Government business attracted big players

The federal IT industry has also become more attractive to M&A activity because it is profitable. "With the rolling up of all these [federal] contracts into omnibus contracts, there is really an impelling need for companies to get bigger and to grow," Knop said. In addition, more capital is available to make acquisitions than there was 20 years ago.

Some experts thought the creation of the Homeland Security Department in 2002 would spur a different type of M&A activity, with less emphasis on services and more on technology, Yanowitch said, because government needed innovative security technology and agencies had the money to pay for it.

“I think we’re just starting to see the beginning of contractors buying technology [companies] with homeland security applications, but that certainly hasn’t mushroomed at all yet,” Yanowitch said. "But a lot of people think that's the next wave of M&A in the sector."

2. Small companies increase and opportunities grow

Many small businesses have persistent cycles of growth and then decline, and those trends are difficult to reverse, according to a study released in December by the Small Business Administration's Office of Advocacy.

But small-business opportunities in the government IT sector have grown steadily since the mid-1980s because of new contract vehicles, small-business set-asides, the growth of mentor-protégé programs and a more aggressive approach by the burgeoning small-business community to gain entry into the federal marketplace.

“The growth of small-business contracting has really come out of small businesses being able to [meet] a particular agency need,” said Lisa Dezzutti, president and chief executive officer ofMarket Connections.“It may be very specific, very niche-oriented.”

The giant integrators that dominated the federal sector 20 years ago now often opt not to pursue a federal contract “because it’s just too small potatoes,” she said. That gives smaller IT providers the chance to jump in on their own or in partnership with other IT firms.

The government has also simplified the procurement process during the past 20 years, said Jim Krouse, director of market analysis at Input. “Vendors find the procurement process incredibly easy, quite a bit easier to deal with now.”

Twenty years ago, requests for proposals and the procurement process were "onerous, time-consuming and costly," Krouse said, adding that vendors now consider the process to be much simpler. "Subsequently, I think it has broadened the competitive market," he said.

Contractors helped simplify the process by showing the government how difficult it was to meet the requirements of some of the larger procurements. "Just by outlining the man-hours to put together a 1,000-page RFP with great detail overall, one has to question the utility and ultimately the effectiveness of a proposal like that," Krouse said.

Many small companies have grown by trailing the big integrators “and eating their bread crumbs,” said Mark Amtower, a federal marketing consultant and founding partner at Amtower and Co.

He said about 75,000 companies were registered to do business with the government in 1987, and the top few hundred got 65 percent of the business. "Now you've got 400,000-plus companies," he said. And although the lion's share still goes to the big integrators, there are many more small businesses that successfully compete for work.

Newly released figures from Input, which tracks government contracting, corroborate that assessment. The percentage of federal IT prime dollars going to large companies increased from 50 percent in 2003 to 65 percent in 2005, Input said. At the same time, small and midsize businesses saw their share of federal contracting dollars decline 15 percent.

But although the portion of federal IT spending with small companies has decreased 15 percent, the number of small companies has increased by 63 percent, said Kevin Plexico, executive vice president at Input. "The money spent by the federal government is getting spread over a significantly larger number of companies, which demonstrates that the barriers to entering the market have decreased," he said.

Amtower said he believes the icing on the cake for small business opportunities was when the General Services Administration combined its Federal Technology Service and Federal Supply Service into the Federal Acquisition Service in 2005. That means "fewer acronyms and more action," he said.

Another milestone in the history of small companies' growth came in 1996 when Congress passed the IT Management Reform Act, also known as the Clinger-Cohen Act. The new law directed all federal agencies to have a chief information officer and adopt best management practices. It also authorized agencies to enter into multiagency IT contracts, further paving the way for small-business growth.

"It was wildly successful in changing the way government approaches the acquisition" of IT, said Paul Brubaker, who helped draft the legislation when he worked for then-Sen. William Cohen (R-Maine).

3. The great Y2K dilemma kicks off a new millenium

Few people worried about the approaching turn of the century in 1986. But by the early 1990s, CIOs and other technology experts had spotted a major flaw in computer software: most programs recognized and rendered years only by their last two digits. So unless there was a massive code correction, computers would render 2000 as 00, which could also mean 1900, and that would create chronological chaos for computing and statistical data. Some technicians feared computers' inability to distinguish between the two years would shut down systems altogether.

