Boeing Goes to Pieces
At a welcoming banquet in Japan in the 1980s, Ford Motor chairman Philip Caldwell received a memorably double-edged compliment. “There is no secret about how we learned to do what we do, Mr. Caldwell,” said the head of Toyota Motor, Eiji Toyoda. “We learned it at the Rouge.”
Toyoda was referring to Ford’s fabled River Rouge production complex in Dearborn, Michigan. In the early days of Japan’s rise, Ford and other American auto companies had been famously helpful to information-gathering Japanese engineers. Know-how gleaned at the Rouge evidently proved particularly valuable.
Similar stories can be told about the complacency of other U.S. industries in the face of emerging Japanese competition. Where Japanese industrial “targeting” is concerned, America never seems to learn.
Now another industry is being targeted—America’s last remaining crown jewel, aerospace. The Boeing Company in particular has long been in Japan’s crosshairs. Yet, in what amounts to one of the most outrageous sellouts in modern business history, the U.S. industry is consciously cooperating in its own demise. Swayed by stock options, top U.S. aerospace executives are increasingly prioritizing short-term profits over the long-term health of their industry.
Japan is arguably already the world’s largest aerospace player. Certainly it is the ultimate source of a vastly larger share of the industry’s most sophisticated parts and materials than a reading of the English-language press would suggest. And given that Boeing now subsumes most of the erstwhile independent companies that put Neil Armstrong on the moon, its eclipse constitutes a major part of a larger story of American decline.
In return for transfers of American technology and manufacturing know-how, the Japanese low-ball their prices for supplying an ever widening and more advanced array of components and materials. In many cases, Japan’s state-controlled airlines further sweeten the pot by paying top dollar for U.S. airframes and jet engines.
All this boosts the American industry’s short-term profits. For the Japanese the seemingly steep upfront costs are a steal given the enormous amount of learning-by-doing that would otherwise be required to reinvent American production techniques. As for the American national interest, the most obvious consequence is an endless stream of layoffs of American blue-collar workers.
Less obviously but equally debilitating, the U.S. aerospace industry’s dependence on Japanese and other foreign suppliers has greatly exacerbated U.S. trade imbalances. By extension, the U.S. Treasury has become ever more dependent on East Asia to fund the trade deficits. (Trade is the key to the real Japan—as opposed to the “basket case” presented in the media. Judged by the current account, the most meaningful measure of its trade, Japan’s surpluses have generally risen from the famously high levels they reached in the late 1980s.)
Already Japan’s successes reach into the aerospace industry’s every nook and cranny. A few examples:
Jet engines. Both Pratt & Whitney and GE Aviation now rely heavily on Japan for engine components. A key supplier is Ishikawajima Harima Heavy Industries (IHI), a little-known Tokyo-based corporation that today ranks as one of the world’s most advanced aerospace players. (In common with several other leading Japanese aerospace companies, IHI got its start in shipbuilding. Hence the seemingly incongruous reference to “heavy industries” in its name.)
Avionics. This is the term of art for a huge panoply of sensors, controls, flight-deck instruments and displays, and communications equipment essential to modern aviation. The field used to be the preserve of U.S. companies like Honeywell, Hughes, and Raytheon but increasingly the serious manufacturing is done in Japan by corporations like Panasonic, Sony, and Toshiba. The Japanese have also assumed leadership in critical avionics materials. An example is gallium arsenide, a superfast semiconducting material vital in advanced computer chips. Japanese companies like Hitachi Cable and Furukawa Electric dominate the supply of gallium arsenide.
Aircraft wings. Companies like Kawasaki Heavy Industries and Mitsubishi Heavy Industries are now world leaders in wing-making, a specialty long considered one of the aircraft industry’s greatest manufacturing challenges. In partnership with the world’s top carbon-fiber producer, Tokyo-based Toray, Mitsubishi has pioneered the manufacture of carbon-fiber wings for passenger planes. Such wings reduce fuel consumption by up to 20 percent per seat-mile.
