Reversing the Shrinking Industrial Base

By Mike Ramos, M.SAME

Incentivizing companies to remain as advanced small businesses, without needing to transition to the large fully open competition market, coupled with difficulties for new small businesses to enter federal acquisition, has resulted in a steady pattern of decline in the nation’s defense industrial base, carrying with it risks to innovation, global standing, and national security.

America’s defense industrial base is a critical element to supplying the material needs of our national security and armed services. However, this once-robust body has seen tremendous erosion in the 21st century. There has been a reported 80 percent drop over the past 15 years in new business entrants seeking to work with the Department of Defense (DOD).

Even as DOD spends more, in total dollars, on national defense than ever before, we are seeing a contraction in the number of firms that continue to work with the department. This contrast presents significant problems. A shrinking defense industrial base impacts the ability to meet national security and military posture objectives. This came to light recently with the outbreak of war in Ukraine. The military industrial complex has been strained to supply both our warfighters and our allies with the full breadth of needed supplies and ordnance.

An SAME National IGE Project addressing the shrinking defense industrial base identified two linked challenges that need to be resolved: how to incentivize advanced small businesses to transition to the large business market; and correctly prioritizing emerging small business growth in the federal market. U.S. Marine Corps Photo by Lance Cpl. Jennifer Sanchez.

Pulling back slightly to analyze the prevailing trends shows that the industrial base has been on a steady, and sometimes purposeful, decline in size for decades. And while a retraction could have been expected after the Cold War, we now face consequences at the other end, with too little industry diversification and engagement.

Changing the swing of this pendulum will require solutions that solve the problem holistically and are not just simple exercises in trying to increase overall spending. That is because, ultimately, the issue of the lack of vibrant competition is not about trying to shift the course of an aircraft carrier; we are talking about changing the direction of the entire fleet.

Trend analysis clearly shows that new entrants to the federal marketplace has dramatically decreased since 2000. Why are we having trouble attracting and keeping companies engaged? Simply put, it comes down to how contracts are awarded.

Previous Efforts

Before the shrinking defense industrial base had been identified as a potential National IGE Project for SAME, the federal government had recognized the severity of situation as a potential issue.

Preliminary government efforts can be categorized into two distinct groups of actions.The first group consisted of actions that were aimed to increase the defense industrial base by encouraging growth in the small business market, such as increasing set-aside spending and data tracking. In the case of increased dollars to small business, the government has followed through. Recent 2022 data from DOD indicates that small business utilization increased to 23 percent. This is a remarkable goal, even if the data might suggest that more contract awards are going to a smaller number of firms overall. The second group of actions consisted of research studies aimed at understanding the market dynamics and issues leading to the decline. Numerous publications have been released over the past several years, from studies conducted by the U.S. Army’s Office of Small Business Programs to the General Accountability Office. These reports have found there are multiple issues within the current federal contracting marketplace that reinforce a shrinking base, with ample data to back up that finding across all business sizes.

Contracting Cliff

The federal small business market is where the government prioritizes growing the defense industrial base. We know this because the government purposefully sets high small business utilization goals. In theory, this should promote a growing sector, as the majority of the industrial base is comprised of small businesses. However, the problem with this approach, and why the defense industrial base continues to shrink, is complicated.

Trend analysis clearly shows that new entrants to the federal marketplace has dramatically decreased since 2000. Why are we having trouble attracting and keeping companies engaged? Simply put, it comes down to how contracts are awarded. For good reason, contracts typically gauge the proposing firm’s qualifications to do the work, since the government is best served by companies that do not create undue risk to the work requirements. But what we are finding is that more and more “advanced” small businesses—that is, small businesses that are close to the size threshold—are outcompeting the “emerging” small businesses (typically new or very small businesses) trying to win opportunities.

The problem is not that a larger and more experienced small business is winning, it is that those companies are no longer transitioning to the unrestricted marketplace. They peak, intentionally, at the top of the small business marketplace, creating a logjam.

