No more ‘must-wins’: Defense firms growing warier of fixed-price deals

WASHINGTON — Lockheed Martin chief executive Jim Taiclet offered a warning during a quarterly earnings call this week,

The government, he said, is putting too much risk on defense companies by flexing its muscle as the sole buyer of military hardware, and his firm is changing its approach.

“We don’t have any must-win programs with Lockheed Martin anymore,” Taiclet said.

Taiclet was one of several defense industry executives who this week aired their angst about the government’s contracting practices. Many were particularly concerned about fixed-price contracts. Under these agreements, meant to secure the least risk for taxpayers, companies pick up the bill when costs run higher than expected. Such cases can be disastrous for defense firms — like Boeing’s $7 billion in overruns on a $4.9 billion contract for the KC-46, an Air Force tanker.

Taiclet argued that, as the defense industry’s only customer in most cases, the Pentagon has enough sway to make its suppliers accept its terms.

“Some of the competitors feel that they’re must-win programs for them, [and] that they will take tremendous risk on costs and pricing,” he said, noting that was no longer the case at Lockheed Martin. Those risks combine to result in cost overruns and delays on major programs, he said.

Taiclet said the problem exists in both fixed-price and cost-plus contracts. But, during the same call, Lockheed chief financial officer Jay Malave noted the company is now seeing an “uptick” in cost-plus contracts, which could mean less risk.

A Pentagon spokesperson declined to comment for this story.

In an earlier interview with Defense News, though, acting deputy for industrial base policy Halimah Najieb-Locke said the department is reconsidering how often it uses fixed-price contracts, especially when it comes to companies that also work in the commercial market.

“We’ve got to return to our buying practices of using all of our tools,” she said. “We’re using [firm-fixed-price] a lot because it was dictated to us by Congress … that’s the best way the government can get the best deal for the taxpayer.”

Despite the intent to save taxpayer money, she said, these contracts don’t account for changes in the market. Sometimes it makes sense for the Pentagon to pay more when that investment keeps a supplier in the market or to secure a supply chain, she said.

“So now we’re reverting to best value” contracting standards, which take into account more than just price, she said.

Opinions vary throughout the Defense Department on the proper role of fixed-price contracts. Air Force Secretary Frank Kendall, for example, has warned over the years that by placing the risk on contractors under such a deal, the government is essentially relegated to a “hands off” role as the program proceeds. Fixed-price contracts can be good deals for the Pentagon, Kendall has said, but the conditions have to be right.

The Space Force, however, has championed the use of fixed-price contracts for satellite procurement, and the service’s acquisition chief, Frank Calvelli, has pushed for program managers to use the contract type whenever possible.

“Fixed-price contracting adds a level of discipline, prevents the constant rethinking of programs and scope changes with each yearly budget build, avoids changes from cost re-estimating, stops requirement changes and promotes competition from more commercial-like/non-traditional space companies,” Calvelli said in an August 2023 memo.

Lockheed wasn’t the only company this week signaling a change in how it approaches fixed-price contracts — and warning of exiting competitions if the conditions aren’t right.

Northrop Grumman too said it has changed its approach to bidding on fixed-price deals where a mature design is not in place since 2015, when it won the contract to build the B-21 Raider stealth bomber. The service used a cost-plus structure for the Raider’s initial development phase, and a fixed-price structure for the low-rate initial production phase that began in the final quarter of 2023.

“We have, to my knowledge, not done that again,” Warden said in a Thursday earnings call with investors. “And we have passed on some high-profile programs as a result of the risk balance that the customer put forward in the [request for proposal] not meeting our standards.”

Northrop Grumman on Thursday announced a nearly $1.6 billion pre-tax charge on the B-21, which included $143 million in cost growth for the Raider’s first LRIP lot.

Warden said Northrop has learned from working on NASA’s lunar exploration module known as the Habitation and Logistics Outpost, or HALO, program.

NASA awarded Northrop a $935 million firm-fixed price contract to build the living quarters for the planned moon outpost in 2021, but Northrop’s losses on the program have since grown. The company previously reported expected cost growth of $36 million on HALO in the second quarter of 2023, and on Thursday, announced further cost growth of $42 million during the fourth quarter.

Besides passing on some fixed-price programs outright, Warden said, Northrop has also come back to the government with its own counter-offers. Sometimes, as in the case of Northrop’s counter-offer to the Space Development Agency on a second tranche of satellites to provide missile warning and tracking capabilities, the government passes, Warden said.

“These are things that are going to happen, and we are going to remain disciplined,” Warden said. “We have plenty of opportunity in this company to grow. We have a strong pipeline of opportunities for pursuing, and a strong pipeline of opportunities that we believe have the right risk-reward balance.”

Chris Calio, chief operating officer and the next chief executive for RTX, formerly known as Raytheon, told investors Tuesday that legacy fixed-price programs are weighing down the company’s profits, more so than rising material costs and suppliers falling short.

RTX expects the outlook of those fixed-price programs to improve as RTX meets milestones, Calio said. But RTX also plans to be “more selective and disciplined about the work we pursue moving forward” in an attempt to stabilize the company’s performance and deliver profits, he said.

Courtney Albon contributed to this report.