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EXECUTIVE SUMMARY PART 1 – BUSINESS PROCESSES Introduction Value Chain Diagram Supporting services Research and Development Product & Process Design Logistics Operations Distribution Marketing Customer Service PART 2 – COSTING SYSTEM Activity Based Costing vs Traditional Costing Systems Adva...

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BOEING

HIBA KHAN, RAYANNE KAREM, MOUHMAD SUCCARI & CHARBEL SUCCAR

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EXECUTIVE SUMMARY

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PART 1 – BUSINESS PROCESSES

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Introduction Value Chain Diagram Supporting services Research and Development Product & Process Design Logistics Operations Distribution Marketing Customer Service

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PART 2 – COSTING SYSTEM Activity Based Costing vs Traditional Costing Systems Advantages and Disadvantages of ABC Activity Cost Pools Rationale Cost Driver Rationale Cost Hierarchy Rationale Direct Costs Indirect Costs

PART 3 – PRODUCT COSTING Step 1: Measuring Direct Costs Step 2: Measuring Manufacturing Overheads Step 3: Allocation of Overhead Costs Step 4: Allocation of Total Costs Step 5: Activity Cost Drivers Step 6: Budgeted Costs Step 7: Identifying OH/unit Step 8: Cost Pricing Conclusion

APPENDIX Appendix 1: Calculation Direct Costs Appendix 2: Calculation of Overheads Appendix 3: Boeing’s R&D Expenses

Bibliography

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EXECUTIVE SUMMARY This report provides an in-depth analysis of the product costing system behind The Boeing Company’s commercial jetliners product range. The report analyses Boeing’s value chain in the production of its 737 aircrafts by examining all primary and secondary activities that create value in the product. Furthermore, this report also analyses the differences between Activity Based Costing (ABC) and traditional costing systems when allocating overheads to products. Although ABC has many advantages and disadvantages, it would assist Boeing to grow the business and develop highlyefficient product costing systems suitable for the company. The final section of this report applies ABC to the Boeing 737 jetliner to calculate an accurate product cost.

PART 1 – BUSINESS PROCESSES Introduction The Boeing Company is the world’s largest aerospace company that manufactures aircrafts, aviation parts, space and security systems, and aftermarket support services. In particular, Boeing’s largest business unit is the manufacturing of aircrafts, such as freighters, commercial jetliners, defence aircrafts and business jets. This report will only focus on one of Boeing’s product categories – commercial jetliners. Boeing currently manufactures the following commercial jetliners:  

Next-Generation

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747-8;

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777X; and

737;

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767;

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787.

737 MAX;

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777;

This section of the report will analyse how the company creates value in its commercial jetliners through its current value chain.

Table 1 - Breakdown of Boeing’s business units and product categories Organisatio n

Aviation parts

Freighters

Business Aircrafts unit

Commercial Product jetliners

Space security systems

Defence aircrafts

Aftermarket services

Business jets

category

Boeing

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Value Chain Diagram A value chain is a set of linked activities and processes that identify the value created from costs incurred in a product. Understanding the link between the costs incurred during a particular activity and the value the activity creates supports Boeing in efficiently allocating and using resources. They can strengthen their competitive advantage over other commercial aircraft manufacturers by tailoring a value chain model that efficiently assigns costs to all primary and secondary activities needed to develop, manufacture and sell a commercial jetliner.

Diagrammed below is an overall value chain for the Boeing 737 commercial jetliners:

Supporting services Support services within Boeing Headquarters include the HR, IT management and Finance teams who work collaboratively to develop new commercial jetliners. They collate and analyse data gathered from customers to understand how their travelling experiences could be enhanced (Blokland et al. 2014, p. 4). These teams analyse customer needs to enhance the value of Boeing jetliners and improve overall operations (Blokland et al. 2014, p. 13).

