Unlocking the Procurement Economy
Below is the Nowak Metro Finance Lab Newsletter shared biweekly by Bruce Katz.
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(co-authored with Domenika Lynch, Ben Preis, Karyn Bruggeman, Ian O'Grady and Brian Reyes)
The Procurement Economy is having its moment in the sun. Last week the National Minority Supplier Development Council held a major conference in Chicago. The conference was an all-star event, attracting Illinois Governor J. B. Pritzker, federal officials like Transportation Secretary Pete Buttigieg and EDA Administrator Alejandra Castillo, private sector leaders like John Rogers and Magic Johnson and a plethora of leaders from financial institutions, public authorities, constituency organizations and local governments.
The energy in Chicago reflects momentum across multiple levels of government and layers of society. As we recently wrote, the Small Business Administration is driving efforts to maximize the impact of direct federal spending. Large corporations that spend over $1 billion with minority- and women-owned businesses have the Billion Dollar Roundtable, while anchor institutions in Philadelphia, Baltimore, Chicago, and elsewhere have collaborated to increase their procurement with local and minority-owned firms.
The outpouring of interest is not difficult to discern. Every year, the Procurement Economy pumps a tremendous amount of money into the economy. The federal government is the heavyweight in this arena, coming in as the world’s largest single purchaser, with $665 billion spent in fiscal year 2020. Collectively, states and localities (i.e. cities, townships, counties, school districts, and special districts) spend even more, reaching approximately $1 trillion in fiscal year 2019. Anchor institutions, like major universities, hospitals, utilities and corporations, spend millions, if not billions, of dollars of their own, and often amplify their power by coordinating with each other.
With unprecedented federal infrastructure spending and growing interest among anchor alliances in major cities and metropolitan areas across the country, the Procurement Economy could provide a vehicle for growing Black- and Latino-owned business at scale. Black-owned businesses comprise only 2 percent of all employer firms in the U.S., and Latino-owned businesses comprise just under 6 percent of employer firms, a vast inequity that impacts wealth creation and economic mobility for people of color. Nationally, Latino-owned businesses are disproportionately concentrated in construction and food service industries, while two-thirds of Black-owned businesses are concentrated in just five sectors, including health care and social assistance; professional, scientific and technical services; administrative, support, waste management and remediation; and retail. Gaps in business ownership rates, as well as the sectoral concentration (which impacts size and revenues), contribute to the racial wealth gap in this country.
Here is the challenge. Unlocking the Procurement Economy is easier said than done. Existing procurement systems, particularly in the public sector, are overly legalistic, inordinately bureaucratic and driven more by compliance than performance. Federal efforts for race-based set-asides have been repeatedly challenged in court, leading to our current system of hundreds of burdensome rules (and dozens of hard-to-decipher forms), a cacophony of different programs, and a complete and inefficient separation of small business financing and entrepreneurship programs from procurement and supply chain systems. For the uninitiated, entering the public procurement world is akin to watching a Twilight Zone episode: a parallel universe with its own language, logic and limitations.
At the state and local level, lawsuits targeting set-asides and procurement preferences have led to an entire industry of disparity studies, wherein local governments must conduct burdensome year-long analyses every five years before they can set race- and gender-conscious goals for contracts. Even then, if the goals are poorly targeted, cities leave themselves open to the possibility of a lawsuit.
One underlying challenge with many of these programs is that the goals are set in relation to the current availability of firms in certain industries. Setting goals in relation to regional availability, rather than setting aspirational goals meant to encourage new business entrants, means that Black- and Latino-owned firms in high-profit professional services industries never get the leg-up that business diversity programs are meant to provide. Instead, as John Rogers recently highlighted in his Congressional testimony, purchasers focus on low-wage, low-margin industries like construction, catering, and janitorial services. This circular reasoning originates in this legalistic approach, where goals can only be set in relation to complying with existing court cases.
