Government Contractor Profits: Where Perception isn’t always Reality

March 16, 2008 by Brian Lustig

Those who keep watch for examples of Federal largess often cast an eye towards government contractors. It is easy to get lost in eye-popping contract awards that can involve billions of dollars, but of course the devil is in the details: the actual amount awarded often ends up far less than contract ceilings, and there are significant cost burdens in fulfilling a government contract.

Perhaps this is why watchdog groups and office holders perceive a level of profitability that exceeds the true numbers. This is at least part of the story one can infer from last month’s 13th Annual Grant Thornton Government Contractor Industry Survey. The findings, drawn from questionnaires distributed and received from 100 government contractors in 2007, indicate that more than three-fourths (76%) of surveyed companies reported a pre-tax profit of 10 percent or below.

The numbers show that government contractors - while growing at a healthy rate relative to the rest of the economy - are not registering obscenely high profits. In addition to the grounded profit picture, other key survey findings include:

• Management and support headcount — Headcount of management and support activities was significantly reduced to 9.9% this year from 13.8% last year.
• Revenue trends — 52% of respondents experienced revenue increases during the past year, continuing the trend from previous years.
• Anticipated growth — 72% of respondents expect increases in revenue from federal prime contracts.
• Uncompensated overtime — 32% of surveyed companies do not account for all hours worked, and as a result, are at risk for losing revenue and profits on time and material contracts.
• Executive compensation — Executive compensation remains the most frequent cost challenged by government auditors.
• Identifying out-of-scope work — Identical to last year’s survey, 66% of survey participants reported that their procedures for identifying out-of scope work are either not effective or only modestly effective.
• Proposal win rates — Survey participants report a 33% win rate from proposals for non-sole source business. The win rate jumps to 58% when the company establishes a special business unit, such as a joint venture or a limited liability corporation to bid the work.
• Intellectual property — 49% of surveyed companies own intellectual property. Of these, only 33% charge their customers license fees for use of the property.
• Exit strategy — Sale of the company continues to be the most favored exit strategy by far. The interest in pursuing initial public offerings of company stock grew even lower than in previous years.
The government contractor industry is also not insulated from its own set of risks impacting current and future growth potential. For example, the survey cites new regulations being created by The Federal Acquisition Regulatory (FAR) Council that pose significant new risks for contractors. At the same time, the upcoming Presidential election - no matter which party wins - adds an element of uncertainty that will impact contract opportunities during the political transition period.

The report further cited how “…government contract terms and conditions impose unique compliance burdens in practically all aspects of the company’s business, and those burdens are continually increasing.” This, in some ways, makes the government contracting business more formidable for companies than commercial ventures.

The Grant Thornton survey is a valuable one, highlighting areas where public perception is not meeting reality. At the same time, it shows an industry that is still very healthy but one that - just like commercial sectors - will have to fight hard for collective profitability.

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