Learning from Boeing’s outsourcing disaster

By Felix Salmon
February 18, 2011
Michael Hiltzik has a fantastic column on Boeing's outsourcing disasters in the LA Times; it's well worth reading the whole thing, complete with a link to a prescient 2001 paper by Boeing technical fellow LJ Hart-Smith.

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

Michael Hiltzik has a fantastic column on Boeing’s outsourcing disasters in the LA Times; it’s well worth reading the whole thing, complete with a link to a prescient 2001 paper by Boeing technical fellow LJ Hart-Smith.

Hiltzik’s point, which is undeniable, is that Boeing’s outsourcing mania has cost it billions. It’s not a new idea (Reuters ran this special report in January), but it’s rarely been this well expressed:

Boeing’s goal, it seems, was to convert its storied aircraft factory near Seattle to a mere assembly plant, bolting together modules designed and produced elsewhere as though from kits.

The drawbacks of this approach emerged early. Some of the pieces manufactured by far-flung suppliers didn’t fit together. Some subcontractors couldn’t meet their output quotas…

Rather than follow its old model of providing parts subcontractors with detailed blueprints created at home, Boeing gave suppliers less detailed specifications and required them to create their own blueprints.

Some then farmed out their engineering to their own subcontractors. At least one major supplier didn’t even have an engineering department when it won its contract.

Not only was all this forseeable, it was foreseen — not only by the unions, but also by executives. And, of course, the aforementioned Hart-Smith:

Among the least profitable jobs in aircraft manufacturing, he pointed out, is final assembly — the job Boeing proposed to retain. But its subcontractors would benefit from free technical assistance from Boeing if they ran into problems, and would hang on to the highly profitable business of producing spare parts over the decades-long life of the aircraft. Their work would be almost risk-free, Hart-Smith observed, because if they ran into really insuperable problems they would simply be bought out by Boeing.

What do you know? In 2009, Boeing spent about $1 billion in cash and credit to take over the underperforming fuselage manufacturing plant of Vought Aircraft Industries, which had contributed to the years of delays.

The lesson here is that Boeing executives, just like most of the rest of corporate and political America, were incredibly bad at pricing moral hazard and tail risk. Outsourcing is a bit like taking collateral from your repo operation and investing it in subprime credit. Most of the time, you make a small amount of money — and then, occasionally and unpredictably, you lose an absolute fortune. Boeing was picking up pennies in front of a steamroller, and ended up getting crushed.

I do wonder what proportion of corporate “efficiencies” are false ones along these lines. Did Mark Hurd improve HP’s margins by cutting back on R&D expenditure? Or did he sign the company’s long-term death warrant? And of course when Win Neuger’s reach for yield in the AIG securities-lending operation was truly disastrous.

Hiltzik concludes:

The company now recognizes that “we need to know how to do every major system on the airplane better than our suppliers do.”

One would have thought that the management of the world’s leading aircraft manufacturer would know that going in, before handing over millions of dollars of work to companies that couldn’t turn out a Tab A that fit reliably into Slot A. On-the-job training for senior executives, it seems, can be very expensive.

The sad thing is that this lesson has to be learned the hard way so many times. Can’t anybody else learn from Boeing’s mistakes?

More From Felix Salmon
Post Felix
The Piketty pessimist
The most expensive lottery ticket in the world
The problems of HFT, Joe Stiglitz edition
Private equity math, Nuveen edition
Five explanations for Greece’s bond yield
Comments
23 comments so far

Let’s not give the unions too much credit in this. It was partly the contentious relationship with the company that pushed management down this path. I’d hand out the blame liberally on both sides of that table.

Posted by TFF | Report as abusive

The problem TFF, is that Unions don’t make the corporate decisions. They may have had a a contentious relationship with management, but that’s to be expected when management seems to be as oblivious as these guys were. They didn’t see the value in their union workers so spent a lot of time and money trying to get around them. It didn’t work out well, did it?

