Boeing's About Face Runs Smack Into Traditional Accounting

By Kevin Meyer

Just the other day I told you how Boeing has apparently learned a lesson and is making an about-face on its outsourcing strategy by buying the assembly operations of a key supplier, Vought.  Well yesterday the deal happened, and the writeup in the Wall Street Journal itself explains why companies continue to go down the path to outsourcing hell.

Boeing Co. agreed to acquire manufacturing operations from one of its key suppliers on the delayed 787 Dreamliner aircraft at a cost of $1 billion. The purchase of a plant in North Charleston, S.C., from Vought Aircraft Industries would mark the second time Boeing has taken over a key part of the Dreamliner's supply chain. Boeing is paying $580 million in cash and will forgive $422 million in cash advances paid to privately held Vought for work on the 787.

The move gives Boeing additional control over a sprawling global supply chain that has created numerous problems for the 787, leading to delays in testing and production.  Those delays have cost Chicago-based Boeing millions of dollars in penalties and concessions and have damaged the companies credibility with customers.

Let's repeat some of those negatives, as they'll soon provide the 2x4 we'll use to smack some people upside the head.  Cash costs, sprawling supply chain, delays, penalties, concessions, damaged credibility.  Pretty expensive, eh?  Since it's almost always overlooked, we'll also tack on the human cost of tens of thousands of years of experience, knowledge, and creativity that Boeing shed as part of their outsourcing adventure.

But some people just don't see that.  In the same article whiz-bang analyst Robert Spingarn at Credit Suisse had a slightly different perspective.

"While such a transaction should afford Boeing greater control over 787 production, we see another negative in that Boeing is bringing more fixed cost into the company."

What rock has this dude been living under?  In what universe has moving "fixed cost" outside of the company been a good thing for Boeing?  So you shed some massive assembly operations, tens of thousands of years of knowledge and experience, but you've somehow created a good thing because if times get rough the assembly operation is magically "flexible" because you can demolish a supplier instead of yourself?  In the words of Dr. Phil, "how's that working for you?"  I know, stupid question.

But here's the really scary part:

Robert Spingarn, aerospace and defense analyst at Credit Suisse (nyse: CS - news - people ), ranks first among all his peers on Wall Street in Forbes.com's 2008 survey of America's best stock analysts. Spingarn earns the award with solid judgment, as measured by our data partner Zacks Investment Research, in both forecasting earnings and picking stocks over a three-year period.

And now you know one reason why it's so hard for public companies to implement lean manufacturing.  Not only do they have to come to grips with the often counterintuitive nature of lean, but they have to battle the traditional accounting and short-term mindset of the capital markets... and the analysts and investors that reward companies that play by traditional rules.

After years of telling them they were going down a very expensive path, I do have to hand it to Boeing for changing direction.  I just hope their shareholders also recognize it's a good move.

Comments

[Bill Waddell]

I suspect that Boeing seeing the light and having the wisdom and courage to buck Wall Street has something to do with their commitment to lean accounting. They are working with Brian Maskell's company, and every year at the Lean Accounting Summit more and more Boeing folks show up. They are probably looking at 'Real Numbers' while the Credit Suisse guy is looking at numbers he found under that rock you mentioned.

The other side of the coin does not bode well for Ford. All of the outsourcing and bad decision making happened on Alan Mulally's watch, or as a result of the management processes he put in place.

[Tim McMahon]

Flawed information will certainly lead to flawed decisions. Many companies can't and won't think long term. The automovtive suppliers are a great example. Many US car companies beat up on their suppliers for lower price while in the end putting them out of business, reducing the number of suppliers, and ultimately crippling their industry. How did that help anyone?

Whether it is insourced or outsourced it still needs to be sourced right? Supply chain gets it's name from the fact that there are links as in a chain. Without everyone doing their part in a partnership then there will only be winners and losers and not just winners.

