Boeing Plays Defense Beset by Airbus and rocked by scandal, the aircraft maker turns to a new CEO--and the Pentagon--for help.
(FORTUNE Magazine) – Climbing into the cockpit of an F/A-18 Super Hornet fighter jet, I push the throttle forward and catapult from the deck of a carrier parked off the California coast. Soaring into the clouds, I bank sharply left and contemplate targets. A bombing run on Paris Hilton's L.A. mansion? Hmmm. That might require a lot of post-op paperwork. Instead I turn back into the desert and decide to level a nearby hill. After dropping my bombs using the Hornet's precision-guided targeting system, I pull the stick back sharply, soaring straight up into the blue sky. Kablooie! Hill gone! The California desert races above me before I right the aircraft and head back to the carrier. On my first approach, I'm way too high and too far left. On my second I descend too quickly and bounce off the carrier, plunging my $50 million fighter into the ocean.
The lights come up, and I cast a sideways glance at Dixie Mays, who runs Boeing's defense simulators in St. Louis. "I have the coolest games, don't I?" he asks. "Do you want to go again?"
No doubt some top Boeing executives these days wish they had a reset button to push. The aerospace giant saw its blue-chip reputation and cherished status as an innovator flipped upside down last year. Two of its top executives became entangled in an ethics investigation by the Pentagon, while other employees faced criminal charges involving industrial espionage. The government penalized Boeing by canceling rocket launches valued at about $1 billion and is holding up a $17 billion aerial tanker contract. Furthermore, Boeing infuriated investors with a billion-dollar surprise charge last summer. And underlying this sorry litany was a simpler, larger problem: In 2003, for the first time, Boeing sold fewer planes than the other global aviation superpower, Europe's Airbus Industrie.
The 88-year-old company closed out the year by overhauling its executive suite. CEO Phil Condit resigned, and the chief financial officer was fired. Such was the management disarray that the board couldn't find an internal candidate to replace Condit; the directors called former COO Harry Stonecipher out of a brief 18-month retirement in Florida to take the top job. "Other candidates either lacked credibility with the government or had problems with their divisions," says Paul Nisbet, an analyst at JSA Research, an aerospace research firm. "The board was left without a clear choice."
Blunt and to the point, Stonecipher may be an interim CEO (he expects to stick around for about three years), but he'll have plenty of time to write his own legacy. Boeing faces some momentous changes. Last year, for the first time in decades, more than half of Boeing's $50 billion in revenues came from the defense business. Besides the Super Hornet, Boeing also builds Apache helicopters and precision-guided JDAM bombs. Under Stonecipher, Boeing is likely to see its reliance on defense contracts grow. The new CEO says he's even looking to acquire some intelligence and defense companies to bolster the mix. This year Boeing expects defense to contribute 60% of its revenues, up from 55% currently. Critics say the timing for that sort of shift couldn't be worse. Loren Thompson, COO of the Lexington Institute, a policy think tank, says, "Boeing is becoming more dependent on the Pentagon at precisely the moment when demand for defense goods looks as if it's plateaued."
On the other hand, Boeing may not have much choice if it wants to grow, because its once-dominant grip on the commercial airplane market has been broken. It is Airbus that has the momentum in passenger jets. And it is Airbus that's wowing the public with the construction of the largest jet ever--the 555-seat, double-decker A380, due out in 2006. "Airbus has done a good job of creating innovative products that attract customers," concedes R. Thomas Buffenbarger, head of the International Association of Machinists & Aerospace Workers, which represents 50,000 Boeing employees. "We need to get off our ass and make a product that's exciting to the customer."
Boeing contemplated building a monster jet of its own but dropped the plan. Instead it is betting its future on an airplane less than half the size of Airbus's, called the 7E7 (the "E" is for efficiency), on the theory that what airlines will want is not a huge craft but a cost-effective one. If Airbus is right and Boeing wrong, Boeing could see its 48% share of the market dissolve to one-third by 2010, analysts estimate. "One has bet on red, and the other on black," says aerospace analyst Brett Lambert of DFI International, a defense consulting firm. "And the wheel is spinning."
Designing an airplane that will fly for 30 or even 40 years is not for the faint of heart. Boeing's history is rich with stories of risk taking that drove it to the brink of disaster. The company bet nearly three-fifths of its cash to build the 707 in the 1950s, and it nearly went bankrupt funding the 416-seat 747 during the recession of the 1970s.
For Boeing's seventh CEO, Phil Condit, the bust-and-boom swings of airplane development were too much. An aloof and conflict-averse engineer who worked on the 757 and 777, Condit was freaked out by the gigantic bets it took to build aircraft. Furthermore, Wall Street disliked the up-and-down airplane cycle, and Condit disliked being disliked. (An often told story is one in which Condit's eyes welled up with tears after a blistering meeting with Wall Street analysts.) Condit sought a source of stable revenues in the mid-1990s. His target? McDonnell Douglas.
