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Why U.S. Contracts For Small Businesses Go to Big Companies

By Gwendolyn Bounds
The Wall Street Journal
November 9, 2004

Cindra Stolk was on the telephone one day in May when her son walked into the office, slapped a fax on her desk, and walked out without saying a word.

Ms. Stolk, chief executive officer of Federal Edge Inc., a small family-run computer reseller in Riverside, Calif., looked at the piece of paper and says she felt "the hair stand up on the back of my neck."

It was a note from the Hill Air Force Base in Utah informing Ms. Stolk that a federal-government contract of more than $600,000 to provide computer equipment was not going to her company, but rather to GTSI Corp., Chantilly, Va.

As part of the government's efforts to help entrepreneurs get a slice of the lucrative federal contract market, this contract had been set aside for bidding by small businesses only. The size standard for "small" differs by industry and contract; for instance, a firm bidding on a telecommunications award can sometimes have up to 1,500 employees while a computer reseller such as Federal Edge or GTSI typically needs 500 or fewer workers to qualify.

With eight employees and $6 million in sales last year, Ms. Stolk's company was allowed to apply. But so was GTSI, which had sales of $954 million in 2003 and employed 685 people as of March 1. "This is small?" asks 49-year-old Ms. Stolk, who opened Federal Edge in 2000 and works alongside her husband and two sons.

That question cuts to the heart of a growing debate over how the federal government awards, counts and monitors its small-business contracts. Each year, Congress establishes small-business buying goals for most federal agencies and for the government as a whole. Contracts get reported into a central database, and the government makes an annual tally of how close it comes to meeting its small-business target. The overall goal is 23% of all prime-contract dollars.

Although there are no legal ramifications if goals aren't met, there is substantial pressure to try, and agencies are encouraged to set aside some contracts for bidding only by small firms. The nation's 25 million small-businesses are the country's economic backbone, paying almost half the private payroll, and have generated the majority of new jobs in the past decade. While the government missed the 23% goal for several years running, the U.S. Small Business Administration announced earlier this year that the Bush administration had met the 2003 target and called it a "victory for America."

Two separate studies, however, have noted that some contract awards reported as going to small businesses have actually been in the hands of large companies. Several weeks ago, the Center for Public Integrity, a nonprofit, nonpartisan research group in Washington, released a report saying that 30% of all defense-contract money reported as going to small businesses and special minority-owned businesses ended up with top defense companies in 1998 to 2003. One business singled out was GTSI for having been the biggest nonminority small-business contractor, collecting $1.2 billion in small-business contracts over the six-year period.

Those findings echo a review completed last year by the U.S. Government Accountability Office, which also found awards to big companies getting recorded as small-business contracts. The GAO said its findings raise "serious questions" about relying on current data to measure federal agencies' efforts to meet the government's overall 23% small-business goal. "Everyone wants to be seen as the good guys to small businesses," says Larry Makinson, the senior fellow at CPI who led its research. "Looking through the data it seems they are cutting every corner they can to get to that 23%."

Controversy surrounding contracting set-asides is nothing new. A Civil Rights Commission draft report in 1986 said 20% to 25% of federal set-aside contracts were going to bogus minority fronts. And there have long been questions as to whether there should be set-asides at all.

Congress didn't set contracting goals for small businesses until 1988. Scrutiny over the parity of award distribution has picked up momentum in recent years as more companies have begun taking advantage of the government's preferential set-asides for small-business bidders. As a result, the SBA has been under increasing pressure to monitor the awards, and last year proposed regulation changes that would strengthen size-certifying policies. Those are still under review.

One of the main issues cited in both studies has to do with federal regulations that have allowed companies to be considered small over the life of a contract -- even if the company grows into a large business or is acquired by a big business.

Of particular concern were long-term government contracts called "multiple award schedules." Essentially, these are big umbrella contracts that preapprove companies to provide goods and services to agencies. The goal is to help agencies make faster, more streamlined purchases. Schedule contracts are maintained through the U.S. General Services Administration and can be extended up to 20 years.

