The 2020 Mid-Year Economic Update_long

Survey: Budget Reductions Hit Federal Contractor Revenues, Profitability

Increased indirect costs and a reluctance to refuse out-of-scope work may be partly to blame for federal contractor profit drop.

Nearly 40 percent of federal contractors whose primary customer is the federal government had less revenue during the past year, according to Grant Thornton LLP’s 18th Annual Government Contractor Industry Survey. Although the fiscal cliff deal Congress reached early this month postponed automatic government spending cuts also known as the sequester, many distributors have already seen dramatic sector revenue drops from the budget reductions already taking place.

In the Grant Thornton survey, 38 percent of participants reported reductions in government contract revenue. Revenue grew for 36 percent, while 26 percent experienced no significant change. This represents a 15 percent decrease in revenue growth and a 9 percent increase in revenue decline compared with the 2011 survey.

“This is the first time in the history of our survey that a higher percentage of respondents experienced reductions in revenue from government contracts than those that experienced growth,” said retired Vice Adm. Lewis W. Crenshaw Jr., Grant Thornton’s national Aerospace and Defense practice leader.

Profit rates are also plummeting. In this year's survey, 60 percent of respondents reported either no profit or profit in the 1-5 percent range, compared to only 37 percent reporting little or no profit in the 17th annual survey.

Stubbornly high indirect cost rates may be one driver of reduced profits. Forty-two percent of survey participants reported an increase in indirect cost rates and 41 percent said there was little to no change to costs. Only 17 percent said rates were decreasing, a 6 percentage point drop from the prior year.

Survey participants' hesitancy to refuse government requests for out-of-scope work may be another reason profits are shrinking. Of the 85 percent of participants who report having received out-of-scope work requests without a contract modification, only 16 percent reported that they always refuse these requests.

Defense contractors are increasingly diversifying their portfolios and moving toward the commercial sector, Grant Thornton's Crenshaw says.

N.H. Bragg, a Bangor, ME-based distributor of industrial, safety and janitorial supplies, is adapting to decreased government spending "by spending less time and effort chasing government business,” says Jon Eames, N.H. Bragg’s president. Eames says the company's government business is down 15 percent year-to-date even as business as a whole is up 7 percent.

Excluding the potential impact of sequestration, the budget for the Department of Defense has been in decline since 2010. Twenty-four percent of respondents to a recent MDM-Robert W. Baird & Co. survey said defense cuts have impacted their businesses in the past year.

For more on how distributors are adapting to government spending shifts, read Defense Cuts Hit Distributors.

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