Defense companies are refusing to work with their largest client due to contract losses

The U.S. Department of Defense is facing a challenge as it seeks to transfer the burden of cost overruns to contractors. This move has resulted in some contractors choosing to abstain from bidding on projects for the Pentagon, despite it being their top client.

Many people are hesitant due to the recent loss of several important contracts.

Northrop Grumman Corp. incurred a pre-tax loss of $1.56 billion in January due to the B-21 Raider program. Back in 2015, the company had placed a bid on the U.S. Air Force project, unaware of the subsequent challenges posed by the pandemic, inflation, and supply chain issues. As a result, the company is now facing cost overruns that it must absorb according to the terms of its contract.

During an investor call earlier this year, Kathy Warden, Chief Executive of Northrop Grumman, revealed that they have declined several notable programs.

Boeing incurred a loss of $7 billion as a result of securing a fixed-price development program for the U.S. Air Force’s upcoming tanker, the KC-46. The contract, which had a firm-fixed-price structure, held Boeing responsible for any additional costs beyond the initial estimate. The overall contract value amounted to $4.9 billion.

Boeing has announced that it will no longer engage in new fixed-price contracts for the development stage of weapons due to the challenges and uncertainties involved in designing and testing a new product.

The KC-46 contract initially appeared to be a fairly simple undertaking. The U.S. Air Force had a requirement for a new tanker to perform midair refueling operations. To facilitate the development of the KC-46, the Air Force opted for a fixed-price incentive contract. This decision was based on the belief that integrating mostly mature military technologies onto a commercially designed aircraft would pose minimal risks. As stated in a 2022 report by the U.S. Government Accountability Office, this contract structure limits the government’s financial liability while offering the contractor incentives to reduce costs and maximize profit.

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The Department of Defense utilizes cost-plus contracts for the development of new weapons systems. Under these contracts, companies receive a predetermined profit while any unforeseen expenses are covered by the government. Once the Pentagon finalizes its requirements and the weapon is fully developed, it transitions to fixed-price agreements. In fixed-price deals, both parties agree on a specific price, and the contractor assumes responsibility if costs exceed the agreed-upon amount.

The KC-46 contract has experienced delays due to problems with the planes and their components. One of the main issues has been with the remote vision system, which includes cameras and a display that allows operators to see and adjust the boom. This boom is a telescoping mechanism used to deliver fuel to the receiving aircraft. These problems, along with other issues, have made the project more complicated.

The 2022 GAO report states that despite facing delays, the government’s financial risk has typically been restricted to the agreed-upon ceiling price of its contract with Boeing.

Boeing expressed its displeasure with the news, as Chief Financial Officer Brian West stated in October 2023, “Rest assured, we have not signed any fixed-price development contracts nor do we intend to.” This statement indicates that Boeing is not in favor of such contracts and does not plan on entering into them.

The U.S. Government Accountability Office, responsible for conducting investigations on behalf of Congress, frequently suggests utilizing fixed-price contracts.

According to a 2023 report by the Government Accountability Office, our previous research has demonstrated the advantages of fixed-priced contracts. These contracts are advantageous because the government pays a predetermined price, while the contractor assumes the risk and responsibility for any cost overruns.

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L3Harris Technologies, a defense contractor boasting a workforce of 50,000 employees, informed investors in the previous year that it had chosen not to pursue certain Pentagon contracts that it would have ordinarily sought after.

During a 2023 earnings call, L3Harris Technologies CEO Chris Kubasik expressed his reservations about committing to a fixed price development program without a clear understanding of the specifications. He emphasized the risks associated with such ventures, citing past instances of write-offs and losses. Kubasik firmly stated that his company would not engage in this risky game.

According to Kubasik, he anticipates that more players will eventually exit the industry.

He stated that they would not submit a bid, and he believes that others will also refrain from bidding in the future. He added that they would instead utilize the appropriate contracting vehicle when the right opportunity arises.

Boeing, along with other defense contractors, is a substantial company with significant financial resources. With a workforce of over 170,000 employees across the United States and operations spanning over 65 countries, Boeing’s fiscal year 2023 revenues reached an impressive $77.8 billion.

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