The Coming Boeing Bailout?

(Big issue 7-3-2019)

Hi,

Welcome to Big, a newsletter about the politics of monopoly. If you like it, you can sign up here. Today I’ll discuss how a merger in the 1990s ruined Boeing, and why the government will have to step in to save the company.

Let’s start by admiring the company that was Boeing, so we can know what has been lost. As one journalist put it in 2000, “Boeing has always been less a business than an association of engineers devoted to building amazing flying machines.”

For the bulk of the 20th century, Boeing made miracles. Its engineers designed the B-52 in a weekend, bet the company on the 707, and built the 747 despite deep observer skepticism. The 737 started coming off the assembly line in 1967, and it was such a good design it was still the company’s top moneymaker thirty years later.

How did Boeing make miracles in civilian aircraft? In short, the the civilian engineers were in charge. And it fell apart because the company, due to a merger, killed its engineering-first culture.

What Happened?

In 1993, Clinton’s Deputy Secretary of Defense, Bill Perry, called defense contractor CEOs to a dinner, nicknamed “the last supper.” He told them to merge with each other so as, in the classic excuse used by monopolists, to find efficiencies in their businesses. The rationale was that post-Cold War era military spending reductions demanded a leaner defense base. In reality, Perry had been a long-time mergers and acquisitions investment banker working with industry ally Norm Augustine, the eventual CEO of Lockheed Martin.

Perry was so aggressive about encouraging mergers that he put together an accounting scheme to have the Pentagon itself pay merger costs, which resulted in a bevy of consolidation among contractors and subcontractors. In 1997, Boeing, with both a commercial and military division, ended up buying McDonnell Douglas, a major aerospace company and competitor. With this purchase, the airline market radically consolidated.

Unlike Boeing, McDonnell Douglas was run by financiers rather than engineers. And though Boeing was the buyer, McDonnell Douglas executives somehow took power in what analysts started calling a “reverse takeover.” The joke in Seattle was, "McDonnell Douglas bought Boeing with Boeing's money."

The merger sparked a war between the engineers and the bean-counters; as one analyst put it, "Some of the board of directors would rather have spent money on a walk-in humidor for shareholders than on a new plane." The white collar engineers responded to the aggressive cost-cutting and politically motivated design choices with the unthinkable, affiliating with the AFL-CIO and going on strike for the first time in the company’s 56-year history. "We weren't fighting against Boeing," said the union leader. "We were fighting to save Boeing."

The key corporate protection that had protected Boeing engineering culture was a wall inside the company between the civilian division and military divisions. This wall was designed to prevent the military procurement process from corrupting civilian aviation. As aerospace engineers Pierre Sprey and Chuck Spinney noted, military procurement and engineering created a corrupt design process, with unnecessary complexity, poor safety standards, “wishful thinking projections” on performance, and so forth. Military contractors subcontract based on political concerns, not engineering ones. If contractors need to influence a Senator from Montana, they will place production of a component in Montana, even if no one in the state can do the work.

Bad procurement is one reason (aside from more and more high-ranking military officials going into defense contracting work) why military products are often poor quality or deficient. For instance, the incredibly expensive joint strike fighter F-35 is a mess, and the Navy’s most expensive aircraft carrier, costing $13 billion, was recently delivered without critical elevators to lift bombs into fighter jets. Much of this dynamic exists because of a lack of competition in contracting for major systems, a practice enhanced by the consolidation Perry pushed in the early 1990s. Monopolies don’t have to produce good quality products, and often don’t.

At any rate, when McDonnell Douglas took over Boeing, the military procurement guys took over aerospace production and design. The company began a radical outsourcing campaign, done for political purposes. In defense production, subcontractors were chosen to influence specific Senators and Congressmen; in civilian production, Boeing started moving production to different countries in return for airline purchases from the national airlines.

