On surviving those UCAs, finding that $125 billion, and becoming the monopsonist’s apprentice.
The mood at the Aerospace Industries Association luncheon this week, Tony Bertuca reported for Inside Defense, was grim. As AIA CEO Dave Melcher put it, it’s a “relatively new phenomenon” for the president-elect to call out the country’s largest aerospace company on a big program like the new Air Force One, pledging to cancel it. Apart from Canadian Prime Minister Trudeau’s contempt for the F-35, there’s really no precedent for it at all. Much of industry is thus scrambling to understand what will come next. I advise that to grasp the implications of Donald Trump’s sudden intervention in military procurement, and his motivations for the fateful tweet, think back to this summer’s negotiations over the Lot 9 Joint Strike Fighter (JSF) contract, and to this week’s reissuance of the “$125 billion” story. Consider how differently this administration may want to think about costs and defense, and how to get there. Back at the end of October, Lieutenant General Christopher Bogdan, head of the JSF program, decided that months of talking was talk enough. In what Lee Hudson of Inside Defense called a “rarely used contracting mechanism,” the general foisted a “Unilateral Contracting Action” (UCA) upon supplier Lockheed Martin. As Valerie Insinna wrote for Defense News, the company stressed that the terms were “not mutually agreed upon.” Commercially minded folks might reasonably wonder how what’s not agreed upon can be a contract. As Sandra Erwin wrote for National Defense, “under national security provisions in the federal acquisition regulations, the government can at any point stop negotiations and issue a contract.” Despite the done deal, Senator McCain of Arizona was upset, as usual, calling this just “another symptom of our flawed defense acquisition system in general and the structure of the F-35 program in particular.”
So what were those terms? As Colin Clark of Breaking Defense reported, the various customers, whose interests the joint program office (JPO) collectively represents, will get fifty-seven F-35s of all types for about $6.1 billion. According to Joe DellaDova, spokesman for the JPO, this Low Rate Initial Production (LRIP) Lot 9 contract affords Lockheed Martin an average of 3.7 percent less per plane than the pricing in the LRIP 8 contract of December 2014. On Twitter, our defense-industrial colleague Andrew Hunter of the Center for Strategic and International Studies (CSIS) exclaimed “wow!” and asked “how do you get all the way to Lot 9 and still can’t agree on the cost curve?” I will venture a possible explanation. The management at Lockheed Martin have been telling investors that F-35 margins would improve. At least a few of the government’s people read the financial press too. It’s possible that they concluded that Lockheed was poised to make more money. As Trump similarly said about Boeing and Air Force One, the government wants the contractor “to make a lot of money, but not that much money.”
That order of monopsony power meant that Lockheed’s share price (NYSE:LMT) dropped about 3 percent on the news. That may have been an overreaction, as the JSF is perhaps 25 percent of Lockheed’s future profit stream, and the dispute was over much less than 3.7 percent of that. Byron Callan of Capital Alpha observed back then that “it may be premature to discount an operating margin impact in 2017 and beyond,” because the company had 90 days from the point of contract imposition in which to appeal the decision to the Armed Services Board of Contract Appeals or the Court of Federal Claims. However, in a sign that not all was well, the F-35 enthusiasts at the Lexington Institute immediately wrote another feel-good essay, without reference to the government’s diktat. What industry may be missing, however, is that this hands-on negotiation by social media does not portend simply another campaign in the war on profit.
Fast-forward to this past Tuesday. President-elect Donald Trump is appalled by the $4 billion cost estimate for the two forthcoming, tricked-out 747s that will serve as dual Air Force Ones. On Twitter, he announced that as deal-guy-in-chief, he would personally negotiate the pricing with Boeing. Otherwise, he wrote, “cancel order!” During a televised interview the next morning on NBC, he noted that he had personally spoken with Boeing CEO Dennis Muilenburg about the issue. American presidents generally don’t do this personally; it’s unlikely that George Washington signed the check for those first six frigates. Meanwhile, Boeing’s share price (NYSE:BA) dropped 0.84 percent on the news. Now that’s some Better Buying Power that Ash Carter and Frank Kendall shuddered to think about. As our Lund Fellow Steve Grundman once wrote, this monopsony power poses a dilemma, as it is occasionally too terrible to use.
