A Big Win for Boeing

The GAO sustains the U.S. planemaker's complaint and calls for a review of the Air Force contract that went to Northrop Grumman and EADS

In a significant boost to the prospects of Boeing (BA), a U.S. government arbiter has sustained the company's formal complaint that the U.S. Air Force unfairly chose to order 179 aerial refueling tankers from prime contractor Northrop Grumman (NOC) and its European partner EADS (EAD.PA), rather than Boeing.

The strongly worded ruling, while not a guarantee that the contract award will be reversed, revives hopes that Boeing can land the $35 billion award. It is one of the most lucrative contracts in military history, and among the most sullied by delay and political controversy. The ruling stunned some analysts and also surprised some Boeing executives.

Citing "a number of significant errors" by Air Force officials that "could have affected the outcome" of the heated competition, the Government Accountability Office urged the Air Force to reassess its needs, reopen discussions with the companies, reevaluate their proposals—and make a new decision. The Air Force has 60 days to say whether it will reopen the competition or make other changes.

"Misleading and Unequal Discussions"

The Air Force errors, according to the GAO, included failing to stick to the evaluation criteria it had announced in the original solicitation to bidders, and giving Northrop extra points for exceeding base requirements in the solicitation. That appeared to endorse Boeing complaints that the Air Force switched the requirements it was considering without telling the company.

Said the GAO, "The Air Force conducted misleading and unequal discussions with Boeing, by informing Boeing that it had fully satisfied a key performance parameter objective relating to operational utility, but later determined that Boeing had only partially met this objective, without advising Boeing of this change in the agency's assessment."

The accountability office also criticized the Air Force for miscalculating anticipated costs over the life of the planes being considered. Boeing offered a derivative of its 767 commercial airliner, while Northrop/EADS offered a derivative of the EADS-built Airbus A330. The GAO said that during testimony the Air Force "conceded that it made a number of errors…that, when corrected, result in Boeing displacing Northrop Grumman as the offerer with the lowest probable life-cycle cost."

Boeing Shares Jump on the News

Both Boeing and Northrop declined immediate comment on the findings, saying they first would review the decision. "We respect the GAO's work," said Northrop spokesperson Brandon "Randy" Belote. "We continue to believe that Northrop Grumman offered the most modern and capable tanker for our men and women in uniform."

Said Mark McGraw, a Boeing vice-president who heads the company's tanker program, "We look forward to working with the Air Force on next steps in this critical procurement for our warfighters." Boeing shares jumped after the announcement. As of 3 p.m., they were trading up 53¢, or slightly less than 1%, to 74.91. Northrop shares fell 69¢, or 1%, to 70.40.

The Air Force isn't bound by the GAO's ruling and could take a month or two to decide its course of action. A document obtained by BusinessWeek indicates Air Force officials feel they made the right choice, for the right reasons, and with minor exceptions, by following regulations. The choice of Northrop was "reasonable, lawful, and valid," Air Force lawyers wrote in the conclusion of a 154-page "Post-Hearing Brief" they filed May 16 after Boeing presented its case and the GAO heard testimony from witnesses.

The lawyers wrote that the Air Force had held a "transparent and unbiased" competition for the tanker contract, immune to the whims of politics or other outside considerations. "We have upheld the Jeffersonian ideal of silencing the complaints of our citizens, whether just or unjust, solely by the force of reason," they said.

Another competition, if it happens, might not occur until next February. Meanwhile, Boeing's backers are sure to use the GAO's findings to garner more support in Congress for financing a tanker program that includes Boeing. Sue C. Payton, the Air Force's top acquisition official, said the service would move swiftly. "The Air Force will do everything we can to rapidly move forward so America receives this urgently needed capability."

Many Fortunes Hang in the Balance

The GAO's full decision, which comprises 69 pages, is under seal because it contains proprietary and sensitive information. The agency, the investigatory arm of Congress, routinely weighs bid protests submitted by government contractors. The question it resolves is whether government agencies have hewed to regulations and laws, not whether one company's product or service is better than that of another. Thus the Air Force could still decide Northrop is the best choice.

The GAO cautioned that its decision "should not be read to reflect a view as to the merits of the firms' respective aircraft." The announcement was highly anticipated, not least because of the ramifications it has for jobs at a time when airlines are cutting back on big-plane orders. Still hanging in the balance are the fortunes of the three aerospace titans and their bevy of global subcontractors and suppliers.

