572 Boeing Dreamliner debacle caused by Outsourcing, Offshoring, "Shareholder Value" - Forbes

Boeing Dreamliner debacle caused by Outsourcing, Offshoring,
"Shareholder Value" - Forbes

(1) Millions of Lithium ion batteries replaced in laptops, because they
caught fire
(2) Yuasa Lithium-ion batteries use petroleum solvent as electrolyte; it
can heat up and ignite
(3) Yuasa batteries have cobalt oxide cathodes, less safe than iron
phosphate or nickel-metal hydride
(4) Dreamliner uses electricity much more than other planes, eg for
dimming windows & de-icing the wings
(5) Boeing Dreamliner debacle caused by Outsourcing, Offshoring,
"Shareholder Value" - Forbes
(6) The Formidable Dimensions of Boeing's Dreamliner Problem - Eamonn
Fingleton
(7) The Dumbest Idea In The World: Maximizing Shareholder Value

(1) Millions of Lithium ion batteries replaced in laptops, because they
caught fire

{visit the webpage to see the photos}

http://prowiki.isc.upenn.edu/wiki/Lithium_ion_batteries

Lithium ion batteries

Lithium ion (or Li-Ion) batteries are most often found in electronics
such as laptops and PDAs. They are useful due to their high power
density and ability to sustain repeated charges without suffering from
the "memory effect" that plagues nickel-cadmium and other types of
rechargeable batteries. Lithium ion batteries were first devised in the
early 1900s, with the technology reaching commercial maturity in 1991.
The technology is perpetually undergoing further development to increase
battery life, as well as to decrease battery size and weight. Recently,
there has been an increase in documented cases of lithium ion batteries
failing and catching fire. ...

Advantages

Lithium ion batteries have a much lower self-discharge than other
batteries: Lithium ion batteries tend to discharge at a rate of 5% per
month, as compared to other batteries which are often closer to 15-30%
per month. This means that between charge and use, Li-Ion batteries are
more capable of retaining a useful charge. ...

Dangers

The failure of Li-Ion batteries has been receiving more and more
attention lately. Research indicates that this sort of failure is not as
uncommon as manufacturers had originally led people to believe. There
are a number of different reasons that a Li-Ion battery can fail, but
the most common is exposure to extreme heat. If a battery is allowed to
sit in extreme heat, such as a hot car, or in a computer under heavy use
on an insulating surface, the likelihood of failure is increased,
especially if the battery is used before it has an opportunity to cool off.

Occasionally, the built in monitors may fail, allowing the internal
temperature of the battery to exceed the safety thresholds. Once this
happens, individual cells may catch fire, likely igniting other cells.
Due to the cobalt oxide in lithium ion batteries, they are also somewhat
susceptible to a process called "thermal runaway", in which the cobalt
oxide reaches a certain, high temperature at which it begins to
self-heat, causing a dramatic rapid rise in temperature which culminates
in explosion to releive the pressure built up inside the battery.
Additionally, if a battery is allowed to erode or be ruptured in some
other manner, the electrolyte fluid inside the battery can cause short
circuits, which will ignite the electrolyte causing what has been
described as a "flame thrower". The Sony-built batteries causing
failures in Dell laptops in the Summer of 2006 were this type of
failure. A number of metal fragments are left floating in the
electrolyte fluid inside individual cells as a result of the
manufacturing process. Unfortunately, in these batteries manufactured by
Sony, the barriers between the anodes and cathodes were more susceptible
to being breached. As the battery gets hotter and hotter due to charging
or use, the metal fragments move around more, increasing the likelihood
of a breach. The breach leads to one of the scenarios above.

Recent Recalls

* In August of 2006, Dell recalled 4,163,495 batteries due to three
confirmed incidents in which the batteries overheated and damaged both
the computers and, to some extent, their surroundings. Batteries
matching identification numbers at the Dell site listed below will be
replaced at no charge to the consumer. ...

* iBook G4/PowerBook G4 battery recall: iBooks and PowerBooks sold
between October 2004 through May 2005 contained lithium ion batteries
manufactured by LG that were prone to overheating, causing a fire
hazard. Batteries matching serial numbers listed at the site below can
be replaced by Apple at no charge to the customer. ...

* In October of 2005 Hewlett-Packard recalled 135,000 batteries on
HP and Compaq laptops manufactured between March and September of 2004.
In 16 reported cases, these laptops suffered an electrical short allowed
the batteries to overheat and melt the casing, sometimes resulting in
fire. ...

Notable Incidents

* At a Japanese conference in June of 2006, a Dell laptop
"exploded" and caught fire, with smaller explosions continuing for about
5 minutes afterward until the fire was put out. This was one of the
incidents that motivated Dell to initiate the recall.
o http://www.theinquirer.net/default.aspx?article=32550

* A Dell Inspiron not covered under Dell's recalls was left on the
floor of the passenger side seat of 1966 Ford F-250 as the owner and his
friend prepared to head home from a hunting trip in July of 2006. The
flames from the laptop were sufficient to ignite the ammunition in the
glove box above, which subsequently detonated the fuel tank, resulting
in the demolition of the truck and all contents. Fortunately, the two
hunters had managed to take cover just before the bullets began firing
out of the truck, and were not harmed by the following explosion.
o http://www.consumeraffairs.com/news04/2006/08/dell_fire.html

* In an engineering office, a Dell laptop plugged into power and
turned on caught fire in July of 2006. The battery burned a hole through
the laptop and caused some damage to the table below. The fire
extinguishers used to put out the fire caused some amount of damage as
well. This incident was well documented by someone with a 7.1MP camera.
This is one of the incidents that motivated Dell to initiate the recall.
o
http://forumz.tomshardware.com/Dude-Dell-freaking-blew-ftopict192887.html

* A 15-inch PowerBook plugged into a wall socket was left in
Standby mode over night in August of 2006. At six AM, the owners were
awoken by acrid smell and smoke. The battery had overheated and ignited.
This battery had been covered under the Apple recall noted above.
o http://www.flickr.com/photos/41783769@N00/ ...

* This page was last modified 14:19, 3 July 2012.

(2) Yuasa Lithium-ion batteries use petroleum solvent as electrolyte; it
can heat up and ignite

http://www.yomiuri.co.jp/dy/national/T130117004677.htm

Battery problem may have grounded ANA 787

The Yomiuri Shimbun

(Jan. 18, 2013)

Overheated batteries may have caused a Boeing 787 passenger jet to make
an emergency landing at Takamatsu Airport on Wednesday after a strange
smell was detected in the plane, according to transport safety authorities.

The incident occurred as the cutting-edge airliner, operated by All
Nippon Airways, was flying over Kagawa Prefecture.

The Japan Transport Safety Board said the incident was likely caused by
the overeating of lithium-ion batteries used for plane operation
control, as an electrolyte leak was detected.

The board examined the plane Wednesday evening to determine whether the
incident is related to the case of a Japan Airlines 787 in which a small
fire occurred at Boston's Logan International Airport after arrival from
Tokyo on Jan. 7. Both planes use the same type of batteries.

The main batteries in the ANA plane are located in a compartment for
electronics systems behind and underneath the cockpit. The batteries,
which can heat up and ignite in abnormal conditions, are stored in a
metal container with a control apparatus.

