Outsourcing Agonistes: Boeing's Billion- Plus Blunder

Received wisdom of the supply-chain management persuasion has emphasized 'driving costs out of the system' so as to stimulate productivity while enhancing returns. Without doubt, there have been advances in logistics, computerized process design, inventory control and other marvels of modern management, many of them technological in nature, that have contributed to global economic growth. However, as the process begins, this is usually fancy consultant-speak for finding a cheaper place to make stuff, which is politely called out-sourcing.

The challenge is to coordinate all of this far-flung activity effectively so that when the final result is being put together on whatever 'export platform' is deemed sufficiently profitable, it all fits, works etc. This is as true for accounting outsourced to India as it is auto parts to China. A complicating factor is that some developing countries are demanding outsourced production as price of entry to their market. It turns out that making all of this work well, let alone profitably, is quite a challenge. When complications arise - a not infrequent occurrence -the costs can outweigh whatever putative gains were optimistically forecast. The lesson is, when beginning the analysis, be realistic about the challenges as well as the savings.

Yves Smith in Naked Capitalism shares the story of Boeing's latest outsourcing travails:

"We’ve repeatedly said that offshoring and outsourcing are often not the big cost-savers that the industry promoting them, Wall Street, and the stenographers among the business press would have you believe.

Direct factory labor is typically just north of 10% of the cost of most manufactured goods; for cars, we are told it’s 13%. Even if you can extract meaningful savings there, you have significant offsets: the upfront cost of re-orgainzing production (which in the outsourcing scenario include hiring costly outsourcing “consultants” and paying attorneys to paper up the deals), higher ongoing managerial costs, higher shipping and related inventory financing costs. Yes, there are cases like Apple where outsourcing has been a big success, but there are also others where the benefits have been underwhelming and have come at considerable costs to US workers, communities, and the economy (see a very good long form discussion by Leo Hindery).

Moreover, these cost savings come with higher risk. The greater span of operations increases business system rigidity and creates more potential points of failure. It is likely to take longer to notice screw-ups and the odds also favor it taking longer to localize and remedy them. Longer lead times mean a manufacturer may wind up with far more unwanted inventory if the economy turns or customer tastes change. Currency price moves can undo much of the expected savings.

But even if outsourcing is only marginally successful, it serves as a transfer from US factory workers to the managers and executives. The top brass can benefit even more, since Wall Street analysts usually look approvingly of outsourcing (I’ve been told by C-level officers of one public companies that they outsourced only because the analysts wanted it; the business case did not support it).

Boeing provides a cautionary case of the possible downsides of outsourcing. In this instance, the losses were so large that the company had to ‘fess up. Query how many lesser failures go unacknowledged.

From the Los Angeles Times (hat tip reader John M):

The next-generation airliner [the Boeing 787] is billions of dollars over budget and about three years late; the first paying passengers won’t be boarding until this fall, if then. Some of the delay stems from the plane’s advances in design, engineering and material, which made it harder to build. A two-month machinists strike in 2008 didn’t help.

But much of the blame belongs to the company’s quantum leap in farming out the design and manufacture of crucial components to suppliers around the nation and in foreign countries such as Italy, Sweden, China, and South Korea. Boeing’s dream was to save money. The reality is that it would have been cheaper to keep a lot of this work in-house.

The 787 has more foreign-made content — 30% — than any other Boeing plane, according to the Society of Professional Engineering Employees in Aerospace, the union representing Boeing engineers. That compares with just over 5% in the company’s workhorse 747 airliner.

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, creating huge production logjams when critical parts weren’t available in the necessary sequence.

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, Mike Bair, the former head of the 787 program, said at a meeting of business leaders in Washington state in 2007. That further reduced Boeing’s ability to supervise design and manufacture. At least one major supplier didn’t even have an engineering department when it won its contract, according to an analysis of the 787 by the European consortium Airbus, Boeing’s top global competitor.

On the one hand, Boeing was astonishingly inept and lacking in caution in going about this major change. But it is also widely seen as a sophisticated manufacturer with a great deal of engineering expertise. The costly outcome appears to be the result of hubris as well as the native hazards of this process.