The
acquisition program has encountered turbulence in recent weeks as Sen. John McCain, chairman of the Senate Armed Services Committee, declared: “I will not authorize a program that has a cost-plus contract.”
Justifying his position, the senator referenced his smart phone, explaining that: “Silicon Valley built the latest one of these without a cost-plus contract.” While Sen. McCain’s frustration with the military procurement system is understandable, his stated solution of turning to a fixed price contract will not deliver the bomber on time, on budget. That would probably have the opposite effect.
used when the goods in question involve known technologies and established production methods. This is not the case with a new stealth bomber design. While the Air Force has sought to reduce risk with the B-21 program by investing $1.9 billion in technology maturation risk reduction efforts over the past few years, integrating existing systems on a new aircraft will still yield unexpected challenges. Recognizing this basic reality, the Pentagon’s top buyer Frank Kendall said it best when he concluded: “Cost plus, versus fixed price, is a red herring…the emphasis should be on matching incentives to the situation at hand instead of expecting fixed-price contracting to be a magic bullet.”
To reflect these circumstances, the Air Force structured the B-21 program in a two-phase fashion. Development, which comprises about 30 percent of the funding, is conducted using a cost-plus incentive contract. Production, which represents about 70 percent of the contract value, uses the fixed price structure advocated by Sen. McCain.
During the Engineering and Manufacturing Development (EMD) phase, contractor Northrop Grumman and the government share financial risk via a cost-plus incentive contract. This structure encourages the government to take a disciplined course when it comes to limiting requirements creep. Too many requirements changes will cause spending to increase. Air Force leaders realize this and are committed to a disciplined approach. No requirements changes have taken place for over four years—and only the Air Force Chief of Staff can approve future changes. As Gen. Mark Welsh, the current chief, explained at a recent hearing: “We can’t take our eye off this ball or it will drift like everything else has. We just can’t let it.” With the long-range strike force
averaging 40 years in age, the Air Force needs this program to succeed.
The development contract gives the government significant leverage over the B-21 manufacturer. The government can penalize poor performance by cutting the company’s fee. The Air Force has also structured the program so the majority of incentives are placed toward the end of the contract to push the contractor to get the bomber into production as quickly as possible. These contractual features—combined with tight control over requirements—effectively minimize the risks of cost growth.
When the B-21 program transitions from development to production, the risks and unknowns will be greatly decreased. The focus then turns to producing a defined product in a reliable fashion—exactly the circumstances that allow the government to seek the lowest price through a fixed-cost contract. Both the contractor and the government can negotiate with confidence over a known set of factors. In fact, due to insights gathered during the development phase of the program, the government will be entering negotiations from a position of strength.
There is also another factor that needs to be weighed if anyone is seriously contemplating re-negotiating the agreed upon contract for the B-21 program solely as a fixed-price contract. Would industry be willing to participate? A bomber is not a smart phone. While it is true that both commercial firms and defense contractors share a common challenge in surmounting major technological hurdles, these actors live in radically different worlds when it comes to market scale. Apple sold over 10 million iPhone 6s their first weekend on the market. This allowed the tech giant to rapidly amortize development expenses across millions and millions of sales. Defense market space prospects never approach this scale. Northrop Grumman is forecast to build and sell just one hundred B-21s. There are no commercial or foreign markets for this aircraft. If the company is asked to invest considerable sums to surmount unexpected development challenges, the company’s financial viability could jeopardized.
Such circumstances are not hypothetical. Many fixed price defense contracts have had to be renegotiated to cost-plus because the contractor risked insolvency trying to solve development hurdles without government assistance. The
. Originally negotiated as a fixed-price contract, the technically challenging effort saw costs grow 200 percent and the program was delayed by six years. Similar events took place with the F-111, C-5, and C-17. Fixed price contracts were in place for failed programs like the A-12 and the Future Combat System (FCS). The reality is that given limited sales opportunities—many of which are restricted by government export regulations — the government needs to share budgetary risk to successfully develop the game-changing technologies we rely upon to keep our nation technologically ahead of our adversaries. Failing that, commercial defense firms will find little motivation to bid for new contracts and will shift their capabilities elsewhere.
There is a reason why Boeing dominates the production of commercial airliner construction in the United States. Firms like Convair, Lockheed, and McDonnell Douglas were all active in producing passenger aircraft in the decades after World War II. However, each company eventually exited the market when they were unable to realize sufficient commercial sales to offset development costs for specific designs. Planes like the Convair 880/990, McDonnell Douglas DC-10/MD-11, and Lockheed L-1011 stand as cautionary examples in this regard. Even Boeing faced precarious times in this regard. It took Boeing 12 years and over one thousand sales to recoup development costs of its pioneering 707. They repeated this experience 20 years later when bringing the 747 to market nearly put the company out of business. Although these examples are from the commercial realm, they demonstrate that firms cannot remain in a market when they are over-extended and their liabilities are not covered by their customer.
Ironically, blocking the current agreed program to renegotiate it wholly under a fixed price contract would result in significant budget growth and schedule delays. Production teams will sit idle, generating costs without delivering output, further delaying a critical capability. Contracts with suppliers will need to be re-negotiated — and costs will increase. With schedules moving to the right, additional funds will need to be invested in legacy long-range strike forces to extend their service lives adding even more cost. Such action is simply not prudent given the vital need for the B-21’s capability. At some point, the realization of effective capability needs to enter the cost-effectiveness equation.
Recognizing that America needs a healthy and viable defense industry, while also respecting fiscal discipline, it is important to address the realities regarding the two different phases of the procurement—development and production. While we all want pricing and schedule stability, history is full of examples that demonstrate it takes more than having the phrase “fixed price” in a contract to deliver such results. Defense Undersecretary Kendall had it right. We need to focus on pragmatic program execution—not contractual semantics. The B-21 program as currently structured already reflects these realities.
