Army Truck Program a Test Case for Cutting Costs, And Profits
Wisconsin-based Oshkosh Defense expects to build up to 26,000 trucks and trailers over the next five years as part of the FMTV (family of medium tactical vehicles) program. The company won the contract in 2009 by offering to build the trucks for about 30 percent less than what the 17-year incumbent — BAE Systems of Sealy, Texas — was charging the Army.
Despite protests by both BAE and Navistar, Oshkosh prevailed, was declared winner in February 2010 and is now on track to begin producing 37 trucks a day by the end of the year.
But the company’s surprisingly low bid and the fact that the contract is firm fixed-price — meaning that any cost overruns have to be paid by the manufacturer, and not the Army — have raised questions about whether Oshkosh will be able to make a profit from FMTV.
The Pentagon plans to increase the use of fixed-price contracts as one way to protect taxpayers from having to absorb the rising costs of weapon systems. Shifting the risk to the contractor makes sense, defense officials said, particularly in programs for commodity-like products that do not require complex technologies, such as FMTV or the Air Force’s new KC-46 aerial refueling tanker.
Investors are cautiously monitoring the progress of these fixed-price procurements as they fear shareholders may end up on the losing end. The tanker’s manufacturer, The Boeing Co., already is having to push back on media reports that the KC-46’s cost estimates will be higher than what the Pentagon agreed to pay, which could put a serious dent in future profits.
A $70 billion company such as Boeing, however, would be in a far stronger position to take on such risks than smaller firms such as Oshkosh, which has annual sales of about $2 billion.
Industry consultant Loren B. Thompson, of the Lexington Institute, questioned how Oshkosh could possibly make a profit by bidding so low on the FMTV program. “Not only would many of the production inputs have to come from the same suppliers that BAE Systems used, but the incumbent had a proprietary design for the truck’s armored cab that Oshkosh would have to replace fast if it was to meet contract commitments,” Thompson noted in a June blog post.
Oshkosh officials said they are bullish about the program being able to deliver both savings to the U.S. government and profits for investors.
“There is no question that we did bid the truck on a small margin,” said Mike Ivy, vice president and general manager of Army programs for Oshkosh Defense.
“We continue to work diligently to ensure this contract makes money over the life of the contract,” he said in an interview.
Challenging BAE with a low-cost bid was seen as a risky move. The incumbent had a mature assembly line, and Oshkosh at the time lacked adequate manufacturing capabilities to make the FMTV. Oshkosh had to spend $45 million to build a new “e-coating” facility to paint truck metal parts with a special anti-corrosion coating that guarantees protection for 22 years.
“There was a learning curve associated with e-coating that caused some ramp-up problems early in the program,” Ivy said. “We are beyond those issues now.”
Based on publicly released data, Oshkosh estimated that, compared to what the Army was paying BAE Systems for a comparable quantity of trucks, it will save the government $2 billion over the life of the program.
FMTV program officials declined to comment on the specific $2 billion savings cited by Oshkosh. In a statement, Col. David Bassett, Army project manager for tactical vehicles, said it is too early to project actual numbers.
“Through competition, the Army has achieved significant savings on the FMTV program,” Bassett said. “The total amount of savings the Army might achieve on FMTV will be determined by the volume of trucks ordered during the period of performance of the requirements contract.”
Ivy said the company is confident that the Army will follow through on its commitment to buy all 26,000 trucks and trailers.
But in today’s unpredictable federal budget climate, there are no guarantees.
As of the end of July, Oshkosh had produced 1,512 trucks and 852 trailers. Its most recent order for 7,000 vehicles to be delivered by June 2013 is valued at more than $904 million.
“We are ramping up very quickly,” Ivy said. “It’s a very challenging ramp up.”
When the Army decided in 2008 to open up the FMTV program to other competitors, the move was seen as a symbolic and unrealistic effort to shake up the status quo. It has been rare for long-time incumbent contractors — which typically enjoy strong political backing — to lose their lifelines. In many instances, manufacturers are able to hold on to their business because they own a weapon system’s intellectual property rights, also known as “technical data rights.” It is often too costly for the government to purchase TDRs. The Army had ownership of at least a portion of the FMTV data package, and released it to competitors so they could offer competitive bids.
The Army made it clear from the beginning that it didn’t want any new frills in FMTV, just the same truck that it had been buying for years, Ivy said. The government didn’t want to pay to redesign any components, technical manuals or to set up new training programs. Oshkosh’s bid, derided at the time as egregious “low-balling,” was an offer the Army could not refuse.
Now it will be up to Oshkosh to try to squeeze profits between now and 2015. The gamble could pay off, but even company executives acknowledge that the defense budget outlook is not what it was three years ago when spending was soaring.
“It certainly is exciting times,” quipped Ivy.
In a July 28 conference call with investors, Oshkosh Corp. President and CEO Charles L. Szews, struck an optimistic but cautious note regarding the military truck market. On the FMTV program, he said the emphasis was on accelerating production and lowering manufacturing costs. Much of company’s military truck revenues today are not from FMTV but from the M-ATV, the all-terrain mine-resistant ambush-protected armored trucks that soldiers and marines use in combat zones. During the third quarter of fiscal year 2011, Oshkosh received $700 million in orders for M-ATVs.
As purchases of M-ATVs dwindle, there will be greater pressure to increase revenues from FMTV. Oshkosh Defense sales decreased 34.9 percent to $1.1 billion for the third quarter of fiscal 2011 compared with the prior year third quarter, Szews said.
Defense operating income in the same quarter dropped 63 percent to $112.5 million, measured against the prior year. The decline, he said, “was largely due to the decrease in M-ATV volumes and costs associated with the ramp-up of production on the FMTV contract, which resulted in a loss on that contract during the third quarter of fiscal 2011.”
Ivy said the company is hedging its bets by seeking new opportunities in the military truck sector. Oshkosh already owns a large share of the military’s heavy- and medium-truck markets, and is considering jumping into the light-vehicle segment.
The Army and Marine Corps will be spending billions of dollars either buying new light trucks to replace aging Humvees or refurbishing current Humvees. Oshkosh may be eyeing opportunities in both areas, Ivy said. “If we are going to continue to grow, we have to find new ways to do that.” Oshkosh might even throw its hat into a completely new line of business: combat vehicles. The Army is about to embark on a procurement program for next-generation combat vehicles. Although combat vehicles tend to be tracked, it is not completely clear yet whether the Army might seek a wheeled variant, Ivy said. If that is the case, Oshkosh could enter the competition.
“I don’t think we are going to venture off into tracked vehicle production. But there is some indication that the Army may see room in the GCV [ground combat vehicle] portfolio for some wheeled vehicles.”
BAE Systems, for its part, has been working to recover from the FMTV setback, and expects to remain in the truck market. During the FMTV competition, BAE executives had warned that if the company lost that contract, it would have to close its Sealy facility and eliminate hundreds of jobs.
So far the Sealy plant remains open and production is ongoing, said Jennifer Robinson, a spokeswoman for BAE Systems Land and Armaments. The company is manufacturing other vehicles there, including the Caiman mine-resistant armored vehicle and the high-mobility artillery rocket system known as HIMARS.
“While we can’t go into specifics at this time, I can confirm that we are now producing specialized vehicles at the Sealy plant, which are earmarked for non-military jobs,” Robinson said.
In June 2011, BAE delivered its last FMTV order but will continue to manufacture armor until January 2012. “We just received a new contract award for armor kits,” Robinson said.
Topics: Land Forces