Historical data tells us that of the small businesses that venture into the large market, only 2.5 percent will still be federal contractors within five years. In fact, from 2006 to 2020, only 7 percent of small businesses transitioned to winning an “other than small business” award, from a total of 2,832 companies. This “contracting cliff” effectively incentivizes those advanced small businesses to languish at the top of the small business market and outcompete new entrants, which limits emerging small businesses from entering, gaining traction, and growing the defense industrial base. Combined with an active mergers and acquisition market, decline of the base is nearly inevitable.

Federal actions to counter the nation’s shrinking defense industrial base have included increased small business
spending, data tracking, and multiple research studies looking at overall market dynamics and issues.
Photo by Lily Chen, Naval Information Warfare Systems Command.
Coalition For Success

In 2021, Mercedes Enrique, F.SAME, President of CMS Corporation, and Fanyi Meng conducted a study (utilizing data from FedMine) that analyzed one of the previously identified systemic bottlenecks, along with potential solutions, in the existing federal marketplace: the lack of transitioning small businesses. This report, published that September, quickly gained traction and would serve as a precursor to the SAME National IGE Project: “Challenges Facing Transitioning Federal Small Businesses: A Proposed Framework and Solution” (with Enrique to serve as initial project lead).

The overarching goal of this still ongoing effort has been to re-ignite an innovative, diverse, and expansive defense industrial base. While basic in theory, it is much harder in practice. There are many competing challenges and potential solutions that must be analyzed and prioritized. Furthermore, solutions need to be industry-wide—requiring contracting and/or legislative changes.

Beyond just growing the defense industrial base, the IGE project also aims to address the two fundamental challenges facing small businesses: incentivizing advanced small businesses to transition to the large business market; and correctly prioritizing emerging small business growth in the federal market. The project team believes these challenges are explicitly linked together and must be addressed simultaneously to create a holistic solution.

The team has had significant success in the months following the National IGE Project being formalized, finding other small businesses (both advanced and emerging) that support the end goals. As a result, this effort would end up creating a new first for SAME: the formation of a consortium of companies that would complement the IGE project and take on advocacy efforts independently. Formed at the end of 2021, the SUCCESS Coalition (Solving the Unnecessary Contracting Cliff for Enterprises to Scale Successfully) comprises 13 advanced small businesses that are pooling resources together to make tangible change in Congress. Along with these directed efforts, a total of 150 additional emerging small businesses have committed their support to both the SUCCESS Coalition and SAME’s IGE efforts, so as to support any Congressional legislation that might be introduced in 2024 and beyond.

The problem is not that a larger and more experienced small business is winning, it is that those companies are no longer transitioning to the unrestricted marketplace.

The coalition spent 2023’s Congressional cycle meeting with members of both the Senate and House Small Business Committees to drive legislative change. Specifically, the group has been advocating and drafting legislation for review on creating a formal small-to-large transition program to break the small business market logjam, in addition to setting new requirements for contracting that would prioritize contract awards to emerging small businesses. This legislative approach builds on the solution identified in the 2021 report, which preceded the IGE project, to create a temporary NAICS code size limit moratorium for advanced small businesses, letting them enter into a formal program sanctioned by the Small Business Administration that would allow them to outgrow their NAICS size standard while still being considered a small business over a four-year period. Based on Congressional feedback, a Rule of Two is being considered, which would ensure that emerging small businesses would also be protected, so that small business awards would not be unduly going to transitioning companies.

Taking the Next Steps

Moving into 2024, the SUCCESS Coalition aims to build on the strength of last year. With strong relationships having been established, there is now ample time to work with Congressional members to find more support, backing, and buy-in for new legislation. Still however, there is much work to be done to find the right solution.

Progress made to date was readily evident by a hearing of the House Small Business Committee held on Feb. 6, 2024. Many of the comments were directly in line with coalition’s strategy points. Progress was also reflected by the small business executives who were asked to testify on the challenges related to being successful in the federal contracting marketplace. The coalition expects to carry this momentum forward into this year’s legislative session.

Michael Ramos, M.SAME, is Executive Vice President, Raymond Engineering-Georgia Inc.; mike.ramos@raymondllc.com.

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