Incumbents ruling less of the day in federal contracting

The Obama administration’s push over the last eight years to inject more competition into the federal procurement process seems to have resulted in two major changes across the vendor community that are only now becoming clear.

First, the incumbent win rate dramatically dropped over the last year.

Second, contractors diversified into other markets, including state and local and commercial sectors, at a more aggressive rate than in the recent past to deal with the shrinking federal procurement pie.

“This gives a strong indication that competition is increasing and possibly driving down pricing and profit percentages on federal contracts,” stated the 2016 federal contractor survey sponsored by Grant Thornton released on May 30. “Companies should be looking at their current pricing techniques to determine if adjustments are necessary to win greater percentages of proposals.”

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Rich LaFleur, a partner Grant Thornton and co-leader of the government contracts industry practice, said in an interview with Federal News Radio, the win rate for incumbents dropped to 54 percent in 2016 from 75 percent in 2015.

Additionally, win rates for companies bidding on new contracts — those without an incumbent or ones that weren’t previously awarded — dropped to 26 percent, the lowest rate over the six years of the survey. For instance, companies reported a 36 percent win rate on new contracts in 2011 and 35 percent win rate last year.

“My clients tell me federal awards as an incumbent or not continue often to be determined by lowest-price technically acceptable (LPTA) bids,” LaFleur said. “They see decisions as being more arbitrary. They see more capricious awards made on LPTA instead of best value. This is perhaps having an impact on how important being an incumbent is.”

The concern over the government’s use of LPTA remained unchanged despite efforts by Defense Department officials to instruct contracting officers and other acquisition professionals to use it only as appropriate.

Respondents continued to say the use of LPTA by both DoD and the civilian sectors is pushing down costs and profits of contracts.

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“There’s a notion that at least in the past, government contractors are wasteful or very profitable at expense of citizens and taxpayers is supported by the data. I think 85 percent of those respondents are earning 1 percent-to-10 percent profit before taxes,” LaFleur said. “Yes, 11 percent say they are earning over 10 percent profit, but that’s 1 in 10 contractors. There are solid returns being made off of government contracts, but not anywhere in true technology where margins are 30 percent-to-50 percent higher off of software sales.”

Concerns over LPTA have pushed Congress to be more prescriptive in the use of this approach. Lawmakers passed a provision in the 2017 Defense authorization bill trying to limit the use of LPTA for technology and professional services contracts and requiring DoD to justify its use.

Now, two House members, Reps. Mark Meadows (R-N.C.) and Don Beyer (D-Va.), on June 23 introduced the Promoting Value Based Procurement Act of 2017. The bill aims to require civilian agencies to use specific evaluation factors, similar to those DoD now is supposed to be using, when deciding if LPTA makes sense.

The Grant Thornton survey also found 51 percent of the companies say more of their revenues came from multiple award indefinite-delivery, indefinite quantity (IDIQ) type contracts last year.

This isn’t surprising as agency spending on these types of contracts increased by $5 billion to $111 billion in fiscal 2016, according to Bloomberg Government.

One of the most interesting findings in the survey is about 60 percent of the companies, especially those in the mid-range $50 million to $100 million in revenue, expect to be involved in a merger or acquisition in the next five years.

“What wasn’t surprising that half of those companies involved in M&A were using 5-to-7 times the cash flow to determine the price,” he said. “What was little shocking to us was we saw 25 percent of the M&A transactions were 9 times the cash flow. So the question is why are the deals priced so high? It could be the competition for the company or even the high degree of value on diversification that companies place. We’ve seen transactions around cyber and data analytics come in at 15 times the cash flow.”

LaFleur said the survey also found an uptick in employee stock ownership plan as a favorite exit plan. He said firms like the strategy because it gives ownership to a broader group of employees, which is useful when you have one founder out of the group who’s interested in selling, but the entire ownership group is not interested.

Overall, LaFleur said federal contractors are optimistic about the current state and future of the federal market.

He said wages increased by 2.3 percent on average, and there is a low amount of employee turnover, meaning companies have a stable workforce so they are looking for ways beyond compensation to boost retention and keep employees motivated.

“Despite some uncertainty, companies successful in managing their businesses,” he said. “Given the respective amount of profitability, 66 percent say they are growing. This will continue to be a strong and stable industry. What will be interesting is how the change in the White House and any additional spending on infrastructure and so forth will impact the survey in the future.”