How will Boeing profit from tanker contract?

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.

23 Comments on “How will Boeing profit from tanker contract?

  1. Within 10 days of winning the contract, we’re told Boeing went to the USAF with a series of proposed change orders

    They tried to get them to buy extra toilet seats?

    • Seats?
      No those were included but the high tech fasteners were missing.
      For reducing flapping noises in the plane Boeing probably offered a real
      bargain to government procurement.

  2. Boeing’s profit comes from preventing Airbus from building a (U.S.) government subsidized final assembly facility in North America, with Dollar costs instead of Euro costs.

    Now if Airbus wishes to build a facility in the U.S., it will have to be paid for on their own dime, not from a tanker contract.

    But there is always KC-Y and KC-Z../

    • If the US doesn’t find some rich uncle fast even the KC-46 project may have less future than expected.

    • Yes, Boeing effectively prevented the USA from importing the only other wildly successfull LCA integrator from adding at least some, but probably a significant portion of their value stream (~65 BUSD) to a US taxable region. While Boeing keeps outsourcing more and more of it’s activities abroad (see Japan and Italy workshares on the 787 for example), it is of course vital to keep your sole competitor out of you own backyard – if only to make sure you remain the only viable target of aerospace subsidies and major government contracts.
      YOU and every other american are paying ~2 usd for this cost overrun – the gov’t is paying 600 MUSD extra, and you can bet your behind that they’ll pay for Boeing’s part as well – As Boeing stated, they will turn a profit! That includes any interest Boeing pays on the extra money out of pocjet at this point…

      What I find wonderfull is how everybody apparently accepts the initial cost overrun. It was a prolonged aqcuisition. Boeing knew what they were selling and could have been under no illusions what the USAF would be paying… where does this addition 1 billion USD come from – Why would the USAF accept to pay anything if these extra costs were apparently known before the contract was awarded?

      • FWIW, were it up to me we’d be seeing the initial dry contact tests of the KC-45 right about now.

  3. “But there is always KC-Y and KC-Z../”

    Perhaps, but with huge defense budget cuts, now projected to be at least $800B over the next 10-15 years, or so, one or both programs may never happen.

    But based on the KC-135 and KC-10 maintenance and modification contracts that Boeing has won in the past, they provided excellent service, as well as made money on them. Boeing did loose the latest KC-10 maintenance and modification contract to NG awarded in 2010, I believe.

    “Having said that, low-ball, loss-leader bids are not at all unusual in aerospace.”

    I guess that is the real bottom line here, from all the OEMs like Boeing, EADS, LM, and NG.

  4. Amortization of Non-Recurring or NRE over the Recurring or RE is common practice in Aerospace. This goes for 100% of all commercial and defense product developments.

    Question is “does it pencil” when considering the Design To Cost (DTC) data the product life-cycle.

    The business baseline data for the program is available and the amounts targeted by the media are important but not significant to the overall cost model of the program. In my opinion, it comes down to ROI and the distributed cost model over the entire Supply Chain, Tier I to Tier VI.

    Regards,

  5. With this programe still in it’s embryonic stage it’s already making the headlines for the wrong reasons. Loss leaders may well survive the defence cost mathmatics on the back of support packages, but to have to be asking when the airframe will arrive & at what cost so early on does not bode well.

    Seems once again that Boeing wins at the cost of the taxpayer & sadly in this example also the USAF

  6. not really any substance for discussion in my opinion; Boeing got what it wanted -ie keeping A out of the contract as well as a foothold in the US manufacturing -for tanker and freighter.
    The rest is secondary; I am not clear why Boeing’s profitability is being looked at so early in the contract.
    The tax payer got a good deal ,the AF got what it wanted , let us move on.

    • If the taxpayer is already footing an extra part of the bill, it is not that good a deal for them.
      Furthermore during the competition, Boeing and its supporters kept harping on the possibility that Airbus would bid a money losing bid and condeming them for it.

      Now they have proven themselves to be hypocrites as well as willing to take advantage of the american taxpayer.
      That is why there is so much focus on their profibility. That the loss was reported within a couple of months of awarding of the contract and a second announcment of further loss reported within 5 months after the contract was awarded does not bode well for the taxpayer.

      Had Airbus won the contract and come out with the same announcements, the howls for blood would have been deafening. But since Boeing is an American company, this “subsidy” is heartily accepted by the politicians.

    • Don’t forget: Boeing will not lose money on this program in the long run – the taxpayer is not getting a good deal, they are just paying the bill (plus interest) a bit later.

  7. Is it possible that Boeing deliberately bid low, NOT to win the contract, but to make it more expensive for Airbus, based on the general expectations by most insiders that Airbus would win the T/T contract?
    Boeing won at the last minute, because it benefited from a recalculation done by a senator on the selection committee, concluding that the total amount of fuel burned by the KC-30, would be much more compared to what the KC-67 would use over 40 years instead of the 25 years used for calculations in the selection process earlier.
    Really? The KC-30 burns more fuel compared to the KC-76, period. But, as far as I can tell, the greater payload/range of KC–30 was NOT taken into account!
    Boeing, in the process, may have bought itself a “cat in the bag” with this contract!”

    • No foe required with friends like these ;-?
      Not impossible.

      One could describe a bunch of scenarios that would fit the final outcome.

