WASHINGTON — After more than a year of plodding negotiations, the Pentagon disclosed that it had reached a $6.1 billion contract with Lockheed Martin for a ninth batch of 57 F-35 joint strike fighter aircraft. A few minutes later, Lockheed released its own bombshell of a statement — instead of the usual congratulatory language about working together, the company said it was “disappointed” with the government for definitizing a contract that had not been mutually agreed upon by both parties.
In short, the government had pulled the trigger on the contract without Lockheed’s approval, using a vehicle known as a “unilateral contract action.”
At the core of the dispute was the total value of the agreement, specifically the price per plane and the level of profit Lockheed stood to make from the deal, sources from industry and the F-35 joint program office (JPO) have confirmed. Although the difference between Lockheed and the Pentagon’s cost positions was a small one, the company believes the government did not present a realistic cost per plane or a fee that recognized Lockheed’s investments and risk.
hether the contract stands is yet to be seen, as Lockheed officials may opt to appeal the decision. But analysts said the outcome could send shockwaves into the relationship between the JPO and Lockheed and bring it back to the contentious association of years past.
“I think that this decision will cause a challenge in that relationship,” said Andrew Hunter, senior fellow at the Center for Strategic and International Studies. “I honestly can’t imagine Lockheed won’t bring this to the board of contract appeals. I don’t know why they wouldn’t.”
“You have to assume that they violently disagree with this cost position and that they’re then going to appeal it, and that I think fundamentally will put them in a position of having to criticize, in a public way, the JPO and the Navy contracting team that generally does these negotiations, and that’s just going to have its effect,” he said. “It’s not necessarily devastating. It doesn’t necessarily poison the well, but it’s definitely going to have some impact on the relationship.”
The LRIP 9 contract as it currently stands includes42 F-35As, 13 F-35Bs and 2 F-35Cs, with deliveries starting in early 2017. The JPO originally planned to ink a deal for the ninth and tenth LRIP batches concurrently, and the government’s push forward on a unilateral contract for lot 9 could color future negotiations for lot 10 or an international block buy planned to start in lot 12.
ven if Lockheed appeals the contract, the outcome may not be completely negative, Hunter said. The Pentagon and Lockheed have agreed in principle about bringing down the cost curve of the F-35, but have long disputed how low unit prices can go and the timeline for bringing those costs to bear.
For instance, the government has always pushed Lockheed and its suppliers to drive down production costs past the point that the company believes is reasonable – an issue that also came to a head during LRIP 5 negotiations in 2012. Having an impartial board of judges arbitrate production costs for the F-35 might be the best option for settling this longstanding disagreement, he said.
“Maybe they’ll have to split the baby, but maybe this actually helps them finally resolve where the cost curve ought to be,” he said.
Loren Thompson, a defense analyst with the Lexington Institute who has consulted for many top defense firms, agreed that Lockheed will likely challenge the contract through the Armed Services Board of Contracts Appeals.
“I think Lockheed has to appeal contract terms that don’t offer a reasonable rate of return or impose unacceptable risk. They don’t have a choice,” he said. “Companies can’t survive unless they generate a reasonable contract margin. They need to be able to return their labor, their material and their capital costs while still keeping shareholders engaged.”
If the government manages to force Lockheed to accept the terms of the contract, it could begin using unilateral contract actions more widely for other programs such as the B-21 bomber, T-X trainer and other new-start aircraft, Thompson argued.
“The government actually has a lot of leverage here because it’s the only customer for most military products, so it’s in a position to force conditions on companies, but it could weaken this industrial base in the process,” he said.
Moving forward with an appeal — particularly one that is long and drawn out — could risk further deterioration of the Lockheed-JPO relationship, and that’s something the company will have to weigh, said Richard Aboulafia, an analyst with the Teal Group.
However, Aboulafia stated that he did not think it likely that the government would begin using unilateral contracts more often. The reason is simple: The Department is already cracking down on cost-plus arrangements and is increasingly structuring contracts to be more favorable to itself, while expecting defense contractors to take on more risk.
“Certainly bomber, tanker and trainer all have [fixed-price expectations] embedded in it,” he said. “The F-35 in that context is sort of the last of the old days of cost-plus and a relatively risk free, relatively contractor-friendly programs. Maybe this represents an effort to try to impose new terms, some new realities onto a program that began years ago.”
t the time of press, Lockheed officials had not determined whether to appeal the contract. The board is unlikely to void the initial deal, Hunter said, but it could change the contract value, and thus the revenue picture of Lockheed and its suppliers. For that to happen, the company will have to state its case for why it needs more money to cover its costs and the risk of executing the contract.
Thompson said the fact that Lockheed is making less than a 9 percent profit on the F-35 is evidence that the government may have been too aggressive in negotiations. Typically, prime contractors make anywhere from a 10 to 15 percent profit during production on major programs.
“I don’t think that they’ve ever gotten to a 10 percent return for their work for F-35, so you can see why they need to get a reasonable rate of return and a reasonable risk profile,” he said. “People assume that because this program is so big, Lockheed Martin must be rolling in money, but in fact its rate of return is relatively modest.”
But Aboulafia pointed out that it’s hard to classify whether the F-35 should be considered in production or in development. Companies only make around 5 percent profit during the research and development phase, a figure that increases to more than 10 percent once full rate production starts.
“What is LRIP? A hybrid between full production and R&D? It’s probably more towards production, but there’s an element of learning,” he said. “Nine percent might not be what they want, but reasonable given the circumstances. On the other hand, I’ve never seen an LRIP program like this before.”
