When Will This Company Learn You Can't Get Ahead by Being Stupid?

For the past few months, I've questioned if Boeing (NYSE: BA  ) would be able to deliver the tanker on time and on budget. While the question of on time still remains up in the air, it's starting to look like Boeing is headed for a $300 million cost overrun on the KC-46 tankers. For Boeing shareholders, this could mean problems.

When aggressiveness bites you back
The possibility of a cost increase on Boeing's tanker contract was first disclosed at this year's Paris Air Show. Ash Carter, head of Pentagon acquisitions, was referring to the projected $300 million cost overrun when he said, "It's not our problem because it's a fixed contract, and it was written with protections for the taxpayer."  

With continuing talks of defense budget cuts, and projects like Lockheed Martin's (NYSE: LMT  ) F-35 program seeing skyrocketing costs, maintaining fixed prices on contracts has become a high priority for Pentagon officials. In the case of Boeing, officials have made it clear that going over budget is the company's, not the government's, problem.

Although Boeing is maintaining that it's not yet over budget and "expects to make money on this program," Boeing tanker spokesman Bill Barksdale admitted that the Boeing's bid on the tanker contract was "aggressive."

Carter responded to Boeing's statement by saying that Boeing has decided to absorb a loss on the EMD contract, but expects to make up for it on the production side. What does all this likely mean? Yup, Boeing is over budget on the tanker -- no surprise there -- and will be forced to absorb the cost because of the nature of the contract. However, Boeing is hoping international sales of the tanker will offset that loss.

Really? Already?
While it doesn't surprise me that Boeing will go over budget on the tanker contract, it's a little surprising that there's already talk of being over budget, and this brings to mind bigger questions:

  1. At this stage in the game, is it likely to think that Boeing will be able to stick with being just $300 million over budget, or is it plausible to think that the KC-46 tanker is headed for further turbulence down the runway?
  2. Boeing already has a reputation for underbidding contracts. If it goes way over budget on such a high-profile contract, how will this affect the chances of it being awarded future contracts?

Will it fly?
Although Boeing may still be able to pull off a win with its tanker contract, because of Boeing's past performance, I'm remaining skeptical. Add in Boeing's recent downturn in stock price, and it appears I'm not the only one. This is of course great news for Boeing's competitors Northrop Grumman (NYSE: NOC  ) , General Dynamics (NYSE: GD  ) , Textron (NYSE: TXT  ) , and L-3 Communications (NYSE: LLL  ) , but undoubtedly bad news for Boeing shareholders. Look to see these companies 1) manage their own project costs like hawks (not doves), and 2) snare any business they can away from the reeling Boeing. With defense spending likely to decrease, you can expect competition for contracts, and between contractors, to take off.

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Fool contributor Katie Spence owns shares of Northrop Grumman. She does not own shares of any other company mentioned above. The Motley Fool owns shares of Textron, L-3 Communications Holdings, Northrop Grumman, Lockheed Martin, and General Dynamics. Motley Fool newsletter services have recommended buying shares of L-3 Communications Holdings. 

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Read/Post Comments (12) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 29, 2011, at 12:22 PM, steve3452345235 wrote:

    You do realize, of course, that the 'agressively' low bid was in large part to keep Airbus from building an assembly plant in Alabama, right?

    Airbus would then have a production foothold in the 'relatively' lower cost southern US, and would surely later use that plant for producing commercial aircraft.

    Also, ALL US defense companies low-ball bids in order to win, because that's how the Pentagon issues contracts. Contractors know that they can just come back and ask for more later saying "we're already half way done, it would cost more to recompete than just up the contract value".

    Dont hate the player, hate the game...

  • Report this Comment On July 29, 2011, at 1:10 PM, TMFKSpence wrote:

    Hi steve3452345235,

    Thank you for your comment. However, you've failed to realize what a fixed price contract is. It is exactly as the wording implies: fixed. So no, a contractor cannot go back to the gov. and say give us more money, because the gov. at that point has the right to force the company to eat the cost overrun.

    Also, if you look at the history of the tanker contract you'll realize that Northrop Grumman and Airbus were in a joint venture to acquire the tanker contract, and actually had won it until Boeing protested the win.

    Last, no, not ALL US defense companies low-ball bids. That's not how contracting works, ESPECIALLY on a fixed price contract. Trust me, I'm ex-Air Force, I've worked alongside many contractors, and my husband is currently a defense contractor.

  • Report this Comment On July 29, 2011, at 1:23 PM, jamess355 wrote:

    Unfortunately, politics does seem to play a lot into where contracts are worked and where the business goes. But only the irresponsible contractors low-ball the government and expect that they can go back and demand more money...that's why Boeing has won so many contracts and is behind schedule and over budget on most of them. Good luck with that...

    Luckily, the government finally caught on to the "game" and is now demanding fixed price contracts to force responsible bidding. I think it's a good move for the federal budget and taxpayers. Contracting is just one of those areas where out of control spending needs to get on a leash. Case-in-point? Tanker, Dreamliner, F-35...

  • Report this Comment On July 29, 2011, at 1:45 PM, steve3452345235 wrote:

    I'm well aware of what a fixed price contract is. My two comments were intended to address two separate parts of your article, not suggest that the tanker contract was cost-plus.

