When the word about Boeing's plans were announced in 2003, many veteran workers on the factory floor knew the company's plan to outsource much of the work was bound to create a multiplicity of unanticipated, costly, time consuming problems. Boeing's top executives at the time seemed to have little appreciation of the complexities involved in transplanting the production processes for manufacturing some of the world's most complex machines.
A 'prescient' warning to Boeing on 787 trouble
"We spent a lot more money in trying to recover than we ever would have spent if we'd tried to keep the key technologies closer to home," Albaugh told his large audience of students and faculty.
Boeing was forced to compensate, support or buy out the partners it brought in to share the cost of the new jet's development, and now bears the brunt of additional costs due to the delays.
Some Wall Street analysts estimate those added costs at between $12 billion and $18 billion, on top of the $5 billion Boeing originally planned to invest.
Most of the workers on the factory floor knew the company's outsourcing strategy wouldn't work as well as management anticipated in 2003. But they couldn't have guessed just how serious the problems in getting Boeing's new plane ready for delivery would eventually grow. Boeing's 787 program is now over 3 years behind schedule.
One person in Boeing Management had a good picture of all the problems that the company was likely to encounter if it pursued its leadership's pet outscoring strategy. John Hart-Smith had worked for Douglas Aircraft and moved to Boeing when the two companies merged in 1997 and became one of Boeing's Senior Technical Fellows. In 2001 Hart-Smith presented his paper on the perils of outsourcing.
His paper was a biting critique of excessive outsourcing, a warning to Boeing not to go down the path that had led Douglas Aircraft to virtual obsolescence by the mid-1990s.
The paper laid out the extreme risks of outsourcing core technology and predicted it would bring massive additional costs and require Boeing to buy out partners who could not perform.
His analysis of the likely outcomes of perusing an outsourcing strategy for Boeing's new plane the 787 were quickly swept aside, and he was ignored. Boeing 's top executives were too distracted chasing a shiny object named RONA.
Albaugh said that part of what had led Boeing astray was the chasing of a financial measure called RONA, for Return on Net Assets.
This is essentially a ratio of income to assets and one way to make that ratio bigger is to reduce your assets. The drive to reduce RONA thus spurred a push within Boeing to do less work in-house — hence reducing assets in the form of facilities and employees — and have others do the work.
Hart-Smith argued that it was wrong to use that financial measure as a gauge of performance and that outsourcing would only slash profits and hollow out the company.
"We went too much with outsourcing," Albaugh said in the interview. "Now we need to bring it back to a more prudent level."
The two top executives who were most responsible for making the decision to outsource the 787 have since left Boeing. The first was Harry Stonecipher, led McDonnell Douglas during its downward spiral, and became Boeing C.E.O. in 2003 six years after the two companies merged. Stonecipher was ousted in 2005 after being involved in a scandal stemming from an office affair. The other was Alan Mulally who was in charge of Boeing's Commercial Airplanes division. Mulally is now is Ford's C.E.O.
Here some excerpts from Hart-Smith paper that the Seattle Times obtained and made available on its website:
OUT-SOURCED PROFITS – THE CORNERSTONE OF SUCCESSFUL SUBCONTRACTING pdf
History suggests very strongly that it is the supplier, not the prime manufacturer, who has benefited the most, with no indication that the trend would ever change.
3. Identify the minimum amount of production work that must be retained in-house to generate sufficient cash to develop future products. Do not let the tasks performed in-house fall below this level even if some tasks have a higher profit margin than others.
4. Retain sufficient in-house production manufacturing that it is possible for future engineers to acquire the skills needed to develop new products, without which all businesses will fail. Even the work that is out-sourced requires internal expertise to write the specifications.
5. Out-source only on the basis of better facilities; never on the basis of a temporarily lower labor rate. Out-sourcing as offsets for sales must be acknowledged as an increase in cost, on average, not a desirable cost saving.
6. Understand that out-sourcing work increases total span time and transportation costs. It out-sources all of the profits that are associated with that work. It also entails additional inhouse activities that would not have been needed if the work had been retained in-house.
7. Recognize the importance of precision in early tasks in reducing the larger subsequent tasks. Pay particular attention to self-assembling (jigless) structures as a proven method for eliminating expensive intermediate tooling that has no value once a program is over
8. Acknowledge that cost-saving techniques that work in other high-volume industries are often quite inappropriate for low-volume industries like aerospace.
9. Find work to fill excess capacity; do not close it down or sell it off to boost RONA. Take on non-core activities, from time to time, if that is what is needed to reach a balance between head-count and budgets. Otherwise, irreplaceable critical skills will be lost and it will not be possible to deliver even core products.
10. Listen more to your own employees about how to save cost than to any outside business consultants who have never run a factory producing your kind of product. In any event, if the advice they offer changes every year, it cannot possibly be correct.
From Hart-Smith's conclusion:
Excessive downsizing can lead to an increase in costs, it can also reduce a company below the critical mass of technology needed to develop future product to stay in business. Work may need to be undertaken outside defined core competencies merely to ensure that the staff and facilities are available to perform work that is defined to be within core competencies. It can also be far more profitable to add work to fully utilize existing facilities than to sell off the facilities and out-source the work. The fate of the former Douglas Aircraft Company, which was reduced to a systems integrator in the early 1970s by excessive outsourcing of DC-10 production, is a clear indicator of what will happen to other companies which fail to sustain the conditions under which it is possible to launch new products. It is hoped that this sacrifice can save the new and expanded Boeing from a similar fate.
When it was presented in 2001 Boeing executives dismissed the report's recommendations, including number 10. Following Boeing's 2003 outsourcing decision management labor relations soured, and management opted to take a hard line with the company's Machinists Union with contract negotiations ending in a strikes in 2005 and again in 2008.
In 1970s Boeing was world leader in wind turbine technology, applying its expertise in wing assembly to building turbine blades. But it didn't go any farther than completing several prototypes, foregoing a significant opportunity. Boeing MOD-5B wind turbines
Boeing other new plane is the 747-8 Its manufactured in-house.
Here's an excerpt from Seattle Times article from 2003 about the controversy created by Boeing's outsourcing plan. Included in the article are some of Boeing management's wildly optimistic projections.
Boeing buzzes about 'source' of work
Sunday, March 9, 2003
Tightly integrated product teams of engineers from both inside and outside the company will collaborate over the Web on a paperless, digital 3-D mathematical model of the airplane design; large composite parts will snap together in the factory. Labor, time and cost savings are major goals.
"The new processes are ready for prime time and easily transferable to the commercial unit," Ennis said. "The bottom line is that it'll take a lot fewer engineers to do this, a lot fewer tools, a lot fewer suppliers."
At the same time, expect more big global partners ready to buy their way onto the 7E7 program with hefty investments.
Becker says that at this bleak time in the industry, Boeing is seeking to slash its upfront development costs.
"My belief is that we'll have more risk-sharing partners on the 7E7," Becker said. "We want to dramatically reduce the cost of introducing an airplane."
Now we all know how far short of their original goal their strategy to reduce costs through outsourcing fell.
Boeing failed to learn from what happened to McDonnell Douglas and ended up repeating some of its mistakes when the former head of McDonnell Douglas became Boeing's C.E.O. and tried to remake Boeing in failed McDonnell Douglas's image. I just hope other American manufacturers will be able to learn some valuable lessons about outsourcing from Boeing's very costly experience with the 787.