Small Firms Seeking Federal Contracts Face Uphill Climb

Pentagon officials are fond of saying that small businesses are critical engines of innovation that not only are essential to the military but to the larger U.S. economy. According to recent government statistics, however, the Defense Department awards fewer contracts to small firms than it is obligated under federal guidelines.  

In 2007, approximately $269 billion in total Defense Department contracts were awarded. Of those, about $55 billion, or around 20 percent, were prime contracts to small businesses. That falls three points short of the statutory goals for the  federal government to purchase at least 23 percent of all its goods and services from small  businesses.

Because the Defense Department purchases about two-thirds of all goods and  services the federal government buys, its purchasing practices greatly affect the success of federal procurement policy favoring small businesses, said a Rand Corp. study that was commissioned last year by the Defense Department. The Pentagon has had “mixed success” in meeting the procurement goal for small businesses, the study noted.

A recent industry conference on contracting opportunities for small businesses illustrated some of the challenges that small, disadvantaged firms face as they try to break into the arcane world of military contracting.

Several small business executives at the conference complained that the Defense Department often comes up short on its promises to increase participation by disadvantaged firms. A case in point is information technology contracts. Of several dozen contracts recently awarded by the Army, only eight were given to small businesses. There are no plans so far to increase the share of IT contracts that are awarded to small firms, said Simone Jackson, associate director of small business programs at the Army Contracting Command.

David Mugrage, president of Maintenance & Inspection Services, said that government rules often contain pitfalls for small businesses.

When a small company wins a prime contract, it may have to team up with a larger firm to share the workload. But that small entity must perform 51 percent of the work. If it is unable to do so, it could lose that contract. That hurts small companies, Mugrage said.

Part of the problem is that many contracts are structured so that only large corporations are capable of taking on the work. Under a practice known as “bundling,” agencies consolidate multiple contracts into a single bid. “Such bundling has been identified by the president and congressional leaders as a leading impediment to small business participation in federal contracting opportunities,” the Rand study said. “The prevalence of such practices in the Defense Department and other  federal contracting is difficult to determine.” One estimate of bundling contends that more  than half of Defense prime contract spending is on bundled contracts, according to Rand. “The Defense Department’s own data on bundling are lacking,” said the study.

Mugrage said that federal agencies should consider breaking up some of the larger jobs into smaller contracts. But he gives credit to the Defense Department for making a considerable effort to educate government agencies and large corporations about their obligations to subcontract work to small businesses.

Another reason why small businesses are coming up short of their 23 percent share is that in many instances government agencies “miscode” large contractors as small companies.

The issue came under the spotlight recently following a story by The Washington Post that reported that in 2007, $5 billion of federal contracts that had been coded as having gone to small businesses actually went to large companies. The U.S. Small Business Administration confirmed the Post’s numbers and noted that in 2006, SBA’s own analysis of contracting found $4.6 billion in miscodes.

The SBA office of the inspector general said in a report that one of the “most important challenges facing the Small Business Administration and the entire federal government today is that large businesses are receiving small business procurement awards and agencies are receiving credit for these awards.”

SBA Administrator Sandy K. Baruah attributed the miscoding problems to a “recertification rule” that took effect in summer 2007. The rule requires small businesses with federal contracts to recertify their size if they merged or were acquired, and to recertify their size a minimum of every five years on contracts longer than five years.

In some cases, businesses have won contracts when they were small, but then grew, merged, or were acquired by large firms and were still recorded as small businesses, Baruah said in a statement. The agency estimates that at least $10 billion in incorrectly coded small business contracts will be cut from federal rolls in the near term as a result of the new rule.

The IG report said, “The main reasons contracts to large businesses have been incorrectly coded as small business contracts relate to data entry mistakes, reliance on incorrect data, and a failure on the part of contracting officials to verify business size reported in Central Contract Registration.”

Tracey Pinson, director of small and disadvantaged business utilization at the office of the secretary of the Army, said many contractors may not have accurately reported their size. Her department has put processes in place to prevent such mistakes from happening again, and she is constantly reminding employees of the issue, she said at the conference.

The Defense Department has also fallen short of its goals for “service disabled veteran owned businesses.” It is required to set aside 3 percent of its contracts for such enterprises. It missed the mark last year by more than half, awarding $1.9 billion, or 0.7 percent, to such firms.

Maj. Gen. Robert Radin, commanding general of the Army Sustainment Command, said he would like to rectify this, but his agency’s efforts to find such companies have been unfruitful.  “We have worked our butt off on this, but it is still lagging,” he said.  

It is often challenging for the Army to find qualified small businesses, he said. And an added difficulty is that many contracts are too large for smaller entities to handle.

The challenge is how to shape procurements so that small firms can better compete against large corporations for contracts, he said.

Rose Wang, president of Binary Group, a small information technology consultancy that does work for the military, said some government practices that are meant to assist small businesses can actually hurt them.

If a firm wins a $20 million contract that is reserved for small companies, it could suddenly cease to be considered “small” by the government’s standards, simply because of the contract’s size. It could find that it is no longer eligible for contracts that are reserved for smaller enterprises, Wang said.  

While $20 million may represent a hefty sum for many small business entities, they must still pay employees and purchase materials. They might have to repay creditors. After doing all this, they could have little money left to reinvest into the company if they are precluded from bidding on more contracts that are meant for small firms.

“If you are awarded one set-aside, it could take you right out of the small business arena,” she said. “[That] is hurting the small business community in the long run.”  

Wang’s company has matured through military contracts and her experience has been mostly positive, but the Defense Department still must work through these issues, she said.

Still, there are opportunities. Marlene Cruze, principal assistant responsible for contracting at the Army Aviation and Missile Life Cycle Management Command, said her organization plans to add billions of dollars worth of small business contracts during the next several years. But only a limited number of firms can meet her department’s needs, as there are few who know how to make missiles.  

Kathryn A. Condon, executive deputy to the commanding general at the Army Materiel Command, said, “If I had a crystal ball, I truly think in the future the area where we are going to grow is probably in communications and electronics.”

Maj. Gen. Dennis L. Via, chief of the Army Communications and Electronics Life Cycle Management Command, said that there will be significant opportunities in vehicle maintenance, as the Army will be investing heavily in vehicles during the next several years.

Pinson said that one bright spot for small businesses will be the construction work associated with base realignment and closures. As many of the Army’s units relocate, there will be many construction opportunities for small businesses. Fort Bliss, located in Texas, is one example. It is gaining 20,000 soldiers. Facilities must be built to accommodate them, she said.

But small companies face many uncertainties in the current economic climate. Christian Lundblad, a finance professor at the University of North Carolina at Chapel Hill, said the economy could negatively affect firms that need loans for their every day expenses, as obtaining credit could become more difficult than in years past.

In spite of the shaky economy, Lundblad said that if some of the fiscal stimulus package that is planned by the next presidential administration ends up in the form of government expenditures, funds are likely to trickle down to small contractors.

Topics: Defense Contracting