JSF Cost Increases May Imperil the Fighter Program -- and Lockheed

Massive cost increases in the Joint Strike Fighter (JSF) program are creating major new headaches for prime contractor Lockheed Martin (LMT) -- and raising the possibility that production of the multipurpose F-35 may be scaled back dramatically, or even canceled altogether.

Currently, Lockheed and the joint Air Force-Navy program office are negotiating the latest batch of production aircraft. This will be lot 4 of the low-rate production and will be highlighted with the start of the Conventional Take Off and Landing (CTOL) version of the advanced fighter and attack plane.

The Pentagon told Congress on April 1st that the average price of the aircraft had increased to over $100 million, which means that President Obama's administration must certify to Congress that the program is still required and will be fixed. This price includes all of the money spent on research and development as well as actual procurement costs. This means that the negotiated production price for each lot will actually be much lower then that estimate.

How much lower is the nub of the negotiations, as Lockheed needs a price that covers its production cost and some profit. The government wants the best value for its money, so DoD pushes for the lowest possible price. Normally the two sides arrive at a price in the middle. The JSF is more complicated as Lockheed expects to build 3,000 to 4,000 JSFs, and the current price could be adjusted with the hope that costs would be made up on future production. If the total number of F-35s ordered shrinks -- certainly a potential solution to the cost increases -- then Lockheed won't be able to do that.

A good example of where this happened was the F-22 Raptor Advanced Tactical Fighter. The original Air Force estimates were for several hundred to replace large numbers of F-15 fighters. Now Lockheed and Boeing (BA) will deliver about 180 aircraft, so each one will cost tens of millions more then originally estimated. The JSF may be facing the same fate.

Reportedly, the price Lockheed and the Air Force are haggling over is much lower than the estimate arrived at by the independent cost team that reviewed the program last year. That team was the first to begin reporting the problems with the program. It is also lower then Lockheed has asked for.

At the same time the government is pushing for the use of Firm Fixed Price (FFP) contracts for these aircraft. Normally FFP contracts are used when production has stabilized. Low-rate production is not stable, as problems found in testing are subsequently fixed in the production process. FFP protects the government, but limits the profit for the contractor. This is most likely a negotiating tactic, because past experience shows that using FFP to pay for development hasn't worked well -- costs increase beyond the fixed amount and the contractor ends up eating it or getting the government to cover it anyway.

In worse news for the program, the Dutch parliament has voted to cancel a planned F-35 order and to withdraw from the current test program. Partly this is because the Dutch want to have the cost estimate for their planned purchase re-done due to the reported price increases of the last two years. Some Dutch legislators also feel the program is so broken there's no point in continuing it right now. This vote doesn't mean that the Netherlands will actually withdraw completely, but it's a significant psychological blow. If the troubles continue, there will be more pressure both in the U.S. and among its allies planning to bow out.

The JSF is starting to emulate many previous programs that went down this path. The script goes like this:

• Costs and schedule increase dramatically.
• Blame and angst are shared among the program manager and contractor.
• Production orders get cut.
• More reports and investigations by Congress, the Government Accountability Office (GAO) and defense auditors.

Some in the media and industry have suggested ending the program due to its troubles. So far, the U.S. government and Congress still support the F-35, although more foreign-government withdrawals could erode that significantly. It behooves Lockheed and the DoD to get the plane on schedule and cost. The longer this takes, the farther support will fall.

The JSF may be "too big to fail," but the same was said of other programs in the past. With the budgetary shortfalls facing the U.S. in the next ten years, the F-35 may be one of the biggest casualties of the 2008 recession.

[CORRECTION: Edited to note that Lockheed and Boeing will be delivering 180 F-22s, not Boeing alone.]