Market Watch | Federal contract policy squeezes mid-tier players

Life continues to get tougher for middle-market federal suppliers. Executives and company owners in the federal technical and professional services business have sensed a significant change in the demographic profile of this market since the mid-1990s. Large companies and small businesses have gained ground at the expense of those companies in the middle.

Factors driving these changes are well known and include contract bundling; proliferation of large, multiple award, indefinite-delivery, indefinite-quantity contracts; implementation of agencywide enterprise architectures; IT infrastructure standardization and centralized buying approvals; and the continuing success of the small business setaside programs.

Additionally, when large aerospace and defense prime contractors look to acquire other companies, they typically cast their nets not at small businesses but at that shrinking pool of mid-sized companies.

Should the government be concerned about this and, if so, what actions might help? And what can the emerging companies do to succeed in this market?

A recent study by the Defense Industrial Initiatives Group at the Center for Strategic and International Studies includes a statistical analysis of the federal professional services market's demographics. The report provides statistical evidence of the distribution of federal prime contract dollars over time and breaks federal services contractors into three categories: large companies with revenues of more than $1 billion, small companies that meet federal small-business parameters and mid-sized companies.

The study examined the share (by percentage) of federal prime contract dollars directed to each of the three segments from 1995 to 2004. The large segment share increased from 37 percent to 49 percent, while the mid-sized segment declined from 44 percent to 29 percent, and the small-business share grew from 19 percent to 22 percent.

Federal programs that help small businesses to grow continue to have strong political and public support. However, government should reassess to better understand the full impact of small-business programs and overall acquisition activities, on itself and its contractor base ? not to create more programs but to determine what refinements to procurement guidelines and goals might help stop the shrinking of the mid-sized companies pool.

Balancing quality and cost, many government projects could be best accomplished by mid-sized contractors.

These businesses are capable of full-and-open competition and often have distinguished professionals, domain expertise and subject matter knowledge that may exceed that of all other companies.

Displacing these high-quality mid-size companies to meet small-business quotas or as part of a bundling exercise can be costly to both the government agency and the taxpayer. Additionally, it diminishes the stockholders' equity value and reduces the number of good-quality companies eligible to become publicly traded or attract private investment. Some of the best technology for federal applications is developed by mid-sized businesses.

The cycle of nurturing, then destroying companies needs re-examination, including government requirements that recommend annual size re-certifications for historically awarded contracts. Federal procurement policy should not first nurture development of a small business only to begin to disqualify it for success, once it's grown to mid-size.

Recognition of these issues by the legislative and executive branches can provide a first step to developing a better federal acquisition framework, and one that does not overlook the importance of the mid-tier segment.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hlhz.com.