October 26, 2011 / 12:44 AM / 8 years ago

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

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.


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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