Bottlenecks at Boeing. Operations Clash with Finance?

Photo: REUTERS/Jason Reed

Reuters is bringing an interesting article (h/t Cameron Zuroff) about operational issues and financial pressures at Boeing (NYSE:BA).

Boeing is struggling to cope with the 787 production schedule, after the production ramp up to 10 planes per month late last year. The bottleneck seems to be fuselage complex wiring done in their South Carolina plant. But the bigger picture is that Boeing has committed to deliver 10 planes per month and missing the schedule would involve steep penalties. What does Boeing do? They send half ready components to the factory at Everett for rework and final assembly.

To me this is an example of clash between operations and financial goals:

Boeing’s ability to churn out the Dreamliner is crucial to its financial performance this year as the company is relying on commercial jetliners to offset a weak defense business. While Boeing still loses money on each 787 that it builds, it gets closer to breaking even as production increases.

Cash flow from the 787 is expected to improve next year, provided the factories stay on pace, Boeing said. The cash is needed to fund new plane development, as well as fulfill investors’ desire for share buybacks and dividends.

Clearly, Boeing is between a rock and a hard place. They try to ramp up capacity in South Carolina, hire temporary workers, but that leads to higher cost, further delaying the break even point. Sending “pre-routed” components to Everett, is also a questionable move. From the classical quality management standpoint, defects should be fixed immediately after they are detected. Unless there is an excess capacity at Everett that would allow to finish work quicker than it would have been done in South Carolina, sending half ready components would only delay the production.

One thing is evident. Learning curve for the new 787 production turned out to be steeper than originally thought. All the pressure is now on Boeing to catch up with it.

Is Amazon.com cashing on consumer behavior?

I am very much tempted to answer – YES. The genesis of this post is the recent report by NPR’s Stacey Vanek Smith; the case under consideration is Amazon.com potentially raising the cost of its Prime membership from $79 to $99 per year or more.

Prime membership gives consumers free shipping on their orders and free access to numerous books, movies, and TV shows. The volume of Prime subscribers is estimated to be well over 10 million and growing rapidly. Could it be that Amazon.com has decided to curtail the growth of membership? This could be sensible if Amazon has reached capacity limitation for shipping or content streaming. Neither seems likely, though. So what is the logic behind the (possible) decision?

The report offers this explanation:

But the rationale for raising prices, may not be fast cash, speculates Michael Levin, co-founder of Consumer Intelligence Research Partners in Chicago.

“At Amazon, nothing is ever what it seems,” he laughs. “If they charge more, I think customers are probably going to spend more. So quite ironically, by raising the price of this membership, they may end up getting people to shop there even more.”

A more expensive Prime membership equals a customer who is all the more motivated to get his or her free-shipping’s worth.

Having done some research on the topic of consumer behavior, my explanation for this phenomenon is the so called Sunk Cost effect. This is a well-known phenomenon in Behavioral Economics. In simple terms, the effect occurs when consumers continue to use products that have become obsolete. Moreover, the usage increases if consumers spent more money to purchase these products. As such, this behavior is irrational in the classical economic rationality sense: a decision to use a product should depend only on the current or future cost and benefit, but not on a past one.

So by raising prices of the Prime membership, Amazon.com could be just targeting our irrational tendency to recover sunk costs. Even if there is an identical product couple of dollars cheaper, Prime members would still buy from Amazon, driven by the (sunk) cost of membership.