This week, the FAR & Beyond blog features guest bloggers on a topic of interest to our members. The comments herein do not necessarily reflect the views of The Coalition for Government Procurement.
Authors:
Moshe Schwartz, President of Etherton & Associates and the Former Executive Director of the 809 Panel on Acquisition Reform
Brad Nathan, Assistant Professor at Rutgers University, and a former Electrical Project Engineer at Intel Corporation
The Federal Government’s small business strategy dates back to 1953, when President Dwight D. Eisenhower signed the Small Business Act, establishing the Small Business Administration. President—and General—Eisenhower recognized that equity dictates that small businesses be given a fair opportunity to compete for government contracts. However, he also recognized the importance of small businesses to national security. From experience, he knew that small businesses can be more nimble and less bureaucratic, allowing them to develop capabilities faster and shift focus more rapidly. Over the years, the Department of Defense (DoD) has significantly benefited from its small business efforts.
Unfortunately, DoD is currently struggling to attract many of the most innovative and promising small businesses to the defense market. When partnerships do occur, DoD faces obstacles to effectively capitalize on technologies developed by small businesses, due to factors such as complexities with integrating designs and scaling production. DoD moves too slowly; startups and investors find it hard to justify the upfront investment and endure long cycle times to get a return on investment—even if the return would otherwise be attractive. For these reasons, many vital technology start-ups are deterred from government collaborations.
While DoD consistently meets its targets for the dollar-number of contracts that it awards to small businesses, these targets appear to be an end in themselves, rather than a catalyst for a small business strategy that prioritizes small business’ capabilities to improve national defense. As the Section 809 Panel found,
“DoD is not fully capitalizing on small businesses’ innovativeness. Instead, DoD appears to focus its small business policies and programs on acquiring goods and services based on meeting societal goals not related to mission.[1]”
These findings led the Panel to recommend that DoD refocus its “small business policies and programs to prioritize mission[…].” We concur. DoD needs to reimagine its small business strategies to focus more on capabilities developed by, not dollars awarded to, small businesses. Awarding contracts to small businesses that are not adding value to goods and services should not be the primary barometer of success. Rather, how rapidly DoD identifies and integrates small businesses’ novel capabilities into its military and business operations, as well as the utility of these capabilities, are examples of better metrics. As the most recent National Defense Industrial Strategy points out, speed of acquisition and production/adoption at scale are critical for defining success. In its effort to implement innovative industrial base strategies, DoD should establish a mentor-purchaser pathway, focused on rewarding small businesses (and investors) who develop needed capabilities, and then rapidly scaling and integrating these capabilities into the force.”
Enticing Small Businesses
DoD and other government agencies can entice small businesses to enter the government industrial base by enabling profitable exit strategies on projects. For example, DoD could establish a mentor-purchaser pathway, focused on rewarding small businesses (and investors) who develop needed capabilities, and then rapidly scaling and integrating these capabilities into the force. The Army unrolled a program called Project Vista that partially addresses this goal by incentivizing large defense contractors with source selection credits if they include in their proposals technology developed through the Small Business Innovation Research (SBIR) program. Let us take this one step further—DOD should consider leaning into programs that combine government and private sector-funded venture capital with mentorship from experienced defense contractors. These larger contractors can, when beneficial to all parties, eventually purchase, scale, and/or more seamlessly integrate such technologies for faster use by DOD.
The argument for a mentor-purchaser pathway is simple. Some small companies (and their investors) have neither the resources nor the desire to try to slog through the “Valley of Death.” They may require a faster exit strategy. They may prefer to remain an engineering or R&D-oriented company. They may not want to run the DoD acquisition gauntlet of excessive regulation and confusing bureaucracy. Or they may lack the expertise and capital to rapidly grow and develop a promising capability into production at scale. A mentor-purchaser pathway can provide incentives for private venture capital to support entrepreneurial small businesses developing groundbreaking technologies. This can allow small businesses to thrive in their element– nimbly developing capabilities–and allow larger defense contractors to leverage some of their core competencies (i.e., their balance sheets and infrastructure) to more rapidly produce and integrate capabilities at scale. The ability to marry emerging capabilities developed by small businesses with the production capabilities of large businesses seems to be an ideal way to meet the goals of DoD’s Replicator effort. This can apply to production or widespread implementation of technology or software.
This is not about encouraging small businesses to exit the defense industrial base; it is about encouraging more entrants. Creating more promising and easier pathways to exit will entice more small businesses to enter the DIB in the first place. More entrants means more competition, more access to new capabilities, and a more resilient industrial base.
Key to this pathway is for all parties to benefit: providing the financial rewards that will incentivize small businesses by creating a profitable exit strategy, rewarding large companies for their institutional know-how and production capabilities, and most importantly, letting DoD integrate capabilities at speed and scale. This approach can reduce the risk of hesitancy on behalf of DoD in moving forward with start-ups or small businesses who lack the experience producing at scale. At the same time, this approach can assuage small businesses’ reticence to partner with DoD due to uncertainties about funding or the lack of a viable exit strategy.
As the Wall Street Journal reported, while venture capital firms have poured over $100 billion into U.S. defense-related startups since 2021, DoD investment in potentially useful technologies developed by these companies has been scant. This is partly because DoD has been slow to identify how to integrate and scale these technologies. Venture capital may not continue investing in defense technologies without a clear exit strategy pathway that provides competitive financial returns.[2] A mentor-purchaser program provides an exit strategy for developers of useful tech that will keep many venture capitalists interested in the defense markets and willing to keep money flowing into defense-related investment.
A mentor-purchaser program is not right for all small businesses. Many companies will choose to grow and remain independent. This is to be encouraged. But a mentor-purchaser program may be ideal for some, where their founders’ and engineers’ primary passion is creating technological advancements, rather than navigating bureaucratic hurdles, mastering the ins and outs of contracting, or becoming marketing mavens. This new pathway is aimed at those serial entrepreneurs who would rather develop a new capability, realize returns, and move on to the next creation. In implementing this new pathway, certain issues will have to be addressed, including to what extent the large company is a mentor, partner for scaling, or purchaser, how to avoid conflict of interest issues, and how to protect the IP rights of small businesses.
Other Ways to Support Small Business
A Mentor-Purchaser program is not the only way to reimagine the small business strategy and both expand small business participation in the defense industrial base and identify promising capabilities offered by small businesses. For example, companies seeking to compete for classified contracts require a workforce that has security clearances and facilities that are accredited to handle classified work. The process to establish, build, and accredit Secure Compartment Information Facilities (SCIFs) takes time and considerable financial resources—resources that small businesses generally cannot afford. This creates a barrier to entry. However, such small businesses could be supported through a program that creates shared SCIFs, either through allowing access to underutilized existing SCIF space—or establishing new SCIFs in excess GSA facilities. To offset the costs to the government, a WeWork time model could be adopted where companies pay for the time they use the spaces.
Novel approaches to a new small business strategy, such as establishing a mentor-purchaser program and creating shared SCIF spaces, can help foster a more innovative, responsive, and collaborative ecosystem that drives progress and ensures a competitive edge for DoD in an ever-evolving technological landscape.
[1] Report of the Advisory Panel on Streamlining and Codifying Acquisition Regulations. Volume 1, January 2018. See: https://discover.dtic.mil/wp-content/uploads/809-Panel-2019/Volume1/Sec809Panel_Vol1-Report_Jan2018.pdf
[2] The Wall Street Journal (Jan. 25, 2024). “Investors Are Betting on Defense Startups. The Pentagon Isn’t.” by Heather Somerville. See: https://www.wsj.com/tech/defense-startups-risk-becoming-failed-experiment-without-more-pentagon-dollars-dc9e663a?utm_campaign=dfn-ebb&utm_medium=email&utm_source=sailthru&SToverlay=2002c2d9-c344-4bbb-8610-e5794efcfa7d