Notably, both studies reported that if a business was certified as "small" when its original multiple award contract was signed, then it was often treated as a small business for years after it outgrew the contract's size standard. In addition to affecting the government's annual award goal totals, this can have implications on the bidding process because larger companies often benefit from economies of scale that smaller rivals don't.

In GTSI's case, the company landed one of these broad multiple-award-schedule contracts to provide information-technology computer products in March 1996. GTSI says it qualified as a small business at the time. But an acquisition in February 1998 expanded the company's ranks; and in its 1997 annual report (filed in March 1998), the company disclosed that it would no longer qualify as a small business for future new contract awards.

However, in 1999 and again in 2002, the government extended GTSI's old IT schedule contract and didn't require the company to update its size standard. Because of that, GTSI still uses this contract to apply for some new awards reserved for small businesses -- such as the Air Force's computer order this May. Today, GTSI is one of the nation's largest resellers of computer equipment to the government.

To mitigate this type of situation, the government has since changed its rules and now requires that size standards be updated when a schedule contract is extended. Meantime, the SBA has proposed requiring companies with these schedule contracts to recertify their small-business status annually. Unless that happens, GTSI spokesman Paul Liberty says the company anticipates recertifying in 2007 "as a large business" but will continue to qualify as a small business for awards until then. Mr. Liberty says GTSI is "fully compliant with government regulations regarding our small business status."

Privately, many small-business owners express frustration with this practice but are reluctant to speak out for fear of jeopardizing future contracting opportunities both on their own, and also as subcontractors to bigger companies. "People tell me this happens all the time, but they're terrified of the repercussions of protesting," says Lloyd Chapman , president of the American Small Business League, a trade group in Petaluma, Calif.

Ms. Stolk was different. After learning GTSI had won the Air Force contract, she immediately faxed a letter back to the contract officer at Hill Air Force Base challenging the award based on GTSI's current size. The next day she received another fax acknowledging her challenge and telling her that GTSI's order had been canceled and would be awarded to the next lowest offer -- which eventually was determined to be Federal Edge's.

GTSI and a spokeswoman for Hill say the GTSI order was canceled because the company made a mistake on its original quote. Ms. Stolk says she intends to continue protesting such awards to bring attention to the matter and is encouraging other small businesses to do the same. "There's too much to lose otherwise," she says.

Meantime, there remain concerns about the general policing of companies' size in other key areas. For instance, the Small Business Administration maintains a list of "small" businesses wishing to do business with the government. It serves as a marketing tool, with government agencies sometimes using it to find small-business bidders.

However, the SBA says it doesn't routinely check to see whether companies on its list are truly "small." Part of the problem is manpower: More than 180,000 companies are on the list and the SBA has only two employees helping maintain it. "Unless there's an obvious error or someone brings our attention to it, it's hard to challenge the information," says Gary Jackson, the SBA's assistant administrator for size standards.

That being the case, it is often left up to business owners themselves to protest to individual agencies if they think another company is competing unfairly. The SBA says it has received 1,408 size protests since 2002; about a quarter of the protests' targets were found to be unqualified as small businesses.

Under the Small Business Act, a penalty of $500,000 or up to 10 years in prison can be imposed on any company that knowingly misrepresents its status as a small-business concern to obtain a contract. But the SBA doesn't readily seek such penalties. For instance, in late 2002 the agency had to remove some 600 names from its list of small businesses, in large part because they didn't meet the size criteria.

No action has been taken against them, Mr. Jackson says, because the SBA believes the erroneous listings came through "computer glitches" or from low-level company employees accidentally checking incorrect boxes that would classify them as small businesses. "It's not as nefarious as it sounds," he says.

Mr. Chapman of the American Small Business League disagrees. He favors prosecution or penalties for some of the companies removed; otherwise, he says, "the harm experienced by legitimate small businesses will be perpetuated."

 
 

 
 

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