Boeing Projects About $300 Million Overrun on Tanker Contract

Boeing Co. (BA) is projected to exceed its cost ceiling by as much as $300 million -- about 6 percent - - on the initial contract to develop and build U.S. Air Force aerial refueling tankers, according to government officials.

Air Force officials this month briefed congressional defense committees and Pentagon officials on the projected increase on what’s now a $4.9 billion engineering, manufacturing and development contract that includes four tanker aircraft. The contract calls for 14 more tankers to be delivered by September 30, 2017.

The $300 million projection was obtained by Bloomberg News from government officials who spoke on condition of anonymity because they weren’t authorized to comment publicly.

After the contract was awarded, Boeing revealed “that it proposed a ceiling price that is less than its actual projected cost to execute the contract,” according to an Air Force statement from spokesman Lieutenant Colonel Jack Miller. “There is no legal barrier that prohibits pursuing a below-cost proposal strategy and Boeing’s met all rules.”

“Boeing is responsible for all costs over the $4.9 billion ceiling price,” according to the Air Force statement. The contract would allow the government to save 60 cents and Boeing 40 cents of every dollar below the target cost.

Boeing spokesman Bill Barksdale confirmed the company projects it will exceed the $4.9 billion ceiling and is prepared to absorb the extra costs.

“We are not there yet. It’s a projection,” he said in a telephone interview. Barksdale declined to comment on the $300 million or outline when the company concluded it would exceed the ceiling.

‘Low-Ball Offer’

Boeing in February beat out European Aeronautic, Defence & Space Co. ending an almost 10-year process for deciding who would build the new tankers. EADS didn’t protest the decision. EADS North America Chairman Ralph D. Crosby in March said “what determined the outcome here was price,” calling Boeing’s offer “an extremely low-ball offer.”

Pentagon officials told the House Armed Services Committee this year that the competition resulted in at least a 20 percent per-aircraft savings.

Disclosure of the projected overrun comes as congressional defense committees crafting the fiscal 2012 defense budget have included provisions for close scrutiny of the overall $35 billion program. A House Armed Services Committee provision requires an annual audit by the U.S. Government Accountability Office.

Protecting the Taxpayer

The projected overrun “highlights the importance” of fixed-price contracts “to protect the government and taxpayer,” Pentagon spokesman Bryan Whitman said. Outgoing Defense Secretary Robert Gates has pushed these contract types so that companies assume more risk for rising weapons costs.

Barksdale said Chicago-based Boeing offered “an aggressive and responsible bid” that came with a risk the company might exceed the ceiling. “We decided to accept the risk,” he said. “This was an intentional step.”

“We completely understand our contractual requirement to pay above the ceiling and we are prepared to do that,” Barksdale said. “We are comfortable with how we bid. We had to be competitive.”

The projected overrun “doesn’t impact the schedule,” Barksdale said. “It’s just the way we bid and we are going to press ahead.”

Boeing will manufacture basic 767-model aircraft in Everett, Washington, and convert them into tankers in Wichita, Kansas, during the first stage of a three-part Air Force program stretching decades to replace its tanker fleet.

The Pratt & Whitney unit of United Technologies Corp. (UTX) will provide the engines. Boeing says winning the contract will create and sustain 50,000 jobs among 800 suppliers in 40 states.

The Air Force’s large tanker fleet consists mostly of 415 KC-135R aircraft that first entered service in 1956. The last was delivered in 1964.

To contact the reporter on this story: Tony Capaccio in Washington at acapaccio@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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