To be sure, the Japanese have so far confined themselves almost entirely to components and materials, leaving Americans and Europeans to affix their logos to completed engines and airframes. But precedent suggests the Japanese may not be content to play second fiddle forever. Mitsubishi is already working on a 90-seat regional jet scheduled to enter commercial service in 2017. Although this plane will not present much direct competition for the American airframe industry, it will stand in much the same position to that industry as, say, the Honda Accord did to the U.S. auto industry in the 1970s—the thin edge of a wedge.
As Robert Scott of the Economic Policy Institute points out, a little more than a generation ago Boeing planes were still almost entirely American-made. In the 1980s, however, Boeing came under increasing pressure to enter into “work-share” agreements with various technology-hungry foreign partners, most notably the Japanese.
The trend intensified as Boeing planned the 777, which entered service in 1995. According to Boeing’s numbers, various Japanese companies took on, in aggregate, about 21 percent of the 777’s airframe—up from about 16 percent for the Boeing 767, which had been launched in 1982. Boeing allocated much of the 777’s fuselage to a government-led Japanese consortium.
Then came the 787, Boeing’s newest passenger plane, which entered commercial service in 2011 in the livery of All Nippon Airways. For several reasons the 787 constitutes a watershed not only for Boeing but for the entire global aerospace industry. Otherwise known as the Dreamliner, it is the most technologically advanced passenger jet ever built.
It is also the first progeny of a portentously redefined relationship between Boeing and Japan. On the company’s own figures, the Japanese account for a stunning 35 percent of the 787’s overall manufacture, and that may be an underestimate. Much of the rest of the plane is also made abroad, not least in Italy, Germany, South Korea, France, and the United Kingdom.
The 787 story began more than a decade ago when, in the manner of a man undergoing a mid-life crisis, Boeing suddenly embraced a New Age redefinition of itself: it aspired to be primarily a “systems integrator,” not a manufacturer. According to one online dictionary, the term systems integrator connotes “an individual or company that specializes in building complete computer systems by putting together components from different vendors.” As the commentator Mark Tatge has pointed out, the term suggests a largely service-oriented role similar to that of Dell Computer in the PC industry. (Dell confines itself to the design and marketing of products assembled in East Asia from components supplied under contract by countless independent manufacturers.)
Wearying of trying to stay ahead of Airbus, already then in the passing lane, Boeing would henceforth delegate many of its most technologically challenging manufacturing tasks to a consortium of three Japanese “Heavies”: Mitsubishi Heavy Industries, Kawasaki Heavy Industries, and Fuji Heavy Industries. These rank first among equals as Boeing’s so-called Tier 1 suppliers and have been the recipients of much of Boeing’s most advanced know-how.
Boeing’s changing view of itself dovetailed with Tokyo’s agenda. For decades Japan had identified aerospace as one of its most crucial industrial targets. At a stroke Boeing’s transition to systems integration put the prize of global leadership in aerospace within Japan’s grasp.
On the surface, Boeing’s strategy seems like any other case of outsourcing, and to mainstream economists—if not to blue-collar American workers—outsourcing is a good thing that helps nations allocate their capabilities more efficiently.
There is, however, another side to this story, as Ralph Gomory points out. A former director of research at IBM who is better known these days for his mathematical debunking of the traditional case for free trade, Gomory observes, “If the world economy were working in textbook fashion, Boeing’s technology transfer policy would not make sense. The Dreamliner story illustrates in high relief a fundamental, hitherto generally unnoticed, flaw in the theoretical case for globalism.”
For a start, in contrast to the standard case for outsourcing, Boeing’s increasing reliance on Japan can’t be explained as a search for cheap labor. Japanese wages are high—probably, when all is said and done, higher than American levels. Labor costs in several other nations where key Boeing suppliers hang their hats—Germany, France, and South Korea, for instance—are also high.
Even more anomalous is Boeing’s acquiescence in other nations’ requests for technology transfers. Gomory argues there is no place for such transfers in the standard case for free trade. After all, if American corporations have a comparative advantage in plane-making, they should keep it. By transferring production know-how to overseas partners, the American aerospace industry is cutting its own throat, and why would anyone do that?
