What MBB was playing with was the "Neuen Kampflugzeug", a single engine variable wing design, that if memory serves was to be powered by an F100 engine. Of which the Germans supposedly wanted, or claimed to want 600 (I have my doubts to put it mildly). Compared to Tornado, it is relatively simpler and lighter and one presumes cheaper (back in 1981 when Tornado was offered to Greece unit cost was 17.5 million dollars, at the same time the F-18 offer was 13.11 million and Mirage 2000 13.65)
There are certain obvious questions raised from this of course.
1. Why Britain was kept out of the program? My favourite answer: Because it is still part of AFVG. How this was managed? Give Dassault the lead of airframe development and Rolls or Bristol the lead on engine development as originally proposed. End result "Tornado" is effectively Mirage G8 with British engines and electronics. Or ACF if they decide to ditch the variable wing as the French did after initial testing. Jaguar never happens TTL instead what becomes Hawk is also bought by France (and Germany) as well as a trainer. No Mirage 4000, Mirage 2000 possibly happens as a lower cost complement to G8, sorry Tornado, after all it start out as Delta 1000 for export. More fun is likely down the 1980s, for example for a while the Germans were apparently quite interested on ACX powered by F404 (the idea was France would get a M88 variant and Luftwaffe an F404 variant) but Dassault could not privately fund its part due to Mirage 4000 costs. If that is not around...
2. If the Brits are out and the Panavia bird is kept cheaper and simpler do the Canadians, Dutch and Belgians stick with it? I think the Dutch likely do. Less certain about Canada and Belgium. Dassault may well get the Belgians to buy French as in OTL. Canada... how much is on offer industry wise and does it suffice?
3. The so called deal of the century has ceased to exist. The Dutch are out as they are buying alt-MRCA. The Belgians if not in the project are likely to buy Mirages, they nearly did in OTL. The Norwegians and Danish alone are less than 150 aircraft. So no agreement either that if USAF buys the winner of LWF they'll consider the same. How much does this affect the USAF actually going forward with the program? Counter-argument F-4 and F-105 still need to be replaced and F-15 is... pricey.
A few remarks :
1. VG has many draw backs, like the weight and the complexity which augment the cost of production and the cost of maintenance. I think an alt-AFVG without VG (in ACF style) will give you (roughly) a buying price 5% lower and maintenance price 5 to 10% lower.
2. After the whole F-104 "Widow maker" PR fiasco, Germany all but banned new single engine military planes (I even think it's a law) in their Air Force. That's why the Alpha Jet had 2 engines (Hell, even the Franco-German UAV in development have twin engines, much to the distress of the French who think the UAV will be too big to export).
So even if MBB's demonstrator is a single engine, the final product for Germany will be a twin-engine.
3.
If MRCA ... Tornado isn't developed would Germany & Italy go for license built F-16's as a cheaper option and commonality with the USA, Belgium, Denmark, Holland and Norway?
For the same reasons than 2., Germany won't buy F-16, but it's a strong possibility for Italy. I think the most probable American fighter in the German Air Force is the F/A-18, as the F-15 is still air-to-air only at the time.
4. I highly doubt that Germany and Italy, even by pulling their resources together, have the technical know-how to construct a first line fighter by themselves, at least in a realistic time frame. Developing and constructing a first line fighter is one of the most difficult engineering task at the time (second only to space exploration). Not only one need to possess every brick of knowledge to make an airplane, but you also need to know how to make those parts work perfectly together. And what was the most advanced airplane that either country developed on their own, the Fiat G.91 15 year prior. The step is simply too big.
Of the other 4 members of the F-104 replacement team, Canada is the only one with more know-how than Germany and Italy because they developed the Avro Arrow. But they destroyed everything and dispersed the research team, so it's really a stretch.
So, the six countries either need to buy an existing (or in development) fighter, or attach themselves to a country with the know-how, in the western world, their was (and still is) only four (USA, UK, France and Sweden). I think the deal of the century is still on, with Italy added to the group of four. Germany and Canada will buy the F/A-18, with a slight possibility for the AFVG.
5. I like the possibility of a continued AFVG (with or without VG to limit costs), specially if it's carrier capable (like the French wanted). But there are many problems with the continuation of the collaboration from the French point of view, even with your of task's repartitions. France, since the end of WW2, spent billions upon billions to catch up technologically. For the sake of simplification, there are 3 main area in the construction of an airplane, the air-frame and the wings, the electronics and the engine(s). On the air-frame and the wings, Dassault had catch up during the 50's and 60's, if anything they needed to be better than average because they have a weaker engine. On the electronics, Thomson-CSF (now Thales) is catching up and it's new generation is competitive, the main draw-back is the size of the noses of the french fighters due to the weak engine(s) and costs considerations. On the engine(s), SNECMA is still sub-par and will only fully catch up with the M-88, but, not developing the M-53 will set back SNECMA by, a least, a decade.
So, to keep the French on board, you need to still give the lead for the air-frame to Dassault, ensure SNECMA get enough new competences to keep them happy and keep the possibility that the electronics are developed, partially, on a national basis like OTL Jaguar. So nothing complicated at all
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6. The Jaguar was originally developed as a supersonic trainer with a secondary light attack role. During the end 60's, France and the UK found out that the supersonic trainer role was only marginally interesting and the canceling of the AFVG ensured that the light attack role became the main role of the Jaguar. The Hawk used the same engine than the Jaguar and (I think) some of it's downgraded avionics, so an outright cancelling of the Jaguar might, at least, delay the Hawk.
My take is that there was a market for a light attack/recon aircraft in Europe at the time (Mirage 5 in Belgium, trans-sonic Alpha Jet in Germany, later AMX in Italy, ...), even if Dassault have some aircraft on the same segment (Mirage 5 and some versions of the Mirage F1). The Jaguar might be more successful if Bréguet doesn't go bankrout in 67 and Dassault forced to buy it, specially if you give Germany some stakes in it's development.
On the Hawk, I can see it being jointly developed by the UK and France in place of the Alpha Jet. Whether Italy or Germany buy it, I don't know, specially for Germany with the two-engines rule, but they might develop an alt-Alpha Jet together.