The defense industrial base’s disappearing middle

The defense community spends considerable time talking about competition, innovation, and the health of the defense industrial base. We should. All three are fundamental to our national security.

The government invests heavily in building the small business ecosystem, encourages non-traditional companies to enter the defense market, and increasingly looks to private capital to accelerate emerging technologies. At the same time, the government routinely expresses concern about consolidation, vendor lock, and the relatively small number of large companies capable of competing for the nation’s most complex defense missions.

Each side of this polarity is important to explore. Taken together, they expose a systemic problem that receives far less attention: The defense industrial base does not simply have a small-business challenge or a large-business challenge. It has a transition problem.

Government has built mechanisms to help companies enter the defense market and have access to an established ecosystem of major primes capable of operating on an enormous scale. What has not been built nearly as effectively is the bridge between small and large. That sparse middle ground may be one of the greatest long-term threats to competition in the DIB.

Competition Requires Competitors

Competition is healthy whether a company is small, mid-tier, or one of the nation’s largest defense contractors. Small businesses play an indispensable role in that ecosystem. They introduce new ideas, create competitive pressure, develop specialized expertise, and frequently operate with an agility larger organizations struggle to replicate. The government’s continued focus on expanding the small-business industrial base is appropriate and should continue.

Creating more small businesses is only one component of creating more competition. Industry routinely hears concerns about excessive consolidation and vendor lock-in among the largest defense contractors. It is clear that government leaders want access to alternatives. They want companies willing to challenge existing approaches, invest ahead of requirements, integrate emerging technologies, and compete for increasingly complex missions.

That raises a basic question: Where does the federal government expect the next generation of large, fully scaled competitors to come from?

Companies capable of competing against established primes do not suddenly appear. They are built over a span of years.

These organizations invest massive amounts of time and capital developing technical capabilities, recruiting talent, establishing infrastructure, building management systems, earning customer trust, and reinvesting profits. Eventually, the best of them grows beyond the statutory definition of a small business.

That should be viewed as success. Too often, it instead becomes a cliff.

The Mid-Tier Trap

The Small Business Administration’s recent proposal to modernize its size standards is an important development. SBA estimates that its proposed changes would expand small-business eligibility by approximately 114,500 firms, or 1.8 percent of employer firms, while also simplifying the structure used to establish size standards.

Increasing outdated thresholds can give successful companies additional runway to mature before entering full-and-open competition. Raising size standards alone, however, does not solve the larger problem.

A company can become too large to receive many of the benefits associated with small-business status long before it develops the balance sheet, contract diversification, infrastructure, and capital base of an established large defense contractor.

This creates a “mid-tier trap.”

These companies have proven they can perform. In many cases, they have hundreds or thousands of employees supporting critical missions. They have invested in cybersecurity, engineering, quality systems, facilities, recruiting, business systems, and increasingly sophisticated management infrastructure. For all their progress, they are still not hyper-scaled versions of the major primes, particularly in services and engineering businesses, where revenue growth often follows workforce growth. More employees therefore do not automatically translate into the financial capacity or institutional scale required to compete against corporations measured in multi-billions of dollars.

Yet the federal government’s system can effectively treat the moment a company crosses an administrative threshold as though that transformation has already occurred. It hasn’t.

Don’t Shorten the Runway We Already Built

The problem of mid-tier purgatory becomes acute with multiple-award IDIQ contracts. A company may compete for and legitimately win a position on an IDIQ while qualifying as a small business. It may spend years building capabilities and successfully performing work under that vehicle. But what happens when the firm grows?          

Current acquisition rules provide mechanisms for size re-representation, including circumstances where contracting officers can require re-representation at the individual order level. FAR 19.301-2 also makes clear that a change in size status does not itself change the terms and conditions of the underlying contract. That distinction matters.

Government should absolutely preserve opportunities for the next generation of small businesses. Acquisition leaders should also consider the long-term industrial-base consequences of unnecessarily accelerating the exit of successful graduating firms from competitive opportunities they legitimately earned. A company that has outgrown a size standard is not suddenly less innovative, less capable, or less valuable to the mission the following morning. Nor does excluding that company necessarily create more competition. Sometimes it simply removes a viable competitor from the market.

Good competition should create choices for the government, not remove them. This is the distinction the American industrial-base policy needs to confront. If an acquisition decision produces another healthy competitor, that can strengthen the market. But if it removes a proven mid-tier competitor before that company has developed the scale necessary to survive in full-and-open competition, it may only achieve a short-term small-business objective while weakening the government’s long-term competitive position.

The Capital Paradox

There is another contradiction. Across the defense ecosystem, government increasingly encourages industry to invest ahead of need. Companies are asked to develop technologies before requirements are finalized, build capacity before demand is guaranteed, hire specialized talent, strengthen cybersecurity, and put more private capital at risk.

