Boeing Is Haunted By Years Of Aggressive Bidding On Defense Contracts

Business

Boeing
BA
CEO David Calhoun insisted on a conference call Wednesday that “we’re not embarrassed” by the whopping $2.8 billion in losses the company booked in its third quarter on five defense and space programs. He blamed the poor performance on parts and labor shortages, broader problems that he noted “were challenging for everybody” in the aerospace and defense industry.

That competitors like Lockheed Martin
LMT
and General Dynamics
GD
have reported healthy profits despite those concerns points to an uncomfortable difference for Boeing, which reported a net loss of $3.3 billion for the quarter. It has much less of a margin for error because of decisions it made during the past decade, when its commercial jetliner business was booming, to bid low on big Pentagon contracts that were offered on a fixed-price basis, meaning the winner had to swallow any cost overruns.

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“Boeing is uniquely vulnerable to labor and other costs,” says Richard Aboulafia, managing director at AeroDynamic Advisory. “The pandemic-related jetliner downturn and the 737 MAX shutdown hit commercial revenue hard, leaving these [up-front] money-losing defense contracts to stand alone, and they’re now costing the company dearly.”

Chief among them is the long-troubled KC-46A aerial refueling tanker, which Boeing booked a $1.2 billion reach-forward loss on in the third quarter, bringing its total charges on the program since 2014 to $6.6 billion. Boeing won the U.S. Air Force contract to develop and produce the tanker in 2011 with a lowball bid to beat out Airbus that was motivated by a desire to keep its European arch-competitor from establishing production facilities in the U.S., says Loren Thompson, an industry consultant and chief operating officer at the Lexington Institute. The victory proved Pyrrhic, as Boeing has faced years of delays on the tanker and struggled to fix a faulty vision system that allows operators to guide the refueling boom to connect with aircraft, while Airbus ended up establishing a factory in Alabama where it’s assembling A320 and A220 passenger planes.

Boeing also booked $285 million in losses on the Air Force T-7 trainer it’s developing, a contract it also put in a notably low bid to win in 2018, bringing total charges on that program to $1.1 billion, according to Aviation Week; and $351 million on the Navy MQ-25 refueling drone ($867 million to date), a bid which was also aggressively priced, if not to the same extent as the KC-46 and T-7, says Aboulafia, a Forbes contributor.

The company also booked $766 million in losses on the two new presidential jets it’s outfitting – another price-fixed contract that it has now eaten $1.9 billion in cost overruns on.

Two factors fueled Boeing’s low-ball bidding: years of fat profits on its 737 and 787 passenger jets and a string of losses in major weapons competitions, including the Joint Strike Fighter (won by Lockheed) and Long-Range Strike Bomber (Northrop Grumman
NOC
), that threatened to consign its defense business to a collection of declining legacy programs.

Under CEO Dennis Muillenburg, the company made the wager with the T-7 and MQ-25 bids that any losses it might incur in development would be counterbalanced by years of sales and service revenues.

That bet was soured by a damaging halt to 737 MAX production following two deadly crashes followed by the Covid pandemic and the steep downturn in air travel and jet orders, which led to sharp cutbacks at aerospace parts makers and airframers that they’re still struggling to reverse amid a tight market for skilled labor.

Boeing could still turn a profit on the KC-46A program, says Aboulafia — if it doesn’t lose an Air Force competition for up to 160 tankers to a joint bid by Lockheed and Airbus.

Profitability for the T-7 may be harder to achieve, he says. “The Air Force locked in a bunch of planes at a very aggressive price.”

The struggles of Boeing’s once-mighty commercial aviation business over the past three years delayed senior management from dealing with festering problems in its defense division, says Thompson, a Forbes contributor. The task has been handed to Ted Colbert, who was appointed CEO of Boeing Defense & Space in March after 2.5 years running Boeing’s aftermarket parts and services division.

“If he does well, then he’ll be a candidate to be Boeing’s next CEO,” Thompson says. “But first, he’s got a mess he’s got to fix.”

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