Brake
problems. A fuel leak. A cracked windshield. One electrical fire. Then
another. An emergency landing in Japan. A safety investigation imposed
by the FAA. Then two premier customers—Japan’s two main airlines, ANA
and JAL, ground their fleet of Boeing [BA] 787s. Then the FAA grounds
all 787s used by the only American carrier. Now other regulators around
the world follow suit, grounding all 50 of the 787s delivered so far.
The regulatory grounding of an entire fleet is unusual—the first since
1979—and relates to a key to the plane’s claimed energy-efficiency: the
novel use of lithium ion batteries, which have shown a propensity to
overheat and lead to fires—fires that generate oxygen and hence are
difficult to put out.
And keep in mind: Boeing’s 787 project is already billions of dollars
over budget. The delivery schedule has been pushed back at least seven
times. The first planes were delivered over three years late. In fact,
out of a total of 848 planes sold, only 6 percent have been delivered.
Yet grave as these issues seem, they are merely symptoms of a deeper
disease that has been gnawing at the US economy for decades: flawed
offshoring decisions by the C-suite. Offshoring is not some menial
matter to be left to accountants in the backroom or high-priced
consultants armed with spreadsheets, promising quick profits. It raises
mission-critical issues potentially affecting the survival of entire
firms, whole industries and ultimately the economy.
Not just Boeing: an economy-wide problem
Thus Boeing is hardly alone in making flawed offshoring decisions.
Boeing is just the latest and most spectacular example of an
economy-wide problem.
“Many companies that offshored manufacturing didn’t really do the
math,” Harry Moser, an MIT-trained engineer and founder of the
Reshoring Initiative told me. As many as 60 percent of the decisions were based on miscalculations.
As noted by Gary Pisano and Willy Shih in their classic article, “
Restoring American Competitiveness”
(Harvard Business Review, July-August 2009), offshoring has been
devastating whole US industries, stunting innovation, and crippling
capacity to compete long-term.
Pisano and Shih write: “The decline of manufacturing in a region sets
off a chain reaction. Once manufacturing is outsourced,
process-engineering expertise can’t be maintained, since it depends on
daily interactions with manufacturing. Without process-engineering
capabilities, companies find it increasingly difficult to conduct
advanced research on next-generation process technologies. Without the
ability to develop such new processes, they find they can no longer
develop new products. In the long term, then, an economy that lacks an
infrastructure for advanced process engineering and manufacturing will
lose its ability to innovate.”
Pisano and Shih have a frighteningly long list of industries that are
“already lost” to the USA, including: compact fluorescent lighting;
LCDs for monitors, TVs and handheld devices like mobile phones;
electrophoretic displays; lithium ion, lithium polymer and NiMH
batteries; advanced rechargeable batteries for hybrid vehicles;
crystalline and polycrystalline silicon solar cells, inverters and power
semiconductors for solar panels; desktop, notebook and netbook PCs;
low-end servers; hard-disk drives; consumer networking gear such as
routers, access points, and home set-top boxes; advanced composite used
in sporting goods and other consumer gear; advanced ceramics and
integrated circuit packaging.
The list of industries “at risk” is even longer and more worrisome.
Now unless Boeing can quickly fix the technical issues afflicting the
787, its entire airline business will also be “at risk”. Manufacturing
airplanes could even become an addition to the list of industries
“already lost.”
These issues are a wakeup call not just to Boeing but to every CEO
whose firm or whose suppliers have been or will be involved in
offshoring. Every CEO must learn seven lessons.
1. 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. This is easily done with the help of the
Reshoring Initiative, whose website includes an analytical tool enabling
companies to calculate the full risks and costs of offshoring. It’s
called the
Total Cost of Ownership Estimator[TM]. And the price is right. It doesn’t require hiring high-priced consultants: it’s free.
The Estimator poses a series of questions. What’s the price of the
part from each of the destinations? How far is it away? How often are
you going to travel to see the supplier? How much intellectual property
risk is there? How long do you think you are going to make it? It uses
the answers to calculate twenty-five different costs. When they are
added up, that’s the Total Cost of Ownership.
Most companies have tended to make their sourcing decisions based on
the wage rate or the ex-works price or the landed cost, and leave out
another twenty cost categories. The Estimator makes it easy for the
company to calculate the other twenty costs.
