DealZone

A400M – Running on empty but not running away

February 25, 2010

By Jason Neely

A 20 billion euro project is great, but not if it costs 31 billion to deliver. Most companies don’t walk away from deals that bad. They run.

But Europe’s biggest and now most fraught defence collaboration, the A400M military transport plane, is no ordinary deal.

European countries haggled for years before agreeing on it, despite their desire for a home grown alternative to U.S. planes such as the C-130 Hercules.

Governments in the end wanted the jobs and sophisticated technology.

For manufacturer EADS it was a project so vast the firm overlooked one disastrous clause – it was a fixed-price deal.

The company’s current showdown with governments over the A400M centres on that clause – and the risk that EADS may have to absorb a big chunk of cost overruns now topping 11 billion euros.

U.S. President Jimmy Carter famously cancelled the B-1A bomber in 1977 citing its high costs but European governments have tied each other into the A400M. Hence the current impasse.

EADS is unlikely to simply walk away either, but the two sides could very well shrink the number of planes required.

At least 180 deliveries spread out over perhaps a decade, the very size of the project is EADS’ biggest problem. That’s a long time to work for less than nothing.

Rival BAE Systems could offer a tip or two on squaring off with government over fixed-cost deals.

BAE was forced to take a 750 million pound charge for cost overruns on submarines and spy planes in 2003.

But it demanded Britain shoulder risk in any future deal and has since looked mostly to the United States for work.

EADS will have to take a hit on the A400M, but if it’s wise, it too will seek a deal that safeguards itself from similar disaster in the future.

The company got rich building Airbus planes but has big ambitions in defence, where it has worked mainly in consortia making Eurofighter jets and MBDA missiles.

That ambition, much like its over-budget A380 superjumbo airliner, is now hurting EADS. It’s time for the company to think if not small, then at least smaller.

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