Senior executives at Northrop Grumman have made a tentative decision not to bid in the Air Force’s pending re-competition of its KC-X aerial-refueling tanker. Only a year ago, Northrop looked like the odds-on favorite to win the contract for the future tanker, which will be worth about $35 billion for the first increment of 179 planes, but could ultimately be valued at over $100 billion as the service replaces the rest of its 450 Eisenhower-era refuelers. Northrop’s startling reversal of fortune is traceable to the collision of two forces: a new administration determined to tighten up terms on contractors, and a new corporate CEO determined to assess rigorously the risks and rewards of business opportunities.
The new guard at the Pentagon is represented by acquisition czar Ashton (Ash) Carter, a widely admired Harvard professor who is a protégé of former defense secretary William Perry. The new Northrop Grumman CEO is Wesley (Wes) Bush, a hard-charging MIT graduate who has a mandate from his board to run a tight ship even if it means passing up big revenues because returns are too hard to quantify. That latter description certainly fits the tanker solicitation, since Carter’s Pentagon team is demanding that offerors bid fixed prices on items stretching far into the future — items that are intrinsically hard to predict. Because the winning contractor would have to absorb any cost overruns, the fixed-price features of the contract entail huge financial risk.
Carter’s team recently has signaled that it might loosen up the fixed pricing demands, but that isn’t the issue that most troubles Northrop execs. Their biggest worry is that the performance requirements set forth in the expected “request for proposals” would be scored in a way that makes cost the chief determinant of who wins, and the modified Airbus A330 that Northrop planned to offer is much more expensive than the 767 competitor Boeing plans to bid. When Northrop first entered the tanker contest, it hoped to convince the Air Force that a big plane with more range and carrying capacity was better suited to future refueling needs than the Boeing 707 airframes the Air Force currently uses. But now the Air Force wants each offeror to satisfy 373 equally-weighted “mandatory” performance requirements with no credit for exceeding the minimum thresholds, which eclipses the key advantages of the A330.
If both teams have to satisfy all 373 requirements and there is no extra credit for longer range or bigger fuel carriage, then price becomes crucial to prevailing. Northrop Grumman might still stay in the game by bidding a lowball price for its bigger plane, but Boeing has been so unrelenting in its attack of European aircraft subsidies (recently ruled unacceptable by the World Trade Organization) that any concessionary price is likely to bring heavy political scrutiny. So Northrop Grumman has good reason not to bid: the key virtues of its plane are nullified by the proposed selection criteria; its ability to offer a competitive price has been minimized; and even if it did somehow win, the fixed pricing features of the resulting contract would expose it to heavy financial risk.
For Boeing, the prospect of Northrop Grumman not bidding presents an interesting dilemma. Without the threat of being undercut by a competing bid, it could price its offering high to reduce the risks associated with fixed pricing of a development contract. But if it bids too high, that might produce a backlash in the Pentagon or in Congress. So what looks like a windfall could easily become a trap, and Boeing execs will have to think through how to assure the program is profitable without getting more controversy in the bargain.
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