How Sequestration is Affecting Government Contracts

By: Jordan Stivers

At the end of 2012, there seemed to be one term that Americans heard on the news more than any other – the “fiscal cliff.” The much-discussed “fiscal cliff” really boils down to another term – “sequestration.”  In 2013 sequestration specifically refers to a section of the Budget Control Act of 2011 that was initially set to begin on January 1, 2013 as an austerity fiscal policy.  The budget cuts were postponed two months thanks to Congress’ passage of the American Taxpayer Relief Act of 2012, until March 1, 2013 when the budget cuts went into effect. The cuts in spending authority are approximately $85.4 billion during fiscal year 2013, and there will be similar cuts for the years 2014 through 2021.  The Congressional Budget Office predicts that the total federal outlays will continue to increase even with sequestration by an average of $238.6 billion a year during the next decade. http://www.cbo.gov/publication/43907

While the purpose of sequestration is to reduce the federal debt and improve the country’s financial situation, the deep cuts may be having a negative effect on the economy.  The budget cuts are hurting small businesses that contract with the government, and the economic health of small businesses is essential for a strong economy. A recent Boston Post article addressed the hardships currently faced by contractors who are coming to terms with a changed acquisitions market. The author writes that “large and small, local defense contractors – faced with canceled military contracts and fiscal uncertainty owing to government sequestration cuts, are aggressively pursuing new commercial markets and overseas customers to save jobs and boost sagging revenues.”http://web.governmentcontractors.org/content/news/Americans_some_contractors_feel_sequester_woes.aspx

The Boston Post article quotes the President and CEO of Oasis Systems of Lexington, Massachusetts, a company that provides technology and consulting services to the Department of Defense.  He says that “the people we compete with won’t be here in five years if they do not adapt and change and go after new markets…The [Department of Defense] market is shrinking, and what usually happens is, when its shrinking, everybody doesn’t just get smaller – the weaker players and players who can’t adapt just get crushed.”  The article explains that Oasis Systems’ own plan for living to fight another day in the shrinking market for Department of Defense contracts entails adapting its tech savvy to serve Fortune 500 companies, hospitals, schools and banks nationwide, and making investments in areas such as cyber-technology, and also shedding nearly 75 employees this past year.  http://web.governmentcontractors.org/content/news/Americans_some_contractors_feel_sequester_woes.aspx

Other defense contractors are trying to survive by finding new business in other countries.  According to Chris Anderson, President of the Defense Technology Initiative, with sequestration in effect for the past three months, larger defense contractors are now looking to expand contract relationships with foreign governments. In addition to Oasis Systems, other Massachusetts defense firms that are in search of new business and therefore looking overseas include:  Textron Systems, which won a $113 million contract to build armored vehicles for the Afghan National Army and is pushing for more foreign deals; iRobot, which has $7.2 million in new contracts in Brazil and is exploring other South American and Asian markets; and Raytheon Corp., which is on the verge of a $2.1 billion air defense system deal with Oman.  http://web.governmentcontractors.org/content/news/Americans_some_contractors_feel_sequester_woes.aspx

In early March, right after the sequester went into effect, many large law firms who deal with government contracts issued bulletins discussing the possible impact the budget cuts would have on government contractors.  For example, on March 6, 2013 Pillsbury law firm issued a client alert titled “Sequestration is Here – Now What Happens to Government Contractors?” http://www.pillsburylaw.com/publications/sequestration-is-here-now-what-happens-to-government-contractors.  The alert states that just before the sequester took effect on March 1, 2013, the Office of Management of the Budget (OMB) issued broad guidance on how the sequester should be administered, including how agencies should approach acquisition.  OMB stated that “agencies should ensure that any contract actions are both cost-effective and minimize negative impact on the agency’s mission to the extent practicable.” As for new contracts, OMB instructed that agencies “should only enter into new contracts or exercise options when they support high-priority initiatives or where failure to do so would expose the government to significantly greater costs in the future.”  Pillsbury predicts that as a result of this, contractors may face longer lead times until award of contracts for procurements that an agency deems lower priority.  Also, agencies may cancel solicitations previously issued, weighing that certain contract actions are not cost-effective during this time of austerity.  http://web.governmentcontractors.org/content/news/Americans_some_contractors_feel_sequester_woes.aspx

For contracts currently being performed, OMB stated:  “Agencies may also consider de-scoping or terminating for convenience contracts that are no longer affordable within the funds available for fiscal year 2013, should no other options exist to reduce contracting costs in these instances.”  Also that agencies are to evaluate the “costs and benefits of such actions, and appropriately inform and negotiate with contractors.”  Based on this OMB guidance, Pillsbury recommends that its clients who are contractors should do their utmost to communicate with the Contracting Officer on each of its contracts to ascertain whether the agency intends to terminate part or all of a contract. The contractor should make its case against any proposed cuts, but be prepared to provide advice to the agency regarding restructuring work under the contract to minimize monetary impact to the contractor while maximizing delivery of goods and services to an agency.   http://web.governmentcontractors.org/content/news/Americans_some_contractors_feel_sequester_woes.aspx

Despite the fact that sequestration is undoubtedly impacting most small business government contractors, the negative effects of sequestration are felt less by a few large contractors.  In an article titled “6 Degrees of Sequestration” on www.marketplace.org, Nancy Marshall-Genzer writes that while many government workers are being furloughed due to sequestration, some government contractors have taken a hit while some are “sitting pretty.” http://www.marketplace.org/topics/business/6-degrees-sequestration/sequester-hits-government-contractors-unevenly.

As an example of a government contractor who is actually benefitting instead of suffering from sequestration, the author interviews Robin Lineberger, who head up the government contracting arm of the consulting firm, Deloitte.  His division is huge and occupies eight floors of an office building in Arlington, Virginia.  Lineberger says that Deloitte will lose three to four percent of its contracting business because of sequestration, but that the budget cuts have a silver lining for Deloitte.  Smaller government contractors who are feeling the budget cuts call Lineberger and ask if he wants to buy them, and are even offering him a bargain.  The value of these companies has fallen thirty to forty percent in the past eight months.  While Deloitte is doing okay, many small business contractors are not. Small firms, such as Davis Interiors, which is a family owned business founded in the 1950s that makes specialized furniture and fixtures for Navy ships at a small complex in Norfolk, Virginia, are feeling the cuts.  The company’s administrator says that normally at this time of year, the upholstering shop would be very busy.  Instead, she has laid off six employees, and the twenty six employees who remain are only working four days a week.  http://www.marketplace.org/topics/business/6-degrees-sequestration/sequester-hits-government-contractors-unevenly.

While cutting government spending is one possible way to improve the country’s financial situation, lawmakers should consider the impact the cuts are having on small businesses, whose economic health is often an important indicator of the health of the larger economy.

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