    • what use is payload range when it is not required. current OPS using KC-135 and KC-10 show they fly circuits relatively close to home and most cycles are training rather than operational.

      • Whatever the missmatch at “time of engagement” the rules were “lowest bidder by more than 1?% else better in an additional performance comparison.”

  8. Pingback: Can Boeing make money on Air Force tanker after bid boosts? | Android Informations 2011/2012 pp

  9. Uwe :If the US doesn’t find some rich uncle fast even the KC-46 project may have less future than expected.

    That, unfortunately may be true, looking at what our “political leaders” are doing to the US economy.

    John S :FWIW, were it up to me we’d be seeing the initial dry contact tests of the KC-45 right about now.

    Well, no. The USAF (and the FAA) will not be ready for flight testing before 2014 or 2015, or so. Also the USAF would be very interested in the Boom failure on the RAAF KC-30A during flight testing. They would also be interested why the RAAF flight testing took so long, and the first delivery was finally done some 2.5 years late.

    The Italian KC-767A and Japanese KC-767J do not apply here as the KC-46A is very different from those two KC-767s. But the KC-30 EADS was offering was near identical to the Austrailan KC-30A, accept minor equipment differences.

    Rudy Hillinga;

    “Boeing won at the last minute, because it benefited from a recalculation done by a senator on the selection committee, concluding that the total amount of fuel burned by the KC-30, would be much more compared to what the KC-67 would use over 40 years instead of the 25 years used for calculations in the selection process earlier.
    Really? The KC-30 burns more fuel compared to the KC-76, period. But, as far as I can tell, the greater payload/range of KC–30 was NOT taken into account!
    Boeing, in the process, may have bought itself a “cat in the bag” with this contract!”

    The extra payload and range would have only been considered “if the final bids were within 1%”. They were not. According to some reports, Boeing undercut EADS’s bid by some 10%. Even the day of the award, the SecAF said “it wasn’t even close” meaning the final bids received.

    Now, I agree, Boeing did get the contract they wanted, now they have to produce the KC-46A, even if it is at a loss to them.

    • “The extra payload and range would have only been considered…”

      That mandated undercutting EADS on price by a large margin for a Boeing win.
      i.e. worst case EADS price elasticity – 2% ?
      They should be able to recoup that with a bit of tears and screaming if they
      stay below the project killing level : 25% ?

      apropos time to target:
      what if any is the functional/effort difference between the Italian/japanese tankers and the tanker conversion done by IAI. IAI didn’t take all that long ( and as projected) for theirs.
      ( ItaAF and JDF have a boom each, ok, but that didn’t seem to effect the holdup).

  10. boeing won by stopping airbus beachhead on u.s. territory

    and will surely lose on the developmental aircraft

    then will win on the other of the 179 units

    then win again on maintenance (though not sure)

    the u.s. taxpayer wins when compared to airbus kc30 pricing

    kc30 losses from potential world beater

    to a niche tanker

    my take is that boeing will use a low-cost approach usaf milspeced kc767i

    then grumble along for bigger profits

  11. ikkeman :what use is payload range when it is not required. current OPS using KC-135 and KC-10 show they fly circuits relatively close to home and most cycles are training rather than operational.

    Uwe :Whatever the missmatch at “time of engagement” the rules were “lowest bidder by more than 1?% else better in an additional performance comparison.”

    The current KC-135 and KC-10 have never allowed any receiver to go without the fuel he needed. They fly to where they are scheduled to refuel, and often on operational mission, conduct unscheduled refueling far from where they were scheduled to refuel. It is the tanker crews that make their tankers maintane operational flexibility, and change the “plan” on the run while over the combat area. The KC-135 crews first did this during the Vietnam War, making more than 500 aircraft ‘saves’ by flying directly into North Vietnam. Just ask any USAF fighter pilot, and they will confirm it.

    So, there is no ‘mismatch at the time of the engagement’. Yes the KC-X bid rules were ‘lowest bidder by more than 1%’. Boeing and EADS knew this. EADS gambled hoping they could bid within 1% of Boeing, so the optional 93, or so ‘extras’ they wanted might have turned the selection in their direction. All Boeing had to do was beat the EADS bid by more than 1%, and they did that, and then some. Now Boeing has their KC-46A contract (at least the initial contract), and have to deliver on the price.

  12. Come 8/2/2011uncle Sam might have a busted hand unless dem’s/rep’s pull royal flush out of the hat the tanker may have to canceled and make do with what you have got for the time been THE BOEING 707 TANKER how much fuel does that use in the next 40 years senator??? good luck and don’t come crying when someone say’s we should have got the airbus.

  13. AirBus Tanker :Come 8/2/2011uncle Sam might have a busted hand unless dem’s/rep’s pull royal flush out of the hat the tanker may have to canceled and make do with what you have got for the time been THE BOEING 707 TANKER how much fuel does that use in the next 40 years senator??? good luck and don’t come crying when someone say’s we should have got the airbus.

    The KC-135 is not a B-707 tanker. It is a different airframe, with different wings and fuselarge. The 4 SDD KC-46s are already funded, so the 2 Aug date has no effect on them, unless the Congress defunds them. The 2 Aug date is not the end of the world, nor will the US Government default on that date. The government still takes in more than $200B each and every month. The monthy outlays are some $170B. That leaves enough money each month to pay the debt and debt interest.

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