Flying High

I used to think that clapping when a plane successfully landed was a bit silly. But after Boeing’s recent troubles, maybe it was me being a bit silly. You will have heard that Boeing has had recent safety issues. It started with the 737 Max, where the positioning of the engines led to the plane being more likely to pitch up. Boeing’s engineers built the Manoeuvring Characteristics Augmentation System (MCAS) software to help alleviate the “pitch-up tendency at elevated angles of attack”. However, issues with the software and the lack of pilot training meant that MCAS led to fatal crashes in Indonesia (Lion Air Flight 610) and Ethiopia (Ethiopian Airlines Flight 302). Then there have been quality issues with the plane’s fuselage, including misassembled fittings in the tail and mis-drilled holes in cabin components, built by Spirit AeroSystems, which itself was spun out of Boeing’s Wichita division in 2005.

Many of Boeing’s issues can be traced back to its merger with McDonnell Douglas Corporation in 1997 and a change of philosophy as a result. Prior to the merger, Boeing focused on manufacturing and aviation excellence. Over time, Boeing became solely focused on maximising shareholder value — actually, that’s not quite right. They became focused on maximising short term shareholder value. 

To put this into perspective, between 2013 and 2018, Boeing spent $41.5 billion on share buybacks. Now, there is nothing inherently wrong with share buybacks. If, and only if, it’s the best possible return on money, then it should be done. If the stock is undervalued, and you expect it to appreciate and you can get a greater return than spending the money elsewhere, share buybacks are a rational thing. However, share buybacks also signal that you’ve got no other ideas, no new market expansion to fund and no technology or big bets to invest in. If you’re in that position, then it’s problematic for the company. If any company wants any ideas, I’d be happy to lend some for free. Here’s an idea: Boeing, build a supersonic jet.

I’m doubtful that share buybacks were the best use of Boeing’s money. By 2018, Boeing's capital expenditures lagged those of Airbus by half, as Boeing spent less than 2% of sales on capital expenditures.

I’m, perhaps, a bit unusual in that I love economics, but I think that economic growth doesn’t start on a spreadsheet - it starts with manufacturing, industrial and software excellence and building something amazing.

I’m not an engineer, but I would humbly suggest that Boeing should not have spent on share buybacks and instead spent the money on building a plane that didn’t crash. In fact, you can trace this whole mess back to the decision not to build a brand new plane to replace the 737. The decision not to do that was to save costs, as building a new plane is expensive. The estimated cost to develop a new narrow body jet right now is $50 billion. Of course, cost discipline is a good thing, as it allows a company to spend where it needs to. But mindless cost cutting is not a good thing.

Building a brand new jet would have achieved two main things. Firstly, Boeing planes would not lag behind Airbus A320neo in capability, electronics and now deliveries. Secondly, over the long term, shareholder value would have been maximised.

In the long run, building high quality products, focusing on technical and manufacturing excellence, and not being beholden to short term Wall Street fluctuations would have delivered far more shareholder value than the route Boeing took. Boeing’s competitive advantage and reason for being was manufacturing might. It should go back to that.

Part of the reason Boeing could reduce their focus on quality is the lack of competition: commercial aviation manufacturing is a duopoly. Whether the market can sustain more than two major players without an increase in the demand for commercial jets remains to be seen.

At this junction, it’s worth explicitly stating that commercial aviation is incredibly safe, and it’s getting safer.

Advances in avionics, embedding software systems and autopilot into modern jets have drastically reduced the fatality rate. In particular, flight management systems for optimal flight paths, collision avoidance systems (TCAS) and Automatic Dependent Surveillance-Broadcast (ADS-B)  systems to warn and prevent pilots of collisions, as well as ever improving weather radar systems mean that flying is as safe as it ever has been.

But the cautionary tale of Boeing tells us something else. 

Software that makes planes safer needs to be built; it doesn’t just happen, just as technological progress doesn’t just happen. The aviation manufacturing market dynamics aren’t conducive to low market concentration and high competition, which results in an absence of competition driven innovation forces. Therefore, what can be done? 

Well, one thing that generally works is a CEO and board members who have a high volume of their net wealth tied up in a company. I’m thinking greater than 90%. It’s why founder led companies often perform well, and Berkshire Hathaway does so well: if the company loses, the founders or executives lose as well. Once you have aligned incentives, things are much better. Founders, we need you to build planes.