For a number of years, there has been a certain relationship between different segments of the federal information technology market. But those relationships are changing as agencies have had to come to grips with stark new budget constraints, which are expected to be reflected in the new federal budget being released by the White House today.
Those changes are already having an important implications for the companies competing for federal IT contracts as well as for the federal and military leaders responsible for acquiring and operating the IT technologies that support their civil and military agency mission requirements.
This article was adapted from introductory remarks made Feb. 13 at the 25th Annual Federal Networks by conference chairman, Warren Suss, president of Suss Consulting. For more news and insights on innovations at work in government, please sign up for the AOL Gov newsletter. For the quickest updates, follow us on Twitter @AOLgov.
The federal information technology marketplace can be divided into two primary corporate segments.
The federal segment consists of companies whose main corporate focus is on winning and managing federal contracts. These include the weapons systems manufacturers who have expanded into the civil and defense agency IT space as well as the medium and small businesses that focus primarily or exclusively on federal deals.
On the other hand, the commercial segment consists of a wide range of corporations, including carriers, hardware and software manufacturers, integrators, and professional services firms, that primarily operate in the corporate IT space but also sell to the federal government. These generally represents a much smaller portion of their total corporate sales and revenues than their sales to large businesses, small businesses, state and local governments, educational institutions, residential, and international customers.
Many commercial segment companies have a significant position in the federal IT marketplace, and some have established huge federal divisions, but their non-federal business represents their primary corporate market focus.
I’m highlighting these two segments – the commercial and the federal players – because I believe that recent changes, primarily those brought on by federal budget pressures, will disrupt the competitive balance between these two types of companies in the federal IT space.
As the size of the average deal shrinks, so do some competitive advantages of the largest federal sector players.”
Many companies in both segments are misreading the changes in the marketplace.
Some are over-reacting to the headlines about reductions in the federal budget. Others are in denial, still embracing yesterday’s strategies and tactics, which don’t fit the emerging new federal marketplace reality.
Both sides need to adjust their strategies to protect against the risks of today’s turbulent marketplace and take advantage of emerging opportunities for growth.
At the same time, agencies that understand the current marketplace disequilibrium can do a better job acquiring and managing their next generation IT capabilities.
Where Federal Players Have An Edge
Let’s first look at the advantages and disadvantages that each segment brings to federal marketplace competition.
The firms with a primary focus on the federal space – the “federal segment” players – can optimize their entire organization to win and manage federal contracts.
Some have turned their cost accounting structures to competitive advantage. They can meet stringent government Cost Accounting Standards while, at the same time, maintaining the flexibility to get the prices needed to win different types of federal deals. They can compete at higher rates and margins for the Defense Department and intelligence agency work where competition is limited to firms that maintain costly facilities and equipment to meet government-unique manufacturing, integration and testing requirements and that maintain a bench of specialized, high priced engineering talent.
These federal segment players can also get very aggressive on the less specialized, lower-end deals involving the integration of commercial-off-the-shelf IT equipment, because they have built organizational components with accounting structures optimized for low-end federal work. They’re located in low rent facilities. They have a very thin overlay of divisional managers. They populate these lean divisions with personnel who receive lower salaries and benefits. Some hire retired military and government personnel who don’t need expensive healthcare and retirement plans.
Most established federal segment players have also invested in the processes and related software tools demanded by government customers on big deals. The leading federal segment players have gone through lengthy, costly and sometimes painful certification programs to demonstrate that they comply with processes including ISO9000, ISO20000, and, more recently, ISO27000 as well as higher level CMMI certifications for software development and ITIL certifications for their personnel.
The leading federal segment players have invested in software systems, including government cost accounting systems, earned value management systems, program management systems, and proposal management systems, which provide their executives with the visibility and controls to optimize federal sales and operations.
These investments enable competitors in the federal segment to meet the formal requirements set forth in federal RFPs or to use their process certifications and related software systems as proof of their ability to manage the largest federal deals successfully. In addition to fine tuning their accounting structures, program management processes, and supporting software systems to win and manage federal contracts, the leading players in the federal segment have also optimized their organizational structures and corporate cultures for success.
For the leading players in the federal segment, success equates to winning very big deals. They maintain deep benches of capture managers and proposal managers who have dedicated their careers to the pursuit of opportunities valued at over $100 million dollars. The executives who move up the corporate ladder are the ones who know how to command the corporate resources and develop the strategies and tactics needed to win these big deals.
Advantages of Commercial Players
The firms in the commercial segment, those corporations that are primarily focused on commercial customers but who are also players in the federal marketplace, have a different set of competitive advantages when they go after federal opportunities. If the strength of the federal sector firms can be summarized in terms of capture, proposal, and project management, the firms in the commercial segment have unique strengths in product and service management.
The commercial sector firms make huge up-front investments to bring new systems, software and services to market. The commercial sector firms are able to spread costs of product and service investments across a wide base of customers in corporate, government, educational, consumer and international markets. As a result, they don’t need to load the full cost of their product and service investments on any single market segment, such as the federal government customer.
