New DOD contracting rules put small businesses in harm's way

In the weeks since Defense Secretary Robert Gates announced policies reforming the way the Pentagon spends its money, defense contracting firms are wondering what the new acquisition rules, outlined in a memo dated Sept. 14, and the accompanying budget cuts mean for business.

Perhaps the biggest uncertainty hovers over the small-business community that thrives on defense contracting activity. In fiscal 2009, small businesses garnered $96.8 billion in federal prime contracts (or 21.9 percent of the total), and $63.9 billion came from the Defense Department, according to the Small Business Administration’s 2009 Procurement Scorecard. Small companies account for 20 percent of DOD procurement contracts and more than 30 percent of DOD subcontracting opportunities, according to Business.gov.

Without a doubt, a crackdown on DOD contracting could deal a blow to small business. What’s more, the potential impact goes far beyond the viability of a few organizations. These companies are driving the national economy by creating 65 percent of new jobs, according to Ashton Carter, the Pentagon's acquisition chief. So a blow to small business could send shock waves through an already deeply troubled financial system.

“Small businesses are, by nature, the least able to weather significant market shifts,” said Alan Chvotkin, executive vice president and counsel at the Professional Services Council, a trade association for service contractors.

To combat such a scenario, the government — including DOD in its newly released acquisition reform guidance — is pushing programs designed to protect small businesses. They are at the center of a new directive from President Barack Obama designed to jump-start economic growth by allocating $30 billion in lending and $12 billion in tax breaks for small businesses.

But will this be enough?

The new cuts Gates has ordered aren’t small. At 10 percent per year for the next three years, his mandate to cut spending on contract services isn’t a one-time hit. The first year could mean relinquishing jobs; the second and third years could prove harder to find costs to shed, according to a recent white paper from research and consulting firm Deltek.

“Further cuts to indirect labor may be difficult or impossible," the white paper states. "And the successive cuts in the direct labor base may cause some rates to rise to uncompetitive levels. Some firms may find themselves in such a disadvantaged market position that they can no longer win business at all,” which could prove fatal to the companies.

Lost business could hinder the Pentagon’s goals of improving competition. “Competition is a major source of productivity in the defense industry, as it is in commercial industry,” acquisition chief Carter said at a Pentagon briefing Sept. 14. "And this guidance gives our [contract] managers some further direction in how to obtain real competition."

Despite the grim outlook, the guidance for acquisition reform does outline specific measures for protecting small businesses. Carter has ordered reviews of high-value contracts and small-business set-asides for multiple-award contracts used for acquiring services. He is also calling for increased outreach and directing DOD acquisition executives to emphasize the use of small businesses.

Furthermore, the shift to service-based contracts could favor the flexibility that small businesses can offer. Such agility would be essential to their survival, and at least one small-business executive is confident that adaptable companies can remain solvent.

“Some small businesses are niche players, so if their program gets cut, they see the negative impact,” said Carl Houghton, vice president for strategic planning at Intelligent Software Solutions. “It’s really about having diversified customers and the ability to adapt rapidly and get past the transition.”

Deltek's white paper also outlines suggestions for another feature that is essential to survival: preparation. Proactively assessing the company's health, planning for what to do with assets and bolstering partnerships could all help fortify small businesses.

“It has been said that ‘luck is what happens when preparation meets opportunity,’" the paper states. "Service support contractor firms that prosper over the next few years will need all three.”