As the federal government prepares to roll out infrastructure grants and contracts in amounts not seen since the New Deal and the defense industrial base (“DIB”) gears up to support billions in new spending to support Ukraine, a new Department of Defense (“DoD”) report raises serious concerns about the state of competition within the DIB. The report recently released by the Office of the Under Secretary of Defense for Acquisition and Sustainment analyzes the state of competition within the DIB and concluded that it can be summarized in one word: poor. The report discusses the causes for the lack of competition and makes recommendations for improving the solicitation process to increase competition, inspire innovation, reduce prices, and improve quality.

Consolidation

Foremost among the causes for the lack of competition identified by the report is consolidation of the DIB. Of 51 aerospace and defense prime contractors in the 1990s only five exist today. Although the report failed to find significant correlation between this consolidation and increased pricing, the consolidation raises additional concerns for DoD, such as national security, mission risk, and strategic technology innovation. The report notes that “having only a single source or a small number of sources for a defense need can pose mission risk and, particularly in cases where the existing dominant supplier or suppliers are influenced by an adversary nation, pose significant national security risks.” The report recommends that when a merger is likely to harm one of these interests, DoD work closely with the Federal Trade Commission and Department of Justice to take structural or behavioral measures deemed necessary, up to and including blocking the merger.

Data Rights and IP

According to the report another key cause for the lack of competition is the DIB-specific “data rights” and intellectual property (“IP”) rules first introduced in the mid-1980s. The report notes that since 2011, over 88 percent of DoD’s new contracts have been awarded for acquisition of commercial items where the DoD can be backed into a corner by a vendor’s exclusive data rights to a critical subsystem or component. The report further highlights two additional hindrances to competition that can be mitigated if they are addressed early in a program’s lifecycle.

First, the DFARS generally prohibits requiring greater than standard data rights licenses as a condition of awarding a contract. To counter this, “DoD will implement best practices for identifying its long-term IP needs early in the competitive phases of acquisition programs, ensuring IP is an evaluation factor in competitive awards and a negotiation objective in sole source awards, and contracting with vendors who are willing to provide the government the IP deliverables and rights it needs.”

Second, the DoD’s current system allocates data rights based on the source of funding for development at the “lowest practicable segregable level,” leading to large systems funded primarily by the government that have licensing gaps for components that have been funded and developed by private entities. These licensing gaps prevent the contracting agency from releasing the component system information necessary to effectively complete system support efforts. The report suggests that DoD prevent this complication by implementing a modular open systems approach (“MOSA”) whereby “black boxes” of publicly releasable data are used as placeholders for any privately developed components. “This allows other vendors to identify suitable alternatives for the proprietary black boxes, or, if necessary to contract with the OEM for support for those black boxes, limit such sole-source efforts to the black box itself.” Alternatively, DoD is permitted to enter into negotiations for special licensing agreements with these license gap holders at the beginning of their programs.

Finally, the report notes that the use of Other Transactions (“OTs”) and Commercial Solution Openings (“CSOs”) can provide additional flexibility. In all, the report sets forth multiple steps in a long-term effort to modernize rules and procedures for an industry that is rapidly consolidating resources and data rights.

Small Business

A third concern related to the DIB is the decline in small businesses. The DoD report emphasizes the importance of expanding the participation of small business concerns in defense procurements to increase competition and spur innovation. In 2021, DoD made $80.3 billion in awards to small businesses, with 45 percent of that amount going to disadvantaged or woman-owned businesses. However, over the past 10 years, small business participation in defense acquisitions has declined by over 40 percent. DoD estimates that if this trend is not reversed, it could lose 15,000 suppliers over the next 10 years, posing a significant risk to national security and the U.S. economy.

To increase small business participation, DoD plans to expand outreach to suppliers, make better use of existing small business programs, and reduce barriers to entry. To improve outreach to small businesses, DoD is engaging with industry associations that have significant small business memberships and is streamlining the dissemination of information and resources through its Office of Small Business Programs website (business.defense.gov). DoD is also encouraging suppliers to take advantage of its Procurement Technical Assistance Program (“PTAP”), created in 1985, which provides counseling services and training to small businesses, while also helping them identify potential contract opportunities with DoD and other agencies.

DoD also wants to use the Mentor Protégé, Small Business Innovation Research (“SBIR”) and Small Business Technology Transfer (“STTR”) programs to bring new entrants into the national security and defense technology markets more quickly, and to ensure it has a diversified supplier base available to support mission requirements. DoD is expanding the Mentor Protégé program into more components of DoD and is taking steps to shorten the time to secure a Mentor Protégé agreement. It is also enhancing training for acquisition personnel to increase understanding of the of the SBIR and STTR programs and has implemented a new program designed to accelerate the transition of SBIR and STTR-funded technologies into defense programs.

Barriers to Entry

Lastly, DoD is studying ways to reduce barriers to entry faced by small businesses. In September 2021, DoD published a Federal Register notice to solicit feedback from small businesses currently in, or interested in becoming a part of, the defense industrial base. DoD sought input on such topics as (1) how government practices or regulations might deter small businesses from contracting with DoD; (2) the impact of DoD’s major programs, such as the Mentor-Protégé, PTAP, SBIR and STTR programs, in supporting small business participation; (3) the impact of contracting timelines on small business; and (4) policy recommendations for creating more resilient supply chains, greater competition in the defense industrial base, and more small business participation during the procurement process. DoD plans to use the feedback it received to develop a Small Business Strategy and to make recommendations for reducing the regulatory burdens on small businesses.

Promoting competition “to the maximum extent possible” is a top priority for the DoD. DIB contractors, and potential contractors, will benefit from analyzing these DoD priorities and tailoring proposals to meet them.