The balkanization of infrastructure deserves a special focus. The federal government funds hundreds of infrastructure programs through a fragmented mix of special, often independent, public entities including school districts, city agencies as well as metropolitan or even state agencies and public authorities. These separate entities have different definitions of disadvantaged businesses (as well as lists of such businesses), use separate processes for procuring goods and services and engage (or fail to engage) with different stakeholders in the ecosystem, including entrepreneurial support organizations and financial institutions. There is simply no unified approach to supplier diversity, meaning that the whole is less than the sum of the parts. In addition to the institutional issues this creates, it also leaves firms filling out excessive — often duplicative — paperwork to qualify for similar contracts with different agencies.
We propose a fundamental shift towards market making to unlock the full potential of the Procurement Economy. Growing the supply of Black- and Latino-owned firms, particularly in growth sectors that pay quality wages, cannot be the exclusive responsibility of a fragmented set of public entities and a small network of procurement officers. In a legal system that requires feigned ignorance of historical racial injustices, the biggest challenge many public agencies face is the under-representation of Black- and Latino-owned firms in the high-wage, high-growth sectors or specializations on which they rely to conduct business. That challenge requires a sustained, collaborative focus on growing the market of firms capable of selling their goods or services to governments. And that focus must harness the talents and energies of the entire ecosystem of financial institutions, investors, chambers of commerce, entrepreneurial support organizations, anchor institutions, and corporations.
Put simply, we need a paradigm shift in public contracting, away from an individual agency’s short-term buying needs and toward contracting as a tool to promote regional market dynamism, sectoral innovation, and business- and wealth-building.
Making markets begins with market intelligence. Procurement does not implicate every type of business. In a 2020 paper, Mercedes Delgado and Karen Mills explain that supply chain businesses are those that sell to businesses and governments, which are different from business-to-consumer firms, such as retailers and restaurants. Procurement purchases also include far more than construction services or manufactured goods, historically the frequent focus of supplier diversity conversations. Governments and corporations purchase sophisticated services, such as software, legal, accounting, communications, and operational services. For diverse businesses to compete for more government contracts, they must have a strong presence in these fields.
In the corporate world, this is well understood. Supply chains are complex and sophisticated. Large firms develop suppliers around the world, as they seek to ensure best value over best price. In the absence of labyrinthine rules, court precedent and regulations, corporations, universities and hospitals are able to identify their desired vendors, helping them grow to the size that they need and, in doing so, prepare them to compete in the marketplace for contracts with other firms in their industry. We must encourage widespread rethinking of what governments, corporations and nonprofits are purchasing, where there may simply not be enough diverse firms available to meet a broader range of contracts and steps a broad set of actors can take to grow business diversity.
5 Elements of Making Markets
The shift from rule-driven compliance to business building markets will require innovations and routines in a broad set of activities: procurement practices for sure but also data collection and reporting, small business financing and lending, sophisticated and connected technology solutions and effective ecosystem governance and networks. Below, we lay out the direction we believe the field needs to go to achieve real change.
Change #1: Make Innovative Procurement Practices the Norm
As in any system, the infrastructure world is populated with a group of authorities and agencies that are generally considered to be best-in-class. Entities such as the Chicago Transit Authority, the Port of Long Beach and the Denver International Airport have reformed their practices to be both compliant and impactful. These practices cover a broad front.
- Business outreach & pre-bid meetings: This involves issuing forecasts of buying plans and contracts, robust outreach to diverse firms eligible to bid, business outreach partnerships with other procurers, and pre-bid meetings that offer learning opportunities for newer or smaller firms.
- Firm capacity building: Mentor-protégé programs and contract management systems designed to help build firm capacity are two examples here.
- Streamlining processes: Simplifying SWMBE certification processes, proposal language, and contracting processes so they are user-centric and maximally inclusive of firms with less contracting expertise.
- Improving supplier payment: Improvements include switching from paper to electronic invoicing and setting policies that require contractors to be paid quickly, especially sub-contractors who have more fragile cash flow needs.
- Supplier financing and bonding: This typically includes bonding education programs, connections to surety bond programs, referrals to capital providers and lenders, or at best, a direct partnership with an insurance firm to offer contract finance and bonding.