So why Trump, why now, and negotiating over what exactly? Military aircraft are complicated purchases; the JSF JPO and Lockheed spent months arguing about the short-term shape of a learning curve. The commentariat inside the Beltway, presuming that Trump couldn’t possibly understand what’s involved in designing a “flying White House,” seems ready to write this off as a public relations stunt. Public outreach is certainly part of the strategy, but there’s an unfortunate tendency around Washington, DC to misunderestimate this PEOTUS as merely a swaggering braggadocio with more dumb luck than business substance. To be sure, Trump has a well-developed sense of personal style, but his madness may have method.
This week the Washington Post broke the non-story that McKinsey and the Defense Business Board have identified $25 billion in avoidable annual overhead in the Defense Department. (The figure is often reported as $125 billion over five years, but we all know it’s huge.) As Inside Defense first reported the story almost two years ago, and as the documents have been publicly available on a Pentagon website for all that time, there’s not so much to see. If there’s news now, it’s that the Post’s Freedom of Information Act (FOIA) request turned up embarrassing e-mail messages amongst Defense Secretary Carter, Deputy Secretary Work, Under Secretary Kendall, and Navy Secretary Mabus about the disinterest of the first three for doing much about all that. However, with an actual shipbuilding budget to protect, Mabus was outspoken, and Work instructed him to “refrain from taking any more public pot shots [to prevent] this spilling over into further public discourse.”
Public discourse! In a democracy, even! Most inconvenient. (And when will these guys learn to stop using e-mail?) I guarantee that the new team will be looking for that couch-cushion-change. But think also about the change in tone from outgoing to incoming administrations. Trump’s taking to Twitter may be relaunching a dormant national conversation about the gold-plating of military requirements. Tweeting from over at the CSIS, Todd Harrison seems to find a reasonable price in “$4B for two planes that operate as a flying command post for POTUS in a national emergency, have EMP protection, etc.” I’m less convinced. For his part, the PEOTUS seems to be saying that he doesn’t need a flying White House, but just a national leader’s airplane. In any case, this discussion—along with all others about what kinds of weapons the country really needs—might be too important to be left to the Air Force generals.
So what has Boeing done wrong? Absolutely nothing. The company only has a contract for the first $170 million in design work (Lara Seligman laid out the details in Aviation Week). Boeing was named as a sole-source by Air Force Secretary Deborah James, as she thought there was something distasteful about asking Airbus for an A380 from Toulouse. So, Boeing’s engineers have proceeded to try to design—as the USAF has seemingly requested—a jetliner that can microwave burritos for the entire press entourage while dodging the electromagnetic pulses of nuclear blasts. The incoming White House staff doesn’t really know how much all this additional capability costs, and frankly, plenty of people in Frank Kendall’s acquisition enterprise don’t either. As Deputy Assistant Navy Secretary Elliott Branch explained at the CSIS this past Groundhog Day, the government’s lawyers have roundly discouraged useful communication with industry over what industry can actually cost-effectively do. And that needs to go away.
By lambasting Boeing, and then demanding negotiation, Trump may be signalling that he needs the company’s help against his own bureaucracy. Trump may just be looking for some frank talk from the plane-builders and arms-makers about what’s reasonable and what’s not. As is his nature, he wants to do a deal. As Jake Novak observed for CNBC, Boeing was immediately talking about working with the USAF to deliver planes “at the best value.” It’s too late to thoroughly rethink what a JSF alternatively could have been; as the contractor, the worst you can get now is a UCA. Everything in earlier stages of development, however, is game. Trump has repeatedly said that he wants to cut overhead, cut excess, impose business discipline on government, and deliver deals that ordinary Americans will respect. He also probably wants another quick win, like the Carrier deal, to put industry and government on notice about what he personally expects.
James Hasik is a senior fellow at the Scowcroft Center for Strategy and Security.