Government has simultaneously worked to attract venture capital, private equity, and other private investment into national security markets. That is positive. America needs private capital participating in national security.

Consider the paradox. We are searching for new sources of capital to create tomorrow’s defense competitors while making it unnecessarily difficult for some organically grown defense companies to become those competitors themselves. That deserves scrutiny.

Independent and organically growing businesses have a unique role in the ecosystem. When profits can be reinvested directly into employees, infrastructure, technical capabilities, and customer missions, management can make decisions around long-term mission value rather than exclusively around short-term financial returns.

Private investment and organic growth are not opposing models. We need both. The question is whether public policy unintentionally makes one path substantially harder than the other.

This Is a Warfighting Issue

This discussion can easily sound like an argument about protecting businesses. It isn’t. The objective isn’t to protect companies from competition. It is to preserve the competitive marketplace that fuels American industry.

Future military advantage will increasingly depend upon integrated capabilities spanning software, platforms, sensors, networks, cyber, data, workforce, testing, sustainment, and supply chains. The Department of Defense needs contractors capable of understanding those mission threads and integrating them across traditional organizational and technical boundaries.

That capability takes years to develop.

When proven suppliers disappear, consolidate, or are forced into acquisition because they cannot navigate the transition between small and large, the government can lose more than a vendor. It can lose technical knowledge, customer understanding, experienced workforces, intellectual capital, and another independent source of competition.

Over time, the market becomes increasingly polarized: many small entrants at one end and a comparatively small number of enormous enterprises at the other.

The middle gets thinner. And then we wonder why there aren’t more choices at the top.

Small Business and Mid-Tier Growth Are Not Competing Objectives

While increasing size standards is a step in the right direction, if they are raised too aggressively, larger companies that remain classified as small could compete against genuinely early-stage businesses for set-aside opportunities. SBA itself estimates its current proposal could add more than 110,000 businesses to small-business eligibility.

This raises a valid concern for small businesses; however, promoting growth for small and mid-tier businesses is not a zero-sum game. The answer lies in designing an intentional      ecosystem capable of developing both ends of the spectrum.

SBA should consider protections for micro and early-stage businesses, continue mentor-protégé programs and meaningful subcontracting opportunities, and examine graduated set-asides or other mechanisms that recognize meaningful differences between a 25-person startup and a mature organization approaching the upper boundary of a size standard. Additionally, the SBA should examine how task-order recertification decisions affect companies already transitioning out of the small-business ecosystem.

The objective should be a continuum, with each tier benefiting from realistic standards that promote growth:

Small → Emerging Mid-Tier → Mature Mid-Tier → Full-and-Open Competitor

Each stage should prepare companies for the next. That is how an industrial base reproduces itself.

Measure Graduation, Not Just Participation

The health of the small-business industrial base is frequently measured by participation rates and federal contracting dollars.     These measures matter, but there is another metric worth considering: How many successful small businesses become sustainable full-and-open competitors?

Graduation into the next tier should be one of the ultimate measures of whether small-business policy works. If companies enter the ecosystem, succeed, grow, graduate, but      then disappear, sell, consolidate, or retreat from federal markets because they cannot survive the transition, the nation has not necessarily created a healthier industrial base. It      has created a pipeline with a leak near the end.

The SBA’s proposed modernization of size standards provides an opportunity to begin      addressing this problem directly. The agency itself describes the proposal as intended to allow rapidly growing firms to continue qualifying for existing work rather than forcing successful businesses out of eligibility prematurely.

That principle should extend beyond size standards. Acquisition policy, IDIQ structures, task-order recertification practices, access to capital, mentor-protégé programs, and industrial-base strategy should collectively create a deliberate transition pathway. Not permanent protection or insulation from competition. A true runway toward success.    

Build The Future of American Industrial Dominance    

The American industrial base needs startups, small businesses, and private investment. And we need the scale, integration capacity, and resources of industry’s major defense contractors.

Between those groups sits another strategically important part of the industrial base: companies that have demonstrated they can grow, innovate, execute, and compete but have not yet developed the scale of the largest primes. They are not merely too big to be small; they are the potential competitors that have successfully built capacity to deliver more for the mission.    

Every time one of these successful mid-tier companies transitions into full-and-open competition, the government gains another choice. Every time one disappears during the transition, it loses one. Every time one disappears during the transition, it loses one. If the federal government is serious about reducing vendor lock, increasing competition, accelerating innovation, and building a more resilient DIB, then it must think beyond small business entry. America must design for successful passage through the middle-tier to ignite the next era of industrial dominance.