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The Risks of Government Contracts

Ellie Falcone explores the complicated business dynamic. 

Ellie Falcone studies the optimal amount of government customer concentration for businesses. Photo by Rodger Mallison

The Risks of Government Contracts

Ellie Falcone explores the complicated business dynamic. 

ELLIE FALCONE, ASSISTANT PROFESSOR OF SUPPLY CHAIN MANAGEMENT in TCU’s Neeley School of Business, is committed to research that aligns with real-world business needs. So when she heard from Cathy Harter, president of Kemper Manufacturing Corp., that the company’s work for the government was detrimental to her business, Falcone was inspired to research how such sought-after contracts, perceived as steady and lucrative, could go wrong.

Falcone, together with Brian Fugate, associate dean of the University of Arkansas’ college of business, and Matthew Waller, emeritus dean, explored how contracting with the government can create challenging and complicated relationships for businesses. Their study, “Growing, Learning and Connecting: Deciphering the Complex Relationship Between Government Customer Concentration and Firm Performance,” was published in the April 2024 Journal of Supply Chain Management.

Falcone, Fugate and Waller discovered that businesses need to act strategically when procuring contracts with government customers. The team determined that a company’s size, its ability to apply new information, and its connections to suppliers, customers and stakeholders allow the business to navigate the challenges of building a government customer portfolio.

Part of the problem comes with business interests that aren’t aligned, Falcone said. While private businesses need to be profitable, the government isn’t profit-driven; its mission is to improve society while keeping costs to a minimum. Suppliers must develop products to meet government standards, she said, and they also must navigate lengthy processes, formal regulations and stringent accountability measures that are uncommon in the private sector.

Kemper Manufacturing Corp., for instance, had an Air Force contract to produce brass belt buckles and slides for military dress uniforms. During the manufacturing process, one of the machines left scrape marks on the metal.

“Most other buyers would say, ‘That’s not a big deal. You can polish it up and then just send it over.’ It’s still a good product, that’s all superficial,” Falcone said. “But the government inspector told her to redo the production because they wanted it 100 percent scratch-free.”

Harter had to throw away the products, purchase a new machine and hire additional employees to meet the customer’s specifications and time frame.

A CAREFUL CONCENTRATION

The authors began by gathering qualitative data from interviews with decision-makers from 11 businesses that had taken on government contracts; the subjects shared their experiences and perspectives. The team later interviewed more professionals to verify their findings.

Ellie Falcone at the Neely School of Business with a projected image of a generic network.

Ellie Falcone is a supply chain expert at TCU’s Neeley School of Business. “Too much [government-customer concentration] can overwhelm a business,” she said. “You can only have so much. You don’t want to have too much, as it may sabotage your business.” Photo by Rodger Mallison

Much of the paper’s quantitative data, meanwhile, came from calculations the authors made based on three databases that compile information on government contracts with publicly traded U.S. manufacturers, wholesalers and retailers, as well as transportation and warehousing industries.

The authors found that building a solid relationship with one government agency often attracted other agencies, bringing in more contracts and more revenue. Some companies also leveraged government contracts as a marketing tool to appeal to customers in the private sector.

“If you are a government contractor, and you said that in your website, for example, that’s definitely a demonstration of your… capability,” Falcone said. “As a firm, you are on time, and you provide high-quality products at low cost.”

However, the team also found that as the ratio of government contracts goes up, the performance of the company improves only to a certain point. The quantitative research was marked by a downward curve, signaling that taking on too many government contracts had a negative impact on company performance.

“Contracting with the government may not always be good,” Falcone said. “There are some costs, especially if you look at it from a customer portfolio perspective. Too much [government-customer concentration] can overwhelm a business. You can only have so much. You don’t want to have too much, as it may sabotage your business.”

The team’s research suggests a range of 20 percent to 40 percent of government contracts is optimal.

“Large companies could potentially exceed that 20 to 40 percent range,” Fugate said, “due to their ability to learn and adapt. If not, staying with that range would probably be advisable.”

Some firms might decide to forgo further government contracts, as Kemper eventually did.

“I talked to another guy — he is in charge of a health care equipment company — and they contracted with the veterans’ hospitals … provided the monitoring devices for those hospitals,” Falcone said. “And he had the same problem — that is, at the beginning, he sees everything goes very well, but up to a point when they take on too many hospitals … problems just emerge all over.”

RIPPLE EFFECTS

While the team’s work focused primarily on the advantages and disadvantages of firms securing government contracts, Waller said the research also could impact national policy. “The government should be aware of this too,” he said. “A lot of the implications in our paper speak to companies. But they also speak to the government.”

The paper notes that government initiatives encouraging sustainable practices could influence business practices that would affect society. Falcone said some government agencies also look to private businesses to develop trailblazing products and technologies, such as artificial intelligence or robotic implementation, which can drive innovation.

“When they post their contract, their call for bids, they often have specific requirements. If they are pushing for innovativeness or pushing for sustainability, they would highlight those in their requirements,” Falcone said. “And we’ve seen a lot of cases that government contracting actually drives innovation. … It forces the whole industry to follow suit, to be more innovative so they can get the government contract.”

Even with the challenges, government contracts can still be appealing, Falcone said, because of their potential to provide a long-term, stable source of income.

“The suppliers — a lot of them say, ‘OK, I’m contracting with the government. I’m doing pretty well because the government is the largest buyer,’ ” Falcone said. “But in reality, it’s more complex than that.”

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