As Federal Contracts Grow, Medium-Size Firms Can't Keep Up
By Zachary A. Goldfarb
Washington Post Staff Writer
Monday, September 3, 2007
For many years, the middle tier of companies in the $200 billion federal services industry was regarded as a source of innovation and productivity. They grew into companies that today are big names in the contracting space -- SRA, Alion, CACI and Mantech.
Despite a six-year boom in government contracting, the next generation of mid-size players is seeing its share of federal dollars erode. Larger companies increasingly dominate the service industry, which helps the government run its computers, analyze intelligence, conduct scientific research and even mop the floors.
With $50 million to more than $500 million in revenues, mid-size companies are too big to qualify for federal dollars reserved for small companies, especially those owned by women, minorities or disabled veterans or members of other disadvantaged groups
But they are too small to keep up with the largest companies, which as a result of consolidation and changing contracting practices have grown and own more of the federal marketplace. A decade ago, a federal services contractor was considered among the 20 largest if it won a few hundred million dollars in contracts. Now that figure is well over a billion dollars.
"Even though the dollars are getting bigger, the relative growth for mid-tier firms is staying put or declining," said Alan Chvotkin, senior vice president and counsel at the Professional Services Council, the trade association of services contractors.
Together, the federal services industry, the hardware industry (weapons, vehicles, etc.) and other contractors experienced an increase in the amount spent by the government to $412 billion in 2006 from $203.1 billion in 2000, according to a report by the House Oversight and Government Reform Committee. More funds now go to big defense contractors for providing hardware for the wars in Iraq and Afghanistan, and their services divisions have seen boosts as well.
In 1995, mid-tier services companies received 44 percent of government contracts, while large firms took 37 percent of the market, according to a study by the Center for Strategic and International Studies. By 2005, mid-tier companies took 33 percent of the market while large firms shared in 46 percent. Small companies' percentage stayed steady at about 20 percent.
Joseph M. Kampf, who sold Fairfax contractor Anteon last year to Falls Church's General Dynamics for $2.2 billion, is troubled by the trend.
"It's important that a market this big . . . not be owned by just a small handful of large companies and thousands of small companies," Kampf said. Many small companies aren't equipped to handle the big contracts they're awarded under the small business program, he said. At the same time, big companies don't provide the tailored service that a smaller shop does.
"You have to have a middle market . . . which are well-developed companies with long histories of service," Kampf said.
Driving the growth of big companies has been a shift in the way government does business. In the past, federal agencies would hold competitions for each project -- specific jobs for which medium-size firms could effectively compete.
Starting in the mid-1990s, government-wide contracts became more popular. Generally, the contracts are so large that only big companies can compete for them. A recent example is the $50 billion, 10-year Alliant information technology contract, awarded earlier this summer to 30 companies, all but a few of them billion-dollar-plus firms.
More recently, agencies seeking to customize their contracts have begun issuing their own awards. Often, several companies will win access to these agency-issued contracts but then have to bid again for specific assignments under the award.
"The contract process is a perpetual process," said Sudhakar Shenoy, chief executive of mid-size Reston contractor IMC.
All told, the new contracting practices raise costs, said Pierre Chao, author of the CSIS report. "Companies have to spend money to bid and win positions on these [agency] vehicles, in addition to government-wide ones, and the agencies have to hire people to administer these contracting vehicles," he said.
The trend has contributed to a frenzy of consolidation among government contractors, thinning the ranks of medium-size firms. The consolidation rate has doubled since 2000.
After the Sept. 11 terrorist attacks and the dot-com bust, investors were lured to the growing contracting industry as a "flight to safety," said Richard Knop, head of the defense and government contractors group at investment bank BB&T Capital Markets, Windsor Group.
Contractors -- in particular defense companies that in the past focused on building planes and tanks -- went public and "became aggressive buyers of services and technology companies," Knop said, adding that there have been roughly 400 mergers and acquisitions a year in the sector in recent years.
In 1995, for instance, General Dynamics received $360 million in federal services contracts, making it the 20th-largest contractor. A decade later, after buying 30 companies, it was the 10th-largest firm, awarded $3 billion in contracts, according to the CSIS report.
Kendell Pease, a General Dynamics spokesman, said the company takes pains to make opportunities available to medium-size firms. "We open up ourselves to show them -- here's what we're doing, what do you have to make this work?" he said.
John Chapel, chief executive of McLean contractor Aviel, which has 400 employees and almost $80 million in annual revenue, said mid-tier companies like his are looking to buy smaller firms or merge with companies of similar size "because of the mass that's needed to compete."
The challenge to medium-size companies can sometimes feel like a whack on the back of the head -- and create unusual incentives to stay small.
With $500 and a personal computer, Enrique A. Tessada, a Mexican immigrant and Navy veteran, created his government contracting shop in 1993. Under a special small-business program to help people from disadvantaged backgrounds, Tessada Associates, in Springfield, grew from $40,000 in revenue the first year to $69 million by 2005.
But making the leap to the next level is proving a lot harder. Tessada no longer qualifies for the small-business program, and his company is having trouble keeping pace with bigger rivals. As a result, "we've been pretty flat this last two years. We've lost a couple of bids we were operating," Tessada said.
CTI of Fairfax, a contractor specializing in translation services, is a small business that years ago was in the middle tier. Its chief executive, Celestino Beltran, has no intention of going back up to the middle tier and missing out on the small-business set-aside.
He recalled his experience in the middle tier as a "rough, rough time."
Beltran added: "We're totally depending on the big guys including us on their team."
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