Don’t put all your eggs in one basket: New research highlights the pitfalls of business dependence on government contracts

GAINESVILLE, Fla. – If you’re one of the millions of Americans preparing to file your taxes, you might be wondering, how is the government planning on spending my money?

Of the estimated $1.8 trillion that the federal government is projected to receive from income taxes in 2020, about $550 billion goes to paying for goods and services provided by businesses through contracts with the government. These goods and services range broadly – your money could be used to purchase telecommunications software for the armed forces or binoculars for a national park ranger.  

For businesses across the nation, landing a government contract and a chance at the billions up for grabs might seem like the ideal situation to boost sales. Previous research has supported this idea for years, finding that government contracts offer businesses both a stable source of revenue and limited uncertainty when it comes to paying for the goods and services purchased.

“Taken together, the revenue derived from government contracts is especially predictable and reliable, enabling firms that receive it to plan and configure resources accordingly – i.e., firms will have a source of stable, period-to-period demand that allows for configuring resources (e.g., logistics; operations) towards profit-generating efficiency,” write researchers Aaron Hill, Mirzokhidjon Abdurakhmonov and Jason W. Ridge. “Thus, it may be no surprise the market tends to value the winning of new government contracts.”

However, in their new research, Warrington’s Hill, the University of Nebraska’s Abdurakhmonov and the University of Arkansas’ Ridge suggest that businesses shouldn’t be putting all of their eggs in one basket. In the paper “Unpacking firm external dependence: How government contract dependence affects firm investments and market performance,” the researchers find that the more businesses increase their dependence on government contracts, firm investment and market performance decline. 

“Our results demonstrate that being dependent on government contracts constrains firm market performance,” Hill, Abdurakhmonov and Ridge write.

The researchers root their findings in an extension of resource dependence theory, which is the idea that organizations are dependent upon other organizations for vital resources and thus try to manage such dependencies through various strategic actions, by hypothesizing on the internal implications of a dependent relationship. Building resource orchestration, or how resources are configured or deployed within a firm, into resource dependence theory led the researchers to their conclusion that a more-dependent business makes internal adjustments of investments within the firm, such as capital expenditure and R&D, which prompts a negative market response.

“We offer a counter perspective with respect to possible drawbacks of government contracts, advancing the idea that while government contracts often net benefits to a firm’s bottom line with the market reacting positively to both awards and rumors of an attempt to secure government contracts, it also advances market skepticism of these firms,” Hill, Abdurakhmonov and Ridge write.

While it might not be possible for certain businesses to survive without government contracted-work, Hill suggests that it’s important for businesses to remain flexible and not focus all their efforts on one client.

“Businesses need to have inherent flexibility and not be dependent on one single source,” he said. “Business should consider if their dependencies are going to put too much constraint on their processes. If so, then flexibility needs to be built in.” 

“Unpacking firm external dependence: How government contract dependence affects firm investments and market performance” is forthcoming in the Academy of Management Journal.