The outcome could affect Boeing's ability to secure buyers for its tanker overseas, and its competition for a share of another $65 billion in tanker sales in the U.S. Meanwhile, EADS, which is based in France and Germany, is eager to gain a foothold in the U.S. market, and awaits a final decision before going ahead with plans to build an Alabama factory where it would convert A330s into tankers.

A Presidential Election Issue?

Not surprisingly, the decision to go with Northrop's European-designed A330s rather than Boeing's 767 ignited passions among U.S. voters. The issue could become a factor in the Presidential campaign as well. Republican John McCain is a member of the Senate Armed Services Committee, and it was McCain's investigation in 2003 of corruption in a tanker contract between Boeing and the Air Force that effectively scuttled that deal and opened the door for a bid by Northrop and EADS.

In a significant development only hours after the GAO's ruling, Carl Levin, the Democratic chairman of the Senate Armed Services Committee, called for a new competition for the tankers. "We now need not only a new full, fair and open competition in compliance with the [GAO] recommendations, but also a thorough review of—and accountability for—the process that produced such a flawed result," the Michigan Democrat said in a statement.

Patty Murray, a Democratic senator from Washington state, has called the Air Force award to Northrop and EADS shortsighted for "placing the future of America's aerospace industry and national security in the hands of an illegally subsidized foreign competitor."

What has sometimes been lost in the rhetoric is how much the U.S. Air Force needs the tankers. The planes, which are essentially flying gas stations, refuel military jets in midair, allowing them to stay for hours in combat zones. Moving matériel and troops, refueling warplanes, and maintaining intense coordinated attacks—all these depend on the refueling tankers.

Not Expecting a Slam Dunk

But the existing tankers are high-maintenance, Cold War-era machines (in the opening of Stanley Kubrick's classic 1964 satire Dr. Strangelove, a KC-135 refuels a B-52 bomber). Today the planes are 40-plus years old and are rapidly wearing out thanks to the demands of faraway conflicts. The Air Force considers replacing them with more sophisticated aircraft its top weapons purchasing priority.

The GAO analyzed thousands of documents—many of them proprietary or internal records of Air Force deliberations—and took testimony from a raft of Air Force witnesses. Because of the murkiness of the bidding process, even Northrop executives weren't expecting a slam dunk. But the GAO's tone was striking to many observers. A day before the decision, Northrop spokesperson Belote had predicted the GAO would identify "a couple of minor issues" in the way the Air Force awarded the contract.

"At the end of the day the protests will be denied and we'll move on," Belote said. "If we get an A-minus rather than an A-plus on the ruling, well, in our book an A-minus is still a passing grade and we can move forward." He added: "We'll be vindicated. The Air Force will turn the contract back on."

European Subsidies Gave Advantage

Northrop previously said it considered the competition the "most rigorous, fair, and transparent acquisition process in Defense Dept. history."

The central complaint behind Boeing's appeal was the aircraft chosen by the Air Force is very different—most significantly, bigger—than what the Air Force initially said it wanted. Otherwise, say Boeing executives, they would have offered a modified 777 rather than a 767, which is smaller and can carry less cargo and fuel than the winning A330-based tanker. Boeing also complained about European subsidies that the company asserts gave Northrop/EADS a cost advantage.

The ruling is likely to fan controversy surrounding the award. Loren Thompson, a Lexington Institute defense analyst with close ties to the military, had once been dismissive of Boeing's assertions that it had been wronged. But Thompson came to see signs of merit in some of its complaints about the way the Air Force made its decision. "It's hard to have confidence in a process that repeatedly confounds warfighters and technical experts," Thompson said.

Waiting for the Air Force to Make its Move

In a June 16 interview with BusinessWeek, Boeing Vice-President Mark McGraw predicted if the company's complaints are sustained, "We'll end up in a re-competition" for the contract, perhaps next February.

Deciding how to proceed could still be among the toughest and most fateful moves in the career of Boeing CEO Jim McNerney, who has said he recognized the "extraordinary step" of formally challenging a decision by one of Boeing's most important customers, the U.S. military. For now, at least, he doesn't have to decide much. Other executives say the company will wait for the Air Force to make its move.

There's more at stake than the $35 billion contract. The winning aircraft manufacturer and its subcontractors will likely have an edge on the entire $100 billion replacement of the U.S. aerial refueling tanker fleet, and the military in other countries likely will favor the manufacturer as well. For EADS, the contract could mean an all-important first step toward ambitions in North America—and that would be a threat to long-dominant aerospace player Boeing.