As recently as nine months ago, a U.S. Air Force plan to build a fleet of 100 Long Range Strike Bombers was expected to cost taxpayers $55 billion.
That was already a big number -- more than a half-billion bucks per plane. So, I knew I was climbing way out on a limb when, in August, I suggested the actual cost of the program would be closer to $93 billion.
Now, imagine my surprise when the Air Force admitted in October that I was right! (Or, at least, that my estimate was closer to the true price of $79 billion than their own initial $55 billion figure.) When you add $23.4 billion in development costs to the $55.8 billion budgeted for production, it's going to cost $79.2 billion to buy 100 LRS-Bs from Northrop Grumman (NYSE:NOC).
And imagine my surprise when, just a few weeks later, a Washington, D.C., think tank urged the Pentagon to buy twice as many bombers as originally planned!
Surprise, surprise, surprise!
At first glance, this looks like a very big (and pleasant) surprise for Northrop Grumman, indeed. If the original LRS-B contract was supposed to be worth $79.2 billion, then a contract for twice as many planes would bring in more than $158 billion, right?
Well, no, actually. Not quite right. Because there's actually some method to this madness. I'll explain.
Writing for the D.C.-based Mitchell Institute for Aerospace Studies, retired Lt. Gen. Michael Moeller declares that "a modernized and capable Air Force bomber force of 150 to 200 aircraft is required to maintain America's asymmetric advantage in long-range precision strike over any potential future adversary."
In fact, the U.S. possesses a bomber fleet of roughly that size today. The problem is, out of the 160 strategic bombers in the Air Force fleet, 78 are B-52 Stratofortresses (first introduced 60 years ago) and 62 are B-1 Lancers (30 years old).
With the B-1s approaching retirement age and the B-52s well past it, roughly 88% of America's bomber fleet will soon be grounded. Once that happens, even building 100 new LRS-Bs won't be enough to get our numbers back up to the "150 to 200 aircraft" range. As Lt. Gen. Moeller bluntly states: "Limiting production of the new bomber, LRS-B, to 100 airframes would severely decrease the options available to national decision-makers during times of crisis or periods of instability."
That means 200 new planes will become a necessity.
There is, however, a side benefit to doubling purchases of the new bomber: It will almost certainly reduce the cost per plane. Consider this: Based on the numbers revealed in Northrop Grumman's contract award, each LRS-B built is expected to cost about $558 million in 2015 dollars. Development costs of $23.4 billion, amortized across a fleet of 100 planes, would jack up the "all in" price to about $792 million per plane.
Spread those development costs out over 200 planes, however, and the per-plane cost declines to $675 million. Presto-chango, that's a 15% reduction in unit cost.
And it gets better. As any warehouse store shopper can tell you, goods almost always cost less when bought in bulk. Bigger purchases permit contractors like Northrop to command bigger discounts on airplane parts purchased from their suppliers -- and to pass those savings on to their customer, the U.S. Air Force. In one recent example, Northrop rival Lockheed Martin (NYSE:LMT) asked the Air Force to sign a multiyear bulk-buy of F-35 fighter jets, offering in exchange a unit-price reduction of about 10%. In 2010, Boeing (NYSE:BA) offered the Navy a similar deal in exchange for that service agreeing to buy F/A-18 Hornet fighter jets in bulk.
(At this point we should probably point out that Lockheed Martin and Boeing -- the losing bidders on the LRS-B contract -- are contesting its award to Northrop. A decision on their protest is expected sometime in mid-February.)
Still, assuming the LRS-B gets built at all, could the Air Force finagle a similar discount out of Northrop Grumman by upping its order by an additional 100 planes? Chances are, the answer is yes. And a 10% discount on production costs, combined with amortizing development costs across a larger fleet, could conceivably drop the per-plane cost of the LRS-B below $620 million.
What it means to investors -- and to taxpayers
By now you should be getting the picture. A 200-plane bulk-buy at $620 million per plane would mean a lot more money for Northrop Grumman and a lot more profit for its shareholders -- probably as much as $124 billion in revenue and perhaps as much as $10.5 billion in profit. (According to S&P Capital IQ, Northrop earns about an 8.5% net profit margin on its revenues.)
Granted, this assumes a much bigger program than taxpayers were initially expecting. On the other hand, through bulk discounts and amortization over a larger base of planes, each LRS-B, individually, would at least end up costing closer to what taxpayers were originally promised. That might be enough to make the deal politically palatable to legislators -- and to taxpayers.
And if it means nearly twice as much business for Northrop Grumman -- why, that will make this a win-win-win deal for all parties involved.