Pentagon diverted small business fund to defense industry giants

In just one year, more than $300 million earmarked for small businesses ended up going to Lockheed Martin, Raytheon, L3Harris, and other top defense contractors, according to a recent report from the Project on Government Oversight (POGO).

The funds come from a pool of $33 billion that the Pentagon set aside to support small businesses in the defense industry, which have rapidly disappeared as the military sector has consolidated in recent years. 

Experts say this misuse of funds threatens to force more small companies out of business, eliminating competition and empowering defense giants to drive up prices. 

And since the program uses middlemen, taxpayers end up paying extra for gear from companies that have no problem selling directly to the Pentagon.

The sheer size of the program also allows officials to make big claims about supporting small businesses while pumping money toward traditional defense giants, according to Robert Burton, a lawyer who previously served as a high-level federal procurement official. 

“We don't generally have $33 billion contracts over 10 years,” said Burton. “This one is special because the DoD is getting credit for all $33 billion going to small business.”

David Goodreau, the president of the Small Business Aerospace Industry Coalition, said small businesses that contract with the Pentagon are tired of big promises with little payoff.

“There's all kinds of reasons to exercise supply chain contraction, but not at the expense of telling everybody in your marketing materials and at your conferences [...] about how you're doing more for small business,” Goodreau said. “It’s a lie.”

Not your mother’s small business

The Tailored Logistics Support (TLS) program is administered by the Defense Logistics Agency (DLA), which conducts acquisitions for military services. The program manages the $33 billion small business contract, which it subcontracts to four intermediaries. The resellers are in turn supposed to fulfill their orders by purchasing from small business manufacturers. But not all of that money is getting where it’s meant to go.

To understand how this is happening, let’s look at one of these four intermediaries: Atlantic Diving Supply (ADS), which gets the vast majority of its revenue through the TLS program. At first glance, it might be hard to consider ADS — a corporation with more than $1 billion in annual revenue — a “small business.” But it plays a key role in the program, according to Nick Schwellenbach, the POGO report’s author.

“The idea of the program is that all sorts of federal agencies [...] can go to DLA and say, ‘We have some special ops guys, we have some troops who need knives or rifle scopes or new boots, and we don't want to go through the traditional contracting process. We want to do this quickly,’” Schwellenbach said.

Intermediaries like ADS, which have the know-how to work smoothly with the Pentagon, can in turn seek out small businesses to produce the gear and then sell it to the government. As Schwellenbach argues (and the Pentagon implies in its marketing), contracting to small businesses speeds up procurement, generates new ideas, and keeps prices low by encouraging competition.

But there’s a loophole in the system: ADS can contract out to businesses of any size if it gets a waiver approved by the Small Business Administration. 

POGO found that, in one year alone, ADS funneled at least $150 million of its small business funds to L3Harris, the 11th largest federal contractor. The result? Equipment prices go up, and money meant for small businesses ends up in the hands of big corporations. 

“L3Harris does plenty of business directly with the Pentagon… so why does this gear need to go through a small business intermediary which tacs on its own costs,” wondered Schwellenbach. “The more middlemen you have, the worse the deal is for the customer.” 

A rubber stamp

As the ADS example shows, a big part of the problem is the waiver process. SBA is increasingly approving waivers that allow money designated for small businesses to end up in the coffers of large corporations. 

In 2017, the SBA only granted about half of the waiver requests it received. In 2021, the agency’s approval rate for waivers jumped to 93 percent.

“Why is SBA just sort of rubber stamping these waiver requests?” asks Burton. “It's a rule that's not working.”

In this case, DLA may have gotten a little too used to SBA’s rubber stamp. The DLA initially asked for and received a waiver for a $1.3 billion contract, but it later applied that waiver to a $33 billion contract for the program.

In response to questioning from lawmakers, the SBA said “waivers apply only to the items waived, not to the entire contract,” adding that DLA’s view of the waiver was too expansive. The SBA says that this violates its regulations, while the DLA argues their wider application of the waiver was necessary to meet Department of Defense requirements.

In the end, the question is not necessarily whether this loophole was illegal. As Schwellenbach points out, this is not a criminal violation, so no one can be held individually accountable.

In any case, this problem goes beyond the actions of any individual, according to Burton, who considers such a misleading use of funds to be an indictment of the small business procurement process.

“Either there's a violation of current rules, or the system allows for that,” he said. “Either one is wrong.”