Sequestration and the continuing resolution
What's the impact on middle market federal contractors?
Sequestration is now a reality and is garnering the lion’s share of headlines; however, there is another component to the federal budget impasse that could have an even greater impact on middle market federal contractors – the 2013 continuing resolution (CR). While both relate to the federal budget and appropriations, they may have differing effects on the federal contracting industry.
Sequestration vs. the CR
Sequestration is the blind, across-the-board cut of federal agency budgets for the next 10 years. Many federal agencies did not expect sequestration to occur and find themselves in the position of having to obtain large cost savings in a short period of time. To accomplish this, the defense department, for example, will have to cut large weapons program development and deployments of large assets around the world. On the other hand, the CR is an extension of the fiscal year 2012 defense budget spending levels with an expected minimal increase of less than one percent for fiscal year 2013. The sequestration differs from the CR in that there is no flexibility to realign 2012 funding buckets to more accurately reflect where funding is needed the most in 2013. This has a significant effect on day-to-day and non-essential operations, resulting in cancellations of asset maintenance, reduction in civilian workforce, reduction in base operations support, and other service-based programs.¹
Impact on middle market federal contractors
It is still early to assess the full effect of sequestration on the defense and non-defense contracting community and specifically on middle market contractors. Many small- to mid-size businesses are suppliers to the large weapons systems developers or provide logistics to deployment operations. While sequestration is a long-term provision of the Budget Control Act of 2011, it is subject to revision or outright cancellation via future political negotiations. It is expected that short-term pain will be most felt by service sector contractors, with the large weapons system providers feeling the effects more gradually over time.
The current CR expires on March 27, 2013, at which time it is most likely to be extended for the rest of the federal fiscal year.² The inflexibility in funding realignment and uncertainty as to the funding of desired programs could have an even greater effect on middle market contractors, who may not have the resources available to weather extended funding delays.
Strategies to employ now
Unfortunately, it will take some time before the defense industry can properly react to its funding shortfalls and prioritize in a manner that will allow for contractor planning. There are certain defensive strategies that contractors can employ now in this environment to mitigate financial risks, including:
- Managing indirect costs assuming business volume reductions
- Tracking funded backlog closely and requesting funding increases earlier
- Assessing risk of engaging in potentially CR-effected projects
- Investigating employment alternatives such as reversion from salaried to hourly status
- Reorienting business development strategies to align with the more stable federal agencies in terms of future funding
- Carefully considering substantially increased risk while working on an not-finalized contract
- Awareness of Office and Management Budget guidance to agencies to review which contracts could be terminated for convenience
For more information, contact Dara Castle at 703.336.6400.
¹ The U.S. House of Representatives voted on March 6, 2013, the CR legislation for 2013 by 267 to 151 votes. The $982 billion stopgap measure locks in post-sequestration spending levels but includes protections for defense and veterans’ programs, enabling them to adjust to the cuts brought on by sequestration. The Senate is expected to act on its own government funding bill and an agreement has to be reached before it becomes a law.
² On March 1, 2013, President Barack Obama signed sequestration order for reduction of USD 85 billion in budget spending for Fiscal Year 2013. The order provides a breakdown by budgetary account and reduction amounts in non-exempt budget accounts for each government agency. The order is based on the report to the Congress of March 1, 2013, prepared by the Office of Management and Budget http://www.whitehouse.gov/sites/default/files/omb/assets/legislative_reports/fy13ombjcsequestrationreport.pdf).