Mike the Mad Biologist

Boeing and the Myth of Beneficial Outsourcing

One of the justifications for outsourcing (firing productive U.S. workers and shipping the jobs overseas) is that it will lower costs. Then there’s reality, in which firing productive U.S. workers and shipping the jobs overseas actually costs more. Consider this from the CEO of Boeing about their new plane, the 787:

One bracing lesson that Albaugh was unusually candid about: the 787′s global outsourcing strategy — specifically intended to slash Boeing’s costs — backfired completely.

“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.

And as is always the case with we Dirty Fucking Hippies, this was not only predictable, it was predicted:

And yet, at least one senior technical engineer within Boeing predicted the outcome of the extensive outsourcing strategy with remarkable foresight a decade ago…

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.

Albaugh said in the interview that he read the paper six or seven years ago, and conceded that it had “a lot of good points” and was “pretty prescient.”

(full report available as a pdf)

So why do this? Well, we can thank all the people who believe that the stock market happy leads to improved economic efficiency:

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 increase 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.

That works, except when it increases costs from $5 billion to $20 billion. Then, maybe not so much.

This was not a problem with the engineers or the workers, this was an utter failure by management. It was part greed: stock prices usually rise when outsourcing is announced. But it was also a slavish devotion to ideology; many CEOs actually believed this was more effective. Something to keep in mind as the ongoing assault against America’s workers continues.

A pitchfork-related aside: The Boeing CEO at the time, Philip Condit was described as changing the company culture–and not for the better:

But if there was any lingering sense of shame, it didn’t deter Condit from his taste for lavish living. In the early ’90s, he built a massive medieval-style mansion outside Seattle, replete with a custom miniature train that chugged from room to room, delivering drinks to guests. Condit hosted elaborate parties that often included poetry readings and evenings of Camelot themes, featuring characters from King Arthur.

That extravagance soon began filtering into a company culture that had been based on modesty, fiscal restraint, and the singleminded pursuit of building big airplanes. Former CEOs Bill Allen and T. Wilson both eschewed the trappings of corporate privilege. Wilson lived in the same middle-class house during his whole career at Boeing. When Condit succeeded Frank Shrontz as CEO in 1996, Boeing had three small corporate jets, and senior execs were required to fly commercial airlines to stay in touch with their customers. Now, Boeing has a fleet of corporate jets, including a 737 for Condit, done up in English-library style.

Condit’s salary also increased by 94% during his tenure, even as Boeing cratered, including drops in stock prices, orders, and deliveries.

Comments

  1. #1 Dunc
    February 17, 2011

    On the other hand, it did get rid of those pesky unions!

  2. #2 Drivebyposter
    February 17, 2011

    I can’t imagine how a CEO can be told that outsourcing is going to cost them money and they still go through with it. Cognitive dissonance? Or maybe some sort of arrogance that those goofy numbers people don’t know anything about business?

  3. #3 KeithB
    February 17, 2011

    One unstated advantage to global outsourcing is that it might make the countries you outsource too more likely to buy your planes. (Much like farming contracts all over the US to make it hard to kill your DOD program.)

    DriveBy:
    In a company I used to work for, they outsourced (though it would cost more) because they were gearing up for an IPO and Wall Street *expected* companies in that industry to outsource, so they removed US manufacturing capability.

  4. #4 Lynxreign
    February 17, 2011

    Shareholder capitalism is broken. Capitalism itself can still be fine, but there are flavors that simply don’t work and this is one.

  5. #5 Jim Thomerson
    February 17, 2011

    When we toured the plant im 2007, we were told the 787 was outsourced to 44 countries.

  6. #6 SimonG
    February 17, 2011

    I worked in IT for many years, an industry noted for outsourcing. My own experience and education indicates that outsourcing can be effective, but only if you keep tight control of it. A lot of management don’t like that: they want to get rid of something troublesome and have someone else worry about it. But that’s a clear recipe for poor performance and escalating costs.
    Outsourcing your core competencies is just plane stupid. You might as well sell off the whole company.

  7. #7 Chrisj
    February 17, 2011

    DBP@2

    Simple: it may have cost the company money, but the CEO almost certainly made a hefty bonus for meeting an artificial target (quite possibly an ‘improved’ RONA, as mentioned in one of Mike’s quotes).

    A similar thing happened to a company I worked for a decade or so ago. A new CEO arrived with orders toa big bonus if he managed to double the share price in three years. He duly hacked out the company’s R&D department, in an R&D led industry – but one with a roughly five-year lead time from original research to the product hitting the market. R&D spending went (over a couple of years) from about 10% of income to barely 1%, increasing both RONE and profits substantially. Three years on, the share-price had indeed doubled and the CEO pocketed his big bonus. Two years after that, with no competitive products and no pipeline of stuff coming in, the company was bought out by a competitor (who wanted its substantial patent collection) for a fraction of what it had been worth when I joined. The lucky CEO got another nice big bonus for arranging the sale; pretty much everyone else got laid off, as I understand it. (I was years gone by then; I’d been in R&D.)

    The company was destroyed, as anyone who knew anything about the situation had predicted at the start. The CEO made out nicely, thanks.

  8. #8 Janne
    February 17, 2011

    KeithB above has a point though. You know all those rules of yours, about campaigns to “Buy America First”, and how federal money must be spent on stuff made in the US if possible and so on? Many other countries have similar rules. Consumers in many countries are just as protective of their local jobs as you are, and prefer to buy locally (or regionally) made things. In a number of industries, if you don’t build at least parts of your product locally, then you’re not going to sell your stuff.

    And for most large companies, the world is far more important than any one market. If worse goes to worse, and a company like Boeing, Sony or Siemens is forced to choose between their home market or all their foreign markets they would not hesitate for a moment. You’d hear the sound of tent poles being pulled before you’re finished stating your ultimatum.

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