Coronavirus is hitting small defense companies, but there may be a silver lining

Job layoffs and lost revenue are common symptoms of COVID-19 for defense-focused small business; recent surveys and qualitative evidence find contractors struggling over the past few months.

However, small businesses working with the Defense Department are at least partially insulated from most dramatic economic effects of the coronavirus crisis.

The question, and a point of concern for the Pentagon, orbits around whether the type of small and nontraditional businesses DoD has been courting over the past several years — which are considered a paragon for innovation and essential to buffeting near-peer competitors — will be able to survive as the  financial impacts of COVID-19 drag on and continue their reverberations into the future.

The small business experience

There is no debate that small defense businesses, like companies all over the world, are taking a hit from the way COVID-19 stalled the economy.

Advertisement

A survey from the National Defense Industrial Association found 60% of businesses that responded experienced a disruption to cash flow, and 67% of businesses with annual revenue less than $1 million saw cash flow impacts.

Sixty percent of companies also expect long-term financial and cash flow issues because of the economic slowdown.

Andrew Hunter, a senior fellow at the Center for Strategic and International Studies, said Monday during a web presentation that defense-focused businesses are faring better than other sectors, though.

“The U.S. defense industry continues to operate, so in that respect it’s kind of a good news story compared to other parts of the economy,” Hunter said. “Defense firms are still operating and they still have a pretty strong demand from their customer, the Department of Defense, which is doing quite a bit to, in many ways, even accelerate its demand signal to industry.”

Despite those efforts, the result, especially for smaller companies, is still cuts to billable hours, delayed payments from prime contractors and disruptions to contracts.

Mackenzie Eaglen, resident fellow at the American Enterprise Institute, said the biggest concern for smaller businesses is revenue expectations, followed by the ability to execute a contract and access to capital.

Mary Lockhart, president and CEO of PEMDAS Technologies & Innovations, a woman and service-disabled owned small business, told Federal News Network that is where many of her worries lie.

“We’ve had several no cost extensions because we weren’t able to do the work needed at the government site and deliver what was required,” she said. “Anytime you go into an extension there are always unplanned costs.”

Lockhart’s company specializes in products like atmospheric sensing and weather prediction technologies to help military pilots and other service members stay aware of their surroundings. Her business acts as a prime and subcontractor and does about $5 million a year in revenue.

PEMDAS employs about 25 people, but Lockhart said she’s had to let go of independent contractors since the coronavirus outbreak started. She’s also had to renegotiate terms with some employees by putting them on part-time work.

“It’s very hard for my small business. If I  lose my small workforce, I won’t be able to perform on contracts,” Lockhart said. “Many small business owners are taking out personal loans on their homes to keep things going. It’s a very stressful time for small business because you don’t want to lose your house: you’re already lost a big percentage of your 401k and you certainly don’t want to assume any more risk.”

Lone Star Analysis, a company doing about $15 million in annual revenue, has felt less of an impact to its operations.

“We are not seeing a reduction in cash flow,” Steven Roemerman, chairman and CEO of Lone Star Analytics, told Federal News Network. “That partly goes with what we do, we provide analytics and analytics solutions and support. Those are knowledge-based things that do not require access to a base in most cases to do it. I don’t have folks sitting in chairs on a base someplace doing support contracts.”

Roemerman said that’s beneficial because employees can still do their jobs from home and keep contracts on time. As a result, Lone Star Analytics has not had to lay off any employees.

Roemerman said one of the biggest adjustments to the crisis was waiting for DoD and prime contractors to adjust to teleworking.

He said there were slowdowns in approval authorities and payment delays from big prime contractors adjusting their systems to remote work settings.

Roemerman said everyone was adjusting to firewalls, IT issues, caring for children and all the other new challenges brought by the coronavirus stay-at-home orders.

“None of those things helped the federal cash flow response,” Roemerman said. “The prime contractors probably struggled with that more and they were slower to pay anyway.”

