Is Apotheker destroying HP?

Nine months back, B&E had questioned whether Leo Apotheker was the right choice to fill Hurd’s shoes at HP (article titled, “Wrong person. Wrong place?”). With his recent announcement to restructure HP’s healthy business, the questions are back. Will his bet pay off; or is it a fatal move for HP?

A week before former SAP CEO Leo Apotheker was set to assume the corner office at HP’s Palo Alto headquarters (on November 1, 2010), B&E had put forward two forecasts for HP. First, was an adoption of inorganic means to grow in the enterprise space. [Claim #1: “What is inevitable, is that HP under Apotheker will join the battle to capture the enterprise space from the likes of Oracle and IBM. This would call for an expensive acquisition.”] Second, was a tamper with HP’s old order – the hardware business. [Claim #2: “He (Apotheker) has options. The most irresistible one will be not to tamper with HP’s pride – its hardware business – which he will.”] Both became reality on August 16, 2011, when HP announced the purchase of LSE-listed software-maker & cloud-search specialist Autonomy for $11.69 billion and decided to spin-off (and put on sale over the next 12 months) its $40.74 billion-a-year topline earning Personal Systems Group (PSG unit that includes hardware – PCs, tablets & mobility devices).

Many claim that such a prediction would have been easy. Not so. Even as recently as April 2011, Apotheker was heard singing hymns about HP’s webOS and how it would make up for the core OS on all HP PCs shipped post-2012. In fact, it was only on July 1, 2011, that HP’s tablet – the TouchPad – was launched. The company’s announcement to therefore acquire Autonomy and pull the shutters on hardware is a sign that Apotheker was undecided until the first week of August 2011 (when it announced a discount of $100 on all variants of its tablet to clear out inventory), whether or not he was to adopt enterprise software & services as the sole breadwinner for HP. Now that he has made a public appearance on the subject, question is – will this decision work in favour of HP?

The thoroughly flummoxed stock market thinks otherwise. In the trading session that followed this announcement, the company’s m-cap shrunk by $16 billion – the single-largest fall in a day since the Black Monday crash of 1987 (taking the tally of HP’s value destroyed by Apotheker to $47.52 billion in 10 months; under him HP’s m-cap as on August 29, 2011 had fallen by 47.47% to $51.48 billion). Frankly, the bourses have it rightly calculated. There are reasons.

Forget the risks. Even at face value, the Autonomy purchase is an expensive one. What logic explains the pricing of an entity, whose current revenue equals 1% of your expected annual topline (FY2011), at 13.12% of your est. revenues of $89.12 billion for FY2012 (as per Credit Suisse)? Even if paying a 75% premium over Autonomy’s closing price on August 15, 2011, is not an indication of the deal being overvalued, then a valuation in excess of 64x of Autonomy’s current P/E and 16x its forward revenue (for FY2011) surely is.

The purchase does carry an upside in the sense that it could provide exposure to HP’s enterprise software business (which currently contributes to 46.51% of its topline; FY2010), as well as a push into the analytics arena. But the opportunity cost renders the deal unappealing. What the Autonomy buy has in store for HP is better understood in the light of revenues that will be lost due to the coupling of this inorganic strategy with the hardware unit sell-off. Competition has lowered profits in the hardware business, but “brave” is the only adjective to describe the sacrifice of a business, where HP is currently the indisputed leader. Be it in US, EMEA or globally, HP controls the largest share in the PC market, across geographies (see chart titled “Global market shares of PC sellers”). Financially therefore, it is difficult to imagine a future without the PSG division starting FY2012. The revenues lost?

A $73.64 billion sacrifice at the altar of the enterprise software and services gods between just the two years FY2012-FY2013. Not to say that the hardware unit is not faced with greater competitiveness by the day, but to jettison it in a single shot is absurd. What makes us believe that HP’s most recent shot at restructuring (and Apotheker’s attempt to win over his shareholders) is more about hype than hope? Read the numbers.

