Four issues with the USAF's tanker RFP, Part One

It’s hard to think about the USAF’s long-running effort to buy new tanker aircraft without facing some stiff headwinds of hot air, but the past few months have been particularly hot and breezy. Norm Dicks, predictably, says that the USAF is biased towards Northrop and Airbus. Dick Shelby, perhaps as predictably, says that the USAF is biased towards Boeing. Northrop and EADS’s people, understandably, are torqued about the disclosure of their pricing. The Boeing camp, naturally, wants the WTO’s recent ruling against Airbus factored in. Patty Murray says that the “subsidies are not only illegal, they are deeply unfair and anti-competitive.” And Jay Inslee thinks that sticking it to the French would be a good way to deal with unemployment in his district. Smoot-Hawley? Anyone? Anyone?*

All of this is probably something that a French friend of mine at EADS a few years ago called boule-sheet. I’m not exactly sure what he meant—pétanque on percale?—but it didn’t sound good. For a moment, I was happy that Ashton Carter, the US under secretary of defense for acquisition, was telling Inslee et alia to stuff it. But then, Northrop and EADS decided that they had had enough already anyway, and sent a letter to that effect. Thus was Air Force Secretary Mike Donley asking, effectively, if everyone could please just calm down.

Note that he wasn’t asking why they couldn’t all just get along. If only deeply anti-competitive were worse than merely illegal, that might be possible. No one can reasonably expect cordiality towards one another from Airbus and Boeing, possibly the most rivalrous pair of nearly duopolistic companies anywhere on Earth.** But quite aside from the ordinary complications of any politically-capitve agency trying to do business with two politically astute companies, this latest tanker RFP has caused serious alarm in at least four respects:

• All 373 criteria will be weighted equally. The USAF is asking for 373 attributes on each proposed aircraft, but all 373 will be evaluated as pass-fail criteria. Northrop Grumman has specifically complained that this considers the sink and toilet water flow rates on the same basis as fuel offload rates. The latter is rather more important, and with in-production aircraft like the 767 and the A330, we pretty much know that the former are adequate to the job. What’s embarrassing for the government is that no procurement professional outside the US federal bureaucracy would contemplate doing things this way. Sit in on any graduate class on procurement management at any of the leading schools in the field—Ohio State, Michigan State, Arizona State, Tennessee, etc.—ask about that approach, and watch the jaws drop around the room. It’s just crazy.
• It’s an eighteen-year fixed price deal. Ashton Carter is further saying that, whatever the case, one of those companies should sign up for an eighteen-year fixed-price contract. This may be what Wes Bush, in that letter to him, termed “contractual and financial burdens on the company that we simply cannot accept.” Indeed, we should ask if anyone can find another example of a similarly durable fixed-price contract—anywhere. It’s almost inconceivable. As a Texan politician asked me some weeks ago, would this contract be denominated in dollars or gold? Or euros, for that matter? Who could be found to take the counterparty risk of an eighteen-year contract denominated in dollars, at least for a bidder much of whose costs are paid in euros? One could darkly assert that this is just another protectionist Obamanista scheme—if Todd Tiahrt weren’t a such protectionist Republican—so instead, we’ll just call it crazy. Again.

• It has to be fair, right? Boeing is fulminating, as usual, about supposedly “illegal subsidies” to Airbus. As Joel Johnson noted in a response in early November to an article from Loren Thompson of the Lexington Institute, there are no illegal subsidies under the World Trade Organization accord—just prohibited, actionable, and allowable subsidies.*** Into which category Airbus’s launch aid falls is yet to be finally adjudicated, and the WTO accord specifically prohibits preemptive action before the entire process has been played out. But no matter: the team at the Pentagon may already be again getting worked up about this red herring. Deputy Defense Secretary Bill Lynn told an investors’ conference in New York City on 3 December how much “we want a fair competition; we want a balanced competition.” Fair and balanced? Deep down, I doubt that Todd Tiahrt, for one, wants anything fair and balanced, even if he does watch a lot of Fox News. That said, as I’ll explain in a later column, fairness is a structurally illusory concept in this instance.
• It’s a winner-take-all deal—for eighteen years. These preceding three issues notwithstanding, the length of the commitment to a single supplier is itself notable. Eighteen years is a long time to sign up with any one company for a commercially analogous product. It’s not a long time to stick with one supplier—as evidenced by relationships like Southwest Airlines’ with Boeing—it’s just a long period for precommitment, even if the products themselves are quite durable.

