A Growth Path for Emerging Small Businesses

Increasing federal contracting opportunities for emerging small businesses promotes the long-standing policy objectives of the Small Business Act.

The foundation for developing a pilot legislation to support small business can be traced to the Small Business Act of 1953, as amended. The Small Business Act provides:

It is the declared policy of the Congress that the Government should aid, counsel, assist, and protect, insofar as is possible, the interests of small-business concerns in order to preserve free competitive enterprise, to insure that a fair proportion of the total purchases and contracts or subcontracts for property and services for the Government be placed with small-business enterprises and to maintain and strengthen the overall economy of the Nation.

15 U.S.C.631(a).

The Small Business Act also provides that it is the policy of the United States that small business concerns shall have maximum practicable opportunity to participate in the performance of contracts let by any Federal agency, including contracts and subcontracts for subsystems, assemblies, components, and related services for major systems." And finally the Act expressly declares that it is the policy of the Federal Government to "use all practical means and to take such actions as are necessary to reduce the concentration of economic resources and expand competition."

The law is intended to provide small businesses a "maximum practicable opportunity" to compete for and to receive a fair proportion of federal contracts. Additionally and no less important, a key purpose of the Small Business Act is to expand free and full competition and to strengthen the U.S. economy.

Promoting the availability of federal contract awards for small businesses as they grow larger than the start-up and early-stage phases without yet being large enough to compete with multi-billion dollar companies is essential to fulfilling these policy purposes. Full and free competition is not enhanced, concentration of economic resources is not reduced, and the nation's economy is not strengthened when a successful small business suddenly loses eligibility for small business awards and is forced to "compete" against multi-billion dollar enterprises.

These emerging small businesses or, mid-tier companies are loosely defined as seasoned businesses that have been in the federal market for 10 to 30 years or more. Their revenues can range from $10M to $350M and they employ from 100 to 2000 people. They are no longer considered small businesses, but neither are they large in the federal market place. Small emerging companies are often better-positioned than large companies to offer innovation, flexibility, and lower prices. Small emerging companies also have the capacity to perform larger contracts that would not be suitable for small companies. Every time a small emerging company is "squeezed out" of the federal marketplace after becoming ineligible for small business awards, the Federal Government is denied any return on its investment in the early growth of these companies. As a Special Small Business Task Force organized in April 2010 by President Obama forcefully concluded, ?When small businesses are excluded from federal contracts, the Federal government, American taxpayers and the nation's economy lose out."

Industry consolidation and the competitive advantages of multi-billion dollar companies have severely limited the opportunities for emerging small and mid-size contractors.

Over the last decade, the competitive landscape and dynamics of the federal procurement market and in particular the Federal Professional Services Industry have changed drastically. The primary causes of these changes are industry consolidation and the explosive growth of federal procurement spending. Research conducted by the Center for Strategic International Studies (CSIS) reveals that over the past decade there is a disturbing trend toward gradual disappearance of mid-size companies from the Federal Professional Services Industry. The chart on the next page shows that the market share of mid-size companies had eroded from 44% in 1995 to only 33 percent in 2007. Small firms grew from 19 to 21%, but still did not reach the SBA's own goal of 23% SB Prime contract revenue. In addition, numerous studies have shown that much of the small businesses listed in Federal Procurement Data Systems (FPDS) are actually giants that have acquired those small firms. MTA fully supports efforts to help small businesses achieve the desired levels in federal procurement (the 23% set-aside), but we also support fostering small businesses once they grow beyond current guidelines for being small.

Emerging small firms have done what we all want to do. They began small, became seasoned, and grew. The government should as a matter of policy, support and foster such growth since data from Christopher Yukins and other researchers suggest that maturing small businesses produce more jobs than either very large or new companies. Presently, mid-tier firms have nowhere to grow in the federal marketplace. That is not good for the economy or federal agencies that have derived benefits from their relationships with growing small contractors.

The CSIS report observed that from 1995 thru 2007 mid-sized companies performing in the Federal Professional Services Industry space have been "squeezed from above by consolidation and from below by small businesses holding on to their share of the market." The report concludes that how to replenish the middle tier, thereby generating competition and innovation, remains a key strategic and policy issue for the industry." This substantial reduction trend in mid-size company participation in the Federal Professional Services Industry coupled with the notable growth in market share of dominant multi-billion dollar large companies is one factor that should weigh into policy-makers examination of the distribution of firms by size in the Federal Professional Services Industry.