[Greg Glockner]

I realize you focus more on manufacturing, but I just read that Spring is about to outsource the entire operations of its mobile phone network: http://gigaom.com/2009/07/09/sprint-will-pay-ericsson-5b-to-run-its-network/ - wondering about the parallels between this and manufacturing outsourcing.

[martinb]

What differentiates an "asset" from a "fixed cost?"

[Jon Miller]

I am still in the process of opening my eyes to the true value of lean accounting. In this case it seems to be more of an issue of long-term versus short-term thinking, as Tim said.

The Japanese corporate model is not perfect, and I am by no means an apologist for them. Japanese manufacturers certainly aren't paragons of lean accounting, but they don't let Wall Street shake them around or worry about quarter to quarter share price performance nearly as much as American corporate leaders do.

This is fundamentally not an issue that lean accounting will fix, it is an issue of values - balancing how leaders take responsibility and how they take rewards. In the US this balance is completely broken. When there is no shame in job elimination, and the personal rewards for doing so are ridiculously high, the CEOs make decisions that are bad for people, their companies, if not for themselves.

Lean accounting is certainly necessary, but not sufficient. How leaders are educated, developed and selected, and how they view corporate social responsibility has a great impact on outsourcing and other short-termist decisions. I don't claim to have the answer...

[Dan Markovitz]

Kevin,

Thanks for raising an important point: that public companies in the US can get walloped by Wall Street even when they do the right thing. And those downgrades can make it nearly impossible to get access to capital and run its operations.

[Paul Todd]

There is hope. This excerpt comes from an Automotive News interview with Ford's CFO:
"Booth, who became CFO effective last year, said Ford checks its cash flow daily, a switch from past practices where the focus was on profit and loss. The change has among other things made it possible for Ford to reduce inventory on dealer lots."

[Brian Maskell]

Answering Jon Miller's remarks. I completely agree. No one would suggest that Lean Accounting solves all these problems. The real need is executives and managers who are lean thinkers. What Lean Accounting does do (in regard to these issues) is provide correct financial analysis for the insource/outsource decision. And I am not speaking of the "soft" risk analysis - I am speak of the straight-forward hard numbers. So many companies use standard costing when they assess outsourcing. Standard costs should be eliminated from any decision-making. It always leads you in the wrong direction. I have not come across a company yet where the standard costs are not just plain wrong and dangerous.

There is the classic Boeing example of this when some procurement person (who was measured by some PPV nonsense) outsource wind-tunnel services because the cost per day was lower than the in-house standard cost. This left the company's multi-million dollar wind-tunnel with masses of unused capacity. None of the wind-tunnel costs went away. So the company was left paying for the service twice over.

If you want to know what a fixed cost is..... wind-tunnel for 747 is fixed cost ;-)

[Bill Waddell]

As to Brian's 747 wind tunnel story, I don't think any amount of lean training would have prevented that decision. Lean can only do so much ... as Ron White said, "You can't fix stupid."

[Rick Bohan]

I agree with Bill above. Often, these sorts of discussions (here sometimes, but mostly elsewhere)have a "Reasonable people, e.g., various large company CEO's and CFO's, can come to different decisions looking at different data with different tools than other reasonable people do," tone or slant. My view is...most of the decisions that got banking, auto, steel, etc. in such trouble were simply stupid decisions on the face of them. As Forrest's mother said: Stupid is as stupid does.

[Cory Peters]

What does sourcing decisions have to do with lean accounting? I have seen many companies make bad decisions based on them not getting the right information to the decision makers. Full up rates used to charge various organization to use services has always been a problem if you are comparing obtaining the service from elsewhere, but you do need to get people who understand the finbancial impact of all the parts to explain the effects of the decision on the whole operation. I see the same mistakes made when you purchase companies and again when you decide to source workstatement elsewhere. Bottom line is you need to understand your variable and hard to vary costs and analyze the impact of the transaction to the company from a P&L, cash flow, balance sheet and human capital point of view.

One more item is, to justify building the 787 it was required to bring in business partners who would invest in the work. The old way of building airplanes where all the risk was held by the OEM will not make a business case to proceed.