Lockheed Martin Offers To Shoulder Risks On F-35 Maintenance With Fixed-Price, Performance-Based Contract

Lockheed Martin, prime contractor for all hardware and software on the F-35 fighter other than the engine, has proposed to the government that the company assume most of the risk for keeping the plane in a high state of readiness. The company would guarantee a fixed price to reach and exceed 80% fleet readiness by 2025, higher than most U.S. combat aircraft achieve today.

F-35 is the Pentagon’s biggest weapons program, producing 2,456 fighters in three variants for the Air Force, Navy and Marine Corps, plus many hundreds more for a dozen overseas allies. The cost of building each aircraft has been declining steadily, with the latest agreement aiming to produce the most common variant for less than it costs to manufacture last-generation fighters that the F-35 will replace.

However, most of the life-cycle cost for modern weapons is incurred after production, in the form of what is called “sustainment”—maintenance, spare parts and other items necessary to keep weapons in a high state of readiness. It is the cumulative cost of sustainment during a service life stretching to 2070 that has earned F-35 the reputation for being the military’s first trillion-dollar program.

What Lockheed Martin is proposing is that the Department of Defense transition F-35 to a performance-based logistics approach in which contractors are incentivized to reduce costs. Traditional sustainment concepts measure inputs, whereas performance-based logistics measures success in terms of outputs—in this case, readiness and affordability.

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Under the terms of the Lockheed Martin offer, the government would be guaranteed that the F-35 fleet is over 80% mission-capable by 2025, meeting a goal set by former Secretary of Defense James Mattis. Less than 10% of the fleet could be non-mission-capable due to supply shortages, and less than 10% could be non-mission-capable due to maintenance issues. That is significantly better readiness than is currently achieved by most military aircraft.

The most unusual feature of Lockheed Martin’s offer, though, is the proposal to deliver high readiness levels at a fixed price below what current sustainment practices would permit. The company estimates that $18 billion would be saved over a 15-year period, with savings averaging about $1 billion per year after initial startup of the performance-based approach.

What makes the offer of a fixed price unusual is that Lockheed doesn’t actually control most of the costs driving F-35 sustainment outlays. The company says it accounts for roughly 40% of sustainment costs, with engine maker Pratt & Whitney accounting for 10% and the government generating the remainder (Lockheed and Pratt both contribute to my think tank; Lockheed is a consulting client).

Lockheed therefore needs to negotiate ground rules governing how performance-based logistics would be implemented for F-35. Following the pattern used in other performance-based arrangements, including those Lockheed has with its own suppliers, the company wants sustainment to be negotiated in five-year increments, giving it sufficient time to earn back its up-front investment. The company is proposing to kick off the arrangement, which it began briefing to senior Pentagon officials in early August, by investing $1.5 billion of its own money.

Transitioning to five-year increments would eliminate the current practice of annual negotiations for sustainment, a process that results in considerable price variability from year to year. By migrating to a system of only one negotiation every five years, the government would get a more predictable outcome in terms of cost and performance. It would also shift most of the execution risk to industry, which is a common feature of all performance-based logistics contracts.

Capability and affordability are usually traded off against each other in Pentagon arrangements for supporting combat systems, so analysts will inevitably wonder why Lockheed Martin thinks it can simultaneously increase readiness and decrease costs. The short answer is that it has analyzed processes surrounding the sustainment function and has identified numerous ways in which money can be saved without sacrificing readiness. These include reducing manpower and material costs, improving inventory control, automating tasks and predicting with greater accuracy when maintenance actions will be required.

Many of these enhancements can be implemented whether they are carried out by the government or industry. The fact Lockheed Martin is willing to risk its own funds up front signals that the F-35 has reached a level of maturity where sustainment processes are well understood and thus ready for refinement. The Lockheed Martin approach would implement recognized best practices across the F-35 support enterprise. But it would require significant adjustments on the part of all parties involved.

One Lockheed Martin executive told me that fashioning an optimized sustainment process for the world’s biggest weapons program “is a strategic inflection point—maybe the last.” In other words, with the battle over reducing production costs now largely won, the government and industry need to agree on how best to support the F-35 fighter through the coming half-century of operations. If they get it right, F-35 will be the dominant tactical aircraft in the world for two generations. If they get it wrong, the aircraft won’t live up to its full potential.

I focus on the strategic, economic and business implications of defense spending as the Chief Operating Officer of the non-profit Lexington Institute and Chief Executive...