The feared crisis, called the Year 2000 problem or Y2K, threatened not only government agencies, such as the Internal Revenue Service, but also all major industries, including banking, manufacturing and transportation.

CEOs saw Y2K as a ticking bomb, but many small and nascent IT contractors saw opportunity. They became solutions providers of Year 2000-compliant operating systems and software. And they scrambled for lucrative government contracts before Jan. 1, 2000.

“Anytime a company that has any brains sees an issue like Y2K rearing its
ugly head, you know they are going to jump all over it,” said Lynn Bateman, a retired publisher of regulatory information publications and former government contracting consultant. “Y2K was something that everybody jumped on the bandwagon for,” she said.

Then-Sen. Daniel Moynihan (D-N.Y.) introduced legislation to set up a matching grant program to provide relief to state governments struggling to adjust their computer systems. The Y2K State and Local Government Assistance Programs Act of 1999 called for the federal government to pay $2 for every $1 a state would spend to remediate its systems.

In addition, the National Governors Association posted an instructional primer, "What Governors Need to Know About Y2K," on its Web site that covered economic and liability issues related to states' Year 2000 preparedness.

IT companies worldwide spent billions of dollars to examine all of their application source code to look for the Y2K bug and fix it. Airlines, for example, raced to become Y2K compliant, fearing that the entire air transportation system would be grounded if computers read 00 as 1900. As New Years approached, many utility companies switched off their main computers and resorted to backup systems that they could manually program.

Bateman said that when the calendar turned over to Jan. 1, 2000, the perceived problem “turned out to be a big flop” because there were no major problems or crashes, even with systems that had not been reprogrammed. Power remained on, airplanes flew on schedule, and the world went on to greet the new millennium, which purists insisted was still a year away.

Y2K did have a positive effect by stimulating business in the federal sector, Bateman said. "Anything that stimulates creativity is good for the government. When the commercial sector is the impetus, then the government automatically benefits. And when the government benefits, the contractors benefit because the government wants solutions to its problems. And Y2K looked like a big problem."


4. Ill wind blowing again? More oversight is expected

In 1986, the FBI launched Operation Ill Wind, an investigation into corruption by government and military officials and defense contractors. The operation resulted in the conviction of Melvyn Paisley, assistant secretary of the Navy,who was found guilty of bribery, improper contracts and diversion of contracts to a firm he secretly controlled. The operation also led to the convictions of a deputy assistant secretary of the Navy and a deputy assistant secretary of the Air Force.

In all, Operation Ill Wind produced about 70 convictions involving a half-dozen major defense contractors, some smaller defense contractors, employees, consultants and approximately a dozen government officials.  As a result of the scandal, Congress passed the Procurement Integrity Act in 1988, which introduced new restrictions on the procurement process and procurement officials.

Some procurement experts think lawmakers are poised to initiate a new round of reforms following recent scandals surrounding former Rep. Duke Cunningham (R-Calif.), lobbyist Jack Abramoff and his friend and former GSA chief of staff David Safavian, and former defense contractor Darlene Druyun.

“The environment we’re entering into now is reminiscent of the environment that was kicked off by the Operation Ill Wind scandals [when] you saw a real crackdown on government contractors,” said Dave Nadler, a partner at the law firm Dickstein Shapiro. “In the last two or three years, we have seen a litany of ethical lapses that have caused and will continue to cause Congress to crack down on government contractors.”

The increased oversight could result in more companies and individuals losing the right to do business with the government, he said. "The more that you investigate, typically, the more you find, and companies that are found to have engaged in ethical lapses are likely to be investigated, prosecuted and suspended from doing business with the government," Nadler said.

Sanctions such as suspensions and debarments are designed to protect the interests of the United States, Nadler said, but "they are pretty draconian remedies."

Nevertheless, he added, it's reasonable to expect a continuation of suspension and debarment activity as a result of more oversight and investigative activities.

“Nothing will bring a government contractor to its knees faster than the threat of being suspended or debarred,”Nadler said, “because it literally can drive a company out of business.”