Boeing Versus Airbus

by John Newhouse

  Then, not long after Woodard took over as president of commercial operations, Boeing began a price war with Airbus. Discounts on aircraft sales that had averaged 10 percent under Thornton rose to 18 percent and 20 percent, at times even reaching 30 percent. The Woodard strategy was to outproduce Airbus, sponge up market share in the discount war, and in effect bury Airbus, a stated goal of his. He would be remembered for having cut the budgets for producing airplanes while ramping up production with no apparent concern for the costs.

  Woodard’s explicit contempt for Airbus was also made clear. Airbus, he would say, has no product line and is finished. “Ron Woodard was more arrogant than anyone I’ve ever known,” said Jean Pierson. “He had a simple message: We’ll take prices down twenty to twenty-five percent, and Airbus will be unable to follow. We will flood the market with a lot of aircraft. Airbus will be dead. But we did follow Boeing.”23

  Woodard had chosen a bad moment to go to the mat with Airbus. First, Boeing’s 737 line wasn’t selling well. Second, a cluster of people within the company had begun to worry seriously not just about the costs of making Boeing airplanes but about how these costs compared to Airbus’s. They knew that Airbus had adopted lean manufacturing techniques much earlier. They saw Airbus winning numerous competitions. They doubted that government launch aid to Airbus programs explained what was happening. They concluded that lower production costs were allowing Airbus to price its airplanes beneath Boeing’s prices. And they sensed what one of them later called “a cost crisis.”

  The in-house skeptics organized two studies (by outsiders)—one in the latter part of 1995, the other in early 1996—of Airbus’s cost structure. Airbus plants were visited. The results were closely held but shocking. They showed that Airbus and Boeing each had the capacity to supply one half of the world’s aircraft needs. However, Airbus was using 22–23 million square feet of production space. Boeing was using 55 million square feet. And by any measurement, Airbus was shown to have a 12–15 percent cost advantage over Boeing in production and tooling. Boeing’s production costs were shown to be abusively high.

  If taken seriously, the studies argued for a restructuring of Boeing operations and the closure of several of its large operating sites. The corporate executive council—which, of course, included Condit and Woodard—was briefed, and a handful of other senior executives got a similar briefing.

  Curiously, it was on Phil Condit’s first day as CEO, in April 1996, that the results of the first of the two studies were presented to the corporate executive council. The meeting lasted two and a half hours. It was agreed that a major consolidation would have to be undertaken. It was further agreed that 1997 would be a bad year for Boeing.

  “Phil said, ‘Let’s not shoot the messenger,’” according to one closely involved Boeing figure. “That was a courageous act. But he then said that we must keep this information secret from everyone. The top eighteen guys in the company heard it, but not the others. It’s unlikely that the board was exposed to it.”24

  The leadership then began a vigorous campaign aimed at showing that Boeing would make $3 billion in 1997. But the skeptics had information that clearly pointed in the other direction, indicating that the company would be lucky to finish at zero in that year. The data were about $4 billion apart. An idea to close some plants and redesign the company was spiked.

  Some Boeing people felt that Condit was at the bottom of their problems, in large part because he had chosen what one of them called “a one-dimensional salesman, Ron Woodard,” to replace Thornton. The discount rates had gone up, along with the backlog of orders and production. But the high discounts created expectations that they would become industry standards. In that sense, they did long-term damage.

  More immediately, the conflict between higher production rates and reduced spending for production appeared to harbor major trouble. However, Woodard insisted that the operations divisions produce budgets that one of his colleagues said “understated their actual costs. They were being forced to produce unrealistic budgets. Then, in 1997–98, they found themselves having to live within them. Woodard then said he’d been given budget commitments and the divisions didn’t meet these commitments.”25

  Several people in and around Boeing worried that a tsunami-like event lay ahead. In May 1997, a special team formed to review the problem issued a report that concluded, “Our production system is broken.”26 The company had worked through Thornton’s order base and now would somehow have to produce and deliver the aircraft that Woodard had ordered. The problem, big enough by itself, was enlarged by a series of events and mistakes that started in 1995 when many more employees than expected accepted an offer of early retirement. Several of them were engineers whose absence created a delay in the preparation and delivery of blueprints for various aircraft programs. Others were among Boeing’s most highly skilled mechanics.

