Federal Contracting: Awards to Mid-Sized Businesses and Options for Increasing Their Opportunities
Released: 2019-09-19T00:00:00

Letter

Background

SBA oversees a number of programs designed to provide small businesses with resources and tools, including access to capital, help with federal contracting opportunities, and entrepreneurial counseling and training.

SBA’s Size Standards and Industry Classification Codes

Federal procurement regulations generally define a small business as one that is independently owned and operated and not dominant in its field and that meets the size and criteria or standards established by SBA. The Small Business Act of 1953 authorized SBA to establish size standards for determining eligibility for all procurement programs in which small business status is required or advantageous. SBA uses the North American Industry Classification System (NAICS) as the basis for its size standards. The standards vary by industry and are generally expressed as the average number of employees over a 12-month period or average annual receipts in the previous 3 years. As of August 2019, employee- based size standards for federal procurement purposes ranged from 100 to 1,500, and revenue-based size standards ranged from $1.0 million to $41.5 million. The number of employees or average annual receipts indicates the maximum size allowed for a business and its affiliates to be considered small.

The Small Business Jobs Act of 2010 required SBA to review at least one-third of all size standards during every 18-month period from the date of its enactment and all size standards at least once every 5 years thereafter. SBA completed the first 5-year review in 2016. According to SBA’s size standard methodology, the agency assesses industry structure and the overall degree of competitiveness of an industry and of firms in the industry when establishing size standards. To assess industry structure, SBA analyzes four primary factors: average firm size, degree of competition in an industry, start-up costs and entry barriers, and distribution of firms by size. SBA also considers the ability of small businesses to compete for contracting opportunities under the current size standards. According to SBA officials, for industries with $20 million or more in federal contracting annually, SBA also examines the small business share of federal contract dollars relative to the small business share of total industry receipts.

Small Business Goals and Set-Aside Contracts for Small Businesses

Each year, SBA negotiates small business prime contracting goals with federal agencies that have procurement authority so that, in the aggregate, the federal government meets its goal of awarding 23 percent of prime contract dollars to small businesses. In September 2018, we reported that SBA considers prior-year achievement and other factors in setting annual agency goals. SBA’s procurement center representatives and OSDBUs assist agencies in meeting small business goals.

Agency contracting officers have the authority to enter into, administer, or terminate contracts and are responsible for helping agencies meet small businesses goals, including by setting aside contracts for small businesses. One of the first steps in the federal acquisition process is assignment of the NAICS code that best describes the principal purpose of the acquisition and corresponding size standard (see fig. 1). Generally, the FAR states that if the contract is valued under the simplified acquisition threshold, the contracting officer must set it aside for small businesses. If valued above the simplified acquisition threshold, the contracting officer conducts market research to determine whether a contract should be set aside for small businesses. For contracts not set aside for small businesses, contracting officers generally must include specific small business subcontracting goals for the prime contractor to meet.

Past Performance Requirements

The FAR requires agencies to evaluate price or cost to the government in every source selection and evaluate the quality of the product or service in the acquisition by considering one or more noncost factors, such as past performance.

Contracting officers generally have discretion under the FAR to choose evaluation factors and their relative weights, rating systems, and the past performance they will consider. For example, a contracting officer could consider technical excellence, past performance (including relevance), and price.

To select a firm for contract award, agency officials evaluate offers against the criteria specified in the solicitation. According to the FAR, if an offeror has no record of relevant past performance, the offeror cannot be evaluated favorably or unfavorably on past performance. Contracting officers use the Contractor Performance Assessment Reporting System to enter and review evaluations of past performance. The FAR generally requires agencies to document contractor performance on contracts or orders that exceed certain dollar thresholds. Once a project is complete, the assessing official rates the contractor on elements such as quality of the product or service, schedule, cost control, management, and small business utilization. This information then becomes available to other agencies for making source selection decisions.

Indefinite Delivery/Indefinite Quantity Contracts

Indefinite delivery/indefinite quantity (ID/IQ) contracts provide flexibility when an agency cannot specify the quantities or timing of a product or service. Contracting officers may issue ID/IQ contracts as single-award or multiple-award contracts. Single-award refers to a situation in which one contract is awarded under a solicitation.

The FAR establishes a preference for awarding multiple-award ID/IQ contracts—instances in which more than one prime contractor is awarded a task-order contract (for services) or delivery-order contract (for supplies) under a single solicitation. Once agencies determine their specific needs, such contracts allow agencies to establish a pool of qualified contractors to compete for future orders under streamlined procedures. Contractors compete to be in the pool and generally compete again for task or delivery orders. Multiple-award ID/IQ contracts can be unrestricted (open competition for businesses of all sizes) or restricted to small businesses. They also can have one pool of contractors with separate “tracks” for small and nonsmall businesses to ensure contract opportunities for small businesses (that is, some orders are set aside for small businesses).

After a multiple-award ID/IQ contract has been awarded, an agency places delivery or task orders, generally using the fair opportunities process. An order, which is placed when a specific need arises, obligates funds and authorizes work. Orders must be within the scope, issued within the period of performance, and be within maximum value or quantities agreed to in the contract. For multiple-award ID/IQ contracts, the FAR requires that each awardee be given a fair opportunity to compete for subsequent orders. In April 2017, we found that in fiscal years 2011–2015, federal agencies obligated more than $130 billion annually through ID/IQ contracts. We also found that contracting officers said it was easier and faster to place an order under an existing ID/IQ contract than to award a separate contract when a specific need arose.

SBA’s Mentor-Protégé Programs

A mentor-protégé program is an arrangement in which mentors—typically experienced prime contractors—provide technical, managerial, and other business development assistance to eligible small businesses, or protégés. SBA established the 8(a) Mentor-Protégé Program in 1998 for mentors to partner with 8(a) socially and economically disadvantaged businesses to improve the ability of 8(a) businesses to compete for prime contracts and subcontracts. The Small Business Jobs Act of 2010 and National Defense Authorization Act for fiscal year 2013 authorized SBA to establish a government-wide mentor-protégé program for all small businesses, which SBA named the All Small Mentor-Protégé Program. Small businesses that have a mentor-protégé relationship through either program can form a joint venture with a mentor (which can be a mid-sized or large business) and compete for set-aside contracts as long as the protégé is a small business with at least a 51 percent interest in the joint venture.