The safety board found the container had turned black due to electrolyte
believed to have spilled inside it. The liquid also was found on the
floor of the plane.

Sources said the batteries were replaced in October following a problem
with engine ignition. The airplane was introduced in January last year.

According to GS Yuasa Corp., the Kyoto-based manufacturer of the
lithium-ion batteries, petroleum solvent is used for the batteries'
electrolyte, a solution that can come to a boil and cause a spill when
batteries overheat due to overcharge or overdischarge.

On Thursday, the Land, Infrastructure, Transport and Tourism Ministry
issued a technical circular directive to ANA and JAL to temporarily
ground all Boeing 787s following the issuance of a similar airworthiness
directive by the U.S. Federal Aviation Authority to U.S. airlines.

(3) Yuasa batteries have cobalt oxide cathodes, less safe than iron
phosphate or nickel-metal hydride

http://seattletimes.com/html/businesstechnology/2020149254_787batteryexplainerxml.html

Lithium-ion batteries pack a lot of energy — and challenges

From laptops on up to cars and now planes, lithium-ion batteries offer
benefits but also risks.

By Brier Dudley

Corrected version
Originally published January 16, 2013 at 7:54 PM | Page modified January
17, 2013 at 11:22 AM

The prospect of flying in a so-called plastic airplane was already
unnerving for some.

Now there’s the added concern of Boeing’s 787 Dreamliner using the same
kind of batteries that used to overheat and ignite laptops made by Dell,
Hewlett-Packard, Apple and others.

Lithium-ion batteries are state of the art, producing the most energy in
the lightest package at an acceptable price.

But they have had problems and continue to challenge engineers to manage
the temperature generated in their chemical reactions, particularly as
larger versions are produced for vehicles and now airplanes.

“It’s clear that there are some issues associated with thermal
management,” said Donald Sadoway, a battery expert and the John F.
Elliott Professor of Materials Chemistry at MIT.

Since Sony began manufacturing them in 1990, lithium-ion batteries have
led to a revolution in consumer electronics. They allow companies to
build lightweight phones, cameras, power tools and other gadgets that
run a day or more on a single charge.

In a phone, the batteries are thin and the heat is dissipated by the
front and back of the case, which act like cooling fins, said Sadoway.

It’s a different story when you’re talking about batteries that are
nearly twice the size of a car battery, like those used in the 787.

Tesla roadsters addressed the issue by using thousands of little,
finger-sized batteries, clustered together. Now larger batteries are
being used in cars such as Toyota’s plug-in Prius.

Boeing is the first company to use lithium-ion technology for the main
batteries in a commercial airplane. The supplier of those recently also
won a contract to upgrade the international space station to lithium-ion
batteries.

Safety remains a concern, though, especially if manufacturers try to cut
costs.

Sony learned this the hard way in 2006. Errant metal flakes inside some
laptop batteries it produced caused them to short-circuit, leading to
sudden and sometimes spectacular fires. This resulted in recalls of more
than 7 million batteries around the world, affecting major computer
companies using Sony batteries.

“That’s a concern this industry has: You’re building a very energetic
device; you’d better do it well or you’re going to have problems,’’ said
Vince Battaglia, a specialist in battery design at the Lawrence Berkeley
National Laboratory in California.

So how do the batteries work? Here’s how he would explain it to a lay
person:

“It consists of two electrodes that each accept lithium. But one does it
more easily than another. ... You get a voltage difference because of
that relationship. You can use that energy and control it by discharging
the battery at whatever (level) you want.”

The breakthrough with lithium-ion batteries was in the electrolyte
material. Up until 1990 batteries were water-based. Researchers at
Berkeley found that using an organic electrolyte led to dramatic
increases in energy density, or the amount of energy in the package.

Lithium-ion batteries such as those used on the 787 have safeguards,
such as controllers that trigger a shut-off if temperatures rise too
much; vent built-up pressure; and prevent the batteries from bursting
into flame.

A Boeing executive said the 787 has a redundant safety system with four
controllers on the batteries, although that’s apparently not enough to
prevent incidents and satisfy regulators.

Research continues into improving lithium-ion batteries, but the
technology is now mature, said Jonathan Posner, associate professor of
mechanical engineering at the University of Washington, who called the
technology “a logical choice” for the 787.

“I don’t think Boeing would have used it if it wasn’t mature,” he said.

Posner said Boeing seems to have “an engineering issue that just has to
be resolved. But I would be surprised if they don’t continue to use
lithium-ion batteries in the 787.”

Different materials can be used in these batteries, some safer than
others. Based on information posted on its website, Boeing supplier GS
Yuasa appears to be using lithium cobalt oxide cathode material, which
is the original material used by Sony.

“From a safety point of view, that’s not the best,” said Ji-Guang Zhang,
a researcher at the Pacific Northwest National Laboratory in Richland.
He said cobalt oxide batteries ignite at lower temperature than lithium
batteries made with other materials, such as iron phosphate.

Supplier GS Yuasa declined to discuss whether the batteries in question
use cobalt oxide and referred questions to its partner Thales Group,
which didn’t promptly respond.

Still, it’s all relative.

“Theoretically, it is safe,” Zhang said. “I think it is not less safe
than a gasoline-powered engine. ... Gas is much easier to burn than
batteries.”

Battaglia said iron phosphate “has been known to sort of be safer.” But
he added that “nothing is safe — you’ve still got a lot of energy and an
electrolyte in there that’s flammable.”

So should people feel comfortable flying in a plane with these batteries?

“Everybody in there has a lithium cobalt oxide in their pocket, so it’s
sort of a matter of scale or engineering,” Battaglia said.

One option for Boeing could be to revert to an older, safer type of
battery, but it would be heavier. While nickel-metal hydride batteries —
the type used in the Prius hybrid — would weigh about 50 percent more,
they’d add a relatively small amount of weight to the overall airplane,
Sadoway said.

“It’s not as though we’re talking about making the plane incapable of
getting off the ground,” he said.

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com

This story, originally published Jan. 17, 2013, was revised the
following day to clarify that the type of lithium ion battery with a
higher ignition temperature uses iron phosphate.

(4) Dreamliner uses electricity much more than other planes, eg for
dimming windows & de-icing the wings

http://cjonline.com/news/2013-01-17/boeing-787s-grounded-over-concerns-battery-safety

Boeing 787s grounded over concerns with battery safety

Aircraft depends on lithium-ion batteries that can overheat

January 17, 2013 12:49 PM EST

SEATTLE — Boeing’s 787 Dreamliner, the planemaker’s most advanced jet
ever, is in trouble because of the technology that sets the aircraft
apart from its peers.

The Federal Aviation Administration ordered Wednesday that 787s in the
United States be grounded until their batteries are shown to be safe,
the first such action since 1979. The move came hours after two Japanese
airlines parked half the world’s Dreamliners following a battery fire
and an emergency landing.

Boeing’s plight stems from choices it made years ago to push the
boundaries of aircraft design in a bid to boost fuel economy. The 787
uses unprecedented amounts of electricity, five times as much as in
conventional jets, so less power is diverted from the engines to run
on-board systems. Boeing depends in part on lithium-ion batteries, which
provide quick, powerful charges and can also overheat and catch fire.

