The Small Business Administration is facing rising opposition to a proposed size standard for some companies that are IT value-added resellers.

Since SBA issued the proposed rule in September, which would remove an exception to how these IT VARs are classified as small contractors, more than 200 people responded, mostly voicing their opposition to the potential change.

The SBA wants to eliminate the 150 employee size standard for IT value-added resellers (IT VARs) under NAICS code 541519. Instead, SBA proposed to use the $27.5 million size standard that applies to the rest of the current NAICS code.

Ken Dodds, SBA’s director of the Office of Policy, Planning and Liaison, said having an employee-based size standard under this NAICS code is inconsistent with the rest of the 541519 NAICS code, which is based on total revenue.

He said this change is necessary for several reasons.

“If we go ahead and eliminate the exception, these are supply contracts and they will be subject to all the other NAICS codes and size standards that apply to supply contracts as well as the non-manufacturer rule, which has a size standard of 500 employees,” Dodds said in an interview with Federal News Radio. “That’s kind of the misconception out there. This exception is used for primarily supply contracts, and in any other case when you have supply contracts, you have an employee-based size standard and you have the non- manufacturer size standard of 500 employees.”

He added most of these companies that could be affected by this change would still qualify under the 500 employee size standard under the non-manufacturer rule.

Different ways to buy the same thing

Dodds said there is confusion and concern over this proposal because of the exception. SBA believes the proposed rule would help reduce or even eliminate the confusion over services versus supplies and where value-added resellers fit in.

“We’ve heard from businesses on both sides, but certainly businesses that exceed the 150 employee size standard that nevertheless can qualify for an IT procurement using the 500 employee size standard,” he said. “So basically right now as a contracting officer, if you are buying IT supplies mainly, you can use this exception with 150 employee-based size standard or you can use the computer manufacturing NAICS code with 1,000 employees and use the 500 employee size standard. That’s part of the additional confusion out there. The same procurement can be bought two different ways and it can basically exclude some firms from competing depending on what the contracting officer selects.”

IT VARs are a big market in the government with companies such as the ImmixGroup or Accelera Solutions or Red River Computer Corp, and many others bringing commercial products such as a Dell laptop or a Cisco router to the federal market and offering additional services such as installation or upgrades or training.

IT VARs are big under governmentwide acquisition contracts (GWACs) such as NASA SEWP V or other multiple award contracts such as the Homeland Security Department’s First Source and the Air Force’s NetCents.

SBA’s proposed rule is causing more, not less, confusion for some

At least some experts believe SBA’s methodology for determining the need for this size standard increase is flawed, said James Fontana, a managing member of Dempsey Fontana law firm in Reston, Virginia. He represents several IT value-added resellers.

“There are many small businesses that do business with the federal government that believe the SBA is just totally out of touch with the small business community, and totally out of touch with the realities of the IT value-added reseller. Its business and operational model is much different from that of a service company,” Fontana said. “You have, typically for each employee, higher amounts of revenue because of the high cost of the IT equipment, much lower margins and it would take much more revenue to account for those employees. The SBA doesn’t seem to appreciate that distinction.”

He said he looked at a sample of IT VARs under SEWP V, NetCents 2 and First Source 2 and found at least 50 percent of the awardees would no longer be eligible as small businesses under this proposed NAICS code change.

Fontana said this shows SBA’s claim that the proposed rule change would not affect 99 percent of all IT VARs is incorrect.

He added it’s not just small firms, but several large IT value-added resellers also would be impacted as they partner with smaller firms on contracts.

“One of the problems is in terms of SBA saying you can instead rely on that manufacturing NAICS code is problematic because that alternative purchasing method doesn’t justify eliminating a very well established NAICS size exception. That’s one of the problems with that alternative,” Fontana said. “As the SBA has stated both in 2002 and in 2003, and as recently as 2011, the SBA recognized that this particular NAICS code is unique for the VAR community and its virtual elimination would create an undue burden by the small VARs by forcing them to compete in various manufacturing NAICS codes that are not designed by the supply sector of the federal IT industry, which is dominated by much larger companies.”

Withdraw and start over

The concerns over SBA’s proposed rule also have attracted the attention of the House Small Business Committee.

Chairman Sam Graves (R-Mo.) wrote a letter to SBA on Nov. 10 expressing his dismay and asking SBA to withdraw the proposed rule and start over.

Graves said the proposed rule failed to follow the express language of the Regulatory Flexibility Act. The law mandates SBA make public a detailed description of the industry, an analysis of the competitive environment for the industry, the approach the agency used to develop the size standard and the anticipated effect of the proposed rule on the industry.

Graves said the proposed size standard of $27.5 million is not equivalent to 150 employees.

SBA’s methodology to determine the appropriate size standard also is questionable because recent examples suggest that the agency is prioritizing administrative ease over precision when developing size standards. Graves called the proposed rule irrational because it fails to follow the mandates of the Administrative Procedure Act as well.

“An agency that promulgates a regulation in which the rule is not rationally related to its statutory mandate or objectives also will be considered to have acted arbitrarily and capriciously in violation of the APA’s mandate of rational rulemaking,” Graves wrote. “As a proposed rule directly contradicts the statutory mandate, the tow cannot be rationally related. Therefore, the proposed rule fails the tests of rational rulemaking mandated by the APA.”

Concerns over SBA’s methodology and efforts to update size standards aren’t new.

Under the Small Business Jobs Act of 2010, Congress required the agency to review every size standard, more than 1,100 in all.

Guy Timberlake, the American Small Business Coalition’s chief visionary officer and CEO, said the proposed size standard change is similar to others SBA has offered up over the years, which leaves some people guessing and frustrated, while others are playing on a totally new field.

“What I’ve seen are a lot of companies who play in that space are very concerned about this being very detrimental to small business,” Timberlake said. “I guess what I’m trying to look at from another perspective, how many companies who take advantage of the exception actually exceed $27.5 million? If it’s most of the companies or half of the companies, then my perspective is what I see happening, unless the government is going to fundamentally change the way it does business under that NAICS code, that business will start going to smaller companies who actually fit under the $27.5 million size standard. In this day and age of all the other size standards increasing exponentially from $7 million to $14 million and things of that nature, this would be the reverse in that respect.”

No timetable for a final rule

He added concerns about SBA’s size standards methodology has been discussed for some time, specifically about whether it helps or harms small businesses.

He said when SBA raises the size standard, small companies now face more competition. And when they change it like they are proposing to with IT VARs, Timberlake said, small firms either are now large, or there are new entrants are able to enter the market.

Fontana said he’s talked to SBA informally and formally about his clients’ concerns. He said SBA justifies the need to update the NAICS code because of what the agency says are changes in IT VAR industry.

But Fontana said that’s part of the problem, SBA’s data is inaccurate and old and they need to get better data to truly understand the state of the IT VAR market.

Dodds said the comment period closed on Nov. 10 and SBA now will review those comments to come up with a final rule. He said he couldn’t put a timetable on when the final rule would come out as it still must go through the interagency review process.

Fontana said he’s hopeful that SBA will reconsider the proposed rule, or make major changes to it as the vast majority of the 200 or so comments SBA has received are opposing the proposed rule.

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