Dick Nolan, an emeritus professor of Harvard Business School, notes that Boeing’s traditional policy had been to use foreign suppliers merely for what’s called “build-to-print”: they supplied components and subcomponents made to Boeing’s detailed specifications, an arrangement that enabled Boeing to keep to itself much if not all of its serious know-how.
Even before Boeing redefined itself as a systems integrator, keen observers had noticed a weakening in its resolve to resist Japanese pressure for technology transfers. As recorded by the British author Karl Sabbagh, by the early 1990s Boeing’s willingness to reveal closely held manufacturing secrets to the Japanese became so notorious that Boeing employees vulgarly referred to it as the “open kimono” policy.
Today, not the least surprising thing about the Dreamliner’s work-share arrangements is that the foreign-made sections arrive in Boeing’s final assembly plant in Seattle not only fully “stuffed” with systems and sub-components—a radical departure from previous arrangements—but already certified and tested. Certification and testing had previously been considered core functions that should never be delegated to foreign partners. In a Harvard Business Review blog, Nolan acerbically commented, “Boeing effectively gave Tier 1 suppliers a large part of its proprietary manual, ‘How to Build a Commercial Airplane,’ a book that its aeronautical engineers have been writing over the last 50 years.”
Perhaps the single most controversial aspect of Boeing’s partnership with Japan is that the 787 flies on Mitsubishi wings. These are no ordinary wings: they constitute the first extensive use of carbon fiber in the wings of a full-size passenger plane. In the view of many experts, by outsourcing the wings Boeing has crossed a red line. For a start, as Stan Sorscher points out, the strategy has required the transfer to Mitsubishi of much of Boeing’s invaluable wing-making technology.
“The value of the technology and know-how transferred is probably around $500 million—that is what we call in the business a scientific wild-ass guess,” says Sorscher, a former physicist at Boeing and now an executive of Boeing’s main white-collar union. “Boeing built the tooling for a full-scale prototype of the 787 wings in Seattle and then gave all of that to Mitsubishi. It was a huge boost to Mitsubishi.”
And that was only the beginning. “Boeing gave Mitsubishi the materials technology and the manufacturing processes—the layup processes, temperature and pressure conditions for the autoclaves, for instance,” says Sorscher. “Boeing also transferred its tooling and assembly expertise, and there is a lot of expertise in assembling a wing.” Previously Boeing had regarded wing-making as its ultimate core competency. By keeping the wings largely or totally in-house, Boeing minimized the risk that the Japanese consortium could become a future competitor.
The assumption in the industry is that carbon-fiber wings will be standard in forthcoming passenger jets. By engaging the Japanese to lead the move to carbon-fiber, Boeing may thus be committing the industrial equivalent of assisted suicide. As Richard D’Aveni of Dartmouth’s Tuck School of Business observes, the risk is not only that Boeing will lose the ability to make state-of-the-art wings but that, as it loses touch with manufacturing, its ability even to conduct design and systems integration will atrophy.
His concerns seem to be being belatedly heeded inside Boeing. In recent months, the company has indicated that it wants to bring more manufacturing back in-house. This is implied, for instance, in plans for the new so-called 777X, a stretched version of the 777 which is expected to enter service around 2020.
The question is whether Boeing is closing the barn-door after the horse has bolted. Certainly, as William Lazonick, head of the University of Massachusetts Center for Industrial Competitiveness, points out, the Japanese are looking increasingly formidable. He explains:
Japan’s competitive advantage is its deep expertise in machining, its know-how with advanced materials, and its capital goods. Where you are looking for very high-quality engineering, and labor that maintains its capabilities over long periods, the Japanese are superior.
This sort of work has been abandoned in the United States because the Japanese are there to do it. They have tremendous expertise in precision engineering using complex materials—materials that have to be dealt with in a particular way such as getting the weight down to a minimum. They will low-ball their prices to get work because they know they will keep it.
The problem for a systems integrator is that technological progress is very rapid. “Once you fall behind in advanced manufacturing, the costs of catch-up are just too great, and a chief executive aiming to maintain quarterly earnings cannot afford to incur them,” explains Richard McCormack, editor of Manufacturing & Technology News.