Team Arrangements

Contractor team arrangements take two forms: two or more companies form a partnership or joint venture to act as a prime contractor or a prime contractor agrees with one or more companies to have them act as its subcontractors under a specified federal contract or acquisition program. Companies generally form a contractor team arrangement before submitting an offer. Businesses of all sizes can form joint ventures to compete for contracts. Joint ventures generally have to consist only of small businesses to compete for small business set-aside contracts—the exception being small and nonsmall businesses entered in a mentor- protégé agreement under one of SBA’s programs.

A Very Small Percentage of Small Businesses Grew to Be Mid-Sized and Continued to Receive Federal Contracts during Fiscal Years 2008–2017

Most Small Businesses Awarded Set-Aside Contracts in 2017 Were Well Below SBA Size Standards

Most small businesses awarded set-aside contracts in fiscal year 2017 did not appear poised to outgrow their size standard. According to FPDS-NG data, about 86 percent of the 121,604 set-aside contracts awarded in that year were to small businesses with revenue or employees at or below 25 percent of the size standard for their industry (see fig. 2). These businesses received about 64 percent of the dollar obligations for set-aside contracts in fiscal year 2017. The small businesses closest to their SBA standards (above 75 percent of the size standard) were awarded about 2 percent of the set-aside contracts and about 7 percent of the contract dollar obligations in fiscal year 2017. We performed the same analysis for fiscal years 2013–2016, and the results across the four quartiles were generally the same throughout the time period.

A Very Small Percentage of Small Businesses Awarded Set-Aside Contracts in Fiscal Year 2008 Grew to Mid-Sized by 2013 and Continued to Obtain Contracts

Based on our review, a very small percentage of the small businesses that were awarded set-aside contracts in fiscal year 2008 grew to mid- sized in subsequent years and continued to receive any type of contract. As shown in table 1, more than 93 percent of the businesses that were awarded only set-aside contracts in fiscal year 2008 and received any federal contract (including a set-aside or competed contract) in fiscal year 2017 remained small. About 2.5 percent of such businesses had become mid-sized by fiscal year 2017.

In addition, we analyzed the extent to which small businesses that grew to be mid-sized in 2013 continued to receive any type of contract in fiscal years 2014–2017. Of the 5,339 small businesses awarded only set- aside contracts in fiscal year 2008 and awarded any sort of federal contract in fiscal year 2013, 104 grew to mid-sized by fiscal year 2013. Of those 104 mid-sized businesses, 23 remained mid-sized in subsequent years and were awarded 75 contracts, and three grew to large and were awarded six contracts (see table 2). Seventeen of the 104 mid-sized businesses became small again. Thirty-seven of the 104 mid- sized businesses were awarded 306 contracts and were categorized as small, mid-sized, or large depending on the NAICS code listed in the contract. That is, businesses can be awarded contracts under several NAICS codes, each with a different size standard. Of the 24 mid-sized businesses not awarded any contracts in 2014–2017, nine were no longer registered in the System for Award Management, a central registration system for federal contractors.

Mid-Sized Businesses Can Provide Services and Goods on Contracts Set Aside for Small Businesses under Certain Circumstances

Businesses Can Keep Contracts If They Exceed Size Standards during the Life of a Set-Aside Contract

Federal regulations generally allow a small business with a contract to continue performing under its contract if it outgrows the size standard that it met in its initial offer. If a business qualified as small and was awarded a single-award contract under a small business set-aside, it generally would be considered small for contracting purposes for the life of that contract. The business can continue providing the service or product. Additionally, the agency can continue counting the contract towards its small business goals unless the business is required to recertify, whether through a regulatory or contractual requirement, and in doing so is deemed other than small. Once the contract ends, the follow-on or renewal contract is a new contract; size is determined as of the date the business bids on the new contract.

The regulations are applied similarly to multiple-award contracts. Some multiple-award contracts are set aside for small businesses only. If a business qualified as small at the time of its initial offer, it is generally small for each order issued against the contract for the life of the contract even if it outgrows the size standard. Multiple-award contract orders awarded to businesses that have grown to be other than small during the course of the set-aside contract generally still may be counted toward agency small business goals. They would not be counted if the contractor were required to recertify, whether by a regulatory or contractual requirement, and in doing so was deemed other than small.

There are a few instances in which a business must recertify its size status after its initial offer. In the case of an awarded multiple-award, set- aside contract, this would make the concern ineligible for the placement of orders or exercise of options. For example:

SBA has stated that mergers and acquisitions create an exception to the general rule that a firm’s size and status is determined at the time of the initial award. Generally, if a business becomes other than small pursuant to a merger or acquisition after its initial offer, the business must recertify its size.

Certain requirements for recertification become effective just before the end of the fifth year on a multiple-award contract. A multiple-award contract that runs for more than 5 years, including options, requires each business to recertify size within 120 days before the end of the fifth year and 120 days before exercising options thereafter. The determination of small or other than small is based on the size standard at the time of the recertification. Size determinations are not permanent; a business can recertify later as small if it meets the size standard.

A contracting officer may require a business to recertify its size status in response to a solicitation for an order. An SBA recertification determination is based on the size as of the date the business submits its response to the order.

The rules are different for agreements, including blanket purchase agreements. A blanket purchase agreement is a simplified method of filling anticipated repetitive needs for supplies or services that functions as a “charge account” with qualified sources of supply. Where the agreement is a set-aside or a reserve award to any type of small business, a business must qualify as small both at the time of the offer and at the time of the order to be considered for the order. The agency may count the business toward its small business goal if the business is small at the time of the order.

Businesses That Form Joint Ventures under SBA Mentor-Protégé Programs Generally Can Access Set-Aside Contracts

Both SBA’s 8(a) and All Small Mentor-Protégé programs allow the mentor (including those that are mid-sized businesses) and the protégé to form a joint venture and bid on set-aside contracts based on the protégé’s status as a small business. Once a protégé no longer qualifies as small, the mentor-protégé joint venture will no longer be eligible to bid for new small business set-asides. But, a change in protégé size generally does not affect contracts previously awarded to a joint venture between the protégé and the mentor.