One alternative that might address all four of these issues is a split procurement. This has been touted as a solution by some interested politicians—and not just supporters of Airbus, but just folks who want all this contract protesting nonsense to stop so that the USAF can actually get some new airplanes. The split procurement approach would effectively rerun a small competition every so often to keep (in theory) each contractor’s pencil sharp, awarding variable quantities based on each new bid and the relative past performance of the suppliers. It’s not uncommon practice in commercial procurement, though there are good reasons that it’s not commonplace. All the same, Ashton and his boss Bob Gates have more staked out a firm position on the idea of splitting the awards. They’re opposed, and adamantly.

So it this idea eo ipso daft, or would there be merit under the particular set of conditions in which the USAF, the potential suppliers, and their political supporters find themselves? In my next column, I’ll review the economic theory and evidence behind that question, and apply it to this particular contracty competition.

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* Ben Stein is a national treasure, isn’t he?

** About those two companies—I do feel compelled at this point to state categorically that I am working for neither on this issue. This is simply a matter that is apparently not well understood legally or economically by the decision-makers involved, and which thus demands some serious exposition by someone without a vested interest in the outcome or even the process. I should also note that I am not explicitly endorsing the split procurement concept—I am merely arguing that it deserves a more thorough hearing than it appears to have gotten in the Pentagon to date.

*** Note to the public relations and legal departments in Chicago: as Johnson noted in his brief,
A good explanation of the WTO dispute settlement process can be found in a Congressional Research Service article by Jeanne Grimmett, legislative attorney, dated September 8, 2009. She specifically points out that the US, in its Uruguay Round Statement of Administrative Action (H.Doc 103-316), noted that the USTR would use its statutory discretion to implement Section 301 (retaliating against unfair trade practices) of the Trade Act of 1974, in a way that was in conformity with WTO obligations. This would appear to reinforce the notion that the US should not short-circuit the WTO dispute settlement process.

Comments

[Loren Thompson]

I agree with your assessment of the revised tanker RFP. The equal weighting of 373 "mandatory" selection criteria is illogical, and the demand for fixed-price commitments many years into the future is ridiculously risky for the offerors -- so much so that it will probably backfire by driving up prices charged to the customer. If I were Wes Bush or Jim McNerney, I would never sign up to such an open-ended commitment.

I also agree that dual sourcing may be the only politically feasible way of breaking the tanker logjam. But it isn't just politically expedient -- it would deliver more modern tankers faster to the joint force, and allow avoidance of many billions of dollars in maintenance costs on the current, decrepit fleet of Eisenhower tankers.

Having said that, though, I hasten to add that your assessment of the subsidies issue is wrong. If nations enter into legally binding agreements prohibiting specific sorts of behavior and then proceed to engage in that behavior, then their actions are by definition illegal. You can use the treaty terminology of "prohibited" if you wish, but that is just splitting hairs.

Furthermore, it is not true that the government is precluded from responding with sanctions, because once the World Trade Organization finding of unacceptable behavior is final -- now only weeks away -- the response is no longer "preemptive." Saying that Washington must wait until Europe has exhausted all its appeals would be like saying a convicted felon cannot be jailed until his case has been heard by the Supreme Court.

But there is a more fundamental point here about subsidies. For 40 years, European governments have conspired to destroy America's lead in the commercial transport market. They have largely succeeded due to the use of low-cost or no-cost launch aid that Europe does not even allege Boeing has received. To describe the subsidies controversy as no more that an argument between two self-serving companies twists reality at a time when the political support in America for free trade is eroding fast. The simple truth is that tens of thousands of Americans have lost their jobs and hundreds of billions of dollars in export earnings have been lost because Europe engaged in unfair, illegal trade practices.

[Matthias Torchia]

Just about every major piece of hardware our warfighters have is supplied by... wait for it... One, Uno, Eins, supplier. What's the problem?

