The saga of the ITVAR nonmanufacturer rule

Here's a story. Back in 2002, a couple years after the dotcom bust, the government had a problem: it was spending almost $19 billion on contracts for computer hardware, software, programming, and other related services. But, agencies were struggling to use small-business set asides for IT services.

That's because, in 2002, the government had a policy that divided the acquisition world into one of two categories: supplies and services.[1] And under the prevailing rule at the time, the government looked to whichever thing—supply or service—had the larger share of the contract award to decide whether it was a supply contract or a service contract.

Remember this point: the reason that the government was having a hard time meeting small-business goals was a self-inflicted rule about how it approached acquisition. Foreshadowing: this point will come again up later.

Anyway, most of the time, when government bought supplies in 2002, it applied a rule called the "nonmanufacturer rule." We've actually talked about this rule before. It's pretty simple: if the government wants to (1) buy supplies and (2) set aside the contract for small business, then (3) the manufacturer of those supplies needs to be small. And the nonmanufacturer rule has an employee-based limit: 500 employees. If you're larger than 500 employees, you're not small. If you're smaller than 500 employees, you're good under the nonmanufacturer rule.

This was good for small manufacturers; small manufacturers would necessarily get a share federal contracts (or subcontracts). And the policy goal of the NMR was to prevent small businesses from "fronting" a large manufacturer by, say, white labeling something or simply just sourcing stuff from large manufacturers.

Obviously, practically, though, some things are only manufactured by large manufacturers. You couldn't, for example, buy a car from a small manufacturer. To address this reality, the government created an exception: the SBA could grant waivers to the nonmanufacturing rule. The SBA could, through a process involving the Federal Register, grant waivers to an entire class of supplies, or it could grant a waiver for an individual contract. And so it did.

But, you see, IT was tricky. Because at that time, two things were true: (1) computers and the associated hardware and software were very expensive; and (2) the government needed help managing all of that IT. Which meant that, when the government even when the government bought IT services, the acquisition would get coded as a supply contract.

Which meant, you see, that IT procurements needed to adhere to the nonmanufacturer rule. This was a problem because the manufacturers of computers and hardware were large businesses.

And therefore, in 2002, the SBA did the unusual thing of creating another exception, this time to the prevailing NAICS rules at the time. It created the IT Value Added Reseller (ITVAR) exception to NAICS code 541519.

The idea at the time was that, even though the hardware was expensive, the ITVARs were providing important service offerings. So, the SBA made a hybrid NAICS: it (a) used the employee-based limit that applies in the nonmanufacturer rule (500 employees); and (b) reduced the size that would normally apply to manufacturers from 500 employees to 150 employees and limited the application of the NAICS code exception to contracts with between 15% and 50% value-added services.

Remember why the government was having a hard time getting small businesses involved? Was it because of how we defined small businesses? That doesn't seem right, but whatever, let's proceed.

A little more than a decade later after it adopted the new ITVAR exception, SBA had doubts. And in 2014, the SBA proposed eliminating the ITVAR exception, citing "some inconsistencies, confusion, and misuse" of the exception. In that proposal, SBA claimed that "the proposed elimination of the ITVAR sub-industry category and its 150-employee size standard, if adopted, will have very minimal impact on businesses below 150 employees."[2]

The response to this proposal was, however, pretty imbalanced. There were 168 responses to SBA's proposal. Here's what the SBA wrote about them:

Of the 168 comments relating to the ITVAR size standard, five supported SBA's proposal to eliminate the ITVAR exception to NAICS 541519 and its 150-employee size standard, while the rest opposed it. Among those opposing the proposal, two also asked for a 60-day extension of the comment period. Of the 168 comments on the ITVAR size standard, four were from attorneys, one of which was on behalf of 13 small business ITVARs and three each on behalf of individual ITVAR businesses. One also provided a list of individuals who submitted concerns about the SBA's proposed rule to their Congressional representatives through a Web site that the company had developed.

In other words, the SBA got blowback. And, look, I'm not going to run the play by play on this one, but in reading through the final rule, you get the distinct impression that SBA was both (1) unimpressed by the arguments against the proposal; and (2) not gonna go there.

The ITVARs claimed that the sky would fall. The SBA claimed that they'd just have to compete with small businesses between 150 and 500 employees. Nonetheless, the SBA allowed the exception to survive, with one notable addition; the SBA explicitly added the nonmanufacturer rule into the exception.

That's realpolitik for you. And, again, remember why small businesses were having a hard time selling into the government? Because the nonmanufacturer rule wasn't being consistently applied to a newly created category? Hmm, that doesn't seem right either.

Which brings us to the present day. As we discussed last week, the proposal of NASA to move the next generation of the NASA SEWP vehicle to NAICS Code 541512 has created quite a stir in the community, including a letter from a congressional committee.

In that letter, the committee tips off the fact that the nonmanufacturer rule is very much still part of the conversation.

And, as of a year ago, the SBA appears to continue to hold the view that the ITVAR exception may not have been a smart choice back in 2002. Here's what the SBA said last year:

SBA is concerned that without the compliance with the nonmanufacturer rule, the ITVAR exception may allow small IT resellers to simply serve as "pass throughs" for large OEMs and other large manufacturers. While SBA recognizes that the nonmanufacturer rule may work better for some products than for others, it strongly believes that the rule must apply to all supply contracts equally. Thus, like all other products and supplies, the nonmanufacturer rule must also apply to IT products, including those purchased through the ITVAR exception.

The SBA is out here worrying that ITVARs are actually "pass throughs." Yikes.

All of which suggests that the SBA may be disinclined to grant a nonmanufacturer-rule waiver on a contract involving more than $12 billion per year, because even if they're technically small under the NAICS code?

Some observers are clearly hoping that NASA will pursue a waiver from the SBA and stick with NAICS code 541519 instead of NAICS code 541512 like they've proposed. To them, NASA SEWP is a smashing success because it manages to bring many billions of dollars to companies, even if most of that money (by definition) goes to large businesses.

Perhaps. Perhaps not. Any way you look at it, there are not really great answers. Either some vendors will be allowed to get big while staying small. Or, due to the sheer physics of SEWP, they will be forced into the larger pool of vendors.

But that's not the real story, is it? Why do small businesses have a hard time selling into the government? Surely, it's because we still have work to do on our size standards.

Right? Right?!?!

[1] And, I guess, construction. Stay focused.

[2] The SBA also wrote: "[t]he selection of a NAICS code should never be based on the contracting officer's desire for a particular size standard or firm size." Hahaha. Sure.

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