9. Federal Procurement Policies and Practices

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Federal Procurement Policies and Practices

9. FEDERAL PROCUREMENT POLICIES &AMP; PRACTICES

This Part summarizes the Review Team's examination of affirmative procurement efforts administered by the Department of Defense, the Department of Transportation, and the Small Business Administration, including implementation at those agencies of government-wide efforts to contract with Small Disadvantaged Businesses. These agencies were surveyed because they administer programs accounting for a large percentage of government contracting.

9.1 Overview and Background

9.1.1 General

Throughout the federal government, several programs seek to increase procurement and contracting with minority- and women-owned businesses. The largest of these efforts are government-wide programs overseen by the SBA; this overall effort is supplemented in some cases by agency-specific initiatives. Under these programs taken as a whole, some procurement contracts are set aside for sole-source or sheltered competition contracting, eligibility for which is targeted to minority-owned businesses (and in some cases non-minority women-owned businesses), but by statute available more broadly to "socially and economically disadvantaged" individuals. There is also a broad, race-neutral, sheltered competition or setaside for small businesses generally. This operates separately and has a lower priority than the more targeted efforts; still, over 93 percent of procurements are with non-minority firms.

We conclude that flexible goals for procurement from minority- and women-owned businesses make sense, remain important, and are not in themselves unfair. They have successfully fostered minority and women entrepreneurship, and can be a necessary counterweight to continuing discrimination faced by those businesses. However, to ensure against unintended consequences and abuses, certain additional safeguards are needed.

9.1.2 History and Background

MBE programs were enacted as a response to specific executive and congressional findings that widespread discrimination, especially in access to financial credit, has been an impediment to the ability of minority owned businesses to have an equal chance at developing in our economy. (56) This congressional cognizance was recognized by the Court in Fullilove v. Klutznick, when it upheld a set-aside program established by Congress at the Department of Transportation. (57)

In Fullilove, Chief Justice Burger reviewed the legislative history of the Public Works Employment Act of 1977 and its documentation of the extensive history of discrimination against minorities in contracting and especially federal procurement. The Chief Justice quoted from the 1977 Report of the House Committee on Small business, which explored discrimination in contracting in the construction industry and found: "The very basic problem disclosed by the testimony is that, over the years, there has developed a business system which has traditionally excluded measurable minority participation." (58) The report concluded that " [minorities, until recently, have not participated to any measurable extent, in our total business system generally, or in the construction industry, in particular." (59)

The Chief Justice summarized the congressional findings regarding the difficulties confronting minority businesses as "deficiencies in working capital, inability to meet bonding requirements, disabilities caused by an inadequate 'track record,' lack of awareness of bidding opportunities, unfamiliarity with bidding procedures, preselection before the formal advertising process, and the exercise of discretion by government procurement officers to disfavor minority businesses." (60) Because of these difficulties, in fiscal year 1976 less than 1 percent of all federal procurement was concluded with minority business enterprises." (61)

During the 1980's, Congress repeatedly examined racial discrimination in federal contracting and consistently found that it persisted. (62) In 1987, evidence compiled by Congress showed that little progress had been made in overcoming discriminatory barriers to minority business success: "[o]nly six percent of all firms are owned by minorities; less than two percent of minorities own businesses while the comparable percentage for nonminorities is over six percent; and the average of receipts per minority firm are less than 10 percent the average receipts for all businesses." (63)

The data regarding federal procurement revealed a similar picture. In 1986, "total prime contracts approached $185 billion, yet minority business received only $5 billion in prime contracts, or about 2.7 percent of the prime contract dollar." (64)

Such discrimination -- and the impact of prior discrimination -- continues today. The U.S. Commission on Minority Business Development reported in 1992:

[S]tereotypical images of minority owned firms limit their access to the factors of production . . . Our nation's history has created a 'cycle of negativity' that reinforces prejudice through its very practice; restraints on capital availability lead to failures, in turn, reinforce a prejudicial perception of minority firms as inherently high-risks, thereby reducing access to even more capital and further increasing the risk of failure." (65)

In 1990, African Americans accounted for 12.1 percent of the population but they owned only 3.1 percent of the total business and 1.0 percent of receipts of all U.S. firms. That same year, Hispanic Americans accounted for 9 percent of the population, but only 3.1 percent of U.S. businesses and 1.2 percent of all receipts. The typical minority firm has annual receipts that are less than half that of white-owned firms. And while in 1987 the average payroll among white-owned firms with employees was $85,786, for minority-owned firms the average payroll was $38,318. (66)

