CHAPTER III. SMALL BUSINESS SUBCONTRACTING

PROGRAM

A. COMMISSION RECOMMENDATION No. 48, PART A

Procurement from Small Business

Test mandatory small business subcontrating on a selected basis to determine its feasibility."

The Commission on Government Procurement reported that, of the Department of Defense military subcontracting dollars, between 35 to 43 percent went to small business (statistics based on fiscal year 1967-72). The Commission found that there had been a decline in the percentage of subcontract dollars being awarded to small business. This was attributed to the fact that large prime contractors became concerned about maintaining their work force and operating facilities during times of declining Federal procurement expenditure, resulting in a tendency on their part to "make" rather than "buy" the component parts or other supplies in performing the Government contract. This theory also assumes that during times of declining procurement activity, large firms would tend to subcontract with each other, resulting in small business being squeezed out of new or continued subcontracting opportunities.

B. FINDINGS OF SUBCOMMITTEE

As one means of promoting the goal of small business's receiving greater benefits from the Government's contracting programs, Congress amended the Small Business Act in 1961 to establish a small business subcontracting program. Under this amendment, the Administrator of the SBA, the Secretary of Defense, and the Administrator of GSA are to develop a subcontracting program to (A) enable small business to be considered fairly as subcontractors or suppliers under Government contracts, (B) insure prime contractors and subcontractors will consult with SBA, (C) enable SBA to obtain information and records necessary on prime and subcontracts.2

In implementation of this legislated policy, both the Armed Services Procurement Regulation, at § 1-707.3, and the Federal Procurement Regulations, at § 1-1.710-3,3 contain guidance and clauses to be used in appropriate contracts. There are essentially two contract clauses which are selected on the basis of the size of the contract. For contracts in excess of $5,000, a contract clause is used which merely exorts the contractor to maximize his subcontracting with small business to the extent consistent with the efficient performance of the contract. Another contract clause is used in contracts which may exceed $500,000. In this case, the contractor is required to designate an officer for liaison with the Government on small business

1 Report of the Commission on Government Procurement, Vol. 1, Part A, Chap. 12, p. 125. 115 U.S.C. 637(d)(1).

• Sections of regulations reprinted in Appendix B.

matters and to administer the contractor's small business subcontracting program. To this end the contractor is to consider the potentialities for small business in "make-or-buy" decisions and assure that small business is given an equitable opportunity to compete for subcontracts.

The SBA conducts plant reviews of prime contractors with major prime contracts to examine and assist in their small business subcontracting program. The number of these reviews has grown from 503 in fiscal year 1971 to 813 in fiscal year 1973.5

TABLE 12.-U.S. PROCUREMENT THROUGH SUBCONTRACTING PROGRAMS WITH PROPORTION OF AWARDS TO SMALL BUSINESS

1 Compiled by the Senate Small Business Committee.

2 Military subcontracts by reporting large contractors. 1971 data are preliminary. 3 Not available.

In fiscal year 1973, there was an improvement in the value of subcontracts placed with small businesses reported both by the civilian and military agencies. This precedes a period of decline which caused concern for the Commission on Government Procurement and which in part prompted their recommendation.

The information provided on the subcontracting program by civilian agencies is not as extensive and helpful as that presented by the Department of Defense. From the above table, it is evident that only the Department of Defense provides the number of firms which report their subcontracting activity. This is highly significant in attempting to analyze the effectiveness and progress of the subcontracting program. It would be more helpful still to have the number of contracts both above and below $500,000 which contain the subcontracting clause.

The Commission's recommendation is based on the experience of the Department of the Navy on two contracts in which there was incorporated a "mandatory subcontracting" clause. The first contract was with the Aerojet Manufacturing Company, Sacramento, California, for the supply of MK 56 Mod O mines in July 1967. This firm fixed

4 Hearings before the Subcommittee on Government Procurement, Senate Small Business Committee, on Procurement from Small Business in Labor Surplus Areas and Small Business Subcontracting Program, 93d Cong., 1st Sess., Oct. 10 and 11, 1973, p. 85.

See Appendix C, letter from Hon. Thomas S. Klepne, Administrator, Small Business Administration, to Senator William D. Hathaway, Chairman, Subcommittee on Government Procurement, Dec. 12, 1973.

price contract for $38 million was completed in August 1971. Under the mandatory subcontracting clause in the contract, the company was to place 25% of the contract price with small business subcontractors. The Navy reports that when the contract performance was virtually complete, 4,232 orders totalling $12.28 million had been awarded to small businesses under the contract."

The other contract containing a mandatory small business subcontracting clause was with the Edo Corporation, College Point, New York, to supply underwater mine conversion kits. Although the contract was not completed at the time the Subcommittee corresponded with this company,' the Edo Corporation had met their small business contract obligation.

The companies took differing positions on whether they would want this type of clause in future government contracts. The Aerojet manufacturing Co. would oppose the obligation because of the growing number of large companies. The Edo Corporation evidently would not object because customarily a large proportion of its subcontracts go to small businesses. It notes, however, that the monitoring and reporting function contained in the obligation is costly and timeconsuming.'

During your subcommittee's hearings in October, the Small Business Administration took the position that it was premature to take a stand on the Commission's recommendation for further testing of mandatory subcontracting. Since the SBA is the lead agency on a study task force for this recommendation composed of various agencies of the Executive Branch, it could not report on its position until it had completed its study.10

The Department of the Navy, however, concurred without hesitancy with the recommendation for further testing. In light of its experience with the clause, the Navy provided the Subcommittee guidelines for how the clause should be used:

A primary prerequisite for testing is the ability of the Government to develop a meaningful mandatory small business subcontracting percentage applicable to the procurement involved. To do this, we must have good historical information, reflected in Government records or prime contractors' experience, as to the approximate dollar value of the components and other items and services that could reasonably be furnished by competitive and qualified small business subcontractors.

