Showing the Private Military Contracting Sector the Money, Redux

12/02/2011 12:47 pm ET | Updated Feb 01, 2012
  • David Isenberg Author, 'Shadow Force: Private Security Contractors in Iraq'

It is time for an update on showing, or is that showering, the PMSC industry the money; something I last wrote about in May. On November 23 the ace analysts over at the Defense-Industrial Initiatives Group at the Center for Strategic and International Studies published a new report, Structure and Dynamics of the U.S. Federal Services Industrial Base, 2000-2010

This fourth report analyzes the trends for all services from 2000 through 2010, the most recent full fiscal year for which reliable data from the Federal Procurement Data System (FPDS) are available. Unlike the past three reports this one also includes service contracts in the construction and medical categories. Some of the main results are:

Federal services contracting increased from $159 billion in 2000 to $333 billion in 2010 -- an overall growth 109 percent. The compound annual growth rate (CAGR) for the 10-year period was 7.6 percent, though for the last five years examined (2006-2010) this growth slowed to 4.7 percent per year. The largest year-on-year growth in services spending occurred between 2002 and 2003, largely driven by service contracts awarded by the Department of Defense. However, 2010 was the first year in the 2000-2010 timeframe that federal spending on service contracts did not grow; instead, it decreased by some $10 billion.

As a share of total federal contract spending, services accounted for 62 percent in 2010, slightly up from 61 percent in 2009 and higher than at its relative low point of 57 percent of federal contract spending in 2008.

From an oversight perspective one positive bit of news is that fixed-price contract actions experienced robust annual growth (by value) of 8.5 percent over the last eleven years compared to a slower 6.2 percent CAGR for cost-reimbursement contract actions (by value). This is good because fixed price contracts are less susceptible to overcharges and other kinds of contract abuse. In the last five years, value growth for fixed-price contract actions remained steady at 6.7 percent while the cost-reimbursement category's annual growth slowed to 2.9 percent.

However, the biggest growth was in combination contract actions, which incorporate more than one type funding mechanism. In 2000, combination contract actions were seldom employed, but by 2009, their total value surpassed $33.4 billion.

But in 2010, the total value of combination contracts fell to $5.9 billion. In the last year there was also a 63 percent decline in contract actions with unlabeled funding type, which is a sign that the push to improve the quality of data entered into FPDS has had an effect.

Another bit of good news is that competition seems to have improved. For those who have not taken a Capitalism 101 course it is, of course, robust competition that makes the private sector's invisible hand work properly.

This report uses three main categories to ascertain the degree of competition in services
contract actions: competed awards that received two or more offers, competed awards that received one offer and awards that were not competed.

The largest sub-category, at $159 billion in 2010, consists of awards with full and open competition involving at least two offerors, which we refer to as "full competition awards". An additional $46 billion were awarded to limited competition contract actions with multiple offers. The second category, competed contract actions that received a single offer, stood at over $52 billion in 2010. The third category is contract actions that were not competed, which were obligated $65.3 billion in 2010.

Of course, that is looking at service contracting across the whole of government. For the Defense Department R&D service contracts they are for the most part cost-plus contracts.

Note that the fastest-growing areas of the federal services contracting industry during the past ten years were medical services (MED), professional, administrative, and management services (PAMS), and equipment-related services (ERS) with 14.7 percent, 10.8 percent, and 7.5 percent 10-year CAGRs, respectively. Increases in ERS contracting occurred predominantly after 2005, fueled by demands from operations in Iraq and Afghanistan [My emphasis].

As one would expect wartime spending by the Pentagon accounted for much of the $11.3 billion in growth of ERS from 2000 to 2010. Large companies were awarded 59 percent of ERS contract actions, and single award IDC vehicles were the most commonly used contract vehicle (with 40 percent of total ERS contract value in 2010).

The Department of Defense remained the dominant consumer of services during the period analyzed, accounting for nearly 60 percent of total federal dollars spent from 2007 to 2010. In 2010 it spent $198 billion on service contract actions.

Obviously, the private sector has not been blind to the torrents of money being shoveled, oops, I mean awarded, to those working in the professional services sector. Between 2000 and 2010, the total number of contractors in the services industry increased from 60,000 to slightly more than 157,000.

The good news is that it is not all going to 800 pound gorilla type companies, i.e. KBR or DynCorp, for example.

