Why Does The FPIF Contract For The KC 46 Tanker Look Like It Does?

[bob7947]

Yesterday, I posted a letter from Senator McCain about the FPIF contract for the KC 46 Tanker. If you haven't read it, here it is. McCain Letter. If you don't know about an FPIF, read My Article. Pay attention to how the FPIF can be manipulated.

Initially, I read about the FPIF structure in a news article. The article was so botched that I couldn't understand it. So, I focused on a simple buy-in with the contractor sucking up a $300 million loss. That's a business decision and I am fine with that.

However, this is an FPIF! Between the target cost and the point of total assumption (PTA), which is almost to the ceiling price, the U. S. taxpayers suck up part of the overrun--about $600 million in this case, if that letter correctly states the structure.

Let's look at the history of the KC 46: one government employee was jailed and one procurement was torn apart by GAO's bid protest unit. The oversight for the latest procurement included the Secretary of Defense. So, we must have had the best, the brightest, and the most morally fit assigned to this new procurement. With the ferocity of the competition, they must have known a buy-in was possible, if not probable.

Now, soon after the contract award, we find we are not only beyond the target cost, not only beyond the point-of-total-assumption, but we are $300 million beyond the ceiling price. With all the cost and price analysis the Secretary of Defense, the Secretary of the Air Force, the Director, Defense Procurement and Aquisition Policy, etc., could muster for this procurement, how is that possible? How is it possible that a realistic FPIF stucture wasn't constructed?

[joel hoffman]

So, I focused on a simple buy-in with the contractor sucking up a $300 million loss. That's a business decision and I am fine with that.

However, this is an FPIF! Between the target cost and the point of total assumption (PTA), which is almost to the ceiling price, the U. S. taxpayers suck up part of the overrun--about $600 million in this case, if that letter correctly states the structure.

Now, soon after the contract award, we find we are not only beyond the target cost, not only beyond the point-of-total-assumption, but we are $300 million beyond the ceiling price. With all the cost and price analysis the Secretary of Defense, the Secretary of the Air Force, the Director, Defense Procurement and Aquisition Policy, etc., could muster for this procurement, how is that possible? How is it possible that a realistic FPIF stucture wasn't constructed?

To state it differently, the target cost to develop the first four planes is $3.9 million. Note that Boeing didn't have a fully developed 767 Tanker, while EADS has been producing and selling their version to other countries. Now, only two months or so later, Boeing announces a cost increase of $1.3 million or $0.3 million over the ceiling cost of $4.9 million! It will cost the taxpayers some $600 million or so and Boeing will supposedly absorb $700 million or so (40% of the first $1 million and all of the $300 million above the ceiling price).

I would say that this was a pretty good investment on Boeing's part to prevent EADS from establishing a US airplane production factory in Mobile, AL. Probably amounts to the cost of ne or two B787 Dreamliners. It is a deliberate strategy, in my opinion, having followed the competition somewhat over the past three years. Yes, Boeing lowballed its proposed price to the Air Force. And you can't convince me that they didn't know EADS' pricing.

The long term stakes were too high for Boeing to take the risk of losing this contract.

[Guest Vern Edwards]

What if the Air Force had negotiated a $5.5B FFP contract instred of an FPIF contract?

[bob7947]

What if the Air Force had negotiated a $5.5B FFP contract instred of an FPIF contract?

Vern:

I now have a FFP contract of $4.9 billion, so I'll stick with that. If the $5.5 billion was a realistic price based on good cost data and a fair profit at the beginning, I'd go with it.

Here, the issue for me is honesty and integrity. I don't know what else there is! If the government people that negotiated the target cost of $3.9 billion truly believed that was a good, realistic, target, I'm fine with it. However, at this point, I cannot believe that.

[joel hoffman]

Vern:

I now have a FFP contract of $4.9 billion, so I'll stick with that. If the $5.5 billion was a realistic price based on good cost data and a fair profit at the beginning, I'd go with it.

Here, the issue for me is honesty and integrity. I don't know what else there is! If the government people that negotiated the target cost of $3.9 billion truly believed that was a good, realistic, target, I'm fine with it. However, at this point, I cannot believe that.

There has allegedly been a cost growth of 33% ($1.3 billion) within the first T-W-O months of the contract. That 's $3.9 Billion target cost plus $1.3 Billion growth = $5.2 Billion.

That's a "B" for B-I-L-L-I-O-N.