“These aren’t minor issues — it isn’t a matter of a coffee maker going
on the fritz or the in-flight entertainment system not working as
expected,” said Henry Harteveldt, an aviation analyst at Hudson Crossing
in San Francisco. “It could be expensive and lengthy to fix the problem.”

The Dreamliner already was the focus of a special FAA review triggered
by last week’s fire on a Japan Airlines jet at a Boston airport gate.
FAA officials certified the plane before it entered service in late 2011
and said last week that while they considered the plane to be safe, they
wanted the evaluation to remove any doubts.

Fresh questions surfaced Wednesday after a battery-fault warning on an
All Nippon Airways Dreamliner in Japan forced an emergency landing, and
at day’s end in Washington, the FAA issued its airworthiness directive.

United Continental Holdings, whose six Dreamliners make it the lone U.S.
operator so far, pledged immediate compliance with the FAA, which didn’t
say what corrective steps are needed or how long they may take. Christen
David, a United spokeswoman, declined to comment on any costs that might
result from repairs or passenger rebookings.

Japan’s Transport Ministry said it also would order a grounding, while
Indian aviation regulators said Air India will park its fleet of six
787s. There are 50 Dreamliners in service worldwide, according to the
FAA, whose grounding directive was the first for an entire model in
almost 34 years, after a DC-10 crash in Chicago killed 271 people.

The moves are a blow to Boeing as chief executive officer Jim McNerney
works to increase deliveries, trying to shed the weight of more than
three years of Dreamliner delays. Boeing is set to double 787 output
this year, to 10 planes per month, to help fill remaining orders for
about 800.

“We are confident the 787 is safe and we stand behind its integrity,”
McNerney said in a statement. “We will be taking every necessary step in
the coming days to assure our customers and the traveling public of the
787’s safety and to return the airplanes to service.”

Above all else, the 787 was designed to conserve fuel, the largest cost
for airlines. Boeing promises a 20 percent gain in fuel efficiency over
comparably sized planes.

Lightweight composite materials, the greater use of electrical power,
wings with improved aerodynamics and new engines all help shave fuel
burn compared with the Boeing 767 that the Dreamliner replaces, said
Hans Weber, the CEO of aerospace consultant Tecop International Inc. in
San Diego.

Boeing lists a range for the 787-8 model, the first to enter service, of
8,200 nautical miles. It seats as many as 250 passengers, retails for
$207 million and is aimed at airlines that want long-haul nonstop routes
without resorting to a bigger 777 or a 747 jumbo jet. Japan Airlines,
for example, has a 787 serving Boston and Tokyo.

“The 787 is a pioneering effort by necessity,” Weber said. “The plane is
very tightly designed to what Boeing’s perception is for the future of
the market.”

Electricity on the Dreamliner powers the usual needs, such as
instruments and air conditioning, as well as new touches that include
dimmable windows in place of traditional pull-down plastic shades.
Boeing also opted to turn to electricity for functions such as de-icing
the wings.

The electrical content is unique to the 787, shunning traditional power
systems that rely on hot, high-pressure air bled off the engines. Boeing
said its approach extracts 35 percent less power from the engines than
conventional pneumatic systems, so the extra air goes to produce more
efficient thrust.

“The lithium-ion battery was the right choice given the design
constraints that we had,” Mike Sinnett, Boeing’s 787 chief engineer,
told reporters last week on a conference call.

“It doesn’t mean that it was the only choice. It means that it was the
right choice.”

Dreamliners carry the batteries in electronics bays in their bellies.
Sinnett described the units as “something that’s one and a half to two
times bigger than your car battery.”

The lithium-ion batteries are made by Tokyo-based GS Yuasa Corp. and are
part of an electrical power conversion system built by France’s Thales
SA. United Technologies Corp.’s Aerospace Systems unit supplies the
overall system, which uses 1.45 megawatts of electricity, enough to
power 400 homes.

Resolving the electrical questions so would restore the luster that drew
airlines to the Dreamliner in the first place, from fuel savings to
more-comfortable cabins, said Hudson Crossing’s Harteveldt. The trick
will be in successfully making changes to a plane with an array of
technological firsts, he said.

“Don’t underestimate the complexity of the Dreamliner,” he said. “This
isn’t like taking your laptop to the computer repair shop and getting a
phone call the next day. This is not a quick fix.”

(5) Boeing Dreamliner debacle caused by Outsourcing, Offshoring,
"Shareholder Value" - Forbes
The Boeing Debacle: Seven Lessons Every CEO Must Learn

Steve Denning

Forbes, January 17, 1013

http://www.forbes.com/sites/stevedenning/2013/01/17/the-boeing-debacle-seven-lessons-every-ceo-must-learn/

Brake problems. A fuel leak. A cracked windshield. One electrical fire.
Then another. An emergency landing in Japan. A safety investigation
imposed by the FAA. Then two premier customers—Japan’s two main
airlines, ANA and JAL, ground their fleet of Boeing [BA] 787s. Then the
FAA grounds all 787s used by the only American carrier. Now other
regulators around the world follow suit, grounding all 50 of the 787s
delivered so far. The regulatory grounding of an entire fleet is
unusual—the first since 1979—and relates to a key to the plane’s claimed
energy-efficiency: the novel use of lithium ion batteries, which have
shown a propensity to overheat and lead to fires—fires that generate
oxygen and hence are difficult to put out.

And keep in mind: Boeing’s 787 project is already billions of dollars
over budget. The delivery schedule has been pushed back at least seven
times. The first planes were delivered over three years late. In fact,
out of a total of 848 planes sold, only 6 percent have been delivered.

Yet grave as these issues seem, they are merely symptoms of a deeper
disease that has been gnawing at the US economy for decades: flawed
offshoring decisions by the C-suite. Offshoring is not some menial
matter to be left to accountants in the backroom or high-priced
consultants armed with spreadsheets, promising quick profits. It raises
mission-critical issues potentially affecting the survival of entire
firms, whole industries and ultimately the economy.

Not just Boeing: an economy-wide problem

Thus Boeing is hardly alone in making flawed offshoring decisions.
Boeing is just the latest and most spectacular example of an
economy-wide problem.

“Many companies that offshored manufacturing didn’t really do the math,”
Harry Moser, an MIT-trained engineer and founder of the Reshoring
Initiative told me. As many as 60 percent of the decisions were based on
miscalculations.

As noted by Gary Pisano and Willy Shih in their classic article,
“Restoring American Competitiveness” (Harvard Business Review,
July-August 2009), offshoring has been devastating whole US industries,
stunting innovation, and crippling capacity to compete long-term.

Pisano and Shih write: “The decline of manufacturing in a region sets
off a chain reaction. Once manufacturing is outsourced,
process-engineering expertise can’t be maintained, since it depends on
daily interactions with manufacturing. Without process-engineering
capabilities, companies find it increasingly difficult to conduct
advanced research on next-generation process technologies. Without the
ability to develop such new processes, they find they can no longer
develop new products. In the long term, then, an economy that lacks an
infrastructure for advanced process engineering and manufacturing will
lose its ability to innovate.”

