How 'healthy' is the GovCon industry?

In late May, I had the honor of participating in an outbrief by a class at the Industrial College of the Armed Forces (ICAF). Their study was on the government services sector, particularly that portion supporting the Defense Department, and sought to address two key issues: how important the sector is (or isn’t) to the department’s missions and whether it is healthy or not.

The class was a mix of acquisition and non-acquisition officers and also included civilians from the Homeland Security Department. On the question of the importance of the industry, this diverse and impressive group was unambiguous. Their conclusion after months of research, site visits and more, was that a healthy and vibrant services sector—cutting across the entire spectrum of capabilities—was essential to mission execution.  And on that point, I, and most people I know, would fully agree.

To assess the industry’s health they reviewed the publicly available filings of four firms, spent time meeting with top Wall Street bank officials, and studied both market analytics and Porter’s Five Forces theory. Here, their conclusion was also unambiguous. Despite the budget downturn, the industry is competitive and healthy. And while their research was sound and their conclusions logical, this is where the discussion got most interesting.

How do you define “healthy?” By some Wall Street metrics, firms that have strong profitability despite a market downturn are considered healthy.

But it’s not clear to me that the chosen metrics really tell the story.

Many experts point to companies, like Lockheed Martin, that had excellent earnings during a very difficult budget year. What is often missing from those assessments, however, is how the company achieved what they did.

In Lockheed’s case, the company was forward-thinking and spent several years preparing for a downturn they knew was on the way. They sought new market opportunities through targeted acquisitions. They eliminated thousands of jobs and dramatically cut other costs. As such, they were able to demonstrate strong profitability despite the budget reductions affecting them.

But are they really “healthy?”

How much deeper can they or other companies cut without losing key capabilities? How much longer can companies perform at a high level in a market frequently driven by low price rather than quality? After all, market volume is one thing; market quality—the ability to innovate, improve, invest and be appropriately rewarded for doing so—is an entirely different matter.

And by many measures, those quality factors are largely missing in today’s government services market.

This is not just an academic problem. It is a practical application of government policy on the market. We see it all the time with the dominance of lowest price, minimally technically acceptable, contract awards, unrealistic and deleterious employee compensation caps, and continued efforts by some inside DOD and elsewhere to both commoditize and de-commercialize the services sector.

And regrettably, because some of the financial sector’s analyses tend to focus on short-term financial results and trends, they often ignore the factors that drive long-term company health in a real way.

Beyond quality, other factors determine the relative health of a market. For example, no one argues the value of our small business programs or the great value small businesses bring to the department and to the economy.

But when the Air Force pushes as much systems engineering and technical assistance (SETA) work as possible to small businesses, even beyond the nearly 40 percent in small business awards already being achieved, principally because of the Air Force’s poor performance on small business awards in virtually every other segment of its spending, it’s hard to define that market as “healthy.”

Similarly, in program management and acquisition support, small business awards across the government have grown by nearly 200 percent in just three years—strongly suggesting that a priori decisions based on numeric goals rather than strategic thinking are driving the market, thereby creating significant challenges for the bulk of the firms competing.

Is that a healthy market?

Such strategies not only disproportionately impact “other than small businesses” that specialize in certain types of work, but also pose a risk to the very small businesses that are winning work today. What happens to them tomorrow when they can no longer compete in their specialty because they have outgrown the small business size standard and work continues to be set-aside exclusively for small business? Is that a healthy economic or market model?

Services today account for over half of all DoD contract spending and over 60 percent of all government contract spending. Yet, real understanding of the dynamics of this diverse industrial base, and the impacts of a range of government policies and behaviors, remains sadly limited, both in the acquisition schools (ICAF’s efforts aside) and in the operational components.

Indeed, as my fellow panelists and I made clear to the ICAF students, it is not even “an industry;” rather, it is an amalgam of industries cutting across numerous areas of capability. And each segment is experiencing different, and at time conflicting, dynamics.

Is it a “healthy” sector?  By some measures, definitely. It continues to play numerous vital roles across government missions, is growing is some key areas, and as government missions become ever more complex, will necessarily continue to grow. By other measures, however, the answer is far less clear. In the end, the government, like any customer, benefits from a truly healthy supplier base. Thus, it’s time to pay attention to the measures of health that matter most, in both the near and long term.