Posted by Henk_sg | Report as abusive

To be fair to Boeing they were picking up hundred dollar bills in front of the steamroller. Most of the outsourcing has been tremendously succesful. Many of the parts they buy overseas are 50-75% cheaper than they could make themselves.

Boeing wanted to have a global supply chain so that when they sold a plane to a national airline (70% of all buyers) they could say 2 million worth of every plane we sell were sourced in your little fifedom.

Part of the Dreamliner delay was totally intentional… keep buyers waiting for the almost ready (ya right) 787 from buing from Airbus. The other issue that scared Boeing into action was the Chinese short haul 737 clone which some say will under cut the U.S. built plane by 50% on price.

AAPL outsources 100% of production as far as I know and they are now by some measures the most successful company and most valuable brand on Earth.

Posted by y2kurtus | Report as abusive

I’m no aviation expert, but there’s a slightly different way of looking at this. Boeing saw a far broader worldwide market for its 787, but it believed that you accessed that market through more than price and features (in fact, it probably didn’t want to compete on price). Instead, it offered a bit of local pride to far-flung countries that might have no other compelling reason to choose Boeing over Airbus. In short, Boeing wants to see itself as a truly global enterprise, with design/manufacturing partners pulling strings to help sales around the world.

It’s a dangerous way to do business, but one that the corporate groupthink probably believed was forward-thinking. Too much is outside of your control when you start playing politics on the global level.

Posted by Curmudgeon | Report as abusive

Agreed, Henk_sg, however the relationship has been overly contentious at times. No skin off my back personally, I just don’t think either side has managed it well.

Posted by TFF | Report as abusive

I’d trace part of it to Boeing moving their corporate headquarters in 2001 from Seattle (where many of their plants are located) to Chicago (where they make nothing) — it was as if their executives were deliberately saying they didn’t care about manufacturing and didn’t even want to be near it.

Posted by fgfg | Report as abusive

nor sure that offshoring is that successful. nobody really ever goes back and looks. maybe it will make management look bad? and they do it for only one reason because they think it will be cheaper! in then end its not. the cost of shipping goods long distance overshadows local labor costs. and with oil going up, expect that get worse. and it won’t matter if we ever could be energy independent because the cost of shipping would be impacted by oil in the country shipping to us. not what we pay for it. and consider your last call to customer service, was it answered some place else? and could you understand them and they understand you? that is the result of offshoring other than goods.

Posted by willid3 | Report as abusive

Outsourcing sounds great to accountants and CFOs who believe every part of a business can be compartmentalized into neat little tasks that anyone can do, anywhere. It works for computer manufacturers who are basically system integrators and sell products differentiated only by color and brand name, but the CFOs that become COOs don’t realize that jet airliners are a little more complex, and outsourcing subsystems for jets that are custom built for maybe a few hundred a year isn’t the same as buying commodity power supplies or motherboards for computers that ship in the tens of millions per year.

Even so, the the outsourcing fad that Boeing latched on to may not be the biggest mistake they made. They have formed joint ventures in China, where local companies there will be learning all about how to make the world’s best jet airliner parts and subsystems. Maybe Boeing thinks this will yield just lower cost parts, but my guess it will yield a much lower cost competitor. And then Boeing can jump on the latest fad among business school disciples, transforming themselves into an IP licensing company.

Posted by KenG_CA | Report as abusive

Two simple, highly readable books that help in understanding how corporate “efficiency” is often based on erroneous models are “The Mythical Man-Month” by Brooks and “The Goal” by Goldratt.

Outsourcing well-defined, quality-controlled parts in cheaper locales makes sense if you can do it while maintaining system throughput. Boeing does not appear to have figured out how to do this.

Out-sourcing production into potential client locales also makes sense, especially if the governments are players in the decision-making. The Italy parts of the out-sourcing clearly appear to fit into this model and might actually make sense.

Out-sourcing production to manufacturers in a country that wants to take over your business is short-term insanity that only the CFOs and near-retirement CEOs should love (think China which wants to learn from the West and then eat their lunch).