Pisano and Shih have a frighteningly long list of industries that are
“already lost” to the USA, including: compact fluorescent lighting; LCDs
for monitors, TVs and handheld devices like mobile phones;
electrophoretic displays; lithium ion, lithium polymer and NiMH
batteries; advanced rechargeable batteries for hybrid vehicles;
crystalline and polycrystalline silicon solar cells, inverters and power
semiconductors for solar panels; desktop, notebook and netbook PCs;
low-end servers; hard-disk drives; consumer networking gear such as
routers, access points, and home set-top boxes; advanced composite used
in sporting goods and other consumer gear; advanced ceramics and
integrated circuit packaging.

The list of industries “at risk” is even longer and more worrisome.

Now unless Boeing can quickly fix the technical issues afflicting the
787, its entire airline business will also be “at risk”. Manufacturing
airplanes could even become an addition to the list of industries
“already lost.”

These issues are a wakeup call not just to Boeing but to every CEO whose
firm or whose suppliers have been or will be involved in offshoring.
Every CEO must learn seven lessons.

1. Use the right metrics to evaluate offshoring

In analyzing offshoring, firms must get beyond rudimentary cost
calculations focused on short-term profit,, such as the cost of labor or
the ex-factory cost and incorporate the total cost and risk of extended
international supply chains. This is easily done with the help of the
Reshoring Initiative, whose website includes an analytical tool enabling
companies to calculate the full risks and costs of offshoring. It’s
called the Total Cost of Ownership Estimator[TM]. And the price is
right. It doesn’t require hiring high-priced consultants: it’s free.

The Estimator poses a series of questions. What’s the price of the part
from each of the destinations? How far is it away? How often are you
going to travel to see the supplier? How much intellectual property risk
is there? How long do you think you are going to make it? It uses the
answers to calculate twenty-five different costs. When they are added
up, that’s the Total Cost of Ownership.

Most companies have tended to make their sourcing decisions based on the
wage rate or the ex-works price or the landed cost, and leave out
another twenty cost categories. The Estimator makes it easy for the
company to calculate the other twenty costs.

“Often what firms find,” says Moser, “is that whereas the offshoring
price is perhaps 30 percent less than the US price, all these other
costs add up to more than 30 percent. If they are willing to recognize
all of them, then they can see that it may be profitable to bring the
work back.”

“For instance,” says Moser, “I took the last 27 cases where users
compared China to the US. On average, the US price was 69 percent higher
than the production price in China. It turned out that the US total cost
of ownership was 4 percent lower. So it made a huge difference to make
that calculation. That’s an indication that a substantial portion of the
work that has been offshored would come back if people would use the
right metrics.”

2. Review whether earlier outsourcing decisions made sense

Let’s back up a bit and note that Boeing’s problems have been visible
for some time. In August 2011, my article drew attention to the perilous
offshoring course on which Boeing was embarked.

In December 2012, fellow Forbes contributor Jonathan Salem Baskin wrote:
“The company was convinced by one or more management consulting firms to
outsource design and production of the 787’s components. While this idea
might make sense for sourcing coffeemakers, it was a nonsense approach
to assembling perhaps the most complicated and potentially dangerous
machines shy of nuclear reactors. I’m sure blather from Harvard Business
Review supported the idea that distances between factories in Seattle
and Outer Mongolia were no farther than a VOIP chat, but the reality was
a mess. Parts didn’t fit together with others. Some suppliers
subcontracted work to their suppliers and then shrugged at problems with
assembly. When one part wasn’t available, the next one that depended on
it couldn’t be attached and the global supply chain all but seized up.
Boeing had to spend $1 billion in 2009 to buy one of the worst offenders
and bring the work back
in-house.”

“The grounding — an unusual action for a new plane — focuses on one of
the more risky design choices made by Boeing, namely to make extensive
use of lithium ion batteries aboard its airplanes for the first time,”
write Christopher Drew, Jad Mouawad and Matthew Wald in the New York
Times: “The 787’s problems could jeopardize one of its major features,
its ability to fly long distances at a cheaper cost… The maker of the
787’s batteries, Japan’s GS Yuasa, has declined to comment on the
problems so far. “

What was Boeing thinking when they opted to embrace such extensive
offshoring? Moser believes the error lay in using the wrong measure of
the impact of offshoring on earnings. “Many companies that offshored
manufacturing didn’t really do the math,” Harry Moser, an MIT-trained
engineer and founder of the Reshoring Initiative told me. “A study the
consulting company, Archstone, showed that 60 percent of offshoring
decisions used only rudimentary cost calculations, maybe just price or
labor costs rather than something holistic like total cost. Most of the
true risks and cost of offshoring were hidden.”

For many companies, it’s time to redo the math, and then verify whether
they still have the expertise to bring manufacturing back.

3. Don’t outsource mission-critical components

“Boeing has acknowledged, says Moser, “that its biggest problem was in
outsourcing not only manufacturing but also a lot of the engineering.
There were multiple tiers of outsourced companies who were supposed to
be making their designs consistent so that the parts fit together. And
they didn’t fit together. If Boeing had taken full responsibility for
the engineering and then had jobbed the parts out and gotten them made
to print, their problems would have been a lot less severe. It seems
like they had this brilliant idea of outsourcing a lot of engineering
with the manufacturing. There’s almost nothing as complicated as a
Dreamliner.

“For example, an iPhone isn’t nearly as complicated. The downside risk
isn’t as great. Apple has succeeded with outsourcing almost everything
to Foxconn, mainly because they first completely manufacture the new
product in the US. They make sure it’s right, while Foxconn is working
in parallel with them, developing their tooling and whatever. So Apple
has a finished product and they say to Foxconn: make it just like this!
What Apple has done has worked amazingly well, because they have the
capability to do the perfect prototype here, before it gets offshored to
Foxconn. Most companies don’t have that.

“Thus Boeing didn’t have a finished product. So there were all kinds of
risks of things not coming together. The tendency is too often for
companies to try to do the engineering over here and the manufacturing
over there. Eventually the innovation declines and the risk increases,
as outlined by Pisano and Shih.”

4. Bring some manufacturing back

Moser estimates that when the total costs are included, around 25
percent of manufacturing that is currently outsourced could be
profitably brought home, if the manufacturing expertise still exists.
Looking ahead, changes in relative economics are likely to increase that
percentage.

It is important to take into account rapid changes in relative costs.
Oil prices are three times what they were in 2000. Natural gas in the US
is a quarter of what it is in Asia. Chinese wages are five times what
they were in 2000 and are expected to keep rising rapidly. And in any
event labor is a steadily decreasing percentage of the cost of
manufacturing.

Reshoring is already happening to a limited extent. Apple [AAPL]
announced recently that it will resume manufacturing of one of the
existing Mac lines in the US next year. GE [GE] is spending some $800
million to re-establish manufacturing in its giant facility—until
recently, almost defunct—at Appliance Park, in Louisville, Kentucky.
Whirlpool [WHR] is bringing mixer-making back from China to Ohio. Otis
is bringing elevator production back from Mexico to South Carolina. And
Wham-O Toys is bringing Frisbee-molding back from China to California.
Based on the Reshoring articles in the ReshoreNow Library, Moser
calculates that at least 50,000 manufacturing jobs have recently been
reshored in the last three years.