Why is wing-making so crucial? For a start, wings have to pack the strength to withstand occasional extreme buffeting, but at the same time they must be instantly and smoothly responsive in routine conditions—and they have to do all this while weighing next to nothing. If components don’t fit perfectly, this greatly increases wear and can lead to catastrophic failures in flight.
Wings for large passenger jets pose unique challenges because the larger a part is the greater the difficulty in machining its surfaces to required tolerances. Given that some wing parts these days can be as long as 100 feet, only a few factories in the world have the massively expensive machinery and rich endowment of tacit knowledge to meet the task.
In the case of carbon-fiber wings, the challenges are compounded because carbon fiber is a notoriously fickle material. Extremely strong in normal aeronautical use, it can be brittle if mishandled. A few tiny cracks invisible to the naked eye can doom a plane.
In outsourcing so much of the Dreamliner, Boeing has flouted the opinion of its own top engineers. The company received a particularly well-argued caution at an in-house conference back in 2001. One of Boeing’s senior engineers, John Hart-Smith, delivered a paper on the dangers of excessive reliance on outside partners. Referring to the American aerospace industry’s ever increasing outsourcing, Hart-Smith asked, “Is it really all that difficult to comprehend that, along with the work involved, the revenue and profit associated with it have also been outsourced?” He added: “One must be able to contribute in some way to products one sells to avoid becoming merely a retailer of other people’s products.”
Hart-Smith’s views were probably shaped by the fact that he had previously worked for McDonnell Douglas, a once brilliant company that flamed out after decades of increasing reliance on foreign partners. It eventually succumbed to a merger with Boeing in 1997. Hart-Smith had joined McDonnell Douglas at the height of its success in the 1960s, when in many ways it still overshadowed Boeing. He subsequently watched its commercial aircraft business outsource itself to death. A key problem was that designers became so out of touch that they no longer understood basic manufacturing realities.
Hart-Smith’s message should have packed a special significance for Boeing’s future chief executive, Harry Stonecipher. A classic “numbers guy” who had come out of Jack Welch’s General Electric, Stonecipher had served as chairman of McDonnell Douglas and presided over a particularly toxic outsourcing fiasco involving technology transfer to China. By 2004 he was CEO of Boeing and oversaw the early stages of the 787’s development.
How does Boeing justify its retreat from manufacturing? The company refuses to comment and a spokesman declined even to confirm information gleaned from independent sources. He would not “fact-check” this article, he said. (The defensiveness is not confined to Boeing. One outspokenly pro-manufacturing U.S. Senator, a Democrat from the Mid-West, at first ignored this writer’s requests for comment and then, after repeated reminders, offered a few irrelevant platitudes that avoided criticizing Boeing.) The company and its Washington surrogates seem increasingly uncomfortable with well-informed questions. The result, in the words of the prominent Washington-based aerospace analyst Richard Aboulafia, is that watching Boeing these days “resembles Kremlinology.” The company does have some excuses, albeit weak ones. A significant factor are so-called offsets, which are requirements by foreign air forces and government-controlled foreign airlines to favor their nations’ manufacturers in outsourcing aerospace contracts. No nation has benefited more from offsets than Japan, and the Tokyo’s ability to manipulate the U.S. aerospace industry is legendary.
But this does not mean that Boeing had to roll over. At all stages it held the high ground. In buying full-size passenger jets, the Japanese have had only two choices, Boeing or Airbus, and Airbus, as a prime manifestation of German-French industrial policy, has no inclination to transfer technology or jobs to Japan. And as Matthew Lynn, author of Birds of Prey: Boeing vs. Airbus, has shown, the Japanese have long been under a strong geopolitical obligation to buy from Boeing to help reduce their nation’s chronically large bilateral surpluses with the United States.
In the circumstances it should have been easy for Boeing executives to hold the line. Their failure to do so seems all the more surprising for the fact that Japan’s work share in Boeing planes has long been far greater than the proportion of final sales accounted for by Japanese airlines.
