Army truck program a test case for cutting costs, and profits.

• Author: Erwin, Sandra I.
• Position: Tactical Vehicles

A relatively small Army procurement--the $3 billion family of medium tactical trucks--is being watched closely by industry executives and investors as a harbinger of what might be in store for manufacturers of military equipment.

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.

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Oshkosh officials said they are bullish about...