Where companies see that it could be profitable to bring manufacturing
back, they will need to ensure that they either have or can rebuild the
necessary expertise—sometimes a daunting challenge.

5. Adequately assess the risk factors of offshoring

In Boeing’s case, as Jonathan Salem Baskin notes: “It didn’t help that
the outsourcing plan included skipping the detailed blueprints the
company would have normally prepared, and allowing vendors to come up
with their own. Delivered components arrived with instructions and notes
written in Chinese, Italian, and other languages. Oh, and they decided
to build the airplane out of plastic along with other novel materials
and technologies, so it would have been a big experiment even if Boeing
approached manufacturing like it always had.”

Clearly firms have underestimated the risk of having extended
international supply chains. I asked Moser whether Total Cost of
Ownership Estimator can help firms get a better handle on that risk.

“The TCO Estimator assigns no factor values apart from freight,” says
Moser. “The user assigns all the factors. The user answers questions
about the delivery time, and the price. That enables the Estimator’s
algorithm to assess the inventory and the inventory carrying costs.
There’s a section on opportunity cost. If the firm will lose orders
because it can’t deliver, then put a value on that. There are sections
on natural disaster risk and political risk. “

If Boeing had been using this earlier what would be the implications? If
they underestimated the delay risk or the technical risk as low, the
Estimator would have reflected the underestimation of the risk.

“The Estimator would have encouraged them to try to estimate each of the
risks,” says Moser. “When you have twenty-five of them, you only have to
put in 1 percent in each to balance the savings you might get from going
offshore.

“If you are buying pencils, not much intellectual property risk; if you
can’t get it from this source, you can get it from somewhere else. The
margins aren’t big, so you don’t lose so much. You don’t have much image
to lose. But when you are making airplanes, there’s a lot of risk.
Instead of having one size fit all, the Estimator lets you adapt for
each product, each market, and make a more holistic and informed decision.

“The Reshoring Initiative site also offers resources. Library contains
articles about transportation industry and equipment, and firms can
understand where production was reshored and why. They might conclude:
‘Looks like a lot of companies are having problems with these things.
Maybe we should increase our risk levels?’

“The Initiative also has information on what other users have found on
the distribution of average costs. If they look at that, they might
realize that some costs and risks have been underestimated. So the
Estimator can help them make better decisions.”

6. Adequately value the role of innovation

Much of the offshoring that has taken place has assumed that the
outsourced items are “little do-hickeys” with low value and so didn’t
really matter much in the overall scheme of things. The little
do-hickeys are worth pennies or less and have next-to-no margin. While
those “little do-hickeys” might seem cheap in themselves, the lessons to
be learned in improving their manufacture in the end can turn out to be
highly valuable. (In cost accounting and economics, which usually don’t
explicitly value knowledge, this loss is invisible and so doesn’t get
taken into account.)

Firms often haven’t thought through how often they are going to redesign
this product. “If it’s a bracket and you’re not going to redesign it for
30 years, it doesn’t matter very much,” says Moser. These days however
there are very few components that are good for another thirty years.
“If it is something that you are updating every six months or every
year, then that becomes a lot more important. It’s the difference
between a commodity and something that’s design-driven. The result of
answering those questions is an ‘innovation cost of being at a
distance.’ The Reshoring Initiative has resources so that firms can
develop the understanding to make better decisions.“

The opportunity cost of lost innovation can be significant. Thus when GE
decided to bring manufacturing of its innovative GeoSpring water heater
back from the “cheap” Chinese factory to the “expensive” Kentucky
factory, the cost of production went down. “The material cost went down.
The labor required to make it went down. The quality went up. Even the
energy efficiency went up. GE wasn’t just able to hold the retail
sticker to the ‘China price.’ It beat that price by nearly 20 percent.
The China-made GeoSpring retailed for $1,599. The Louisville-made
GeoSpring retails for $1,299.

GE’s water heater as originally designed for manufacture in China had a
tangle of copper tubing that was difficult to weld together. In the
past, GE had been shipping the design to China and telling them to “make
it”. Confronted with making the water heater themselves, they discovered
that “in terms of manufacturability, it was terrible.” So GE’s designers
got together with the welders and redesigned the heater so that it was
easier and cheaper to make. They eliminated the tangle of tubing that
couldn’t be easily welded. By having those workers right at the table
with the designers, the work hours necessary to assemble the water
heater went from 10 hours in China to two hours in Louisville.

“For years,” Charles Fishman writes in a great article in The Atlantic,
“too many American companies have treated the actual manufacturing of
their products as incidental—a generic, interchangeable, relatively
low-value part of their business. If you spec’d the item closely
enough—if you created a good design, and your drawings had precision; if
you hired a cheap factory and inspected for quality—who cared what
language the factory workers spoke? … It was like writing a cookbook
without ever cooking…. there is an inherent understanding that moves out
when you move the manufacturing out. And you never get it back.”

What is only now dawning on the smart American companies, Lou Lenzi,
head of design for GE appliances says, is that when you outsource the
making of the products, “your whole business goes with the outsourcing.”

7. Get to the root of the problem: maximizing shareholder value

While several decades of outsourcing were under way, why didn’t these
smart managers think about the importance of innovating and protecting
intellectual property? Why didn’t these well-educated managers realize
that it was important to have designers, engineers, and assembly-line
workers talk to each other? Why didn’t these MBA graduates realize that
outsourcing might be mortgaging the future of their firms?

“There was a herd mentality to the offshoring,” John Shook, the CEO of
the Lean Enterprise Institute, in Cambridge, Massachusetts. “And there
was some bullshit. But it was also the inability to see the total
costs—the engineers in the U.S. and factory managers in China who can’t
talk to each other; the management hours and money flying to Asia to
find out why the quality they wanted wasn’t being delivered. The cost of
all that is huge.”

When managers manage with a spreadsheet rather than real-world knowledge
about what is actually going on in the factory and what were its
possibilities, they overlook hidden costs of the erosion of skills, the
loss of quality and constraints on innovation. They also missed the
potential added value to customers that could be generated by designing
and manufacturing things differently. They also missed the costs and
risks of an international supply chain, which is increasingly out of
step with the shorter, faster product cycles.

Why did all these smart, highly educated people make all these mistakes?
The root cause of these errors is a focus on the dumbest idea in the
world: maximizing shareholder value. Focusing on short-term shareholder
value ended up destroying vast quantities of long-term shareholder value.

A focus on maximizing shareholder value leads the firm to do things that
detract from maximizing long-term shareholder value, such as offshoring,
favoring cost-cutting over innovation, and pursuit of “corner cutting”
and “bad profits” that destroy brand equity. The net result can be seen
in the disastrously declining ROA and ROIC over the last four decades in
large US firms as documented by Deloitte’s Shift Index.

The errors of offshoring are thus not isolated events. They are the
result of the underlying philosophy of shareholder value, rather than
the true purpose of every firm: create value for customers. The
resurrection of American manufacturing will require more than simply
bringing back production to America. Global manufacturing is at the cusp
of a massive transformation as the new economics of energy and labor
plays out and a set of new technologies—robotics, artificial
intelligence, 3D printing, and nanotechnology—are advancing rapidly.
Together these developments will spark a radical transformation of
manufacturing around the world over the next decade. The winners in the
rapidly changing world of manufacturing will be those firms that have
mastered the agility needed to generate rapid and continuous
customer-based innovation.