  Next came a sixty-three-day strike that began late in 1996, coinciding with the production buildup, which in turn led to the hiring of thousands of new workers. But there remained a shortage. Also, the workers who had been on strike had to be resettled in their jobs.

  Finally, in the fall of 1997, the industrial equivalent of a tsunami struck Boeing. The production line couldn’t keep pace with what were being called “the steepest production increases since the dawn of the jet age.” The airline market was coming back from the downturn, and Boeing’s heavily discounted products sold briskly—too briskly. The factories seized up under the strain. Airplanes got out of sequence. Some were being painted before they had been fully built and assembled.

  Boeing’s suppliers were also unequal to the pressure; they couldn’t deliver enough parts, or even the right parts, to the factory floors in Everett, where the 747’s are assembled, and in Renton, where the 737’s are made. The other lines, including the 777, were similarly affected. The plants were running out of aluminum and a broad range of small items such as fasteners used to attach parts to fuselages.

  The largest number of orders involved the 737NG, of which derivatives were being developed and sold. “The 737 had the fastest ramp-up ever,” said John Hayhurst, a highly regarded former Boeing vice president who had at one time been general manager of 737 programs, with responsibility for design and production of that family. However, in the disorder that was under way in Renton, derivatives were being launched before deliveries of the base airplane had been completed. Several Boeing customers whose deliveries were delayed or postponed probably became better targets for Airbus.

  A reporter who covered this string of events recalls seeing “chaos and even panic. There were uncompleted planes parked everywhere—in Renton, around Lake Washington—more parked airplanes than anyone could remember seeing. There were special teams of top mechanics working around the clock, but the workers at every station were way behind. All the lines were out of control. Angry mechanics and machinists were calling the press, saying they were working triple shifts and still behind. But the factory bosses, when called, would say, ‘Everything is fine.’”27

  On October 3, 1997, the company was obliged to announce that it was halting production of both its 737’s and its 747’s for about three weeks. Halting the lines was a radical step. Nothing comparable had occurred in twenty years. And the company would have to pay heavy penalties caused by late deliveries of aircraft.

  A few days later, Harry C. Stonecipher, who had run McDonnell Douglas before the merger with Boeing and was now Boeing’s president and chief operating officer, sent Condit a terse e-mail: “We do know for certain that there is a big surprise coming, and I think we owe the Street a heads-up.” On October 22, Condit did come clean. Boeing’s production meltdown would force the company to write off $2.6 billion, the largest such charge in its history. Overnight, shares fell 8 percent, wiping out about $4.3 billion in value.28

  Condit’s announcement was followed nine days later by a federal lawsuit filed on behalf of shareholders against Boeing’s senior management, specifically Condit, Woodar
d, and Boyd Givan. The suit charged them with knowing the previous spring that sharply hiking production was risky and would cost the company money. “Boeing,” the suit noted, “should have recognized much of [the] known production inefficiencies in the June 30 quarterly financial statements. No such recognition was made due to Boeing’s…desire to maintain [the] stock price until the merger with McDonnell Douglas was complete.” For that reason, ran the argument, “Boeing had to keep the price of its stock increasing, or at least be certain that the price did not decrease, in order to ensure that the merger would be approved by McDonnell Douglas’s shareholders.”29

  In September 2001, four years later, Boeing reached a $92.5 million settlement in the shareholder lawsuit. In an investigation lasting three months, BusinessWeek reported that

  the company did not admit guilt. Although some of the evidence uncovered by the plaintiffs’ lawyers was revealed in court documents, the vast majority was locked under seal at Boeing’s request.