Research and Development Research is conducted to determine which primary and secondary activities will add significant value to the aircraft and is worth allocating resources to. These activities would be implemented into new aircraft projects and usually focus on maximising customer satisfaction and fuel efficiency. These aircraft projects include blueprints of the new aircraft, its information systems, detailed financers and other management activities. Refer to appendix 3 for additional graphical information.

Product & Process Design 7

Once the aircraft project is finalised, Boeing enters into partnerships with various suppliers and financiers to provide the resources needed to manufacture the aircraft (Blokland et al. 2014, p. 3). Boeing uses many global external suppliers to manufacture physical components and develop new software technologies for the aircraft. Some of Boeing’s suppliers include Mitsubishi located in Japan, Group Latecoere in France, and Rolls-Royce in the UK which are responsible for manufacturing the aircraft wings, passenger entry doors and aircraft engines respectively (McKenna 2017, p. 1). These components of the aircraft are then shipped to the Boeing Renton Factory in Washington.

Logistics INBOUND LOGISTICS Inbound logistics involves planning the process of transforming raw materials into a finished product. Boeing first develops strong relationships with its suppliers and allocates part of the Renton Factory to the production process of 737 aircrafts. The logistics behind material handling, storage of physical components within the warehouse, the distribution and handling of raw materials and setup of the production line are all strategically planned to reduce time, energy and resources needed to build the aircraft (Leonard 2019, para. 3).

OUTBOUND LOGISTICS Boeing’s outbound logistics include all activities involved in distributing the finished aircrafts to its global customers. This primarily revolves around communicating with wholesalers, enhancing Boeing’s distribution network, order processing, and transporting finished aircrafts to customers. Through Boeing’s optimisation of its outbound logistics, it gains a competitive advantage and accomplishes growth objectives. It is essential for Boeing to efficiently run its outbound logistics activities to deliver the finished jetliner to its customers in a time-efficient manner.

Operations To begin producing Boeing 737 jetliners, the company’s Factory in Washington, USA must first be set up to accommodate for the production line. Staff within the factory ensure there is a section that is allocated purely for the production of the aircrafts and begin installing all materials and tools needed during the production line (Blokland et al. 2014, p. 3).

Initially, the hollow fuselage of the plane (the tube-like body) is built in Whichita, Kansan and then transported to the Boeing Renton Factory by train (Stewart 2016, 0:39). The fuselage is then unloaded

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from the train and placed inside the factory at the beginning of the production line. The plumbing and electrical systems are installed into the fuselage, followed by a layer of insulation that coats the hollow aircraft body (Stewart 2016, 0:51).

The aircraft’s wings are manufactured by Mitsubishi in Nagoya, Japan and then shipped to the Renton Factory. Similarly, the passenger entry doors are developed by Group Latecoere in France and the jetliner’s engine is developed by Rolls-Royce in the UK (McKenna 2017, p. 1). All these physical components of the Boeing 737 are transported via shipment to the Washington Boeing factory, ready to be used in the assembly process.

The wings and landing gears of the aeroplane are attached to the body with the assistance of laser guiders. The horizontal stabiliser of the aircraft is then installed, and multiple functionality tests are conducted (Stewart 2016, 1:10). Assuming all functionality tests are successful, electricians install the wiring for air control functions needed for pilots and then install the engine. Support staff begin fitting the interior of the plane with floor boards, galleys, bathrooms and seats (Stewart 2016, 1:20).

Once this is complete, the aircraft is switched on to ensure power is generated and large-scale functionality tests are conducted to ensure the plane is functional. These tests aim at ensuring the engine, flight control, wing flaps and flight control deck work efficiently (Stewart 2016, 1:37). Finally, the customer is provided with the opportunity to have a walk-through inspection of the jetliner before it is towed out of the factory and taken for a test flight (Stewart 2016, 2:12).

This production process is extremely complex as the Boeing 737 consists of 367,000 parts and 58 km of electrical wire (The Boeing Company, 2001).