Success in this new world of manufacturing will require a radically
different kind of management from the hierarchical bureaucracy focused
on shareholder value that is now prevalent. It will require a different
goal (adding value for customers), a different role for managers
(enabling self-organizing teams), a different way of coordinating work
(dynamic linking), different values (continuous improvement and radical
transparency) and different communications (horizontal conversations).
Merely shifting the locus of production is not enough. Companies need
systemic change—a new management paradigm.

Pursuit of maximizing shareholder value at Boeing led to offshoring that
has caused massive damage to shareholder value. The eventual scale of
the damage can only be guessed at today. The remedy lies not in pointing
fingers at Boeing’s management, but rather in treating the economy-wide
disease that caused the problem.

(6) The Formidable Dimensions of Boeing's Dreamliner Problem - Eamonn
Fingleton

The Formidable Dimensions of Boeing's Dreamliner Problem

Eamonn Fingleton

Forbes, January 17, 2013

http://www.forbes.com/sites/eamonnfingleton/2013/01/17/the-formidable-dimensions-of-boeings-dreamliner-problem/

How serious is Boeing‘s 787 problem? Gerhard Fasol, chief of the
Tokyo-based consulting firm Eurotechnology, takes a pessimistic view.

He believes that one key paragraph in last night’s statement by the
Federal Aviation Administration defines Boeing’s problem: “Before
further flight, operators of U.S.-registered, Boeing 787 aircraft must
demonstrate to the Federal Aviation Administration (FAA) that the
batteries are safe.” As Fasol points out, this sets the bar high, given
that the 787's lithium-ion batteries, made by GS Yuasa of Japan, have
never before been deployed in a commercial aircraft. “It could be weeks,
if not months, before they get to the bottom of this,” he says.

A key part of the problem seems to be that, compared to nickel-cadmium
batteries, which have hitherto been standard on commercial jets,
lithium-ion batteries require more careful handling. They are more
volatile and if overcharged, for instance, are more prone to causing fires.

So, if these batteries are the root of the problem, why not go back to
nickel-cadmium? This unfortunately is easier said than done. For a start
it would require major reworking of software and circuitry. Even more
problematic, however, is the fact that lithium-ion batteries are much
more compact than nickel-cadmium ones. They can store about twice as
much energy per unit volume. They also can be moulded to make maximum
use of irregular spaces in an aircraft. “As lithium-ion batteries were
built into the design from the start, space constraints may make it
difficult to revert to more traditional batteries,” says Fasol.

One thing is clear: selling of Boeing’s stock continued today. Meanwhile
shares of EADS, the Netherlands-based company that makes Airbus planes,
continued their recent outperformance. Compared to last Thursday’s
Boeing is down 3.5 percent, whereas EADS is up 5.8 percent. As for
Thales and United Technologies, two key Boeing suppliers whose inputs
may come under scrutiny, their stocks are more or less level over the
last week, in line with the S & P index.

(7) The Dumbest Idea In The World: Maximizing Shareholder Value

http://www.forbes.com/sites/stevedenning/2011/11/28/maximizing-shareholder-value-the-dumbest-idea-in-the-world/

by Steve Denning

Forbes.com, 11/28/2011 @ 1:19PM |439,751 views

There is only one valid definition of a business purpose: to create a
customer.

Peter Drucker, The Practice of Management

[...] In today’s paradoxical world of maximizing shareholder value,
which Jack Welch himself has called “the dumbest idea in the world”, the
situation is the reverse. CEOs and their top managers have massive
incentives to focus most of their attentions on the expectations market,
rather than the real job of running the company producing real products
and services.

The “real market,” Martin explains, is the world in which factories are
built, products are designed and produced, real products and services
are bought and sold, revenues are earned, expenses are paid, and real
dollars of profit show up on the bottom line. That is the world that
executives control—at least to some extent.

The expectations market is the world in which shares in companies are
traded between investors—in other words, the stock market. In this
market, investors assess the real market activities of a company today
and, on the basis of that assessment, form expectations as to how the
company is likely to perform in the future. The consensus view of all
investors and potential investors as to expectations of future
performance shapes the stock price of the company.

“What would lead [a CEO],” asks Martin, “to do the hard, long-term work
of substantially improving real-market performance when she can choose
to work on simply raising expectations instead? Even if she has a
performance bonus tied to real-market metrics, the size of that bonus
now typically pales in comparison with the size of her stock-based
incentives. Expectations are where the money is. And of course,
improving real-market performance is the hardest and slowest way to
increase expectations from the existing level.”

In fact, a CEO has little choice but to pay careful attention to the
expectations market, because if the stock price falls markedly, the
application of accounting rules (regulation FASB 142) classify it as a
“goodwill impairment”. Auditors may then force the write-down of real
assets based on the company’s share price in the expectations market. As
a result, executives must concern themselves with managing expectations
if they want to avoid write-downs of their capital.

In this world, the best managers are those who meet expectations.
“During the heart of the Jack Welch era,” writes Martin, “GE met or beat
analysts’ forecasts in forty-six of forty-eight quarters between
December 31, 1989, and September 30, 2001—a 96 percent hit rate. Even
more impressively, in forty-one of those forty-six quarters, GE hit the
analyst forecast to the exact penny—89 percent perfection. And in the
remaining seven imperfect quarters, the tolerance was startlingly
narrow: four times GE beat the projection by 2 cents, once it beat it by
1 cent, once it missed by 1 cent, and once by 2 cents. Looking at these
twelve years of unnatural precision, Jensen asks rhetorically: ‘What is
the chance that could happen if earnings were not being “managed’?”’
Martin replies: infinitesimal.

In such a world, it is therefore hardly surprising, says Martin, that
the corporate world is plagued by continuing scandals, such as the
accounting scandals in 2001-2002 with Enron, WorldCom, Tyco
International, Global Crossing, and Adelphia, the options backdating
scandals of 2005-2006, and the subprime meltdown of 2007-2008. The
recent demise of MF Global Holdings and the related ongoing criminal
investigation are further reminders that we have not put these matters
behind us.

“It isn’t just about the money for shareholders,” writes Martin, “or
even the dubious CEO behavior that our theories encourage. It’s much
bigger than that. Our theories of shareholder value maximization and
stock-based compensation have the ability to destroy our economy and rot
out the core of American capitalism. These theories underpin regulatory
fixes instituted after each market bubble and crash. Because the fixes
begin from the wrong premise, they will be ineffectual; until we change
the theories, future crashes are inevitable.”

“A pervasive emphasis on the expectations market,” writes Martin, “has
reduced shareholder value, created misplaced and ill-advised incentives,
generated inauthenticity in our executives, and introduced parasitic
market players. The moral authority of business diminishes with each
passing year, as customers, employees, and average citizens grow
increasingly appalled by the behavior of business and the seeming greed
of its leaders. At the same time, the period between market meltdowns is
shrinking, Capital markets—and the whole of the American capitalist
system—hang in the balance.”