Even if you were to go by the rate at which the contribution of hardware (PCs and mobility devices) to HP’s topline has been declining over the past half-a decade (4.09%; primarily because on one hand, while the former CEO Hurd focused little on innovation in the mobility platform, on the other, Apotheker, had little clue about what could potentially be done with a PC-plus-services portfolio), post sell-off of the PSG unit, the company stands to lose $400.74 billion in expected revenue earnings over the next 20 years (arrived at using a binomial regression forecast model; R2=0.99; Eq. y = -37.75x2 - 1395x + 42154). In stark contrast, the complimenting move of buying Autonomy – assuming optimistically that the entity’s current CAGR of 20% in revenues will be maintained – will end up adding $49.03 billion to HP’s topline over the same period. Translation: a direct loss of more than $350 billion over the next two decades! This comparison especially assumes importance considering the valuation of HP’s hardware business. Based on a review of PC focused peers (Lenovo, Dell, Acer and Asus), HP’s PSG segment could warrant a valuation of 0.3x EV/Sales (or 4.8x EV/EBITDA) multiple, which would put the pure enterprise value of the business at roughly $12 billion – the amount that is being spent on Autonomy to save its service dream. A bad bargain. The restructuring also brings to surface the inability of HP to keep its head above the water in a world of devices where convergence is the magic word. The company has made clear its intentions to wash its hands off webOS devices. The HP management has confessed that it lacks the innovation and the execution to become an Apple in any decade soon. Come Q4, 2011, and webOS will live no more. The webOS write-off will further put pressure on HP’s cost base, as there will be a $1 billion cash charge over the next quarter due to inventory clearance costs and supplier commitments with respect to the Touchpad tablet. In addition, there could be a non-cash charge at a later date if goodwill is marked down.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

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Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
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Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

A Modern Hype called Mergers & Acquisitions!

Prof. Bill Kaufmann, Faculty of M&A Integration, College of William & Mary's Mason School of Business and at Sum COX School of Business, Writes about why M&As can go bad, and why 75% of them actually Destroy Shareholder value for the acquirers. Co-Ordinated

During the past 40 years, I have been part of the merger and acquisition world in many different ways – both as an acquirer many times over, then being acquired once, plus teaching M&A Integration for the College of William & Mary’s Mason School of Business and at SMU Cox School of Business at the MBA level. Let me outline what I have observed and learned over the years.

WHY DON’T M&As WORK?
You can name a hundred reasons why M&As don’t or cannot work. I can name some going by what I have seen in first person. Here they are: (1) Inadequate due diligence: When too much emphasis is on the numbers and not other factors. One example is that of cultural synergy. Often you would find that in M&As which have failed, the acquirers have failed to integrate the cultures of the two companies. Daimler Chrysler was a good example of this. Conflicting corporate cultures is perhaps the most destructive of all the reasons why two companies don’t “fit”; (2) Lack of a compelling strategic rationale: The key word is compelling. As I mentioned before, some companies go ahead for an acquisition or a merger even if they find no real strategic sense in the deal. This is not right; (3) Unrealistic expectations of synergies: Top management oversells the value of the combination. And the acquiring firm ends up paying too high a premium, often much more than can be achieved through various synergies. Paying too much is a problem, and this happens especially when there is a bidding war between two egos; and (4) Failure to move quickly enough to meld the two companies: This creates uncertainty in the workforce.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
IIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

The Difficult game of M&As: A Practitioner’s view

M&As often only create value for The Acquired, but not for the acquirers – exactly The Opposite of what is expected. Why are M&As not so successful? The answer lies in their complexity says Prof. Pablo De Holan, Faculty of Strategy & Organisation, Incae Business School (Costa Rica). Co-Ordinated

M&As are tools used by firms to grow, along with corporate venturing and organic growth. Unfortunately, it is a tool that is fraught with difficulties. Indeed, research shows that M&As often only create value for the firm that is being sold, but not for the acquirers, exactly the opposite of what it is expected.

To understand why this is so, we need to explore the degree of diversification of both firms. Obviously, the more different the participating firms are at the onset, the more complicated the integration process is, and as a consequence, the higher the chances to make costly mistakes that have the potential to reduce, often in a significant way, the value created by the M&A. This is so because the cost of the acquisition is set early on and can only increase, but the value generated will only happen after the integration process begins. In addition, it is not uncommon to see firms exaggerating the potential of the M&A to justify the acquisition, only to find that these inflated expectations cannot be fulfilled easily.

