Tony Capaccio of Bloomberg Business News reported last week that Boeing may end up spending $300 million more than is budgeted under its contract to develop a new Air Force tanker. Bad news for taxpayers, right? Wrong — because the company will have to eat every cent of expenses above the ceiling on the development contract, which means if there actually is an “overrun,” taxpayers will be getting extra value at Boeing’s expense. The story could be bad news for Boeing shareholders, but something tells me when the contract is completed Boeing will come in right at the ceiling. Of course, that still could mean a zero rate of return, but the development contract leads to production of 179 planes where the big aerospace company is likely to do just fine.
What some observers don’t seem to get about the Bloomberg story is that the Obama Administration really has tightened up on contracting practices, so if companies don’t stay within budgets they lose money. That’s a powerful incentive not to run up costs, and helps explain why the administration pushed for an early transition from cost-plus contracts to fixed-price arrangements on the F-35 fighter too. In both cases, contractors will get the best results if they stay within budgets, which is exactly what policymakers were aiming to achieve. There’s no advantage in bidding low to win and then trying to raise prices, because contract terms are too tight to allow recovery, so the new acquisition practices reward honesty and realism.
If you’re still stuck in the old way of thinking, then the fact that Boeing might have to eat some extra expenses suggests the company didn’t have a good handle on costs when it wrote its proposal. Not so: it bid the price it needed to bid to beat rival Airbus. Both companies knew they would have to price their proposals aggressively to have any chance of winning, and as one senior Boeing executive put it to me, “we left a lot of shekels on the table.” In other words, Boeing was willing to break even or maybe even lose money in the development phase in order to preserve its 50-year tanker franchise and keep Airbus out of its home market. Thus, Tony Capaccio’s story doesn’t signal that anything has gone wrong with the tanker program. Quite the opposite — it shows government negotiators got the best deal possible from the winner.
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