Tankers: How Northrop Can Win the Deal of the Century
(Source: The Lexington Institute; issued Feb. 13, 2007)

(© The Lexington Institute; reproduced by permission)
By Loren B. Thompson, Ph.D.

Monday's announcement that Boeing will offer its 767 jetliner in the competition to build a next-generation aerial refueling tanker was no surprise. The 767 is similar in size to 500 Eisenhower-era tankers that must be replaced and the Air Force had already tried to lease the plane for that purpose.

The bigger surprise came last week when Northrop Grumman and a European partner decided to offer their own entry in the competition, the much larger Airbus A330. Northrop Grumman had complained the Air Force's selection criteria were so unfavorable to its plane that it might not bid at all, so when the final solicitation was released with only minor changes Northrop executives had a hard choice to make. Why did they decide to bid?

The biggest factor, obviously, was that the Air Force's initial buy of 179 planes will be worth $40 billion, with follow-on buys eventually pushing the total value of the program well above $100 billion. That makes the tanker program the biggest purchase of commercial transports likely to occur in the first half of this century, and for Northrop Grumman it would be virgin territory -- a huge breakthrough into a new line of business.

Since Northrop doesn't build airliners and the tanker program called for modifying a commercial transport, it had to team with the parent of Airbus to come up with an alternative to the Boeing plane. And therein lies the beginning of a theory for how Northrop Grumman could win the tanker competition.

Boeing is a quintessentially capitalist enterprise that exists first and foremost to serve the interests of its shareholders. Usually, serving the shareholders means doing right by its customers and workers, but there are times when the interests of the three groups diverge. In the case of tankers, Boeing is not going to offer 767s at a loss just to preserve jobs, because that would harm the interests of shareholders. So there is a price below which it cannot go.

Airbus operates on a completely different principle. It was created by European governments and exists mainly to preserve the jobs of its employees. Airbus will price its planes at whatever level makes sense to keep its workforce employed, and rely on subsidies to make up the difference. Just last week, European governments argued they should be allowed to continue giving subsidies to Airbus.

What that means for the tanker program is that even though the Northrop Grumman team will be offering a much bigger plane than the 767 with a much higher list price, it will either match or underbid the price of the Boeing bid. That is easy to predict, because Airbus almost always underbids Boeing in commercial competitions.

The reason Boeing wins commercial orders is because it bids a superior product (like the new 787 Dreamliner) or it promises lower operating costs. But it isn't so clear either of those advantages will work in the case of tankers. The 767 is not superior to the A330, although Air Force analysts will argue its smaller size is a better fit for the mission. And while the operating costs of the 767 are likely to be much lower than those of the A330, the Air Force is going to have a tough time explaining to Congress why it doesn't want to buy a bigger plane -- one that can carry a lot more fuel and cargo -- for a price similar to that of the 767.

The Northrop Grumman team also has a different definition of victory than Boeing does. For Northrop, winning a quarter or a third of the tanker business would be a big deal, because they are breaking into a new market. For Boeing, anything less than prevailing in a winner-take-all award would look like defeat. But when you're already building 500 airliners each year as Boeing is, losing a contract for 15 more per year (the likely rate of tanker production) wouldn't be disastrous.

So the Northrop team may be willing to take more risks, including getting Congress to split the buy -- in which case Northrop is sure to win something.


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