Tuesday, October 27, 2009

The Price Guarantee

It sounds like something you'd hear on a late night TV commercial for a local car dealer. You know, that irritating guy who promises the lowest price on a vehicle...guaranteed! And if he can't match a competitor's offer, he'll give you the difference, yada, yada, yada.

Of course, no one puts much stock in such promises. So why is the same tactic being applied to the Air Force's $35 billion dollar contract for new aerial tankers?

According to Amy Butler of Aviation Week, the CEOs of Northrop-Grumman and Boeing (the two firms competing for the tanker deal) must sign a certification letter as part of their forthcoming contract proposals. In the letter, the CEOs must guarantee "the performance, schedule and cost claims made in the bid," according to a defense industry source familiar with the requirement. The official spoke with Ms. Butler on the condition of anonymity.

The Pentagon's insistence on a "CEO guarantee" has a lot of aerospace executives scratching their heads. As the defense executive told Amy Butler:

*First, shouldn't the bid itself -- on Boeing or Northrop Grumman letterhead -- implicitly be personally guaranteed by the CEO as well as all officers of the company that submits it? So, why does USAF need this extra certification?

*Second, why then would this rile industry? A CEO should personally back his proposals -- all of them. The only reason I see to distance yourself as a CEO from your company's bid is if the bid is bogus, in which case you are doing harm to your customer and, potentially, your shareholders by proposing it and, possibly, winning on a false strategy (a la FIA).

*Third, is there some extra layer of legal liability this puts personally on the CEO, rather than his or her standard responsibilities? And, so, if not, why does DOD go to the trouble? Is this basically saying that procurement has gone so awry that the proposals aren't worth the paper they are written on?

From the USAF's perspective, there are plenty of reasons to be concerned--and request an extra level of certification. We've devoted numerous posts to the debacle that was--and is--the next generation tanker program. The service's attempt to field a new aerial refueling platform is roughly a decade behind schedule, and past efforts were riddled with corruption, accusations of favoritism, shifting program requirements, and legal challenges.

Judging from the recently-released Request for Proposals (RFP) for the tanker contract, it's clear that the Air Force is making every attempt to hold the line on costs, believing that there is little margin for error (or potential overruns) in its plan to acquire 179 new tanker aircraft. Hence, that request for a CEO guarantee.

But much of this mess can be pinned squarely on the Air Force. The original plan to lease KC-767 tankers from Boeing went down in flames, after it was learned that the service's senior civilian acquisition official had arranged jobs for herself--and two family members--with the defense contractor. Political and legal fallout from the failed lease program set the program back at least five years.

A second try at awarding a contract resulted in a victory for Northrop-Grumman and its European partner, EADS, which offered a tanker version of the Airbus A330 jetliner. But Boeing cried foul, claiming that Air Force specifications were vague, and that the service actually favored the larger Northrop-Grumman entry when its requirements suggested a smaller airframe like the 767. Boeing's protests were eventually upheld; the Northrop-Grumman contract was tossed out and the acquisition process returned to square one.

But the tanker woes didn't stop there. At one point, the Pentagon stripped the USAF of its authority to select a new refueler, transferring that responsibility to then-DoD acquisitions chief John Young. The service eventually regained control of the selection process, but it's no surprise that Air Force acquisition managers are a little bit nervous--and gun-shy.

Meanwhile, members of Congress aligned themselves with the two competing teams, hoping to bring home the bacon to their constituents. Several key members of the House and Senate actually suggested a "split buy" for the tanker, with Boeing and Northrop-Grumman sharing in the spoils. Never mind that such a program would result in significantly higher costs for parts, maintenance, and training, since the Air Force would wind up with two new tankers, rather than just one. Thankfully, support for the split buy seems to have cooled in recent months, but it shows the level of in-fighting associated with the tanker deal.

As for the newly-mandated price guarantee, it's supposed to prevent a common tactic in defense contracting. You probably know how it goes; a defense firm offers a rock-bottom price for a new system, which the Pentagon quickly accepts, believing it is getting a great deal. But, inevitable cost overruns creep into the picture, forcing DoD to re-open the contract and provide more funding.

With its emphasis on cost, there's nothing (at least in theory) to stop the same thing from happening in the tanker program. And that's where that CEO letter apparently fits into the scheme. By forcing the firm's chief executive to certify price and performance data, DoD will have something to use against the company when it requests more additional money.

Unfortunately, that "strategy" ignores a few critical points. With its over-emphasis on cost, the new tanker RFP almost guarantees that one--or both--tanker competitors will submit low-ball bids, aimed at securing the contract at all costs. That would mean the company would take a bath on development expenses, then plead poverty when operational production begins. At that point (several more years and billions into the program), the Air Force would have little choice but to pony up.

Additionally, we wonder how the "CEO guarantee" can be enforced when some corporate leaders are hired (and fired) at the frequency of baseball managers. In other words, can the Air Force--and the Pentagon--hold Boeing or Northrop-Grumman to guarantees made by a former CEO?

Put another way, "price guarantees" for the next-generation tanker will prove as reliable--and trustworthy--as the deal promised by your local car dealer. Somehow, the defense acquisition process has taken another step backward, at the very moment the Air Force needs new tankers.


herb said...

Purely meaningless. The Proposal is based on a thousand assumptions both economic and technical as well as a bunch related to time. The govt messes with any of them the proposal is no longer binding.

The worst that can happen is that some CEO gets tortured by congresscritters. Or held up as an enemy of the people.

jayemarr said...

As someone who owns a business, I can tell you that YES, this would expose the CEO to personal liability, and I would never sign such a thing.

In the normal course of business a CEO can only be held personally liable in the case of gross misconduct or negligence. Otherwise it is the responsibility of the company -- not him/her personally -- to remedy the situation.

Anyone signing such an agreement is setting themselves up for financial ruin.

If CEOs are going to be pressured to sign such things to land government contracts, I am not really sure this is a positive development.