Punitive contracts could harm U.S.-Northrop

December 11, 2009 ~ Boeing Co. Northrop Grumman Corporation
By Andrea Shalal-Esa
WASHINGTON (Reuters) - Industry, Congress and the Pentagon must jointly tackle cost overruns and schedule delays in weapons procurement because simply imposing punitive contract terms is not the right answer, Northrop Grumman Corp (NYSE:NOC - News) Chief Executive Ron Sugar told Reuters on Friday.
Sugar said he was particularly concerned about the Pentagon's move to use fixed-price type contracts for development of new weapons, saying such contracts were better once a weapon was finalized and in production.
"The inappropriate contract type at the wrong point in the contract can create a lose-lose situation," Sugar said in a telephone interview ahead of the Reuters Aerospace and Defense Summit in Washington next week.
Northrop told the Pentagon earlier this month it would not bid against Boeing Co (NYSE:BA - News) to build new refueling aircraft, barring significant changes in draft terms for the competition, which also called for a fixed-price development contract.
The defense industry, military planners and Congressional lawmakers eager to protect local jobs share some of the blame for existing problems in Pentagon procurement, he said. But cost overruns and schedule delays result from a complex set of factors.
Some of Northrop's best contracts had fixed-price terms, but they were for weapons already in production, Sugar said.
For example, the Navy successfully used fixed-price contracts to buy F/A-18 fighters built by Boeing Co (NYSE:BA - News). Northrop is a key subcontractor on that program.
But applying strict, fixed-price terms to development programs was not a good idea because of unanticipated issues that can arise while new technologies are being tested, he said.
In at least two cases -- the A12 combat aircraft and the Tri-Service Standoff Attack Missile (TSSAM) -- the programs were ultimately abandoned, Sugar said. The C-17 transport plane built by Boeing also saw major cost increases, despite the fixed price terms of its development contract.
Sugar, who retires at the end of the year, said the industry was experiencing more "headwinds" than in recent years and the significant growth of recent years was probably over.
"We're now looking at a time when resources for the (Pentagon's weapons) investment accounts are going to be challenged," Sugar said, although he stopped short of predicting declines in defense spending.
Still, he said the big challenge for the Defense Department in coming years would be to adequately fund the ongoing wars in Iraq and Afghanistan, while continuing to invest in new technologies and future weapons.
At the same time, weapons makers would have to focus on delivering weapons on time and on budget, while providing adequate returns on investment for shareholders.
He cautioned against subjecting contractors to highly punitive procurement measures as a reaction to cost overruns on some programs. Such a short term pendulum swing could have negative consequences for the overall economy and employment in the sector, he said.
Moreover, shareholders would not allow companies to accept undue amounts of risk.
"People in industry have to be able to demonstrate an acceptable return on investments," he added.
(Reporting by Andrea Shalal-Esa; editing by Andre Grenon)
(For summit blog: http://blogs.reuters.com/summits/)