APRIL 10, 2003, NEWS ANALYSIS By Stanley Holmes
A new study says the giant plane maker's actions point to an exit strategy for the low-margin commerical-aircraft business
For several years now, aerospace experts have watched the operations of Boeing Co.(BA ) and wondered: Is the world's biggest commercial-airplane manufacturer angling to get out of that business? Now, a new academic study makes a bold prediction. "Ten years from now, Boeing will be making military and special aircraft, but its days of manufacturing large passenger jets will probably have come to an end," says Alan MacPherson, professor at State University of New York at Buffalo and a co-author of the study published in the March issue of the journal Futures. The study argues that Boeing will transform itself from a manufacturing operation into a global services corporation.
Boeing quickly dismissed the study as "wrong" and declared it has no intention of giving up on a business that accounts for nearly 60% of its total revenue. "This report is riddled with factual inaccuracies and mistaken conclusions," Boeing spokesman Todd Becher told BusinessWeek Online. "We intend to continue our leadership in commercial airplanes for the long term." But MacPherson and co-author David Pritchard base their case on a trend that will be hard to reverse: the shifting of commercial-airplane manufacturing to low-wage outposts overseas, caused partly by the rise of European competitor Airbus Industrie.
PALTRY BACKLOG. What's more, without government help, building commercial airplanes is increasingly too costly and too risky. And Boeing is already moving out of metal-bending to focus on higher-margin tech services and defense businesses. "All the evidence suggests they want to get out of airplane manufacturing," says Pritchard, a PhD candidate with 20 years experience in the aerospace industry.
Other evidence supports their prediction: more than 30,000 layoffs from Boeing's commercial-airplane division over the past two years, continued outsourcing of factory work to Asia and Russia, the sale or closure of 10 million square feet of factory space, and a 60% decline in Boeing's commercial-airplane backlog since 2001. Four of Boeing's six airplane production lines have backlogs of less than 50 aircraft -- a paltry number, Pritchard contends. Generally, the industry considers a backlog of 100 jets or higher to be financially healthy.
Perhaps the biggest barometer will be whether Boeing launches its new superefficient airplane -- the 7e7. Boeing's Blecher says it has a "commitment" to funding the 7e7. But Pritchard is pessimistic in the study. "If they fail to launch the 7e7, this would be the third false start [of new aircraft in recent years], and you have to wonder whether they'll be in the business for the long term," he says. Boeing killed recent efforts to enlarge the 747 and to build a radical superfast jetliner called the Sonic Cruiser.
WHOLE NEW APPROACH. Boeing officials insist they plan to develop a new airplane to replace the aging and slow-selling 767 jetliner. Vice-President Walt Gillette, in charge of designing the new plane, says the company will decide whether to launch the program by yearend. In a recent memo to employees, Gillette wrote, "We all understand how important our performance on this program is to the future of Boeing. We take this responsibility very seriously."
Mike Bair, senior vice-president in charge of the 7e7 program, says his team is working aggressively to put together a competitive business case that will redefine how big jets are designed, built, and sold. The new approach, which is still evolving, aims to keep design and production costs down while improving the fuel and aerodynamic efficiency of the new 250-seat aircraft.
"This program is both a requirement for our future survival and an opportunity for long-term success," Bair said in a recent company publication. "We want to lead the way into the next phase of our industry." At the same time, Bair knows the stakes. "To be in the commercial-airplane business, we have to be able to build new airplanes. If we can't do that, we won't be in the commercial-airplane business for long."
"A LOUSY BUSINESS." Yet Boeing faces some steep financial hurdles. Its last all-new airliner -- the 777 -- cost nearly $14 billion to develop. Pritchard says the 7e7 could cost even more because it will incorporate expensive composites in the wing and switch from aluminum to a titanium-layered fuselage.
Boeing will get its risk-sharing partners to absorb some of the development cost. But with its market cap shrinking to $23 billion on a declining share price, investors might be wary. Says Richard Turgeon, fund manager for Victory Capital Management, which owns 2.1 million Boeing shares: "The commercial-aircraft market is [becoming] a lousy business. It's a commodity." Turgeon says Boeing will have to guarantee that the 7e7 would produce at least an 8% margin over the program's 20-year life to make it worthwhile.
Pritchard thinks he knows what the decision will be. "Is Boeing going to bet the capitalization of its company on the 7e7 when its actions show it's moving away from supporting the commercial-aircraft division?" he asks. "I think the answer will be no."
A NEW NO. 1? The rise of Airbus also has had an impact on Boeing's commercial-airplane division. For the first time, the European jetmaker will surpass Boeing in deliveries in 2003. Boeing lost the largest plane order in 2002 to Airbus -- up to 240 jets -- from European discount carrier EasyJet, which had previously bought only Boeing. And with United Airlines (UAL ) facing possible Chapter 7 liquidation and American Airlines (AMR ) teetering close to declaring Chapter 11, either outcome could mean more surplus aircraft on the market. That could drive production rates even lower.
What's more, Airbus' order backlog is larger than Boeing's -- 1,487 vs. 1,160 planes -- giving it parity with Boeing for the first time since the European consortium's creation 30 years ago. In fact, many analysts who follow the business believe Airbus is poised to supplant its U.S. rival as the No. 1 maker of commercial jetliners.
Part of the reason is that Airbus has been pumping money into the development of new airplanes, such as its 555-seat A380 mega-jumbo jet. Last year, Airbus directed 9% of its sales into research and development, compared with Boeing's 2.7%. The American company's last all-new airplane was the 300-seat 777 jetliner, which is based on early-1990s technology.
EXPORTING KNOWLEDGE. And another dynamic is at work: The new centers of airplane manufacturing are shifting from Seattle, Wichita, and Southern California to Russia to the Asia-Pacific region, the study's authors say. They point to generous transfers of U.S. manufacturing technology and subcontracting agreements that exchanged factory work for the sale of airplanes.
Take South Korea, which had virtually no presence in the sector a few years ago. In 1995, Hyundai obtained engineering and technical specs for building the wings of Boeing's 100-seat 717 airplane. Within two years, Hyundai had purchased state-of-the-art equipment and had successfully built wings for the airplane. Boeing's own equipment for building the same parts is 30 years old, the authors point out.
To Pritchard, that's evidence that Boeing is bailing out of the plane-making business. In an industry with high costs and low volume, offset agreements have been a mechanism to promote sales and shift production work to low-wage countries. "Direct offset agreements between airlines and aircraft producers are designed to transfer a segment of the manufacturing work to the buyer," Pritchard says. "They are prevalent where unit costs are high and sellers are desperate to make a sale."
"NOT COMING BACK." Russia and China are developing 70-seat regional jets, and other countries such as Japan, India, and South Africa are getting into aerospace subcontracting. It's possible that, 10 years from now, Boeing will continue to sell two product lines under its brand -- the 777 and the smaller 737, the study postulates. But gone will be the 717, 747, 757, and 767 jetliners.
What's clear, the authors assert, is that even if a plane bears the Boeing brand, the parts and even final assembly will likely come from another country. "We're foreseeing a radical shift in production of commercial aircraft from the U.S. to overseas," Pritchard says. "And it's not coming back."
Such a strategy could be positive for Boeing and its shareholders because aviation services and high-tech military manufacturing tend to have higher profit margins than the commercial business. But the price would be high -- the likely loss of an additional 20,000 high-skilled engineering and factory jobs in the U.S., the authors say, and the transformation of America's No. 1 exporter in dollar terms into a new kind of 21st century multinational that provides global services.