These disparities have been linked to past and present discriminatory practices, especially in the provision of capital:

Traditional sources of financial capital, such as commercial banks, have frequently been unavailable to minority business owners. A recently released report by the Federal Reserve Bank of Chicago provides the most recent evidence of unequal access to credit. (67)
The effects of current and past discrimination in the labor market creates a glass ceiling on minority earning potential and limits inherited income, resulting in compounded difficulties for minorities in generating initial equity investments.
Scarcity of financial capital has forced the overwhelming majority of minority owned businesses to concentrate in fields that do not require large amounts of capital (very small service businesses with few employees). (68)

The exclusion from entrepreneurial opportunities demonstrated by these statistics is not limited to any single business sector. As the United States Commission on Minority Business Development stated:

The Commission has compared the statistics by major industry category and has found a pattern of disparity across all lines of business endeavor that we believe is correlated to the ethnicity of the business owner. In 1987, the typical minority owned firm's total annual receipts were only 11 percent of all United States firms. In Agriculture/Mining that difference was 51 percent; in Construction 45 percent, in Manufacturing 25 percent; Transportation 37 percent; Finance/ Insurance-Real Estate 36 percent; and in the services industry-- where the greatest numerical share of all businesses are located-- the typical minority firm had receipts of 43 percent of the average service firm in the country. (69)

Discrimination against women has hampered the development of women-owned businesses and limited their ability to compete once formed. Until enactment of the Equal Credit Opportunity Act of 1974, women suffered disabling discrimination in lending which prevented the accumulation of capital: single women were frequently found unworthy of credit, married women were impeded in their efforts to establish a credit history because financial records were in their husbands' names, and alimony and child support were excluded from income. As a result of the barriers confronted by women, "[w]omen owned businesses averaged just $19,876 per year in annual receipts in 1990, which is 45 percent of the overall average." (70)

The share of federal procurement dollars going to women-owned businesses has been limited. In 1985, for example, only 0.6 percent of all Department of Defense prime contract awards went to women-owned businesses. While that percentage has climbed steadily, it has climbed slowly, reaching only 1.7 percent for 1994.

9.2 Policies & Practices

9.2.1 Government-Wide Efforts

Goals: Federal law establishes several overall, national goals to encourage broader participation in federal procurement: 20 percent for small businesses; 5 percent for small disadvantaged businesses (SDBs); and 5 percent for women-owned businesses. (71) The SBA consults with each agency to set annual agency-level goals to ensure progress toward the overall goal. (For contracts and firms above certain thresholds, the law requires subcontracting plans in furtherance of these goals.) The goals are themselves flexible, and hence relatively non-controversial. The government-wide SDB goal was met for the first time in 1993.

Sole-source contracting: Under the §8(a) program, which is statutorily mandated, small SDBs can secure smaller contracts (usually less than $3 million) without open competition. This "sole sourcing" is accomplished when an agency contracts with SBA, which in turn subcontracts with the SDB.

For a company to participate in the §8(a) program, SBA must certify that the firm is controlled and operated by socially and economically disadvantaged persons. (72) By statute, persons from certain racial and ethnic groups -- but not women -- are presumed to be socially disadvantaged; persons are considered economically disadvantaged if they face "diminished capital and credit opportunities" -- measured by asset and net-worth standards.

In FY 1994, the §8(a) program accounted for about 2.7 percent of all government procurement -- about $4.9 billion. The number of certified §8(a) firms grew from 3,673 in 1990 to 5,833 in 1994, of which 47 percent received contract actions.

Once a firm is certified and brought into the §8(a) program, the 1987 amendments to the statute establish both a "graduation" period of nine years and a requirement that, over time, firms achieve an increasing mix of business from outside the §8(a) program and outside federal contracting. (73) Under the prior Administration, the SBA did not aggressively implement these 1987 statutory changes, but it has now done so. Moreover, in recent years there has been increasing emphasis on using competition among §8(a) and SDB firms rather than sole-source procurements.

