can go up. Why do you think Jim McNerny and the BOD has authorized Boeing to spend 2 billion on a stock buy pack. Don't you think that money should be invested in Boeing. It is because the parasites on Wall Street pay CEO to gut and kill a productive company.
Why does anyone think that paying a CEO 20 million dollars a year will cause the CEO to care about the company? What is his motivation to care? All his needs are taking care of for a life time in one year. It doesn't matter whether he/she runs the company into the ground or not. He doesn't even have to think. He just hires some outside consultant (with company money) to tell him what to do.
Sentiment: Strong Sell
Boeing made a huge mistake in outsoursing critical componeints for the 787.
That being said, I feel we have board members that continue to award their top management with large somes of money.
I have made this point year after year.
Recently HPQ had a bad year and what did they do?? They awarded the CEO with millions.
The same goes with any company that does not meet guidance on revenues, should not give a dollar to upper management.
Pay for performance is the name of the game!
As a stockholder you should vote out all these board members for allowing this to happen.
P.S. I believe Boeing will get to the battery problem sooner than later.
Holding my shares and not concerned.
There is more to BA than the 787.