As Barry Lynn, a senior fellow at the New America Foundation, points out, Boeing’s policies appear to be at odds with its obligations to the American public. “Much of the technology that Boeing has transferred abroad was subsidized by the U.S. taxpayer and it was entrusted to Boeing to look after,” Lynn says. “Instead Boeing has sold it off. There has been a substantial amount of cashing out and top executives have treated themselves extremely well.”
By one estimate, in the three decades to the mid-1980s more than 70 percent of the U.S. aircraft industry’s development funding came from Washington, D.C., mainly thanks to spinoffs from military and space projects. More recently, Boeing benefited from low-interest finance from the U.S. government. According to the industrial geographers David Pritchard and Alan MacPherson, Boeing also received a $3.2 billion subsidy package from the state of Washington in support of the Dreamliner program.
A factor often mentioned in mitigation of Boeing’s outsourcing is a perceived need to enlist financial partners who can help fund the development of new planes. In the case of the Dreamliner, the Japanese Heavies provided much of the funding. But did Boeing need such help? As William Lazonick observes, Boeing had plenty of in-house financial muscle. It chose instead to use its cash to reward shareholders via rising dividends and—even more irresponsibly—huge buybacks of its own shares.
“Most of the buybacks came in two periods, first between 1998 and 2001, and then between 2004 and 2008,” says Lazonick. “Boeing’s buybacks cost more than $20 billion in total. And it is not as if they were not paying dividends. They were paying substantial dividends. I reckon between the beginning of 1996 and the end of 2007 their dividends totaled $8 billion. When you add it all up, buybacks plus dividend payments totaled $29 billion.”
“This is not atypical for major U.S. companies these days,” he adds. “They are looking for every way to cut what they spend on investment. Boeing could have done all the investment they wanted. Boeing’s buyback policy is a big difference with Japan. Companies there do very little buying back of their stock. They reinvest in their businesses.”
Boeing’s stock has done well. Measured from the end of 1997, it is up more than 170 percent. The rising stock price has in turn powerfully boosted executive stock options. Thus, Boeing’s current chairman, Jim McNerney, made $27.5 million in 2012—compared with a total of $1,725,000 for then chairman Phil Condit in 1997.
The Boeing story strongly suggests that America’s defense base has eroded. It is further evidence of a trend identified in a little-noticed 2005 report by the Defense Science Board. The board’s focus was mainly on the electronics market, and it found that even among suppliers who mainly or solely served the U.S. defense industry hollowing out had reached shocking levels. According to the report:
There is no longer a diverse base of U.S. integrated circuit fabricators capable of meeting trusted and classified chip needs. From a U.S. national security view, the potential effects of this restructuring are so perverse and far reaching and have such opportunities for mischief that, had the United States not significantly contributed to this migration, it would have been considered a major triumph of an adversary nation’s strategy to undermine U.S. military capabilities.
In discussions of the unintended consequences of globalism, the transfer abroad of valuable production technology is the elephant in the room. It is consistently ignored in all standard theoretical accounts of free trade. In an era when information can move around the world at light speed, this is an oversight of epochal importance. Almost everyone assumes that no matter how fast American industrial know-how leaks abroad, an abundance of new production methods and new industries will keep bubbling up to provide additional sources of prosperity. Not only do people not stop to consider whether this assumption is valid, they don’t even realize they are making an assumption.
Many of America’s most sophisticated competitors do not run their trade policy on a free-market basis, argues Ralph Gomory. By intelligent use of trade barriers, among other things, they can hope to finagle advanced production technologies out of the United States. Employers in such nations are often under considerable pressure—political, economic, and societal—to keep their own most advanced production technologies at home and well away from the risk of theft by foreign rivals.
A historic ratchet effect is at work. With high-value jobs disappearing never to return, America’s imports and current account deficits rise with each succeeding economic cycle. The deficits have to be financed—and this means ever greater reliance on major creditor nations, not least China and Japan, but also Saudi Arabia, Russia, and Germany. On present policies, the United States is continuing down a spiral of indebtedness similar to that of the late Ottoman Empire. The tale can end only in bankruptcy—or a drastic change of course.
Eamonn Fingleton is the author of In Praise of Hard Industries: Why Manufacturing, Not the Information Economy, Is the Key to Future Prosperity.