According to Defense Undersecretary for Acquisition and Sustainment Ellen Lord, 106 of the more than 10,509 prime companies closed due to cash flow and other issues; 68 others closed previously, but have since reopened. For vendor-based companies, 427 of the 11,413 closed. A total of 147 closed and reopened.

Overall, both Lockhart and Roemerman said DoD is doing a good job trying to keep funds injected into small businesses and pay them on time. DoD increased progress payments to small businesses from 90% to 95% and worked to continue awarding contracts.

The Navy and Marine Corps announced Monday that they are investing $30 million in rapid-funding opportunities for small business.

“During this national emergency, the Naval Research Enterprise must engage all activities to ensure we accomplish our current workload, make sure vital naval partners survive current economic conditions, and bring in new partners,” said Department of the Navy Small Business Innovative Research/Small Business Technology Transfer Research Director Bob Smith, in a statement.

Smitten with a new DIB

Even with the efforts to keep injecting money into a fledgling industrial base that DoD has been courting the past few years, it may be a mixed bag for small, nontraditional companies trying to work with the Pentagon during or after coronavirus.

Since Chuck Hagel was defense secretary under the Obama administration, DoD has been courting innovative, technologically savvy businesses that can fail fast, come up with exciting ideas and bring the military into a new age of warfare.

DoD set up hubs like the Defense Innovation Unit, the Strategic Capabilities Office and other rapid procurement entities to work with these companies.

“We’ve got to send a message loud and clear that innovation is not a COVID-19 victim,” Will Roper, Air Force acquisition chief, said a couple weeks ago. “We will keep it immunized from this disease and we will keep it moving so that warfighters now, and in the future, have the systems they need.”

However, the COVID-19 world may be a mixed bag for companies trying to jump on DoD’s innovation train.

“For small businesses it is now hard to do business development and maintain your work opportunity pipeline with the DoD,” Lockhart said. “Now we have to think of even more innovative ways of building our pipeline through phone calls, emails, and video conferencing. Going forward, I think it will be a very difficult time for new small businesses to enter into the defense contracting market. If you don’t already have a relationship established with your government partner, it’s going to be harder to do so. If you don’t have those face to face relationships, if you’re not at key industry pitch trade shows, then your ability to network and secure potential work is severely hampered.”

Roemerman has similar feelings.

“There are a lot of small businesses I believe won’t survive the storm,” he said. “It’s really hard if you’re on the outside with social distancing to be able to pitch your innovative idea to a government agency that won’t talk to you face to face.”

The NDIA survey noted that the defense technology sector — one that DoD is trying to grow — is feeling the effects of COVID-19 more than the manufacturing sector.

But if you’re a small or nontraditional business that already has ins with DoD, this may be your time to shine.

“They’ve already made that face-to-face contact and maybe they have a seed contract,” Roemerman said. “Those businesses who’ve gotten a start may flourish now because you’ve got a customer with a more stable cash flow and who has been doing a good job at paying quickly.”

It also may work out for DoD too. Roemerman said elusive companies that may have already made a mark, but are still reticent about working with the Pentagon may find DoD a more attractive partner since businesses are less willing to take risks in a retracting economy.

A post-COVID DoD

The Pentagon may not be as stable of an investor as it has been in the last few years when it’s enjoyed cushy budget.

Todd Harrison, director of defense budget analysis at the Center for Strategic and International Studies, says there may be a reckoning coming for DoD finances after the United States racked up record deficits to stimulate the economy.

“This is just off the charts compared to what we have seen in the past,” Harrison said. “We are going to be running huge deficits here for the next few years and I think we’d be kidding ourselves to think that  there won’t be increasing pressure in Congress and maybe in the public to reduce the deficit and reduce government spending.”

Harrison noted that DoD accounts for about half of the government’s discretionary spending.

While there may be a short-term boon for small companies cozy with DoD, it’s likely in a few years the belt will start to tighten.