A Shift for Defense Contractors

Washington Post staff writers Renae Merle and Griff Witte were online to discuss defense contractors that are now competing for state and local information technology projects.

They write in an article today that as federal spending slows, state and local governments -- flush with cash from rising property-tax revenue and a generally healthy national economy -- are an increasingly juicy target for government contractors.

A transcript follows.

An archive of Renae Merle's articles is online here . Griff Witte's articles are archived here .

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Griff Witte: Good morning everyone, and welcome. We're looking forward to today's chat on our piece in this morning's Business section dealing with the increased attention being paid to state and local contracting opportunities. If you haven't had a chance to read the story yet, take a minute to do that now. Otherwise, let the chat begin!

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Myersville, MD: Greetings,

Do you forsee any mergers or acquisitions between any major IT companies in the next 2 years?

Renae Merle: Yes. There has been a steady stream of acquisitions over the last few years and I don't see any end in sight. There are a few things driving this trend. The government continues to bundle small contracts into large ones. To be competitive, small to midsized companies feel they need to bulk up. Also, small intelligence companies continue to be attractive to large companies that recognize that government spending in that market will continue to increase.

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Alexandria, VA: To what extent does the language and culture of the state and local contracting processes differ from that at the federal level? Do the large firms have to start from scratch with each state and municipality?

Renae Merle: I heard from several companies that relationship building is very important in the state and local market. So in that sense they are starting from scratch. While a large defense contractor will likely have a relationship with the Air Force or Army that dates back decades, they will have to introduce themselves to a state government not familiar with their work. I think that is why some companies said they have to start in smaller state and local markets to prove themselves before pursing contracts with large states like California.

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Falls Church, Virginia: I work for a large defense contractor in the Northern Virginia area. I haven't noticed a reduction in the defense/intelligence workload here. I assume the shift is from other areas of defense to local level issues? What sort of services/solutions are the local gov't contracts for?

Griff Witte: I'm not surprised that you haven't noticed a reduction. Defense, intel and homeland security contracting for the federal government have been and remain businesses where opportunities abound. That's been especially true since 9/11/01. What we're seeing now, though, is a bit of leveling off in the government's spending levels. The wars in Iraq and Afghanistan have eaten up a lot of cash, and the government will increasingly have to reckon with that by cutting programs in other areas that can wait. Some IT modernizations are included in that.

As far as the needs of state and local, they're looking for a lot of different things. One major need they have is to upgrade their IT systems for government services such as health care, public assistance, motor vehicle departments, etc. Many of those systems are decades old, and they've long since passed the end of their useful lives.

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Fairfax, VA: Are partnerships are prevalent in state and local contracts? Do those contracts require small business participation, etc?

Griff Witte: On the state and local level, we're not sure you'll see the same kind of teams you see on the federal level -- where dozens and dozens of players are involved in providing various aspects of a solution. But teaming definitely occurs. As the acquisition workforce shrinks overall -- whether it be at the national or state levels -- governments are making the contracts bigger so they won't have as many to manage. The result is that many contracts are so big that no one firm can do all the work. In those cases, prime contractors are looking for subs. Some small business owners have told us that the state and local markets can be easier to break into than the federal market because state/local is more fractured and there are better opportunities for the niche player.

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London, Ontario, Canada: How come, when reporting the number of U.S. troops in Iraq, they never include the thousands of private contractors hired and paid by subsids of Haliburton, so I've heard?

Ralph L. Smith

Renae Merle: This is a bit off topic but ...

Because contractors are not soldiers. Halliburton and the dozens of other companies with employees in Iraq do not go through basic training or any of the other things that make soldiers different from civilians.

That being said, hundreds of contractors have died in Iraq and myself and others have written many stories that have highlighted that.

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washingtonpost.com: Renae's recent articles are archived here .

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Falls Church, VA: How do you see the contracting environment changing over the next 2-5 years? Will there continue to be consolidations as large companies eat up the smaller players, or will there still be niches for the smaller companies to fill?

Griff Witte: Wish I had my crystal ball handy for this one. I think there's a lot that's up in the air at the moment -- namely Iraq, and the elections. Both are factors that are going to have a big effect on how the contracting biz evolves. If Congress changes hands, I doubt you'd see a major change overnight. But that coupled with a new president in two years and, at some point, a new direction in Iraq, could change the contracting environment substantially.

As far as your question on consolidation goes, as we've said there will likely be quite a bit of it. That's particularly true in fairly fragmented markets such as intel -- and it could become true for state and local markets, if they continue to heat up.

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Olney, MD: Aside from the fact that business is always looking for new markets, do you think that any of the recent push by defense contractors to look to the states for business has anything to do with a fear that a change in the control of Congress and, if it happens the White House, in the future may lead to a tightening up on Federal contracting rules as they pertain to what states may do in programs that operate under Federal grants?