Distribution Boeing sells its products to customers through TV commercials, print media and air show displays. Boeing’s customers are predominantly airline companies, such as Qantas and Virgin Australia. Boeing also sponsors major events, projects and organisations to enhance its brand presence and visibility to customers. Boeing also has global distribution centres that communicate with existing and potential customers to answer any concerns, queries or questions they may have about the aircrafts.

Marketing

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Boeing must have an efficient marketing strategy to reach its objectives within the target market. They focus on the 4p’s of marketing to lead the aviation industry and dominate its competitor, Airbus.

PRODUCT - Each commercial jetliner is developed to suit the differing needs of customers, meaning that it is vital for Boeing to understand their relevant target market when developing marketing strategies.

PRICE - Correct pricing is vital as overpricing a product can drive consumers away, and under-pricing a product can give consumers the impression that the product is of low quality. Boeing’s pricing strategy is predominantly premium as their only main competitor is Airbus. This means that Boeing can charge higher prices for their products without driving away customers.

PROMOTION - Promotion refers to how Boeing informs consumers about its products. Boeing uses TV commercials, print media and air show displays to promote their products. Boeing also uploads information videos on Facebook and YouTube and sponsors major events to increase brand exposure.

PLACE/DISTRIBUTION - Distribution revolves around how the business gets its products to its customers around the world. Boeing has distribution centres across the globe that facilitate existing and potential customers in understanding Boeing’s products.

Customer Service Boeing has a Commercial Airplanes Operations Centre where customers across the globe are given 24/7 support. The fundamental goal is to respond to customers’ urgent needs, provide technical support, assist in resolving engineering issues and deliver spare parts if needed (Nuic et al., 2005). Boeing has added further value to its customer service by developing MyBoeingFleet - an online information web portal providing customers with information about their fleets and allowing them to remotely access statistics relating to their fleets.

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PART 2 – COSTING SYSTEM Activity Based Costing vs Traditional Costing Systems Activity-based costing (ABC) is a modern method of overhead allocation that is used to allocate costs to specific activities and monitor resource consumption. On the other hand, traditional costing systems allocate manufacturing overheads based on the volume of cost drivers.

The main differences between the two costing systems include: -

Traditional costing uses fewer allocation bases to distribute manufacturing overhead, resulting in the over- and under-costing of products, whereas ABC uses numerous cost drivers to accurately calculate the cost of products

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Traditional costing systems are simpler to use whilst ABC is more complex and time consuming

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Traditional costing allocates overheads either to separate departments or plantwide, whereas ABC allocates overhead to separate activities, making it more accurate

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ABC’s precision in detecting where reducing costs can be made enables accurate decision making, compared with traditional costing.

Advantages and Disadvantages of ABC Table 2 – Summary of Advantages and Disadvantages of ABC

ADVANTAGES

DISADVANTAGES

Provides accurate information of costs

Time consuming

Can be used for a diverse product range

Expensive

Facilitates in making improvements to

The benefit of conducting ABC costing may

production

not justify its high cost Development of ABC costing system requires

Clearly identifies inefficient materials and

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an individual with a lot of expertise

non-value-adding products

Allows management to make strategic costing decisions

For Boeing to implement the most effective costing system, it must analyse the advantages and disadvantages of activity-based costing. In reference to Table 2, ABC is advantageous to Boeing as it allows the company to access more detailed and precise information about their direct and indirect costs and manufacturing overheads (Park et al, 2019). Breaking down and allocating each cost to an activity will enable Boeing to determine costs need to be cut and where most expenses are being incurred. In addition, ABC information will allow Boeing to identify which production activities need to run more efficiently and require greater attention. By doing this, Boeing will work to implement more efficient and cost-effective strategies that improve production efficiency and product value. Furthermore, ABC allows Boeing’s managers to determine which activities create the least value in the product and are overall effortless. From there, managers can decide whether to eliminate or replace the existing activity with another that is more cost-efficient. Finally, Boeing can create a costing system that is appropriate for a range of diverse products with different operational activities by implementing ABC. On the other hand, ABC is disadvantageous as it requires a lot of time and resources to implement, thereby putting an economic strain on the company. There is also a chance that Boeing will not benefit from using ABC as the information it provides may not outweigh the costs of composing the system. This may occur in cases where overhead costs constitute a small portion of all overall costs, resulting in ABC providing information that is extremely similar to that of traditional costing systems. Table 3 – Summary of relevant activity cost pools, cost drivers and cost hierarchy

