How The Feds Starve Small Contractors
Dodgy definitions, legal loopholes, and deep-pocketed corporations are depriving small businesses of the federal contracts earmarked for them.
By Arlyn Tobias Gajilan

(FORTUNE Small Business) – As an entrepreneur and weekend tri-athlete, Cindra Stolk thrives on competition. All she wants is a fair shot. That is not what she got last May when Federal Edge, her eight-employee technology services company in Riverside, Calif., was a leading candidate for a $600,000 Air Force contract designated for a small business. Instead, the contract went to GTSI of Chantilly, Va., which posted nearly $1 billion in revenues last year and employs about 700. "It took 18 months and a lot of our blood, sweat, and tears to put that bid together, only to have it picked off by a big business," Stolk says angrily.

At a time when federal contracting is at a record high, Stolk's experience is increasingly common. According to goals set by Congress, 23% of federal contracts are supposed to be set aside for small firms. While the SBA reported recently that the Defense Department exceeded that goal by nearly two percentage points in 2003, Larry Makinson of the Center for Public Integrity, a nonpartisan Washington think tank, says those numbers "just don't add up." Makinson is the editor of a recent CPI report that found that in the past six years more than $47 billion of the Pentagon's small-business contracts has actually gone to large companies. Among the heavyweights singled out in the report is Stolk's rival, GTSI, which won nearly $1.2 billion in small-business contracts.

How are large companies getting away with it? A well-financed lobbying effort helps. So does an unsupervised bureaucratic system with loopholes so large that a billion-dollar defense company can, for instance, classify itself as small. Despite the rhetorical embrace entrepreneurs receive for being the country's leading source of jobs, official Washington shows little interest in fixing a system that is getting worse for small business. "We can't monitor each and every contract," says Emily Murphy, the SBA's senior advisor for government contracting and business development. "Changes do need to be made, but the regulatory process can take six months to a couple of years." Until then, big business is reaping the rewards. Consider, for example, the aptly named San Diego firm Titan, which employs 12,000 and had $2 billion in revenues last year. It has grown in part by acquiring smaller firms that hold lucrative, long-term contracts that were originally set aside for small businesses. A curious regulation permits those acquired contracts to retain their small-business status even after they are swallowed by giants. That means a big payment for the happy owner of the acquired company. But each acquisition depletes the pool of set-asides for companies that remain small and independent. According to Murphy, the SBA is considering a rule that would require firms to recertify their size after an acquisition.

In the meantime, under pressure to streamline their balance sheets, federal agencies are "bundling" small contracts into a single, consolidated contract. Only the largest prime contractors apply, leaving small firms out of the running or forced to bid for subcontracts from the same companies they compete against. That is exactly what happened last summer to John Pless's translation services company, REM Holding Group of Wilmington, Del., when the Army bundled its translation needs into one, massive $2.5 billion contract. Just as the Army was set to anoint Titan as its exclusive supplier, Pless protested to the General Accounting Office that the Army's bundling was unnecessary. But his claim was dismissed, and Titan remains the Army's favorite, leaving Pless in the awkward position of asking his mammoth rival for work.

Its critics blame ordeals such as Pless's on the SBA's standard procedures. The agency relies on a kind of corporate honor system, allowing businesses seeking federal contracts to self-certify as small or large on their applications. Since few federal agencies have time to scour applications for miscoding, or possibly even fraud, policing of the system is left up to small-business owners willing to file a complaint. "It's a system that's just begging to be abused," says Michael Watkins, a former Harvard Business School professor who consults on corporate and government relations. Catching that abuse can end up feeling like a full-time job, says Monty Mauldin of Coats, N.C. Mauldin and his wife, Lilian, run Tiger Enterprises, which leases laundry equipment to nearby Army and Air Force bases. The Mauldins have filed ten complaints with the SBA since 2000. "I don't mind losing in a head-to-head with another, truly small business," says Monty Mauldin. "But we were losing small-business set-aside contracts to big companies." Lloyd Chapman, president of the American Small Business League, a 3,500-member national trade group based in Petaluma, Calif., says the SBA is concealing the extent of the system's disrepair. In October the ASBL sued the SBA in hopes of getting the agency to release a report it completed in January 2003 that Chapman says "confirms widespread fraud in federal contracting." The SBA denies any coverup and is "vetting the report," says Murphy.

Fixing the federal procurement system won't be easy, especially not with the big bucks being spent to keep things just the way they are. In its report, CPI found that the country's ten largest defense contractors spent $450 million on campaign contributions and lobbying over the past six years—a pittance considering the $340 billion in contracts those companies earned. For now at least, entrepreneurs such as Stolk are relying on sheer resourcefulness. After Stolk dug through the SBA's online records and found her rival's original bid, she discovered that GTSI had miscoded itself as a small business. Stolk filed a protest with the Air Force and SBA; she eventually won the contract. (Aside from losing the business, GTSI faced no other consequences and declined to comment for this article.) "I don't want GTSI to keep getting away with this sort of thing," says Stolk, who filed a lawsuit against the company in November charging "unfair business practices." "If I don't fight back, who else will?"