How did capitalism get into this mess?

Martin says that the trouble began in 1976 when finance professor
Michael Jensen and Dean William Meckling of the Simon School of Business
at the University of Rochester published a seemingly innocuous paper in
the Journal of Financial Economics entitled “Theory of the Firm:
Managerial Behavior, Agency Costs and Ownership Structure.”

The article performed the old academic trick of creating a problem and
then proposing a solution to the supposed problem that the article
itself had created. The article identified the principal-agent problem
as being that the shareholders are the principals of the firm—i.e., they
own it and benefit from its prosperity, while the executives are agents
who are hired by the principals to work on their behalf.

The principal-agent problem occurs, the article argued, because agents
have an inherent incentive to optimize activities and resources for
themselves rather than for their principals. Ignoring Peter Drucker’s
foundational insight of 1973 that the only valid purpose of a firm is to
create a customer, Jensen and Meckling argued that the singular goal of
a company should be to maximize the return to shareholders.

To achieve that goal, they academics argued, the company should give
executives a compelling reason to place shareholder value maximization
ahead of their own nest-feathering. Unfortunately, as often happens with
bad ideas that make some people a lot of money, the idea caught on and
has even become the conventional wisdom.

During his tenure as CEO of GE from 1981 to 2001, Jack Welch came to be
seen–rightly or wrongly–as the outstanding exemplar of the theory, as a
result of his capacity to grow shareholder value at GE and magically hit
his numbers exactly. When Jack Welch retired from GE, the company had
gone from a market value of $14 billion to $484 billion at the time of
his retirement, making it, according to the stock market, the most
valuable and largest company in the world. In 1999 he was named “Manager
of the Century” by Fortune magazine. Since Welch retired in 2001,
however, GE’s stock price has not fared so well: GE has lost around 60
percent of the market capitalization that Welch “created”.

Before 1976, professional managers were in charge of performance in the
real market and were paid for performance in that real market. That is,
they were in charge of earning real profits for their company and they
were typically paid a base salary and bonus for meeting real market
performance targets.

The change had the opposite effect from what was intended

The proponents of shareholder value maximization and stock-based
executive compensation hoped that their theories would focus executives
on improving the real performance of their companies and thus increasing
shareholder value over time. Yet, precisely the opposite occurred. In
the period of shareholder capitalism since 1976, executive compensation
has exploded while corporate performance has declined.

“Maximizing shareholder value” turned out to be the disease of which it
purported to be the cure. Between 1960 and 1980, CEO compensation per
dollar of net income earned for the 365 biggest publicly traded American
companies fell by 33 percent. CEOs earned more for their shareholders
for steadily less and less relative compensation. By contrast, in the
decade from 1980 to 1990 , CEO compensation per dollar of net earnings
produced doubled. From 1990 to 2000 it quadrupled.

Meanwhile real performance was declining. From 1933 to 1976, real
compound annual return on the S&P 500 was 7.5 percent. Since 1976,
Martin writes, the total real return on the S&P 500 was 6.5 percent
(compound annual). The situation is even starker if we look at the rate
of return on assets, or the rate of return on invested capital, which
according to a comprehensive study by Deloitte’s Center For The Edge are
today only one quarter of what they were in 1965.

Although Jack Welch was seen during his tenure as CEO of GE as the
heroic exemplar of maximizing shareholder value, he came to be one of
its strongest critics. On March 12, 2009, he gave an interview with
Francesco Guerrera of the Financial Times and said, “On the face of it,
shareholder value is the dumbest idea in the world. Shareholder value is
a result, not a strategy… your main constituencies are your employees,
your customers and your products. Managers and investors should not set
share price increases as their overarching goal. … Short-term profits
should be allied with an increase in the long-term value of a company.”

The shift to delighting the customer

What to do? Given the numbers of the people and the amount of money
involved, rescuing capitalism from these catastrophically bad habits
won’t be easy. For most organizations, it will take a phase change. It
means rethinking the very basis of a corporation and the way business is
conducted, as well as the values of an entire society.

“We must shift the focus of companies back to the customer and away from
shareholder value,” says Martin. “The shift necessitates a fundamental
change in our prevailing theory of the firm… The current theory holds
that the singular goal of the corporation should be shareholder value
maximization. Instead, companies should place customers at the center of
the firm and focus on delighting them, while earning an acceptable
return for shareholders.”

If you take care of customers, writes Martin, shareholders will be drawn
along for a very nice ride. The opposite is simply not true: if you try
to take care of shareholders, customers don’t benefit and, ironically,
shareholders don’t get very far either. In the real market, there is
opportunity to build for the long run rather than to exploit short-term
opportunities, so the real market has a chance to produce
sustainability. The real market produces meaning and motivation for
organizations. The organization can create bonds with customers, imagine
great plans, and bring them to fruition.

“The expectations market,” says Martin, “generates little meaning. It is
all about gaining advantage over a trading partner or putting two
trading partners together, then tolling them for the service. This
structure breeds a kind of amorality in which information is withheld or
manipulated and trading partners are treated as vehicles from which to
extract money in the short run, at whatever the cost to the relationship.”

By contrast, the real market contributes to a sense of authenticity for
individuals. Because individuals can find meaning in their jobs. They
are not playing a zero-sum game. They are doing something real and
positive for society.

Examples of the shift

Martin cites three examples of firms that are, even within the legal
limits of today’s world, focused on the real world of customers and
products more than gaming the stock market.

One is Johnson & Johnson [JNJ]. In 1982, when the Tylenol poisonings
occurred, “J&J was in a terrible bind. Tylenol represented almost a
fifth of the company’s profits, and any decline in its market share
would be difficult to reclaim, especially in the face of rampant fear
and rumor. Yet, rather than attempt to downplay the crisis—it was after
all, likely the work of an individual madman in one tiny part of the
country—J&J did just the opposite. Chairman James Burke immediately
ordered a halt to all Tylenol production and advertising, distributed
warnings to hospitals across the country, and within a week of the first
death, announced a nationwide recall of every single bottle of Tylenol
on the market. J&J went on to develop tamper-proof packaging for its
products; an innovation that would soon become the industry standard.”
Burke’s actions were not the heroic act of a single individual, says
Martin. The actions flowed from the company credo
which is engraved in granite at the entry to company headquarters,
which makes crystal clear that customers are first, then employees, and
shareholders absolutely last. Martin contrasts J&J’s handling of the
Tylenol crisis with the handling of the Deepwater Horizon oil spill in
2010 by BP [BP], which he sees as driven by a short-term concern for
BP’s profits.

A second example is Procter & Gamble [PG] which “declares in its purpose
statement: ‘We will provide branded products and services of superior
quality and value that improve the lives of the world’s consumers, now
and for generations to come. As a result, consumers will reward us with
leadership sales, profit and value creation, allowing our people, our
shareholders and the communities in which we live and work to prosper.’
For P&G, consumers come first and shareholder value naturally follows.
Per the statement of purpose, if P&G gets things right for consumers,
shareholders will be rewarded as a result.”

