Boeing tanker strategy shifts $600 mln to taxpayer

Mon Jul 11, 2011 11:27pm EDT

* Boeing could be out $700 mln in development overrun

* Company says bid had to be aggressive and responsible

* Bidding strategy denied deal to Europe's EADS

By Jim Wolf

WASHINGTON, July 11 (Reuters) - Boeing Co's (BA.N) winning bid for the U.S. Air Force's fiercely contested tanker development deal means it likely will show no profit in the program's first phase and shift $600 million in development costs to taxpayers, new government figures showed.

Boeing could be on the hook for $700 million in development costs of its own, according to a compilation of figures provided by the government and a congressional source.

Boeing's below-cost bid for the contract was part of a carefully crafted strategy to deny the deal to Europe's EADS EAD.PA, parent of rival commercial jet builder Airbus SA.

EADS was to have opened an assembly plant in Mobile, Alabama, to produce the tankers used to refuel other planes in flight.

The competition between Boeing and EADS resulted in significant savings to taxpayers, Air Force spokesman Lieutenant Colonel Wesley Miller said last month.

Chicago-based Boeing knew it had to be "aggressive and responsible" to beat EADS for the so-called KC-46 tanker contract "and that's the decision we made," William Barksdale, a company spokesman, said last week.

"We will make money on the KC-46 program," he added in response to a question. At issue for now is only the contract that covers engineering, manufacturing and development, or EMD.

With deliveries through the 2020s for a total of 179 aircraft, the overall deal is valued at more than $30 billion, one of the Pentagon's costliest purchases.

The Air Force, in a written reply to queries from Reuters, said on Monday that Boeing's target cost had been $3.9 billion to develop the aerial-refueling plane based on its 767 widebody and to deliver an initial 18 aircraft by the fourth quarter of 2017.

"For every dollar the program costs above target cost of $3.9B, the government pays $0.60 and the contractor pays $0.40, until the total amount paid to Boeing reaches $4.9 billion," at which point Boeing assumes all further costs, the service said.

Under this formula, taxpayers would pick up $600 million up to the $4.9 billion ceiling. Boeing would cover the other $400 million plus any ceiling overrun.

Last week a congressional source said Boeing had predicted it would have cost overruns above the ceiling of $300 million for the development phase.

Boeing told the Air Force on April 25 that it projected that it would spend more than the ceiling price for the development phase of the contract, Miller said.

The ceiling is set at 125 percent of the target cost. Boeing's potential profit under the deal likewise was built in and would have totaled 12.5 percent, or about $500 million, if the target were hit. The company would break even if the development phase is completed at the ceiling.

The Air Force said it was neither improper nor uncommon for a company to bid a development price that is below actual cost in a competition.

The Air Force and Department of Defense "will now tightly control" the program's execution to make sure Boeing delivers on its promises within negotiated cost, schedule and performance baselines, said Miller, the Air Force spokesman.

The competition between Boeing and EADS resulted in significant savings to taxpayers, Miller, said in a June 28 written reply to a query.

Previously, Boeing's target had been reported to have been $4.4 billion, the figure used in slides at a March 4 news briefing by EADS' North American arm. The losing bidder at the time cited U.S. government-supplied data it received a week after the Feb. 24 contract award.

The difference between the two figures matters because the lower the target cost, the more the government chips in up to the ceiling under a risk-sharing formula.

Conversely, the government would keep 60 cents and the contractor, 40 cents, if the program ended up costing less than the target.

Boeing lost an initial tanker competition in 2008 to EADS, which was then partnered with Northrop Grumman Corp (NOC.N).

Boeing successfully protested that award to the Government Accountability Office, Congress's investigative arm, and the Pentagon staged a new contest in which EADS went it alone.

Northrop said it pulled out because, it alleged, the Air Force specifications were written to favor Boeing's smaller plane.

Jacques Gansler, the Pentagon's top arms buyer from 1997 to 2001, said he suspected Boeing in effect had low-balled its bid to cash in on any changes to Air Force requirements over time.

"It certainly looks as though they made it as attractive as possible in order to win it and then try to 'get well' later," he said by telephone earlier this month. Boeing declined to respond on the record.

The Air Force has failed to respond to repeated questions about whether the gap between Boeing's bid and its subsequent overrun estimate could have changed the bidding's outcome had it been known at the time that the evaluation was done.

Under the bidding rules, the companies had to meet a threshold of 372 mandatory requirements. If their bids were less than one percent apart then, and only then, would the Air Force have taken "nonmandatory capabilities," or tiebreakers, into consideration.

Such capabilities did not enter into the equation because Boeing's bid was more than one percent lower than EADS', Air Force Secretary Michael Donley said in announcing the winner in February.

Richard Aboulafia, an aerospace analyst at the Teal Group consultancy in Fairfax, Virginia, said last week, "Given the politically charged environment that led to this contract, if there's any trouble executing it, it's very much Boeing's problem."

EADS looks to the Air Force "to execute the tanker program within the terms of the contract as it was awarded," said Guy Hicks, a company spokesman in Arlington, Virginia said on Monday. (Reporting by Jim Wolf; editing by Carol Bishopric)

Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.