The mentor-protégé joint venture may seek any small business contract for which the protégé would qualify. Therefore, the size of the mentor generally does not affect whether a mentor-protégé joint venture can bid for a small business contract. According to SBA officials, the agency does not track the size of mentors. As of September 2018, there were 106 joint ventures formed under the All Small Mentor-Protégé program and 171 joint ventures under the 8(a) Mentor-Protégé program (see table 3).

We analyzed FPDS-NG and SBA data to determine the size of the mentors participating in joint ventures under SBA’s All Small Program that were awarded set-aside contracts in fiscal years 2016–2018. Of the 29 joint ventures awarded set-aside contracts during these years, 13 of the 26 mentors were mid-sized businesses.

Options Proposed by Stakeholders for Assisting Mid-Sized Businesses Vary in Terms of Their Potential Benefits and Involve Tradeoffs

We reviewed options proposed in literature to enhance contracting opportunities for mid-sized businesses and asked stakeholders for their perspectives on potential benefits and drawbacks.

Some options for increasing federal contracting opportunities for mid- sized businesses identified in our literature review would help mid-sized businesses more than others, according to stakeholders. They noted that establishing a set-aside for mid-sized businesses—the option designed to help mid-sized businesses most directly—also would pose challenges for small businesses and agencies. In contrast, some options primarily would help small businesses that were growing (revenue or employees approaching the size standards). This, in turn, could offset any of the advantages that mid-sized businesses would derive. For instance, benefiting small businesses could increase competition and result in fewer awards to mid-sized businesses.

As shown in table 4, we grouped the options into four categories: (1) establishing a set-aside for mid-sized businesses, (2) modifying the rules for multiple-award contracts, (3) changing how past performance is considered when evaluating bid proposals, and (4) modifying SBA’s size standards.

A Mid-Sized Set-Aside Could Increase Contracting Opportunities but Affect Other Businesses and Agencies

Several stakeholders told us that establishing a separate set-aside category for mid-sized businesses would increase contracting opportunities for mid-sized businesses, but others expressed concerns that the potential threat to small businesses and administrative burden on agencies might outweigh this benefit. Some literature suggests that when businesses outgrow their size standards they struggle to compete against much larger, established businesses for contracts. Also, literature we reviewed suggested small business goals motivate agencies to set aside more and larger contracts for small businesses, resulting in a scarcity of smaller contract solicitations for mid-sized businesses. Members of Congress have proposed establishing pilot programs that would help mid- sized businesses, either defined by business or contract size.

Several stakeholders commented directly on separate set-asides and contracting opportunities for mid-sized businesses. An OSDBU director noted former small businesses (those that outgrew their size standard) would benefit from an opportunity to compete with firms of similar size for prime contracts. However, some stakeholders believed the set-aside would not increase opportunities for mid-sized businesses. Specifically, one trade association executive noted that this option continues to shelter small businesses that become mid-sized businesses from competition with larger businesses. The stakeholder added that a set-aside would not address the ability of mid-sized businesses to compete against large businesses on an unrestricted basis. Another trade association executive said there still would be a need to help mid-sized firms develop expertise and encourage competition.

Some stakeholders believed the option would have a limited impact or was not necessary. Specifically, one trade association executive said that its members want a good path to growth for small businesses, not a set- aside. Another trade association executive similarly believed mid-sized businesses want to open up contract opportunities, not restrict them by creating more set-asides. One stakeholder also argued that the option could create incentives for large businesses to split their companies to fit new set-aside size standards.

Most stakeholders believed the set-aside for mid-sized businesses would take away opportunities from small businesses, with several noting that contracts that normally would be set aside for small businesses might be set aside for mid-sized businesses instead. SBA officials stated that a set- aside would have a negative effect on all small business programs and support the use of larger contracts, resulting in fewer contract awards to small businesses. However, one trade association representative said the set-aside could be structured so that small businesses still could compete for the mid-sized set-aside contracts. An OSDBU director told us contracting officers could limit the effect on small businesses by considering small businesses first, mid-sized businesses second, and large businesses last. In this scenario, it would be large businesses that would be most affected by a set-aside for mid-sized businesses.

Stakeholders cited more limitations than benefits for agencies if this option were implemented. Most stakeholders told us a mid-sized business set-aside would increase agency burden, including additional time and cost to define and implement the new set-aside and additional tracking and reporting costs. SBA officials noted that it would create an additional burden for contracting officers and that further study would be needed before implementing a mid-sized set-aside. Some stakeholders also noted the potential burden on agencies of complying with additional contracting goals, with one OSDBU director saying that agencies do not have the resources to meet current small business contracting goals, let alone meet mid-sized contracting goals. Another OSDBU director believed that mid-sized business set-asides likely would violate the World Trade Organization’s Government Procurement Agreement because the United States negotiated exclusions for small businesses in the agreement, but not for mid-sized businesses. Some stakeholders believed it would be very difficult for agencies to define a mid-sized business. One OSDBU director told us that contracting officers would have to perform new market research for mid-sized set-asides and abide by a new layer of requirements. Several stakeholders questioned which agency actually would administer the new set-aside program.

Stakeholders identified a few benefits for agencies. Two stakeholders told us agencies could benefit from having a larger supplier base and more choices for services. One OSDBU director said agencies might benefit from retaining former small business contractors for a longer time, and a researcher said agencies might gain access to talent and value they might not get from large businesses.

Modifying Rules for Multiple-Award Contracts Could Help Mid-Sized Businesses

Stakeholders told us that allowing small businesses that grow beyond their size standards to move to the unrestricted version of multiple-award contracts could help mid-sized businesses. As discussed previously, multiple-award contracts can be unrestricted or restricted to small businesses or have separate tracks for small and nonsmall businesses (such as by using set-aside orders). This option proposes that small businesses on the restricted track of a multiple-award contract that outgrow the contract’s small business size standard be moved to the unrestricted track. This practice can be referred to as “on-ramping.” According to the stakeholder proposing this option, if a small business contractor grew to mid-sized, but could not transition to the unrestricted track, all the effort the business put into winning the contract would be wasted simply because it grew.