Rather than focusing on the difficulties of M&As, it is important we understand under what conditions they create value for the acquirer. While research shows that highly diversified firms tend to have lower returns than highly concentrated ones, the causal relation is unclear. Recent research shows that the lower returns can be explained by the fact that firms often embark in a diversification campaign (through M&A, for example) when their results in their core business are declining or are expecting to decline. M&As, then, are seen as a remedy to a bad strategic position rather than a way to consolidate it. This is particularly detrimental to firms because in M&A, as in many other situations in life, one can buy only what is up for sale or pay a huge premium to convince someone to sell something he was not willing to sell, increasing the risk of overpaying for the acquisition.

Some interesting ideas emerge from these findings. First, managers need to understand the importance of thinking about M&As as key strategic tools, and wonder how (or whether) M&As fit or don’t fit into their current strategy. Second, managers should remember that M&As can support and sustain a strategy of diversification, but will not easily replace declines in their core markets. To expect M&As to be the short-term, quick-fix solution to competitive weaknesses is to ask too much of this tool, and disappointment is almost guaranteed by design. Well applied, M&As and diversification in general can add a great deal of value to a company, but only if we understand the dynamics of acquisitions and their cycle, which may or may not correspond to the company needs at that time. Also, managers need to avoid underestimating the difficulties of integrating different companies. This is somehow counter-intuitive, as very different firms can look complementary and thus show great potential ex-ante if the integration goes well, while more similar firms, whose integration would be simpler do not look as promising. Finally, managers need to keep in mind that firms who have built a successful strategy of growth through M&As, have done so by conducting extensive due diligence exercises, which obviously include the financial aspects of the M&A and integration of the company once the M&A has been completed. As it is the case with many other dimensions of life, in M&As, “chance favours the prepared mind”, so a little preparation of the integration process can go a long way to avoid issues later on.

Conclusion is: M&As can produce outstanding results when used properly. However, as it is the case with any tool, the context in which they are used, and their applications, vary a lot from one situation to the other, requiring managers to spend time thinking whether the tool being used is adequate for the circumstance and whether it fits with the strategic objectives, or not.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
IIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

Prof. Kishore Kulkarni, Metropolitan State College of Denver

Without reservation, and by any standard one wants to measure the growth, the Indian economy has been moving in an enviable fashion. But to some sociologists, this may seem only an exercise that has increased income inequality. A simple statistical fact is that when some sectors grow, even if others stay at the same level, the inequality of income automatically increases. The Indian case is not very different from this trend. When 33% of the population is still below the subsistence level (defined as an income of $2 per day), India needs to keep growing for a long time to reduce absolute poverty to a manageable level. Second, one can point out the “digital divide” that has created two separate population groups within India. The so called “skilled” (and elite) people live a whole different lifestyle than the poor and unskilled ones. Bridging this divide will be a challenging and a monumental task in the future.

Indian lawmakers need to overhaul the legal system urgently to manage this problem. There are three ministers of the ruling party already in jail, and few more deserve to be with them. It is a matter of public trust that moves the country successfully and efficiently. For economic growth, as many economists have already pointed out, no other factor is more important than the public enthusiasm, productivity, entrepreneurship and enterprise. Without these important ingredients, even the current economic growth can be in jeopardy unless the ruling party takes care of the public perception of impropriety.

Second, the effect of Indian economic growth seems to have created fewer jobs than economic growths across the world. Here is the dilemma: In the service sector, where the growth is concentrated, labor productivity is significantly higher than in manufacturing or in agriculture. Therefore, the “growth without employment” is a possible logical outcome when the service sector grows the fastest; Indian economic growth tends to fall in this category. The young, inexperienced, religious minorities, poor and illiterate still find job hunting a tedious exercise.

Third, in recent months, the inflation of food items has created a major worry for policymakers. The prices of gasoline, onions, cooking gas, diesel, rice and tomatoes have all skyrocketed for one reason or another. While price controls are not a solution for any inflation, an efficient market system where the government takes away all impediments for the smooth flow of supply and demand is necessary. It will also help if the production of these necessities is promoted with special subsidies. Some short-run solutions on an emergency basis are necessary if the inflation has to be brought under control.

Finally, political trouble in the Northeast (by Communist forces), in the south (by Naxalites), and up north (by so-called Kashmir liberators) cannot be ignored. These forces have a propensity to get stronger, and unless the government watches them carefully, they can significantly lower the economic growth rate. Additionally, the supply of real ingredients needed for meaningful sustainability has to be increased. This should include improved infrastructure facilities, a steady supply of necessities such as items for food, clothing and shelter, and improved efficiency in the public sector – which is still very dominant and intrusive in the Indian business environment.

