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Jim McNerney, Chairman and CEO of Boeing, issued a downbeat assessment of the US Aerospace industry at the Wings Club in New York November 11 when he expressed concern that the US industry may atrophy due to a shrinking labor talent pool.. In doing so, he cited the failure of the Boeing business model that delegated too much work to partners in an effort to share the costs and risks of the large scale development program for the 787. He is now concerned about competition from China, Russia and Japan.

The irony about the emerging competitors is notable because Boeing has long relied upon these three countries for outsourcing and stepped up the work in Japan and Russia for the troubled 787 and 747-8 programs. In essence, Boeing has had a major hand in creating its own competitors. (Airbus, Bombardier and Embraer also are guilty as well.)

Boeing’s path down this slippery slope began under the stewardship of former CEO Harry Stonecipher and the McDonnell Douglas-dominated Board of Directors. Harry and the McDonnells bought into the whole outsourcing/integrator concept for the MD-11 and MD-90/95, insisting on it for the 787 before the project would be approved. The die was cast in 2003 when the Boeing Board of Directors approved the 787’s outsouring model.

More irony: the purpose of the outsourcing was to spread the financial risk (a fat lot of good that did); and, according to a Wall Street Journal article at the time, one Boeing Board Member warned that too much focus on cost might backfire on Boeing and that Airbus could benefit from the outcome. The Board Member: James McNerney.

What were Boeing’s mistakes? In a nutshell, the basic mistake was a failure to take responsibility for the success of the 787 program, instead sharing financial and development risks with a series of international partners and subcontractors without having processes in place to ensure proper collaboration and quality. This fiasco cost Boeing, the only remaining US commercial aircraft producer, the opportunity to develop an all new narrow-body aircraft, instead ceding a major portion of the market to new competitors from China, Russia, Brazil, Canada, and Japan.

Why Outsourcing Doesn’t Work Easily

Outsourcing isn’t new, of course. The airframe manufacturers have been doing it for decades. But the 787 program took it to new heights (or new lows, depending on your point of view). Outsourcing requires a communication process, both before the job is done and after, to make certain it was done correctly. Airbus and Bombardier have successfully utilized international supply chains for multiple programs. For Boeing, the 787 was the first at this level, and it failed miserably.

The program has been plagued with inadequate planning and communications, shoddy work, missed deadlines, and the need to rework components that simply didn’t meet specifications required for a state-of-the-art aircraft. Compound those problems with the introduction of new materials never before utilized in airliner structures at this magnitude, and a new production method, dramatically increasing the complexity and need for coordination, and the potential failure points become obvious.

To Boeing’s credit, it has publicly acknowledged the obvious (which many CEOs won’t do regardless of the evidence) and admitted it was wrong in its approach. McNerney’s Wings Club appearance was as candid and forthright as he has been to date. Boeing is bringing 787 work back in-house, but challenges remain. The company bought out Alenia and Vought in Charleston (SC), but it still has enormous work to undo the deficiencies there, and a sharp learning curve to overcome. Tailwork for the 787-9 is going to be brought back to Boeing from Alenia, whose contract for the 787 tail assemblies runs only through airplane #150.

But McNerney and Co. still believe in outsourcing production to international suppliers. This remains risky on many fronts, with political and currency risks added to the risks of quality, performance, language, communications, and capabilities that would be found with any subcontractor, whether domestic or international. In Boeing’s case, problems occurred both domestically and internationally. This would indicate that the source of the problems wasn’t a language barrier, but flawed processes and poor management.

The Impact is Significant

The net result is that the 787 has recently had more cancellations than orders -it has garnered only a handful of new orders in over a year. Cancellations were due to program delays, perhaps compounded by the global economic environment; the lack of new orders stems from no delivery positions and a high degree of program uncertainty.

While the 787 will eventually become a successful aircraft and perform well in service, the delays have tarnished Boeing’s reputation, and with the difficulties at Rolls-Royce and a test flight fire, may not be finished.

Is the 787 program now under control? Just when management got a handle on most of the issues, two “unknown unknowns” occurred to skew the schedule farther to the right. The explosion of the Trent 1000 on the test stand, followed by an in-flight explosion by the sibling Trent 900 in the same area on an A380 has raised issues that will likely result in delays for Rolls-Royce powered models, which are the first scheduled for production.

The electrical fire during flight test has resulted in additional delays, and while ground testing continues, test flights have stopped. Each day that goes by needs to be added on to the end of the program, as the slack in the test program schedule had already been decimated by prior delays and management’s decision to accelerate the process as aggressively as possible.

