The noise surrounding LPTA, sequestration masks a deeper shift in the market

In this exclusive analysis, Washington Technology explores how the noise surrounding lowest price contracting and budget cuts are disguising a profound shift in the market. In part one of a two-part series, industry expert Jim Kane explores how this shift impacts contractors and the risks they take on in their government projects.

There has been a fairly dramatic shift in the risks and rewards of competing in the government market. This shift is driven by changes in technology and related changes in buying behavior.

The risks and accompanying rewards of serving the market have decreased as government agencies increasingly adopt technologies and behaviors that are not inherently unique to the government market space. That is a signal that shouldn’t be ignored.

But the current emphasis on budgets, sequestration, lowest price, technically acceptable procurements, etc. is to some extent masking this signal for the noise.

While these are all significant business issues, companies could be better served by focusing on the underlying economic signal of this new market reality and adopting strategies better aligned with it. 

This shift is the second major change over the past ten years.

Until the early 2000s the government market was a relatively low-risk and low-reward world of systems integration. Government and industry each had their respective risk-reward profiles that are notionally represented in the graphic labeled M1. Systems integration procurements (M1) specified the inputs – equipment, software and even the years of experience for personnel assigned to the program.

Market Chart 1

Industry responses emphasized compliance with the specifications and the “low-risk” of the proposed integration approach. While this was relatively low risk for both parties, there was typically a gap (G) between government and industry for the given level of risk.

Industry was able to close the gap and achieve its target reward over the life of the program through negotiation, engineering change orders and other mechanisms that leveraged program incumbency. 

Both sides recognized the shortcomings of this model not the least of which was that government was always buying last year’s version of the specified technology.

Agencies recognized those shortcomings and buying behavior eventually shifted from “systems integration” to “solutions provider” during the Bush years. Service level agreements replaced detailed technical specifications.

Companies had the flexibility to propose solutions that fulfilled the government’s service requirements and leveraged a company’s competitive strengths. However, this loosening of the rules introduced new risks for both government and industry, represented by the shift from M1 to M2 in the graphic labeled M2. What had been a workable gap for industry to close through negotiation in the systems integration model was now much larger.

Companies used three methods to close that gap to again attain the reward commensurate with the risks of being a solutions provider:

  • Reduce overhead and G&A costs through acquisitions to achieve economies of scale
  • Implement process discipline (CMMI, ISO 9000, ITIL, ISO 20000, etc.) to reduce risk and improve margins through predictable, replicable outcomes
  • Adopt commercial products and service models to reduce risk and improve margins.
Market Chart 2

Taken together these actions enabled industry to achieve rewards consistent with the risks of being a solutions provider.. The solutions provider market became more rewarding than traditional systems integration.

One need only look at the stock market performance of solutions providers during this time relative to the overall market. Largely unnoticed was that the government market was becoming increasingly attractive to companies that were providing commercial products and service models being implemented by solutions providers.

Even more unnoticed was that government agencies were beginning to recognize that it was no longer necessary to pay a risk premium for supposedly government-unique solutions when solutions providers were relying on commercially available products and service models to fulfill agencies’ requirements. These forces have emerged to drive the shift we see today.

Where is market risk and reward in 2013?

Consider the disruptive technologies that most executives agree will drive the market over the next few years: cloud; smart phones and mobile computing; cyber; big data and predictive analysis; virtualization.

Every one of these is primarily commercial. There is little that is government-unique or high technical risk with any of them, with the exception of some variations of cyber-security. Government largely has been a follower in their adoption and has become just another vertical segment in which these technologies are driving change.

The government market is losing some of its uniqueness and the risk premium that contractors had enjoyed is decreasing. Essentially the same technology solutions being implemented in commercial market segments are available to the government market at comparable commercial prices and margins.

No wonder LPTA might make sense to an agency – it’s how much of the commercial world operates.  

I’m not yet certain where the new equilibrium position (M3) for industry and government risk and reward will be in response to these changes.

It is depicted as a general range in the graphic labeled M3.

Market Chart 3

I am confident it will be closer to M1 rather than M2, and fairly certain it will not be to the left of M1. 

I believe 2013 will be a disruptive transitional year but that this-year we will have enough information for companies to accurately assess their market position and to adopt or refine their preferred business strategy. I'll explore these strategies in part 2.