Sidelining Small Businesses

Over one year, at least $339 million in defense spending funneled through a program set aside entirely for small businesses ultimately ended up in the hands of the largest federal contractors, according to a Project On Government Oversight (POGO) review of contracting data. Those dollars went to companies like Lockheed Martin, Boeing, General Dynamics, Northrop Grumman, Raytheon, and L3Harris – and POGO’s tally is likely an undercount. The awards are from a massive Defense Logistics Agency (DLA) program worth up to $33 billion over 10 years.

And while this program is not the only one where mammoth defense companies ultimately win subcontracts that pass through small businesses, the Defense Logistics Agency recently came under fire from the Small Business Administration for potentially running afoul of the law. In a previously unpublished letter dated January 25, 2022, theSmall Business Administration wrote that the Defense Logistics Agency may have made “improper use of a small business set-aside” due to subcontracts to large manufacturers under the program.

The Defense Logistics Agency’s administration of the program is a case study in how agencies can bend and potentially even break laws and rules that are in place to protect the share of federal contract dollars going to small businesses. Given that DLA’s alleged violation wasn’t noticed by the Small Business Administration until Republican lawmakers on the House Small Business Committee raised questions, it also shows how the Small Business Administration isn’t overseeing the increasing use of waivers it grants to agencies that bypass a provision of the Small Business Act.

“Plain and simple, no one is immune from the law, especially government,” Representative Blaine Luetkemeyer (R-MO), the top Republican on the House Small Business Committee, told POGO in an emailed statement. “It is the SBA’s responsibility to look out for America’s small firms and I’m concerned they are not.”

Originally, the Defense Logistics Agency’s Tailored Logistics Support program was meant to help rapidly and nimbly equip special forces with specialized tactical gear that is often manufactured by small businesses: scuba gear, knives, jackets, rifle scopes, mountaineering backpacks, and the like. A cottage industry of small businesses around the U.S. makes high-quality gear, which can improve performance in austere and niche environments some troops operate in — particularly those in special operations — far from robust supply lines. (This story focuses on the Special Operational Equipment Tailored Logistics Support program. There are other TLS programs run by the DLA, but this one is the largest.)

But the Defense Logistics Agency’s actions “may be resulting in limiting opportunities for small businesses,” Luetkemeyer told POGO. That’s because, even though the agency relies on a handful of small business resellers to source gear, it doesn’t require that those resellers buy equipment manufactured by other small businesses. And the Small Business Administration says that might be a violation of the law.

The Defense Logistics Agency said it is operating within the law and that it is committed to maximizing small business contracts while meeting the needs of the military and federal government as well as getting favorable prices. “DLA is compliant with the terms of the waivers that SBA granted,” a spokesperson for the agency told POGO in a written statement, adding that the agency regularly exceeds the federal government’s rate of small business contracting. The SBA did not respond to a request for comment.

Waivers

Generally, by law, companies must spend at least 50% of the federal small business contract dollars they receive on their own manufacturing costs instead of passing on the lion’s share of the award to a subcontractor. But under certain conditions, the Small Business Administration can grant other federal agencies a waiver to that requirement under its non-manufacturer rule, which allows the government to award small business contracts to firms that are resellers.

The way this is supposed to work is that an agency such as the Defense Logistics Agency, which uses small business resellers, should identify specific equipment where there is a need, but that need cannot be met by small business manufacturers. Thus, a waiver is needed for those small business resellers to buy equipment from a manufacturer that is a large business. The agency can then seek a waiver from the Small Business Administration for just that specific equipment, such as a drone. If the agency can justify its case to the administration, then the SBA may grant a waiver — but the waiver only applies to those specific items.

The Small Business Administration has approved hundreds of these little-examined waivers in recent years, according to administration data. And their use has gone up significantly from 2014 through 2021, according to the available data.

Source: Small Business Administration

The crux of the current dispute is that the Defense Logistics Agency has asserted that a waiver it received from the Small Business Administration applied to an entire program worth up to $33 billion, allowing four small business intermediaries to source gear through subcontracts from any other company, regardless of their size. The Small Business Administration says it outright rejected the Defense Logistics Agency’s request for such an expansive waiver and that the DLA then misused a far narrower waiver for only a $1.3 billion subset of that program that the administration had granted earlier.

“SBA was never informed by DLA that it was applying the waiver to what SBA would consider a different procurement,” the Small Business Administration wrote. “The value of the contract awarded is in SBA’s view out of scope for the waiver that was granted.”

