Government Contracting: Under Pressure

Kwesi Rogers
President & CEO
Federal National Payables, Inc.

This article was published in the July 2011 issue of the Commercial Factor, a publication of the International Factoring Association.

The words of the Roman lawyer, scholar, and orator, Marcus Tullius Cicero, referring to some of the most threatening problems faced by that once great, long-fallen empire seem to presciently describe our Federal Government’s current imperatives. “The budget should be balanced. Public debt should be reduced. The arrogance of officialdom should be tempered, and assistance to foreign lands should be curtailed, lest Rome become bankrupt.” Those words and the fierce budget debate surrounding them nearly caused in ancient Rome the type of budget impasse that caused our Federal Government to shut down in 1995 and threatened it the first half of 2011.

Shrinking the Budget

Our elected officials succeeded in avoiding a shut down this year but the intense budget discussions will continue for quite some time. One of the results of the Federal Deficit is a Federal Government Contracting Industry that is under pressure. Allow me to put the state of the Government Contracting Industry into perspective for you. In fiscal year 2010 contract spending fell for the first time since 1997. If you are not familiar with how the Federal Government Procurement engine works this may not be an impressive fact at first glance. Consider, however, that unlike private sector budgets primarily derived from profit driven motives, Federal budgets are driven by the “use it or lose it” rule. Just by way of their own inertia, federal budgets tend to increase by at least 2% to 3% annually. The average annual increase in federal budgets from 2000 to 2010 was just shy of 6%. So, with the down-tick in 2010 and the clarion sounding for budget reform, one would logically ask one’s self where the opportunity lies for factoring providers to the federal government?

The government will almost certainly rely upon small businesses to provide more innovative solutions more quickly and, most importantly given the federal government’s recent procurement preferences, less expensively than can government employees or large corporations. The nimble, expert, low overhead and highly driven, contractor that approaches and solves the government customer’s challenges in new and innovative ways is generally the small undercapitalized business. Even in this difficult budget environment the government will continue to maintain its position as the largest buyer of goods and services in the world. Our government will continue to procure goods and services from America’s small businesses. Furthermore many of the programs that the government will target for cuts will be the large programs that require large businesses to provide the solution. Many small businesses will flourish in this environment and in many cases will require specialty financing to fuel their growth.

Pricing

According to Grant Thornton’s 16th Annual Government Contractor survey, government contractors report a decrease in profit margins from the previous year. If you were to interview a high ranking government official and you asked what drives the government’s buying decisions that official would almost certainly respond with “value”. However if you were to interview a number of business people who earn their living by selling goods and or services to the federal government they would likely tell you that the government has recently been making awards that were clearly based almost entirely upon price. Though squeezed in their margins, most would admit that government contracting offers the efficient provider a very stable customer who prefers to issue long term contracts. At first glance these are reasonable trade-offs. However government contracting demands that management teams navigate complicated regulatory environments and burdensome reporting requirements. These requirements are becoming more intense at a time when the government is demanding its contractors tighten their belts and become more cost competitive than may be sustainable. The continued squeeze on margins has created a Darwinian competitive field. Companies that are slow to recognize the changing environment will cease to exist and those that survive to fight another day will often be weakened and unattractive to conventional lenders. Tough award battles, thin profit margins and turnaround plans will provide many opportunities to factors that understand the industry.

Insourcing

Just a year ago, if you were to ask a government contractor his greatest concern, he would surely reply, “Insourcing”. It was just about that time, you may recall, that I reported The Obama Administration had made Insourcing a priority. The Insourcing policy establishes that inherently governmental work should be performed by federal employees and not vended out to private contractors. The Administrator for Federal Procurement Policy at the Office of Management and Budget stated that the Obama Administration’s 2011 budget proposal will rebalance the relationship between government and its contractors through more oversight and Insourcing. The 2011 budget proposed adding nearly 20,000 new civilian and military personnel to the Department of Defense and spending $158 million at civilian agencies to hire over 10,000 acquisition personnel to perform work previously done by contractors. It was assumed that acquisition support and information technology jobs would represent about a third of the jobs the government planned to Insource.

Allow me to bring the threat close to home. Let’s use the same example I used last year. You hypothetically have a factoring client who does $10,000,000 in annual revenue with the federal government and has approximately 75 employees providing information technology support and acquisition support services. There are real-life examples of companies like the one I just described losing 50% or more of their billable employees to Insourcing. The aforementioned circumstance would place any client under stress and would threaten to put many out of business. Increasingly aware of the hazards to the small business community and the faltering national economy, The Department of Defense, considered by many to be the most aggressive supporter of Insourcing, is putting on the brakes. Not only are agencies altruistically and politically attuned to the damages, it also begins to appear the government has come to understand that Insourcing does not save money. It actually costs more in both the short and long terms if they replace contractors whose rules of engagement allow the government varying levels of flexibility to increase and or decrease the contracting activity and do not burden federal payroll with employee benefits and other costs inherent to an employee-based workforce. While this recent caution by no way means Insourcing is no longer relevant, it does suggest Insourcing may not have the impact this year that it did last year. Any sign that the Insourcing threat is dying is good news for small business and all of its stakeholders.

Regulatory Environment

In preparation for this article I decided to take an informal survey. I asked the participants to name the industry that has recently been required to provide the government with compensation information for their top executives while being subjected to additional regulatory requirements in an environment of deteriorating profits. Not one of the parties surveyed named the Government Contracting Industry, though many named the banking industry. Indeed, government contractors share this plague. Dick Duvall, Holland and Knight’s National Government Contracts Practice Leader summed up the assault on the federal contractor thus, “There are some significant bureaucracies that seem to grow more invested in finding wrongdoing with each passing year.” 

The government continues to impart strict regulation and increased enforcement activity upon the contracting community. As of December 24th, 2007 a contractor code of ethics and conduct was inserted into all federal contracts with a value in excess of $5,000,000 and a performance period in excess of 120 days. The code requires contractors to make disclosure to the agency’s Office of Inspector General and the contracting officer if the contractor has reason to believe that a principal, employee, agent or subcontractor has committed a violation under the Federal Acquisition Regulations. The government has also decided to place more emphasis on the Federal False Claims Act. While falsifying claims to the government is an obvious violation, merely not complying with some of the complex rules could lead to false statements and lead the government to charge the company and its principals under The False Claims Act. To avoid devastating consequences, small business owners must dedicate more of their resources to compliance. Any factor that endeavors to provide financing to government contractors should be steadfast in their due diligence to assure they are providing financing to a management team that understands what is required of them as a government contractor and has the ability to manage and assure their company’s compliance. Should you find yourself financing a company whose principals willfully violate regulations, proceed with the knowledge that the consequences are often crippling if not terminal for the contractor and will more than likely expose you, the factor, to losses.

In Closing

Unless and until our “empire” goes the way of Cicero’s, the federal government will remain the largest buyer of goods and services in the world. The days of 6% annual budget increases are gone for now and last year’s contraction – sure to be followed by slower growth - will impart pain and suffering among a portion of the contracting community. However I believe the nation’s small businesses will flourish in this environment providing cutting edge solutions to a nation that must become increasingly efficient and exploit innovation and technology. It is also my belief that the factoring community will play an increasing role.