How mature is the GovCon market?

A few months ago, I was preparing some course material to address corporate strategy in the government contracting space.  I wanted, as almost all business school professors do, to use a case study or two from any one of the famous business schools that produce them.

Out of tens of thousands of case studies, I could hardly find one done about a government contracting firm.  When I asked a former Harvard Business school professor why this was so, he offered that he doubted that many professors producing these case studies thought that government contracting was a “real” market.

The view is more widely held than one might suspect – even in the national capital region.  Many thoughtful members of Congress involved in acquisition policy, senior leaders in the executive branch, members of media, academia, and elsewhere that I’ve spoken with think that the GovCon market is really more of a political process than a “real” market characterized by competition, innovation, and transparency.  Their prevailing view is that if a GovCon firm can figure out the political process and play that game better than the next guy, they win the contract, right? One monolithic buyer served by a few cartels in a closed cottage industry, right?

Maybe fifty years ago, when the GovCon services market truly was a few firms getting directed work from customers they knew well and with little competition. And maybe today still in places - after all, there were 1.4 million separate federal contracting actions in 2012 – and more than a few were likely not done in transparent competition. 

But overall, in 50 years the GovCon market has matured dramatically – even if it is now only leaving what might be seen as its teenage years.

If a “real” market is characterized by traits such as a diverse array of buyers and sellers, many choices in buying methodology, innovation, transparency, fair and not onerous barriers to entry, the availability of capital for investment or mergers and acquisitions, different kinds of capital structures, ownership, governance, and management, then the GovCon market is becoming a “real” market.

GOVCON’s INFANCY

 There is no big bang moment marking the birth of the technology and services oriented GovCon market. Like most complex things, it evolved over time and from a number of different directions. The US government, of course, has relied since the Revolutionary War on private industry to supply key products and even some services. But, government buying for the first two centuries of our existence was overwhelmingly oriented on products – and supplies.  And those items were overwhelmingly bought by the military.

 The expansion of government responsibilities and the advent of accessible computer technology coincided in the late 1960’s. Those complementary trends really launched what we know today as the GovCon market. Prior to that, most government services outsourcing was research and development oriented, and often done through government-sponsored labs, universities with government research contracts, or FFRDC’s such as the RAND corporation.

Some early corporations that later became great local GovCon IT firms, like BDM and CACI, were founded in the early 60’s based on research and analysis, not unlike a RAND but as for profit companies.

In many ways one of my old companies, American Management Systems, was indicative of the birth of GovCon. Five young analysts, formerly “Whiz Kids” in Robert McNamara’s analytics-driven Pentagon, had the crazy idea that they could use modern computing power to analyze and solve business problems – in government and commercially. Thus AMS was founded in 1969 and became one of the first truly homegrown Northern Virginia GovCon companies.

Others followed over the next ten years, including SRA International, ManTech International and others. And semi-locally in the form of companies like SAIC and CACI, who eventually moved their operations to Northern Virginia because of the proximity to the government customer.

THE TODDLER YEARS

The toddler years of the GovCon market, in the 80’s really, marked a rapid maturation of both buyer and seller. The buyer, still overwhelmingly the Pentagon (which was spending 40 percent of the federal budget in the 1980’s, now down to less than half that percentage), was having to figure out how to procure complex services – when almost the entirety of the voluminous acquisition regulations and procurement systems were oriented on buying materials – buying stuff.

The sellers, more of them now, were having to compete – business was no longer won by a previous or somehow privileged relationship with a government client who had a need and would then write the contractor a contract to fulfill that need. Now programs were out for bid, with requirements and specifications (framed in tandem with the consultation of other pre-award oriented advisory government contractors) driving a new transparency in the market.

 In the meantime, the potential of technology was exploding – and the systems research and analytical methodologies that went along with it. New hires that were oriented on technology and its accompanying disciplines flooded into these GovCon companies, professionals with no long government experience but a better understanding of the potential of the possible solutions.

Many GovCon companies of the time, as I remember SRA to be, were a mixture of an older generation of retired government professionals who understood the clients and their problems and a younger mix of solutions experts who understood the new means. Most companies at this stage were still owned by, and founder led. There was not a lot of capital in the space.

CHALLENGES OF YOUTH

Youth, namely in the late 80’s and 90’s, as it always does, provided an odd series of ups and downs – but through it all the industry continued to grow – pushed along by the relentless dynamics of 1) the expansion of government responsibilities and services, 2) the rapidly changing nature of technology and innovation, and 3) the realization within government itself that integrating the confluence of those two trends was not a core competency of government itself.

At the very least the implementation of technology solutions needed to be outsourced to a professional technology and administrative services industry. In the meantime, the ups and downs of the budget, driven mainly by the end of the Cold War and the search for a peace dividend,  prompted several movements that furthered the maturation of the industry.

