Big Surprise: Boeing's 787 Outsourcing Cost Money Instead of Saving It

To the tune of billions of dollars:

The airliner is billions of dollars over budget and about three years late. Much of the blame belongs to the company's farming out work to suppliers around the nation and in foreign countries.

It should be noted that aircraft manufacturers do not make money off of the sales of aircraft, but rather on spares and support down the road, and in outsourcing, Boeing has thrown that revenue stream to its suppliers, an act that Atrios calls, "obviously insane," additionally, it makes the entire process of creating an aircraft more riskier, because you have less control over whether tab A fits in slot B, or, as Felix Salmon notes, it's like, "picking up pennies in front of a steamroller".

Boeing was told that this was an issue by a senior fellow, L.J. Hart-Smith in 2001, (also here, where the PDF cuts and pastes better) and but chose to ignore it:

The inescapable problem with outsourcing work that could be done in-house is that it necessarily increases the tasks and man-hours to carry out the work way above those needed to perform all assembly, including most subassemblies, at one site. Experience in the electronics industry has shown that out-sourcing work to regions of low labor rate is only a transitory phenomenon. The reason why the rates were low was that there had previously been no work there. Once the work became available, hourly rates increased, so that the primary electronic companies kept moving the work to yet another as-yet-under-developed area, and the cycle was repeated. This may be cost-effective for small items, with production lives of only a few years at most, but it is inappropriate for large aircraft that may need spare parts throughout a service live in excess of 50 years (80 or more for some military aircraft) and for which the manufacturing program itself may last 40 or 50 years. There are so many aircraft components that must be out-sourced, such as engines, avionics, and systems, because today’s prime aircraft manufacturers are no longer equipped to undertake such work themselves, that the retention of a determinable minimum fraction of the structures work is a pre-requisite to developing sufficient cash to develop new products. Without new products, as distinct from derivatives, all companies will go out of business, no matter what their line of business.

The correctness of the author’s position on these matters is easily confirmed by two facts. It was the suppliers who made all the profits on the extensively out-sourced DC-10s, not the so-called systems-integrating prime manufacturer. (The same thing has happened on aircraft assembled by Boeing, in Seattle, too.) Also, when plans were being formulated for the proposed MD-12 very large transport aircraft, almost all potential suppliers indicated a preference for being subcontractors rather than risk-sharing “partners”. Could they have known more about maximizing profits, minimizing risk, etc., than the prime manufacturer who sought their help even though it could borrow money at lower rates of interest than potential suppliers could? The DC-8 was manufactured and assembled almost entirely within the Long Beach plant, with only the nose coming from Santa Monica. That policy was changed after the acquisition of the former Douglas Aircraft Company by the former McDonnell Aircraft Company, but the change did not improve the company’s profitability. It is time for Boeing to reverse this policy.

(emphasis original)

So, McDonnell, a company which was a complete failure in the commercial arena (only 1 project, a failed bizjet), took over what was the number two (and had been the number 1) commercial aircraft manufacturer in the world, and implemented its defense contracting monopsony^* driven business model, where it failed, and then Boeing bought McDonnell Douglas, and implemented their failed business model.

Boeing bought MACDAC, but MACDAC took over Boeing, and set the tone for its corporate culture, despite the fact that it was largely a failed company, having lost the JSF competition, and having only 2 major programs that it had initiated, the F-15 and the C-17 over the past 30+ years (the F/A-18 was initiated by Northrop).

One good thing that has come of this is that it will make a fascinating case study for the size of operations for economists, as Paul Krugman rather smugly notes:

In Boeing’s case, they outsourced far too much, only to find that they were getting parts that didn’t do what they were supposed to — and also to find that the subcontractors were seizing a lot of the rents. They discovered, in effect, that there are times when it’s better to rely on central planning than to leave things up to the market.

Obviously this isn’t always true. There’s a tradeoff. But that’s the point — and it’s this tradeoff that determines how big firms should be. Boeing has now provided a clear motivating example. Their loss, the economics profession’s gain.

Heh.  Here's hoping that I'm never a good case study for some academic.

^*A monopsony is the flip side of a monopoly. Instead of having only one seller and many buyers, a monopoly, you have only one buyer and many vendors, in McDonnell's case, the US military.