The flaws inherent in this management model were widely judged to far outweigh its benefits. The driving principle—making money on every deal—excluded a sharp focus on gaining or protecting market share. By contrast, Airbus, which seemed then to be doing everything right, was all about market share. In the five years preceding 9/11, it had erased Boeing’s dominance and pulled even in aircraft sales.
In late July 2003, the Economist zeroed in on Boeing in a long and highly critical piece. “Boeing,” it began, “this week reported a net loss of $192 million in the second quarter, due largely to a $1.1 billion write-off in its space business. This is the latest misfortune to hit the firm, which has been remarkably accident prone since moving its head office to Chicago from Seattle in September 2001, days before its civil aviation business was thrown into crisis by the terrorist attacks. The move was supposed to symbolize its strategy of diversifying into defence, space and aviation services markets, such as air-traffic management.
“The latest troubles, though, concern a business that was to offer relief from the woes of civil aviation. Boeing has poured $5 billion into its space business since the mid-1990s, assuming a boom in satellites and launcher rockets as demand for broadband communications grew. The telecoms bust ended that boom before it began. Boeing is now shrinking its satellite business and focusing on government contracts.”5
By the spring of 2004, the Puget Sound area had lost a hundred thousand jobs. By then, Boeing was being widely seen as peripheral, “an ex-spouse who is still hanging around the neighborhood,” as some people described the relationship. For them, Boeing’s transplanted headquarters were better suited to an investment bank; there were no airplanes to be seen in downtown Chicago, none of the large interior spaces in which aircraft are assembled.
BOEING’S AFFAIRS were actually less bleak than they impressed Seattle as being. The company was holding huge reserves of cash and marketable securities, even while spending heavily to shore up its pension plan. However, the Seattle-based Boeing Commercial Airplanes group (BCAG) had been steadily losing ground to Airbus and was widely seen as mismanaged.
In looking hard at BCAG, a few investment banks saw company strengths, real and potential, as more than offsetting obvious weaknesses. That view was held by the IAM (International Association of Machinists), a persistent critic/antagonist of Boeing Seattle. The union’s leadership felt that BCAG lacked direction and was being underfunded by management. Transferring the company’s headquarters to Chicago struck the IAM as a move aimed, in effect, at demoting the company. The IAM felt that it could do a much better job of running it.
In the fall of 2003, the union’s leadership had discussions with one investment bank, Merrill Lynch, about looking into the merits of separating the commercial group from the defense and space parts of the company—in effect, undoing the mergers, since nearly all of the people in those divisions were products of McDonnell Douglas or from Rockwell International, which Boeing had acquired in 1996. As seen by various Wall Street analysts, separating the Boeing Commercial group would amount to reaffirming its commitment to building airplanes. Serious doubts had been planted. The move would also detach Boeing Commercial from heavily politicized Defense Department budget allocations and the high-profile struggles for contracts to build weapons. The thinking was that an independent enterprise could achieve cost savings that would not be possible if it remained part of a conglomerate.
Besides Merrill Lynch, the union spoke with a private equity group that knew the aerospace business (and insists on anonymity). “We talked to the Wall Street people about equity and debt management,” recalls Steve Sleigh, IAM’s director of strategic resources. “The analysis showed that Boeing Commercial was a tremendously undervalued asset. At the time, Boeing stock was trading at $35 per share. Boeing Commercial’s contribution to that valuation was less than $3. So we thought, ‘Spin Boeing Commercial off and create new value for it and restore its focus.’ We believed that this plan would get a lot of support on Wall Street.”6
It did. The private equity group was prepared to write a check for $1 billion then and there as an earnest of its intention to invest seriously in the venture. The spin-off of BCAG, if agreed to by Boeing’s leadership, would mean buying very cheaply the aviation industry’s preeminent name and one of its two remaining suppliers of big airliners.
IAM’s president, Thomas Buffenbarger, discussed the proposal with Condit, who said he would take it to the board. But Condit was deposed within a few weeks of the meeting. Asked about the IAM proposal, he said, somewhat guardedly, “In the long run, the commercial [business] will always be cyclical. It’s always undervalued at the bottom and over-valued at the top. I always listened carefully to any proposal.”7 He declined to elaborate.
Once he had replaced Condit as leader, Stonecipher’s third phone call, he says, was to Buffenbarger; he wanted to get off on the right foot with a very powerful union. Stonecipher recalls that, at a breakfast together, Buffenbarger “asked me to look at the proposal.” Condit had not mentioned it to the board, of which Stonecipher, of course, was a member, or to him privately. Stonecipher reviewed the proposal and rejected it. He remembers saying, “I am the second-biggest individual shareholder. This company has a great future. [He meant Boeing Commercial.] It can become a lot better than it has been. If the company is undervalued, I intend to demonstrate that to the shareholders.”8 Stonecipher is not evasive. He is unsubtle and direct, a lot more so than many of the senior people whom he worked with at Boeing. He is described as having said, “This would have been a great idea with Phil running the company, but I think I can run it a lot more productively than he did.”