Increased concentration of Federal Professional Services Industry contract awards being performed by large companies stifles competition because mid-size companies simply cannot successfully compete with the largest players. Larger firms have several advantages that make competition between mid-size and the largest firms illusory. Multi-billion dollar companies leverage the talent of well-paid business development and marketing staff as well as teams of professional technical writers and graphic artists that can dedicate their efforts solely to proposal development. Additionally, large size companies can use their expertise to operate in multiple industries. This increases the relative competitiveness of the largest companies in the bidding process. In contrast, mid-size companies have limited bid and proposal budgets and typically do not have teams of individuals solely dedicated to business development and marketing. This lack of infrastructure at mid-size companies constrains their ability to compete successfully against larger actors.

Faced with the reality of these systemic competitive disadvantages, a small emerging/mid-size company that has lost its eligibility for small business set-asides often has to immediately posture itself for acquisition. In a recent Washington Post article, acquisitions of small service vendors defined as deals valued at $50 million or less rose last year 22.4 percent to 71, according to Houlihan Lokey, an investment bank based in Los Angeles that advises on government contractor transactions. That was the highest level since at least 2000, and the firm projects that this year's total will meet or exceed last year's, said Jean Stack, a managing director at Houlihan Lokey.

Competition is stifled when multi-billion dollar companies force mid-size businesses into their supply chain through acquisition after these companies have become ineligible for small business awards. If not acquired, a mid-size company may have to modify its business model to focus on subcontractor relationships with other large or small companies. Being limited to subcontractor roles impairs a mid-size firm's ability to gain project management experience essential for further growth.

In the worst case scenario, a small emerging firm will fail. This shuts down competition and deprives the Federal Government from realizing any return on its initial investment in companies during their early growth.

We believe that passage of H.R. 1812 is critical to establishing a fair and competitive federal contracting environment. The following points address what we believe are the specific areas where H.R. 1812 is misrepresented and misunderstood:

1. Infringement on the 23% set-aside for small businesses: The process outlined in H.R. 1812 ensures that safeguards for small businesses are protected. The decision to reserve an opportunity for a small emerging business to compete is taken only after a government official has determined that none of the small businesses who have expressed an interest is capable of satisfying the requirements or objectives outlined in the Statement of Work or Statement of Objectives. The small business will be able to compete, just as small businesses are allowed to compete for unrestricted contracts today. The existence of this pilot will not lessen the 23% set-aside pie for small businesses but it will come from 77% of the work that is theoretically allocated for large business.

2. Contribution to job growth: The current data addressing job growth among small businesses is collected based upon a general description that a small business is a business with less than 500 employees. Therefore, it is difficult to differentiate between small businesses and mid-sized businesses. However, we are able to extrapolate from recent Economic Census Data to gain some understanding of the relationship between company size, i.e., small or mid-size, and overall employment numbers. Census data from 2008 says that businesses with less than 500 personnel employ 61% of the workforce. However, further analysis of the data indicates that 10% of those companies have annual revenue in excess of $7.3M which could potentially preclude them from competing in the small business category. The remaining 10% of businesses with less than 500 employees have annual revenues between $10M and $20M+ which are the group of companies MTA represents.

We believe the information provided above explains why we need a pilot program similar to that proposed in H.R. 1812. Establishing a pilot program that could eventually be codified into a permanent program for small emerging/mid-sized businesses will provide a path to success for current small businesses when they graduate from their small business status and create an environment that supports the future viability of current and future mid-sized businesses.

Other related legislation

Congressman Mike Rogers (R-Ala.) offered an amendment to Title VIII of H.R. 1540, the pending Defense Authorization bill, which would establish a similar program in the Defense Department. However, that program would provide for federal contracts over $25 million.

Mid-Tier Advocacy (MTA) is an industry coalition that represents a community of small and mid-size firms that provide employment for thousands of people across the United States and across multiple industries that are veteran-owned, service disabled, hub-zone certified, minority-owned and woman-owned businesses.