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Analysts: Fiscal 2013 Budget Will Alter IT Market

Next week’s release of President Obama’s budget for fiscal year 2013 won’t be great news for the government contracting industry, especially as we finally get to see specifics on the long-expected spending cuts. But the information technology (IT) industry has less to fear than what might be expected. In fact, there are opportunities for growth even as federal spending contracts.

That was the takeaway from a conference call for investors, organized by Lazard Capital Markets this week. The entire Deltek Federal Industry Analysis team briefed investors on what to expect from government IT spending next year.

“In the near term, as well as out to 2016-17, it’s clear that IT is not a target,” said Deniece Peterson, Senior Manager of Federal Industry Analysis, “but it will definitely have some collateral damage.”

Peterson sees several trends that will alter the landscape for IT contractors.

“What we’re seeing from a budget perspective across the government with regards to IT is what we’re terming an ‘ER triage’ situation,” Peterson explained. “The total IT budget will remain relatively flat, but we’re seeing a shifting of dollars from one agency to another, reflecting the administration’s priorities.”

Acquisition Strategy Changes

Changes in acquisition strategy will do as much to shape the market in future years as actual spending cuts, she said. “Small policy changes can have huge budget implications.”

For instance, she noted, a move toward more modular contracting — ” breaking out large contracts into small projects that are easier to manage” — could mean more opportunities for small businesses. It could also, however, put the smallest companies into competition with large contractors.

Also, she highlighted that, “A requirement set in place by the Office of Federal Procurement Policy,” under which “agencies have to develop business cases to justify the creation of a new contract vehicle or the continuation of another,” could force some federal buyers to squeeze more projects out of existing task order-based contract vehicles. “That will impact contractors that are on a specific vehicle, and those that aren’t,” and are closed out of competition for new work, she noted.

“The fundamental issue is that it takes far too long to compete and award contracts, especially within the IT space,” explained Senior Principal Research Analyst Alex Rossino. “If Moore’s law applies, and capability doubles every 18 months, it can still take three years to award a contract. So there is pressure at the congressional level and the agency level toward streamlining the process.”

“One solution,” he noted, “Is Multiple-Award, Task Order Contracts (MATOCs).”

This has a particularly harsh impact on small businesses. “You see an acceleration of spending once contracts are awarded, but small business can’t remain waiting” through the long competition and award process, he said, so smaller businesses have to compete for other business while waiting for task orders to begin under a vehicle.

Defense Impacts

The largest chunk of the contracting sector will feel the impact of the new budget, said Senior Principal Research Analyst John Slye.

“For the next few years, we’re expecting to see nearly $260 billion in reductions that are slated” to impact the Department of Defense and other national security agencies, he said.

“They’re looking to cut services contract spending in 2012 AND 2013 and roll them back to 2010 levels,” he noted. “The other side of this deals with the labor rates — for any new contracts or task orders awarded in FY 2012 and 2013 that are more than $10 million, they are mandating a rollback to 2010 levels. They’re getting into the nuts and bolts of what firms can offer as far as labor rates in these contracts.”

Still, he said, “there are some areas where we expect to see targeted opportunities.”

Among them, he cited the Command, Control, Communications, Computers, and Intelligence, Surveillance, and Reconnaissance (C4ISR) market, cybersecurity and clean energy initiatives.

Data Center Consolidation

The federal plan to consolidate data centers will also create opportunities, noted Senior Principal Research Analyst Angela Petty.

“This offers some opportunities for contractors in virtualization, helping agencies move toward the cloud, replacing servers and cooling equip, et cetera,” she explained.

“We feel agencies will probably accomplish their goal of closing 525 data centers in 2012,” she said, but “some of that will come from changing the definition of data center,” as new federal CIO Steven Van Roekel has proven willing to “accept smaller targets” than his predecessor.

Moving Into the Cloud

Rossino cited another growth space — cloud computing — but noted that the landscape of competition for federal cloud dollars is not clear.

“We are forecasting growth of $3.5 billion by 2016 — that’s the addressable market,” he said. “It’s being touted as the new way to save money, but the way agencies are working, it isn’t doing that. The way to save money is to move services into the public cloud, but what we’re seeing is that every agency wants to set up its own private cloud.”

The market at the moment seems to favor large contractors. Rossino cites the possibility of what he called “the dreaded ‘cloud cartel’ scenario,” in which, “the market could become dominated by a few large businesses that have the ability to stand up cloud services quickly.”

Mergers and Acquisitions

One possible outcome for some smaller companies, however, isn’t just defeat at the hands of industry giants. It’s acquisition.

“We expect Merger and Acquisition (M&A) activity to continue to be robust over the next few years,” noted Senior Principal Research Analyst Brian Coyle, “especially within high-growth markets,” like health care IT.

“Right now it’s mostly large companies buying small and medium sized companies within niche markets.”

Some of those acquisitions are driven by capability, as larger companies absorb smaller firms that have capabilities they don’t. Others, he noted, are driven by the growth of MATOC vehicles. “A lot of small and mid-tier companies are actually winning seats on large contract vehicles, which makes them very attractive to large companies that missed out.”

On Feb. 21, join Deltek’s Ray Bjorklund, Kevin Plexico and Deniece Peterson for a GovWin Webinar:

“First Thoughts on the FY2013 Federal Budget Request.” The three experts will provide initial thoughts and analysis on the budget request, and preview findings from their full report.

Register now, free.

Sean Tucker covers the federal government and the contracting industry for GovWin.com, the network that helps government contractors win new business every day. He can be reached at [email protected].

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