As 2013 begins, government contractors of all shapes and sizes await meaningful progress on the years-old Federal Government budget debate. Although the New Year headlines tell us that we averted our Thelma & Louise moment over the 'fiscal cliff,' very little has changed. The Federal Government has long since soared off the fiscal cliff – persistently and increasingly spending far more than tax collections support. Really, only two questions remain: how long until we hit bottom and what will we crash into? We all hope for more time and a soft landing. We should expect a less favorable outcome; after all, what cannot continue – won’t.
The psychological tide is already turning deep within the machinery of Government. While the political stalemate continues over budget reform, most Government agencies have accepted – and began adapting to – leaner times ahead. This asymmetrical adaptation process will be a growing source of uncertainty and frustration for government contractors. We view this process as the natural reversal of the unsustainable trend in government spending that began after September 11, 2001. Then, our Government wanted more – and Congress obliged by handsomely increasing budgets for many years; this was a great time to be a government contractor.
The Government’s strong desire to maintain the status quo for less money will, for many unlucky contractors, devolve from "more for less" into "something for nothing."
As increases in deficit spending slowed in 2010, the Government still wanted more but had relatively less incremental funding to get it. Goodbye best-value procurements; hello 'low price technically acceptable' procurements. A variety of other tactics have also emerged as a means for obtaining more for less, each of which squeeze contractor competitiveness and profitability. We may be nearing the conclusion of this phase as many agency budgets shrink – either by arbitrary sequestration, legislative design, or financial market discipline.
Likely starting this year, we will see many agencies having to buy the same or less – for a lot less. We will continue to experience the same buying tactics used in 2012, plus a growing preference for fixed-price contracting; but, we do not expect to see consistently well-defined requirements. We caution, however, that the Government’s strong desire to maintain the status quo for less money will, for many unlucky contractors, devolve from 'more for less' into 'something for nothing.' While contract terms provide protections and remedies for such circumstances, we believe many contractors will be reluctant to pursue disputes in this highly competitive environment. Beyond 2013, contractors that survive industry consolidation and attrition will slowly begin to regain negotiation and pricing power.
On the regulatory front, we don’t foresee any significant new cost accounting or contract pricing rule-making in 2013 – at least nothing as impactful as the DFARS Business System Rule, which sprang to life in January 2010 and became effective in 2012. We may, however, see the DFARS Business System regulations appear as a FAR rule and become applicable to civilian agency contractors.
With respect to allowable contractor compensation, we are relieved that the final version of the 2013 National Defense Authorization Act did not contain the onerously-low cap ($230,700) adopted by the Senate’s version. However, because contractor compensation has become a perennial political hot potato, we expect GAO’s study on the implications of reduced allowable compensation to leave the door open for a new compensation limit set at something below the current cap of $763,029. Obviously, such an outcome would create further competitive and profitability strains on contractors.
We expect the government contract audit and oversight environment to deteriorate further in 2013. Over the last several years as deficit spending became highly politicized, we’ve seen renewed focus on contractor 'fraud, waste, and abuse' and intolerance for anything other than perfect compliance. Such an environment will persist throughout 2013 and contractors will continue to bear the significant cost of these high expectations.
The same austerity psychology taking hold at agency buying commands is also becoming increasingly prevalent at the Defense Contract Audit Agency – not because it’s budget is being cut, but because DCAA now serves 'the public interest as its primary customer' rather than the Government’s contracting officer. While increasingly creative procurement tactics will be designed to drive down contract prices, DCAA auditors will be 'questioning' as much cost as possible so the Government can 'save' even more. Making matters worse, contracting officers have little or no incentive to disagree with audit results having dubious merit.
As the government contracting environment continues its metamorphism in 2013, one thing remains true: luck is what happens when preparation meets opportunity. Contractors with strong cultures of compliance and risk management will be best suited to endure the Government’s increased oversight and heightened compliance expectations. Contractors positioned to fulfill the Government’s strongest needs and wants at the lowest cost will continue to thrive. Skillful and timely contract management will be as critical as excellent contract performance. Contractors accustomed to bidding, winning, and successfully completing fixed-price contracts will have the best odds of preserving profitability.
Brent Calhoon is a partner in Baker Tilly’s Government Contractor Advisory (GCAS) division with over 20 years of experience specializing in complex cost accounting, contract pricing, and regulatory compliance matters. Contact Brent via email email@example.com. Learn how Baker Tilly helps navigate complexity.