Labor Category Mapping Spreads

We've talked about NAICS arbitrage before, which is fundamentally about taking advantage of differences in size standards for different industries to obtain small-business set asides. NAICS arbitrage exists because of the government's small-business policies. Without set-asides, there's no obvious market-driven reason for a company to choose one NAICS code or another.

Today we're going to talk about a different common pattern in federal contracting: labor-category mapping spreads.

Here's how it works. Suppose you're a contractor and that the government wants to hire carpenter. Good news! You have a carpenter on staff and you pay the carpenter a labor rate of $35 per hour! But your carpenter also has a PhD in, I dunno, economics or whatever. Normally, the market doesn't really assign a value to that PhD; the market will price a carpenter in the neighborhood of other contractors. Let's say the market rate is $40 per hour for a carpenter. You make an offer to the government for $40 per hour for the carpenter's services, and the government accepts. Congrats!

Now, imagine that the carpenter comes to you with a suggestion. She observes that you're making a $5 margin on her labor, but if you hired a junior carpenter at $25 per hour, you'd make a $15 margin (remember, the carpenter has a PhD in economics!) on the same contract. With a junior carpenter and another contract with a $40 per hour labor rate, you could swap the junior carpenter for her and suddenly make a $20 per hour margin on $80 per hour revenue. You've doubled the value of your business. Congrats!

But then someone in the government might get all bothered. "Why are we paying $40 per hour for a junior carpenter?" they'll ask. "We should be getting senior carpenters for $40 per hour! If the IG knew we were paying $40 for a junior carpenter, we'd get bludgeoned!"[1]

So, in the next contract, they'll specify that they want a senior carpenter. And to make sure you don't pull a fast one again, they'll insist that, to qualify as a senior carpenter, she must have a graduate degree. Problem solved, right! If you offer that senior carpenter, you have to use that senior carpenter on the contract during the performance of the contract, or at least another carpenter with a graduate degree.[2]

When the contract comes out for bid, though, you go back to the government and ask: "look, I don't have another carpenter with a PhD in economics. But I do have a mechanic with a graduate degree in astrophysics. And I have a carpenter with an undergraduate degree in woodworking. Will either of those work?" What should the government do? On one hand, it wanted the graduate degree as a proxy for seniority, so the mechanic might be preferable. But it wants a carpenter, so maybe the woodworking degree is more relevant? Ok, the government says: "both are fine." Congrats, you've snuck in your junior carpenter!

This is where labor-category mapping comes into play. Contractors map their employees to the government's defined labor categories. And the variables that contractors use to map the labor categories to the government's definition are the nature of the work (can a mechanic do carpentry?), education (do they have a degree?), and the years of experience. This mapping is an exercise that exists to make sure that the government actually gets the skills they need, without overpaying.

The spread exists when the mapping of government's labor category requirements is flexible. If you have a wide spread, you might be able to get in a mechanic to work carpentry. If you have a narrow spread, you can't. And where the spread really comes into play is trading off experience and education. A screen actor doesn't always need a degree, but you might prefer to cast one with a Master in Fine Arts, I dunno.

The situation I mentioned above is, admittedly, kind of silly. The government wouldn't really expect a carpenter to have a PhD in economics. After all, usually the government uses education as a proxy for relevant experience and expertise. And usually, you expect the government to have loose spreads.

But not always! In practice, the government really will use tight spreads. The government really will expect service providers to have academic credentials. Some folks don't like it, but the use of degrees in labor categories is ubiquitous. And in some cases, tight spreads are perfectly reasonable. I really do want a lawyer with a JD! If you haven't gone to law school, you're not going to be my lawyer.

Last week, we saw a pretty extreme version of the government expecting a tight spread play out in the Court of Federal Claims. In a case called System Dynamics International v. Strata-G Solutions, the Court found that the awardee (Strata-G) should have been disqualified from winning the contract because it offered personnel for labor categories with strict minimum educational requirements.

Specifically, the court found that Stata-G should have received a "Deficiency" not a "Significant Weakness" because offering personnel without minimum academic credentials was a "material failure of a proposal to meet a Government requirement."

Notably, though, the government accepted the vendor's labor-category mapping spreads. Even though seventy percent of the personnel did not meet the minimum requirements, the government felt that these academic credentials were effectively negotiable. For example:

Pointing to the Program Manager III example, the Government emphasizes that Strata-G proposed an individual with a Bachelor degree and 15 years of related experience to fulfill the Agency’s requirement of a Bachelor of Science or Engineering degree and 10 years of experience.

Right, sure. You might rationally think that a 5 years on the job is more important than 4 years of college. And the government agreed that a wide spread was a good option! But that's not how the court saw it. The court said that the solicitation demanded a tight spread, and Strata-G fell on the wrong side of it.

[The Government's] evaluations acknowledged that Strata-G’s proposal failed to meet the Government’s educational degree requirement. As a result, the [Government] found that over 70 percent of Strata-G’s proposed personnel were not qualified to accomplish the PWS requirements and in each instance recommended Strata-G “hire an appropriately degreed individual” for the position. The [Government] further concluded that the insufficient match to the Government’s educational degree requirement “prevented the Government from evaluating the personnel capabilities being proposed.” According to the plain language of the Solicitation, those findings qualify as a Deficiency under Technical Subfactor 2.

Ah, well. Strata-G hoped for a wide spread, the government liked the wide spread, but the solicitation demanded a tight spread. Them's the breaks!

As with NAICS arbitrage, this category of problem is one of the government's own making. If the government didn't care about whether a particular person fit a given labor category and instead just focused on outcomes, labor-category mapping spreads wouldn't be a Thing. But the government does care and, as a result, the government will spend time and energy deciding whether the spreads should be wide or tight, and vendors will spend time and energy navigating those spreads.

[1] Or, like, why are we hiring senior carpenters when juniors will do? Nah...

[2] You may be thinking: "or they make the senior carpenter a key personnel." And sure, that's true. But you can still swap key personnel later. The point is that there's a labor rate.

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