Some multiple-award contracts allow small businesses that outgrow the size standard to move to the unrestricted track of the multiple-award contract, but this is not always the case. Agencies have discretion when making this determination. If a business is allowed to move to the unrestricted track of such a contract, it would be able to place bids on additional orders resulting from the contract. In cases in which a business cannot move to the unrestricted track, it has to leave the contract after completing any ongoing orders. For example, the General Services Administration’s One Acquisition Solution for Integrated Services allows businesses that have outgrown their size standards to move to the unrestricted track, while EAGLE II does not.

Most stakeholders we interviewed said this option could increase contracting opportunities for growing small or mid-sized businesses. An OSDBU director said the option would let businesses that grew to be mid- sized move to the unrestricted pool of the multiple-award contract so they could keep their existing contract. A researcher said the option gives more time for small and mid-sized businesses to prepare for full and open competition. But two stakeholders noted that mid-sized businesses already in the unrestricted pool may be negatively affected by increased competition from additional contractors placed in the pool for task orders.

Stakeholders offered differing opinions on how this option would affect agencies. Several stakeholders said that agencies would benefit from being able to retain contractors even if the contractors outgrew their size standard. For example, a trade association executive said it would be less disruptive for the agency if the business could continue its contract. Two stakeholders thought that moving a business to the unrestricted pool would reduce agency time and paperwork (compared to re-competing the contract and performing additional evaluations). However, several stakeholders told us that allowing small businesses that grew beyond the size standards to “on-ramp” might increase administrative burden on agencies. For example, it might take longer for an agency to evaluate proposals for unrestricted task order competitions if the pool of competitors grew. SBA officials expressed concern that if task order competitions grew too large, businesses in the unrestricted pool that objected to the increased competition from new contractors might pursue litigation.

Changing Past Performance Requirements Could Increase Contracting Opportunities for Mid- Sized and Small Businesses but May Increase Risk for Agencies

Stakeholders told us that changing past performance requirements could increase prime contracting opportunities for mid-sized and small businesses, but might increase risk for agencies. Some of the literature we reviewed considered requirements based on the size or number of past contracts (“quantitative past performance requirements”) as a barrier to entry for mid-sized businesses. Options have been proposed that would regulate what types of past performance contracting officers consider and how they establish solicitation requirements.

Lower or Eliminate Quantitative Requirements for Past Performance

This option proposes lowering (for example, limiting their use or making their terms more flexible) or eliminating quantitative requirements for past performance.

Nearly all the stakeholders we interviewed said that lowering quantitative requirements would increase contracting opportunities for mid-sized businesses, small businesses, or both. For example, one researcher said that mid-sized and small businesses would benefit because the barriers to entry on some large contracts would be lowered. Similarly, an OSDBU director said that smaller mid-sized businesses and small businesses get shut out of contract competitions because they cannot meet the past performance requirements, and lower past performance requirements would give them a chance to compete. One trade association executive also pointed out that this option could help mid-sized and small businesses develop a performance record for future solicitations.

More than half of the stakeholders told us that eliminating quantitative past performance requirements entirely also would increase contracting opportunities for mid-sized businesses, small businesses, or both. Specifically, two stakeholders said eliminating these quantitative requirements would enable mid-sized and small businesses without records of past performance to substantiate their qualifications in other non-quantitative ways.

Stakeholders noted trade-offs for agencies. Some stakeholders believed lowering past performance requirements would benefit agencies because more contractors would be eligible to bid. For example, one OSDBU director said agencies might receive proposals from businesses that could not have met quantitative requirements but have enough expertise to submit a high-quality proposal. However, some stakeholders said lowering quantitative requirements may increase agency burden, citing a longer evaluation period due to a larger pool of bidders. More than half of the stakeholders said eliminating requirements entirely would increase the burden on agencies, for various reasons. One researcher said agencies might not have staff with the technical expertise to assess bids based on a strictly qualitative evaluation. Additionally, several stakeholders noted challenges for agencies in obtaining qualitative performance information using the Contractor Performance Assessment Rating System, citing rating subjectivity and verification difficulties.

Several stakeholders said lowering or eliminating quantitative requirements for past performance would increase the risk to the agency of awarding contracts to firms that cannot successfully complete the project. For example, one OSDBU director pointed out that “conventional wisdom” for contracting officers is that a project’s success rate is higher when a company can meet higher past performance requirements. Another OSDBU director said that qualitative forms of evaluation, such as testimony from another agency, are not sufficient and could put the agency’s project at risk for lack of an objective measure of a contractor’s capabilities. In contrast, the third OSDBU director said that quantitative requirements do not lower the risk to the agency because completing a certain number of contracts is not a guarantee of satisfactory future performance.

Require Agencies to Consider Past Performance of Each Company in Team Arrangements

This option proposes that contracting agencies be required to consider the past performance of individual companies in team arrangements as opposed to evaluating only the aggregate past performance of contractors in team arrangements. The literature suggested that requiring agencies to consider each team member’s past performance would provide incentives to mid-sized businesses to work together to compete for contracts with past performance requirements that each would not be able to meet individually. According to SBA officials, the Small Business Act already requires agencies to consider the past performance of each participant in a joint venture or team for bundled contracts and multiple-award contracts above a certain dollar threshold. Also, agencies generally consider the relevant past performance information of individual members of a team arrangement in certain situations if they will perform major or critical aspects of the requirement. However, there are other situations—such as when the contract is not specifically for a small business but instead is bid on by a joint venture that includes a small business—in which agencies are not required to consider each team member’s past performance.

Stakeholders identified some benefits to a more flexible consideration of past performance for mid-sized businesses. More than half of the stakeholders believed this option would increase contracting opportunities for mid-sized businesses. For example, a trade association executive said mid-sized businesses currently struggle to fulfill past performance requirements, and this would allow them to combine their past performance with another business to qualify for new and larger contract opportunities. However, some stakeholders noted that mid-sized companies probably have won prime contracts. Therefore, they already might have the requisite past performance to bid on a contract.