I do not envision the application of this mandatory technique to a procurement if such action would unduly restrict competition. For example, where there are numerous potential offerors with differing types and quantities of in-house production equipment, a high mandatory small business subcontract percentage may exclude some offerors from

See Appendix D, letter from Hon. Charles L. Ill, Assistant Secretary of Navy (Installations and Logisties) to Senator William D. Hathaway, Chairman, Subcommittee on Government Procurement, April 27,

1973.

* See Appendix E, letter from J. Robinson, Subcontract Manager, Edo Corp., College Point, New York, to Senator William D. Hathaway, Chairman, Subcommittee on Government Procurement, Sept. 14, 1973. * See Appendix F, letter from C. H. Anderson, Aerojet Manufacturing Company, Fullerton, Calif., to Senator William D. Hathaway, Chairman, Subcommittee on Government Procurement, Sept. 21, 1973. Letter from J. Robinson, Edo Corp.

10 Hearings before the Subcommittee on Government Procurement, Senate Small Business Committee on Procurement from Small Business in Labor Surplus Areas and Small Business Subcontracting Program, pp. 87-88, 91.

participating in the procurement. Similarly, a low mandatory
small business subcontracting percentage would present no
incentive to an offeror with limited in-house production
facilities to maximize subcontract awards to small business.
Finally, I do not anticipate application of this technique to
weapons systems, currently under development, where
there are many unknowns and limited information as to
contribution that could be made by small business sub-
contractors.11

In response to a question from the chairman of the subcommittee asking whether this mandatory subcontracting technique could be used widely, Mr. Morris Questal, Special Assistant for Small Business and Labor Surplus, Department of the Navy, answered that, in his opinion, this concept could be used only "in very selective cases." 12 Mr. Douglas S. Dillman, President of the Horn Corporation, Ayer, Massachusetts, a small business, testified that he supports the recommendation for testing of mandatory small business subcontracting; however, he felt the contractor must be given flexibility.13 He also asserted that SBA should have the authority to enter into the make-orbuy decisions with the contractor.

Mr. Herbert W. Hutchison, Director of Materials, RCA Corporation, Cherry Hill, New Jersey, stated that he opposed mandatory subcontracting set-asides for small business, since they would appear neither practical nor cost-effective. He felt further testing would not produce meaningful information on the feasibility and desirability of use of the concept. Mindful of the difficulties to the Government and contractors in the implementation of such a program, he saw a real problem for RCA if the Government were to use a 25 percent mandatory small business subcontracting requirement in an RCA contract. The average total value of RCA's subcontracting is approximately 30 percent of the total contract price, with about 50 percent of the subcontracts being awarded to small business. A mandatory requirement of 25 percent small business subcontracting of the total prime contract price would mean approximately 83 percent of RCA's total subcontracting would necessarily have to be placed with small businesses.14

Both contractors that performed under contracts containing the clause, Aerojet Manufacturing Co. and the Edo Corporation, objected to the future use of the mandatory subcontracting requirement. The Aerojet company's position is that the "business climate" has changed so that it would be difficult to reach a 10 to 12 percent of the total contract price requirement.15 As for the Edo Corporation, the requirement had no appreciable effect on the company's performance; however, the company reported that the monitoring and monthly reporting were "costly and time-consuming."

11 Ibid., pp. 101-102.

12 Ibid., p. 107.

18 Ibid., p. 121.

14 Ibid., pp. 124-129.

" 16

15 Letter from C. H. Anderson, Aerojet Manufacturing Company.

16 Letter from J. Robinson, Edo Corporation:

Alternatives

The Subcommittee was also interested in looking at other means. to improve subcontracting opportunities for small business. Witnesses were advised in advance that the Subcommittee would be interested in hearing suggested alternatives for promoting this program.

1. SUBCONTRACT GOALS

Mr. Hutchison, in his testimony, and Mr. Bowers, in his written statement which was elaborated upon by Mr. Questal, suggested that small business subcontracting goals for prime contractors might be effective. The contractual goals would be particularly useful in major development programs where there is insufficient information on anticipated small business subcontracting participation. The goals could be set in individual contracts or on the total government contract work handled by a contractor.17

The principal drawback to this technique would seem to be the lack of enforcement. The Government would not have any recourse if the contractor failed to meet the goal. As a result, there is little inducement for the contractor to meet a goal that exceeds what would naturally have gone to small business.

2. SUBCONTRACT SET-ASIDE FOR SMALL BUSINESS

The Air Force has had a program under which contractors under facility contracts are required in their subcontracting to set-aside solicitations for small business. By a deviation granted from the Armed Services Procurement Regulation Committee, the Air Force uses this authority only in situations where there is an Air Force representative located physically in the plant who can keep a close watch on the subcontracting performance. This procedure is only being tested during fiscal year 1974.18 No statistics on the effects of the program are available yet.

3. INCENTIVE FEE

Although not suggested in your Subcommittee's hearings, it has been proposed that the Government incentivize its small business subcontracting program by either increasing or decreasing the rate of profit of the prime contractor depending on the extent of small business subcontracting accomplished. The price contract would provide that the prime contractor award either a certain percentage of his subcontracts to small business or a percentage of his subcontract dollars would go to small business. Failure to meet this requirement would result in a reduction in the profit as determined by the contractual guidelines. Likewise, exceeding this contractual goal would permit the contractor a higher rate of profit.

Hearings before the Subcommittee on Government Procurement, Senate Small Business Committee, on Procurement from Small Business in Labor Surplus Areas and Small Business Subcontracting Program, pp. 98-112 and 124-129. See Appendix G for deviation authority by Armed Services Procurement Regulation Committee on July 56, 1973.

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