Exclusive: Lockheed, Pentagon vow to attack F-35 costs

FORT WORTH, Texas Thu May 12, 2011 7:20pm EDT

FORT WORTH, Texas (Reuters) - Lockheed Martin Corp (LMT.N) says it is attacking costs on every aspect of the F-35 Joint Strike Fighter program, but the real key to making the new warplane more affordable is to speed up production.

The Pentagon's No. 1 supplier is building about two of the new radar-evading fighters a month now in its mile-long plant here, but Lockheed says it could produce at least twice that number, in part thanks to new automated equipment.

The company has invested about $1 billion to modernize the same factory where "Rosie the Riveter" and other workers churned out 10 B-24 bombers a day during World War Two.

These days, there's a new bright blue rail that moves airplane pieces down the line, and laser-guided machines that cut labor costs and eliminate expensive errors.

The new machinery is working wonders, but Lockheed says accelerating production would have even more impact. The producer and the purchaser may agree on the need for lower costs, but they face a long summer of tough negotiations on how to get there.

As recently as February, Pentagon acquisition chief Ashton Carter slowed production to allow more testing and fix technical challenges that have doubled the cost of the $382 billion weapons program over the past 10 years.

Lockheed says that move -- part of a second major restructuring in two years -- is making it tough to drive costs lower since it was counting on larger quantities to trim supplier costs and tap the resulting "economies of scale."

"If you don't build the airplane in high production rates, you're never going to get the economic benefit of having that infrastructure in place. It's going to be just a cost to you," Tom Burbage, executive vice president and general manager of the F-35 program, told Reuters in an interview.

Once the plane hits full production, Lockheed expects to produce 17 to 22 planes a month -- a little less than daily production of one F-16 a day during that program's heyday.

COSTS MUST COME DOWN

Rising costs and delays are a big concern for the U.S. military and eight foreign partners on the huge weapons program since many of the dozen warplanes the F-35 will replace are wearing out rapidly. But U.S. and European defense budgets are being squeezed and room to maneuver is limited.

"Everybody knows the same truth, which is that we've got to drive down the cost of the airplane," Ashton Carter, the chief weapons buyer for the U.S. military, told Reuters this week.

Carter says the F-35 assembly line is still "not mature enough" to build more planes, although he acknowledged that slowing production too far could affect affordability.

"At this transition here, you don't want to go too fast in production because you may discover things in test that will cause you to have to go back and redo airplanes that you've already built," Carter said.

Defense consultant Jim McAleese said Lockheed's higher-than-expected bid for a next batch of 35 F-35 fighters could prompt the U.S. and foreign buyers to rethink how many planes they want to buy.

He said it is critical that Lockheed and its key subcontractors, Northrop Grumman Corp (NOC.N) and BAE Systems Plc (BAES.L), figure out how to avoid "the death spiral" in which rising prices lead to lower quantities and even higher costs.

The cost of new weapons usually goes down as manufacturing matures, but Lockheed submitted a bid that was about $7 million higher per plane than in the last contract, sources familiar with the program told Reuters last week.

Carter's deputy, Shay Assad, came to Fort Worth last week to review Lockheed's costs amid growing frustration that only about 15 percent of the plane's cost is linked to "touch labor," work on the plane actually done in the plant, with the rest linked to Lockheed's overhead.

"There should be a learning curve," Carter said, noting that the Pentagon's top experts will examine "every ingredient of the cost structure with an eye to skinny it down where we can."

The goal is to look at every piece of the plane and examine why its production is costing more than it should -- reviewing supplier costs, labor hours, materials, and work done at a different site, Carter said.

Robert Powell, head of F-35 operations for Lockheed, said the company has cut way back on the amount of "travel work" done on the plane, and costs are coming down significantly.

Burbage said it is "very, very simplistic" to focus on overhead, which accounts for about 85 percent of the plane's cost. Lockheed clearly needs a corporate headquarters, research laboratories, and work by people who buy tools used in the plant and get parts to the mechanics, he said.

"All of those things are a necessary cost, but they're not touch labor," Burbage said. "It's all things that we are attacking, because we need to continue attacking cost on the program. But it's not things that are unnecessary."

Cutting back the number of planes also has consequences for suppliers, who account for about 70 percent of each plane, Burbage said, noting that the number of Marine Corps variants to be built in 2011 has dropped from 17 in 2010 to just three.

He also said that Lockheed's work is heavily audited and government rules wouldn't allow it to submit costs that weren't accurate. "We can't just take an arbitrary $10 million an airplane reduction in cost and start negotiations at that point," he said. "Our costs are our costs."

Lockheed and its suppliers already made big concessions during the last round of negotiations, accepting fixed-price terms two years earlier than planned, which increases the company's liability for any cost overruns.

Lockheed is also taking its case to U.S. lawmakers to seek their help in getting more airplanes funded each year, but congressional aides say they are wary given technical issues that have driven up costs and delayed work in the past.

Congress added three planes to the proposed F-35 budget for 32 planes in fiscal 2011, but one senior Senate aide said there was little appetite for more significant changes in 2012 given the concerns about spending and earmarks.

"They haven't proven that they can build more airplanes yet," said the aide, who was not authorized to speak on the record.

(Reporting by Andrea Shalal-Esa; Editing by Mary Milliken and Gerald E. McCormick)