A spokesperson for the Defense Logistics Agency disputes the SBA’s view that it misused the waiver, stating that it has received waivers from the SBA “for the past three iterations of this program, dating back to 2008. Since then, the acquisition strategy as a 100% small business set-aside has not changed.”

Running to the tune of billions per year, the Tailored Logistics Support program makes up a significant percentage of the Defense Logistics Agency’s amount of annual contracting with small businesses. “Since 2018, DLA contracts with small businesses were worth an annual average of $14.8 billion,” a DLA spokesperson told POGO.

But congressional critics say these numbers deserve closer scrutiny.

“The DLA, in awarding this procurement as a total small business set-aside, can claim the total value of the contract ($33 billion) towards its small business prime contracting goals,” five House Small Business Committee Republicans wrote in a December 2021 letter. (The $33 billion is over a ten-year period that started in 2021.)

But when a “small business prime vendor may merely be passing through the products of large manufacturers to the DLA,” their letter adds, the result is “large manufacturers [are] capturing an unknown but presumably significant share of federal dollars tapped as going to small business.”

It is unclear what, if anything, will happen to the Defense Logistics Agency. “The Small Business Act and SBA regulations do not provide for SBA to take action for NMR [non-manufacturer rule] violations,” the Small Business Administration’s letter states.

Truly Commercial?

Critics say the Defense Logistics Agency not only flouted the law but has deprived small manufacturers of potentially billions of dollars in contract opportunities and allowed the Pentagon to avoid rules that protect taxpayers from being overcharged. The criticisms reflect complex policy debates over how the government can expeditiously get the gear it wants at good prices while steering taxpayer funds towards small businesses.

“Particularly in this current economic environment where the lingering effects of the pandemic, burdensome government mandates, labor shortages, and rising inflation is wreaking havoc on small manufacturers, it is of vital importance that the federal government act swiftly to rectify this abuse of the nonmanufacturer rule waiver which constrains our small manufacturers, and in turn, our domestic supply chain,” wrote five House Small Business Committee Republicans in December.

Referring to the Defense Logistics Agency’s Tailored Logistics Support program for special operations equipment, a veteran defense industry insider said, “Program managers are using TLS to skirt acquisition laws.” He spoke only on the condition that his name not be used due to his continuing work with the Pentagon.

He said tens of millions of dollars spent on gear — like electronic systems that detect radio “emissions from submarines, surface ships, aircraft and land-based radars” — from some of the biggest defense companies should not be bought through the program.

Such sophisticated equipment is not generally sold to the public in significant quantities, and therefore is borderline commercial. That’s a problem, as POGO has long highlighted, because the program is supposed to be used for commercial gear. Companies supplying gear deemed to be “commercial items” do not need to provide the government with certified cost and pricing data to ensure the prices being charged to taxpayers are fair and reasonable.

Yet the definition of what can qualify as commercial items has been elastic, excluding only some of the most obviously non-commercial gear like tanks, fighter jets, and aircraft carriers. In many cases, vital equipment and parts almost exclusively used inside of those weapon systems is deemed commercial, even though there may not be any actual substantial commercial market for these goods. And over the life span of those weapon systems, big money is spent replacing those parts, which can add up to even bigger bills than necessary when there are insufficient protections for taxpayers. In several striking cases, the Air Force “inappropriately” sought to buy C-130J transport planes, refueling tankers, and simulators for F-16 jet fighters as commercial items, according to a 2006 Government Accountability Office report.

A Defense Logistics Agency spokesperson said the Tailored Logistics Support program encourages its intermediary vendors “to seek out alternate items manufactured by both small and other than small manufacturers that offer new or improved technology to military and whole-of-Government customers at more favorable pricing or with better terms.” He said, "this process is in place to ensure competition between contract holders and to ensure customers may take advantage of the best commercial products available at fair and reasonable prices.” The spokesperson said federal contracting officers determine whether goods can be purchased legally as commercial items.

The Rule of Two

The other big problem with the Defense Logistics Agency’s approach is big companies might be taking opportunities away from small businesses that could meet these needs. While it’s challenging, and often impossible, to find small businesses that can build some of the sophisticated or niche equipment purchased through the program, it’s a different story when it comes to apparel and many other kinds of gear, including some electronics.

Under federal laws and rules, generally if there are two qualified and competitive U.S. small businesses that will bid on a contract between $3,500 and $150,000, the contract is supposed to be set aside for small businesses. This is known as “the rule of two.”