Production at suppliers was halted a couple of weeks ago to allow the line to “catch-up” with the required repairs to Alenia manufactured structures. These new events will compound the existing delays—likely with 10-12 month delays for most customers. Boeing needs an initial delivery in early 2011 to maintain credibility, and may force an airplane through the system, rebuilding it by hand if necessary to deliver it to ANA. But the ramp-up afterwards looks to be excruciatingly slow to airlines expecting deliveries.

The US Industry Should NOT be in Atrophy

To compensate, Boeing is aggressively selling its bread and butter 737NG series as rapidly as it can offer discounts and take orders. In 2010, Boeing has taken 480 orders, of which 432 are for 737s. The company can’t afford an all-new aircraft in the near term, until its 787 and 747-8 programs are completed, and can’t easily re-engine the 737 due to the larger fan sizes for new generation engines.

The result is the unthinkable. By the middle of 2011, Boeing will be the only major manufacturer in the world without a new narrow-body model that takes advantage of a new generation engine!

Airbus will offer the PW GTF and the CFM LEAP-X on its NEO. The COMAC C-919 will be powered by the LEAP-X, the Bombardier CSeries, Irkut MS-21 and Mitsubishi MRJ by the PW GTF, and by that point Embraer will announce its plans, currently rumored to be a re-engining of the EJets with the GTF and an all new aircraft in the 120-150 seat range.

The ONLY manufacturer without a new narrow-body offering for the 2015-16 time frame will be Boeing—who will rely on a model initially introduced in 1967 as the standard-bearer. Say that again to yourself out loud. For the first time EVER, since the Wright Brothers, no US manufacturer will be producing a aircraft taking advantage of new engine technologies pioneered in the US.

An on-time 787 would have provided Boeing the revenues necessary for a 777 replacement to counter the A350XWB and the financial wherewithal to design a 737 replacement to leapfrog Airbus and Bombardier, who will have the most efficient narrow-body aircraft in service within three-five years, and appear to be on target with their development program. Boeing will be selling a 170-seat 737-800 with higher seat-mile costs than the 130-seat CS300, and significantly higher aircraft mile costs. As an airline, I’d choose the new technology and fill my airplanes, happily turning away customers while undercutting competition flying larger 737s.

Can Boeing Come Back?

Of course. Look at Pratt & Whitney. After their domination of the industry with the JT8D, it lost its way and didn’t effectively compete with the CFM-56, which took the mantle of industry leadership. But PW continued R&D, and after 20 years, have a breakthrough in the GTF, which is poised to regain industry leadership. That breakthrough, however, took vision, determination, and working through a number of technical issues to produce what is a disruptive technology in the engine market. Boeing now needs to do the same for the narrow-body market, with innovative thinking and investment.

Boeing still has market share leadership, and can rely on the innovation of its engineers — trusting that it too can come up with a disruptive technology that will change the market, as it did with the 707, 747, 777 and hopefully 787. The key to its success in the past has been American ingenuity from a team of professionals in Seattle. To claim that America has lost its workforce or lacks the capabilities to produce aircraft is absurd.

The shrinking labor pool has resulted from poor management at Douglas that drove the company out of business, and outsourcing policies at Boeing that shipped jobs off shore. The CEO of Boeing, who helped caused that demise, can’t now credibly turn around and claim that a shortage of labor is holding them back.

Boeing must respond, and respond quickly once it completes its existing developments. Two programs are needed: a 777 replacement to compete with the A350XWB, and a 737 replacement to compete with the new “International Five.” Both need to be leapfrog designs, innovative enough to make a difference without taking undue technical risks. A short-medium range twin aisle aircraft would be innovative in a 2+2+2 configuration, finally meeting the airline needs expressed two decades ago by Jan Carlsson of SAS. A 777 replacement taking advantage of GTF engine technology and second generation materials could leapfrog the A350XWB.

What does Boeing need to do to regain a position leadership? The answers are straightforward. First, return to the 777 business model for aircraft development within the United States, and second, obtain the external financing required to fully fund the new Y1 and Y3 programs (code named Yellowstone internally) needed to sustain the company over the next two decades. If Boeing can come through the difficulties with the 787 and 747-8 programs without further delays, it is still possible for Boeing to compete with a new program in the 2017 time frame, assuming a five year development cycle launched in 2012.

The result could determine whether long-term industry leadership stays in Seattle or moves to Toulouse, or eventually Tianjin. Boeing management can recover – but the works needs to begin now, not 10 years from now. Boeing shareholders and the market would not likely object to a bit of dilution through an additional public offering if those proceeds were used for development of new aircraft programs that will increase market share and profitability. The question is whether the Boeing board has the vision, ambition, and frankly the “stones” to maintain a leadership position in commercial aviation. Time will tell.

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