U.S. Air Force Can lead by Example on ULA

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Recently, the Office of the U.S. Secretary of Defense (OSD) distributed preliminary funding cuts among the military services for the budget years 2007 through 2012 . There are additional rumors that the U.S. Air Force cuts could grow significantly this December, as the Future Year Defense Plan for 2007 is finalized.

Air Force leadership clearly is moving to protect some of its aircraft programs like the F/A-22, and tanker recapitalization, which is likely to create a glass ceiling on Air Force space programs.

Space programs have other problems. Congress is distrustful of Air Force space program management due to several recent Nunn-McCurdy cost disclosures. In addition there is congressional fear that the Air Force is prematurely rushing some new space programs into development before key technologies are mature.

There is an immediate opportunity, though, for the Air Force to show some leadership in this realignment by properly handling the proposed formation of United Launch Alliance (ULA), the proposed merger of the Lockheed Martin Atlas and Boeing Delta launch vehicle families.

If done properly, the creation of ULA will increase launch reliability, free-up funding for priority space programs, maintain a competitive playing field with other competitors on both launch and spacecraft programs, and reassure Congress that the Air Force is truly leading by example.

Within the Air Force Missile Procurement Account, approximately $3 billion to $3.5 billion is generally available each year on a sustainable basis for unclassified space procurement. This includes the Evolved Expendable Launch Vehicle (EELV) program; and space programs like the Advanced Extra High Frequency satellite program, Wideband Gapfiller and the Global Positioning System. It eventually will include both the Transformational Space satellite and Space Radar.

However, EELV costs currently dominate the majority of Air Force space procurement, particularly once the 23 Block 3 EELV launches are awarded to Lockheed Martin and Boeing. This will immediately increase the quantity of EELV launches for the Air Force and the National Reconnaissance Office. The figures are currently 2-3 per year by Lockheed Martin and 2-3 per year by Boeing. Once Block 3 is under way it should lead to an average of at least 10 United Launch Alliance launches per year from 2008 to 2011 for the National Reconnaissance Office and the Air Force.

This excludes NASA launches and commercial customers. With all likely Defense Department , NASA and commercial launches, ULA’s average projected annual EELV launches would be about 14-16 per year.

The Air Force does have a clear need to maintain at least two independent launch vehicle families. That redundancy guards against one family being grounded for 6-18 months during any launch failure investigation.

Launch vehicle operations are extremely high-risk, with enormous working-c apital and capital- expenditure requirements. This also requires contractors to maintain large standby or surge – sustaining engineering capabilities, to support mission contingencies, as well as potential launch failure investigations.

This dominance by EELV of the Air Force Missile Procurement Account arose when the EELV program experienced cost growth in December 2001, September 2002, and September 2003, before dramatically breaching the Nunn-McCurdy Act with an unexpected $13.3 billion projected cost growth in December 2003, when the total projected EELV program costs for the period 2004-2020 exploded upward from an estimated $18.8 billion to a projected $31.8 billion. This was primarily due to the lack of a commercial launch vehicle market to absorb recurring overhead and allocable infrastructure costs.

During that Nunn-McCurdy restructuring, the U.S. Air Force agreed to a $12.8 billion increase in EELV launch infrastructure sustainment payments through 2020 budget year. This was a significant increase, given that as recently as 2002 the Air Force estimate for EELV “Assured Access” and “Mission Assurance” had been $1.1 billion.

Now the EELV sustainment subsidies represent 63 percent of all costs for 95 U.S. Air Force launches, and 44 percent of the total costs of all 137 planned EELV launches for U.S. Air Force, National Reconnaissance Office and NASA/commercial customers. The total EELV sustainment payments from 2004- 2020 average $818 million per year on a straight-line basis.

This EELV launch sustainment subsidy was understandably required to finance both the allocable infrastructure and recurring overhead costs when the EELV was certified in April 2004 as “essential to national security” under the Nunn-McCurdy Act.

Additionally, both Lockheed Martin and Boeing had fiduciary duties to shareholders to attempt to re negotiate the 28 originally awarded Block 1 EELV launches that were competitively awarded in 1998 at severely deficient firm, fixed prices of $72 million and $73 million each. Because the 28 original Block 1 launches were competitively awarded at the same time as the two $500 million “Other Transaction Agreements” for EELV development, all parties appear to have been mutually mistaken as to the true launch quantities that were going to be possible and the allocable costs.

Ultimately each EELV launch has an average unit-procurement cost of $226 million over the 137 total planned EELV launches. The average unit cost is $232 million per launch, once the $834 million of U.S. Air Force research development, testing and evaluation expenses also are allocated over the 137 total planned launches through 2020.

The Air Force announced March 22 that it would award two sole source EELV Launch Capability Contracts to Lockheed Martin and Boeing, in parallel with the planned award of 23 additional Block 3 EELV launches on an allocated basis under launch service contracts. Specifically, the EELV launch capability contracts include virtually all the costs of launch vehicle development, production and launch, other than materials and direct labor for EELV launch vehicle assembly.