Bid price preferences: Procurement reforms enacted by Congress last year authorize government-wide use of the 10 percent bid preference for SDBs which previously was a tool available primarily at DOD (the so-called "§1207 program" -- see below). Implementing regulations are scheduled to be finalized this summer. These regulations could have a significant effect on procurement by SDBs in those agencies that do not use an effective set-aside scheme such as DOD's "rule of two," described below.

9.2.2. Agency-Specific Efforts

Department of Defense: In addition to participating in the goal-setting and §8(a) efforts, DOD has two additional efforts, which are significant because DOD executes roughly two-thirds by amount of all federal prime contracts. These additional programs are part of DOD's effort to meet its share of the government-wide goals mentioned above.

- SDB shelters or rule-of-two set-asides: Contracting officers are authorized to limit bidding on a particular contract to small disadvantaged businesses (SDBs) if two or more such firms are potential bidders and the officer determines the prevailing bid will likely be within 10 percent of the fair market price.

- SDB 10 percent bid preferences: Whenever there is full and open competition and procurement is based on price factors alone, contracting officers nationally add 10 percent to the price of non-SDB bidders, and then award the contract on the basis of the revised bids. (This is the "§1207" program. Although the applicable statute merely makes this tool available to DOD as a means of achieving its contracting goals, the Department's procurement regulations mandate its use.) (74)

- Comparative usefulness of tools: Over 60 percent of DOD's contracting with SDBs occurs through either this "rule of two" set-aside or through the §8(a) program; the 10 percent bid price preference has been little-used in recent years because regulations require that the "rule-of-two" be used whenever possible, as it generally is. (See the accompanying chart.)

Department of Transportation: In addition to participating in the goal-setting and §8(a) efforts, DOT manages an effort to encourage business with minority- and women-owned firms through its grants to state and local entities. (75)

- Subcontracting preferences: In addition to setting goals for subcontracting with women- and minority-owned firms, DOT requires that grant recipients (usually state or local authorities) provide an additional payment to contractors who attain certain levels of contracting with women- or minority-owned subcontractors and who provide certain technical assistance to those subcontractors. The payment is designed to compensate the prime contractor for additional costs for assisting the subcontractors. This compensation incentive is up to 1.5 to 2.0 percent of the total contract. (76)

Graduation from sheltered competition: Unlike the §8(a) program, the DOD and DOT programs do not require that firms graduate from preferences, or that firms have a mix of federal procurement and other business. There is, of course, the "natural" graduation which occurs if a firm becomes bigger than the "small" business size standard established by the Small Business Act, or the owner's wealth rises above the applicable threshold. (77)

Certification of eligibility in these programs differs from SBA's certification for participation in the government-wide §8(a) program. In the DOD programs, the firms self-certify that they are qualified; in the DOT program, the state/local grant recipient is responsible for certifying the subcontractor's status. (78)

9.2.3 Complementary Programs: Technical & Other Assistance

A number of agencies have other programs to assist women- and minority-owned firms seeking procurement opportunities. These include:

SBA maintains several programs that serve small businesses generally, by providing technical assistance, loan guarantees, and equity capital through Small Business Investment Companies (SBICs).
The Minority Business Development Administration (MBDA) at Commerce provides technical assistance and support for women- and minority-owned firms.
Several agencies maintain "Mentor-Protegé" programs which encourage majority firms to advise and nurture new and growing minority-owned firms by providing managerial and technical assistance.
SBA's Surety Bond Program provides up to a 90 percent guarantee for bonds required of contractors and subcontractors on many public and private construction contracts, thereby lowering the small firm's cost of doing business. In FY 1994, SBA approved more than 22,000 bid bond guarantees, resulting in 6,591 final bonds, for a total bond guarantee amount of $1.08 billion. Although this program is not specifically targeted, 24 percent of bonds went to minority firms; nearly half of these were African-American, and one-quarter were Hispanic.

9.3 Performance & Effects

In the face of continuing barriers to full minority participation in economic life, most of these efforts have been very successful in expanding federal procurement from women- and minority-owned firms. (79) Agencies first achieved the 5 percent SDB goal in 1993 and, government-wide, prime contracts for minority-owned businesses were 6.4 percent of the total dollar volume. This approaches the proportion of minority-owned businesses among all U.S. firms, but is considerably below the 10.4 percent minority representation among adults with college degrees. ( See the illustration.)

