Why the federal contracting mid-tier is bulging

Most federal contracting professionals wouldn’t be surprised that small businesses gained U.S. government market share in 2014 at the expense of large vendors, thanks in large part to the growing use of small-business set-asides. What they may be surprised to learn is that mid-tier federal contractors gained market share too. In fact, the mid-tier gained more.

Mid-tier contractors grew their share of federal awards by 2.7 percentage points, to 28.4 percent in fiscal 2014 from 25.7 percent in fiscal 2013. The smallest companies, with annual contract obligations of less than $25 million, grew their share by 1.5 points. The top tier, comprising companies with $500 million or more in annual contract dollars, saw their share decline by 4.2 percentage points.

BGOV selected the thresholds dividing the tiers based on discussions with market participants. There’s no standard definition of tiers in the federal market. By using contract obligations, the definition of mid-tier contractors may include companies that would be considered large if commercial revenue were counted.

The number of mid-tier contractors, those with $25 million to $500 million in annual contract dollars, grew despite the rise of small-business set-asides and the competitive might of the large primes. The number of mid-tier companies grew by 120 and their combined contract dollars increased to $125 billion in fiscal 2014 from $118 billion in fiscal 2013.

The sudden improvement in fortune for mid-tier companies comes as federal contract spending has shrunk 18 percent, and the number of vendors has fallen by 21 percent, in the past five years.

Multiple-Award Contracts Key to Mid-Tier Success
Mid-tier contractors face unique challenges competing for federal dollars. Most are too large for small-business preference programs, and they must battle large vendors’ hefty marketing budgets and extensive past performance qualifications.

The biggest contract vehicles for mid-tier vendors are multiple-award contracts (MACs) for technology and professional services. The General Services Administration’s IT Schedule 70 is the largest MAC, followed by NASA’s Solutions for Enterprise-Wide Procurement IV (SEWP IV), Navy SeaPort-e and GSA’s Mission Oriented Business Integrated Services (MOBIS). Definitive contracts for professional services are also very important for mid-tier companies.

Mid-tier contract obligations from these four MACs increased to $7.7 billion in fiscal 2014 from slightly less than $7.5 billion in fiscal 2010.

Creative Destruction in Federal Contracting

Several factors explain the excellent mid-tier performance. Mid-size contractors form and keep strong ties with top customers, and leverage long-standing relationships into adjacent markets. About 53 percent of mid-tier companies in fiscal 2010 were still in the mid-tier in 2014. Greenbelt, Md.- based SGT Inc., for example, gained ground by sustaining order flow from its main customer, NASA, and generating orders from a new customer, the Transportation Department. (You can examine SGT’s and other companies’ trends using BGOV’s Contracts Intelligence Tool.)

Some large contractors are now mid-size, measured by contract obligations. A number of companies, including Triwest Healthcare Alliance Corp., KBR Inc. and BP Plc, slipped into mid-tier status for different reasons:

Triwest lost its big “Tricare West” Defense Department health insurance delivery contract in 2012 to UnitedHealth Group Inc.
KBR’s revenue declined quickly, along with that of other military contractors, with the end of the Iraq war.
BP was suspended from receiving federal contracts in 2012 following its 2010 Gulf of Mexico oil spill. This suspension was lifted in March 2014.

Multiple-award contracts (MACs) helped propel 478 small businesses in fiscal 2010 into the mid-tier of fiscal 2014. For example, Aaski Technology and Adams Communication & Engineering Technology were small in 2010 but each collected more than $100 million in orders through the Army’s Rapid Response Third Generation contract in 2014. Such MACs have a limited pool of competitors for orders.

Some mid-tier companies benefit from small-business preferences. Wholesalers and IT resellers operate on an employee-based size standard set by the Small Business Administration, rather than a revenue-based size standard. Alaska Native Corporations retain small-business preferences even as mid-tier or large-tier companies. The largest mid-tier vendors of 2014 include reseller Mythics Inc. and Alaska-based Afognak Native Corp.
Other mid-tier contractors are riding the surge in new federal spending for health care and renewable energy. MetLife Inc. won the $1.8 billion Tricare Dental Program Services contract in 2011 that is currently spending out more than $300 million annually.

Stuck in the Middle
It’s hard to become a top-tier contractor. Just 15 mid-tier companies in 2010 were large vendors in 2014. Even maintaining mid-tier status is no easy task. About 646 mid-tier companies, or 41 percent, dropped into the small tier during the period. In the current budget environment, even maintaining market position is no small victory.

One of the key barriers to becoming a large vendor may be the restrictive past performance conditions agencies place on bidders for tasks on contracts such as GSA’s OASIS. Few mid-size vendors will have the requisite history of successful performance in multiple market segments to bid on complex tasks.

What’s Ahead
If agencies continue their recent success with small-business outreach — and the Top 20 Federal Opportunities indicates that they will — look for a larger number of small contractors moving up to mid-tier status. Those companies will need to amass an outstanding performance record if they are to survive when they lose their preferential status as small businesses.
As large companies’ contracts decline, the bulging mid-tier may be a good place to hunt for acquisition targets. CEOs who toiled to build successful mid-sized vendors may find being an attractive M&A target is the easiest way to break into the top tier.

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