Showdown Ends in Cancellation
U.S. Navy Scraps LCS 3 After Dispute With Lockheed
By CHRISTOPHER P. CAVAS
The U.S. Navy’s abrupt decision to cancel construction of a Lockheed Martin Littoral Combat Ship (LCS) leaves many wondering what it means to Lockheed, the LCS program, shipbuilders, service acquisition and the fleet itself.
Navy Secretary Donald Winter, who has pledged to use any method at his disposal to hold down shipbuilding costs, has repeatedly urged industry to modernize and find new ways to build ships.
But shipbuilders are digging in, tired of the badgering from Navy officials and lawmakers alike. They say too little attention is given to shipboard equipment and other things that are sending ship costs skyrocketing.
“Both sides are sending messages that they need to change the way they do business,” said Byron Callan, a defense industry analyst.
The decision capped a month of negotiations in which the Navy sought to change the contract for LCS 3, the second Lockheed ship, from a cost-plus to a fixed-cost-plus-incentive model. On March 15, Winter declared that unless a “meeting of the minds” on a new contract could be reached, the Navy would cancel construction. On April 12, he made good on that threat.
The cancellation of LCS 3 was only the latest setback to the program, which envisions a 55-ship fleet of small, fast warships designed to counter threats in contested coastal waters.
At its inception in 2002, the program was viewed as a prime example of the transformational concepts envisioned by then-Defense Secretary Donald Rumsfeld. Adm. Vern Clark, Rumsfeld’s chief of naval operations, championed the LCS, promising a low-cost warship that would depend largely on a family of mission-specific “modules” of weapons, sensors and vehicles.
“I need it yesterday,” Clark told lawmakers, reporters, contractors and sailors alike.
When Adm. Mike Mullen succeeded Clark in 2005, he became just as emphatic in his support. But lately, “yesterday” is looking further off.
At the beginning of this year, the Navy had four LCS ships under contract and was authorized to buy two more. But in March, Winter said that more than $400 million authorized for the fifth and sixth ships would be used to cover cost overruns on the first four. The cancellation of LCS 3 means there are only three ships under construction.
Further, the Navy will scale back plans to ask for three ships in 2008 and six in 2009 to a likely two ships in ’08 and three in ’09.
That means that by 2010, when the service will decide on a single design for the remainder of the fleet, a total of eight ships will be in service, under construction or under contract, rather than the 15 envisioned just three months ago.
Winter’s cancellation decision follows an April 3 address at a Navy League symposium in Washington where he declared a policy of “tough love” with shipbuilders to hold down costs. The secretary has been deeply involved in the LCS program since the end of the year, when the Navy discovered that costs had grown unexpectedly on the USS Freedom (LCS 1), Lockheed’s first ship.
The ship, which was launched in September at Marinette Marine in Marinette, Wis., was originally planned to cost about $220 million. But design and production problems, coupled with a tight building schedule, have driven the price to between $350 million and $375 million by the Navy’s estimates. Others believe the cost could ultimately top $400 million.
In January, the Navy began a deep inquiry into the program to understand what was happening with costs on both Lockheed ships and two other ships being built by General Dynamics to a competing design. On Jan. 12, Winter issued a 90-day stop-work order on LCS 3, which was to be built at Lockheed’s second shipyard, Bollinger, in Lockport, La.
The stop-work order itself was an indication of the tough approach Winter is taking. Several industry sources said a less-formal move — even a phone call — would have had the same effect pending the Navy’s re-evaluation of the program.
A ‘Disastrous’ Decision?
“At first glance, this appears to be a disastrous decision by the secretary,” said Bob Work, an analyst with the Center for Strategic and Budgetary Assessments in Washington who has long followed the LCS program.
“This obviously is part of the secretary’s tough-love approach to shipbuilders,” Work said. “But whether this is the program he should be putting so much uncertainty into is a really big question. It’s a blow to the program.”
