We’re coming up on the two-year anniversary of the FAA’s announcement of a comprehensive review of the Boeing 787′s (the Boeing Dreamliner’s) critical systems, including the design, manufacture, and assembly of the aircraft. The events leading up to that review would be a bad dream for any manufacturer (i.e., brake problems, a fuel leak, a cracked windshield, electrical fires, and an emergency landing), but an article by Steve Denning in Forbes points to extensive outsourcing and offshoring as major factors in this debacle that has lessons for every CEO.
Denning notes that the offshoring issue goes far beyond Boeing and the Dreamliner; it is, he says, “the latest and most spectacular example of an economy-wide problem.” His seven lessons are worth revisiting here:
- Use the right metrics to evaluate offshoring. In analyzing offshoring, firms must get beyond rudimentary cost calculations focused on short-term profit, such as the cost of labor or the ex-factory cost, and incorporate the total cost and risk of extended international supply chains.
- Review whether earlier outsourcing decisions made sense. What was Boeing thinking when they opted to embrace such extensive offshoring? Harry Moser, an MIT-trained engineer and founder of the Reshoring Initiative, believes the error lay in using the wrong measure of the impact of offshoring on earnings. “Many companies that offshored manufacturing didn’t really do the math,” he says. “A study by the consulting company, Archstone, showed that 60 percent of offshoring decisions used only rudimentary cost calculations, maybe just price or labor costs rather than something holistic like total cost. Most of the true risks and cost of offshoring were hidden.”
- Don’t outsource mission-critical components. According to Moser, Boeing acknowledged that its biggest problem was in outsourcing not only manufacturing but also a lot of the engineering. There were multiple tiers of outsourced companies who were supposed to be making their designs consistent so that the parts fit together. And they didn’t fit together. If Boeing had taken full responsibility for the engineering and then had jobbed the parts out and gotten them made to print, their problems would have been a lot less severe. And there’s a huge difference between an iPhone and an airliner. An iPhone isn’t nearly as complicated, yet Apple does its prototyping in the States—first manufacturing the product completely here—before having Foxconn produce it at scale.
- Bring some manufacturing back. When total costs are included, around 25 percent of manufacturing that is currently outsourced could be profitably brought back to the States—if the manufacturing expertise still exists. Looking ahead, changes in relative economics (e.g., energy costs, relative labor costs) are likely to increase that percentage.
- Adequately assess the risk factors of offshoring. Firms have underestimated the risk of having extended international supply chains. In Boeing’s case, the outsourcing plan included skipping the detailed blueprints the company would have normally prepared, and allowing vendors to come up with their own. Delivered components arrived with instructions and notes written in Chinese, Italian, and other languages. And they decided to build the airplane out of plastic along with other novel materials and technologies, so it would have been a big experiment even if Boeing approached manufacturing like it always had.
- Adequately value the role of innovation. Much of the offshoring that has taken place has assumed that the outsourced items have low value and so it didn’t really matter much in the overall scheme of things; they are worth pennies or less and have next-to-no margin. While those items might seem cheap in themselves, the lessons to be learned in improving their manufacture can turn out to be highly valuable. (In cost accounting and economics, which usually don’t explicitly value knowledge, this loss is invisible and so doesn’t get taken into account.)
- Get to the root of the problem: maximizing shareholder value. When managers manage with a spreadsheet rather than real-world knowledge about what is actually going on in the factory and what are its possibilities, they overlook hidden costs of the erosion of skills, the loss of quality, and constraints on innovation. They also miss the potential added value to customers that could be generated by designing and manufacturing things differently. They also miss the costs and risks of an international supply chain, which is increasingly out of step with the shorter, faster product cycles.
Why do all these smart, highly educated people make all these mistakes? The root cause of these errors is a focus on the dumbest idea in the world: maximizing shareholder value. Focusing on short-term shareholder value ends up destroying vast quantities of long-term shareholder value.
Since Denning’s article appeared in the beginning, we’ve seen evidence that some of these lessons are being taken to heart. In particular, re-shoring has emerged as a growing tactic as the hard savings that initially drove offshoring have been eroded by energy costs (i.e., low energy in the U.S.), the rising cost of labor particularly in China, and logistics issues that increasingly favor locally-based manufacturing.
As the Gryphon said, the reason they’re called lessons is that they lessen every day. We can only hope so as manufacturing moves forward.