Not only can they spread their up-front product and service development costs across customer groups, but they can also spread a large portion of their ongoing operating costs across their customer segments. Whether it’s their product management, help desks, field service, quality assurance, marketing, or brand advertising, they gain efficiencies by spreading costs associated with these functions across a wide and varied base of customers.
This is very different from their counterparts in the federal sector who tend to build their business cases on a deal-by-deal basis, and who operate each contract as a one-off project, which minimizes opportunities for cross-project efficiencies.
The federal groups within commercial segment firms can leverage their broader corporate capabilities and positioning to penetrate and grow in the federal space. With the addition of a customer-facing federal sales organization, they can reach back into their core commercial organization for resources, though this matrixed approach to resourcing federal sales and operations can create management challenges.
Generations of new federal rules and regulations that favor the use of commercial systems and services have reduced barriers to entry and growth for commercial sector firms.
Commercial sector firms can sell their systems and software to federal customers “out of the box” using a wide array of schedule and IDIQ vehicles. There are plenty of channels to the federal market that commercial sector firms can leverage. For more complex requirements, established federal players are always on the lookout for new commercial products and services that can give them an extra edge on the next federal deal.
But few commercial sector firms have reached the upper echelons of the federal IT contractor community.
What Holds Commercial Firms Back
Until recently, there have been three main factors holding commercial segment companies back from pursuit of the largest federal deals as prime contractors.
The first is concerns about channel conflict. Many commercial segment firms rely for a large portion of their revenue on channel partners, and they don’t want to compete directly with these channel partners for federal business.
Second, they make hefty margins on their COTS products, systems and services, and they stay away from taking the lead on big federal deals because they’re not profitable enough. As high technology IT products and services become commoditized, there are new pressures on corporate margins that should make the pursuit of federal deals more attractive.
However, there’s a third factor that holds commercial sector firms back from the aggressive pursuit of leadership positions in the federal marketplace. Executive decision-making on the allocation of corporate resources is driven by what it takes to succeed in their commercial markets, which differs from the priorities and investments needed to succeed in federal markets.
Unlike their federal sector counterparts, the accounting systems, processes and facilities of commercial sector firms are geared towards commercial sales and operations.
Most haven’t established a variety of cost centers to allow them to bid deals using either high priced and low priced labor, depending on what’s needed to win. Some really aren’t in the business of selling separately priced labor at all, the largest component of most big federal deals. They focus on the sale of their core systems, software or services, which have labor costs embedded in the total prices for their offerings.
Most of their technical professionals are responsible for designing and delivering their core services, and if they put these resources on project work, it would be like farmers selling their seed corn – it would interfere with their ability to develop, sell and deliver their core corporate offerings. They will offer hourly professional labor, often at high rates, only to augment their core offerings.
Shifts in the Federal Contracting Landscape
In yesterday’s stable federal marketplace, the federal and commercial segment players settled into established roles. The large players in the federal segment took the lead as prime contractors on big federal deals, and the commercial segment firms took a second position as team members, except on programs that focused primarily or exclusively on their commercial products and services. They generally ceded the lead role on large, labor heavy government prime contracts to their counterparts in the federal segment.
But there are important changes afoot that are destabilizing yesterday’s competitive equilibrium. These changes are creating threats and opportunities for both the federal and commercial segment firms that we’ve just described.
The primary factor driving changes in today’s federal marketplace is the budget. Though the budget is under attack, and overall federal spending will see dramatic reductions, the impact on federal and military IT spending will be less severe than the impact on other areas including major weapons systems, the federal payroll, and federal benefits. It’s not just that IT is essential to keeping the government in business, but the IT costs are small in comparison with these other budget items.
Yes, the growth in federal IT spending is leveling off, but it doesn’t look like there will be a dramatic reduction in the total dollars spent on federal and military information technology.
Instead, there will be significant changes in the way the government spends its IT dollars. I’d like to highlight three.
One is the decline in large programs of record.
The second is the shift to fixed-priced and usage-based contracting.
The third is the growing interest in cloud services.
Why Smaller Deals Make A Big Difference
In today’s pressure cooker political environment, “programs of record” — the big IT deals that show up as line items in the federal budget — will draw fire from Congress, OMB and the Pentagon. The underlying requirements behind these large programs of record aren’t going away, but agencies are looking for different ways to address their needs so that they fly beneath today’s political radar.
They’re breaking up big programs into multiple smaller contracts. They’re shifting more of their buying to task order competitions on indefinite-delivery, indefinite quantity or IDIQ contracts that have already been awarded. And they’re replacing expiring contracts that were previously awarded on a full-and-open basis with contracts set aside for small and disadvantaged businesses.
This decline in large programs of record is a major threat to the federal segment players, who have optimized their operations and built a corporate culture focused on full-and-open competitions for deals worth $100 million or more.