“Our investors were very disappointed,” said Sleigh. “They thought the Boeing Commercial group would be a great asset. We all thought the merger [with McDac] produced the worst possible synergy. What did Boeing get? Granted the stock has gone up, and granted the company had deeper pockets to fall back on. But what it also got was the move to Chicago and military scandals.”9
IN 2001, Boeing lost the F-35 combat fighter award to Lockheed Martin. It was the biggest defense contract ever. Then, over the summer of 2003, the company began reeling from a series of setbacks in the military and space sectors. After it had just expanded its space business at a cost of $5 billion so as to build in an offset for losses on the commercial side, overcapacity in both the satellite and the launch markets dictated a heavy cutback in the space sector. In July, a grand jury indicted Boeing executives for swiping twenty-five thousand pages of proprietary documents belonging to Lockheed Martin during bidding for rocket contracts from the air force. The air force reacted by stripping about $1 billion from Boeing in current and future rocket business.
Condit then took the questionable step of sending an open letter of apology, a corporate mea culpa, that was published in several newspapers. Calling attention to the affair was seen by a number of people in and out of the industry as a mistake. Pointing up the incident, they felt, could further threaten the credibility of Boeing’s efforts to reduce its heavy dependence on commercial aircraft sales by diversifying into military hardware.
In the past, Boeing hadn’t invited serious trouble of this kind because it had taken steps to avoid it. In the mid-1960s, Boeing had shifted its priorities away from the Pentagon to the commercial airplane business, after deciding that the U.S. government was not a reliable customer for its airplanes because of the arbitrary, if not outrageous, manner in which the winners of major military airplane programs were chosen. In changing direction, Boeing took a gamble on the commercial sector to a degree unmatched by any other American company.10 And as it began to dominate the market for LCA, Boeing’s leadership took steps to insulate its commercial sector from corrupt practices that were endemic in the defense sector.
But that scrupulous leadership style began to change in the late 1990s, or more exactly, after the merger with McDonnell Douglas in 1997. What was destined to be an awkward marriage was worsened by the contem
pt in which two very different entities held each other.
Actually, McDonnell Douglas did in an earlier time conceive and manage some first-rate military programs, but it had not done so for many years. It had become identified with the incestuous relationship in which the military services operate with defense contractors and are indulged and protected by tame members of Congress. “The Iron Triangle” is a term widely used to describe parties whose collaboration greatly benefits an industry where the margins are good, the profits and shareholder security high.
A weapons program is normally managed by a so-called integrated product support team. And it is a team. There is a corporate product manager and a government product manager. They work together as team players. Suppose they are working on a combat aircraft and the air force’s project manager, possibly an experienced and fast-track colonel, sees the program falling short of agreed performance benchmarks. Should he flat out complain? He isn’t expected to. Complaining carries the risk of being seen as a non–team player, a judgment to be avoided, especially if he takes the complaint to OSD (Office of the Secretary of Defense) or Congress.
This air force colonel may be approaching retirement age and thinking about sustaining or, even better, raising his income level. The cost of educating children may be a concern. Holding his opposite number too closely to the program’s specifications might weaken his chances of being offered a postretirement job by the prime contractor. Under rules aimed at discouraging conflicts of interest, the colonel could not upon retiring turn up there working on a program that he had been managing. But he could acquire a role in another of the company’s several military programs. (In June 2004, the Project for Government Oversight found that since 1997 Lockheed Martin had made the largest contributions to the campaign funds of political parties of any federal contractor and had hired fifty-seven senior government officials as executives or lobbyists. Pete Aldridge, former undersecretary of defense for acquisition, became a director soon after approving a contract for F/A-22 fighter planes from the company. Boeing came second on the list of the top twenty contractors that had hired senior officials.)11
There is no clear dividing line separating the interests of government and those of defense contractors, at least not as seen from the Pentagon, either by its uniformed or civilian components. The system’s vulnerabilities are not a source of serious concern, unless, that is, something goes very wrong.
In October 2003 something did go very wrong, and it happened to Boeing. The company was charged with having manipulated an air force plan to upgrade its fleet of aerial refueling tankers. Boeing had assumed, as did all interested parties, that the air force would award Boeing a contract worth $23.5 billion to replace the existing tankers with a hundred modified 767’s. Boeing was counting heavily on the deal. That and probably nothing else would allow the company to keep open the 767 line, and the proceeds could be used to help with developing the 7E7, its first new airplane in a decade.
But like so much of what had befallen Boeing in recent years, the tanker deal was derailed by the company’s gaffes, in this case very serious ones. Boeing had maneuvered the deal into the $87 billion appropriations bill for Iraq. And earlier Michael Sears, the company’s chief financial officer (and judged a potential CEO), had offered a job to Darleen Druyun, who was about to retire from the air force, where for many years she had been an influential procurement official. Sears had previously discussed Ms. Druyun with her daughter, a Boeing employee, who had contacted him to discuss her mother’s postgovernment employment prospects.
Unfortunately for Boeing, Senator John McCain, the popular and on occasion relentless Arizona Republican, got on the company’s case. McCain was serving then as chairman of the Senate Committee on Commerce, Science, and Technology. For him, the shabby jet tanker deal amounted to corporate welfare, and he said so. At times, in fact, he appeared to like nothing better than to talk about the matter. And in doing so, he was particularly harsh in describing what senior Boeing and air force people did. The deal was temporarily put on hold.