With $14 billion in sales, McDonnell Douglas was one of the nation's largest defense companies. It had done a good job of turning around the C-17 transport plane program, which a few years earlier was nearly canceled by the Air Force over technical flaws and delays. But its commercial-aircraft arm, Douglas Aircraft, was a disaster, caught in the tailwinds of Boeing and Airbus. In 1994, McDonnell Douglas's board shocked investors by bringing in an outsider--a brash, controversial former GE executive, Harry Stonecipher--as CEO.
At first Stonecipher insisted that the firm was committed to building passenger airplanes. At one point he said the business was so good that if Douglas wasn't in it already, "we would be looking for a way to get in." But years of underinvestment had resulted in planes with little imagination, and Douglas would need to spend billions to catch up. Ultimately Stonecipher wasn't willing to make that investment, preferring to focus on short-term stock performance. During his tenure as CEO, McDonnell Douglas's stock quadrupled (Stonecipher carries a laminated copy of the stock chart in his briefcase), but critics say the failure to invest in R&D would have been disastrous eventually. "This is a company that would have gone out of business in five years," says Richard Aboulafia, an analyst at Teal Group, an aviation research firm. "It was headed to oblivion." But Boeing was looking to do a deal.
On Dec. 10, 1996, in a 12th-floor suite at Seattle's Four Seasons Hotel, Stonecipher and Condit scratched out details of the $14 billion merger in an hour, including who would do what. "Harry's job is chief operating officer. It is 'How are we doing?'" Condit later explained to the Seattle Times. "Mine is chief executive. It is 'Where are we going?'" Sadly, Boeing was going over a cliff.
For years, Euro-rival Airbus had been coming on strong, grabbing 30% of the passenger-jet market by the mid-1990s, to Boeing's 60% share. Led by hard-charging salesman Ron Woodard, Boeing decided to deal Airbus a crippling blow. It wanted a 67% share of the market and began offering deep discounts on its aircraft to get it. The result was bedlam: Orders poured in and overwhelmed Boeing's 1960s-era manufacturing facilities. The company was forced to shut down its 737 and 747 lines for the month of October 1997. Boeing's stock dove from near $60 in mid-1997 to a 1998 low of $31. That year it reported a record $45.8 billion in revenues; it also posted a loss of $178 million.
Stonecipher, who took over as COO just two months before the manufacturing shutdown, realized that he had a mess on his hands. Cleaning it up, he ignited something of a culture war between the merged companies. He labeled Boeing people "arrogant" and derided their inability to calculate costs as well as they did drag and lift. Stonecipher pushed out several Boeing executives, introduced new manufacturing concepts, outsourced more parts, and diversified into businesses like airplane services. Wall Street began calling it a reverse merger; at Boeing, employees used the phrase "the Boy Scouts are being taken over by the mercenaries." Their feelings of hurt and betrayal were heightened in 2001, when corporate headquarters were moved to Chicago, of all places.
Still, Stonecipher's cost-cutting efforts may have provided a cushion for the big blows yet to come. The 9/11 terrorist attacks and the emergence of SARS crippled the airline industry and sent aircraft deliveries plunging. In 1999, Boeing sent a record 620 planes out its factory door. By 2003 that number had fallen to 281. The division's revenues sank from $38 billion to $22 billion.
His jowly features etched with deep creases, Harry Stonecipher can be charming and jocular. But he's no pussycat. Stonecipher spent 26 years at General Electric, where he admired "Neutron" Jack Welch's style. Later he ran with Washington's elite when he took over a defense company stumbling in a post--Cold War world. He's renowned for his blistering verbal attacks and once threw an empty soda can at a co-worker in a fit of anger. Stonecipher, 67, says with a shrug, "I'm not proud of my style. But it's been effective, and I'm probably too old to learn new tricks."
Only a few months into the CEO job, Stonecipher has already ruffled feathers. "In our first meeting he asked me if I was running a business or a hobby," says Scott Carson, the president of Boeing's in-flight Internet venture, called Connexion. Stonecipher says he held a "nose-to-nose management session" with Jim Albaugh, 53, the head of Boeing's defense group, which sideswiped Wall Street last year with a $1.1 billion surprise charge. "Oh, yeah. We talked about how we weren't going to get a repeat of that," says Albaugh from his office in St. Louis. The unions, meanwhile, are furious over Stonecipher's efforts to kick them out of Boeing's Wichita facilities and his demands that employees sign a code of conduct amid the ethics probe or leave the company. "It's like the Salem witch trials," says Charles Bofferding, executive director of the Society of Professional Employees in Aerospace.
