For Liz Lasater, founder of Red Arrow Consulting, a supply-chain management and logistics company in Issaquah, Washington, the federal government is in some ways her ideal customer. Her small firm probably wouldn't survive without contracts from government agencies, she says, and as the defense budget rises, Uncle Sam offers a seemingly inexhaustible supply of new deals. If Lasater, 42, performs well, government agencies will be more loyal, less demanding clients than their private-sector counterparts. "Government can deliver enormous volume," Lasater says. "Almost no one in the private sector [can] match it."

At the same time, the government is Lasater's most difficult client. "You have to have a lot of capital to wait out the process of getting approved to fill a contract," Lasater says. "Then you have to figure out which contracts you can really compete for, and which are already reserved for large companies." She sighs. "It can be very frustrating."

Lasater's problems wouldn't shock most small businesses trying to win federal contracts. Despite promises over the past five years by government agencies to make the contracting process more accessible and more transparent to small businesses, recent reports show that only limited progress has been made. To many small businesses, accessing contracts still doesn't seem worth the effort and cost required to play the game. And in the wake of Hurricane Katrina, which devastated many small companies along the Gulf Coast, small-business advocates argue that few reconstruction opportunities have gone to entrepreneurs. Still, as Lasater knows, entrepreneurs willing to brave a contracting system that seems tilted in the big boys' favor can prosper.

The World's Most Powerful Customer
The size of U.S. government contracting is staggering: In 2004, the federal contracting marketplace was nearly $300 billion--and growing. Following the national trend toward outsourcing business functions, the Bush administration has prodded the government to outsource more work. The rising defense budget, the creation of the massive new Department of Homeland Security, the extensive rebuilding in the Gulf Coast, and the reconstruction efforts in Afghanistan and Iraq also add to contracting opportunities.

For decades, entrepreneurs were often shut out of these marketplaces. Government agencies favored large contractors, many of which were led by executives who had previously worked in government. In recent years, however, congresspeople and small-business advocates have forced the federal government to focus more on small companies. In 2000, Congress passed the Equity in Contracting for Women Act, which increased the number of federal contracts set aside for women-owned companies. Congress had already created broader set-asides under which small companies are supposed to receive 23 percent of all federal contracts. (This is not a huge number, considering companies with less than 100 employees account for more than 95 percent of U.S. businesses.)

The government also took on contract "bundling," where government agencies consolidate several individual contracts into one larger, more complex deal. Bundled contracts are ideal for giant companies that can provide a range of services. In 2002, President Bush vowed, "Whenever possible, we are going to insist that we break down large federal contracts so small-business owners have a fair shot." Backing the president, SBA head Hector Barreto added that "the consequences of bundling are serious"--a 2000 report by the SBA's advocacy office suggested that, for every 100 bundled contracts, small companies lost out on 106 individual contracts they might otherwise have received.

Yet the truth is, the contracting door has only opened a crack. The high cost and complicated red tape of obtaining certification dissuades small companies. Meanwhile, federal agencies often prefer companies with extensive contracting experience. And many of today's consolidated contracts are longer term than in the past, or they're automatically renewed, so large companies that win them are locked in for years.

"This is directly related to the decline in the size of the [government's] acquisition work force," says Paul Murphy, president of Eagle Eye Publishers Inc., which researches contracting trends. With fewer government procurement specialists due to federal cuts, says Murphy, overworked contracting officers prefer to hand out bundled mega-deals to big corporations rather than sift through hundreds of small-business proposals.

In fact, Murphy believes the number of bundled contracts is now reaching record levels. Eagle Eye's research suggests that between 1992 and 2001, the number of bundled contracts rose by 19 percent. Though more recent numbers seem rosier (according to Murphy, an official estimate puts bundled contract expenditures at less than 1 percent of total procurement in 2004), many believe inaccurate measures of bundling are masking the true gravity of the problem. Indeed, a May 2005 report from the SBA's Office of Inspector General estimates that, between 2001 and 2004, a minimum of $384 million was potentially lost to eligible small businesses due to bundling.

Noncompetitive bidding also remains common. According to a report by research organization The Center for Public Integrity, 40 percent of Pentagon contracts awarded between 1998 and 2003 were given without taking bids from numerous potential competitors--a lack of competition that favors entrenched defense firms. This sometimes happens because large corporations take advantage of loopholes, such as rules allowing them to buy small firms and inherit those firms' small-business set-asides.

Many small-business advocates say the set-aside rules themselves are problematic. "One of the most obvious flaws in the current size-standards methodology is the arbitrary nature of size measures," says Nydia Velázquez, ranking Democrat on the House of Representatives' Committee on Small Business. An SBA study released in December 2004 suggests that, in one year, some $2 billion in federal contracts targeted for small businesses actually went to corporate giants. Similarly, The Center for Public Integrity's report reveals that, between 1998 and 2003, the Pentagon gave over $47 billion in small-business set-asides to large companies. And a recent study by Eagle Eye found that 39 of the leading contractors listed as small businesses were actually large companies.

"There is just no prosecution of anyone who gets federal contracts in this way," says Lloyd Chapman of the American Small Business League, an advocacy group that fights to expand access to contracts.

The SBA says it recognizes the problem. There are concerns about the size standards used to judge whether companies should qualify as small businesses, admits Gary Jackson, an SBA assistant administrator responsible for size standards. Jackson says the SBA has held a range of meetings across the country with entrepreneurs to solicit feedback about appropriate size standards for small-business contracts. The SBA, he says, is using this public feedback to craft workable new size standards, though he's still not sure when those will be released.

On a micro level, all these barriers add to entrepreneurs' costs and frustration. "When we survey our membership, the vast majority want to get federal contracts, yet 80 percent say they wouldn't try" because they think the system is still rigged, says Barbara Kasoff, co-founder and president of Women Impacting Public Policy, a nonprofit, bipartisan public-policy advocacy organization. "They just don't have the energy to go through the complex maze [of contracting]."

Alan Castillo understands the feeling. "When you're researching contracting, you may start to get the details of it and see the risk is too high," says Castillo, 37, founder and president of Phoenix-based Castillo Technologies, a provider of IT services to public-sector and business clients.