“This was all cooked up by Boeing, the Defense Department, and Congress,” he told a visitor in February 2005. “It’s the Iron Triangle. These are massive scandals. The corruption extends to Congress, too. It involves a lot of campaign donations. They act as if DOD [the Department of Defense] has done nothing wrong. But the most guilty is DOD. They are far more culpable than Boeing. Boeing was trying to make money. The people at DOD are supposed to have standards and ethics.”12
The process of defining the specifications for the new tanker was, McCain said, one example of what he was talking about. “Boeing was allowed to define everything,” he said.13 The air force, according to official documents, gave Boeing five months to rewrite official specifications for the tankers so that its 767 aircraft would get the contract. In doing so, Boeing eliminated nineteen of twenty-six capabilities the air force originally wanted, and the air force went along to keep the price down.14
In this kind of transaction, the Pentagon would normally require an analysis of alternatives (AOA). But a report by the Defense Department’s inspector general showed that procedure to have been bypassed, in this case on the instructions of Air Force Secretary James Roche. “Don’t even begin to start an unnecessary AOA,” he wrote to a deputy. “All this would do is give enemies of the lease an excuse from DOD to delay.”15
According to McCain, the tanker deal was inserted into an appropriations bill by a fellow Republican stalwart, Senator Ted Stevens, who was then chairing the Appropriations Committee. The record supports this contention, as does Stevens himself. In a hearing of McCain’s committee, he took credit for his lead role, indeed expressing pride: “I challenge anyone about my backroom dealing or anything else. We offered that amendment. It was right in front of God and everybody. It was in the bill when it was reported. It was there to be debated. As a matter of fact, there was some debate about it.”16
Among the hard questions spilling out of the affair is why so many people in Washington—people with voices that carried—played this hand so crudely and risked so many ugly consequences. The explanation, according to some knowledgeable staff people on Capitol Hill, is that President Bush let it be known that he wanted the Boeing–air force deal done. In October 2002, he said as much in a meeting in the Oval Office with House Speaker J. Dennis Hastert, one of the arrangement’s most strenuous advocates, and he then instructed Andrew Card, White House chief of staff, to become his point man in the struggle that lay ahead.
Bush was indebted to Hastert, who not long before had guided the first of the president’s massive tax cuts through a divided and rather skeptical House of Representatives. The two actually met twice to discuss the Boeing–air force problem. Helping Boeing was important to Hastert, according to his spokesman, if only because the company’s headquarters lay close to his district and a number of Boeing people lived there. “Yes, the speaker goes to bat for Illinois and he’s been personally involved in this; he makes no secret of it,” his spokesman, John Feehery, told the Washington Post. But Hastert’s interest in the deal, Feehery said, was more than pork-barrel politics: “He’s not just fighting for the sake of his constituency, it’s also for the country’s sake.”17
“This state of corruption won’t change until we start putting people in jail,” McCain said early in 2004.18 Within a year, two of the people he probably had in mind were there. Darleen Druyun was tried and sentenced to nine months in prison for having negotiated a job with Boeing while serving as the air force’s second-ranking procurement officer. In tears, she admitted to having boosted the price on the tanker deal as a “parting gift” to Boeing. She also acknowledged steering other contracts to Boeing over a four-year period, influenced by prospects of a job for herself and the fact that she had succeeded in obtaining positions for her daughter and son-in-law at the company. She also told about having warned Boeing several times that a competing bid by Airbus on the long-range tanker deal was significantly lower per plane
than the company’s own proposal, although one Boeing e-mail noted: “Meeting today on price was very good, Darleen spent most of the day bringing the USAF price up to our number.”19
Druyun damaged the system of which she had been a part and gave it a bad name, although not so much because of what she did as because she got caught doing it. Mike Sears, who had been seen as a likely successor to Condit, was fired in November 2003. Fifteen months later he was tried and convicted for having recruited Druyun while she was handling military contracts. Sears drew a four-month jail sentence and a fine of $250,000.
Thanks to the pressure from McCain, assorted colleagues in the Senate, and heavy press coverage, the tanker deal was canceled. The Pentagon then dealt an additional blow to Boeing by announcing that any decision to upgrade the air force’s aerial refueling fleet would be reopened to competition.20 Airbus then could see itself as a serious competitor for the tanker deal. The A330, having once chased Boeing’s 767 from the middle market, would be the Europeans’ contending airplane and, it appeared then, a stronger candidate.
A backward look at the terms of the discredited jet tanker deal points up sharply not just the flaws in the procurement system but some of what had gone wrong at Boeing. Instead of selling the 767’s outright, Boeing was going to transfer them under a lease-purchase agreement, which allows the buyer, in this case the air force, to pay for the new aircraft incrementally and thereby be positioned to buy more new hardware. Leasing can be described as a method by which buyer and seller can improve the terms of a transaction with smoke and mirrors. The leases are usually not funded by the procurement budget but in O&M (operations and maintenance).
Boeing Versus Airbus Page 23