In 1994, 32 of the largest 100 African-American owned firms and 17 of the top 100 Hispanic-owned firms were or had been in the §8(a) program.
Between 1982 and 1991, the dollar volume of all federal procurement contracts over $25,000 increased by 24 percent. At the same time, contracts awarded to women-owned firms increased by more than 200 percent; contracts awarded to minority-owned firms increased by more than 125 percent.
Agency-level data show similar trends: for example, between 1985 and 1994, contracting with small, disadvantaged businesses grew from 2.1 percent of DOD procurement to 5.5 percent--an increase of more than $3 billion.
Discussions with GSA contracting experts revealed that subcontracting with minority- and women-owned firms on large federal construction projects would likely not occur but for federal pressure in order to meet overall goals. This is also the strongly held view of SBA officials and of leadership in the SDB community.
While the overall goals and levels of these programs are relatively small nationwide (less than 10 percent), there appears to be a tendency for agencies to concentrate their minority contracting in certain fields -- such as construction -- where there are a significant number of existing minority firms. (80) While this makes operational sense, it also means that, in practice, effective goals, set-asides, and preferences in some fields can exceed the overall goal. Indeed, reports indicate that in a few regions and fields, set-asides account for more than half of all procurements. (It bears emphasis, however, that there are many offsetting situations in which there is little or no SDB contracting done at a particular site or in a particular subindustry.) The government contractor community has pointed out that these types of unintended effects have caused resentment.
Some proponents of these procurement initiatives argue that they are valuable not only because they combat discrimination and the lingering effects of discrimination facing minority and women entrepreneurs, but also because they indirectly promote employment of socially disadvantaged workers and development of economically distressed areas. The very limited evidence on these hypotheses suggests that there is, indeed, a meaningful correlation between minority ownership and minority workforce, (81) but the anecdotal evidence is that the relationship varies considerably across sectors. There has not been adequate study of the broader economic development hypothesis.
The data regarding the effect on business formation and subsequent success of these programs is limited, but somewhat encouraging: SBA statistics for FY 1993 indicate that of the 710 firms that were graduates in that or previous years, 56 percent were still fully operational, 6 percent had curtailed operations, 3 percent had been acquired by other companies, and 35 percent had ceased operations. Comparisons with census data suggest that the failure rates of graduated §8(a) firms are no worse than, and in fact may be better than, those seen in small businesses generally. (82)

9.4 Evaluations & Proposed Reforms

These programs have been the object of a number of studies, including a Congressionally mandated study during the prior Administration which recommended maintaining and strengthening the federal effort to ensure minority- and women-owned business participation in federal procurement. (83) SBA, this past August, proposed a comprehensive reform of the §8(a) program in testimony before Congress. That proposal is responsive to the great majority of common criticisms.

Generally, critics and commentators reviewing these programs have made the following points:

Reorganization: Some observers emphasize the need to rationalize and coordinate the web of federal programs serving minority- and women-owned firms. For example, in 1992 the U.S. Commission on Minority Business recommended the creation within the Commerce Department of an Administration for the Development of Historically Underutilized Businesses which would assume SBA's §8(a) responsibilities. (84)

Graduation: The §8(a) program now requires "graduation" after nine years, and has phased requirements of non-8(a) and non-federal business mix designed to wean firms from sheltered competition and dependency on federal contracting. In February 1995, of the 1,038 firms in the fifth through ninth year of §8(a) participation, nearly two-thirds met or exceeded the minimum non-8(a) business levels. Some observers have emphasized the need for analogous graduation and business-mix requirements in the DOD and DOT programs.

Regional/Sectoral Concentration: Our analysis found SDB contracts and limited competition concentrated in certain industries and regions, which is undesirable for minority and non-minority firms alike. For example, while DOD's overall goal for SDBs was only 5 percent, more than 35 percent of all DOD construction awards went to SDBs, and more than two-thirds of these were awarded under sheltered competition. Moreover, in ten States, more than 40 percent of all construction contracts awarded to small business were awarded to SDBs. This concentration occurs at particular sites as well, where in rare instances virtually all small business contracting is with SDBs. On the other hand, some degree of sectoral concentration in SDB procurements is inevitable to "balance" the many sites and subindustries with virtually no SDB participation, and huge procurements for weapons systems and the like, for which no SDBs are available as prime contractors, and still too few as major subcontractors. Additional efforts are clearly needed to expand SDB opportunities more broadly.