Nearly all the stakeholders we interviewed thought this option would increase contracting opportunities for growing small businesses because they would be able to team with a small or nonsmall business to bid on contracts for which they otherwise would not have the past performance to qualify. One researcher described a dilemma for small businesses: they cannot compete for contracts without past performance, but they cannot get past performance without winning contracts. SBA officials said that businesses prefer that the past performance of each member be considered instead of the past performance of the joint venture, which could be minimal, especially if it was a new joint venture.

Stakeholders identified trade-offs for agencies. More than half of stakeholders said considering past performance of both members in a team arrangement would benefit agencies because more contractors could meet requirements to bid. One OSDBU director said that this option also might allow agencies to benefit from the enhanced capacity and innovative solutions offered by mid-sized businesses. However, several stakeholders cautioned that this option could increase risk for an agency. For example, one trade association representative believed that because team arrangements are the companies’ creation and the government has no involvement in administering them, there is more risk to the agency that the contracting team might not be able to complete the contract.

Consider Subcontracting Past Performance in Contract Evaluation

This option proposes that agencies should consider subcontracting past performance when evaluating bid proposals. It has been suggested that this could be done in two ways. First, agencies could be required to consider a business’s past performance as a subcontractor—a route for many small businesses to gain access to federal contracts—when competing for prime contracts. Second, agencies could be required to count the past experience of both the prime contractor and its significant subcontractors towards a solicitation’s past performance requirements.

Stakeholders had differing opinions on whether this option would help mid-sized businesses. Several stakeholders believed that allowing mid- sized businesses to leverage their subcontracting experience to meet requirements would increase contracting opportunities for these firms. Furthermore, one researcher thought mid-sized businesses could secure more subcontracting opportunities because large firms might be more willing to team with them. However, some stakeholders believed this option would not increase contracting opportunities for mid-sized businesses, with two stating that this option is less important for them because they likely outgrew their size standard by winning set-aside prime contracts. An OSDBU director thought it also might increase competition from smaller firms.

Nearly all of the stakeholders we interviewed said this option could increase prime contracting opportunities for growing small businesses. For example, one OSDBU director said that considering subcontracting as past performance would help small businesses compete for prime contracts, grow, and move forward. A researcher noted this could help small businesses transition to mid-sized. SBA officials similarly stated that small businesses want agencies to consider their subcontracting past performance so they can access contracts for which they would not normally qualify. In May 2019, SBA officials said they were working on implementing legislation that requires SBA to create a pilot program to provide past performance ratings for small business subcontractors.

Similar to previous options, stakeholders contrasted the benefits and drawbacks of increased competition for agencies. Several stakeholders thought this option would expand the pool of bidders, making contracts more competitive and bringing more value to agencies. However, four stakeholders noted that verifying prime and subcontracting experience could create more work for agencies. Specifically, two of the four noted that it could be difficult for agencies to determine subcontracting past performance because the ratings in the Contractor Performance Assessment Rating System are tied to the prime contractors.

Some stakeholders also noted this option could increase the risk to agencies that projects would not be completed successfully. Specifically, because subcontracting agreements are between the subcontractor and prime contractor, and therefore are not enforceable by agencies, a prime contractor might not use a subcontractor whose past performance was considered during the evaluation process. For example, a researcher pointed out that a prime contractor could use the subcontractor’s experience to win a contract, but then not use the subcontractor for any of the work.

Modifying SBA’s Size Standards Could Help Some Small Businesses Transition to Mid-Sized

Several stakeholders noted that modifying SBA’s size standards would not help mid-sized businesses as such; rather, the modifications could allow a few mid-sized businesses to become eligible for small business set-aside contracts again and help growing small businesses prepare for the transition to mid-sized. It has been noted that agencies increasingly use large, multiple-award contracts that can cause small businesses to outgrow their size standard before they build the capacity (financial resources, business infrastructure, or past performance records) they need to successfully compete for contracts. To address such issues, options have been proposed to modify SBA’s size standards.

Change the Calculation for Revenue-Based Size Standards

This option would change the number of years of revenue considered when applying revenue-based size standards. SBA would allow businesses to consider their past 5 years of revenue, pick the lowest 3 years in that period, and average them to determine if they met revenue- based size standards. In a December 2018 amendment to the Small Business Act, Congress extended the number of years of revenue that service businesses use to calculate their size from 3 to 5 years but included no provision related to selecting lowest-revenue years.

Stakeholders expressed reservations regarding this option for mid-sized businesses. Some stakeholders said that this option may not increase opportunities for mid-sized businesses because they already had outgrown their size standard. Several stakeholders also said the option offered only a temporary solution. One noted that this option would delay “graduation” from the size standard, but would not address the issue that mid-sized businesses need to continue to grow to secure additional federal contracts. An OSDBU director told us it is critical that small businesses develop and execute a marketing and business plan to transition from small to successful mid-size.

Nearly all the stakeholders we interviewed noted that allowing businesses to choose their lowest 3 years of revenue in a 5-year period could prevent an outlier revenue year from causing a small business to prematurely outgrow its size standard. For example, an OSDBU director said that a large, 1-year award is not indicative of a business’s revenue over the long term. Nearly all of stakeholders also said that enabling businesses to choose the lowest 3 years of revenue would help ease the transition to mid-sized. For instance, an OSDBU director said businesses could stay below the size standards for longer and establish a performance record to help secure future contracts.

However, several stakeholders expressed concern that very small businesses might lose contracting opportunities due to increased competition (that is, more and larger-sized firms would remain under the size standards). Finally, SBA officials pointed out that this option could be perceived as unfair because it would not benefit businesses in industries with employee-based size standards.

Subtract Research and Development Expenses

This option proposes that businesses be able to subtract research and development expenses from their total revenue when calculating their eligibility for small business status. The stakeholder proposing this option said that businesses close to the size standard have to focus their revenue on pursuing contracts that will support their company as they transition to full and open competition, and so cannot spare money to further invest in researching and developing new products or processes that might improve their business. In addition to encouraging more investment in research and development, subtracting these expenses would lower revenue and allow some mid-sized businesses to be classified as small again.

One researcher told us this was a strong option for mid-sized businesses, particularly information technology businesses, because research and development investment is such a large part of their expenses. However, some stakeholders said this option would not increase contracting opportunities for mid-sized businesses. For example, one OSBDU director believed this option would not benefit mid-sized businesses because it did not help these businesses to compete with larger businesses.

