Just whenever you think there’s nothing more to write about the air force aerial tanker, more news pops up.
The news that Boeing would first lose $300m on the initial KC-46A tanker contract, and now perhaps another $400m (will there be still more to come?), isn’t particularly surprising.This is on top of the $600m the USAF (read that “taxpayers” agreed to absorb of the first $1bn in excess program costs.
In fact, when the first loss projection was announced, Wall Street aerospace analysts noted the news but shrugged it off as falling under the “what did you expect?” category. We didn’t even both to write about it, except in passing.
Having coincidentally been in Washington (DC) when EADS held its post-contract award press conference, we attended and listened to EADS Chairman Ralph Crosby explain to reporters in obvious bafflement that Boeing must have bid the contract at a loss.
EADS, having been the target of so much political campaigning that illegal subsidies to Airbus would all but guarantee EADS would bid a money-losing contract to win the deal, was around 10% higher than Boeing’s bid. Crosby was clearly dumbfounded at the Boeing price.
In fact, we later learned that an Airbus official had urged EADS to be even more aggressive in its bid pricing–but that even the price urged by the Airbus official (which we were unable to learn) still would not have been low enough to beat Boeing’s bid.
Still, with taxpayers now set to get clipped at least another $600m, we can’t help but wonder about the hypocritical politicians so concerned about taxpayer subsidies (which is all this will amount to) that will now be going into Boeing’s tanker. (This is obviously rhetorical sarcasm.)
Having said that, low-ball, loss-leader bids are not at all unusual in aerospace.
Boeing’s tanker spokesman Bill Barksdale declined comment on this specific news to various media but is quoted as saying the program overall will be profitable. How, you might ask?
Reuters has this story with some figures.
Within 10 days of winning the contract, we’re told Boeing went to the USAF with a series of proposed change orders, where, it is assumed, Boeing would make money. We’re told USAF rejected these change orders. It was after that Boeing officials said they would be just the tanker awarded, nothing more, nothing less.
The follow-on groups of airplanes might be priced better, of course, than the first 18 or the first four. More likely, Boeing is counting on the maintenance and parts support as the foundation for profit. In commercial deals, it’s rare but not unknown for the airframe and engine OEMs to lose money on the initial deal only to make it up in maintenance, repair and overhaul contracts. Boeing’s Commercial Aviation Services division posted $1bn in profits in 2009 and did similar numbers in 2010.
Boeing has a long history of obtaining DOD contracts to maintain tankers. In fact, we always felt this was a key attribute Boeing failed to exploit in its PR and political campaign during the tanker competition, and one that EADS could not remotely match in experience.
Then there is selling the USAF parts for the KC-46A. Part sales has always been a DOD scandal, with contractors routinely over-charging (sometimes by massive amounts) price vs cost.
This 154-page government study is replete with examples of Boeing massively over-charging DOD for spare parts.
Whether Boeing will ever make money on the baseline tanker contract is obviously up for question; company officials and aerospace analysts said the program would be a “small margin” one, but really didn’t define what this means or where the margin would come from.
But MRO was always part of the baseline assumption, in our view. This is where we believe the real profit is likely to come from.