Budgets, technology give advantages to nimble government contractors over the larger competitors.
A profound and dramatic shift is underway in the government market that will dictate the type of companies that succeed and fail going forward.
We are witnessing a change from “economies of scale” to “economies of skill” as a successful business strategy in the government information technology market.
A significant share of new business will be driven by companies’ ability to adapt legacy programs to new technology and budget realities rather than capture entirely new programs.
Mergers and acquisitions will be driven by the highly differentiated capabilities of the company to be acquired rather than by the acquiring company’s objective of efficiencies through growth in market share. And if you doubt this is the case, you haven’t attended recent conferences for investors in this market.
Two key market drivers are behind this change in business strategy: budgets and technology.
The outlook for budgets is relatively flat. The implication is that there will be less spending on new program starts but relatively more spending on enhancements and improvements to existing programs. At the same time new technologies not only are being increasingly introduced but also increasingly disruptive.
Disruptive technologies and incremental enhancements are not a good match the classic “design-build-operate” paradigm. Companies in the past have leveraged their scale in the design-build-operate procurement model to win new programs. Companies in the future that can leverage their unique skills, smaller scale and agility in the new world of “adopt-insert-improve” will have a competitive advantage to capture business.
This evolution of the market negates many of the advantages of scale that have driven business strategy. Companies could gain market share and drive top-line growth through acquisitions, while at the same time achieve bottom-line growth through less than proportional increases in overhead and general and administrative costs. Disciplined engineering processes and program management practices provided additional competitive advantage to larger companies in the pursuit of new programs. As a result, many decisions to be a sub rather than prime on new program procurements were driven by the reality of being unable to “compete against the big guys.”
In contrast, just as specialized remodelers have distinct advantages over new homebuilders in renovating buildings, so too do niche companies have competitive advantages in the new adopt-insert-improve environment. Their competitive advantage can reflect specialized expertise in a technology, disciplined architectural and systems engineering capabilities for technology insertion, and subject matter expertise in mission operations.
Traditional reliance on agency relationships and domain knowledge will continue to be necessary but no longer be sufficient to win business for technology enhancements to legacy programs.
There are implications of this new environment for different segments of the market. Niche technology-driven companies will be increasingly attractive – both as teammates and potential acquisitions. Classic systems engineering and technical assistance contractors will be vulnerable if they lack technical knowledge and engineering expertise required for major enhancements to their current programs. Large primes will be on the look out for niche technology companies, and at the same time could likely divest their commodity-type service organizations.
Irrespective, we are seeing the demise of bigger is better as a successful strategy for this market.