More than half of the stakeholders we interviewed said that this option might encourage small businesses to invest in research and development. However, several stakeholders noted that this option only would help the small percentage of small businesses that perform research and development. SBA officials pointed out that this option could be perceived as unfair because not all businesses have research and development expenses. They also pointed out that modifying revenue calculations would not benefit manufacturing businesses, which invest more in research and development than other sectors but primarily use employee-based size standards.

Stakeholders also noted potential trade-offs for agencies. Several stakeholders told us this option would benefit the government by encouraging investment in research and development with one stakeholder stating that it might result in higher-quality bids. However, several stakeholders and SBA officials also told us that allowing small businesses to subtract research and development expenses would increase the administrative burden on agencies or add too much complexity. For example, two OSDBU directors said it would be difficult for an agency to verify that research and development expenses were correctly claimed and subtracted from revenue. SBA officials noted that there were no industry-by-industry data on research and development expenses. Some stakeholders observed this option could lead to an increase in fraud or manipulation, with one trade association executive saying the option would not increase innovation, just claimed expenses.

Raise Revenue-Based Size Standards

This option proposes increasing SBA’s revenue-based size standards. The trade association representative who proposed the option believed that small business size standards should be raised so that high revenue- generating small businesses that still are not dominant in their field would not be shut out of set-asides.

Increasing revenue-based size standards would benefit some mid-sized businesses by making them eligible again for small business set-asides. However, more than half of the stakeholders told us the option would have a limited impact—it would apply only to the mid-sized businesses small enough to fall under the newly raised standard—or no impact at all (for most other mid-sized businesses). To illustrate the limited impact, one OSDBU director used the example of management consulting services (NAICS 541611), which has a size standard of $15 million (revenue). If the standard were increased to $17 million, it might not affect many businesses. Rather, it would help only the $16 million company to compete for set-asides again, the director said. Furthermore, one researcher said that the increase would not address the systemic disadvantage that mid-sized businesses face in competing with large businesses.

Stakeholders identified tradeoffs for small businesses related to this option. Nearly all stakeholders said that raising revenue-based size standards could help growing small businesses better prepare to transition to mid-sized while remaining eligible for set-asides. One OSDBU director said small businesses could add to their performance record and have more time to become competitive with larger businesses. One researcher said that small businesses could get additional time to diversify contract portfolios and fund professional certifications. However, some stakeholders cautioned the option could harm very small businesses because as one stakeholder explained, there would be more competitors for small business set-asides. As noted previously, we found that most small businesses awarded set-aside contracts in 2017 were well below the size standards.

Stakeholders also identified trade-offs for federal agencies. Several stakeholders said agencies would benefit from the increased competition. For example, one OSDBU director said agencies might have more bidders, which could lower pricing. Some stakeholders said the option could help agencies reach small business goals more easily because more businesses would be considered small. However, a stakeholder advised that agencies also might need more time and resources to evaluate an increased number of bids.

SBA officials explained to us that they comprehensively review all the size standards every 5 years, looking at factors, such as industry trends and small business market share. They contended that if contracts became larger to the detriment of small businesses, small businesses then would have a decreased market share. If small businesses were losing market share, that would be captured by the SBA size standard methodology and the size standards would be adjusted accordingly. They also noted that revenue-based size standards were getting higher and higher as a result of adjustments during SBA’s reviews and adjustments for inflation and that further increases might allow firms that were dominant in their industry to be small, which is contrary to statute. Finally, they stated that just raising size standards without taking into account industry structure and market conditions would enable more experienced businesses to qualify as small and hurt small businesses that need federal assistance the most, especially in competing for set-aside contracts.

Agency Comments and Our Evaluation

We provided a draft of this report to the Department of Homeland Security, Department of Defense, General Services Administration, and SBA for their review and comment. The Department of Homeland Security provided technical comments, which we incorporated where appropriate. In emails, the OSBDU director at the Department of Defense and an audit liaison at the General Services Administration stated that the agencies did not have any comments.

SBA provided technical comments in an email from the GAO Liaison, which we incorporated as appropriate. We considered a number of these comments to be more than technical in nature and therefore, summarize them here:

SBA offered new views on three specific options for increasing federal contracting opportunities for mid-sized businesses presented in the report, which we incorporated where appropriate. SBA also made the larger point that they believe any option to help mid-sized businesses would hurt small businesses. In discussing the various options in the report, we present the views of various stakeholders and SBA on how the options would affect small businesses.

SBA stated that we created our own methodology for determining a mid-sized business by multiplying the current size standards and that a formal study should be performed to establish a baseline definition of a mid-sized business. Our goal was not to establish a baseline definition of a mid-sized business. As we note in the report, there is no statutory or regulatory definition of a mid-sized or large business. We applied multipliers to SBA’s size standards only for the purposes of our analysis—specifically, to identify businesses that had outgrown small business size standards and continued to receive federal contracts.

SBA stated that we multiplied size standards by a factor of five to define mid-sized businesses in all industries and cited analysis that it had done that indicated that more than 95 percent of businesses are at or below SBA’s size standards. The agency concluded that this means that in some industries, almost all firms would be considered mid-sized under our definition of mid-sized. However, only those firms with revenue or employees up to five times above the SBA small size standard would be considered mid-sized in our analysis. We counted any businesses with revenue or employees at or below the small size standard as small.

SBA stated that considering a factor of two or three times the SBA size standards to identify mid-sized businesses would improve our results. We considered a number of different factors when developing our methodology. As noted in the report, we used five times the small size standard to distinguish between mid-sized and large businesses based on the distribution of contracts and obligations among businesses in these two groups.

SBA stated that (1) the report should explain the basis and method for selecting the sample of 5,339 businesses awarded set-aside contracts in 2008 and (2) a sample of 104 out of 5,339 firms over that period of time was too small to be generalizeable. The 5,339 businesses awarded set-aside contracts in 2008 and awarded any sort of federal contract in 2013 were not a sample; rather, they were all the businesses that met these criteria. Therefore, we did not generalize to the population based on a sample. Our analysis showed that only 104 of these 5,339 businesses grew to mid-sized by 2013.

