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Originally published February 5, 2011 at 10:00 PM | Page modified February 9, 2011 at 2:49 PM

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Corrected version

Sunday Buzz

A 'prescient' warning to Boeing on 787 trouble

Boeing commercial airplanes chief Jim Albaugh had some unusually candid comments about the 787's global outsourcing strategy at a recent Seattle University talk.

Seattle Times business staff

In a late January appearance at Seattle University, Boeing Commercial Airplanes Chief Jim Albaugh talked about the lessons learned from the disastrous three years of delays on the 787 Dreamliner.

One bracing lesson that Albaugh was unusually candid about: the 787's global outsourcing strategy — specifically intended to slash Boeing's costs — backfired completely.

"We spent a lot more money in trying to recover than we ever would have spent if we'd tried to keep the key technologies closer to home," Albaugh told his large audience of students and faculty.

Boeing was forced to compensate, support or buy out the partners it brought in to share the cost of the new jet's development, and now bears the brunt of additional costs due to the delays.

Some Wall Street analysts estimate those added costs at between $12 billion and $18 billion, on top of the $5 billion Boeing originally planned to invest.

Interviewed after the Seattle U. talk, Albaugh avoided directly criticizing the decisions of his predecessors.

The 787 outsourcing strategy was put place in 2003 by then-Boeing Chairman Harry Stonecipher, who was ousted in 2005, and Commercial Airplanes Chief Alan Mulally, now chief executive at Ford.

"It's easy to look in the rear-view mirror and see things that could have been done differently," Albaugh said. "I wasn't sitting in the room and I don't know what they were facing."

And yet, at least one senior technical engineer within Boeing predicted the outcome of the extensive outsourcing strategy with remarkable foresight a decade ago.

Albaugh and other senior leaders within Boeing may be belatedly paying attention to a paper presented at an internal company symposium in 2001 by John Hart-Smith, a world-renowned airplane structures engineer.

Hart-Smith, who had worked for Douglas Aircraft and joined Boeing when it merged in 1997 with McDonnell Douglas, was one of the elite engineers designated within the company as Senior Technical Fellows.

His paper was a biting critique of excessive outsourcing, a warning to Boeing not to go down the path that had led Douglas Aircraft to virtual obsolescence by the mid-1990s.

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The paper laid out the extreme risks of outsourcing core technology and predicted it would bring massive additional costs and require Boeing to buy out partners who could not perform.

Albaugh said in the interview that he read the paper six or seven years ago, and conceded that it had "a lot of good points" and was "pretty prescient."

In his talk at Seattle U., the first specific lesson Albaugh cited as learned from the 787 debacle seemed to echo Hart-Smith's paper.

Albaugh said that part of what had led Boeing astray was the chasing of a financial measure called RONA, for Return on Net Assets.

This is essentially a ratio of income to assets and one way to make that ratio bigger is to reduce your assets. The drive to increase RONA thus spurred a push within Boeing to do less work in-house — hence reducing assets in the form of facilities and employees — and have others do the work.

Hart-Smith argued that it was wrong to use that financial measure as a gauge of performance and that outsourcing would only slash profits and hollow out the company.

Reached by phone in his native Australia, where at 70 he is now retired, Hart-Smith said he'd heard in recent months on the grapevine from former colleagues that senior executives at Boeing Commercial Airplanes have been reading his paper.

"I'm glad they got the message," Hart-Smith said. "It took far too long."

After he presented his paper at a company symposium in 2001, he received hundreds of supportive e-mails from engineers and lower-level managers, he said.

But a senior executive present at the symposium spent a half-hour after his presentation attacking the paper, and afterward Boeing leadership ignored Hart-Smith.

He had hoped to join the 787 program but wasn't permitted to do so. He felt sidelined, he said.

In Hart-Smith's analysis, the seeds of Boeing's outsourcing ideas grew out of the McDonnell aircraft business, which focused on military-airplane programs. On the military side of the business, the U.S. government was the major, often the only, customer and it funded development costs in full.

"The military approach didn't require you to risk your own money," Hart-Smith said. "That was the McDonnell Douglas mentality."

He blamed that attitude for the major outsourcing on the MD-95 and proposed MD-12 programs, the failure of which led to the decline of Douglas' commercial-airplane business in California.

The same ideas were transferred to Boeing with the McDonnell Douglas merger and led directly to the 787 outsourcing strategy, he said.

Taken to its extreme conclusion, Hart-Smith said mockingly, the strategy of maximizing return on net assets could lead Boeing to outsource everything except a little Boeing decal to slap on the nose of the finished airplane.

Though most of the profits would be outsourced to suppliers along with all the work, and all the company's expertise would wither away, the return on investment in a 25-cent decal could be 5,000 percent.

Has Boeing belatedly seen the light and embraced Hart-Smith's analysis?

Clearly the 787 has brought a serious rethink at the top.

"We went too much with outsourcing," Albaugh said in the interview. "Now we need to bring it back to a more prudent level."

That likely includes building the horizontal tails of the next version of the Dreamliner, the 787-9, in the Seattle area. And for the next all-new airplane that Boeing will build, Albaugh vows that "we can do things differently and better."

"Doing the new airplane the way we did this one is not what we want to do."

But the rethink may not be as radical as Hart-Smith would like.

In his paper he wrote that while some selective outsourcing is necessary, Boeing should keep most of the work it has traditionally done in-house.

Albaugh balked at going that far.

"I haven't said keep most of the work in-house," Albaugh said. "I still believe we need to make sure we try to access the best technologies and capabilities that are available around the world."

And despite what Hart-Smith has heard on the grapevine, no one from Boeing's leadership has actually called him up to talk about his analysis.

Hart-Smith retired from Boeing in 2008. He still presents engineering papers at academic conferences around the world.

Yet that startlingly prescient 2001 paper focused on business economics. Where did a structures engineer get that kind of expertise?

"It's common sense," Hart-Smith said.

— Dominic Gates

Comments? Send them

to Rami Grunbaum:

rgrunbaum@seattletimes.com

or 206-464-8541.

Information in this article, originally published Feb. 6, was corrected Feb. 7. A previous version of this story referred to "a drive to reduce RONA (return on net assets)" when the effort was to increase that financial ratio.

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