For High-Tech Firms, Allure of Defense Contracts Is Tarnished by Red Tape

The Pentagon is by most measures a government contractor’s promised land. Last year it spent $400 billion on products and services.

But even in today’s struggling economy, the prospect of scoring a big defense contract is not enough for many companies to want to do business with the Defense Department. That is especially true among high-tech firms, which, coincidentally, are the ones the Pentagon is most interested in recruiting.

“We must do more to encourage commercial firms that are in the leading edge of technology to supply products to the Defense Department,” says Brett Lambert, director of industrial policy at the office of the undersecretary of defense for acquisition.

The U.S. military is saddled with aging technology and is in dire need of modernizing. Many of the innovative products the Pentagon seeks — particularly IT and electronics — are being financed by the private-sector.

“Among the companies we represent, many of them have zero interest in bidding for defense contracts,” says Patrick Wilson, director of government affairs at the Semiconductor Industry Association.

Some businesses simply don’t want to spend millions of dollars creating an in-house bureaucracy to handle government work. Others fear that their prized intellectual property will be compromised once it is turned over to the government. For many firms, the mountains of red tape are too high to climb.

“They look at the ratio of what it takes to comply with all of our procurement rules, and it’s just not a good investment,” Wilson says. In the high-tech sector, firms compete aggressively for the best engineers, who may not stick around if they have to work on plodding government programs, he adds. “You don’t want to put them on a project that’s going to require four bureaucrats for every one engineer.”

Decades of acquisition reforms have created a maze of regulations that require companies to hire expensive legal staff to help them navigate through. For large defense contractors, new rules are relatively easy to absorb. But small businesses often struggle to cope, says Rep. Jim Moran, D-Va., whose district is home to many defense contractors. “Congress has to reduce the barrier to entry for small and mid-tier commercial firms to inject needed competition and innovation into the defense base,” he says. Moran’s comments may strike many as ironic, since Congress has been blamed for piling on layers of laws that overlap with existing regulations and, not surprisingly, exacerbate the complexity of complying with the rules.

While he calls for change, Moran notes that the Pentagon’s byzantine procurement system exists for a reason. “With all the scrutiny being applied to federal spending, they’re not going to take a chance,” he says. “That’s why it’s so long and tedious and paper intensive. … It’s all about CYA. Very inefficient, but that’s the way of the world as long as there’s no pity for anyone who makes a mistake.”

What critics regard as an industry-unfriendly environment today is a product of the excesses of the post-9/11 era of unfettered military spending. A slew of procurement scandals fueled a regulatory backlash that continues to this day.

Companies that sell commercial products face a real dilemma when they must decide whether to bid on a government contract, says Louis D. Victorino, a partner at Sheppard Mullin Richter and Hampton’s government contracts practice. A perennial concern is intellectual property. In many cases, they have legitimate grounds for worrying. The risks of turning over proprietary technology to the government are high, Victorino says. For second-tier suppliers and below, the cost of complying with the regulations can bankrupt a business, he says. “Many companies realize it will cost them a fortune to set up the bureaucracy they’ll need.”

There are numerous good reasons to become a government contractor, but a company ultimately has to balance the potential gains against the drawbacks.

Rhetoric that calls for greater participation by commercial vendors clashes with the reality of what it takes to sell to the government, says Victorino. He notes that the Defense Department doesn’t speak with a single voice on this issue. While policy makers at the Pentagon support lowering the regulatory barriers, others, including senior military officials, take a much narrower view and advocate for greater government control over technical data rights, for example.

For commercial companies, higher overhead costs are minor headaches compared to the exposure to criminal charges if they screw up and get accused of fraud, he says.

Jonathan Aronie, also a partner at Sheppard Mullin, cites the two-year-old “mandatory disclosure rule” as an example of the increasing complexity of doing business with the government. The rule makes it mandatory for contractors to disclose any form of wrongdoing. Prime contractors already have hired in-house staff to handle this, he says. “What worries me are the small and mid-size companies. … They’re more at risk than the big players” because they may not have the expertise to determine what information they have to divulge. “The government is looking for its first opportunity to nab a contractor that didn’t report what it should,” he says.

Lambert agrees that for companies that have not worked with the Pentagon before, the road can, indeed, be rough. When the Pentagon does manage to recruit vendors from the commercial sector, he says, it ends up draining their innovative spirit by turning them into “defense contractors.”

Topics: Business Trends, Service Contracts, Defense Contracting