Golden Age of Federal Contracting Is Over

The political paralysis in Washington has dealt crushing blows to the national security establishment. There are no predictable budgets for the Pentagon to map out its weapons wish list, or for contractors to project their future business.

The gridlock has created a policy vacuum, not just in defense but also in energy, immigration and other key areas. This in turn has upended deeply held assumptions of the government-industrial complex. Pentagon leaders and CEOs of federal contractors are perplexed and outraged that issues like national security can’t seem to rise above partisan bickering. The way they see it, the world is falling apart. Congress is only interested in getting reelected in November, and the administration would prefer to keep the country focused on domestic concerns rather than on the geopolitical chaos.

Steep cuts to government discretionary spending began in 2012 and are expected to continue, although nobody can predict what will happen in this topsy-turvy political environment. The Defense Department has a “president’s budget,” which is billions of dollars more than the “sequestration budget” that complies with the spending caps mandated by the 2011 Budget Control Act. No agency has pleaded for relief from the BCA as eagerly as the Defense Department, the largest spender of discretionary federal dollars.
 
The Pentagon’s top generals are still in disbelief that their push to overturn sequestration has been fruitless. Not helping their cause either are the Obama administration’s latest troubles dealing with world crises and deciding what role the armed forces should play. The military is drawing down based on an administration policy to not engage with boots on the ground unless we absolutely, no kidding, have to, points out former Army budget director Ed Stanton, a retired lieutenant general and now vice president of the consulting firm LMI. The military says it can’t meet the current defense strategy with BCA-level budgets, but it is not clear what the strategy is, he says. “As a nation, we are at a standstill.”

The partisan war over government spending has wreaked havoc on the Pentagon’s highly structured planning process that can’t cope with unpredictability. And it has caused turmoil across the vast contracting industry that also seems unable to handle Washington’s fiscal fickleness.

After three years of dysfunction, it might be time for government contractors to admit the business will never be the same.

“I think this is a different time, the worst I have seen in 40 years,” says Michael A. Daniels, long-time entrepreneur and chairman of LMI.

Daniels has made a career of starting, buying and selling government contracting firms, including giant ones like SAIC. Over the past four decades, entrepreneurs like Daniels have built a thriving industry around the federal government, making lots of money for investors. “In government contracting, your revenue was always up, and your profit was up if you knew how to run a business,” Daniels says. “We don’t have that situation anymore.”

A deeply polarized government has been “poisonous,” he says. “The problem for companies and for government agencies is that they don’t know what to do with their money,” and a climate of indecision is not compatible with the business model of federal contractors. “I’ve never seen a period with more problems with forward planning and execution because of sequestration,” says Daniels. “And nobody I know in this town, from Capitol Hill and the administration on down, thinks this is going to change.”

But not all hope is lost.

If the political morass is here to stay, it will be up to the private sector to take control of its destiny by becoming more entrepreneurial and innovative, Daniels suggests. “We have built an enormous structure of science, technology and business in cooperation with the U.S. government. … We need to reinvigorate that. Otherwise this is no longer going to be the place we have known for the past 40 years.”

While budget uncertainty can be a government contractor’s worst enemy, there is also a growing cadre of companies and investors that are not bothered by the political chaos and see the government as a huge target of opportunity.

“Ultimately you need to separate people who are looking to do business the traditional way — getting a contract — from people that are used to ambiguity and really don’t care much about whether there is ambiguity as long as there is an opportunity,” says Jonathan Aberman, a venture capitalist and managing director of Amplifier Ventures.

Financiers like Aberman have been working behind the scenes trying to match startups’ products and services with government buyers. It is undeniable that the politics and current direction of the country are disorienting to many people, he says. “If I’m a government contractor, I find the dysfunction in Congress very upsetting because it dramatically affects my business.”

As surprising at this might sound inside the Beltway, there are businesspeople all over the United States who really don’t care about how functional or dysfunctional government is, says Aberman. “What they care about is whether they can sell something to a customer and make money.”

Investors see the federal government’s $140 billion a year research budget and believe that some of those technologies funded by Uncle Sam eventually could become game changers not just for the military, but for the civilian world. By the same token, it behooves the government to change its stodgy procurement system so it can recapture the spirit of innovation that seems to have been lost.

“The contracting community has to change or it will become roadkill,” says Aberman. To be sure, nobody expects startups to build major weapon systems. But the military increasingly is looking to spend less on complex, ultra-expensive weaponry and more on nontraditional, information-based solutions. “That is why you see a growing number of angel investors in Washington,” he says. “Investors want to get behind technology that can then be put back into the commercial industry and they can make money on.”

Who knows whether the coming age of government contracting will be as profitable as the one that is now coming to an end? But times are certainly a-changing.

Topics: Business Trends, Doing Business with the Government, Defense Contracting