Analysis of Boeing's Initial 787 Supplier Structure: Interdependent Innovation at a Strategic Firm Boundary

Abstract

New airline models are generational developments. For a particular market segment, a new model will be introduced perhaps every thirty years. Any new model will contain many innovations over the older model it supplants. Developing these innovations into an airliner introduces uncertainties, implying cost-performance risks. Airliner assemblers – primarily the Boeing-Airbus duopoly – don’t internally produce all of the subassemblies that undergo innovation in route to becoming part of a new model. Rather, they contract for a subset of these subassemblies from a supplier base that contains just a few firms capable of the needed innovations. This motivates the view that an airliner assembler’s firm boundary is defined by strategic concerns; namely, the suppliers’ have market power rather than existing in competitive industries. In the case of the 787, Boeing organized subassembly development and production using a type of risk-bearing contract that induced, and then ignored, strategic effects among subassembly suppliers due to interdependent innovation. The result was likely underinvestment in innovation by all suppliers, driven by a free-rider strategic equilibrium. The cause of Boeing’s error may have been the adoption of a contract type from an industry in which the suppliers are more subject to competition.