    My first comment was meant to point out the failure of your article to address the broader reality of this situation and that Boeing's agressive bid on that contract is only 'stupid' (as your headline indicates) when looked at through a narrow lense. A case could be made that such an agressive bid is not worth the anticipated benefits to the commercial aircraft market for Boeing, but your article didnt even address those points.

    The second comment was meant to question your assertion that Boeing has a reputation for overrunning and that we should expect competitors to "manager thier costs like hawks". The truth there is that the large defense contractors have similar track records on cost/schedule with large development contracts. (you're right, I shouldnt have used the word 'all', maybe just 'most').

  • Report this Comment On July 29, 2011, at 2:07 PM, TMFKSpence wrote:

    "You do realize, of course, that the 'agressively' low bid was in large part to keep Airbus from building an assembly plant in Alabama, right?" --

    This is your first assertion, unfortunately it's incorrect. As stated before Northrop had already won the bid with Airbus to built the tankers. Boeing contested the win because they wanted the profits. To suggest otherwise is not true. Boeing has no problems with overseas ventures, and it's not like it's lining up to make sure a foreign company doesn't build on American soil. It very simply wanted the profits.

    "Also, ALL US defense companies low-ball bids in order to win, because that's how the Pentagon issues contracts. Contractors know that they can just come back and ask for more later saying "we're already half way done, it would cost more to recompete than just up the contract value"." --

    Your words, not mine, and again wrong. You imply by this comment that Boeing can go back and request more money. It can't.

    And yes, Boeing does have a reputation for overrunning costs. More than any other large defense company. Recent events on Capitol Hill prove this. http://blog.al.com/live/2011/06/boeings_air_force_tanker_con...

  • Report this Comment On July 29, 2011, at 2:23 PM, steve3452345235 wrote:

    sigh...

    Look, I clicked on your article because I thought it would provide some relevant info. It didnt.

    You hooked me with a sensationalistic headline (shame on me) and then showed a lack of understanding of the issue in your simplistic article. I tried to point out two holes in your understanding, but now I've just got you on the defensive, so I've got to move on to better sources of information.

    Next time do some more research.

  • Report this Comment On July 29, 2011, at 2:37 PM, jamess355 wrote:

    It seems highly relevant to me to point out that a big company is making some big mistakes with big contracts, and that it's having big reprocussions to the defense industry. The sad thing is that irresponsible bidding like what Beoing is known for hurts soldiers the most; they already have a hard enough time getting decent equipment...

    You can't deny the facts that she points out. Well, I guess you could, but you'd just be deluded.

  • Report this Comment On July 29, 2011, at 2:56 PM, TMFKSpence wrote:

    Steve3452345235,

    I've responded to both of your "criticisms" with accurate and research facts. It is your choice whether you choice to except them or not. Regardless of your choice, the facts I've presented remain true.

    Best of luck

    TMF Katie Spence

  • Report this Comment On July 29, 2011, at 3:07 PM, SKentsan wrote:

    Katie,

    I think where Boeing hopes to recoup $$ is the same way they screwed the Navy during one of the fixed price multi-year contracts on the F-18 E/F.

    God forbid the Air Force wishes to make the most minor of minor changes to the aircraft configuration, because that will reopen pricing and the gov't may have to pay MUCH more than the change would normally warrant.

  • Report this Comment On July 29, 2011, at 3:33 PM, TMFKSpence wrote:

    Hi SKentsan,

    Thank you for your comment. I think you'll find this article link very interesting given your comment. It is in regards to Boeing's plans with overseas sales of the tanker.

    http://defense.aol.com/2011/06/23/boeing-military-air-seeks-...

  • Report this Comment On July 29, 2011, at 6:00 PM, rowboat9 wrote:

    In 1971, the U.S. Government rushed to the aid of Lockheed with a massive loan guarantee when Lockheed found itself on the brink of bankruptcy due to problems with its L-1011 commercial airliner, and cost over-runs on the very-much-needed C5-A military transport. An early example of "too big to fail".

    Although highly unlikely in today's political environment, we could conceivably see a repeat of this scenario if Boeing encounters major problems with the KC-46. The Air Force has needed a new tanker for a long time, and can't afford to wait another 10 years for a replacement. Hopefully, the Air Force will watch this contract like a hawk, and see over-runs coming way before it finds itself in a position where development has progressed to the point where it has no choice but to stick with what it's got, and back another bailout.

  • Report this Comment On July 30, 2011, at 12:22 PM, kokosmith wrote:

    Three important points to remember here :

    1 ) Boeing had to bid this contract against a euro-government subsidized jobs program. The very fact that the air force pitted one American company against the entire euro economy is criminal.

    2 ) This article with its demeaning ' Boeing is stupid ' heading was written by one of those air force women who all seem to reach the rank of colonel before they're thirty and have no real expertise or experience at any position of importance. They all seem to be "spokeswomen"

    or PR officers as the air force has been mandated have a certain number of non-white or males of high rank !

    3 ) When a person says to me " Trust me, I'm ex-Air Force, I've worked alongside many contractors, and my husband is currently a defense contractor. " I automatically don't trust them. What level of journalist would attempt qualify their article with a " Trust me ."

    It is interesting that this self-proclaimed "x-air force" woman that worked along side many contractors is now married to one of them. What a professional !!!!

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