In other words, there are some major challenges to be faced in the upcoming years. Answering “YES” to whether or not economic growth is sustainable depends upon how the Indian economy finds solutions to these challenges.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
IIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

Apparently, there’s Quite a Lot in a Name!

As Infosys goes Through Massive Transformations in its Strategy & Branding, Virat Bahri discusses what it would take to take The Next Leap

When you consider two names – Apple Computers and Infosys Technologies, there can be very little in terms of comparison; besides the obvious fact that both of them command iconic status that is the envy of companies within and beyond their respective industries. Apart from that, there is a marked difference in their trajectories, right from the fact that while Steve Jobs and Steve Wozniak, the founders of Apple shared an incorrigible passion for hardware, Infosys’ group of 7 led by Narayana Murthy had software as the basis of their vision. Jobs always dreamt of leading the computing industry through innovation and design, whereas Infosys started primarily as an outsourcing company that did application development and maintenance and relied on Indian frugality (though it very steadily moved up). And while Jobs was in a hurry for just about every venture he undertook (and still is) and made large & risky bets, Infosys and its founders have often been considered to be more circumspect, more than eager to be right with every bet they make.

The contrasts can go on way beyond the scope of this article, but there is one interesting development in the recent past in the Infosys camp that is uncannily similar to Apple – the change in name from Infosys Technologies to Infosys Ltd. to tell the world that it is evolving from a technology solutions vendor to business transformation services provider. One can recall how Apple Computers had dropped the ‘Computers’ tag and became Apple Inc. in 2007 to show that it had moved into the wider field of consumer electronics, mobile devices, et al; around six years after they actually made that shift in 2001 with the iPod.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age WomanIIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

Case for a soft dragon!

China is quite concerned after the ‘Jasmine wave’ extended to the Middle East. But its response is worthy of condemnation

Freedom is a birthright, but China seems to believe that economic growth is a very viable substitute. However, post the events in Tunisia & Egypt, China seems to be much more paranoid than ever before.

Firstly, China has increased its defence budget and increased salaries of internal police personnel; ostensibly to avoid the horror of a revolt in uniform, even as it imprisons political activists recklessly. The recent arrest of artist and political activist Ai Weiwei is a case in point. Ai, who openly called for political reforms, was arrested on April 3 at the Beijing Airport on grounds of financial fraud. His friend, Zuoxiao Zuzhou, a Chinese rock star who was trying to urge people to support Ai, was also detained later. His crime was that he displayed “Free Ai Weiwei” in a live concert. Nobel laureate Liu Xiabao is still serving his sentence.

In a span of just a few days, four veteran activists – Liu Xianbin, Ran Yunfei, Ding Mao and Chen Wei – were arrested. The minimum sentence has gone up from 3 years to 10. Gao Zhisheng, a Christian human rights lawyer, was sentenced for subversion after he wrote open letters to the European parliament and US Congress calling for reform. The torture on him has been so severe that he twice tried to kill himself. Since 2010, there is no word about him. Reportedly, over 7-8 million Chinese are currently imprisoned and around 5000 face the death penalty every year, higher than the rest of the world put together.

Fourteen years ago, Libya was on the Chair of the UN Human Rights Council. Later, they were removed. Similar steps need to be taken against China.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age WomanIIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

“Gaming & Hospitality will Drive Our Growth”

Since Inception in 1991, Delta Corp has Risen up The Ranks really fast. In fact, its instant success in The Gaming and Realty space has won it The Trust of Millions. With Mcap Rising by over 160%, Delta is The Second Largest wealth creator in FY 2010-11

Having started as a pure textile player, Delta Corp has today transformed into a diversified company with interests in real estate, gaming & entertainment and hospitality. The sailing has been smooth so far for it, especially in FY 2010-11, when its revenue rose by over 65%. Not only did Delta report a PAT of Rs.1.65 billion, an astonishing 1,269.4% growth over the last fiscal; its m-cap too rose by over 160%, making it the second biggest wealth creator (in % terms) in FY 2010-11. In an exclusive conversation with B&E, Hardik Dhebar, Group CFO, Delta Corp, throws more light on the company’s phenomenal success story.