On the whole, the Defense Logistics Agency’s actions “severely disadvantage the thousands of small business manufacturers and processors capable and willing to supply the products on this solicitation,” wrote House Small Business Committee Republicans last December.

Cui Bono?

Sources familiar with the Defense Logistics Agency’s Tailored Logistics Support program say DLA has a financial incentive to encourage federal agencies to purchase supplies through the program. They say that could be a motive to push the boundaries of what the Small Business Administration’s waiver allows.

For awards under the program, the Defense Logistics Agency collects a standard 5.4% fee, although it can be reduced to 2% in some cases. Those fees supplement DLA’s budget and are meant to cover the agency’s costs for administering the Tailored Logistics Support program. But those fees are relatively high compared to the General Services Administration, which similarly allows federal agencies — including the Pentagon — to buy goods in a streamlined manner through pre-approved contractors. The General Service Administration’s fee is 0.75%. (The GSA fee is deducted from a participating contractor’s sales, whereas the DLA fee is added onto the sales amount charged to the agency buyer.)

DLA’s spokesperson didn’t comment specifically on whether the fee could be a motivation for interpreting the waiver expansively but said the agency “neither forces nor mandates the use of the” Tailored Logistics Support program. He said its federal “customers typically prefer the [Tailored Logistics Support] program because it satisfies their requirements expeditiously and cost-effectively,” and that DLA’s fees and programs are “designed to cover the agency’s costs” and not to generate profit. The spokesperson said the differences in the DLA’s and General Service Administration’s fees reflect differences in the support from the agencies. “The personnel needed to ensure a beneficial procurement process from cradle to grave for military requirements necessitates more man hours per dollar than in GSA,” the spokesperson said.

The Defense Logistics Agency’s expansive use of the waiver has benefitted not only the large businesses that make goods purchased through the Special Operational Equipment Tailored Logistics Support program, but also the four businesses that act as intermediaries for buying gear. And one company, Atlantic Diving Supply (ADS), has historically dominated the program. 

Although there is no indication that it or any of the other intermediary companies have done anything wrong in the matter involving the waiver, Atlantic Diving Supply, along with its majority owner Luke Hillier, has also paid tens of millions of dollars in recent years to settle claims that it manipulated federal small business programs while admitting no wrongdoing. Some of the claims made in a False Claims Act lawsuit alleged that the firm defrauded the government through the Tailored Logistics Support program. A related criminal investigation led to the conviction of individuals who worked at other companies, but no one at Atlantic Diving Supply was prosecuted.

Atlantic Diving Supply gets about 80% of its revenue through the Tailored Logistics Support program, its general counsel, Adam Casagrande, told POGO early last year. Casagrande said the firm has been able to maintain its small business status, which is based on its number of employees, even while its revenue has grown because the firm increasingly sells bigger ticket items made by other companies. As of fiscal year 2020, ADS is the 22nd largest federal contractor.

"If the government orders more high value items, ADS, or whomever is the winning contractor, accordingly has an increase in revenue,” Casagrande wrote in an email to POGO in early 2021.

And many of those high-value items are made by big defense contractors; such purchases are enabled by the Defense Logistics Agency’s expansive view of what the Small Business Administration’s waiver allows.

POGO’s analysis of awards through the Tailored Logistics Support contract shows numerous government purchases of gear manufactured by large traditional defense firms. (See POGO’s methodology below to learn about POGO’s analysis.) Some examples from 2021 include a $44.6 million award and a $37.6 million award, both to Atlantic Diving Supply, for equipment described as “Marine Lifesaving and Diving Equipment” that was manufactured by General Dynamics — the third-largest federal contractor.

In one year, at least $150 million of awards that flowed to Atlantic Diving Supply were for gear made by L3Harris, which is the 11th-largest federal contractor. Other large defense contractors like Boeing, Lockheed, Northrop Grumman, and Raytheon also manufactured gear purchased through the Tailored Logistics Support program, with Atlantic Diving Supply taking a cut as an intermediary and the Defense Logistics Agency adding on its fee.

Over the years, Atlantic Diving Supply and other Tailored Logistics Support prime contractors have held themselves out as a kind of outsourced sales force for small manufacturers that might otherwise find it challenging to handle the specialized needs of federal government customers. And a DLA spokesperson told POGO that ADS and the other intermediaries add value as “integrators, logistics experts, and technical experts” and provide “capabilities that many small business manufacturers with new and critically advanced products to offer simply do not have.”