Stonecipher, the son of a Tennessee coal miner, started working at a 24-hour truck stop when he was 11 years old. For eight hours a day after school, he stood atop crates washing dishes. He earned $1 a day and all the food he could eat--not an unimportant perk, as the family could afford meat only once a week. "Growing up like that, I made up my mind I was never going to be poor," says Stonecipher. "It seemed like everyone in the world had more than I did."
Since his Scarlett O'Hara moment, Stonecipher has made up for his modest beginnings and then some. He collects abstract expressionist canvases by Aaron Fink and Robert Motherwell. He built a $2 million home in St. Petersburg. He's the second-largest individual shareholder at Boeing, with a $72 million stake.
Wall Street welcomed Stonecipher's return. "He's Mr. Fix-It," says Robert Mitchell, a fund manager at Chicago's Northern Trust. Unlike Condit, Stonecipher is respected as a decision-maker, and investors appreciate his focus on the bottom line. Wall Street also figures that his familiarity with the Pentagon will help Boeing cope with the ethics investigations.
Stonecipher isn't a visionary. He doesn't have a new grand design or a even a desire to steer Boeing in a new direction. "I'm here to execute the plan that Phil Condit started," he says. "This is Phil's strategy." So far it's a strategy that hasn't yielded results. For the 15 years before the merger, Boeing's stock returned 27% annually, compared with a 20% average annual gain by the S&P 500 index. Since the merger in 1997, Boeing's stock has lost 2% annually, while the S&P 500 has gained an average of 5% each year.
There are those who suspect that Stonecipher isn't committed to investing the $7 billion or so it will cost to develop the 7E7. He denies it. "People who say Boeing has lost its love of risk have it wrong," he virtually growls. "We will launch this plane." But with $4.6 billion in cash on its balance sheet and a stock price that's climbing, Stonecipher also wants to beef up Boeing's defense business through acquisitions. "I want to get this company on a growth curve," he says. "And we simply cannot develop internally fast enough."
It may not be completely coincidental that the Army's Future Combat Systems program is housed in a former IBM building in St. Louis. (It's painted blue and nicknamed the Blue Zoo.) Craig Borchelt, a Boeing marketer and Operation Iraqi Freedom veteran, doesn't discuss tanks or weaponry as he describes how the system will work. Instead he tosses out terms like "network-centric" and "common operating platform."
Last year Boeing shocked defense observers when it scored the role of lead systems integrator (LSI) for the program, a multiyear, $14.8 billion contract that could eventually turn into a $100 billion deal over the next two decades. That hasn't been Boeing's only recent victory. It snared the LSI role for the nation's missile defense shield and is the prime contractor for the U.S. intelligence agency's supersecretive future imagery architecture system. In all, Boeing's defense group, which had $27 billion in revenue last year, posted a record $50 billion in military orders in 2003. Says the Lexington Institute's Thompson: "Five years ago nobody would have expected Boeing to have competed successfully for the Future Combat Systems contract. The question is, Have the breakthroughs been in marketing, or is there substance to back up their wins?"
Through the merger with McDonnell Douglas, Boeing inherited a number of heavy-machinery programs, including the F/A-18 Super Hornet, the C-17 transport plane, and the Apache helicopter. But the military is increasingly shifting funds away from things like this to software-based programs. Sensing the change, Boeing is seeking out more managerial roles like the LSI (which also require less capital up front). Lead system integrators act like foremen, hiring contractors and collecting fees for overseeing projects.
Yet Boeing's success in winning high-tech, high-profile military contracts was overshadowed last year by a couple of major missteps. In June the government charged two former Boeing employees with stealing thousands of pages of Lockheed Martin papers to win a military rocket-launching contract in 1997. In retaliation, the government stripped away $1 billion in launches.
A much more devastating blow to Boeing's reputation occurred in November, when e-mails between Boeing CFO Michael Sears and Air Force procurement officer Darleen Druyun came to light. While Boeing was negotiating a $17 billion contract to replace aerial tankers with 767s, Sears allegedly offered Druyun a job. Both executives were dismissed--the same week that advance copies of Sears's management book, Soaring Through Turbulence, were released. The Pentagon has put the tanker deal on hold pending an investigation, and in late March, Air Force Secretary James Roche warned that bidding for the contract could be reopened.
The allegations of unethical behavior have reopened old divisions dating back to Boeing's merger with McDonnell Douglas. Current and former Boeing employees say Stonecipher has fostered a win-at-any-cost culture. All the employees involved in the ethical and trade-secret investigations, skeptics note, were "heritage" McDonnell Douglas folk. "Boeing used to be a blue-ribbon company in Washington," says Lawrence Clarkson, a Boeing executive who retired in 1999. "If you look at the people who got in trouble, not one of them is a heritage Boeing person."
