Acquisition Reform Backfires; Northrop Makes the Rational Decision
(Source: Lexington Institute; issued March 9, 2010)

((c) Lexington Institute; reproduced by permission)
Northrop Grumman's leaders hated pulling out of the Air Force's tanker competition on Monday. Having spent four years and $200 million positioning their team to be a credible contender, company leaders desperately wanted to fight and win. But they simply couldn't find a solution to the government's solicitation that was consistent with the guidance handed down by CEO Wes Bush. That guidance directed Northrop's tanker team to avoid excessive risk and formulate an executable approach to generating some reasonable level of profitability. The team couldn't meet those expectations, so Northrop withdrew from the fray.

Wall Street understands better than Washington that Northrop's decision not to bid is a good-news story for the shareholders who own the company. Wall Street is all about the bottom line, and it really doesn't care how big the revenues of a program are if the company doesn't make a profit. In Washington, where there is no bottom line and billions of dollars are routinely wasted on dumb ideas, Northrop's disciplined, rational decision is hard to fathom. That's why former politicians never get put in charge of Fortune 500 firms.

Had Northrop Grumman actually bid and won, its exposure to risk would have been a drag on corporate results for many years to come. The career bureaucrats and tenured academics who run the Pentagon wrongly assumed that they could impose any burden on potential offerors without having to fear companies would walk away.

But the reality is that if Lockheed Martin or General Dynamics had been handed the same options Northrop Grumman faced in the latest round of tanker competition, they wouldn't have bid either. That's what disciplined, well-run companies do: they avoid danger and put their money where it is likely to generate the best returns on a sustained basis.

Boeing now finds itself facing an interesting dilemma. The government's ridiculous request for proposals carries so much potential risk for whoever “wins” that the only rational response is to bid high. If it doesn't, it could be forced to eat hundreds of millions of dollars in cost overruns because the assumptions underpinning its fixed price were too optimistic.

However, if it does bid a price consistent with the level of risk implied in the solicitation, Congress might complain the company is trying to take advantage of the fact that it is the only qualified bidder. So the tanker program remains a tricky proposition for Boeing, despite Northrop's withdrawal.

Maybe it isn't a coincidence that on the day Northrop pulled out and Boeing began to look like a sure winner, Northrop's share price went up and Boeing's went down.

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