* 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 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
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
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
"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
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
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
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,
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
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
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
(Reporting by Jim Wolf; editing by Carol Bishopric)