Engineers immediately recognized this offshoring as a disaster in the making. In 2001, a senior Boeing engineer named L. Hart Smith published a paper criticizing the business strategy behind offshoring production, noting that vital engineering tasks were being done in ways that seemed less costly but would end up destroying the company. He was quickly proved right.

The first disaster was Boeing’s 787 Dreamliner, a test case in how to attempt to cut costs and end up driving up expenses. The company went over budget by something like $12-18 billion. As Sprey and Spinney put it, “You don't have to be wearing a deer-stalker hat to deduce that the rotten practices bred by DoD procurement have finally infected the executive suite of Boeing's commercial division.” Aside from the offshoring of key capacity, the 787 had significant engineering problems, including electrical systems that caused battery fires on the planes.

In 2005, Boeing hired its first ever CEO without an aviation engineering background, bringing in James McNerney, who got his training in brand management at Proctor & Gamble, then McKinsey, and then spent two decades at General Electric learning from Jack Welch how to erode industrial capacity in favor of shareholders. He brought these lessons to Boeing, and hurriedly launched a 737 version with new engines, the 737 Max, to compete with a more fuel-efficient Airbus model.

The key decision was, rather than fix the fundamental aerodynamic control problems caused by the new engine, to bandaid the existing 737 software, while pretending that flying the 737 Max was just like flying old ones. That way, airlines would be able to buy the plane and not have to retrain their pilots, as pilots must be re-certified any changed flight procedures but don’t have to be recertified for new models with unchanged flying qualities. Unfortunately, the aerodynamics of the 737 body didn’t fit with the Max’s bulkier engine, which was obvious during the first wind tunnel tests.

The testing in 2012, with air flow approaching the speed of sound, allowed engineers to analyze how the airplane’s aerodynamics would handle a range of extreme maneuvers. When the data came back, according to an engineer involved in the testing, it was clear there was an issue to address.

The old Boeing would have redesigned the plane’s control surfaces to fix the faulty aerodynamics, but the McDonnell Douglas influenced Boeing new one tried to patch the problem with software. And it was bad software, some of written by outsourced engineers in India paid $9/dollar an hour. The Federal Aviation Administration, having outsourced much of its own regulatory capacity to Boeing, didn’t know what was going on, and Boeing didn’t tell airlines and pilots about the new and crucial safety procedures.

This disregard for engineering integrity and safety had come from the Wall Street driven financialization of the 1990s, through General Electric’s McNerney, but also from military procurement culture. Current CEO Dennis Muilenburg, for instance, has presided over a series of problematic projects in the defense division, from the X-32, the losing entry in the F-35 joint strike fighter contract, to the long-troubled Airborne Laser system. Muilenburg has handled the 737 Max problem the way a defense official would, through public relations and political channels rather than the way a civilian engineer would, which would be through an aggressively honest review of engineering choices.

The net effect of the merger, and the follow-on managerial and financial choices, is that America significantly damaged its aerospace industry. Where there were two competitors - McDonnell Douglas and Boeing, now there is one. And that domestic monopoly can no longer develop good civilian aerospace products. Hundreds of people are dead, and tens of billions of dollars wasted.

Boeing now has a rocky situation ahead of it. Buyers in the international market have little trust in the current leadership of the company, and it will face significant liability from victim families and from airlines who bought the jet, as well as mass cancelations of orders. There is a criminal investigation into the company, as there should be. This like likely to have significant and severe financial consequences.

The right policy path would be Congressional hearings to explore what happened to this once fine company, followed by a break-up of the company into a civilian and military division, or if possible, find a way to create multiple competitors out of this fiasco. Muilenburg should be fired, his compensation clawed back, and the Department of Justice should clean house and indict every relevant executive who empowered what looks like fraud at the core of the 737 Max fiasco. Congress should expand the FAA inspectors so they can once again do their job. With a new leadership team in place, Boeing could fix the 737 Max and begin planning great aircraft again.

In other words, we should put safety conscience civilian engineers back in charge of both building planes and regulating them. Otherwise, planes fall out of the sky.

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cheers,

Matt Stoller