F-35 Cost Decline Due to Lower Labor Costs, Accounting Changes
(Source: defense-aerospace.com; published May 24, 2013)

By Giovanni de Briganti
PARIS --- While the eye-catching conclusion of the Pentagon’s latest report is that the F-35’s cost has declined for the first time, a closer look shows that the decline is tenuous, and not as clear as it could appear. (The paragraphs of the May 23 Selected Acquisition Report document relating to the F-35 program are excerpted below, along with Lockheed Martin’s comment. A link to the full report is at bottom).

The report shows that a $4.4 billion drop in the program’s cost was obtained by lowering estimates of labor costs and price escalation. If slightly different estimates had been used – and over the program’s 30 years, there is much scope for estimates to differ – then entirely different conclusions would have resulted.

This substantially reduces the significance of this first-ever decline, after 12 years of continuous increases, as does the fact that the report’s conclusions are only estimates based on parameters that are, themselves, estimates.

Five points raised in the SAR report are worth a closer look, as they raise questions about whethet F-35 program costs have, in fact, decreased.

The first point is that the Pentagon lowered its estimate of the program’s cost by $7,853.3 million because of lower labor costs at Lockheed Martin and its subcontractors. However, these costs simply reflect lower billings by Lockheed, and not necessarily that its costs that are actually lower.

This is because Lockheed’s Aeronautics unit still cannot keep track of its materials and manpower costs, as was stated by the Defense Contract Managing Agency in October 2010 when it decertified the unit’s Earned Value System. At the time, the system was “deficient in 19 of 32 areas,” a Pentagon spokeswoman told Bloomberg at the time. Since then, the situation has worsened: while the Pentagon began by withholding 2% of Lockheed F-35 billings because of the EVS shortcomings, it has since increased this retention rate to 5%.

Consequently, saying the cost of the F-35 has declined by $7.8 billion because Lockheed says its labor costs are lower seems, at the very least, questionable, especially as at the same time another Pentagon agency - DCMA - is saying, in effect, that Lockheed has no idea of what its real costs are.

Furthermore, labor costs are influenced by two factors: the number of hours worked, and the cost of each hour. Hourly costs are unlikely to drop as time goes on, so the only possible gain is by reducing the number of hours worked. While this can happen as the company moves along the learning curve, Lockheed is spending much energy fixing faults and retrofitting “error” aircraft, which should lead to higher, and not lower, labor costs, than budgeted.

Secondly, the report also notes that a simple revision of “escalation indices” added $7,016.4 million to the cost of the program, nearly twice as much as the drop in the program's cost.

No explanation is provided as to what these “escalation indices” are, or how they are calculated, so future corrections – in case of higher inflation, or higher labor costs, or further hikes in the price of materials – could well substantially increase future costs.

Thirdly, the SAR report states that costs were further reduced (by $1,121.3 million) because of “revised airframe and subcontractor estimates that incorporate the latest actual costs from early Low Rate Initial Production (LRIP) lots.”

This is puzzling, as the actual dollar value of successive LRIP contracts, up to and including Lot 6, has steadily increased, which should have boosted – and not reduced – cost estimates.

Fourthly, the program’s cost was further reduced by $698.3 million by lowering “estimates of required risk for initial spares.” This seems premature at this time, given that the F-35 is still many years away from reaching full operational capability, when large-scale operations will determine actual spare parts usage.

The fifth point is that the “aircraft sub-program” cost was reduced by $981 million by correcting “cost allocations between the aircraft and engine subprograms.” This is another way of saying that the Pentagon “saved” nearly a billion dollars by moving it from one sub-program to another. While this move does not change the overall cost, it does demonstrate a certain bookkeeping "agility" that, like the other points raised above, may not be entirely consistent with accounting best practices.

Selected Acquisition Report (SAR) Summary As of Dec. 31, 2012 (excerpt)

F-35 Joint Strike Fighter – The F-35 program is comprised of two subprograms, Aircraft and Engine. Only the Aircraft subprogram had selected cost changes in the December 2012 SAR; however, the cost changes for the Engine subprogram are also provided.

F-35 Aircraft – Subprogram costs decreased -$4,942.4 million (-1.5%) from $331,855.2 million to $326,912.8 million, due primarily to decreases in the prime contractor and subcontractor labor rates (-$7,853.3 million) and revised airframe and subcontractor estimates that incorporate the latest actual costs from early Low Rate Initial Production (LRIP) lots (-$1,121.3 million).

There were additional decreases to correct cost allocations between the aircraft and engine subprograms that were established in the December 2011 SAR (-$981.0 million), lower estimates of required risk for initial spares (-$698.3 million), other support reductions due to maturation of the technical baseline and further definition of customer requirements and Service beddown plans (-$1,032.9 million). These decreases were partially offset by the application of revised escalation indices (+$7,016.4 million).

F-35 Engine – Subprogram costs increased $442.1 million (+0.7%) from $63,856.6 million to $64,298.7 million, due primarily to revised escalation indices (+$1,301.3 million), correction of cost allocations between the aircraft and engine subprograms (+$981.0 million), and a lower near-term ramp that extended completion from FY 2029 to FY 2032 (+$230.7 million).

These increases were partially offset by revised estimates to incorporate the latest actual costs from early LRIP lots (-$848.8 million), out-year offsets of new escalation indices (-$865.2 million), and lower estimates of required risk for initial spares (-$362.9 million).

Article history:
-- edited May 25 for style and to separate Locheed Martin statement.


Lockheed Martin Statement
(Source: Lockheed Martin; issued May 23, 2013)
Lockheed Martin is pleased with the $4.5 billion reduction in acquisition, operating and support costs reflected in the 2012 Selected Acquisition Report (SAR 12).

This is the first year a cost reduction was noted. We will work with the F-35 Joint Program Office to implement further cost saving measures, which will result in additional significant decreases to the total program cost.

The top priority of the government/contractor team is to continue to cost-effectively deliver the F-35’s unprecedented 5th generation capabilities to the warfighter. (ends)

Lockheed F-35 Cost Declines 1.1%, Pentagon Estimates (excerpt)
(Source: Bloomberg; published May 24, 2013
The development and production cost of Lockheed Martin Corp.’s F-35 fighter, the Pentagon’s most expensive weapons program, has decreased by 1.1 percent, primarily because of reduced labor rates, according to the Pentagon’s latest cost estimates.

The $4.5 billion decrease, to $391.2 billion from $395.7 billion, includes the aircraft and the engines produced by United Technologies Corp.’s Pratt & Whitney unit for an eventual fleet of 2,443 planes.

The latest F-35 projection is included among reports on cost estimates for major weapons that the Pentagon sent to Congress yesterday. The reports cover a portfolio of 78 weapons that the Pentagon now projects will cost a combined $1.66 trillion, an increase of $39.6 billion, or 2.4 percent, over a report published in March 2012.

Even with the improvement for the F-35 reported yesterday, the projected cost has increased 68 percent since the Pentagon signed its initial contract for the fighter with Bethesda, Maryland-based Lockheed in 2001. The revised estimate bolsters findings by government analysts that the military and the contractor are making progress in managing the jet’s simultaneous development and production.

“My immediate reaction is that it reflects the improvements that we found in manufacturing last year,” said Michael Sullivan, who is in charge of producing an annual report on the F-35 for the independent Government Accountability Office. (end of excerpt)

Click here for the full story, on the Bloomberg website.


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