Self-Certification: Because DOD's program is based on self-certification by SDBs, it may be prone to abuse, particularly through "front companies." For example:

- DOD's IG investigated Tyco Manufacturing and referred the case to the US Attorney. The company's owner pled guilty to charges that he falsely represented his firm as Hispanic-owned and controlled.

- Top officials of Automated Data Management, Inc. were convicted of conspiracy to defraud the government for concealing the firm's ownership structure to participate in the §8(a) program.

Self-certification has obvious advantages in terms of reduced administrative expense and regulatory intrusion. Nevertheless, this must be balanced with the importance of ensuring that affirmative action measures are fair, which means as free of abuses as can reasonably be achieved.

Subcontracting: In FY 1993, the most recent data available, small businesses received about $63 billion of federal contract dollars, out of roughly $180 billion in total. About one-third of that amount was from subcontracting. SDBs, on the other hand, received a little over $13 billion in federal contract dollars, but only one-sixth of that was through subcontracting. These figures are consistent with the widely held view that SDBs face greater obstacles to subcontracting participation than do other small firms. The SBA and other agencies believe that expanding the use of SDBs in subcontracting is both feasible and desirable as a strategy for creating more SDB opportunities.

Other Program Changes: Several earlier analyses by the GAO, the SBA Inspector General and commentators have raised criticisms of the §8(a) program, several of which SBA is moving to address by aggressively implementing recent statutory amendments which had languished under the prior Administration. These are reviewed more specifically immediately below.

Past criticisms are that too many §8(a) contracts were awarded on a sole-source basis, i.e., without competition of any kind. This criticism has largely been addressed by recent and pending reforms. The 1988 law reforming the §8(a) program requires that companies in the program compete among themselves for contracts valued at $3 million or more. (There is a higher competition threshold of $5 million for manufactured goods.) Currently, however, many of the larger §8(a) contracts are open-ended agreements that started out as small contracts and grew well beyond the competition threshold when a contracting officer renewed the order. To increase the number of contracts available for competition, SBA has proposed regulations to change this procedure so that an estimated value will be set on these open-ended contracts, which probably will be higher than the initial value. This means more §8(a) contracts will be subject to competitive bidding among participating firms.

Relatedly, the 1988 statute, which will be in full effect at the beginning of 1996, requires §8(a) companies to maintain a specified percentage of private sector business while participating in the program so that these firms are not totally dependent on government contracts. As a result, §8(a) companies will have to compete in both the private and public sectors. This should improve the survival rate of firms graduating out of the sheltered environment of the §8(a) program. It also makes moot an earlier criticism that §8(a) firms were often permanently dependent on a sheltered federal market.

In applying the test of economic disadvantage, the Small Business Act requires exclusion of the §8(a) participant's equity in his/her primary residence, business, and, except in community property states, the spouse's share of the family's wealth. (85) Recent audits of the §8(a) program revealed problematic practices by some firms. These include underreporting of net worth, high salaries and bonuses (more than $1 million per year) for several business owners, and efforts to "shelter" resources in spousal assets and residences. Defenders of the programs correctly point out that the number of such abuses is small and declining. SBA staff has been receiving training in order to better determine an applicant's net worth. Nevertheless, several of these problems are traceable not to staff expertise, but to provisions in the statute. SBA has already proposed certain amendments to remedy this problem. (86)

On another matter, pending SBA regulatory changes will help reduce the extent to which §8(a) contracts are concentrated among too few companies. When the requirement that §8(a) companies maintain a specified mix of government and private sector business is fully implemented, there will be a limit on the dollar value of the §8(a) business one company can control. In addition, the proposed regulation limiting open-ended contracts will mean some of the larger §8(a) contracts will be open to competition and will change hands more regularly. Another proposed change will eliminate the distinction between a "local buy" and a "national buy" system, thereby allowing firms to market to the government without geographic restrictions (except for construction contracts).

SBA's Office of Government Contracting also has negotiated a Memorandum of Understanding with DOD to use §8(a) participants who have never received a contract. SBA is negotiating similar agreements with other federal agencies.

