Revisiting The High Cost of Defense

Back on November 01, 2004, I reported

In June of 2004, Robert Bell, Chairman of the Economics Department, Brooklyn College, N.Y. delivered a paper in Barcelona titled the THE U.S. GOVERNMENT’S BUBBLE BLOWING MACHINE.
The paper describes how in the Spring of 2003 Ken Pedeleose, an analyst at the Pentagon department intended to control program costs at federal contractors, was startled to find that the overhead costs of virtually every airplane that Lockheed Martin sold the U.S. Air Force would soon be skyrocketing in price. Pedeleose had personally researched the massive cost increases on the C-130J transport, which would go up from $1.193 billion in 2003 to $8.352 billion by 2006. Documents widely circulated by others in the Pentagon showed that costs for the F-16 program would jump from $3.49 billion in 2004 to $6.66 billion in 2005 and then on to $14.84 billion the next year. The F/A-22, F-117, and many other programs showed similar vaults in costs.

The question is, why would an established program show an increase in costs, assuming there is no major increase in the number of planes built? Shouldn’t there be a learning curve, meaning the more planes built, the cheaper the cost per plane?

In a 23 June 2003 letter to the Chairman of the U.S. Senate Finance Committee, Charles Grassley, Pedeleose gave the reason: Lockheed Martin “has to make up hundreds of millions of dollars in their pension funds that were invested in the stock market.”

Lockheed Martin and other federal contractors literally operate under a law unto themselves, known as U.S. Government Cost Accounting Standards.

“The total funding requirement for our pension plans under U.S. Government Cost Accounting Standards (CAS) in 2002 was $87 million. CAS is a major factor in determining our funding requirements and governs the extent to which our pension costs are allocable to and recoverable under contracts with the U.S. Government. For 2003, we expect our funding requirements under CAS to increase substantially. This amount is recovered over time through the pricing of our products and services on U.S. Government contracts, and therefore is recognized in our net sales.”

The last sentence is particularly interesting. It means if Lockheed Martin loses pension fund money on the stock market, the company ultimately increases the size of its revenue by adding the losses onto its prices to the federal government.(Emphasis added

From the 3rd Quarter 2004 Lockheed Martin Quarterly Report

The outlook for 2005 operating profit and earnings per share assume that the Corporation’s 2005 FAS/CAS adjustment will be within a range of ($550) to ($300) million.

Today in the NY Times, Looking for Cuts, Pentagon Turns to Jet Fighter Program, the Pentagon is looking at making sharp cuts to the F/A-22. Seems the plane’s cost has gone from $35 million apiece to $258 Million per. Good Luck cutting this program. Not only is the cost written into law, but 1000 contractors in 43 states have a vested interest in the program continuing.
Mover Mike

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