Update, May 19: With all the references in Comments about the GAO ruling, we are linking the 150+ page report here, courtesy of Sgt. Mac: GAO KC-X 2008 Protest
Update, May 17, 4:30PM PDT: Reuters has this story that Boeing will bid for the tanker “despite concerns.”
We had been planning to write a column about whether Boeing may be in danger of being hoisted on its own petard when two news items appeared Friday (May 14) that accelerated this column.
The first appeared in Army Times/Defense News (sister publications), quoting an unidentified Boeing executive as saying Boeing might night bid on the KC-X because officials feared it could not win the contest because EADS would be able to undercut the price due to subsidies at Airbus. (This also would explain the question we raised in our post, Why aren’t they talking about the airplane?)
The second story appeared in The Seattle Post-Intelligencer refuting the Defense News piece.
Whether the Defense News story is true or not, and Boeing’s Bill Barksdale says the angle about potentially not bidding isn’t true, the rest of the News story touches on what we were planning to discuss.
As part of the preparation for this column, we wanted to find the origin of the phrase, “hoisted on your own petard.” When we went to Wikiedia, we were more than struck by the irony: the phrase’s original is—French.
Here is an excerpt from Wikipedia:
A petard was a small bomb used to blow up gates and walls when breaching fortifications. The term has a French origin and dates back to the sixteenth century. In a typical implementation, it was commonly either a conical or rectangular metal object containing 5 or 6 pounds of gunpowder, activated with a slow match used as a fuse.
The word petard comes from the Middle French peter, to break wind, from pet expulsion of intestinal gas, from Latin peditum, from neuter of peditus, past participle of pedere, to break wind; akin to Greek bdein to break wind. (Merriam-Webster) Petard remains a French word meaning a firecracker today (in French slang, it means a handgun, or a joint).
The word remains in modern usage in the phrase hoist with one’s own petard, which means “to be harmed by one’s own plan to harm someone else” or “to fall into one’s own trap”, literally implying that one could be lifted up (hoist, or blown upward) by one’s own bomb.
So how might Boeing be in danger of being hoisted on its own petard?
Boeing and its supporters pushed the Pentagon very hard to have this round of KC-X competition be a best-price competition, while Northrop Grumman wanted a best-value contest.
Both sides believed that if the Pentagon chose a best-price competition, Boeing would have the advantage by offering a smaller airplane that had lower life cycle and lower infrastructure costs (operating costs and Military Construction, or MilCon, costs respectively) and that the extra capabilities of the larger Northrop KC-45 would not count.
The Pentagon’s February Request for Proposal was characterized as a best value RFP by officials, but as Northrop, EADS, Boeing and analysts read the document, it was clear that best price prevailed. The Pentagon made it clear that whoever presented the best price would win if the bid met all 372 technical requirements. Only if the bids came within 1% of each other, including analysis of the life cycle and MilCon costs, would credit be awarded for exceeding the minimum technical requirements.
Boeing asserts its KC-767 has at least a 24% advantage on life cycle costs. Northrop and EADS disputed this figure, but nonetheless were concerned that without initial consideration for the KC-45’s extra capabilities beyond the KC-767 (which are what won Northrop the bid in Round 2, later overturned by the GAO on procedural grounds), the KC-45’s goose was cooked. The additional MilCon costs are figures we have not seen.
Northrop also had concerns about the fixed price nature of the contract, as did Boeing. Northrop withdrew from the contest in April, citing the fixed price provision and the widely-held conclusion that the RFP favored the smaller KC-767.
EADS later decided to make a bid on its own, citing several reasons: it believes it has the best airplane and should go ahead and bid; it has hundreds of millions in sunk costs into the project from the Round 2 bid; the KC-330 Multi Role Tanker Transport on which the KC-45 is a derivative is more mature than it was in 2007 and is about to be delivered to the launch customer, the Australian air force; it is now in production, with the UK’s model now rolled out as well; the Air Force certified EADS as a “qualified” prime contractor, eliminating the need for a lead US company that was necessary with the Northrop relationship; and the Pentagon asked EADS to bid to provide competition for the contract.
Although Boeing’s commercial 767-200ER on which its KC-767 offering is based is some $60m less in list price than the Airbus A330-200 on which the KC-45 is based, Northrop came in lower than Boeing in the Round 2 pricing ($184m vs $200m) largely because the USAF added $5bn to the Boeing cost factor due to risk vs. adding $700m to Northrop. The same risk factor assessment is absent from this Round 3 bidding, which means the USAF’s adding of risk-factor money may not be a significant factor as it was in Round 2.
Boeing’s supporters believe that adding the WTO costs of the illegal Airbus subsidies back into the equation, as discussed in the Defense News article, means an additional $5m to each KC-45. (We don’t know how this figure is derived; $5bn, the amount Boeing and its supporters allege was the illegal subsidy to the A330, divided by 179 airplanes is $28m per airplane according to our calculator.)
But we do note the $5bn figure alleged on the A330 is the same amount the USAF added to the KC-767 cost in Round 2. Flip this figure and it is a swing of $10bn.
EADS is less concerned about the fixed cost provision of the RFP than was Northrop. EADS officials point out that Airbus has been doing fixed priced contracts for decades, competing against Boeing in doing so. Although the same certainly can be said for Boeing-its commercial division has likewise been competing against Airbus with fixed price contracts-the KC-45 is in production and EADS now knows the development costs. Boeing’s KC-767 NewGen is a conceptual airplane. It is not in production and it is a derivative of the troubled Italian KC-767, which is five years late and still undelivered. Developmental costs of the KC-767NG may be much more a crap shoot than EADS believes its costs are for the KC-45, raising more concern for Boeing as outlined in the Defense News piece.
With the withdrawal of Northrop from the KC-45 program, the profit margin associated with Northrop now is out of the financial equation. This enables EADS to offer a lower price. No one will tell us what the Northrop profit margin was other than to say it was “significant.”
EADS also denies that it will low-ball any bid because it can’t afford to. Cost overruns on the A400M and A380 programs, deferred cash flows on the A380 production delays which we estimate to be in the billions of dollars, customer penalties associated with the A380 delays, and R&D funding for the A350 and the A320 re-engine combine to mean that EADS doesn’t have the financial where-with-all to low-ball bids, officials say. EADS also wants to acquire US companies to increase its US footprint.
In addition to Boeing’s belief that the A330 subsidies need to be calculated are aggravated by the elimination of the Northrop profit margin and the development uncertainties of the KC-767NG.
So Boeing is worried that EADS could actually submit the best price, which according to the terms of the RFP–and what Boeing and its supporters lobbied for–EADS would win the contract.
As we noted in our other post, Playing with Fire, you need to be careful what you ask for.
So what’s going on with the conflicting reports out of Boeing?
One observer indirectly associated with Boeing and supporting the KC-767 bid hypothesizes this may be an effort to stir the pot in connection with the bills introduced this week in Congress to force the Pentagon to consider the WTO subsidies. As we previously noted, we think this is playing with fire. Although Boeing believes that any WTO ruling against it with respect to the European complaint about illegal subsidies provided Boeing, this is a big gamble. What if the bet is wrong?
The twists and turns continue in this controversial procurement.