  …Several inside witnesses indicate that Boeing did more than simply fail to tell investors about its production disaster. It also engaged in a wide variety of aggressive accounting techniques that papered over the mess…. Critics say the company should have taken charges for the assembly-line disaster in 1997, even if it meant jeopardizing the McDonnell Douglas merger. They also claim that Boeing took advantage of the unusual flexibility provided by program accounting—a system that allows the huge upfront expense of building a plane to be spread out over several years—to cover up cost overruns and to book savings from efficiency initiatives that never panned out…. None of the outside watchdogs ever barked. The board never forced Condit to come clean about the company’s production problems. Stock analysts and business journalists underestimated them.30

  The events on which the dispute turned occurred in 1997–98, a time when Boeing won a major battle with Airbus for market share, but lost the war. Boeing lost money in 1997 even though it was a peak year for airplane sales. Ron Woodard disappeared, along with profitability. One Saturday in September 1998, Condit summoned Woodard and fired him, according to a cover piece in BusinessWeek. “He told me he had a real close brush with the board, and he was almost dumped two months before,” Woodard told the magazine.31 “In its more than eighty-year history, Boeing has rarely removed one of its top executives,” commented Aviation Week.32

  “One of the most dangerous places to be is first place,” Condit told a visitor late in 2005. “You tell yourself, ‘Our technology is better, our costs are better, and the other guy is cheating.’ You have to be brutally honest with yourself. We should have said what we knew—that Airbus is doing a lot of things superbly. That was not a great lightbulb going off in our heads.”33

  THE FIASCO on the production lines overshadowed, at least for a time, the merger between Boeing and McDonnell Douglas, a far more pivotal and historic event. The merger struck Boeing heritage people—many and probably most of those who were in Seattle—as calamitous; it was, they thought, a marriage of polarized business cultures. It would cost Boeing its equilibrium, they feared.

  Others, notably several major stockholders and various parts of the banking community, were happy to see Boeing join forces with the second largest of the defense and space companies and thereby be able to hedge against the large uncertainties and risks inherent in its core business. Also, the Department of Defense was very glad to see McDac—a preeminent but mismanaged supplier of advanced weaponry—paired with a better and stronger company.

  The merger was never predictable, certainly not in the way that it came about. A few people, including Phil Condit, tried to make it happen, and events played into their hands, as did the steady decline of McDonnell Douglas. In the summer of 1992, it posted a 51 percent plunge in earnings and a 62 percent fall for the Douglas Aircraft division. Wall Street began to wonder whether McDac could or would remain committed to the commercial side of the business. In 1996, Douglas Aircraft obtained only 40 orders for new airplanes, compared to 435 for Boeing and 269 for Airbus.

  Politics at their loftiest inadvertently played a role in the merger. French presidents and British prime ministers have routinely interceded to secure a deal for Airbus. For example, when Airbus sold thirty-six airplanes to Turkish Airlines in July 2004, the announcement was made not by its CEO, Noel Forgeard, who was attending the air show in Farnborough, England, but by Jacques Chirac in Paris.

  Although American presidents have rarely played that game, Bill Clinton did so in October 1995, and thereby probably headed off a bankruptcy filing by McDac. In doing so, he seemed to signal his administration’s intention to do whatever it took to promote the sales of the country’s major earner of foreign exchange.

  The issue was which supplier would be awarded a contract for new airplanes worth $7.5 billion from Saudia Airlines. The Saudis were replacing their entire fleet with sixty-one new aircraft. Shortly before the Gulf War in 1990–91, Saudia had been on the verge of buying a number of Boeing aircraft. After the war, the talks resumed, but by then Airbus had become a major factor and seemed well positioned to capture the business.

  Clinton strongly urged the Saudis, whose security had been bolstered by the war, to buy American. After tilting toward Airbus, King Fahd did change direction and chose to buy off the American shelf, partly because he knew that he was indebted to Washington and partly because of the savage violence in Bosnia. The rejection the year before by France and Britain of Clinton’s proposal to lift the arms embargo in the former Yugoslavia angered Fahd, who had been financing a flow of arms to Bosnian Muslims.