Boeing is the home team, we can rely on them giving us a proven, battle-ready tanker and supplying that tanker well into the future - world politics will play no role.

Boeing will never withhold parts nor will they ever surrender, leaving the USAF standing around with its pants down with the enemy on the horizon.

The same cannot be said for the Franco-tanker. Each and every current and retired KC-135 & KC-10 crew I have spoken with have come back with the same exact response to the question Boeing or Airbus. Do I even need to say what their answer has been?

[James Hasik]

I do appreciate Loren's comments, and I am always impressed when someone is checking my blog at 0-dark-26.

In my next installment on this issue, I will want to treat the volume of the purchasing somewhat separately from the issue of whether the procurement is split. If the total order quantity remains below the point of scale diseconomies for Airbus or Boeing, as their factories and supply chains are currently capitalized and organized, then one could double that replacement rate by just ordering more tankers from one vendor. Of course, at such a high rate, there may be further political or even industrial-strategic benefits to splitting the award.

As for the issue of semantics, I prefer the actual language from the WTO accord. It's possible that the signatories chose not to use the word "illegal" to emphasize that their perceived violations of the accord were to be adjudicated before the WTO before recourse to any domestic court system. I don't have that understanding just yet, but there *was* some reason that this term in common use--"illegal"--was not used in the treaty. I will look into that.

I do doubt that the EU will manage to get the preliminary finding overturned, and if the finding is indeed but a few weeks away, then this particular issue will soon be moot. I also would not try to claim (even if I wanted to do so) that Airbus's launch aid was economically efficient or politically reasonable. It's just that, as I'll discuss later, taking the past aid as a given, the pursuit of fairness (however that might be defined) may not be in the best interests of the US government in this matter.

[James Hasik]

I also might respond to Matthias Torchia's comments:

Not every major piece of military hardware in the US comes from a single supplier. Split awards have been rather common in shipbuilding, where the Navy has engaged pairs of yards to compete to build the same ships. Most notably and recently, this has been used in the Arleigh Burke-class destroyer program, where it appears to have contributed to a declining cost curve, adjusted for inflation, over time. That doesn't mean that it's necessarily a good idea in the case of the KC-X program; it's just that it's more common than Matthias claims.

Matthias also seems to be suggesting that an Airbus factory in Alabama can't be trusted to deliver aircraft to the USAF, and that Airbus's supply chain can't be trusted to deliver spare parts to the USAF, if a future French or German national government finds some grievance with Washington over which it wants to have an industrial spat. This is highly unlikely, for three reasons:

-- First, it has rarely happened in the past, and when it has, the effects have been manageable. The only recent notable case was the Swatch timing circuit matter of 2003, and that was resolved very quickly.
-- Second, and perhaps more significantly, Boeing and Airbus each source parts and assemblies from all over the world, so interrupting supplies to a US military customer could induce a nasty and debilitating retaliation. Would Vought find its shipments of A330 and A340 assemblies embargoed? It's just unthinkable.
-- Third, that's a one-time trick: after playing that ill-advised card, Washington would not buy anything sourced from the offending country for decades. Paris and Berlin are not that stupid, and by far.

Finally, I will note that I have not spoken with any USAF KC-10 or KC-135 crews about the competition. I have talked to a number of pilots of Boeing aircraft, over the years, who have expressed a preference for flying Boeing aircraft. I'm not a pilot, but word is, they're more fun to fly than Airbuses, because they tend to be less automated. It's that silk-scarf culture at work. Part of Airbus's marketing genius, however, was to recognize that this was commercially meaningless, because by and large, pilots don't buy airplanes. As a passenger, I find that the A330 is a particularly comfortable airplane, so I tend to prefer to fly in it when I cross the Atlantic. Airline managers might take note of that, but they definitely don't put a high premium on pilots' airframe preferences. Similarly, I'm not sure why the pilots' opinions about a political matter would matter to this competition; that's not an area of synergistic professional expertise. Thus, I'm not sure how surveying USAF tanker crews--or RAF, or RAAF, or Luftwaffe ones for that matter--would inform this question.