Cancellation of the ship wasn’t the only option available to Winter. Other options included giving in on some of the negotiation points or restructuring the program to account for higher costs and longer building times — at least for the first ships.
Accounts of the failed negotiations varied, but sources said the primary sticking points revolved around price, assignment of risk and intellectual property issues.
The price gap at the break-off point in contract talks also was disputed, with some sources claiming the difference was $50 million to $60 million and others claiming a gap of only about $10 million.
The Navy’s leadership expressed confidence in the soundness of their actions.
“While this is a difficult decision, we recognize that active oversight and strict cost controls in the early years are necessary to ensuring we can deliver these ships to the fleet over the long term,” Winter said in a statement announcing the decision.
Bob Stevens, Lockheed’s president and chief executive officer, said in a statement released following Winter’s announcement that Lockheed was “greatly disappointed” and “frustrated” in the decision and sorry the company “will not have the opportunity … to see this program through to conclusion.”
Investment analysts generally applauded the decision for both the Navy and Lockheed.
“While losing the contract is clearly a disappointment, we do applaud the company for its financial discipline and in walking away from a fixed-price contract that could have been detrimental to shareholder value,” Merrill Lynch analyst Ron Epstein said in a note to his clients.
Callan agreed.
“Companies are saying they’re not going to take contracts their shareholders won’t tolerate,” he said. “For the Navy, they’ve got only so much to spend on their 313-ship fleet and they’ve got to hold the line on cost if they’re to meet their goal of recapitalizing the fleet.”
Many questioned Lockheed’s future in the program, which now puts the company one ship behind competitor General Dynamics. But Rear Adm. Chuck Goddard and Allison Stiller, the Navy’s top ship acquisition officer, speaking to reporters from the Pentagon about the decision, stressed that the number of ships would not affect the Navy’s ability to evaluate the designs.
“We hope and expect that both Lockheed Martin and General Dynamics will compete for … future LCS procurements,” Goddard said.
And while the cancellation decision doesn’t affect the General Dynamics ships, the Navy continued to put GD on notice. “We will continue to monitor General Dynamics’ performance on LCS 2 and 4,” Goddard said. “If GD experiences comparable growth, we will use a similar process to seek to restructure the contract.”
But the nature of Lockheed’s participation in shipbuilding programs — the company owns no shipyard — brings into question the future of integrators as lead ship contractors rather than shipbuilders like Northrop Grumman and General Dynamics.
Winter, in his April 3 address, said he wanted to do away with the lead system integrator approach to shipbuilding. “The Navy should be the lead integrator,” he said.
Analyst Epstein noted the development in his note to clients.
“We believe the termination points to a potential weakness in the system integrator model and suggests that domain expertise is of vital importance,” he wrote.
The Effect on the Fleet
Beyond the hard dollars-and-cents nature of the acquisition decisions lie further questions on how the cutback in LCS procurements will affect the Navy’s ability to integrate the ships into the fleet and develop the concept to maturity regardless of which design is ultimately built.
The questions include proving the Navy’s concept of operations, how the multi-ship manning system will function, how the mission modules will integrate into the ship, the simultaneous operation of multiple off-board manned and unmanned vehicles, the efficacy of a networked command-and-control system and the ability of the logistics train to keep the ships and their modules at peak combat efficiency.
The Navy is well aware of these issues and has spent a great deal of effort building simulation trainers and developing plans. But until the ships are in service, those concepts remain theoretical.
“The ships are a prototype for an entirely new type of battle-networked combatant,” Work said. “They have a host of operational innovations that we won’t be able to determine until we get the ships in the water.”
Further, the LCS ships comprise the biggest chunk — one sixth — of the Navy’s planned 313-ship fleet.
“What has this move done to the Navy’s plan?” Work asked. “It appears to me the entire LCS program is now up in the air, and that means the entire 313-ship fleet is up in the air.”
![[009]](./images/smilies/009.gif)
![8-]](./images/smilies/icon_cool.gif "Cool"){kind=icon}
.jpg)
