Pentagon Business Goes to the Small Fry

Foreign wars create opportunities for small and nimble contractors

Beetle Bailey, the comic strip Army private, has peeled a lot of potatoes.

Real-life army grunts have more important things to do on the modern battlefield, goes the thinking at the Pentagon these days. The scut work—and a good deal more—is outsourced to companies that can swoop in with people, basic resources, and technical know-how.

CACI International and ManTech International have become two of the most successful providers of technical services to the U.S. armed forces as spending on contractors soared because of wars in Iraq and Afghanistan. Together they raked in $3.9 billion last year from the military for providing everything from security services to radar data analysis. “When DOD outsources ​work, it can surge and purge,” says Todd Harrison, a defense analyst at the Center for Strategic and Budgetary Assessments in Washington. “It can tell a contractor, ‘I want you to bring on hundreds or thousands of people quickly,’ and they’ll do it.” And when the job is done, “they’re gone,” he adds.

Services may be a relatively safe haven in an era of deep defense cuts. Pentagon spending on services has grown 13 percent since 2008, to $124 billion last year, while weapons manufacturing declined 14.5 percent during the same period, Bloomberg Government data show. Lockheed Martin still earned the most from military services last year with $5.5 billion. Others in the top five are similarly big names: KBR, Northrop Grumman, L-3 Communications Holdings, and SAIC. The five companies sold the Pentagon services worth $21 billion in 2010. Yet together their service contracts decreased 7.5 percent between 2008 and 2010. In the same period, CACI and Mantech increased theirs by more than 90 percent. In fiscal year 2010, CACI’s revenue was $3.1 billion and ManTech’s $2.6 billion, small change compared with Lockheed’s $45.8 billion.

A willingness to make less profit plays a role in CACI and ManTech’s success, says Brian Kinstlinger, an equities analyst at researcher Sidoti. “You have to be willing to do low-margin work. If you’re willing to do it, you’re going to win a lot more work,” he says.

ManTech’s orders include a bilingual team to support U.S. counter-narcotics operations in Colombia, field technicians to work with software and computer systems overseas, and work on the U.S. Army’s remote controlled airborne intelligence-gathering system, known as Guardrail. CACI’s work ranges from analyzing convoy routes in Iraq so troops can avoid improvised explosive devices, to developing software for biometrics devices used at checkpoints, to protecting sensitive data from cyberattack. Paul Cofoni, CACI’s chief executive officer, says that whatever the Pentagon’s need, “quick turnaround is the driving requirement.”

These midsize vendors, both headquartered in Washington’s Northern Virginia suburbs, are getting bigger every year even while their behemoth competitors are bracing for cuts to the major weapons systems that drive their earnings. “Smaller businesses can often be scrappier,” says Ray Bjorklund, chief knowledge officer for Deltek Information Solutions, a federal market analysis firm. “Companies that are more agile might be able to compete more aggressively and successfully.”

Smaller companies excel at adapting to the military’s changing technological needs and can be faster to respond to changes in pricing or contract terms, says William Loomis, who covers the defense services sector for Stifel Nicolaus, a St. Louis-based financial services company. “We find that the midsize to smaller companies can react more quickly than some of the bigger ones,” he says.

Now, as defense contracts for fighter jets and armored vehicles decline, some defense analysts predict that Lockheed and other big players in the military-industrial complex may turn to services to make up the difference.

Weapons manufacturers tend to increase their focus on services such as those performed by CACI and ManTech only when overall defense contract spending declines, as it did last year for the first time in more than a decade, says David J. Berteau, director of defense-industrial initiatives at the Center for Strategic and International Studies, a Washington research organization. “I would expect that the competition will get keener and tighter,” he says.

Companies will have to get even leaner to thrive in the new environment, especially as funding for overseas wars that bolstered the services sector declines, Harrison says. “They’re going to have to lay off people and do it quickly if they want to remain profitable,” he says.

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