Security Debrief

By Doug Doan

Contrary to popular myth, companies involved in developing new equipment or services for the Department of Homeland Security (DHS) are about to find themselves in real trouble. Dealing with the government has never been easy or for the faint of heart. The current business climate is deteriorating and companies trying to win new contracts, or hang on to their existing contract base, are going to find it harder sledding. These companies are high-risk investments. Here are ten reasons to be concerned about investing in companies doing business with DHS:

1. The government is finally going to have to face the realities of a $1.5 trillion annual deficit. Cuts to once-prized programs are now inevitable. Much to their credit, folks in the Pentagon already understand that defense spending will probably face disproportional cuts from the Obama Administration as the government starts to face the ballooning deficits. Unfortunately, key leaders at DHS may not be as astute. DHS, after all, has come of age in an era when the Department could expect annual double digit increases in the operating budget without much comment or review. Those days are gone.

2. Government contracting is in crisis. Though not widely reported, government contracting officers, stung by years of excessive oversight and finger pointing, have now become extraordinarily risk adverse. As a result, government contracts are rarely awarded on time, and extensions and delays are now the norm. These long delays might serve the government, but businesses competing for homeland security contracts are often forced to absorb the additional costs associated with repeated delays.

3. Multiple awards dilute the opportunities. DHS and other government agencies rarely award a single contract to a company that has submitted a superior bid. Contracting officers know all too well that a single award would trigger an inevitable avalanche of contractor protests, blaming them for even the most picayune procedural error. As a result, almost every company submitting a bid may be declared a winner. Making everyone a winner might be an effective way to mitigate protests and risks to contract officers, but it prolongs the bid and proposal period indefinitely at added expense to the companies involved. Companies “winning” these multiple award contracts are like someone buying a lottery ticket and then, based upon the expecting winnings, seeking to deposit the proceeds in the bank. In reality, they have won nothing except the chance to keep playing a game that is increasingly rigged against them.

4. Contractors and the blame game. Government contractors are increasingly being used as tar babies by the government, and especially by DHS, to heap blame and defer responsibility from government employees for poorly designed programs, constant changes to the scope of the work, and proliferation of the number of government stakeholders that all demand a role in contract oversight. Take a look at the recent decision by DHS to cancel the SBI Contract with Boeing as a prime example. This contract to deploy an electronic surveillance system across the southern border has been a government desire for almost twenty years, and a variety of different companies have been awarded a prime contract to design and deploy the system. Yet each company awarded this contract (there have been 5 over the past 15 years) has failed and been charged and ridiculed by the government for incompetence with hints of fraud.

Let’s be realistic: every complicated project is going to face unanticipated challenges and problems. But, how odd that every company that attempted this project ended in failure and was ultimately ridiculed by the government. Shouldn’t the government also bear some responsibility? Sure looks to me as if the government often uses contractors to absorb the blame and take responsibility for programs poorly designed and poorly managed by the government.

5. Government increasingly renegotiating contracts. The bias against government contractors within the Obama Administration is probably best illustrated by Energy Secretary Steven Chu, who recently announced a decision to freeze the pay of contractors working on DOE projects. Think about that. Chu was essentially saying that the terms and conditions of existing contracts could be unilaterally renegotiated by the government, especially if some political points could be mined.

6. Government poaching contractor personnel. The current rage in government contracting is “insourcing”- bringing jobs that were once performed by contractors in-house and having government employees assume those responsibilities. Folks can argue about the wisdom of that policy, but too often the end result is that employees belonging to companies once performing that work are just being recruited to become government employees. The company losing the work experiences a double hit. First, the company loses the existing contract. In addition, they lose some of their qualified employees and intellectual property. As a result, companies must now enter a government contract with the added risk that they could lose key employees. Hence, risk mitigation strategies and more complicated compensation agreements with employees (all at company expense) are vital for any company doing business with the government.

7. Government payroll problems and desire to protect government employees. Another unreported problem is how organizations, like CBP, have mismanaged their budgets for years and have relied more and more on fees collected from legitimate trade and travel to cover wage costs of government employees. For the longest time, using collected fees to offset government personnel costs worked just fine. But when economic troubles hit, the amount of fees collected from exporters and importers declined. This presented CBP with a new challenge – how to cover payroll costs. Eventually, CBP will most likely seek additional appropriations from Congress to cover personnel costs and become completely independent from collected fees, but that may take some time and is likely to cause a real conniption in Congress when DHS submits a budget proposal for significant new increases in order to meet existing payroll. As a result, CBP and DHS are under short-term pressure. CBP may decide to cut different contracts performed by private companies to gain access to funding needed to meet the payroll requirements of government employees.

8. Margin pressure and declining profitability. Government contracting has always been a very low-margin business, but now government contractors face some real pressure to remain profitable. The cumulative effect of all the new developments translates into one simple and unavoidable fact: cost for government contractors are growing. There are significant new risks to reputation, loss of employees and delays in contract awards. Yet at the same time, companies are going to face a difficult time passing those additional costs back to the government. Compressed margins and lower profits are thus likely.

9. Wimpy CEOs more likely to sock it to shareholders than confront government misconduct. CEOs of government contractors have mostly adopted a “go along and get along” approach in dealing with a government increasingly hostile to contractors. They do not want to upset government masters for fear of losing future business opportunities. Of course, in private, these same CEOs rarely show much hesitation to point out all the government-imposed problems and growing hostility that is hurting their businesses. Maybe their public silence is wise, but it comes with the risk that, like a salami, they are to just getting sliced piece by piece.

10. Contractors have no Champion vs. more powerful government employee unions. Government contractors lack a champion willing and able to argue and fight the too-easy mischaracterization and demonization of businesses that has become the norm. Ironically, these companies may have keen insights on how best to secure the homeland and defend the country but have no idea how to defend themselves. They need a champion to confront the powerful government employee unions that are currently cleaning their clocks. Until they find that champion, government contractors are going to lose.

So, there you have it – ten reasons to be concerned about investing in companies doing business with DHS. These companies face an increasingly hostile business environment, are not willing to fight the government when they are wronged and seem content to allow themselves to be bullied. There are plenty of companies in which you can be proud to be a shareholder and get inspired by innovative leadership. My advice is to pick one of them and think twice before investing in contractors doing business with DHS.

Doug Doan is an active Angel Investor and serves on the Board of the Border Trade Alliance.