“Often what firms find,” says Moser, “is that whereas the offshoring
price is perhaps 30 percent less than the US price, all these other
costs add up to more than 30 percent. If they are willing to recognize
all of them, then they can see that it may be profitable to bring the
work back.”
“For instance,” says Moser, “I took the last 27 cases where users
compared China to the US. On average, the US price was 69 percent higher
than the production price in China. It turned out that the US total
cost of ownership was 4 percent lower. So it made a huge difference to
make that calculation. That’s an indication that a substantial portion
of the work that has been offshored would come back if people would use
the right metrics.”
2. Review whether earlier outsourcing decisions made sense
Let’s back up a bit and note that Boeing’s problems have been visible for some time. In August 2011,
my article drew attention to the perilous offshoring course on which Boeing was embarked.
In December 2012, fellow Forbes contributor
Jonathan Salem Baskin wrote:
“The company was convinced by one or more management consulting firms
to outsource design and production of the 787’s components. While this
idea might make sense for sourcing coffeemakers, it was a nonsense
approach to assembling perhaps the most complicated and potentially
dangerous machines shy of nuclear reactors. I’m sure blather from
Harvard Business Review supported the idea that distances between
factories in
Seattle
and Outer Mongolia were no farther than a VOIP chat, but the reality
was a mess. Parts didn’t fit together with others. Some suppliers
subcontracted work to
their suppliers and then shrugged at
problems with assembly. When one part wasn’t available, the next one
that depended on it couldn’t be attached and the global supply chain all
but seized up. Boeing had to spend $1 billion in 2009 to buy one of the
worst offenders and bring the work back in-house.”
“The grounding — an unusual action for a new plane — focuses on one
of the more risky design choices made by Boeing, namely to make
extensive use of lithium ion batteries aboard its airplanes for the
first time,” write Christopher Drew, Jad Mouawad and Matthew Wald in the
New York Times:
“The 787’s problems could jeopardize one of its major features, its
ability to fly long distances at a cheaper cost… The maker of the 787’s
batteries, Japan’s GS Yuasa, has declined to comment on the problems so
far. “
What was Boeing thinking when they opted to embrace such extensive
offshoring? Moser 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,” Harry Moser, an MIT-trained
engineer and founder of the Reshoring Initiative told me. “A study 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.”
For many companies, it’s time to redo the math, and then verify
whether they still have the expertise to bring manufacturing back.
3. Don’t outsource mission-critical components
“Boeing has acknowledged, says Moser, “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. It seems
like they had this brilliant idea of outsourcing a lot of engineering
with the manufacturing. There’s almost nothing as complicated as a
Dreamliner.
“For example, an iPhone isn’t nearly as complicated. The downside
risk isn’t as great. Apple has succeeded with outsourcing almost
everything to Foxconn, mainly because they first completely manufacture
the new product in the US. They make sure it’s right, while Foxconn is
working in parallel with them, developing their tooling and whatever. So
Apple has a finished product and they say to Foxconn: make it just like
this! What Apple has done has worked amazingly well, because they have
the capability to do the perfect prototype here, before it gets
offshored to Foxconn. Most companies don’t have that.
“Thus Boeing didn’t have a finished product. So there were all kinds
of risks of things not coming together. The tendency is too often for
companies to try to do the engineering over here and the manufacturing
over there. Eventually the innovation declines and the risk increases,
as outlined by Pisano and Shih.”
4. Bring some manufacturing back
Moser estimates that when the total costs are included, around
25 percent
of manufacturing that is currently outsourced could be profitably
brought home, if the manufacturing expertise still exists. Looking
ahead, changes in relative economics are likely to increase that
percentage.
It is important to take into account rapid changes in relative costs.
Oil prices are three times what they were in 2000. Natural gas in the
US is a quarter of what it is in Asia. Chinese wages are five times what
they were in 2000 and are expected to keep rising rapidly. And in any
event labor is a steadily decreasing percentage of the cost of
manufacturing.
Reshoring is already happening to a limited extent. Apple [AAPL]
announced recently that it will resume manufacturing of one of the
existing Mac lines in the US next year. GE [GE] is spending some $800
million to re-establish manufacturing in its giant facility—until
recently, almost defunct—at Appliance Park, in Louisville, Kentucky.
Whirlpool [WHR] is bringing mixer-making back from China to Ohio. Otis
is bringing elevator production back from Mexico to South Carolina. And
Wham-O Toys is bringing Frisbee-molding back from China to California.