Most of this growth can be attributed to the entry of contractors undertaking small (under $25,000 in current dollars) contracts. Between 2008 and 2009 the number of small contractors participating in the market declined for the first time in over a decade. In 2010, however, the number of small contractors rebounded, reaching the highest level in the past decade. An analysis of the 2010 data indicates that out of the 157,000 contractors, 115,000 are small companies (as defined by the Small Business Administration), of which 74,000 undertake only contracts valuing under $25,000. Furthermore, of the 42,000 remaining contractors, between 150 and 200 are large companies (defined as having annual revenue of $3 billion or more). Of the companies identified as medium and large, 26,000 undertake only contracts that were obligated less than $25,000. This implies that the majority of contractors in the federal services industry are small- or medium-sized entities that undertake relatively small government services work.

These represented 89 percent of all actions awarded in 2010. On the other hand:

The cumulative value of all these contracts accounted for only 5 percent of the total dollars awarded. This represents significant contracting activity for a relatively small share of the market. Consequently, 11 percent of contracts received approximately 95 percent of total federal dollars spent on services, with the "sweet spots" of the market represented by contracts with a value of $1-25 million and, to a much lesser degree, those with a value of over $500 million. Contract dollars in both of these ranges increased in 2010 over previous years, while number of contracts valued under $250,000 decreased, indicating a growth in average contract size.

Put another way the top dogs of contracting world have to work a bit harder to retain that status. As the report authors said, "If you're operating in this sphere, the Federal Services Contracting world, you're really, in the recent years, having to run fast just to stay in place. You're -- in order to make the same number of -- of revenue from service contracts, you have to land a larger amount of those dollars, of those contract actions."

The share of the federal services market concentrated in the top 20 service contractors has fallen in the past decade. The top 20 federal service contractors captured about 30 percent of the revenue in 2010 versus 32 percent in 2000. Moreover, in 2000, the 20th-largest contractor had $760 million in services contract awards from the federal government, but in 2010 an entity needed some $2.2 billion of services awards to be the 20th-largest contractor. The market share for the top 5 federal services contractors has also declined: in 2000 it was 19 percent (with $30 billion of revenue), and in 2010 it was 15 percent (with $50 billion).

Still, they are hardly suffering. If one had to choose, being a KBR company man is a better choice than working for Bank of America.

The overall services industrial base remained stable from 2006 to 2009, averaging approximately 142,000 contractors. This stability appeared to be the new norm after the size of the industry more than doubled in the years between 2001 and 2005. However, in 2010, roughly 15,000 contractors, most of which undertaking contracts of less than $25,000, surged into the industrial base. Thus, while the overall federal services market grew at a 7.7 percent CAGR from 2000 to 2010, the number of contractors grew by 17.7 percent per year, with the majority of that growth prior to the 2010 spike occurring between 2001 and 2006. While it appeared in 2009 that the number of contractors may be declining due to financial pressures or declining returns on relatively small contracts, the opposite occurred in the past year.

On the humorous side there was this bit during the press conference.

The example we like best here, I think, is of the LOGCAP Contract, which for years in FPDS was classified as an R&D contract, nobody knows why, at least nobody that we've talked to. There must have been a reason for it. It's now been changed, but of course, in the records of the companies that -- that were performing this contract, this showed up as a logistics support or a professional services support contract. That's now how it's classified.

But again, for several years it was an R&D contract and so there -- and we've seen that with other contracts as well, where there's a mismatch between the way it's classified in FPDS and the way it's classified in the company's records or reports to shareholders.

The Logistics Civil Augmentation Program (LOGCAP) has been the mother of all logistics contracts for over two decades now; way past the R&D stage. Still, one can only imaginatively speculate as to the possible R&D that might have been going on; perhaps making gigantic drones to deliver supplies so the troops wouldn't have to depend on KBR. Nice idea but then KBR would just establish an aerial division to capture the work.

So what's the bottom line for industry? In short, as James Brown used to sing, "Whoa-oa-oa! I feel good, I knew that I would, now."

In the past 10 years, the federal government has increasingly relied on the private sector for the provision of services. Since 2003, federal spending on services has consistently represented about 25 percent of the total federal discretionary budget, reaching a record high (in dollar terms) in 2009 at $343 billion. Every area of services analyzed in this report exhibited mid-single-digit compound annual growth during the past decade.