  Boeing and McDac were invited to begin negotiations in Riyadh on March 20, 1996. Given the wretched state of McDac’s commercial operations, the entire award should probably have gone to Boeing. It didn’t. An article in the Seattle Times in January 1994 warned readers that although Clinton had visited Boeing the previous winter, his administration’s focus had shifted to Long Beach, California, where Douglas Aircraft manufactured its airplanes. California, the piece noted, “was crucial to Clinton’s election.”34 Also, Missouri was a so-called swing state, and Saint Louis was headquarters for McDac.

  In the end, Saudia bought twenty-three Boeing 777’s and five 747-400’s, twenty-eight aircraft in all. And it purchased thirty-three airplanes from McDac, four MD-11 freighters and twenty-nine MD-90’s. As seen from Seattle, the good news—that Airbus was beaten on a deal it had expected to win—was mixed with having to divide the business with McDac. Some of Boeing’s board members reacted angrily. “We have to take them off the street,” one of them said.

  Another Washington figure, Deputy Secretary of Defense (and later Secretary) William Perry, also played an indirect role in the merger. On a Friday evening in the summer of 1993, he gave a dinner for a dozen CEOs from the defense industry and told them they had to consolidate. There would have to be fewer such companies. Defense spending had been sliding for five or so years and was expected to fall much further. Mergers, defense buyouts, and sell-offs were under way, and the process would have to accelerate. “We expect defense companies to go out of business,” said Perry afterward. “We will stand by and watch.”35

  It happened. Fifteen of the top defense companies became four. Perry’s dinner is still talked about within industry and government circles—and usually referred to as “the last supper.”

  Phil Condit, who regarded himself as more of a strategic planner than a manager of operations, wanted to buy a major defense company. Boeing, he thought, should have two or more strings to its bow. Condit was a born diversifier. He wanted to take the company into other businesses—satellites, computers, and so forth. Above all, however, he wanted Boeing to become the world’s largest defense contractor.

  Compared to Lockheed and McDac, Boeing was then a lesser player in the defense business. It built bombers and the Minuteman missile system, but it didn’t have “market breadth.” Serious discussions between Boeing and Lockheed got under way, but they didn’t go very far, mainly because L
ockheed was too expensive and also insisted on preserving its name in any merged company. Boeing ruled out a hostile takeover.

  Harry Stonecipher, McDac’s CEO, was in charge of a company that was spiraling downward—fast. He was disinclined to allow funding for development of a new commercial airplane and, indeed, to fund research and development in that side of the house. McDac’s existing commercial programs were a bust. For many years, the DC-10 had been a troubled aircraft that few carriers were prepared to buy. And the MD-11, a jumped-up version of the DC-10, hadn’t tempted the market, not enough anyway, and the company had to take a $2 billion write-off on that plane.

  In 1992, McDac disclosed a design for an airplane called the MD-12, a four-engine jumbojet with double-deck seating for up to six hundred passengers. Some months earlier, the company had announced its intention to sell 40 percent of its commercial aircraft business to Taiwan Aerospace for $2 billion. Quite clearly, the fortunes of the MD-12 and McDac itself were tied to a successful completion of those arrangements. In the end, however, Taiwan Aerospace backed off, and McDac shelved the MD-12.

  Most of McDac’s available resources were tied up in a strenuous competition with Boeing and Lockheed for the new joint strike fighter (JSF), a program that looked as if it might one day be worth $300 billion. But in November 1996, the Defense Department, in the curious idiom of the Pentagon, “deselected” McDac’s design for the aircraft. Only Boeing and Lockheed remained. Lockheed won, and McDac was left high and dry.

  An acquisition by Boeing of McDac had become the only workable solution for McDac, and Stonecipher was determined to make it happen. His thinking was fully shared by John McDonnell, the chairman, and by Phil Condit. Twice McDonnell and Stonecipher talked with Frank Schrontz about a “merger,” the term both sides chose to call one company’s purchase of another. Schrontz declined both times, partly because Stonecipher wanted an unacceptably large role in the combined company. In Seattle, he was seen as a potent, hard-driving figure who, unless controlled by another such figure, would take control. “Our chief concern was Harry,” recalled one Boeing veteran who is still closely involved with the company. “He was feared—seen as a guy who in three years could become CEO. It took about that long.”36