Minority Employment Effects

Research has shown that minority-owned businesses have a tendency to hire more minority employees than other firms. (87) SBA believes that in industries such as military base maintenance and construction, a significant number of the employees of §8(a) firms are minorities. In high-technology industries such as computer systems integration and radar development, however, the number of minority employees of §8(a) firms reflects the representation of minorities within the relevant scientific disciplines. Currently, the primary goal of the §8(a) program is business development. SBA thinks that the inclusion of a minority hiring requirement would be an uneconomic burden for some companies, and in tension with the program's long-standing focus on entrepreneurship opportunities. This suggests the need for a separate program focused specifically and directly on creating jobs and economic development in economically distressed communities.

9.5. Conclusions and Recommendations

9.5.1 Conclusions

Do the federal affirmative action programs relating to contracting meet the President's tests: Do they work? Are they fair?

Does it work?

The several programs discussed in this section have clearly been effective at increasing the amount of Federal contracting with minority- and women-owned businesses. This comes against a backdrop of continuing underrepresentation of minorities and women in the ranks of entrepreneurs. Agency officials believe that a substantial portion of this underrepresentation is the consequence of current and past practices of exclusion and illegal discrimination; Adarand now requires careful documentation of this factual predicate of discrimination and its effects.

Moreover, experience suggests that contracting opportunities for underrepresented groups would decline sharply in the absence of some form of targeted procurement. After the Supreme Court's 1989 Croson decision involving the minority contracting program in Richmond, Virginia, the share of city contracting dollars won by minority firms plummeted from over 38.5 percent to only 2.2 percent. (Entrepreneurs also reported a sharp drop in private sector work, which they attributed to the "signaling" effect of the public sector retrenchment.) After a new program was designed and implemented, meeting the constitutional test of strict scrutiny, the figures recovered to slightly above the goal of 16 percent. (88)

In summary, then, the continuing justifications for these programs include:

Remedying discrimination. The Federal programs are a remedial counterweight to the exclusion and discrimination that minority and women entrepreneurs continue to face -- a counterweight that not only opens up opportunity to do business in the federal contracting sector, but ideally helps small disadvantaged businesses develop the resources to penetrate private markets.
Mainstream inclusion. Apart from securing individual fairness, these programs reflect a need to build a stronger economy by tapping the entrepreneurial talents and drive of all segments of the population--that means affirmative efforts to open mainstream opportunities to underrepresented groups.
Economic development. These programs are often supported because they are presumed to contribute to job creation and economic development in distressed communities. The evidence is positive, at least regarding employment, though not fully conclusive.
Practicality. If, for the above reasons, it is appropriate for government to use procurement activity to promote minority and women entrepreneurship, then the final key concern is that the measures adopted be effective, not empty aspirations. We must be mindful of the practical realities of the marketplace, and of agency administrative routines.

These preliminary findings and conclusions must be reconsidered in greater detail as part of the post-Adarand review being conducted by the Attorney General and the various agencies. That review must ascertain whether race-based programs are narrowly tailored to achieve a compelling governmental interest, so as to satisfy the strict scrutiny standard of constitutional review.

Is it fair?

The above quite legitimate objectives do not imply that every detail of any conceivable procurement preference would be justified. There are important constraints of fairness, most of which are given substantial effect in the operation of the current contracting programs.

(1) Not quotas.

The contracting programs are not quotas because the statutes and regulations establish flexible goals rather than numerical straightjackets: (89) they reflect an aspiration that 5 percent of contracting be with minority firms, not a guarantee that it will happen. Indeed, for many years it did not happen. On the other hand, it is also clear that the governing statutes and regulations enable contracting officers to use the entrepreneur's race and economic disadvantage, in combination, as a condition of eligibility for participation in various forms of sheltered competition. Individual contracts are set aside for §8(a) firms or SDBs only. As a practical matter, non-minorities find it difficult to establish "social disadvantage" under the terms of the law, so the programs are in effect targeted on members of traditionally discriminated-against groups. Nevertheless, over 18 of every 20 contracting opportunities (by dollar) continue to go to non-minority, male-owned firms.

(2) Race-Neutral Options

The review team examined, insofar as was possible, the consideration given by agencies and the Congress to various race- and gender-neutral approaches to expanding entrepreneurial opportunities for minorities and women. Unfortunately, it is difficult at present to evaluate the effectiveness of such alternatives. There is no readily available data, for example, on the extent to which non-minority entrepreneurs, who already benefit from the long-standing preference for all small businesses, would benefit from a new preference targeted only on economic disadvantage, i.e., on entrepreneurs below a certain threshold of personal assets. We believe, however, that moving from social and economic disadvantage to focus on economic disadvantage only would seriously undermine efforts to create entrepreneurship opportunities for minorities and women, given continuing patterns of exclusion and discrimination.

