Following months of negotiations, seven European governments have reached a deal with EADS, the parent company of aircraft manufacturer Airbus, which should rescue the troubled A400M transport-aircraft project from failure. At a time when persistent gaps in European military capabilities are defying solutions, and with defence-budget cuts expected, many governments have begun to look more closely at multinational cooperation to generate improved capabilities at better value for the taxpayer. However, the A400M saga provides a sobering background to the debate.
On 5 March, the seven customer nations – Belgium, France, Germany, Luxembourg, Spain, Turkey and the United Kingdom – agreed to increase the purchase price by €2 billion to €22bn and to provide €1.5bn in export finance in exchange for a share of sales revenues. The governments also waived their right to possible damages arising from delays to the project so far, and agreed to accelerate payments to Airbus ahead of deliveries. The project is four years late and substantially over budget. Although the deal will help EADS to reduce its losses on the A400M project, on 9 March it announced a charge of €1.8bn against profits to add to the €2.4bn loss provision it had already taken.
The programme’s rationale
European governments first established the programme for a future military airlifter in 1982. As they contemplated potential replacements for their ageing fleets of C-130 Hercules and Transall C-160 transport planes, several options were available. One was to buy a mixed fleet from the United States – a combination of tactical airlift in the form of the updated C-130 and the larger ‘strategic’ C-17 Globemaster. The former is manufactured by Lockheed Martin and the latter by Boeing (since its 1997 acquisition of McDonnell Douglas). However, the European Staff Requirement which was produced jointly by the customer militaries in 1993 was for a new aircraft larger than a C-130 or C-160, but smaller than a C-17. After the purchasing group issued a formal request to Airbus for proposals in 1997 against the staff requirement, Airbus Military was formed in 1999. Previously, Airbus had manufactured only commercial aircraft. Italy and Portugal dropped out in 2001 and 2002 respectively, and the seven remaining customer nations signed a contract in May 2003 for 180 planes at a total price of €20bn.
The argument for the A400M was that it would be a highly capable and versatile plane, bridging the divide between tactical and strategic airlift. Though it would have a higher payload and range than the C-130, it would have short take-off and landing capability and would be able to operate from ‘soft’ airfields, making it ideal for missions in austere environments that would be difficult for the much bigger and more expensive C-17. With this hybrid capability, European forces would be able to tackle many airlift operations with a single type of aircraft.
In addition, it was argued that the project would strengthen Europe’s defence-industrial base. Up to 10,000 jobs are estimated to be directly linked to the A400M programme, with an additional three to four times as many in indirect supplier roles. The preservation of these jobs, the fostering of technical know-how and the opportunity to develop a defence-industrial capacity independent of the US were compelling arguments for policymakers. Finally, the contract sought to streamline the acquisition process by covering both development and production for a fixed price, shifting risk away from governments and on to Airbus. It was argued that this would introduce badly needed commercial industry practices into defence procurement, in which spiralling costs are habitually encountered. At the same time, customers wishing to withdraw would suffer heavy penalties.
Late, overweight, over budget
The A400M made its maiden flight on 11 December 2009. At that point, first deliveries to customers were not expected before 2013, four years late. Total costs were estimated at just over €31bn, compared with the €20bn agreed price. It was also unclear whether the aircraft would be able to meet agreed performance targets. A 2008 report by the French senate suggested the A400M was up to 12 tonnes heavier than expected, bringing into question its specified range of some 4,500km while carrying a 30-tonne payload (its maximum payload is 37 tonnes). Airbus disputed this finding but admitted in 2009 that the plane was some seven tonnes overweight. At the same time the company disclosed that it had run into trouble with the plane’s back-up navigational system and a terrain-masking capability enabling low-level flight.
The engines and the engine software posed the biggest technical difficulties. The A400M is powered by four TP400-D6 turboprop engines, developed by Europrop International, a consortium formed by ITP of Spain, MTU of Germany, Rolls Royce of the UK and Snecma of France. The consortium managed to overcome the initial problems of designing a turboprop engine with the required power. However, the software to run the engines had to be rewritten for the aircraft to obtain civil certification, even though it had been clear all along that this would be required.
As a result of the delays, difficulties and escalating costs, the contracting parties started negotiations in the second half of 2009 to discuss a new delivery schedule, the aircraft’s capability and how to deal with the cost increases. In essence, three options were possible: first, the customers could decide to cancel the contract given that EADS had not been able to deliver. Alternatively, EADS could walk away from the project to avoid its civil-aircraft business being further undermined by its financial exposure, even though it would have to reimburse payments and pay penalties. The third course was a negotiated solution that would accept the delay, share the financial burden and address the capability concerns. Airbus repeatedly threatened to stop work on the A400M and to reassign engineers to civilian projects. Meanwhile, hints came from some governments that allowing the A400M to fail was not out of the question. If a compromise was to be reached, the key issue would be the apportioning of the losses accrued so far.