Posted by ErnieD | Report as abusive

Actually, TFF, a team of university researchers who did a 10-year study on Boeing is out with a book on this, and they’ve determined that the opposite is true: that Boeing’s labor problems are largely the result of the decision to slavishly adopt the GE management philosophy espoused by former McDonnell-Douglas executives: cutting headcount and outsourcing core functions in pursuit of increased ROA.

It’s called “Tubulence: Boeing and the state of American Workers and Managers,” and it’s an interesting read (maybe a little dry) for anyone who studies, works for or invests in U.S. corporations.

Here’s a link to the NY Times book review: http://www.nytimes.com/2010/11/21/busine ss/21shelf.html?_r=1

Posted by RyanB | Report as abusive

I believe some of the enthusiasm from the switch to Computer Assisted Design. As I understand it, the CAD software could turn out instructions for computer controlled machine tools which seemed to say there would be much less slippage between Seattle engineers and foreign fabricators. Even if that analysis were correct, it wouldn’t address factors like supplier moral hazard.

Posted by flevy | Report as abusive

Thanks, Ryan. I’ve known of the labor issues at Boeing for a while (which is why I wouldn’t touch their stock with a ten foot pole), but didn’t realize the whole backstory. Sounds like management has made a real mess of the company.

I grew up in their back yard. Hard to believe they would abandon Seattle!

Posted by TFF | Report as abusive

“AAPL outsources 100% of production as far as I know and they are now by some measures the most successful company and most valuable brand on Earth.’

To the best of my knowledge, no one has ever died when a desktop/laptop “crashed.”

In the end, one has to blame Boeing’s mgmt–they made the decision, and they should be held accountable (i.e.–fired). It will be interesting to see if other multi-nationals actually learn lessons from the 787 experience. It may, in fact, be an issue of implementation of the decision, not the decision to cut the cake per se…but I think others thinking of this approach will take a long hard look at that (or ought to) before proceeding.

Posted by Lilguy | Report as abusive

There is much more to the 787 problem.

Boeing implemented a paperless process. No drawings. Violating centuries of standard engineering practices.

No Drawings? Ah, no drafters.

Engineers would now be used to directly design the 787 using 3D CAD creating solid representation of the parts. But engineers are not drafters and it is not their job. Drafters do fit, form and function and are the group responsible for assuring the parts and assemblies are correct by putting them through a thorough checking process.

This was implemented with what was called 3DPMD (3D Part Model Definition). Now instead of the drawing, the actual 3D part was the authorizing document.

They didn’t have the processes in place to utilize this data through out the manufacturing cycle.

Management seemed to think they could just write a purchase order for a wing, vertical stabilizer etc.

The problem started at the very conception of the 787, just too much change all a once.

Posted by jetero | Report as abusive

Why would CEO’s bother to learn or take the long-term probabilities into account when they can a) make millions next year by puffing stock price (Wall Street loves job-cutting) and b) keep it all under current tax policies? Can’t any economists learn about the incentive effects of tax policy in the real world instead of assuming that the more money capitalists and managers make, the more useful their activities will be?

Posted by skeptonomist | Report as abusive

What mistakes? When you knowingly reduce the work force, threaten and break unions, forget about workers rights, eliminate skill sets and knowledge that made you great, forget about safety being number one in the industry and close down plants to outsource purposefully to save money … those are not mistakes.

Those were willful and deliberate acts that may prove to be ludicrously dangerous. How many defective parts SORTA fit and were used? Where is the quality control? They had the correct part number after all. Profit over safety in the airline business will come back to bite. It’s going to be harder and harder to blame the pilots now, before aircraft inferiority….

The few Corporations that put safety, quality and people before profit, function that way because they have an ethical and safe business model. There are lessons to be learned, but those who need to learn them are already outsourcing and have ALL their attention on the profits, and little of it on the future.