Renae Merle: No, I think those are two different issues. A change in control of Congress will not change the fiscal realities. According to GAO (the Government Accountability Office) and many other independent groups, DOD currently has more weapons in development than it can afford and will have to make cuts. At the same time, states are reporting surpluses for the first time in many years and turning their attention to information technology projects shelved during harder times. That is what is driving many of these contractors to begin turning their attention to the state and local market. I have not heard that members on either side of the isle want to change the contracting rules about what federal grants can pay for. Do you know of some effort like that?

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Albany, New York: How would you rate the capability of state and local governments to make effective IT purchases in this more competitive environment? State and local procurement processes are still mostly written for the purchase of bulldozers and typing paper rather than complex IT systems, and there may be less staff expertise in many smaller governments than in larger ones. What advice would you offer to state and local governments who need IT systems, but want to be sure they get what they need rather than what companies are selling?

Griff Witte: You raise some very interesting points in this question. The federal government has been suffering from a brain drain for years now, with many of its best and brightest jumping ship and heading to the private sector. As this happens, it becomes self fulfilling -- as more work is outsourced, more people leave, and more work has to be outsourced. Eventually, you reach a point where there's not enough expertise left in-house to even know what the government is looking for when it outsources. At the state and local level, there's the potential for the problem to be even more severe. A lot of state and local governments haven't upgraded in many years, and the people who ran the old systems are retiring. In cases like that, it's tough for the state/local employees who are left to know if they're actually getting best value from the private sector. It will be interesting to see whether the current wave of sales results in the kind of improvements the companies are advertising.

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El Paso, TX: Do you see recent 8(a) graduates playing a role in this shift?

Renae Merle: I certainly see no reason why they wouldn't. The large contractors will need subcontractors and some of these contracts are likely small enough for a 8(a) graduate firm to go after. Have you had trouble getting into this market?

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Houston, TX: Your article says that the increase in local and state government contracting activity is due to increased revenues from property taxes. What will happen to contracting activity when state and local revenues decline? Are large contractors willing to accept that risk?

Griff Witte: Great question. My guess is the flattening out that you're seeing now in the real estate market won't hit state/local governments for awhile, if it does at all. The real estate market had obviously been soaring for a long time there before the state/local governments really felt the effects of the boom and started making big purchases. So there's a lag. But state/local governments generally can only spend as much money as they bring in -- if their budgets end up growing less because the real estate market stalls, that could limit the opportunity for the private sector.

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Fairfax, VA: I would like to know the effect of outsourcing and global markets on Federal IT market. I have been working as a consultant in Federal Information Technology Contracting for the last few years. Based on what I observe, a large portion of Federal IT contracting requires clearances. This seems to have the effect of creating a domestic IT market which is sort of protected. What impact do you foresee outsourcing and global IT markets will have on this market in both near and distant future? Will federal IT market get outsourced too in the next may be 10 to 20 years?

Griff Witte: You're right -- IT firms that sell to the government enjoy a level of protection that your average IT firm doesn't have in a global market. The government doesn't want to see its top secret IT work outsourced to other nations. At the state and local level, national security issues are obviously less of a concern. But state and local governments that are deciding which company to award a contract to have something else to worry about -- voters. These contracts are about upgrading government services, but they're also about creating jobs in your state or city. For that reason, I don't foresee a whole lot of outsourcing abroad.

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Alexandria, Virginia: Are there any consulting firms that specialize in helping companies access the state and local government market? Our company just received a mailing from a company called T3 Government Strategies that claims to specialize in this.

Renae Merle: There are tons of consulting firms out there, but I had not heard of T3 until your query. (I just googled them.) I don't know if Input or FedSources also does that sort of thing, but I know they track the market. Before you give anybody any money I was wondering if you have made the rounds at all of the free or cheap events around the Beltway for government contractors. That may be a good way to get a recommendation from someone on a good consulting firm. Maybe you will meet someone who has used T3. Good luck.

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Arlington, VA: Been there, done that. Dealing with state and local governments is way more difficult than dealing with the Feds. They haven't the expertise of dealing with large projects or amounts of money, their procurement and costing rules are written to an incredibly detailed level and they don't understand the burdening and indirect rate structure of federal contractors. To them $100K is a lot of money.

Renae Merle: Yup. As we pointed out in the story, every state and locality does business differently, making it a difficult market to navigate. Also, I understand that they are more likely to require fixed price contracts, shifting the risk to contractors, whereas on the federal level cost plus contracts are common.

Folks, how do you know you have been working in federal contracting too long? When $100K is no longer a lot of money. But for localities operating under balanced budget requirements the numbers matter.

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El Paso, TX: With regards to the follow up question from Ms. Merle's 8(a) answer, our company is in its infancy breaking into other larger state markets outside of the typical defense arena and local utilities.

Like any small company in a niche area, like the border area, we are competing to distinguish ourselves from every other small company.

Thank you for the response!

Renae Merle: I have heard from a lot of small companies that they feel thrown to the sharks after graduating from the 8(a) program. Good luck with everything.

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Renae Merle: Well that's our hour. Thanks for the questions everyone.

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