The Organisation for Joint Armament Cooperation (OCCAR) is the European procurement agency which is formally the contracting party on behalf of the governments. It commissioned PricewaterhouseCoopers (PwC), the accountancy and consultancy firm, to review the financial aspects of the A400M project. Its report in late 2009 concluded that if EADS’s losses on the A400M were greater than €7.6bn and if there were no price increase, the group ‘would be unable to continue without a fresh source of financing support’ because it would most likely be unable to sustain access to its exchange-rate hedging facilities. This would severely undermine the financial position of EADS as a whole. Cancellation by the customer governments would have a significant negative effect on EADS’s evaluation in the market and would likely harm its credit rating and thus restrict the group’s access to funding. However, PwC assessed that a decision by the company to walk away from the project would be even worse for EADS than a cancellation by governments because of the penalties and damages that OCCAR and the governments would demand. PwC argued, therefore, that continuing the A400M programme was the best option for EADS.
Initially, EADS demanded that the customers provide some €5.2bn in additional funding, a figure that was later revised downwards to €4.4bn. The initial figure was a result of the identified €11.2bn cost overruns, minus cost-cutting measures estimated by EADS to be worth some €3.6bn, and the €2.4bn loss provisions already taken by EADS. In February, governments offered to waive penalties for late delivery, and to provide some €3.5bn in fresh funding. They also demanded a share of future export revenues generated by the A400M – Malaysia is currently the only export customer, with four planes on order, following South Africa’s cancellation of an order for eight aircraft. This was the agreement that was reached on 5 March.
Management errors and technical difficulties
The problems of the A400M project – like those of many defence-equipment acquisitions – reflect both project-management errors and technical challenges. Louis Gallois, chief executive of EADS, acknowledged in January 2010: ‘We made a mistake in accepting a fixed-price contract on a programme with huge technology challenges.’ The original six-and-a-half-year scheduled period between contract signature and first deliveries was ambitious from the outset, and it seems clear in retrospect that EADS and Airbus underestimated the technological challenges and project risk. According to media and research reports from Germany, design and development problems were not treated with the necessary urgency or seriousness within EADS, sometimes not being reported to the company’s top level. The PwC report suggests the ‘budgeting process [within EADS] has consistently and significantly underestimated the cost of the A400M programme, year on year’. Clearly, agreeing to a fixed-price contract did not work to EADS’s advantage because the contract provided no flexibility if technological development ran into trouble. However, EADS is hardly the first defence contractor to have taken on a fixed-price contract for a programme in which there was still considerable technical risk.
The customers also introduced risk, for example, by insisting that the allocation of work undertaken in their respective countries should reflect the number of planes they were ordering. Governments also forced the choice of engine; an alternative bid – reportedly 20% cheaper – came from Pratt & Whitney Canada, part of United Technologies of the US. When EADS expressed a preference for the Canadian engine, France, Germany and the UK signalled that the contract should go to the European consortium. Gallois wrote in 2008 that European governments had ‘insisted on a European engine to support and develop the European industrial structure’.
In addition, customers put in requests for national variations of the A400M. The problematic terrain-masking low-level flight technology requested by Germany is one such example. The UK insisted that the A400M would need to be able to carry its future-generation armoured vehicle, the predicted weight of which had risen from an original estimate of some 17 tonnes to over 30 tonnes. To meet this requirement, A400Ms built for the UK will have strengthened cargo-bay floors and ramps. Requests for national additions have bedevilled collaborative European efforts at producing common equipment, introducing inefficiencies and adding to costs.
Implications for collaboration
Ultimately, governments appear to have decided that the A400M project was too big to fail. Its collapse would have caused job losses, would have severely undermined the logic of international collaboration in defence-equipment programmes, and might even have put the future of EADS in jeopardy – as well as that of Airbus, the world’s largest civil-aircraft manufacturer.
However, the project is likely to harden the perception among industry executives that multinational collaboration often carries a time and cost premium. Airbus chief executive Tom Enders said in February 2010 that the proposed deal provided ‘the bare minimum of what we need to continue the programme’. The A400M would be a burden on the company’s finances and resources for years to come, he said.
At the same time, the problems besetting the programme may have damaged the reputation of Airbus and EADS. The A400M, once delivered, will initially be a somewhat less capable aircraft than originally thought and will have cost considerably more than planned.
In spite of these problems, however, collaboration is likely to remain the only credible way of attaining large-scale capability development in Europe. National needs for improved capabilities for modern operations will persist, yet there is likely to be less money for defence. Governments will find it harder to justify the cost of purely national programmes, but will be reluctant to buy too many strategic assets ‘off the shelf’ from outside Europe. They want to preserve industrial jobs and technology, and also wish to limit their dependency for key military assets on outside suppliers. The travails of Europe’s transport-aircraft project underline the need for better risk management in future collaborative projects.
