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Vern Edwards

Boeing Has Protested the USAF Bomber Decision

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Boeing has protested to the GAO against award of the USAF bomber contract to Northrop Grumman. The GAO has 100 days to issue a decision.

The limousines were on the spot, legal-beagles running wild,

Comp Gen lawyers screamed with glee, rolled up their sleeves and smiled,

For it had been a year or more since a big protest was filed,

And the USAF won't fly any time soon.

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From one news source, pasted without verification --

"Boeing and Lockheed Martin concluded the selection process for the Long Range Strike Bomber was fundamentally flawed," read a statement from the two U.S. defense giants. "The cost evaluation performed by the government did not properly reward the contractors’ proposals to break the upward-spiraling historical cost curves of defense acquisitions, or properly evaluate the relative or comparative risk of the competitors’ ability to perform, as required by the solicitation."

It's believed that Northrop won the contract because its aircraft per unit came in at $511 million, far below the Pentagon's cap of $550 million per unit, according to a Defense News report. Boeing and Lockheed claim that this price will increase significantly as Northrop overruns on the contract's budget.

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I had no doubt that a protest would be filed. It was just a matter of what angle the lawyers would take in attacking the award. I am sure both teams had several different scenarios drafted up before the award was even announced. The stockholders expect nothing less when $50 to $80B is involved. With a guestimate of 5 to 8B in profit involved you can hire a lot of top notch lawyers.

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The big question is whether Boeing will go to the COFC if it loses at the GAO. I presume they've hired Wiley Rein to handle the protest. That's the firm that won the tanker protest for them. A superb law firm.

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... The stockholders expect nothing less when $50 to $80B is involved. With a guestimate of 5 to 8B in profit involved ...

It's hard for me to imagine a team of Lockheed and Boeing doing anything for a mere 10% profit.

Unless you mean the "profit" declared in reports to DCAA.

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That is about right in today's market. Securing a multi-year contract is real value nowadays so companies will accept lower profit in order to guarantee orders.

Spares is where the real money is.

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Fair enough, like I mentioned, it touches on it.

"...IG focused on the Army and its failure to "effectively negotiate prices" for spare parts. The report found that the Army paid Sikorsky more than $34 million for helicopter parts that it could have bought from other sources for just under $23 million."

If it was known that they could have saved $11M by using alternate sources why didn't they?

"The Army agency responsible for buying parts replied to the September report in part saying it would focus more closely on parts price negotiations."

If other sources were known why wouldn't the Army reply to the report mention that seeking full and open competition for future procurement is the remedy instead of saying they would focus more closely on negotiations?

I agree that the article doesn't provide definitive support, but a close read, some questioning, and you can see that inflated spare part pricing was a theme. A Google search of "DOD overpay spare parts" will net plenty of cases.

There is a DFARS Subpart, 217.75, dedicated to managing this practice.

Nonetheless, this may provide what you initially requested:

http://www.pogo.org/our-work/articles/2011/ns-sp-20110623-2.html

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Jamaal:

You said,. "Spares is where the real money is."

I assumed that you meant that spares are a defense production contractor's greatest source of revenue. If that's what you meant, then the things that you have been citing do not support that assertion.

I believe that logistics are a greater cost to the government than system production. But are spares, which are only a part of the logistics, the greatest source of revenue to production contractors? Or did you mean something else?

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Vern:

I was speaking to profit margins. The sustainment cycle (operations, support, and logistics) is, in my experience, the largest producer of revenue. I do not know what the spare parts, including repair and overhaul, segment represents therein, but assume it's significant.

Using the figures from the prior post, a company may elect to accept a contract with 10% profit on production because they anticipate huge profit gains during sustainment, specifically citing significant profits for spare parts vs. production.

Shareholders are arguably concerned with return on investment.

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In my experience, when the government orders spares along with the production, the customer gets the benefits of economies of scale, and margins for the spares are in line with the margins of the production program.

But when the government lets the production program shut-down and then orders spares months or years (or sometimes decades) later, then there are no economies of scale and costs skyrocket. There are additional risks, such as rehabilitating tooling and production aids, configuration management concerns, and even finding the learning-curve-gained production expertise/efficiencies. Other risks are supply chain risks, such as learning whether the original source can still provide the same parts/components, or if they've been made obsolete in the meantime. Because of those risks, the contractor generally expects to earn a higher rate of profit on the production of spares.

So yes, spare parts do have a tendency to have higher margins associated with them. But the primary reason is the timing of the orders and not any rapacious greed on the contractor's part.

My two cents, for what they're worth.

H2H

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But the primary reason is the timing of the orders and not any rapacious greed on the contractor's part.

I agree with H2H's statement.

Though, this all changes for the commercial spare parts industry, which is far more lucrative in terms of percentage of profit margin than non-commercial when not faced with statutory caps on fee. For example, look at the toner cartridge industry. Back in 2005, Bloomberg reported that one conglomerate brought in $87 billion in revenue, with a reported earnings of $2.4 billion (a net margin of 2.75%). In contrast, that firm's ink and toner brought in around $21 billion with earnings of $1.3 billion (a 6.2% net margin). In this case, while spares accounted for about a quarter of the revenue, they represented over half of the company's earnings.

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I had another thought yesterday on the subtopic of spare part pricing.

If the contractor produces the spares at the time of production it will obtain the economies of scale and learning-curve efficiencies and, presumably, would produce at the lowest cost. But it if does so without any contractual authorization and thus retains those spare parts on its balance sheet as "inventory" without charging the production costs to any contract ... then, if the government subsequently should want to acquire those spares at a later date, how should they be priced?

This would seem to be the key question: should the contractor use a cost-basis to price the parts (low price, low margin) or market-pricing (higher price, higher margins)? Another factor is that the contractor is presumably sole source. This suggests cost analysis will be used. But there are other factors in play. Certainly, the contractor expects to be paid for its carrying costs and the risk it took producing spares without guarantee they would be sold.

Is this really the issue that Jamaal was addressing?

H2H

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