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Activity Cost Pools Rationale The first step in ABC is to identify the specific activities that play the most important roles in the production process. Activity cost pools are identified from the activities that support the production of the product (Kennedy, 1996). Purchase of Raw Acquiring raw materials is a vital factor in the support of production of aeroplanes and has therefore been Material elected as an activity cost pool. Material handling is an activity cost pool because with the effective storage of raw materials will result in Material handing an efficient production process. For instance, materials that are stored in an ordered and organised manner would ensure an efficient production process. This involves setting up the machinery for production. Machine setups (automated welding machines) are Machine setup an essential step in the aid of production and has been considered as an activity cost pool.

Assembly

Quality Inspection

Dispatch and Distribution

The assembly stage is where the transformation-process occurs (i.e. the attachment of the wings to the fuselage). Assembly has been identified as an activity cost pool because it is an important step in creating the finished goods (aeroplanes).

Product quality and safety is an important concern for customers. Quality inspection is vital part of the production process which results in Boeing sustaining substantial costs in this area.

Dispatch and distribution involve the transporting of the finished aeroplanes to Boeings customers. It has been identified as an activity cost pool because it is the way that Boeing will dispatch their finished products to consumers worldwide.

Cost Driver Rationale Number of purchase orders

Designated as a cost driver as it a required for the activity as it has a direct relation towards the Boeing 737. Boeing relies on a increase number of purchase order in order to generate revenue.

Number of Material Requisition

This was selected as a cost driver because the number of items to be picked from inventory to be used in the production of Boeing 737 is a direct relationship with material handling.

Number of Machine Setup

Selected as a cost driver because it is the activity that causes costs to be incurred for machine setups (Landfield-Smith et al. 2015).

Number of Machine Hours

This was designated as a cost driver as the majority of the manufacturing process of Boeing 737 is predominately completed using machinery.

Number of inspections

This was chosen as a cost driver due to the direct relation it has to the manufacturing process of Boeing 737 and having a higher association to quality inspection.

Number of deliveries

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Nominated as a cost driver due to having the highest correlation with dispatch and distribution and therefore has been selected as the cost driver (Landfield-Smith et al. 2015).

Cost Hierarchy Rationale

Batch

Batch-level activities are those completed in proportion to those number of production batches. The purchase of raw materials such as, aluminium alloy 2024 and copper for Boeing 737 is self-determining on the number of units produced in the batch.

Batch

The material requisition and handling of material are independent on the numbers of units produced in essence are classified as batch-level-activity.

Batch

Machine setup are incurred each time a batch of units is produced, which in essence is depicted as a batchlevel-activity which is self-determining on the number of units produced.

Product

The assembly of Boeing 737 relates to product-level-activity where actions are taken irrespective of the amount of production with Boeing 737.

Batch

Quality inspections is representing as a batch-level-activity as it specifically related to the batch of Boeing 737 manufactured.

Batch/ product

Dispatch and distribution activities are costs that are incurred every time a batch of unites are produced therefore classified as a batch-level-activity. Dispatching is also classified as product level activity for Boeing 737.

Table 4 – Summary of relevant direct and indirect costs Direct Costs Direct Labour Direct Materials  Wages of  Aluminium production  Titanium employees,  Composites e.g.  Paint technicians,  Insulation materials engineers  Rubber  Plastic/tempered glass

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