Making these practices, and many others, the norm rather than the exception provides a strong and essential platform for supplier diversity.
Change #2: Data with a Purpose
The saying “you can’t manage what you can’t measure” applies to business diversity. A lack of consistent data collection and reporting, on racial and gender ownership of firms of all sizes, sub-contracts, and more, hampers buyer’s ability to create more strategic programs. Ironically, we know more about where banks lend than where federally supported institutions spend.
Public agencies should not only create inventories of disadvantaged business enterprises. It is equally important to understand the current state of large firms, often nationally or regionally focused, that are able to garner the lion’s share of lucrative contracts. Motivating these firms to advance business diversity through joint ventures and sub-contracts will be critical moves.
Information regularly collected, routinely reported, and uniformly templated is the foundation of markets. In states like California and Illinois, private utilities may offer a model to replicate or adapt since their procurement practices and outcomes are overseen by state power commissions. As a consequence, Ameren in Illinois, and the Joint Utilities in California have created robust development programs to nurture, scale, and support small businesses. In turn, these businesses become critical players in their supply chains, and go on to compete for bids in other industries. Local players must begin to focus on growing firms in high-growth, high-wage procurement economy sectors.
Change #3: From Capital Access to Capital Innovation
Local and national leaders must also develop and scale innovative capital products that address deep-seated, structural gaps in capital access that inhibit SMWBE firm creation and growth.
Capital products, referred to as “Supply Chain Finance” or “Contract Finance,” already exist, but are often limited to one-off programs from local procurers or are predatory in that they charge exorbitant interest. Public authorities, banks, philanthropies, mayors, community-based nonprofits, and a variety of other local institutions have a critical role to play in designing, instituting, and delivering new capital products where they are needed most, to leverage historic public and private sector investment.
In the construction sector, financing the Procurement Economy for expanded SMWBE access comes down to two core components: (1) Obtaining the bonding necessary to secure contracts, and (2) Obtaining the working capital necessary to fulfill contracts once secured. Between these two contract financing fundamentals, there is significant room for innovation.
Bonding: Bonding is a critical process and barrier for SMWBEs. Large procurers almost always require bonding, or third-party insurance that demonstrate that contractors have the financial and operational capacity to complete contracted work. Without a track record or capital reserves, factors that disproportionately disfavor small-, woman-, and minority-owned businesses, it can be difficult to cross this critical threshold.
Public institutions can offer bond guarantees, which are promises to bond surety companies that potential losses will in part be covered. An example bond guarantee program, timely with new State Small Business Credit Initiative (SSBCI) funds coming online, is the New York State Surety Bond Assistance Program (NYSBAP). New York used SSBCI funds to guarantee up to 30 percent of bonding for state and city contracts, boosting SMWBE bonding capacity and access to public contracts. With this program, the state was able to reach its supplier diversity goals and double its MWBE contracting in just two years, from 9.2 to 21 percent.
Bond guarantees, in New York and elsewhere, combined with adequate technical assistance to help businesses become bond-ready, offer a path for firms to obtain this necessary threshold requirement for participating in the Procurement Economy.
Working Capital: Once SMWBEs obtain bonding, they still need working capital to deliver contracted services. A key financial innovation here is connecting buying entities to capital and underwriting business lines of credit against secured contracts. This arrangement offers surer repayment for financiers (and at large volume) and lowers costs of capital for entrepreneurs.
With the Contract Finance Assistance Program, Los Angeles Metro and LA World Airports connect their contractors to Merriwether & Williams Insurance Services to help SMWBEs get contract- and bond-ready but also for project financing. Merriwether & Williams will directly cover project costs for contractors in anticipation of future payment from its partners, public institutions, helping maximize firms’ cash flow and avoid costly personal loans and other debt.