B&E: What factors would you attribute to the stellar performance by the company during the last fiscal?
Hardik Dhebar (HD): We, at Delta Corp, have been focusing on our core business and execution over the last two years. The gaming & hospitality business has grown multi-fold which is now the core focus area of Delta Corp. The current performance and future potential of the business and industry is what, in our view, aids and supports this growth.

B&E: But do you consider this high pace of growth sustainable?
HD: We strongly believe that the potential for gaming & hospitality is huge in India, and Delta and its subsidiaries haven’t even scratched the surface. Add to it, real estate will continue to grow at a sturdy rate providing a steady supply of income and cash flows, thereby smoothening volatility. Over 2 years, we have grown in excess of 50% on a yoy basis, owing to the gaming phenomenon. We’re presuming similar exponential growth in the future.

B&E: How do you plan to keep investors interested in Delta Corp’s stock?
HD: We have communicated to our shareholders through our actions. The vision that the Delta family shared of creating a world-class gaming company is surely and truly on its way. Further, we will continue to expand and create a pan-India imprint, helping the business go from strength to strength, and in turn, creating shareholder value on a long-term basis.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age WomanIIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

Can Leyland pull off its LCV gig?

After Trailing behind its Bigger rival Tata Motors in The M&HCV Segment, The Company is now betting Big on The Lower-Tonnage Vehicles to reach out to New Markets and Consumers.

When Raghunandan Saran, the son of a Delhi-based car dealer, set up Ashok Motors in Chennai in 1948, his business suffered trying to sell the Austin cars. The bargain may have gone bad but Saran learnt his lesson well: the real potential lay in selling trucks and buses and not cars. The realisation led him into the arms of commercial vehicles manufacturer British Leyland, and laid the ground for the setting up of Ashok Leyland Limited. Over the years, Ashok Leyland and Tata Motors have become the most prominent faces of the commercial vehicle industry in India. The two of them have a combined market share of about 85% of the medium and heavy commercial vehicle (M&HCV) segment. Tata Motors leads the segment with a 63% share, followed by Ashok Leyland at 22%.

Perhaps inspired by the lesson that its founder had taken to heart many decades ago, Ashok Leyland has now decided to venture into manufacture of LCVs in collaboration with its Japanese partner Nissan. LCVs are compact trucks and vans that are built to have low operating costs, fuel-efficient engines that are still powerful enough to carry a heavy payload, and to be used in intra-city operations. The company has already forged a JV with Nissan to enter the high-volume LCV market and will be investing Rs.25 billion for setting up a factory near Chennai. Initially, the plan is to roll out close to 1 lakh units from Leyland’s Hosur factory, before the new plant goes operational. At the same time, the company has roped in Wolff Olins (part of the Omnicom Group), a management consultancy, to work on the new positioning and branding of the company. The move is aimed at positioning Ashok Leyland as an aggressive and national player and reinvent its image from being a conservative South-India based CV manufacturer. The billion rupee question, literally, is: will Leyland finally be able to shed its legacy and succeed in its LCV venture?

At first sight, the challenges appear too overwhelming to overcome. Tata Motors already has product up and running in the LCV category. It launched the Ace truck in May 2005 for just above Rs.2 lakh. The new vehicle has been a big hit selling about 600,000 ACE’s so far and has over 50% market share in this category.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).

For More IIPM Info, Visit below mentioned IIPM articles.

IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age WomanIIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management

The new age Commercial Plane was not Airbus

The Worst start to building The new age Commercial Plane was not Airbus’. It was Boeing’s. Its biggest project – The Dreamliner 787 – has turned a Nightmare. There are other problems too. What went Wrong with Boeing? & can CEO Jim McNerney play Captain America? 

What caused Boeing’s health to deteriorate? McNerney has forever been known as a game-changer – a CEO whose radical change ways revived a corporation like 3M (it was under him that the company slimmed down, returned to profit-making and even dropped its old name – Minnesota Mining and Manufacturing). He tried the same at Boeing. To ensure that bottomlines improve, he adopted the outsourcing model. The idea was that instead of working with the traditionally accepted manufacturing practices, Boeing would work with engineers and labourers outside the company. It first started with the 787 program in 2005 and was then replicated on the 747s & 777s families. That meant trouble. A typical 787 (& 777) has 70% of its parts manufactured in Japan, Korea, Sweden, Canada, Italy, Australia, France, Germany and 15 other locations in US, that Boeing workers in Seattle put together. The entire exercise was destined to end up as a fragmented engineering act and a complex set of 50 confused suppliers, with minimum check on quality and overstretched supply-chain. McNerney took the big risk, Boeing took the beating. While its reputation & revenues did fall, the associated R&D costs have not only hurt bottomlines in the past year by up to $4.1 billion, but also threaten to erode the same in the years to come, as Robert Spingarn, analyst at Credit Suisse tells B&E, “Many bullish analysts and investors have been relying on declining 787 and 747-8 R&D to allow for meaningful earnings growth. But, even as these development programs inch closer to completion, the prospect of new R&D for a refreshed or new 777 and a clean-sheet 737 may offset any benefit. Either way, upside could be an issue if R&D cannot be tamed and if Boeing’s Defense business weakens beyond expectations.”

