Does Boeing Have an Outsourcing Problem?

29 January 2013 at 12:11 am 3 comments

| Peter Klein |

Jim Surowiecki is a good business writer (and my college classmate) and I always learn from his essays (and his 2004 book The Wisdom of Crowds). But I think he gets it wrong on the Boeing 787 case. Jim echoes what is becoming the conventional management wisdom on the Dreamliner, namely that it’s long list of woes (the current battery problem being only the most recent) results from the decision to outsource most of the plane’s production. “The Dreamliner was supposed to become famous for its revolutionary design. Instead, it’s become an object lesson in how not to build an airplane.” Specifically:

[T]he Dreamliner’s advocates came up with a development strategy that was supposed to be cheaper and quicker than the traditional approach: outsourcing. And Boeing didn’t outsource just the manufacturing of parts; it turned over the design, the engineering, and the manufacture of entire sections of the plane to some fifty “strategic partners.” Boeing itself ended up building less than forty per cent of the plane.

This strategy was trumpeted as a reinvention of manufacturing. But while the finance guys loved it — since it meant that Boeing had to put up less money — it was a huge headache for the engineers. . . . The more complex a supply chain, the more chances there are for something to go wrong, and Boeing had far less control than it would have if more of the operation had been in-house.

The assumption here is that vertical integration is better for quality control and for coordinating complex production systems. But that assumption is just plain wrong. As the property-rights approach to the firm has emphasized, control and coordination problems occur in internal as well as external contracting. As Thomas Hubbard points out, 

The more modern thinking about procurement emphasizes that this problem appears — albeit in different forms — both when a company procures internally and when it subcontracts. The problem of getting procurement incentives right does not disappear when you produce internally rather than subcontract; it just changes. Companies struggle to get their subcontractors to produce what they want at low cost; they also struggle to get their own divisions to do so.

In other words, Boeing might have had the same problems with in-house production. “It is certainly possible that the Dreamliner’s current problems are derived from its design — it relies far more on electrical systems than Boeing’s previous planes — and that these problems would have been just as significant (and worse on the cost front) had Boeing sourced more sub-assemblies internally.” Hubbard’s essay includes a number of additional insights derived from modern theories of the firm, such as the Williamsonian idea that adaptation is the central issue distinguishing markets from hierarchies. 

So, the next time you read that firms should vertically integrate to maintain quality, as yourself, are employees always easier to control than subcontractors?

Entry filed under: - Klein -, Myths and Realities, Strategic Management, Theory of the Firm.

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3 Comments Add your own

  • 1. Filipe J. Sousa  |  29 January 2013 at 5:37 am

    In my modest opinion, I guess that this case may reflect the appropriateness of vertical integration (or organic development, for that matter) vis-à-vis complex and lasting cooperative relationships with suppliers, especially when new product development (or any other radical organizational change) implies the coordination of (an extremely high degree of) systemic innovation – clearly in line with Langlois and Robertson (1995, 1992). (Autonomous innovation, on the other hand, may easily be accomplished within the firm or even take place at arm’s-length if transaction costs are relatively low and the aimed for change is not critical to the firm’s survival or growth.)

    Filipe J. Sousa

  • 2. stevepostrel  |  29 January 2013 at 9:55 pm

    You and Tom are of course right,

    From other reading I’ve gotten the idea that the outsourcing was managed poorly by creating too much project-wide risk-sharing with the subcontractors, such that each one was free-riding because its own failures were largely borne by everybody else. That led to propagating delays throughout the system, and some of the smaller players went out of business because they didn’t have enough capital to wait for the delayed progress payments. Boeing had to buy up the failed suppliers to keep the project in line, causing further delays. Similar failures, however, could have been generated with a badly managed 100% “internal” process, as well.

  • 3. Per Bylund (@PerBylund)  |  3 February 2013 at 8:57 am

    I think there may be a point to pointing out the trouble with subcontracting innovation, and it is derived from the Stiglerian point that integration precedes (disintegration and) markets. Any innovative production including immense specialization cannot be effectively (if at all) contracted/outsourced since the details of the process as well as the fitting of the parts and the knowledge necessary is not sufficiently known. There is an open-endedness and, consequently uncertainty, to the workings, and if it requires co-specialization that can only happen through the implementation process, then it cannot be outsourced. This can potentially explain Boeing’s trouble, but I am not an expert in this particular case.

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