Not an easy climb

Graduating from the Small Business Administration's contracting programs should be a time of celebration in the life of a small company growing its way up the federal contracting ladder.

But losing out on small business set-aside contracts and plunging headlong into the mid-tier market is not necessarily an attractive proposition for some small businesses, industry analysts said.

From 1995 to 2004 mid-tier companies lost a significant share of IT services contracting dollars, slipping from 29 percent of federal IT services contract dollars in 1995 to just 13 percent in 2004, according to a study on the U.S. government services industrial base published by Washington-based Center for Strategic and International Studies.

Large companies have taken that business, increasing their market share from 42 percent in 1995 to 59 percent in 2004, according to the study. Small businesses lost 1 percent between 1995 and 2004.

Some small-business owners are not sure that graduating from the SBA's 8(a) business development program is cause to rejoice, said Stan Soloway, president of the Professional Services Council, which funded the CSIS report. Soloway recently spoke with one owner who questioned whether outgrowing the company's small-business designation was a sound strategy.

Mid-tier companies are those that no longer qualify for any SBA designations under the North American Industrial Classification System codes, but are still tiny compared to corporate giants such as Northrop Grumman Corp. and Lockheed Martin Corp. Both have more than $30 billion in fiscal 2005 revenues. The CSIS report uses $1 billion in total revenue as the dividing line between large and mid-size companies.

One reason for a shrinking mid-tier is the frenzied merger and acquisition activity in the federal IT services market, where large companies determined to make their growth projections and enter new markets are buying up smaller companies.

Large businesses are buying both small and mid-size firms, said David Phelps, president and CEO of Merlin International Inc., Denver, an 8(a) IT company on the verge of outgrowing its small-business qualifications.

"That is shrinking the mid-tier," he said.

The CSIS data does not make clear whether the numbers squeeze reflects consolidation in the IT services space, or whether the lack of awarded contracts in the mid-tier is driving consolidation as smaller firms band together or hitch themselves to larger companies to compete, Soloway said.

What is clear is that the firms somewhere between small and large are being squeezed.

"We call that no man's land," said Guy Timberlake, chief visionary officer of the American Small Business Coalition, an advocacy group that also helps small companies partner with large government contractors. "You're no longer under the protection of the small-business set-aside programs, and you are definitely going toe to toe with the big guys."

Companies that have seen the deterioration in mid-tier contract awards are re-evaluating whether they want to outgrow the relative safety of their small-business designations, Timberlake said. "There's a tremendous fear," he said. "All it takes is one contract to push you over the edge, and that can be a good thing or a bad thing."

Phelps is not worried about Merlin. The company had $133 million in fiscal 2005 revenue and expects to reach $200 million in revenue this fiscal year, putting Merlin on a path to lose its last small-business designations, he said.

Merlin, which adapts commercial IT for federal customers, has developed its own marketing, sales and business development functions and has been competing on the full-and-open market almost exclusively for some time, Phelps said. Just 2 percent of the company's revenue over the last six months came from 8(a) contracts, he said.

To grow into the mid-tier, Artel Inc. President and CEO Abbas Yazdani said, companies need sophisticated, flexible business plans. Small companies need a transition plan in place years before diving into solely full-and-open competitions, he said.

Reston, Va.-based Artel has thrived in recent years, its revenue soaring from $10.9 million in fiscal 2000 to $134.2 million in fiscal 2005, largely a result of the company's push to identify and position itself in niche markets where it can focus all its resources, Yazdani said.

A former 8(a), Artel is now a mid-tier services company specializing in IT, information security and telecommunications.

Artel has thrived because it has followed a strategic business plan that identifies with its customers' needs, Yazdani said.

Yazdani's advice to small companies is to follow that model.

"Anticipate [customers'] future requirements and invest to be prepared to meet their anticipated needs," he said.

Yazdani's call for market research and business development was echoed by Merlin's Phelps. If a company can identify need areas, and can build its solutions to fill those needs, they have a better chance of winning prime contracts, as well as being picked up as a subcontractor to fill out a team, Phelps said.

"You have to have a strong business development organization," he said. "That's an expensive proposition, it's a hard one, but it's a 'must have' if you want to grow organically in the federal space."

If companies can't afford to invest in their own market research, they should not be afraid to leverage partnerships to build business intelligence, American Small Business Coalition's Timberlake said.

"You end up having partnerships with other organizations, large and small, who should be part of your market research and business development strategy," Timberlake said.

Staff writer Ethan Butterfield can be reached at ebutterfield@postnewsweektech.com.