As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to the Secretary of Defense, the Acting Secretary of Homeland Security, the Administrator of the General Services Administration, and the Acting Administrator of SBA. In addition, the report is available at no charge on the GAO website at http://www.gao.gov.

If you or your staff members have any questions about this report, please contact William B. Shear at (202) 512-8678 or shearw@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Major contributors to this report are listed in appendix III.

Appendix I: Objectives, Scope, and Methodology

This report analyzes (1) the extent to which small businesses grew to be mid-sized and continued to receive federal contracts; (2) instances in which mid-sized businesses can perform work on contracts set aside for small businesses; and (3) options for increasing federal contracting opportunities for mid-sized businesses and views on the strengths and limitations of the options. We present information on contracts awarded to small, mid-sized, and large businesses in fiscal year 2017 in appendix II.

For the first objective, we analyzed data from the Federal Procurement Data System-Next Generation (FPDS-NG) for fiscal years 2008 through 2017 (the most recent complete data available when we began our review). For a consistent set of data across the 10-year period, we selected all contracts awarded above the micro-purchase threshold. To determine the relevant contract size standard, we matched the size standards data from the Small Business Administration (SBA) to the contract awards data from FPDS-NG based on the year of award and the contract’s North American Industry Classification System (NAICS) code. We then compared the businesses’ annual revenue or number of employees to SBA size standards. We assessed the reliability of the FPDS-NG data we used by performing electronic testing of selected data elements and reviewing existing information about FPDS-NG and the data the system produces. We determined that these data were sufficiently reliable for the purposes of determining the extent to which small businesses that grew into mid-sized businesses continued to receive federal contracts and the size of businesses awarded contracts during a specific time period.

To determine the extent to which contracts were set aside for small businesses, we calculated the percentage of new contracts awarded in fiscal year 2017 that were small business set-asides. To determine the size of the small businesses awarded these set-aside contracts, we divided SBA’s size standards into four segments for each NAICS code— below or at one-fourth of the size standard, above one-fourth to one-half of the size standard, above one-half to three-fourths of the size standard, and above three fourths of the size standard—and determined the number and obligations of set-aside contracts awarded to small businesses in each quartile for fiscal year 2017. We completed this same analysis for fiscal years 2013 through 2016 to see if the results were similar.

To determine the extent to which small businesses grew to be mid-sized and continued to receive federal contracts, we used FPDS-NG data from fiscal years 2008 through 2017. Because there is no statutory or regulatory definition of a mid-sized or large business, we applied a number of multipliers to determine size. Businesses with revenues or employees at or below the SBA small size standards were small. We considered businesses with revenue or employees up to five times above the SBA size standard as mid-sized businesses. We considered businesses with revenue or employees more than five times the size standard as large businesses. We used five times the small size standard to distinguish between mid-sized and large businesses based on the distribution of contracts and obligations among businesses in these two groups. We discussed this approach and methodology with SBA officials and officials at three federal agencies that had large obligations for small business contracts in fiscal year 2017. These officials did not raise any questions about our approach, and some reiterated that there was no legal definition of mid-sized businesses.

Using these definitions, we selected businesses awarded only small business set-aside contracts in fiscal year 2008 and determined whether these businesses also were awarded any type of federal contract in fiscal year 2017 and if they were in the same or different size category in fiscal year 2017. We then determined the number of businesses awarded set- aside contracts in fiscal year 2008 and awarded any sort of federal contract in 2013 that had become mid-sized in fiscal year 2013 and the extent to which those businesses were awarded any contracts in subsequent years.

We also determined the percentage of competed contracts awarded to small, mid-sized, and large businesses in fiscal year 2017. For purposes of this report, competed contracts are those competed using (1) full and open competition, (2) full and open competition after exclusion of sources, and (3) simplified acquisition procedures. To determine the industry sectors with the largest number of set-aside and competed contracts in fiscal year 2017, we collected and analyzed FPDS data for each of the two-digit NAICS industry sectors. See appendix II for more information.

For our second objective, we reviewed the Federal Acquisition Regulation and small business laws and regulations to identify provisions that allow small businesses that grow into mid-sized businesses to continue providing services and goods on contracts set aside for small businesses. We reviewed SBA documentation related to its 8(a) and All Small Mentor- Protégé programs because forming joint ventures with small businesses under these programs is one way that mid-sized businesses can provide services and goods under set-aside contracts. We analyzed lists from SBA of the businesses that entered into mentor-protégé agreements as of July 2018 and the mentor-protégé agreements that had formed joint ventures as of September 2018.

Using FPDS-NG data, we determined the number of joint ventures formed under the All Small Mentor-Protégé program that had been awarded set-aside contracts from fiscal years 2016 through 2018. We began with 2016 to allow time after the program was created in 2013 for businesses to enter into agreements and form joint ventures. We ended with 2018 because it was the most recent complete year of data available when we conducted this analysis. Using the same multiplier methodology designed for our first objective, we determined the number of mentors awarded set-aside contracts as part of a joint venture that were mid-sized businesses. We assessed the reliability of the SBA and FPDS-NG data we used by interviewing SBA officials about their data and performing electronic testing. We determined that these data were sufficiently reliable for determining the number of mentors awarded set-aside contracts as part of a joint venture that also were mid-sized businesses. We were not able to perform a similar analysis for joint ventures formed under SBA’s 8(a) Mentor-Protégé program because SBA does not maintain a Data Universal Numbering System number for mentors participating in that program. This number is needed to determine the size of the mentor.

To identify stakeholder views on options for increasing federal contracting opportunities for mid-sized businesses, we identified a number of proposed options by reviewing literature, including sources identified during our background research and initial interviews. We also conducted a literature search. We used ProQuest to search 13 databases—including Business Premium Collection, EconLit, Global Newsstream, Policy File Index, and ProQuest Dissertations and Theses Global Research Library. We also conducted searches using Lexis Advanced, EBSCO Business Source Corporate Plus, Dialog, DTIC, Scopus, and HeinOnline. The search was limited to 11 years (2008–2018) and to scholarly, trade, think- tank, and government publications.