How on earth could Boeing have been that far off the target price for F-O-U-R airplanes????? They build planes every day for customers. They've been building B767 airframes for years. They've built almost every tanker that the Air Force has ever owned, including the KB-50's, KC-97's, KC-135's, KC-10 (they now own McDonald-Douglas). It's incredulous to ask somebody to believe that they cant get within 33% of the estimated price to build 4 tankers on an existing airframe in an existing plant, but can discover that HUGE amount of cost difference within 2 months of signing the contract.

[bob7947]

What if the Air Force had negotiated a $5.5B FFP contract instred of an FPIF contract?

Vern:

I was just getting ready to eat when a voice from my past said "the contractor bought in, what did you want me to do, negotiate a higher price for the government." The voice was from a contracting officer who had negotiated a contract price on a buy-in many years ago.

Assume that the contractor bought in on the tanker procurement. Can you think of any way the government could have negotiated a realistic FPIF structure on the buy-in? Maybe that is the situation that the government was in.

[bob7947]

There has allegedly been a cost growth of 33% ($1.3 billion) within the first T-W-O months of the contract. That 's $3.9 Billion target cost plus $1.3 Billion growth = $5.2 Billion.

That's a "B" for B-I-L-L-I-O-N.

How on earth could Boeing have been that far off the target price for F-O-U-R airplanes????? They build planes every day for customers. They've been building B767 airframes for years. They've built almost every tanker that the Air Force has ever owned, including the KB-50's, KC-97's, KC-135's, KC-10 (they now own McDonald-Douglas). It's incredulous to ask somebody to believe that they cant get within 33% of the estimated price to build 4 tankers on an existing airframe in an existing plant, but can discover that HUGE amount of cost difference within 2 months of signing the contract.

Joel:

You could assume that it was a buy-in.

[here_2_help]

"What gets my goat was that Secretary of the Air Force Donley assured the public and Congress that Boeing had been awarded a "fixed-price" contract and the only way the company would be able to bill more to the taxpayers would be through change orders, which he promised to control at the highest levels of the Service.

Just this week, Dr. Ash Carter (USD, AT&L) told the public not to worry about Boeing, because it was a "fixed-price program" Here's one quote from a news article on the subject --

The Pentagon's top weapons buyer dismissed concerns on Friday that Boeing is projecting huge cost overruns in developing a new Air Force refueling tanker, saying it was a fixed-price contract and company losses were 'not our problem.'

Defense Undersecretary Ashton Carter said Boeing had made a commercial decision to offer a below-cost bid for development of the aircraft in hopes of making up its losses during production of 179 of the aircraft through the 2020s. ?

Carter, answering questions about defense procurement at the Brookings Institution think tank on Friday, dismissed reports of Boeing's cost overruns, saying, 'It's not our problem because it's a fixed-price contract and it was written with ... protections for the taxpayers.'

He said the issue was the value of the contract at its ceiling price.

'The fact that Boeing decided that it would lose money in the development phase, presumably in the hopes of making money in the production phase, was a decision that they made, and that's not a problem from the Defense Department's point of view,' Carter added.

We know the difference between FPIF and FFP contract types. I'm concerned that our DOD leadership does not."

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H2H:

Thanks for posting that. Let's hope it was simple ignorance.

[joel hoffman]

What if the Air Force had negotiated a $5.5B FFP contract instred of an FPIF contract?

According to an article I just read, there was apparently only 2 billion dollars difference between the EADS and Boeing proposals ($22.6 vs. $20.6). Had Boeing proposed "$5.5B" or even "5.2B" (the current estimate), would the Air Force have selected them over EADS? That is only for the first f-o-u-r planes. Hmm...

see http://www.defensemedianetwork.com/stories...c-x-tanker-win/

Bob - Yes, I do assume that this was an obvious buy-in.

[joel hoffman]

Vern:

I was just getting ready to eat when a voice from my past said "the contractor bought in, what did you want me to do, negotiate a higher price for the government." The voice was from a contracting officer who had negotiated a contract price on a buy-in.

Assume that the contractor bought in on the tanker procurement. If you represented the government, how would you negotiate a FPIF structure on the buy-in? Maybe that is the situation that the government was in.

So, why would one accept an offer for a Fixed-Price Incentive contract with a 60% Government cost share, for overruns above the target cost up to the ceiling price, if he knew that it involved a "buy-in", where the costs would exceed the target price???? Maybe because the Government would allegedly "save" 40% of the overrun amount?

[Guest Vern Edwards]

Vern:

I was just getting ready to eat when a voice from my past said "the contractor bought in, what did you want me to do, negotiate a higher price for the government." The voice was from a contracting officer who had negotiated a contract price on a buy-in many years ago.