A third example is Apple. Steve Jobs seemed to delight in signaling to
shareholders that they didn’t matter much and that they certainly
wouldn’t interfere with Apple’s pursuit of its original customer-focused
purpose: ‘to make a contribution to the world by making tools for the
mind that advance humankind.’ Jobs’s feisty, almost combative demeanor
at shareholder meetings is legendary. At the meeting in February 2010,
one shareholder asked Jobs, “What keeps you up at night?” Jobs quickly
responded, ‘Shareholder meetings.’”

Making needed legal changes

Admonishing CEOs (and investors) to ignore the expectations market and
refocus on delighting the customer isn’t going to work, says Martin.
It’s as likely to be “as effective as admonishing frat boys to stop
chasing girls.” For CEOs, there are massive incentives for staying
attuned to it and severe punishments for ignoring it. Investors,
analysts, and hedge funds continue to reward firms that meet
expectations and punish those that do not. Missing expectations, a
dropping stock-price, and real-asset write-downs can together create an
unstoppable downward spiral. In the current environment, to simply
ignore the expectations market is to court disaster.

One of the great values of the Martin’s book is that he puts his finger
on the needed legal changes that can help shift the dynamic of business
away from gaming the expectations market and back to doing the real job
of delighting customers.

* One is the repeal of 1995 Private Securities Litigation Reform
Act, which contains what has become known as the “safe harbor”
provision. “To move ahead productively,” he writes, “the safe harbor
provision should simply be repealed. Executives and their companies
should be legally liable for any attempt to manage expectations. Without
the safe harbor provisions, there would be no earnings guidance and that
would be a great thing.” Making this change would immediately bring the
practice of giving guidance to the stock market, and so gaming
expectations, to a screeching halt. There is, says Martin, simply no
societal value to earnings guidance. The market will know exactly what
earnings are going to be at the end of the quarter, in just three or
fewer months. Society is not better off to have an executive publicly
guess at what that number is going to be. We need to turn executives
from the useless, vapid task of managing expectations to
the psychologically and economically rewarding business of creating value.

* A second is the elimination of regulation FASB 142 which forces
the real write-downs of real assets based on the company’s share price
in the expectations market. The current rule forces executives to
concern themselves with managing expectations in order to avoid
write-downs. Changing the rule would remove the major sanction that now
exists for executives who ignore the expectations market.

* A third is to restore the focus of executives on the real market
and on an authentic life by eliminating the use of stock-based
compensation as an incentive. This doesn’t mean that executives
shouldn’t own shares. If an executive wants to buy stock as some sort of
bonding with the shareholders or for whatever other reasons, that’s just
fine. However, executives should be prevented from selling any stock,
for any reason, while serving in that capacity—and indeed for several
years after leaving their posts. Stock based compensation is a very
recent phenomenon, one associated with lower shareholder returns,
bubbles and crashes, and huge corporate scandals. In 1970, stock based
compensation was less than 1 percent of compensation. By 2000, it was
around half of compensation. For the last 35 years, stock-based
compensation has been tried. It had the opposite effect of what was
intended. We should learn from experience and discontinue it.

Other needed changes

Martin also argues for associated changes:

* We must restore authenticity to the lives of our executives. The
expectations market generates inauthenticity in executives, filling
their world with encouragements to suspend moral judgment. They receive
incentive compensation to which the rational response is to game the
system. And since they spend most of their time trading value around
rather than building it, they lose perspective on how to contribute to
society through their work. Customers become marks to be exploited,
employees become disposable cogs, and relationships become only a means
to the end of winning a zero-sum game.

* We need to address board governance. Boards have become complicit
in gaming the expectations market, and the associated inflation of
executive compensation.

* We need to regulate expectations market players, most notably
hedge funds. Net, hedge funds create no value for society. They have
huge incentives to promote volatility in the expectations market, which
is dangerous for us but lucrative for them. So, we need to rein in the
power of hedge funds to damage real markets.

In a book that offers so much, one is tempted to ask for more. Perhaps
in subsequent writings, Martin will expand and carry his thinking
forward. In future writings, he might document more of the economically
disastrous practices that enable firms to meet their quarterly targets,
such as looting the firm’s pension fund or cutting back on worker
benefits or outsourcing production to a foreign country in ways that
further destroy the firm’s ability to innovate and compete.

He might also spell out the specific management changes that are
necessary to delight the customer. The command-and-control management of
hierarchical bureaucracy is inherently unable to delight anyone–it was
never intended to. To delight customers, a radically different kind of
management needs to be in place, with a different role for the managers,
a different way of coordinating work, a different set of values and a
different way of communicating. This is not rocket science. It’s called
radical management.

He might also show how the shift from maximizing shareholder value to
delighting the customer involves a major power shift within the
organization. Instead of the company being dominated by salesmen who can
pump up the numbers and the accountants who can come up with cuts needed
to make the quarterly targets, those who add genuine value to the
customer have to re-occupy their rightful place.

He might also build on the theme that the shift from maximizing
shareholder value to delighting the customer doesn’t involve sacrifices
for the shareholders, the organizations or the economy. That’s because
delighting the customer is not just profitable: it’s hugely profitable.
Bottom-line: capitalism is at risk

American capitalism hangs in the balance, writes Martin. His book gives
a clear explanation as to why this is so and what should be done to save
it. A large number of rent-collectors and financial middlemen making
vast amounts of money are keeping the current system in place. The fact
that what they are doing is destroying the economy will not sway their
thinking. As Upton Sinclair noted, “It is difficult to get a man to
understand something, when his salary depends upon his not understanding
it.”

Is change possible? Martin believes so, quoting Vince Lombardi: “We
would accomplish many more things if we did not think of them as
impossible.” Other “impossible” changes have been accomplished.

“Not long ago, it seemed fanciful that public smoking would be
restricted and tobacco companies would sponsor public service ads that
discourage smoking,” wrote Deepak Chopra and David Simon in 2004. “But
this shift in awareness occurred when a critical mass of people decided
they would no longer tolerate a behavior that harmed many while
benefited a few.”

For instance, the Aspen Institute’s Corporate Values Strategy Group has
been working on promoting long-term orientation in business decision
making and investing. In 2009, twenty-eight leaders representing
business, investment, government, academia, and labor (including Warrent
Buffett, CEO of Berkshire Hathaway, Lou Gerstner, former CEO of IBM and
Jim Wolfensohn, former president of the World Bank) joined with the
Institute to endorse a bold call to end the focus on value-destroying
short-term-ism in our financial markets and create public policies that
reward long-term value creation for investors and the public good.

Ultimately, the change will happen, not just because it’s right, but
because it makes more money. Once investors realize what is going on,
the economics will drive the change forward. The recognition that
maximizing shareholder value is the dumbest idea in the world is an
obvious but still a radical idea.

Like all obvious, radical ideas, in the first instance it will be
rejected. Then it will be ridiculed. Finally it will be self-evident and
no one will be able to remember why anyone ever thought otherwise.(i)

Buy the Martin’s book. Read it. Implement it. The very future of our
society “hangs in the balance”.

Roger L. Martin: Fixing the Game: Bubbles, Crashes, and What Capitalism
Can Learn from the NFL. Harvard Business Review Press 2011.

And read also:

Q&A with Roger Martin: Fighting The Kool-Aid Of Stock-Based Compensation