Defense Department Can Split Tanker Buy, And Still Save Money
By Jacques S. Gansler and William Lucyshyn
The benefits of competition are well established: innovation, efficiency, effectiveness, quality and performance. Although competition is frequently implemented in Defense Department programs, its practice is not being maximized.
One program that should consider the benefits of competition is the Air Force KC-X tanker. In this instance, there are two in-production commercial aircraft — made by Boeing and Airbus — with existing worldwide support. Yet the option of competitive dual-sourcing for production of tankers has been overruled with the hope that “this time will be different” and sole-source suppliers will achieve the desired performance and costs. The argument is that two, sole-source, “split buy” awards would not achieve the incentives of competition.
Competition during production is not a common practice, based on the mistaken belief that it will increase costs. In practice, competition during production routinely results in higher performance at lower costs, with steeper learning curves achieved by both suppliers. Numerous historical studies have demonstrated the benefits of including competition during production, with net cost savings that range from 12 percent to 52 percent.
Even in cases when competition is introduced later in production, the results have shown that the second source actually achieves a steeper learning curve — with improvements ranging from 2 to 9 percent. Furthermore, as the two firms progress down the learning curve in a competitive environment, the addition of the second source challenges the first producer’s learning curve — ultimately contributing to far greater cost savings.
There are several high profile examples that demonstrate the dramatic improvements that are possible with production competition.
The so-called “Great Engine War” to supply the F-16 and F-15 aircraft demonstrated that the introduction of a second production source cut the pre-competition shop-visit rate, per 1,000 engine flight hours, in half. The scheduled-depot-return-rate went from every 900 cycles to every 4,000 cycles, all while reducing the warranty costs from an initial bid of $53 million for warranty coverage, on roughly $130 million worth of engines, to a mere 5 percent premium. All this resulted in a dramatic improvement in engine reliability, higher performance and lower unit costs from both suppliers.
Another example is the production of Tomahawk missiles. The introduction of a second production source was estimated to save some $630 million (in then-year dollars), while improving the missile’s reliability from approximately 80 to 97 percent, and also significantly enhanced the overall system performance.
In the case of the F-35 Joint Strike Fighter, Rand Corp. concluded that dual-sourcing the avionics and engines could yield cost savings of up to 30 percent. But the initial investment was deemed by the Air Force to be unaffordable.
Since sole-source production annual contracts are usually based on historical costs, they create a perverse incentive for the contractor to increase, rather than to reduce, costs. This results in learning curves that are generally flatter than projected, or even increasing as changes in “requirements” are bid non-competitively.
One can also consider how competition affects the cost growth of programs. The cost-growth factors on 10 Defense Department aircraft programs, with no production competition — based on actual cost incurred versus program baseline — increased by 46 percent, on average. Only two of the programs presented a modest decrease. By comparison, commercial aircraft produced in a competitive environment show a decrease of between 2 and 27 percent.
A theoretical argument usually given against competitive dual-sourcing is that the two firms cannot achieve “economically efficient production rates.” With careful planning, this barrier can be overcome. Lockheed Martin, for example, was able to reduce the D-5 Sea-Launched-Ballistic-Missile production rate from 60 a year to 12 a year, while reducing the cost at the same time. Another case in point is the Navy’s DDG-51 destroyer program, which had one to two ships built in some years, while having four or five ships built in other years. Despite these low production numbers, the contractors were able to keep the costs fairly stable over time.
Competition should be exploited during all phases of acquisition. If a contractor is continuously improving performance at lower and lower costs, he should be rewarded. But the option of competition must always credibly exist, in order to incentivize such results.
Competition must be the cornerstone of the department’s acquisition strategy. It has provided incentives to not only reduce costs, but, more importantly, to produce higher-performance and higher-quality products. These benefits have been recognized by Congress with the Competition in Contracting Act of 1984.
From the Defense Department’s perspective, competition is not only necessary to efficiently meet day-to-day military needs, but also to bring the best weapons to the battlefield quickly and affordably. Firms in a competitive environment also attempt to improve the quality of a product over time, which has the potential to drive lower-quality firms out of the market altogether. Jacques S. Gansler is a professor and holds the Roger C. Lipitz chair in public policy and private enterprise at the Center for Public Policy and Private Enterprise at the University of Maryland’s School of Public Policy. He was undersecretary of defense for acquisition, technology and logistics. William Lucyshyn is the director of research and senior research scholar, also with the Center for Public Policy and Private Enterprise at the University of Maryland’s School of Public Policy. He is a former Air Force officer and a Defense Advanced Research Projects Agency program manager.