PS…A lesson to be learned from this might be a real disaster. Even so, it is doubtful those responsible will change anything. Look at what they have done (not done) thus far when faced with formidable competition? Boeing: “That’s Why We’re Here, There and Everywhere.” (Our parts and airplane pieces…)

Posted by hsvkitty | Report as abusive

I agree with hsvkitty, and add the following:
The incompetence of Boeing Management does not stop at the top.
It goes all the way down to 1st level management.
When an employee is proven to be worthless, they are promoted to management to prevent them from damaging airplanes…!
A responsible company would terminate these incompetent employees, but Boeing promotes them instead.
Just look at the 787, an epic management-created disaster that may yet bankrupt Boeing.
But the ultimate goal of corporate Boeing is to have the Chinese build all their airplanes, so they can sit back and rake in the profits while unions and american workers are swept aside.

Posted by bastille | Report as abusive

flier wrote:
In all this hand wringing about Boeing’s outsourcing debacle the metrication elephant in the room is conveniently ignored. Isn’t it so much easier to blame everybody else for mistakes made, but the company that still uses medieval inches and expects metric trained engineers to use that cumbersome anachronism without hitches. Airbus outsourcers a lot of work and seems to do fine because almost everybody speaks the same measurement language. The parts sourced in the US are designed in simple mm that even Americans can’t misinterpret.

Posted by flier | Report as abusive

“Boeing implemented a paperless process. No drawings. Violating centuries of standard engineering practices”

———-

They’ve been designing airplanes for centuries?

Posted by Jakesnake | Report as abusive

Once talked to a repair worker (well, a bit more than that)from the Lufthansa shop in Hamburg (IIRC the largest in Europe). He said that relative to Airbus, Boing was built downright sloppy. And this was back in 2003, I suppose it didn’t get better since then.

Posted by owe.jessen | Report as abusive

Michael Hiltzik’s “fantastic” Feb. 15 column came 10 days after the Seattle Times published an article on the exact same subject.

Posted by BradleyFikes | Report as abusive

Both KenG_CA and havkitty have the basic picture correct, I think. The poor misunderstood geniuses running Boeing were unfairly handicapped because nobody told them that, incredibly, they aren’t Nike. Turns out that to manufacture airplanes, you actually need to have people working for you who know how to design and manufacture airplanes. Who could have foreseen this?

The great news for Boeing shareholders and employees is that management has proudly refused to learn anything from this debacle. Instead they are doubling down by moving as much as possible of their US operations to South Carolina, in order to ensure that even when they pay US wages that are higher than those in developing countries, they can make sure that they’re still paying them to people who don’t know how to build airplanes.

I knew nothing at all about Boeing or the airplane business before moving to Seattle to work in an unrelated industry, 17 years ago. But all you have to do is read the Seattle press to see what’s incredibly obvious about the company’s big decisions. Their mistakes are truly at the kindergarten level, and they all have the same cause. Management can’t see *anything* except the cost of making their product. In real life, things just ain’t that simple.

Posted by drownedrat | Report as abusive

The underlying problem with the 787 is evident every time I read about the problems with the aircraft’s “supply chain.” This is not a supply chain problem, but rather a design chain problem. Boeing seems to not understand this difference.

Large aircraft are supplied in sections, and this is possible because each section is modular with highly specified interfaces. However, the design of the sections is not something that can be modularized. The design of each section is highly interdependent with the other parts of the aircraft. In fact, there may be no other product whose parts/sections are as highly interdependent than a large aircraft…a slight change in the center of gravity of one section can have large impacts on the other sections…a slight change in the surface geometry of one section can drastically change the airflow over other sections.

I even recall at one point a few years back that Boeing thought that disintegrating the design would actually shorten the development time…a deeper understanding of the development process would have acknowledged the increased time needed to design an integrated aircraft across companies, countries, cultures, and languages, whereas previously the aircraft and the production process were designed by internal teams.

Posted by bradical | Report as abusive
Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/