Even day-to-day program management, and actual launch costs themselves, are excluded from the EELV launch service contracts. Instead, all of the recurring overhead costs, plus all infrastructure costs have been consolidated into the sole-source EELV launch capability contracts. The Air Force is funding virtually all of the annual working capital, long-term capital expenditures and recurring overhead for all of United Launch Alliance’s EELV launches, including both commercial customers and NASA launches as well.

Lockheed and Boeing agreed May 2 to settle their civil litigation by forming ULA. Lockheed and Boeing agreed to commingle all properties, personnel and operations associated with Lockheed’s Atlas launch vehicle family and Boeing’s Delta launch vehicle family into one entity under common ownership and exclusive control of both corporate parents.

This effectively establishes ULA as a captive Air Force research and development facility. It also establishes ULA as a heavily subsidized launch vehicle production house, with the Air Force funding all recurring overhead costs, plus all infrastructure costs allocable to the 137 total planned EELV launches for Air Force, National Reconnaissance Office , NASA and commercial customers.

Consequently, this ULA merger-to-monopoly triggers presumptions of antitrust market concentrations and risk. It also establishes a Defense Department merger-to-monopoly precedent and raises additional questions such as how the merger affects the previous Air Force grant of $13.9 billion in EELV sustainment subsidies.

Specifically, while the Air Force has used unique contractor subsidies in past launch vehicle programs, such as Titan 4 , th ose were programs that either underwent competitive development or had no commercial counterpart. Conversely, the EELV program was formally derived with assumptions about the existence of a robust commercial market that also could be served and help reduce the Defense Department ‘s launch costs.

Lastly, the Air Force Space & Missile Systems Center, as the service’s program executive office for space, recently declared publicly that the Air Force is proceeding with sole-source award of both EELV launch capability contracts and launch service contracts to Lockheed Martin and Boeing regardless of the ongoing review of the proposed creation of United Launch Alliance.

There are five fundamental issues that the Air Force and the Office of the Secretary of Defense must proactively address in the ULA merger that will allow it to be approved in a transparent manner. That approval is critical because it will improve launch reliability, cut Air Force launch costs to fund other priority space programs, and maintain a competitive playing field in both government launch and space programs.

– First, there must be a clear discussion as to why this does not establish a precedent for merger-to-monopoly in all other Defense Department programs.

– Second, the Air Force must commit to a transparent process for “equalizing competition” in future launch and spacecraft programs. ULA is clearly in a unique position to be artificially rated as “technically superior” and also as “lowest-evaluated cost,” due to the sole-source $818 million average annual EELV sustainment subsidy.

While incumbents are generally entitled to receive superior technical and performance-risk ratings during formal competitions, federal procurement law requires that agencies take actions to equalize competition where that competitive advantage is the direct and foreseeable result of agency action that favors one contractor to begin with.

Additionally, federal procurement law requires agencies to evaluate true costs of performance on an apples-to-apples basis and prohibits the ability of one offer or to obscure true cost of contract performance. OSD could choose to formally condition its antitrust consent on periodic reviews at select chokepoints of the EELV acquisition cycle, or in parallel with key spacecraft down-select competitions.

– Third, the hybrid cost-plus launch capability contract, coupled with sole-source fixed-price launch service contract, leaves the vast majority of cost risk with the U.S. government, since the Air Force is directly funding virtually all working capital and capital expenditures of the merging contractors.

Historic programs, such as Titan 4 , suggest a more balanced risk-reward relationship, such as traditional fixed-price incentive fee, or possibly cost-plus incentive fee, where both government and contractor are transparently tied to contractor’s financial performance. This also ensures that ULA’s fiduciary interests mitigate the potential for preferential ULA treatment of its corporate parents.

– Fourth, in the event that the Air Force refuses to transparently address these issues, OSD should consider maintaining continuing oversight of ULA through a Launch Monopoly Control Board. This board would equalize any improper technical, management or cost advantages by ULA, or ULA corporate parents, against other launch vehicle or spacecraft competitors.

The Launch Monopoly Control Board should be populated with Air Force , NASA, National Reconnaissance Office and National Oceanic and Atmospheric Administration customers to ensure cost transparency between all of the U.S. government customers, as well as U.S. government compliance with existing federal statutes intended to promote equal competition in commercial space markets.

– Finally, instead of an external oversight mechanism, the Air Force could revise the current EELV acquisition strategy to provide for artificial competition of out-year EELV launches. This would have minimal potential for cost duplication under the EELV launch service contracts, since the Air Force already is funding 63 percent of Air Force EELV launch costs under the launch capability contracts, awarded on the sole-source basis of “industrial mobilization” preservation.

These five steps will maximize launch reliability for the U.S. Air Force and the National Reconnaissance Office; will guard against harmful spill-over of EELV subsidies into governmental spacecraft and commercial launch markets; and ensure transparency to Congress and the public in this critical national security function.

Ultimately, the Air Force leadership has both the judgment and the incentive to lead by example on this critical national security issue.

Jim McAleese is principal of McAleese & Associates, a McLean-based aerospace and defense law firm that advises clients on both space and defense programs.