But that argument doesn’t hold for companies like Boeing, Lockheed, Raytheon, L3Harris, Northrop, or General Dynamics — which have no trouble drumming up government business on their own.

Through an external attorney, Libby Locke, Atlantic Diving Supply said, “The majority of ADS’s revenue under the SOE TLS contract is derived from products of subcontractors that are other than large businesses.”

Neither Locke, Atlantic Diving Supply’s general counsel, nor its spokesperson commented specifically on statistics POGO presented over email showing that ADS‘s $339.7 million in subawards to top federal contractors made up only 71.4% of the associated $476 million in prime awards to ADS from DLA. (POGO relied on publicly available federal data, but federal subaward data is widely considered incomplete.)

“For competitive reasons, ADS will not disclose gross margin percentages by supplier, contract, etc.,” wrote Locke, a partner for the law firm Clare Locke LLC. “However, ADS can share that its total company gross profit percentage on its 2021 annual financial statements was less than 9%,” Locke emailed, adding that ADS “makes a much smaller gross margin percentage on sales of large business subcontractor products versus those of other than large businesses.”

There’s no public evidence that Atlantic Diving Supply or any of the other Tailored Logistics Support prime vendors are responsible for the Defense Logistics Agency’s actions regarding the waiver and ADS did not respond to a question about the Small Business Administration’s concerns with the waiver. But the subawards POGO has identified validate the pointed questions raised by House Small Business Republicans last December. They wrote, “We are very concerned that this waiver granted by the SBA constitutes a free pass for the DLA to procure from large businesses under the guise of a small business set-aside.”

SBA: “Massive Contracts” Harm Small Businesses

Winning subcontracts from small businesses is just one way large companies gain access to federal procurement dollars. An array of reports by the government, mediaoutlets, advocacy organizations like the American Small Business League, and others have shown that billions of federal contracting dollars intended for small businesses routinely end up with big companies each year.

There are several reasons why that’s the case — one being how agencies are increasingly using massive contracts. The Small Business Administration’s letter also took aim at these contracting practices, which they say put small businesses at a disadvantage.

“The trend of awarding fewer, larger, and longer contracts has resulted in dramatic decreases in the number of small businesses working with the government,” the SBA letter states.

The decline in the number of both small businesses and larger businesses winning Pentagon contracts was recently documented in a Government Accountability Office report. According to the report, “DOD awarded contracts to almost 25,000 fewer businesses in 2020 than it did in 2011, with the number of larger businesses contracting with DOD decreasing at a similar rate to small businesses.”

The Small Business Administration’s letter states that the Tailored Logistics Support contract is an illustrative example of a federal procurement program that is not small business friendly. “SBA’s position is that this type of contracting runs counter to the promotion and fostering of small business participation. These large contracts are specifically difficult for small business manufacturers,” according to the letter. “Even if there are small businesses that make some of the items that the Government is looking to procure, it becomes increasingly difficult for small businesses to meet the scope and terms of these massive contracts.”

One solution is many smaller contracts, SBA says. “Add to that the fact that the duration of many of these contracts is so long, and the problem is only exacerbated,” the letter states. “It would be better for small businesses and small business manufacturers if the items being acquired were acquired through many more contracts, and contracts that are not 10 years long.”

But the Small Business Administration’s letter makes it clear that its powers are limited. “SBA cannot dictate the terms of contracts or lengths of contracts to contracting agencies,” the letter states, nor can the agency decide to deny waivers solely because contracts are large.

A Defense Logistics Agency spokesperson disagreed that the Tailored Logistics Support program harms small business manufacturers. Instead, he wrote that it helps them because it “affords increased access to potential Government purchasers through small business intermediaries in a way that does not require small businesses manufacturers to set up the extensive, labor and knowledge-intensive infrastructure traditionally required to do business with the Federal Government, which might otherwise deter them.”

New developments at the Defense Logistics Agency underscore the Small Business Administration’s lack of power. Even though the administration has said the Defense Logistics Agency might be illegally asserting a waiver that exempts the entirety of the Tailored Logistics Support program for special operational equipment, DLA is doing the same thing in another similar, multibillion-dollar program. On April 29, DLA wrote that this “100% small business set-aside,” worth $7 billion over 10 years, also has an SBA waiver that allows winning contractors to “supply the product of both large and small businesses.”

Julienne McClure contributed research to this story

This story was updated to clarify that the Tailored Logistics Program is worth up to $33 billion over ten years. It was also updated to reflect that a DLA spokesperson referred to an "annual" average of small business contracting.