Based on the reshoring articles in the
ReshoreNow Library, Moser calculates that at least 50,000 manufacturing jobs have recently been reshored in the last three years.
Where companies see that it could be profitable to bring
manufacturing back, they will need to ensure that they either have or
can rebuild the necessary expertise—sometimes a daunting challenge.
5. Adequately assess the risk factors of offshoring
In Boeing’s case, as Jonathan Salem Baskin notes: “It didn’t help
that 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. Oh, 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.”
Clearly firms have underestimated the risk of having extended
international supply chains. I asked Moser whether Total Cost of
Ownership Estimator can help firms get a better handle on that risk.
“The TCO Estimator assigns no factor values apart from freight,” says
Moser. “The user assigns all the factors. The user answers questions
about the delivery time, and the price. That enables the Estimator’s
algorithm to assess the inventory and the inventory carrying costs.
There’s a section on opportunity cost. If the firm will lose orders
because it can’t deliver, then put a value on that. There are sections
on natural disaster risk and political risk. “
If Boeing had been using this earlier what would be the implications?
If they underestimated the delay risk or the technical risk as low, the
Estimator would have reflected the underestimation of the risk.
“The Estimator would have encouraged them to try to estimate each of
the risks,” says Moser. “When you have twenty-five of them, you only
have to put in 1 percent in each to balance the savings you might get
from going offshore.
“If you are buying pencils, not much intellectual property risk; if
you can’t get it from this source, you can get it from somewhere else.
The margins aren’t big, so you don’t lose so much. You don’t have much
image to lose. But when you are making airplanes, there’s a lot of risk.
Instead of having one size fit all, the Estimator lets you adapt for
each product, each market, and make a more holistic and informed
decision.
“The Reshoring Initiative site also offers resources. Library
contains articles about transportation industry and equipment, and firms
can understand where production was reshored and why. They might
conclude: ‘Looks like a lot of companies are having problems with these
things. Maybe we should increase our risk levels?’
“The Initiative also has information on what other users have found
on the distribution of average costs. If they look at that, they might
realize that some costs and risks have been underestimated. So the
Estimator can help them make better decisions.”
6. Adequately value the role of innovation
Much of the offshoring that has taken place has assumed that the
outsourced items are “little do-hickeys” with low value and so didn’t
really matter much in the overall scheme of things. The little
do-hickeys are worth pennies or less and have next-to-no margin. While
those “little do-hickeys” might seem cheap in themselves, the lessons to
be learned in improving their manufacture in the end 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.)
Firms often haven’t thought through how often they are going to
redesign this product. “If it’s a bracket and you’re not going to
redesign it for 30 years, it doesn’t matter very much,” says Moser.
These days however there are very few components that are good for
another thirty years. “If it is something that you are updating every
six months or every year, then that becomes a lot more important. It’s
the difference between a commodity and something that’s design-driven.
The result of answering those questions is an ‘innovation cost of being
at a distance.’ The Reshoring Initiative has resources so that firms can
develop the understanding to make better decisions.“
The opportunity cost of lost innovation can be significant. Thus when
GE decided to bring manufacturing of its innovative GeoSpring water
heater back from the “cheap” Chinese factory to the “expensive” Kentucky
factory, the cost of production went down. “The material cost went
down. The labor required to make it went down. The quality went up. Even
the energy efficiency went up. GE wasn’t just able to hold the retail
sticker to the ‘China price.’ It beat that price by nearly 20 percent.
The China-made GeoSpring retailed for $1,599. The Louisville-made
GeoSpring retails for $1,299.
GE’s water heater as originally designed for manufacture in China had
a tangle of copper tubing that was difficult to weld together. In the
past, GE had been shipping the design to China and telling them to “make
it”. Confronted with making the water heater themselves, they
discovered that “in terms of manufacturability, it was terrible.” So
GE’s designers got together with the welders and redesigned the heater
so that it was easier and cheaper to make. They eliminated the tangle of
tubing that couldn’t be easily welded. By having those workers right at
the table with the designers, the work hours necessary to assemble the
water heater went from 10 hours in China to two hours in Louisville.
“For years,” Charles Fishman writes in
a great article in The Atlantic,
“too many American companies have treated the actual manufacturing of
their products as incidental—a generic, interchangeable, relatively
low-value part of their business. If you spec’d the item closely
enough—if you created a good design, and your drawings had precision; if
you hired a cheap factory and inspected for quality—who cared what
language the factory workers spoke? … It was like writing a cookbook
without ever cooking…. there is an inherent understanding that moves out
when you move the manufacturing out. And you never get it back.”