First, it prompted the first wave of consolidation. The aerospace industry – closely related to the GovCon services industry but still a little bit distinct from it (focused mainly on product and headquartered outside of Washington (Martin Marietta in Georgia – not Bethesda, Northrop Grumman in LA – not Falls Church) - was encouraged by the Pentagon to consolidate in order to better serve a shrinking military products budget.

Many of these aerospace firms saw that within this overall downward trending business environment, the services businesses were on a steadier trajectory. Thus the traditional aerospace firms entered the GovCon services market as acquirers and today have become the biggest services companies in GovCon, all while keeping their traditional aerospace businesses. 

Second, GovCon services firms experimented with diversification – a sound strategy when their principle market had stalled. Traditional defense contractors reached out to the civilian agencies, small and relatively immature local companies started international operations, many tried commercial products and, some turned to the state and local market.

For the most part, diversification was a failure. Structurally, the nature of a GovCon firm – formed as it was around the heavily regulated requirements of government procurement -- made for a clumsy commercial enterprise.

In retrospect all this was good for the industry – and helped it grow up.

The trials of youth had it acquire a new sophistication, much of this new urbanity caused by the M&A industry that sprang up around Northern Virginia and the national capital region – bringing investment banking, M&A law practices, and many new forms of capital.

Up to that point only a handful of GovCon firms were publicly held or owned by outside investors. Now there were many more sources of capital, and funding for deals. The operational maturity and market sophistication of aerospace firms who had been doing business with the government for decades and on very big projects, rubbed off on the industry – which started adopting commercial best practices and speaking in the language of traditional business – albeit with acronyms still making up 50% of the dialogue.  In essence, the seat of the pants character of the local home grown industry gave way to a new professionalism brought in by these dynamics. 

TRAGIC START TO TEENAGE YEARS

Then came the terrorist attacks of Sept. 11, 2001, and the teenage years for this industry.

In the most tragic way imaginable, the primacy of the government role in defense, intelligence, and security affairs returned to the American consciousness. And, the GovCon industry returned to its roots.

But with a new vigor – federal contract actions grew at a 14.5 percent compounded annual growth rate over the next ten years and spending on services went from $130 billion to $340 billion in seven years.

At this point in time not only was defense and intelligence spending exploding, but the next generation of technological possibility was coming to the fore, with advances in stealth, range, precision, space-based real-time digital systems, signals processing, data fusion, cyber and other fields dramatically upping the ante for how government got its mission done.  Health care, taxes, and other government services other than defense were growing at a rapid pace in technological need.

Capital, of course goes where it is needed…..and can make returns. With the massive buildup of the post 9/11 intelligence and defense capabilities to support two wars and oriented on a new threat, capital rushed into the market to support the growth needed to support the government’s new technology and mission ambitions.

A burst of public offerings happened after 9/11 – SRA, Mantech, Veridian, Anteon, Titan, and others. New entrants flooded the field and many small businesses or 8(a) advantaged businesses grew quickly and prompted a heated M&A market from 2004 – 2009.

Private equity firms, a few of which had dabbled in the GovCon market during the mid-90’s consolidation and reset wave, now flooded into the market – including big PE players such as Carlyle, KKR, and others. 

Long established firms like SAIC, Northrop Grumman, and Computer Sciences Corp. formally moved their headquarters to Northern Virginia from California to cement the centrality of the GovCon services market to their businesses. Huge flows of approved foreign investment in the space created hundreds of defense and intelligence companies that were ultimately foreign owned, but required separate U.S.-based boards of directors to oversee their U.S. government operations.  British Aerospace became the fourth biggest GovCon firm.  Non-defense GovCon companies thrived as well, and public and private capital flowed throughout the whole market.

ENTERING YOUNG ADULTHOOD

The end of the wars in Iraq and Afghanistan, sequestration, and contemporary budget fights on the hill brought an end to the teenage years. Even with spending down from its peak, the GovCon market has become a mature young adult of a market.  Large, diverse, competitive, innovative, transparent, it still remains to be seen if the market can continue to mature, and what might prevent that.
Dr. John Hillen is Executive in Residence and Professor of Practice at George Mason University’s School of Management.  He has led several government contracting companies in his career, most recently Sotera Defense Solutions from 2008 – 2013.  He was the Chairman of the Professional Services Council from 2012-13. 

FORTHCOMING:

Part II:  Challenges to Further Maturation.  What Government and Industry might intentionally or unintentionally do that can stop the maturation of the market and arrest progress.

Part III:   A real market?  To what extent is the GovCon market now a true market or a convoluted political process…or if a mixture, what type of mix.  What’s best?