As the size of the average deal shrinks, so do some competitive advantages of the largest federal sector players. Mid-sized federal sector players are able to muster the resources to compete for these smaller deals.
When large programs are broken up and re-competed using small business vehicles, not only are the large federal segment players restricted from acting as prime contractors, but their maximum potential revenues are cut in half, since the small business primes must perform at least 51% of the value of these contracts.
As the size of the average deal shrinks, and as the government shifts more opportunities into IDIQ vehicles, it’s also easier for firms in the commercial segment to compete for them as primes. The cost to mount a successful capture and proposal effort drops, and it’s easier for commercial firms to command the internal resources to pursue them.
Also, in recent years, commercial segment firms have become more aggressive in capturing government-wide IDIQ vehicles, which gives them tickets to play as more requirements are shifted to these vehicles.
The challenge for the federal sector players here is to re-optimize their marketing and sales resources to allow them to target and win these smaller deals.
The challenge for the commercial segment players is to make the strategic investments in project, capture, and proposal management to take advantage of the growing number of deals they could pursue as credible primes.
Budget pressures have accelerated the second trend – the shift to fixed-priced and usage-based contracting.
The government is using these pricing strategies to minimize contract cost overruns and to avoid paying for under-utilized systems and services. These pricing strategies increase contractor risks, but they also shift the competitive grounds from hourly labor rates, where the federal sector holds a clear edge, to a sharper focus on improved workflows and process improvements.
Commercial segment firms have an enormous opportunity here. They have demonstrated the ability to deliver generations of exponential improvements in the efficiency of IT systems. Now they need to apply similar creative energy to delivering improvements to the professional services needed to implement and operate these systems.
Commercial firms have an opportunity to industrialize IT service delivery with fixed priced, managed services that leverage technology to improve the IT user experience at reduced costs. As more and more advanced IT systems and software are subject to commoditization, there are good reasons for commercial firms to invest in cracking the code on this opportunity to industrialize services, which really cuts across federal and commercial segments.
This is also the next frontier for the government and military IT executives who need new strategies to unleash the genius of industry to help reign in the biggest cost driver in federal IT – professional labor – by setting up the next generation of large, complex federal IT procurements to allow and encourage industry to work smarter, not cheaper.
The current trend towards “low price technically acceptable” or LTPA evaluation criteria, along with fixed priced contracts that offer no relief from rigid federal and military processes and procedures do just the opposite – they lock in today’s inefficiencies and leave little room for innovation in IT service delivery.
Cloud and Cyber Compound the Changes
Finally, the push to cloud services has the potential to disrupt the equilibrium between the federal and commercial segments of the federal marketplace.
Many of the competitive differentiators that have placed federal segment firms in market leadership positions will be threatened if the cloud revolution takes hold. Optimized accounting systems, low cost labor pools, process certifications, and a culture fine-tuned for capture and proposal management in pursuit of huge deals will provide limited competitive advantages if the government is really able to shift a significant share of its purchases towards commercial cloud services and away from last generation’s large, complex IT programs.
This is clearly a big “if”, but the threat is real enough that many of the federal sector players are already shifting resources towards cloud offerings.
Commercial sector firms clearly have an opportunity here as well, because many of the barriers to their successful federal market entry, expansion and dominance fall away if competition moves to the cloud. They’re no longer constrained by their competitive disadvantages in federal program and project management, and they have the opportunity to play on their strengths in commercial product and service management.
Federal cloud services represent one of a growing number of IT areas where the federal government is a leader, rather than a market follower.
Another related area is cyber security, where the federal government has sponsored the development of a new generation of sophisticated cyber security capabilities that were initially designed and deployed to protect federal and military IT infrastructure.
These capabilities are now being introduced as a pilot program to protect Defense Industrial Base firms and they will likely be expanded as services to protect critical infrastructure including national energy and transportation assets. Capacity services for storage, computing and communications represent another category of federal IT innovation, initiated by the Defense Information Systems Agency.
These areas hearken back to earlier federal leadership in computing and network technologies, and create opportunities for federal sector players to leverage their positioning in the federal marketplace to become first movers with services that can then be introduced to Corporate America.
Likewise, commercial sector firms should have more incentive than ever to expand their position in the federal marketplace and leverage their federal investments to build showcase services and accounts for offerings that can also meet the needs of their corporate customer base.
The federal and commercial sector IT firms that overreact to today’s federal budget headlines will miss out on opportunities to defend or improve their federal positions during this period of disequilibrium. They will also be caught flatfooted when others seize first mover advantages as the federal IT community pioneers promising new technologies and service concepts.
Those that hang in and innovate, despite market risks and turbulence, will have unique opportunities to build a stronger future for their companies and for the nation.
Warren Suss is president of Suss Consulting, Inc., which consists of over 70 senior professionals in federal IT, networks, and healthcare IT, and provides strategic planning and management support for corporate clients and federal agencies.