Photo By: Joshua Hoehne
Small businesses have long been a critical part of the U.S. defense industrial base, accounting for an estimated 73% of the companies that make up the sector. Yet their presence in the federal marketplace has been declining. Between 2010 and 2024, the number of small-business vendors working with the Department of Defense fell by 49%, according to industry data.
That decline raises questions about the future of a government marketplace that has traditionally relied on smaller companies to increase competition, introduce new capabilities and expand the pool of available suppliers.
Now, small businesses face another potential shift. The Small Business Administration recently proposed new size standards covering 338 industry groups. The standards are used to determine which companies qualify as “small” for purposes of federal programs and contracting opportunities. Changes to those thresholds could affect which businesses remain eligible for small-business set-asides and other government programs designed to encourage participation by smaller firms.
For companies already facing a complicated federal procurement environment, the changes could add another layer of uncertainty. Selling to the federal government has never been a simple process. Businesses must often navigate detailed solicitation requirements, certifications, compliance obligations, contracting rules and lengthy approval processes. For companies without dedicated government-contracting teams, the time and expense required to pursue an opportunity can be substantial.
The sales cycle can also be considerably longer than in the commercial market. A company may invest significant resources in developing relationships, responding to solicitations and meeting government requirements before knowing whether it will ultimately win a contract.
Even after securing government work, businesses can face administrative demands and payment timelines that place pressure on cash flow. For smaller companies, where a handful of contracts can represent a significant portion of annual revenue, those challenges can be particularly consequential.
The result is a difficult calculation: At what point does pursuing federal business require more time, money and infrastructure than a small company can reasonably justify?
Joanne Frederick, CEO of Government Market Strategies, works with companies navigating the federal marketplace and sees the challenges businesses encounter when trying to understand and compete for government opportunities. Her work sits within a broader ecosystem of consultants, contractors and industry organizations attempting to help companies navigate the rules and processes associated with federal procurement.
The concern extends beyond the individual businesses deciding whether to participate.
A shrinking pool of small and mid-sized government vendors could affect the federal government itself. Competition is a central objective of small-business contracting programs, giving agencies access to a broader range of suppliers while creating opportunities for emerging companies to compete with larger established contractors.
More participants can also provide agencies with alternatives when requirements change or when new technologies and capabilities become available. If fewer companies are willing or able to enter the federal marketplace, agencies could have fewer options when sourcing products and services. A smaller supplier base could potentially affect competition, pricing and the government’s ability to find specialized capabilities quickly.
The issue is particularly relevant to the defense sector. The U.S. defense industrial base has faced growing attention in recent years as policymakers examine domestic manufacturing capacity, supply-chain vulnerabilities and the government’s ability to increase production during a crisis. Small and mid-sized companies can occupy specialized positions within those supply chains, supplying components, technology, services and other capabilities to larger prime contractors or directly to federal agencies.
Those companies can also serve as a source of innovation. Newer firms may develop specialized technologies or approaches that established contractors are slower to pursue. But entering the defense market can require investments that are difficult for a young or growing company to absorb.
Security requirements, cybersecurity obligations, quality standards and other compliance costs can add to the burden. For a company with limited capital and personnel, meeting those requirements may require hiring additional staff or purchasing new systems before any government revenue materializes.
That creates a potential paradox. The government may want a broader and more resilient industrial base, while the companies it hopes to attract may increasingly view federal contracting as too complicated, costly or slow.
The proposed SBA changes are therefore only one part of a larger issue facing federal procurement. The question is not simply whether a company meets the government’s definition of a small business. It is whether the overall structure of federal contracting gives smaller companies sufficient incentive to participate in the first place.
Policymakers must balance the government’s need for oversight, accountability and responsible spending with the practical realities facing businesses. Rules designed to protect taxpayer dollars and maintain procurement integrity can also create barriers if the costs of compliance become disproportionate for smaller firms.
For agencies, maintaining a diverse supplier base may become increasingly important as demand for new technologies, domestic manufacturing and specialized capabilities grows.
For businesses, meanwhile, the decision to enter the federal market is likely to remain a strategic one, requiring them to weigh the potential size and stability of government contracts against the costs and complexity of pursuing them.
The decline in small-business participation suggests that the balance may already be shifting.
If fewer small and mid-sized companies decide that federal contracting is worth the effort, the consequences could reach beyond the businesses that leave. A smaller vendor pool could mean less competition, fewer sources of innovation and reduced flexibility for agencies trying to respond to emerging needs.
The debate over SBA size standards may ultimately be about more than how the government defines a small business. It could become part of a larger conversation about whether the federal marketplace remains accessible enough to sustain the broad supplier base on which the government depends.
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