Lockheed, Pentagon at odds over F-35 costs: sources

WASHINGTON Tue Oct 25, 2011 8:42pm EDT

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WASHINGTON (Reuters) - Lockheed Martin Corp is pushing back against Pentagon efforts to make the company pay for problems that arise with the F-35 fighter jet during testing as a way to lower costs of major weapons programs, according to sources familiar with the emerging dispute.

Company executives will raise the issue in a quarterly earnings report on Wednesday, the sources said.

The Defense Department's push to change the terms of its next production contract for the F-35, or Joint Strike Fighter, could expose Lockheed to possible losses in coming years, said consultant Loren Thompson, who has close ties to the company.

"The government wants to radically change its approach to sharing risk on new weapons programs so that all of the exposure is shifted to industry," Thompson said.

Deputy Defense Secretary Ashton Carter and Pentagon acquisition officials have been targeting overhead costs and other factors as part of a major drive to reform major weapons contracts after years of cost overruns and schedule delays.

Defense officials have put new focus on acquisition reforms as they search for ways to trim the Defense Department's budget by $489 billion over the next 10 years.

Shay Assad, the Pentagon's director of defense pricing, told Reuters in a recent interview that he was braced for resistance from industry to some reforms. "We're going to be breaking some glass here," he said.

Assad and a team of more than two dozen pricing experts are finishing a review of what the fifth batch of F-35 production jets should cost this month, which will pave the way for Lockheed and the Pentagon to begin formal contract talks.

But defense officials have already told Lockheed that they expect it to share in the costs of "concurrency" or changes that must be made to the new warplane, which has already entered production as developmental testing continues.

The extent of the "share line" would be determined during contract negotiations, said one source familiar with the issue.

A second source said the government wanted the company to shoulder all those costs.

The last F-35 production contract already included a switch to fixed price terms with an incentive fee, abandoning the cost-plus type contracts usually signed early in the life of a new weapons program and compelling the company to share the costs if the program exceeded its budget.

MOVE COULD WIPE OUT PROFITS, ANALYST SAYS

Thompson said most changes to the weapons program resulted from government decisions, not contractor error. Forcing Lockheed to pay for such changes could reduce the company's ability to make any profit on the program, and would likely result in strong opposition from shareholders.

"If the government succeeds in shifting the ultimate risk to Lockheed Martin, then it could easily wipe out any profit on the program and leave the company unprotected against future liability," Thompson said.

Officials estimate it will cost $382 billion to develop and build 2,447 of the new radar-evading fighter jets for the U.S. military -- a cost that budget experts say makes the program vulnerable to big cuts as defense spending declines.

But Carter, who moved to the Pentagon's No. 2 job this month from his previous post as chief weapons buyer, has vowed to drive the cost down to a far lower "should cost" level.

The F-35 Joint Strike Fighter program has seen massive cost growth and schedule delays since its start 10 years ago, and is under intense scrutiny now, given the Pentagon's need to cut at least $489 billion from its spending over the next 10 years.

Assad's "should cost" review, one of the first to be done of all major weapons programs, is being closely watched by Lockheed and major F-35 suppliers like Northrop Grumman Corp, Britain's BAE Systems Plc, and other major suppliers on the F-35 program.

Pentagon changes to weapons contractors have also drawn a reaction from contractors bidding to build Humvee replacements for the Army. Sources say several companies are considering withdrawing from that competition if the Army does not change draft requirements issued earlier this month.

(Reporting by Andrea Shalal-Esa, editing Bernard Orr)

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Comments (2)
PessimistNJ wrote:
Besides being exuberant costly. F35 is not needed. But what they want is if they make a flawed product they want us to pay more money to have it fixed. It would be like buying a car and than the auto manufacture would say we just realized that we designed the motor poorly and it wont start, so you have to give us another 10 grand so we can fix it. Just give us a working f35 and it wont be a problem…

Oct 25, 2011 10:46pm EDT  --  Report as abuse
4NewEngland wrote:
Good for LM! Seriously, for the Govt to now to come across as ‘cracking down’ on such unsustainable high-cost Defense contracts, is akin to changing the goal posts half way through the game. Sorry to the folks in Pentagon land, but the raw fact is that JSF/F-35′s fundamental Business model from inception, including the pre-conceived ‘economies of scale’ malarkey, was FLAWED! Hello?

You cannot play so naive and merely come after LM like it’s something to do with their mismanagement. No, it’s not that simple. The matter of fact is that the flawed requirements and dynamics built-into the Program from inception – yep, crafted to a large degree by the Pentagon – was fundamentally Flawed.

Two possible options going forward with respect to ‘continuing the course’ on the F-35:

1) Govt can nationalize the aviation production sector of LM and try out the business themselves, or 2) LM can back out of the Program in the next year or two, calling it a strategic threat to LMT’s core profitability and corporate interests.

If the latter, LMT should immediately invest focus on the competitive UCAV market, possibly make an accelerated in-house development of an advanced F-16 variant and court KAI of South Korea to develop and mass produce the FA-60. Those would be my views on this very unfortunate F-35 Program cluster.

Oct 25, 2011 12:40am EDT  --  Report as abuse
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