Businesses of all kinds are feeling the effects of inflation, supply chain issues and a tight labor market. But the situation is particularly tricky for the businesses I work with most—federal government contractors.

Depending on contract type, these companies may not be able to pass on inflation and labor-related cost increases to the government, which can negatively affect margins and overall profitability. Smaller companies with cost plus contracts can bill for the higher costs, but they may hit the ceiling sooner.

Without the flexibility to raise the cost of their services, government contractors often operate at a loss, which can threaten the flow of goods and services required to support federal programs.

It’s a rock-and-a-hard-place situation, but through employee incentives and rethinking their mix of contracts, contractors may be able to weather today’s unique financial environment.

Labor market challenges

JPMorgan Chase’s 2022 Business Leaders Outlook survey found the worker shortage is the biggest challenge business leaders face across the country, with 68% saying their employees are now working more.

In conversations I’ve had, smaller government contractors said their employees are more willing to speak to recruiters now than they were before. And employees with technical skills are leaving for large corporations that are able to hire faster and offer better pay.

To retain key employees, some mid-tier contractors I know have provided proactive salary adjustments or paid one-time bonuses at year end.

Business type considerations

In the past, companies desired a larger percentage of fixed-price work. They were willing to absorb the greater risk because it offered marginal upside. Cost plus contracts were less desirable, as savings were given back to the government. In this inflationary environment, however, companies with fixed-price work are experiencing the opposite effect. 

Contractors should consider rethinking their mix of contracts, focusing on those with reasonable risks and incentives for efficient performance.