As ta-da moments go, this one is underwhelming. As I step into the mockup of Boeing's new 7E7, a charming and enthusiastic interior designer highlights the so-called Dreamliner's lofty ceilings ("like a cathedral," he gushes), larger windows (so one doesn't haven't to be a contortionist to look outside), bigger cargo bins (amen!), and blue-tinted overhead diode lights that are supposed to look like the sky (Hey! We're in the air!). Whatever. Frankly I still see lots of cramped seating.
The past decade has been frustrating for Boeing's commercial-airplane group. Dogged by the production snafus in the late 1990s, Boeing has also struggled to come up with a new plane. It did rounds of planning and design on two aircraft: a stretched version of its 747, for which it found no demand, and the tricked-out, high-speed Sonic Cruiser, which Boeing says was before its time. Meanwhile, Airbus chomped away at Boeing's lunch--by 2000, it had almost a 40% market share--and announced plans to develop the behemoth A380. "When Airbus made the decision to go with the A380 and take away Boeing's 747 monopoly, Boeing should have responded instead of lying there like it did," says Citigroup fund manager Michael Kagan.
If you want to get under the skin of a Boeing commercial airplane executive, ask about Airbus. In his Seattle office Alan Mulally, Boeing's president of commercial aircraft, spends several minutes deriding his competitor's strategy, its forecasts of the number of planes it will sell, its government subsidies, and its lack of concern about flooding the market--before he stops short. "I don't want to talk about Airbus. We don't spend any time here talking about them," he says curtly.
The real story, he insists, is that Boeing has survived one of the deepest and most protracted slumps in the airline industry--profitably. (Its commercial-airplane business produced operating margins of 4.7% in 2003.) "When we come out of this [downturn], we're going to be a turbo machine," Mulally concludes. "That's the story of commercial airplanes at Boeing. And did you notice I didn't use the 'Airbus' word one damn time?"
What's shocking about the Airbus-Boeing battle is that the combatants are making completely divergent bets on how they think we'll travel in the future. The A380 is designed to shuttle travelers between major hubs like New York City, Beijing, Paris, and Dubai. Airbus has received orders to build 129 planes and predicts that by 2020 there could be demand for another 1,000 large jets. Boeing is betting airlines will fly more frequent trips using smaller planes between less traveled "city pairs" like Memphis and London's Gatwick Airport.
If the first century of travel was marked by the adventure of flying and onboard cocktails, the "second century of flight will be all about value," asserts Walt Gillette, a 38-year Boeing veteran who is head engineer on the 7E7 program. Improved engines, lighter materials, and better aerodynamics will boost the plane's fuel efficiency by up to 20%, predicts Gillette. Furthermore, the cargo hold is larger, to help airlines derive even more revenue. Who says romance is dead?
The speculation is that Boeing's "launch" customer will be either a Japanese or a Middle Eastern carrier, and that first orders could come as soon as this spring. When will a large U.S. carrier step up? Airlines like United and American continue to struggle financially, while Southwest, a loyal Boeing 737 customer, says it isn't certain the plan suits its strategy. "We don't anticipate that the 7E7--as it first comes out--will fit in our structure," says Southwest treasurer Laura Wright. "We don't fly overseas routes." What Boeing needs is a "Southwest of the Atlantic" or a "JetBlue of the Pacific," says Teal Group's Aboulafia. "The ideal carrier for this plane hasn't been invented yet."
One certainty about the 7E7 is that even less of it than current Boeing planes will be manufactured in the U.S. As much as 35% of the plane could be made by Japanese companies. The parts will be flown to Seattle in 747s for final assembly. The trend of sending parts to other companies or overseas has been going on for years--about 24% of the 777 is built outside Boeing. Yet analysts worry about the intellectual-property and economic implications of shipping the projects overseas. "Aeronautical engineers used to want to come to the U.S. to see the latest in airplane design technology," says Roger Bilstein, an aviation historian in Texas. "Now Americans are going to Europe." Furthermore, aerospace has been one of the few industries in which the U.S. had a positive balance of trade. Adds Bilstein: "If we lose aerospace, we don't have much left to work with."
Will Harry Stonecipher go down in Boeing history as one of its great mavericks? Is he this generation's Bill Allen, the Boeing leader who changed the world with the 707 and then followed up with his $1 billion gamble to develop the 747? Or is he following in the footsteps of former Boeing CEO Thornton "T." Wilson, who increased the company's presence in the defense business but whose 757 and 767 passenger jets never set the world on fire?
Years from now we might be regaled by tales about how the 7E7 turned the tide for Boeing, how the efficient little marvel enabled Boeing to recapture its crown and pummel the European competition. Or perhaps Boeing will be proved wrong, and Airbus's domination will grow. One thing Boeing can't afford to do right now is what it has done in the past decade--hem and haw, wringing its hands in consternation, arguing with itself about whether the market is there and whether the risks are worth it. It's too late for that. Boeing must build this airplane. If you're going down, at least go down swinging.