Photo By: Filip Andrejevic
Small businesses play an important role in America’s defense industry. They develop new technologies, manufacture parts, provide engineering services and support some of the country’s largest defense contractors.
But fewer small businesses are working directly with the Department of Defense.
Small businesses make up about 73% of the U.S. defense industrial base. Yet the number of small businesses selling directly to the Defense Department fell by 49% between 2010 and 2024, according to data cited by the Small Business Administration. The number dropped from more than 119,000 vendors in 2010 to about 61,000 in 2024.
That decline comes as the federal government prepares to change the rules that determine which companies qualify as “small.”
The SBA recently proposed new size standards covering 338 industry groups. The changes would raise the size limits for many businesses and could allow more than 110,000 additional companies to qualify as small businesses for federal programs.
The goal is to update rules that have not kept pace with the economy and give more growing companies access to government opportunities.
But there is a bigger question. Even if more companies qualify as small, will they want to compete for federal contracts?
Federal contracts can be difficult to win
Doing business with the federal government can be complicated, especially for smaller companies.
Businesses often have to deal with detailed procurement rules, cybersecurity requirements, accounting standards, certifications and other compliance requirements. Meeting these rules can cost significant amounts of money and time.
For a small company, those costs can be difficult to manage.
There is also the time involved. Government contracts can take months or longer to move from an initial opportunity to a final award. During that time, a company may have to spend money on employees, equipment, inventory and compliance without knowing whether it will win the contract.
Joanne M. Frederick, CEO of Government Market Strategies, has seen the challenges businesses face when trying to navigate the federal marketplace. Her perspective reflects a broader issue facing smaller companies: understanding how to enter the government market is only one part of the challenge. Businesses also have to determine whether the time and resources required to pursue government contracts make financial sense.
That creates a difficult choice for business owners.
A government contract can provide an important source of revenue and help a company grow. But pursuing that contract can also require a major investment with no guarantee of a return.
Payment and cash flow can create another challenge. Smaller companies generally have fewer financial resources to cover expenses while waiting for government revenue.
For some businesses, the potential reward may not be enough to justify the cost and uncertainty of entering the federal market.
The SBA wants more companies to qualify
The SBA’s proposed changes could make it easier for some businesses to remain eligible for federal small-business programs as they grow.
The agency says the changes would simplify the current system and allow more companies to qualify. For businesses that have grown beyond today’s size limits, that could create more opportunities to compete for government contracts.
This could be especially important in the defense industry. Companies often need to invest heavily in technology, equipment and workers before they are ready to compete for major contracts.
However, changing the definition of a small business does not necessarily solve the other problems companies face.
A business can qualify as a small business and still decide that federal contracting takes too much time, money and effort.
Why the shrinking vendor pool matters
The decline in small-business vendors raises questions about the future of the defense industrial base.
If fewer companies compete for government contracts, there may be less competition among suppliers. That could affect prices and give the government fewer options when it needs products or services.
A smaller supplier base could also affect innovation.
Small businesses often bring new technologies and ideas to the defense industry. Some companies specialize in areas that larger defense contractors do not focus on. They can also introduce commercial technology that may have applications for the military.
The Defense Department has said that increasing small-business participation can help strengthen competition, innovation and supply chain resilience.
But attracting those companies requires more than creating opportunities.
Businesses also need a contracting system that they can afford to navigate.
The bigger question
The SBA’s proposed size standards are an important change, but they are only one part of a larger issue.
The government may be able to increase the number of companies that qualify as small businesses. The harder question is whether those companies will actually want to compete for federal contracts.
Businesses already face complicated procurement rules, long sales cycles, compliance costs and challenges with cash flow. These barriers can be especially difficult for companies that do not have large legal, financial or government-contracting teams.
If those challenges continue, more small and mid-sized companies could decide that federal contracting is not worth the effort.
That could have consequences for the entire defense industry.
A larger and more diverse group of suppliers can give the government more choices when it needs new technology, additional production capacity or alternative sources of critical supplies.
For that reason, the health of the defense industrial base may depend on more than how many businesses qualify as “small.”
It may depend on how many are willing and able to do business with the government.
The SBA’s proposed changes could bring more companies into the small-business category. But if the government wants those businesses to compete, it may also need to address the costs and complexity that are keeping some companies away.
The future of the defense industrial base may depend not just on how many small businesses America has, but on how many can realistically participate in the federal marketplace.