Assume that the contractor bought in on the tanker procurement. Can you think of any way the government could have negotiated a realistic FPIF structure on the buy-in? Maybe that is the situation that the government was in.

Bob,

You may be confusing "buying in" with 'investing." There is a difference. Boeing deliberately proposed a price for the development contract that was below the expected cost. It did that because that would enable them to get a production contract worth a lot more money in the long run. It is a sensible investment and a legitimate practice, and there is no evidence that Boeing intends to charge "artificially high prices" on the production contract in order to "get well."

The only thing that makes what has happened seem scandalous is that the Air Force stupidly chose to enter into an FPIF contract when it clearly knew going in that there was absolutely no chance that Boeing would come in at target or under ceiling. The deal makes the Air Force and Boeing look like scam artists. They could have negotiated an FFP contract at a price that would have included the government's share of the cost between target and PTA and publicly acknowledged that Boeing bid below cost as an investment in its future. Then no one would be talking about a "cost overrun" and the Air Force would have come across as hard bargainers.

[Guest Vern Edwards]

How on earth could Boeing have been that far off the target price for F-O-U-R airplanes????? They build planes every day for customers. They've been building B767 airframes for years.

Joel:

Boeing never expected to come in at target. They bid a low target because of the way the Air Force planned to evaluate price. They wanted to underbid the competition. They knew that they would exceed target and probably knew they would exceed ceiling. They "invested" in development and developmental production in order to win the production contract, which is worth a lot more. That's normal. The only thing that makes this seem like a big deal is the Air Force's dumb decision to go with an FPI contract.

[joel hoffman]

Joel:

Boeing never expected to come in at target. They bid a low target because of the way the Air Force planned to evaluate price. They wanted to underbid the competition. They knew that they would exceed target and probably knew they would exceed ceiling. They "invested" in development and developmental production in order to win the production contract, which is worth a lot more. That's normal. The only thing that makes this seem like a big deal is the Air Force's dumb decision to go with an FPI contract.

I agree Vern. An FPIF arrangement with a generous (or any) government share of cost growth doesn't insulate the government from an overrun due to a "buy in". If it was obvious that the contractor was going to "invest" in the development cost for the prototypes, then there should have been no government share and the target and ceiling costs should have been the same - in other words, a guaranteed maximum price arrangement . For the AF acquisition types to say that the overruns are Boeing's problem, when the contract appears to contain a 60/40 share ratio, begs the question - are they nuts or? Just my opinion.

[bob7947]

Bob,

You may be confusing "buying in" with 'investing." There is a difference. Boeing deliberately proposed a price for the development contract that was below the expected cost. It did that because that would enable them to get a production contract worth a lot more money in the long run. It is a sensible investment and a legitimate practice, and there is no evidence that Boeing intends to charge "artificially high prices" on the production contract in order to "get well."

The only thing that makes what has happened seem scandalous is that the Air Force stupidly chose to enter into an FPIF contract when it clearly knew going in that there was absolutely no chance that Boeing would come in at target or under ceiling. The deal makes the Air Force and Boeing look like scam artists. They could have negotiated an FFP contract at a price that would have included the government's share of the cost between target and PTA and publicly acknowledged that Boeing bid below cost as an investment in its future. Then no one would be talking about a "cost overrun" and the Air Force would have come across as hard bargainers.

The FAR at 3.501 defines "buying in" as

"Buying-in," as used in this section, means submitting an offer below anticipated costs, expecting to?

(1) Increase the contract amount after award (e.g., through unnecessary or excessively priced change orders); or

(2) Receive follow-on contracts at artificially high prices to recover losses incurred on the buy-in contract.

Considering (2), it is too early to conclude whether this is "buying in" or an investment. However, I like the term investment better. So investment is fine with me.

I like the idea of taking target price (target cost + target profit) and adding the government's share from target cost to PTA as a negotiating position, and finally a FFP contract. That is what we have now, of course, after the bogus FPIF structure was pointed out. I think it can be justified in a negotiator's memorandum, or whatever they are calling it now. It would have excluded any costs that would have exceeded the ceiling price of the bogus FPIF.

DoD management now admits that the contractor made a commercial "investment" decision and submitted an offer below cost. Since upper level management only knows what it is told by the workers, we must assume that the individuals responsible for the bogus FPIF structure knew it was bogus. It may not have been a typical scam, there may not be any real overruns, but it was dishonest. And that is the real problem, it was dishonest.

[Guest Vern Edwards]

It was not only dishonest, it was dumb. An FPIF contract is much more complex than an FFP contract and more administratively costly to manage. No one in his right mind would award an FPIF contract if there were a reasonable alternative.