Another approach would be to provide preferences to firms that will perform contracts in economically distressed areas, thereby stimulating employment and economic development. These are worthy goals, paralleling those of the Administration's Empowerment Zones initiative. They are, however, only indirectly related to the specific goal of combatting business-related discrimination and opening entrepreneurship to underrepresented groups.

These two approaches are not good substitutes for one another; each has valuable objectives; geographic targeting does not create new problems of racial exclusion, but may do little to address the old problems of gender- and race-based entrepreneurial exclusion and would help create jobs and economic development in distresses areas.

(3) Flexible and minimally intrusive.

As a practical matter, some degree of explicit targeting is the only effective way to ensure that entrepreneurial opportunities are increasingly open to minorities and women. The question remains how best to minimize abuse of the program .

As a threshold matter, it is important to bear in mind that, largely because of race-neutral preferences for all small businesses, non-minority small businesses win roughly three times as much in procurement dollars as minority firms. In that sense, the procurement structure as a whole benefits non-minorities far more than minorities, and is not as intrusive or exclusionary as would be a procurement system in which the only significant preferences were exclusively for minorities.

Nevertheless, because of the special scrutiny focused on distinctions based on race, we have examined some alternatives.

- Tighten eligibility. Eligibility for sheltered competition could be more sharply limited in duration or to a subgroup of those now eligible -- by, for example, using a much more restrictive asset test. While a certain measure of this is warranted to address perceived abuses of SDB programs, a very short graduation period would result in a very high business failure rate, essentially slamming shut the door to opportunity. Similarly, too tight an asset test would be unrealistic; owners of businesses capable of providing essential services and goods to the government will very rarely be economically struggling in an absolute sense, since potential to take advantage of entrepreneurial opportunity depends significantly on such factors as education, experience and personal financial security.

- Expand eligibility to women. The system could be made less race-focused by making all women eligible. This is currently the case only in SDB programs at Transportation and a few other agencies.

- Expand eligibility to economic disadvantage generally. The current eligibility test, requiring both social disadvantage and economic disadvantage, could be broadened to "social disadvantage or economic disadvantage." (Social disadvantage, as explained above, effectively means membership in a discriminated-against group.) Practically speaking, such a preference program would simply key to the assets or net worth of the entrepreneur. Therefore, it would not be an effective tool in areas where discrimination locks minorities and women out of opportunity.

Our conclusion is that the expansion of eligibility would marginally expand opportunities for non-minorities, but that doing so would risk significant dilution of efforts to expand entrepreneurial opportunity to individuals who have traditionally been excluded by virtue of their membership in discriminated-against groups.

(4) Transitional.

Programs should be transitional in two senses. First, an individual beneficiary should be provided with an entryway to entrepreneurial opportunity rather than a guarantee of business success. Second, the program as a whole should have an agreed measure of success, so that once equal opportunity has been achieved, and the field of competition is level, the program can sunset and we can rely exclusively on antidiscrimination and less intrusive measures, such as outreach.

With respect to entryway, only the §8(a) program has a specific graduation limit of nine years, while all SDB programs have implicit graduation based on firm size and assets of the entrepreneur. Still, some form of limit, measured in years or perhaps cumulative contract dollars, seems highly desirable because otherwise the notion of using sheltered competition to provide an opportunity to succeed at business would instead become an effort to guarantee such success.

With respect to sunset, these procurement programs have been subject to a relatively intense level of continuing review by the agencies and by Congress. Annual procurement data are used to set and track goals, and several Members of Congress have long taken a strong interest in the details of how the programs are administered. Nevertheless, additional research and analysis is needed to formulate a set of measures for when a given procurement program will have accomplished enough to be declared "successful," so that it can fairly be terminated.

(5) Balanced.

Finally, we return to the observation that these programs cause only a minor diminution in opportunity for nonminority firms. In that respect, current programs are balanced and equitable in the large.