For the searches, we used keywords such as “advanced small businesses,” “federal contracting,” “mid-tier/mid-sized small businesses,” “middle market,” “IDIQ,” “challenges,” and “opportunities.” Our searches yielded 199 sources. To select relevant sources, an analyst reviewed the titles and abstracts and selected 21 as likely to propose options for increasing federal contracting opportunities for mid-sized businesses. A second analyst reviewed the first analyst’s selection for concurrence. The 21 sources we selected included trade association reports, congressional testimonies, and research reports.

One analyst read the 21 sources and identified any specific options discussed. We eliminated suggestions or recommendations that were unclear, duplicative, or unconnected to mid-sized businesses. A second analyst read the same sources and verified that the first analyst had correctly identified all the options pertaining to increased contracting opportunities for mid-sized businesses. From this analysis, we compiled a final list of 14 options for which we would obtain stakeholder views. The options selected were grouped into four categories. The list of options included in the report is not exhaustive; the options are intended only to be illustrative of potential approaches to enhancing contracting opportunities for mid-sized businesses.

To obtain stakeholders’ views regarding the strengths and limitations of these options, we selected three categories—trade associations, researchers, and federal agencies—from which to develop a nongeneralizable sample of individuals to interview. To identify trade associations, we compiled a list of 20 trade associations that represented small and mid-sized businesses from the literature search and previous GAO work on small business contracting. We searched each organization’s website for any publications the organization may have published on small and mid-sized businesses and federal contracting. We used search terms such as “federal contracting,” “mid-size,” and “size standards.” We identified six trade associations using this process. Because one did not respond to our request, our sample included representatives of the remaining five associations.

We also selected three researchers who published on mid-sized businesses and federal contracting. In addition, we selected the directors of the Offices of Small and Disadvantaged Business Utilization (OSDBU) at three federal agencies—Department of Defense, Department of Homeland Security, and General Services Administration—that were among the top five agencies in terms of total dollar obligations for small business contracts in fiscal year 2017.

We then interviewed the 11 stakeholders. For each interview, we asked them to provide their views on the strengths and limitations of each option in relation to small, mid-sized, and large businesses and for federal agencies.

We performed a content analysis to analyze the responses. First, we created preliminary codes that represented key themes across the interviews of the strengths and limitations of the 14 options, such as “would increase administrative burden on agencies” or “would increase contracting opportunities for mid-sized businesses.” A methodologist reviewed the coding system to ensure it was logical. We pre-tested the coding of responses from three interviews to ensure the appropriateness of the codes. One analyst coded each response to a particular strength or limitation of an option and a second analyst reviewed the coding. If a response did not align with a strength and limitation, the response was coded as “unclassified.” The team discussed the results of the initial coding analysis and made some adjustments to the codes. Once the coding scheme was finalized and the responses from the remaining eight interviews were coded by an analyst, a second analyst reviewed the coding. If the second analyst disagreed with the coding of a particular response, the two analysts spoke and achieved concurrence. After response coding was completed, we tabulated the responses based on the codes. A second person verified the calculation of the stakeholders’ response totals.

Because we selected a nongeneralizable sample of stakeholders to interview, their views are not generalizable to other stakeholders who have knowledge about options for increasing contracting opportunities for mid-sized businesses, but their views offered important perspectives. To characterize the number of stakeholders who offered the same opinion, we used “nearly all” for nine or 10 stakeholders, “most” for seven or eight stakeholders, “more than half” for six stakeholders, “several” for four or five stakeholders, and “some” for three stakeholders. We also interviewed SBA officials to obtain their views on how the options might affect small businesses, as well as to gather information related to our other two objectives.

We conducted this performance audit from April 2018 to August 2019 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Information on Contracts Awarded to Small, Mid-Sized, and Large Businesses in Fiscal Year 2017

In this appendix, we provide information on contracts awarded to small, mid-sized, and large businesses in fiscal year 2017. Because there is no statutory or regulatory definition of a mid-sized or large business, we applied multipliers to the Small Business Administration’s (SBA) size standards. Small businesses were those with revenue or employees at or below the size standard for their industry. We considered mid-sized businesses as those with employees or revenue up to five times above the size standard and large businesses as those with employees or revenue more than five times the size standard.

Percentage of Competed Contracts Awarded in Fiscal Year 2017 by Size

Our analysis of Federal Procurement Data System-Next Generation (FPDS-NG) data showed that mid-sized businesses received the smallest share—9 percent—of competed contracts (compared with small and large businesses) in fiscal year 2017 (see fig. 3). For purposes of this report, competed contracts are those competed using (1) full and open competition, (2) full and open competition after exclusion of sources, and (3) simplified acquisition procedures.

Dominant Industry Sectors in Federal Contracting

We analyzed FPDS-NG data to determine the number of set-aside and competed contracts awarded in fiscal year 2017 by industry sector. In fiscal year 2017, the largest number of set-aside contracts were awarded in the following sectors: manufacturing; professional, scientific, and technical services; and construction (see fig. 4). In that same year, the largest number of competed contracts were awarded in the following sectors: manufacturing; professional, scientific, and technical services; and wholesale trade.

Similarly, in fiscal year 2017 the largest contract obligations (set-aside and competed) were awarded in the sectors of construction; manufacturing; and professional, scientific, and technical services (see fig. 5).

For competed contracts, we analyzed FPDS-NG data to determine if the size of businesses awarded contracts varied by industry sector. In fiscal year 2017, small and large businesses were generally awarded more competed contracts than mid-sized businesses, regardless of sector (see table 5). The industry sectors in which small and large businesses were awarded the most competed contracts in fiscal year 2017 were manufacturing; professional, scientific, and technical services; and wholesale trade. Similarly, in fiscal year 2017, mid-sized businesses were awarded the most competed contracts in the manufacturing and professional, scientific, and technical services sectors. The third dominant sector for mid-sized businesses was information.

Appendix III: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact name above, Paige Smith (Assistant Director), Nancy Eibeck (Analyst in Charge), Edward Chiu, Sarah Garcia, Julia Kennon, Jill Lacey, Barbara Roesmann, Jessica Sandler, and Jena Sinkfield made significant contributions to this report.