01/22/2013 07:07 pm ET Updated Mar 24, 2013

Market Discipline for the Boeing 787

My career is invested in the aerospace industry, so it was very sobering to me when the FAA ordered that 787 airplanes be grounded.

Friends ask me to explain the situation -- what lessons can we draw from the 787? Invariably, we start with "outsourcing."

True, the 787 is heavily outsourced. However, Boeing's previous airplane, the 777, was also heavily outsourced.

The lesson I learn starts with the large investment Boeing made on the 777 program to integrate all the key stakeholders into design and manufacturing teams, so we could react promptly when problems came up. In business school, that's known as a coordination cost.

Years ago, a thoughtful patient financial analyst explained to me that the 777 program went way over budget, because we had too many coordination costs. Do we really need 40 people at status meetings? Does Boeing really need 120 propulsion engineers on a program, when GE and Pratt & Whitney already have 175 propulsion engineers?

He explained to me that markets can perform all that coordination more efficiently. "Market discipline" would replace all those integrated design and manufacturing teams.

At the time I wasn't sure what he meant. Maybe it's this. If your cell phone breaks, you might try another manufacturer. Or if American Airlines strands you in Dallas, you book with a different airline next time.

Now, almost nine years into the 787 program, I think I see it.

Vought and Global Aeronautica -- two key suppliers on the 787 program -- gave Boeing some market discipline when they said, "This isn't working for us," sold their facilities to Boeing, and got off the program.

Air India went after Boeing for $800 million dollars when deliveries fell three years behind schedule, giving Boeing some more market discipline. Boeing and a Japanese battery company are now experiencing plenty of market discipline discipline from the widely publicized battery issues on 787s.

Of course, the entire supply chain and airline customers are sharing extra helpings of discipline too, with delays, rework, lost market opportunities, and production headaches.

Some analysts estimate that cost overruns on the 787 program are at least $10 billion, and maybe much more.

The 777 program leaders built in, from the beginning, the engineering problem-solving culture we used successfully on decades of previous programs. Technical leaders could capitalize on trust built through teamwork to allocate sacrifice to some stakeholders, and focus extra resources elsewhere, optimizing on the program overall. This is best done upstream in the course of a program -- assuming you have the decision-making authority, which was intrinsic to the 777 business model.

It's much harder to solve problems downstream, and harder still, if, like on the 787, you have weak decision-making authority and poor understanding of what other stakeholders are doing.

The 777 was built on schedule and delivered on time; it qualified for long-range operations over water at entry into service; it had great dispatch reliability from the beginning; it is currently making customers happy; and is making money for shareholders.

In contrast, the business culture on the 787 program was structured, from the beginning, to skip all those coordination costs. The 787 business model relies much more on suppliers for design and manufacturing. Coordination and problem-solving are relatively weak. Program leaders seem paralyzed when problems come up, because authority for fixing problems is also diffused into the supply chain.

In business school terms, it can be expressed this way. Are airplanes more commodity-like or are they performance-driven products? I can think of my cell phone as commodity-like, and replace it with another brand. I can switch airlines to get from Dallas to Chicago, which makes air travel more commodity-like.

On the other hand, when airline customers pay $100 million for an airplane with a 25 year service life, they expect a reliable, heavily-engineered, performance-driven product.

Commodities might do well in the global supplier business model, regulated by market discipline. To the extent airplanes are more performance-driven, it makes sense to pay higher up-front coordination costs.

In 2000-2002, financial analysts and some Boeing executives assured me that airplanes were commodity-like. By the way, so did my cousin Sidney, a business school professor, who I greatly respected. He was arguably the smartest guy to come out of my home town, Flint Michigan.

Their thinking was that airplane manufacturing was a "mature" industry, so cost-cutting and outsourcing were appropriate.

At the time, I said, "Well I certainly doubt that our industry is 'mature' or that airplanes are commodities. But, I'm a physicist. Let's do the experiment."

We've done the experiment. Really.

At this point, I don't see how you can argue that the 787 business model is more "efficient" than the strong integrated teams we had in earlier programs.

Now, to see if anyone has learned a lesson.