The Review identified some minor, localized difficulties, however. In a few situations, the operation of the set asides leads to very large concentrations of SDB contract awards at certain government sites, and/or in certain subindustries. This "crowding" or concentration is driven by the appropriate desire of contracting officials to achieve their goals by taking advantage of the fact that a critical mass of SDB firms happen to exist in that region or field. Current rules give agency heads discretion to adjust set asides to prevent such concentrated impacts on non-SDB firms, but such adjustments are not always made. The problem of subindustry, or sectoral concentration of SDB firms is more complex, but also needs attention. Not only is there some risk of unbalanced impact on certain non-SDB entrepreneurs, there is also the danger of effectively isolating SDB's in particular lines of business. The goal of these programs is to open up opportunity broadly, creating and expanding beach heads in the mainstream economy, not erecting entrepreneurial ghettoes. These difficulties can be addressed by proper exercise of agency discretion.

9.5.2 Recommendations:

The efforts of Congress and the Executive branch to provide equal opportunity for minority and women entrepreneurs has succeeded in fostering successful businesses, but that success is neither complete nor unalloyed. In most respects, the use of race and gender by these programs is fair. Significant possibilities exist, however, to address the remaining concerns without risking the gains in opportunity for minorities and women. At a minimum, these possibilities deserve serious consideration by agency heads and by the Congress.

These programs providing sheltered competition for eligible firms should be structured with greater practical flexibility, so that they promote opportunity as broadly as possible, consistent with effectiveness in accomplishing the important goal of opening doors to those who have been historically excluded from business opportunities as a result of group-based discrimination and exclusion. Therefore, we recommend that the President instruct agencies, under the leadership of the National Economic Council as follows:

Reforms: The Administrator of the Small Business Administration, the Deputy Director for Management of OMB, and White House staff will lead formulation of detailed government-wide proposals to address abuses in the current operation of the procurement programs focused on opportunity for minority and women entrepreneurs. Specifically, the proposals should:
1. Tighten the economic disadvantage test. So that business owners cannot hide assets under a spouse's name so as to qualify for a set-aside, reform the asset test to count the value of the personal residence and to consider the spouse's assets (now excluded) in a manner analogous to treatment of a 49 percent owner of the enterprise.
2. Tighten requirements for graduation. Apply §8(a)'s 9 year graduation limit to all SDB programs, but then direct the agencies, with White House coordination, to establish more sophisticated objective industry-specific criteria for determining when any individual firm "develops" beyond the need for sheltered competition. Agencies should consider, for example, establishing caps on the dollar value of contracts, plus a cap on total dollars a single firm can win through sheltered competition, varying by industry if appropriate. These measures will also reduce the concentration of §8(a) awards among a limited number of successful firms.
3. Enforce stringent safeguards against fronts and pass-throughs. Create a uniform, certification process for all SDBs. (Where feasible, specially licensed private firms should conduct the certifications, by analogy with the role of independent certified public accountants.) Require certification audits at time of first contract and periodically thereafter to verify continuing eligibility and to monitor for "fronts" and "pass-through" companies. Increase penalties.
4. Establish measures to reduce regional/industry concentrations. Direct the agencies, with White House coordination, to exercise oversight to prevent excessive use of sheltered competition in particular regions or industries. Direct the agencies, with appropriate interagency coordination, to determine industries/areas where sheltered competition programs may be phased out based upon successful inclusion.
Adarand compliance: In accord with the Directive issued by the President, the agencies will examine the extent of continuing patterns of discrimination and exclusion in the industries and regions with which they do business. Agencies should use those findings to develop guidelines for measuring when minority and women entrepreneurs have achieved a full measure of equal opportunity to participate in the economic mainstream, making sunset of the programs appropriate. (The Attorney General has the leadership role as regards the legal aspects of this task, and the White House staff will provide any necessary interagency coordination of policy considerations.)
Empowerment contracting: Under the leadership of the Community Empowerment Board chaired by the Vice President, agencies should develop an "empowerment contracting" program to target procurement dollars on small firms located in communities suffering persistent, severe economic distress, or employing a substantial number of workers from those communities. Looking beyond the issue of fair and effective responses to discrimination, we must recognize that there are communities and regions in our country where the free enterprise system is not working to provide jobs and opportunity. Although the Administration has taken several steps to help poor communities directly -- including, for example, Empowerment Zones, Community Development Banks, the reinvention of HUD, and more effective enforcement of the Community Reinvestment Act -- more is needed. This initiative would help bring jobs and economic development to areas in great need.