Cost vs. Value: Which Is the Better Metric?
The development and delivery of every product or service risks experiencing problems, from a delivery driver taking a wrong turn to fighter pilots getting sick while flying advanced aircraft. However, expecting and preparing for these setbacks can help business executives navigate even the most challenging obstacles, and, in turn, keep their earnings, reputation, and client relationships intact.
An article published in April’s Popular Mechanics caught my eye, comparing the cost of two aircraft recently acquired by the Defense Department: the F-35 Lightning II and the CH-53K King Stallion, a new cargo helicopter being built for the Marine Corps. As a Marine Corps veteran who holds a degree in aerospace engineering, this comparison immediately captured my interest. While describing some highly advanced technologies that are imbedded in the aircraft, the author focuses on the cost per aircraft, or per unit cost, which are higher for the King Stallion than for the Lightning II. I must say that simplistic metrics such as per-unit cost are a poor indicator of the true value of a defense program.
Anyone with a passing interest in the defense industry or national politics has likely heard of the F-35, also known as the Joint Strike Fighter. Manufactured by defense giant Lockheed Martin, the F-35 is designed to replace several types of older aircraft and equip the armed forces of the United States and several key allies. The F-35 program has become notorious for cost overruns that have made it the most expensive weapons system in history.
Over the course of the F-35’s development, observers continually emphasized the cost per aircraft, often comparing it to other, less expensive types. Predictably, as the program matured and end-users committed to buying more aircraft the cost per airframe dropped. The most current cost estimate for the F-35 is somewhere between $80 million and $100 million per aircraft. In contrast, the CH-53K King Stallion helicopter, also built by Lockheed Martin, comes with a sticker price closer to $140 million.
Reporting that a relatively boring cargo helicopter costs more than an advanced stealth fighter may attract clicks but this comparison ignores several important factors. Developing a new aircraft, or any complex machine for that matter, incurs tremendous one-time costs known as “non-recurring engineering” or NRE in industry parlance. NRE costs are table stakes for building the machine and change very little in relation to how many machines you plan to build; it costs the same to design and test a machine whether you plan to build one or one-hundred.
When calculating the true cost per unit of a defense program NRE costs must be spread across the number of units acquired. In reality, it is very likely that the NRE costs for designing a cargo helicopter based on a proven design are actually far lower than for the most advanced fighter plane in history. However, the CH-53K suffers from a much smaller volume than the F-35, about two-hundred rather than the over 3,000 F-35s that Lockheed Martin expects to build. Obviously cost per unit is a complex and potentially misleading metric.
While cost must always be considered, especially when the taxpayers are footing the bill, value is a more appropriate metric. We must remember that these technologies , the F-35, the CH-53K and countless others, are ultimately intended for one solemn purpose, to fight and win battles. What is the value of a battle won? What is the cost of a battle lost? The value of victory and the cost of defeat are both immeasurable.
We must find a way to measure the value of defense programs that recognizes both the incalculable value of victory and the cost of defeat. The Marine Corps, backed by the Department of Defense and Congressional oversight have determined that the capabilities provided by the CH-53K are superior enough to drive value and worth the nine-figure price tag per aircraft. The Marine Corps executed a contract with Lockheed Martin in which these capabilities will be developed and the value of the program delivered according to an agreed upon schedule and budget. Here we see the truly appropriate quantitative metrics for a defense program, that is, adherence to cost and schedule estimates in delivering the specified capability.
The Department of Defense and constituent services must obviously concern themselves with the costs of their acquisition programs. However, total program cost and per-unit cost are only part of the picture. Effective program management, manifested as delivering the specified capability on-time and on-budget, forms the other equally important part of assessing defense acquisition. Rather than breathlessly reporting to the public that a cargo helicopter costs more than a stealth fighter jet, the more accurate and equally compelling headline should focus on the delays and cost overruns that are apparent in both programs; to do otherwise is comparing apples and oranges. For its part, Lockheed Martin must play an active role in managing the public perception of its programs. Before exploring what Lockheed can and should do, we must first understand why programs like the F-35 and CH-53K present such a challenge.
Managing Perceptions and Expectations
Regardless of how the true value of a program should be assessed and reported, Lockheed Martin must contend with how its various programs are in fact perceived by customers and other stakeholders. Conventional wisdom states that “the customer is always right.” Further, explaining to a concerned client why their concerns are irrelevant and unfounded is not a viable business model. What can Lockheed’s headaches with the F-35 and CH-53K teach us about client management?
An examination of the defining characteristics of these two Lockheed Martin programs provides insight:
- Intense public scrutiny. These two programs are highly visible to the public. Further, the programs are subject to Congressional oversight conducted by elected representatives who need to answer to the voters every two or six years. Understanding and, when appropriate, responding to public commentary is critical.
- High price tag. The per unit and total program costs for these two aircraft are well into the billions of dollars, yet even the smallest business program likely means the world to someone, somewhere. Assessing price against costs and value is necessary.
- Highly complex value proposition and product. The F-35 is arguably the most advanced fixed-wing combat aircraft ever-built and the CH-53K is one of the most advanced helicopters ever built. Lay observers may find it difficult to fully understand why these two aircraft are so important to the end user. For instance, President Trump famously suggested that he would consider purchasing additional F/A-18 Super Hornets from Lockheed Martin’s arch-rival Boeing, due to cost concerns, showing that stakeholders at any level can have trouble understanding the value of the product. Having a cogent and readily available statement of value will ease or eliminate misperception.
- Diverse and demanding user base. Much like the failed TFX aircraft project of the 1960’s, the DoD intends the F-35 to fill many different roles across numerous organizations. Delivering an aircraft intended to be used by three U.S. Armed Services as well as several key allies means keeping many constituencies happy and satisfied at once.
By following these best practices, and educating customers and the public, companies can accurately estimate the demand for these technologies, and they can properly assess the value provided. In turn, companies are better able to navigate the whirlwind that often comes from media and public scrutiny. Highlighting the alignment between the end user and the technology puts cost in perspective and shifts the discussion to the more appropriate question of value. Such perspective is vital given the investment of public funds and the advanced technological characteristics involved in these programs. Ultimately, communication and consistency is key. Highlighting the value of the program furthers its success.