The Pentagon’s program manager for the F-35, Lieutenant General Christopher Bogdan (USAF), has a well-deserved reputation for speaking his mind. This is a good thing, assuming you know what you are talking about. However, his latest criticisms of the two companies leading the program, suggest that he doesn’t understand defense economics or the current acquisition environment. According to press reports today, the General criticized Lockheed Martin and Pratt & Whitney for trying to “squeeze every nickel” out of the government and for not recognizing that the program will be around for 40 years and that, therefore, there will be time to make a profit. He went on to say about the companies that “I want them to take on some of the risk of this program, I want them to invest in cost reductions. I want them to do the things that will build a better relationship. I’m not getting all that love yet.”
If the General wants some love, perhaps he and the Department of Defense should give a little back. Rather than accusing the companies he has to work with of gouging him, General Bogdan should be thanking them for being willing to stay in a business where the profit margins are low and the environment fraught with uncertainty. It might interest him to know that the average profit margin in the defense and aerospace industry (which includes both defense and commercial activities) last year was 10.3 percent while that of all U.S. industry was much higher at 18.3 percent. In 2012, the average profit for the top 20 defense companies was only 2.96 percent compared to the Dow 30 companies of 11.24 percent. Operating margin for defense companies was 5.07 percent compared to 15.79 percent for Dow companies. Lockheed Martin’s profit margins for the last three years have never exceeded 9.5 percent and have averaged around 8.75 percent. As one industry expert observed “Lockheed would do better for shareholders making diapers or burgers rather than the world’s best fighter.”
Lockheed Martin, Pratt & Whitney and the other members of the F-35 team have worked hard to move down the production learning curve and reduce costs to the government. This has been rendered much more difficult by government decisions to restructure the program and to move production of hundreds of aircraft farther out in time. The company lowered the price for the Lot 5 aircraft by four percent even as labor and material costs went up. The team has managed to deliver the planes for less than government cost analysts predicted in every production lot to date. In addition, Lockheed agreed to share the risks associated with so-called concurrency costs.
We are one day away from sequestration. The service chiefs have already signaled that they expect to cut the number of F-35s they will buy in 2013. If sequestration stays in effect, further cuts are likely over the next decade. It isn’t as if this is the only example of a program which the Pentagon cut back or cancelled outright, even though they were performing well. What about the B-2 and F-22? The Air Force is planning to mothball its entire fleet of brand new Global Hawk Block 30s. Perhaps defense companies can be excused, particularly in this environment, for not wanting to count too much on the benefits of a multi-decade franchise in establishing current prices for products and services. Under the circumstances, it is odd that General Bogdan should be hectoring F-35 contractors for not giving him a better deal up front. Is he willing to commit now to the production rate for the next several decades and to a total buy? I don’t think so.
Find Archived Articles: