Everyone talks about the potential budget cuts to defense spending. What is the impact on companies doing business with the government?

The Talk

First, let’s clarify what the talk is. Last year’s Budget Control Act mandated $259 billion in defense spending cuts in the next five years and nearly $500 billion in cuts over the next 10 years. Defense Secretary Leon Panetta requested $525 billion for the fiscal 2013 base budget, which is about $6 billion less than the previous year. Purchases of the new F-35 stealth fighter jets and Virginia class submarines will be delayed. 

Talk also centers on another round of base closures. We’ve already seen the impact of that close to home, with the closure of the Willow Grove Naval Air Station about a mile from Kreischer Miller’s office. Many local businesses, from restaurants to hotels to service providers, have been affected negatively.   

Panetta also said, “We have to retain a decisive technological edge. That means protecting and increasing investments in cyber capabilities. In order to protect vital investments for the future, we’ve protected science and technology programs as well.”

The Impact

Government contractors in our area may not see as many cuts; however, they will be under much more pressure to reduce costs and/or profit. One concern we have, along with many of our clients, is that the government will be focused more than ever on price versus value and other value discriminators. For companies conducting significant business with the government, this pressure to cut costs and profits may mean job losses or reductions in research and development. Larger, publicly held companies may look for strategic acquisitions to capture market share. The key to surviving and maybe even thriving under these conditions will be to deliver superior products and services to the government at a fair and reasonable price – much like any other business. 

The good news is that the insourcing trend appears to be nearing its end, with the government capping the number of employees it will hire. This insourcing was especially troublesome to many contractors who hired the best and brightest employees only to have the government hire them directly.

The Other Changes

The government has some contracts with private businesses that will reimburse the company for their “allowable costs” and provide some profit, either as a fixed percentage or based on performance factors. These are typically referred to as cost-plus contracts. Prior to the current proposal, allowability of contractor executive compensation was limited to the just the five most highly paid executives of each company. Proposed regulations expand the allowability of compensation to cover all contractor employees.

President Obama finally formally repealed the 2005 law that required the government to withhold 3 percent from all vendor payments greater than $10,000. The original legislation would have adversely affected cash flow, especially for small businesses, and would have cost more to implement than the benefit gained.

The debate about requiring government contractors to disclose their political contributions continues. In 2011, the administration circulated a draft executive order that would require the disclosures; almost instantly, senators objected to it.

We have definitely noted much stricter government enforcement. The Defense Contract Audit Agency continues to expand the audit scope to previously routine areas such as contractors’ accounting systems, internal controls to avoid defective pricing, and cost data for commercial items.

David E. Shaffer can be reached at Email or 215.441.4600.