Change #4: Explore New Technology Platforms to Facilitate Change
Another area worthy of investigation is the future potential of technology and data analytics to improve public procurement. Many public procurement offices struggle to stay up to date on market metrics or their current spending, let alone actively track detailed spending on small, minority, or women-owned firms. Data on active or past contracts, aggregate outsourced spending, and the ownership status of vendors can be spread across multiple databases within a single agency, with individual staff lacking universal access to every set of information. Individual public agencies, such as transit systems, utilities, and school districts buy from suppliers within the same region but rarely collaborate, and instead each have their own procurement systems, software, business outreach programs, and tracking mechanisms, and can lack access to common databases of regional businesses available to participate in contracts.
The use of custom or subscription software, such as B2Gnow or Oracle’s Textura, mobile applications, and digital platforms (or lack thereof) impacts every step of the contracting process, from how opportunities are advertised, how bids are made, how databases of certified or emerging small, minority, and women-owned firms are managed, contract management, and how vendors are paid, which too frequently still happens with paper invoices.
More sophisticated, integrated digital systems could reduce pain points for small firms and empower contracting staff to collaborate with their regional peers to take a market-oriented approach.
Change #5: Build New Intermediaries and Ecosystems
A strong business diversity system needs an entity that can both coordinate and align procurement efforts across multiple public entities as well as work across sectors to form and grow disadvantaged businesses. A strong ecosystem should match the demand coming from public entities with the supply of local vendors that can (or could) meet these needs; in other words, market matching and market building. This will require not only a change in public procurement practices which, in the past, has often inhibited disadvantaged enterprises from applying for and securing major government contracts. In addition, disadvantaged businesses will also require significant business coaching and mentoring as well as access to quality capital to be able to compete for and successfully deliver public contracts.
The current system of fragmented and balkanized agencies is not equipped to pull this off. Imagine if all major cities and metropolitan areas hosted a Business Diversity Hub. The Hub would perform multiple functions: (a) provide advisory services to multiple public authorities and agencies around how to alter internal procurement and bidding practices to advance supplier diversity; (b) work with federal and state entities to reform statutory, regulatory and administrative provisions that inhibit supplier diversity; (c) work closely with a Business Diversity Consortium of entrepreneurial support organizations, chambers of commerce and capital providers to provide the full suite of necessary services to target firms; and (d) help set up a tech empowered Business Diversity Marketplace to, among other things, bring transparency in goal setting and reporting across multiple entities.
Watch This Space
Unlocking the Procurement Economy represents one of the nation’s best shots at unleashing the market making potential of our diverse population and reducing longstanding disparities on business ownership and growth. Our two organizations, the Aspen Institute’s Latinos and Society Program and the Nowak Metro Finance Lab at Drexel University, are partnering together (and with others) to further a nationwide focus on procurement. Efforts to watch include the following:
- The Illinois Hispanic Chamber of Commerce (IHCC) is pioneering a Procurement Academy in Chicago to consolidate disparate federal and state supplier diversity programming that too often misses the newest and smallest firms interested in procurement.
- The San Antonio Area Foundation and Congressman Joaquin Castro have catalyzed an effort to advance Supply SA, a public-authority focused research-and-action effort that will culminate in a Procurement Playbook for the region.
- The Equity in Infrastructure Project is launching a national pledge among leading public authorities (e.g., airports, ports, public transit agencies, water and sewer authorities) to support Historically Underutilized Businesses. Public authorities are a particular type of special purpose government, and, incredibly, there are more special purpose governments in the US than municipalities.
The full potential of the Procurement Economy has not yet been even remotely unlocked. The tidal wave of federal infrastructure spending creates an imperative and urgency to reform practices within the public sector as well as create a new market making system across multiple sectors. The opportunity to advance business diversity at scale is there for the taking.
Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Domenika Lynch is the Executive Director of the Latinos and Society Program at the Aspen Institute. Karyn Bruggeman and Ian O’Grady are Research Officers at the Nowak Lab; Ben Preis is a Research Fellow and Brian Reyes is a Graduate Research Analyst at the Nowak Lab.
 Delgado, Mercedes, and Karen G. Mills. “The Supply Chain Economy: A New Industry Categorization for Understanding Innovation in Services.” Research Policy 49, no. 8 (October 1, 2020): 104039. https://doi.org/10.1016/j.respol.2020.104039.