Monday, August 11, 2003 Sharing the risk for 7E7 Partners and suppliers expected to bear more costs for Boeing
By JAMES WALLACE SEATTLE POST-INTELLIGENCER AEROSPACE REPORTER Not willing to "bet the company" on the development of its next all-new jetliner as it has done with past planes such as the 747, The Boeing Co. is looking at a bold and different approach with the 7E7 that will spread the risk and development costs among partners and suppliers. With the program facing a critical review by a cost-conscious board of directors in a few months, Boeing appears to be closing in on key decisions about these risk-sharing partnerships. Partners and suppliers that shoulder the risks and help foot the bill could save Boeing hundreds of millions of dollars in the overall design and development of the new plane. They would then have the opportunity to share in the long-term revenue potential of the plane. The idea is not new. Brazilian airplane maker Embraer is relying on 16 risk-sharing partners for its new 70- and 90-seat regional jet program. And risk-sharing partners and equipment suppliers will cover about $3.1 billion of the $10.7 billion development cost of the Airbus A380 superjumbo What Boeing envisions for the 7E7, however, would go far beyond what the industry has ever seen. "Boeing has typically had their hands in all facets of design and development of new planes," said Peter Jacobs, an analyst with Ragen MacKenzie who once worked for Boeing. "But times have changed and development techniques have evolved. It is now appropriate that they use partners to share their risks. Part of that is the increase in the level of outsourcing (work once done by Boeing that is now done by others). To be effective, you need to give those third parties more control of the tasks assigned to them so they can also reap the benefits while assuming part of the downside risk." It is not, however, without controversy within Boeing. Many engineers are concerned that Boeing may be giving away the design, development and manufacturing secrets and expertise that made it the world's commercial airplane leader. Although Boeing has not yet said what parts of the 7E7 its partners will make, Japanese industry is expected to manufacture the composite wings of the 7E7. Boeing has never allowed a supplier to take the lead in production of its high-value jetliner wings. Boeing is expected to announce later this year who will manufacture what parts of the 7E7. The company has only said the Japanese will get about 35 percent of the 7E7 airframe work. That's more than the 21 percent that Japanese companies now have on the 777 airframe. It's not yet known to what extent Boeing's partners and suppliers will buy -- or already have bought -- into the 7E7 program. "We have no target set for that sort of thing," Mike Bair, vice president of the 7E7 program, said when asked how much of the 7E7 development costs would be shouldered by risk-sharing partners and suppliers. "A couple things weigh on that," he said. "What is the appetite for partners to be risk sharing? One of the things we have to balance is that if you give away risks you also give away the upside. We think this plane is going to be a runaway best seller. So part of our thought process is how much of that do we want to give away?" Boeing will not reveal design and development costs of the 7E7, but analysts have estimated the total could range from $7 billion to $10 billion. It is believed that the development of Boeing's last all-new jetliner, the 777, cost the company about $7 billion. Boeing has never disclosed the amount. Bair said the design, development and production costs of the 7E7 will be "significantly less" than for the 777. Some industry analysts say they think risk-sharing partners and suppliers could pick up as much as 40 percent of the design and development costs. In exchange, they will get a bigger chunk of the work and more opportunity to make money if the program is successful. But they also assume more risk if the 7E7 is not a best seller. Although the three Japanese "heavies" -- Fuji, Kawasaki and Mitsubishi heavy industries -- are sometimes referred to as risk-sharing partners on the 777 program, it depends on how the term is defined. Airbus wanted these Japanese companies to take an equity stake in its A380. It didn't happen. Boeing made it clear to the Japanese companies that they could have only one partner -- Boeing. Japanese companies will build parts for the A380, but they are not risk-sharing partners. Some of the suppliers that Airbus is counting on for that $3.1 billion in A380 development costs are not full revenue-sharing partners. Rather, they are only assuming non-recurring tooling and infrastructure costs. In the past, Boeing has also had many suppliers who fund some portion of the non-recurring costs of their product and then hope to earn that investment back over the life of the contract. But Boeing has never had partners or suppliers that took an equity stake in its airplane programs. "One thing that you will see differently in this business model (the 7E7) is a recognition that we should all get our share of the value that is created in this process," said Mike Sears, Boeing's chief financial officer. "Let's say someone gets a huge downstream (revenue as the program goes along). They may have to throw some cash up front to balance this out. Maybe they pay for some of our development costs," he said. He used the example of Boeing selecting a supplier for flight-control systems on a new jet. That supplier gets a stream of revenue from the initial supply of equipment as well as from spares and services later. "My return on that revenue stream does not reflect that," Sears said. "My return reflects the fact that I'm going to build and sell an airplane. So I have created value and not gotten a fair return for that creation." Boeing has picked only a limited number of partners and suppliers for the 7E7. It intends to have far fewer direct relationships with companies than on past programs such as the 777. In the first phase, Boeing in June picked six companies from among more than two dozen contenders as structural partners. They included Fuji, Kawasaki and Mitsubishi, all of which have a long relationship with Boeing. Boeing also picked Alenia Aeronautica of Italy, another long-time partner, and Dallas-based Vought Aircraft, which makes much of the 747 fuselage. More recently, Boeing issued requests for proposals to a limited number of suppliers to develop systems for the 7E7. Alenia was one of about a dozen risk-sharing partners that McDonnell Douglas signed up for its MD-95 program in the mid-1990s. Alenia makes the 717 fuselage. The MD-95 was designed as a successor for the popular DC-9. "At the time, McDonnell Douglas was struggling and we were searching to find a way to launch a new airplane despite the fact that we did not have the financial depth we had had at other points in our history," said Pat McKenna, director of the Boeing 717 program in Long Beach, Calif. The risk-sharing partners and suppliers on the MD-95 program helped with both non-recurring and recurring development costs. Tooling represents the biggest non-recurring costs for a new airplane program. "Because they had large pieces of the airplane, they did the engineering, planning and tooling, and did them at risk," McKenna said of the MD-95 risk-sharing partners. Around the same time, airplane makers Bombardier and Embraer were pioneering the risk-sharing approach with their jets. In the mid-1990s, Embraer had only four risk-sharing partners but 350 suppliers when it set about to develop a series of small regional jets. Today, Embraer has 16 risk-sharing partners and only 22 suppliers for its bigger 170/190 program. "You have to sell them on the economic viability of the program downstream, which we did early on to get them to sign up," Doug Oliver, director of corporate communications for Embraer Aircraft Holding in Ft. Lauderdale, Fla., said of those 16 risk-sharing partners. Embraer has said its costs to develop this new family of jets is about $850 million. "That's remarkable. This is a highly advanced, fly-by-wire jetliner," said Ronald Epstein, an analyst with Merrill Lynch. His point is that it would have cost Embraer much more had it not been for those risk-sharing partners. Boeing will have to spend at the very least several billion dollars of its own money to develop the 7E7. But if it can persuade a select group of partners and suppliers to invest up front in the 7E7 and come along for the ride, it will help Boeing make the critical business case to its board for a plane that industry experts and analysts agree the company must go forward with if it is to regain the initiative over Airbus. P-I aerospace reporter James Wallace can be reached at 206-448-8040 or [EMAIL PROTECTED]