What is only now dawning on the smart American companies, Lou Lenzi,
head of design for GE appliances says, is that when you outsource the
making of the products, “your whole business goes with the outsourcing.”
7. Get to the root of the problem: maximizing shareholder value
While several decades of outsourcing were under way, why didn’t these
smart managers think about the importance of innovating and protecting
intellectual property? Why didn’t these well-educated managers realize
that it was important to have designers, engineers, and assembly-line
workers talk to each other? Why didn’t these MBA graduates realize that
outsourcing might be mortgaging the future of their firms?
“There was a herd mentality to the offshoring,” John Shook, the CEO
of the Lean Enterprise Institute, in Cambridge, Massachusetts. “And
there was some bullshit. But it was also the inability to see the total
costs—the engineers in the U.S. and factory managers in China who can’t
talk to each other; the management hours and money flying to Asia to
find out why the quality they wanted wasn’t being delivered. The cost of
all that is huge.”
When managers manage with a spreadsheet rather than real-world
knowledge about what is actually going on in the factory and what were
its possibilities, they overlook hidden costs of the erosion of skills,
the loss of quality and constraints on innovation. They also missed the
potential added value to customers that could be generated by designing
and manufacturing things differently. They also missed the costs and
risks of an international supply chain, which is increasingly out of
step with the shorter, faster product cycles.
Why did 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 ended up destroying vast quantities of long-term
shareholder value.
A focus on maximizing shareholder value leads the firm to do things
that detract from maximizing long-term shareholder value, such as
offshoring, favoring cost-cutting over innovation, and pursuit of
“corner cutting” and “bad profits” that destroy brand equity. The net
result can be seen in the disastrously declining ROA and ROIC over the
last four decades in large US firms as documented by Deloitte’s Shift
Index.
The errors of offshoring are thus not isolated events. They are the
result of the underlying philosophy of shareholder value, rather than
the true purpose of every firm: create value for customers. The
resurrection of American manufacturing will require more than simply
bringing back production to America. Global manufacturing is at the cusp
of a massive transformation as the new economics of energy and labor
plays out and a set of new technologies—robotics, artificial
intelligence, 3D printing, and nanotechnology—are advancing rapidly.
Together these developments will spark a radical transformation of
manufacturing around the world over the next decade. The winners in the
rapidly changing world of manufacturing will be those firms that have
mastered the agility needed to generate rapid and continuous
customer-based innovation.
Success in this new world of manufacturing will require a radically
different kind of management from the hierarchical bureaucracy focused
on shareholder value that is now prevalent. It will require a different
goal (adding value for customers), a different role for managers
(enabling self-organizing teams), a different way of coordinating work
(dynamic linking), different values (continuous improvement and radical
transparency) and different communications (horizontal conversations).
Merely shifting the locus of production is not enough. Companies need
systemic change—a new management paradigm.
Pursuit of maximizing shareholder value at Boeing led to offshoring
that has caused massive damage to shareholder value. The eventual scale
of the damage can only be guessed at today. The remedy lies not in
pointing fingers at Boeing’s management, but rather in treating the
economy-wide disease that caused the problem.
And read also:
________________________
Steve Denning’s most recent book is:
The Leader’s Guide to Radical Management (Jossey-Bass, 2010).
Follow Steve Denning on Twitter @stevedenning
British Prime Minister David Cameron wants nothing to do with
a United States of Europe, an idea that's gaining currency as the
countries that use the euro struggle to fix their debt crisis.
Nigeria's external reserves stood at
US$43.849 billion at the end of 2012, representing an increase of
US$1.682 billion or about 3.98% from the level of US$42.167 billion
recorded by the end-October last year.
39-year-old Mikel Ruffinelli, who lives in Los Angeles has the widest hips in the world.
We remain the most prosperous, powerful nation on Earth. Our workers are
no less productive than when this crisis began. Our minds are no less
inventive, our goods and services no less needed than they were last week or
last month or last year. Our capacity remains undiminished. But our time of
standing pat, of protecting narrow interests and putting off unpleasant
decisions - that time has surely passed. Starting today, we must pick
ourselves up, dust ourselves off, and begin again the work of remaking
America.
