ITT Profits Squeezed as U.S. Ups Price Pressure on Vendors
By Brian Friel
Aug. 29 (Bloomberg) -- After 14 years of uninterrupted spending increases, federal agencies are cutting back on contracts, reducing their duration and forcing more incumbent vendors to compete to keep their current business. Agencies are also setting more fixed prices rather than paying contractors for time and materials or using other pay-as-you-go methods.ITT Corporation, the 23rd biggest government vendor by federal contract dollars last year, had operating margins for its defense and information solutions business fall to 9.5 percent on $1.5 billion in sales in the second quarter of 2011 from 12.9 percent on the same level of sales in the second quarter of 2010, as U.S. agencies increased pricing pressure on service contracts, according to a July 29 company presentation.
Jacobs Engineering Group Inc., a construction and technical services company based in Pasadena, California, had an 82 percent drop in the value of government work it won without competition between 2009 and 2010, to $23.5 million from $140 million, according to data compiled by Bloomberg. The 34th largest U.S. supplier by federal contract dollars, Jacobs maintained its $2.1 billion annual federal business by undercutting other companies, President and Chief Executive Officer Craig L. Martin said on a July 29 earnings call.
“Across industries, revenues and profits are likely to decrease over time as federal discretionary spending is reduced,” Trevor Brown, Ohio State University associate professor of public affairs, said in an Aug. 25 e-mail. ”Federal agencies will buy less and try to squeeze more out of each contract.”
Multiple-Award Contracts L-3 Communications Holdings Inc., the eighth largest contractor, announced in July it would spin off some government services work. Michael Strianese, chief executive officer of the defense contractor based in New York, estimates that the 8 percent to 10 percent margin from an expiring Pentagon translation contract will fall to 3 percent to 4 percent under a new contract it shares with three other companies.
The Defense Department replaced L-3‚ single-company translation contract with a multiple-award deal under which L-3 is now one of four companies providing the services under a contract issued in July. Agencies across government are turning from exclusive to multiple-award contracts, compelling companies to compete both for spots on those deals and for each task order issued under them. Contracts awarded to multiple vendors increased in value from $48.5 billion to $88.5 billion, an 82 percent increase, between 2009 and 2010, according to Bloomberg data. Revenue at Risk Hewlett Packard Co. will have to give up an exclusive billion-dollar-a-year contract with the Navy in 2014. The Navy is taking a new approach, creating one or more contracts for which top Navy vendors Raytheon Co. and Lockheed Martin Corp. may compete with HP.
Martin of Jacobs Engineering told analysts that the government‚” shift from single-company contracts to multiple- award task order contracts, or MATOCs, put Jacobs‚” revenue at risk but also allowed it to take business from other companies that previously had sole-source status.
“On the one hand, we‚Äôre exposed on our own contracts when they get converted to MATOCs,” Martin said on a July 26 call with analysts. ‚”But we get the opportunity in a much large base of contracts to try to take share of what was other people’s fiefdoms.” New Sales Approach John Edward Coleman, president and CEO of Unisys Corp., said the company is adjusting its government sales approach because agencies are breaking up big projects into smaller transactions.
Unisys is changing “the way we operate a bit from focusing the business on large, multi-year programs, which have difficulty in getting funded, to more tactical task-order kind of business, shorter-term projects, smaller transactions and projects that we see are getting funded,” Coleman told analysts on a call on July 25.
Unisys, based in Blue Bell, Pennsylvania, won $786.4 million in federal prime contracts in 2010, making it the 87th- largest federal vendor by contract awards, according to Bloomberg data.
To rein in contracting costs, the Obama administration has instructed agencies to award more contracts at fixed prices, rather than under terms that pay firms based on time and materials or that allow for unexpected cost increases. More Competition In 2010, 54 percent of contract dollars were awarded at a fixed price, according to Bloomberg‚ analysis. The data, derived from government databases, shows that 48 percent of contract funds in 2009 were awarded at a fixed price, though inconsistencies in reporting methods between the two years makes it difficult to compare.
“In theory, short-term, fixed-price contracts lead to more supplier competition,” Ohio State‚”Brown said. “If the type of good or service is fairly standard, say copy paper or trash collection, suppliers will likely compete on price. The result will be lower margins for some suppliers.”
ManTech International, based in Fairfax, Virginia, has been cutting administrative expenses to make up for the shift from time-and-materials contracts to fixed-price contracts, said Executive Vice President Kevin Phillips on a July 27 second-quarter earnings call. The company reported that fixed-price contracts made up 15.4 percent of its federal business in 2010, up from 12.3 percent in 2009.
“We continually focus on operational efficiency, which is an integral part of our ability to sustain profitability,” Phillips said.
"Even companies in sectors that enjoy higher profit margins, such as consulting; will be affected by the overall pressure on the federal budget," Brown said. “If federal policy makers significantly reduce discretionary spending, agencies will simply buy less stuff,” Brown said. “Less spending equals less profit for contractors regardless of the type of contract in place.”