So what can Boeing do to expedite the process and ensure that cost control (outsourcing) and timeliness go hand in hand in future? Airbus, which contracts 52% of its aircraft body-making, is the answer. It assembles parts (in France & Germany) manufactured in 12 locations in the four nation cluster – Britain, France, Germany and Spain. And if cost reduction be the prime condition, Airbus’ assembly line for the smaller A320s in China is quite an example. The solution to convert Boeing’s global outsourcing mess into a strategic geographic advantage lies in creating regional assembly hubs. Like Airbus, it could begin with an assembly station in China for the new planes, to cater to the demand in the Asian region (like the $10 billion order from Air China & HNA Group for 5 747-8s, 6 777s & 32 787s received in March 2011). And considering that Boeing has to fast increase delivery pace in order to cater to a fresh demand, the newer assembly stations will only reduce its order-delivery lag. The question now is not whether it can cultivate a conservative approach to outsourcing or not. Rather, it is how Boeing can learn fast and act. Airbus, despite a more calculated approach saw its jumbo A380 suffer a couple of initial delays, resulting in $24.8 billion in added costs & lost orders between 2006 & 2009. Boeing has already lost many times more. Question is – will the hole in its pocket get bigger?

Fire on board, to software integration issues, to discovery of weak points in the composite metal used, to an in-flight engine shutdown, the Dreamliner has been more of a ‘nightmare’liner for Boeing. Though experts are of the opinion that this is not the end of the road for Boeing, and that revenues will continue flowing despite the fires and engine malfunctions of the 787s & 747s. The hefty order-log already recorded and expectations of huge demand from Asia and replacement orders in US & Europe will help its cause, as New York-based Alexandria Carroll of Goldman Sachs tells B&E, “For the near term, 787 & 747 challenges have the potential to create further volatility. However, we expect very strong new aircraft order demand, strong global air traffic, and the company’s supply restraint through the last cycle to all be larger positive drivers of the stock than challenges, which are a negative. The associated R&D tailwind catalyst are likely to be realised over the next few quarters.” Adds S&P’s Tortoriello, “Emerging economies in Asia and the Middle East will continue to improve, which should sustain demand for narrow-body aircraft, supporting Boeing’s total backlog of about 3,400 aircraft as of December 2010. In addition, US airlines continue to take deliveries to improve fuel efficiency of aging fleets. Further, the third-quarter 2011 delivery of the 787 should act as a catalyst for the stock, with about 850 aircraft recently on order.” While Goldman Sachs estimates revenues for Boeing in FY2011 to to touch $67.97 billion (a y-o-y rise of 5.69%), the figure as per Credit Suisse stands at $69.76 billion (rise of 8.48%).

Having said thus, McNerney has to realise that the storm will only gather over the coming quarters, faster and stronger than it did in the three years gone by. It’s more than half of his company’s revenues at stake (assuming that the Pentagon will continue to patronise Boeing’s Defense business as EU does to EADS-Airbus), and the clock for him is running backwards. He’s done nothing to make investors smile (Boeing’s Mcap has fallen by $2.13 billion since he took over in June 2005) and McNerney might be out before Boeing even gets out of this rut. In short, he has little time to prove that an intergalactic outsourcing strategy can work. If it hasn’t in seven years, it perhaps never will. Many airlines have bet their future on Boeing, and this equation can turn turbid sooner than expected, irrespective of how many dollars and elbow grease the new projects have called for. And it is already showing signs of that.

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Source : IIPM Editorial, 2012.

An Initiative of IIPM, Malay Chaudhuri 
and Arindam Chaudhuri (Renowned Management Guru and Economist).

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