To stay in business, Wallace Forman had to stay small -- at any cost.
To stay in business, Wallace Forman had to stay small -- at any cost.
Wallace Forman likes to think of himself as a reasonable, rational man. Until recently, he had a company called Gibraltar Industries Inc. It was a vigorous enterprise. Although small, with fewer than 500 employees, it was nevertheless among the half-dozen largest and most successful competitors in an industry comprising several hundred companies. Forman, for his part, enjoyed running the business, which he had founded with his father and brother back in 1952.
None of which explains why he walked away from it last December. In a nutshell, he did so because, try as he might, he could not keep the company from growing, and the ultimate reward for growth in the Alice-in-Wonderland industry he worked in is failure.
Gibraltar Industries is -- or, at least, was -- one of the leading manufacturers of military apparel and equipment. Its particular specialty was protective clothing, a business Forman and his father eased the young company into in the early 1960s. By the late '70s, nearly all of Gibraltar's growing revenues were coming in from successful bids on Pentagon contracts.
Sales continued to increase, reaching $46 million in 1980. Deciding that the time was right to take the company public, the Formans arranged for Gibraltar to be acquired by Pope, Evans & Robbins Inc. (PER), a small, publicly held energy-engineering design and consulting firm. Wall Street blessed the marriage by lifting the price of PER's stock from $1.50 just before the Gibraltar acquisition to a high of $14 a year later. As Gibraltar's sales climbed to $76 million in fiscal 1981, PER made a big commitment to its future with the $1.9-million purchase of an industrial plant in East Stroudsburg, Pa., which Forman planned to modernize, making it state of the art in the manufacture of specialized textiles. Meanwhile, PER further bolstered itself with the acquisition of Putnam Mills Corp., a textile converter whose year-earlier sales came to nearly $94 million.
By 1983, PER looked to most investors like a healthy, integrated textile and apparel manufacturing company. The price of PER's common stock hit 17 5/8 on the American Stock Exchange. To all appearances, the company was thriving, and the directors' annual report to shareholders for the year ending June 30, 1983, contained no hint that within six months the Pennsylvania plant would be sold, that Gibraltar would be out of the textile manufacturing business, and that Forman and his brother would be out of the company.
The turnabout makes sense, but only in the context of the peculiar market in which Gibraltar did business. In the defense-apparel industry, normal business strategies are turned inside-out and upside-down. One perverse objective overrides all others: To survive, a company must stay small.
When the Formans started Gibraltar in 1952, the company produced industrial textiles, so it was of no concern to them that during the following year, Congress created the Small Business Administration and charged the SBA with, among other things, seeing that a "fair" proportion of federal procurement from private industry was made from small business. When Gibraltar itself began bidding on Pentagon contracts in the mid-1960s, Forman recalls that about 15% of the military's apparel purchases were then specifically set aside for small business.
Gradually Gibraltar found that an ever-increasing proportion of its sales were being made to the Pentagon as the company became more expert at processing the specialized fabrics that went into clothing designed to protect military personnel from chemical and biological warfare agents, shrapnel and small arms fire, and even rain and fire. By the late 1970s, nearly all of the company's products were defense related, and in a market that approached $1 billion per year, there was still plenty of toom for growth.
But while the company was evolving, so were the small business set-aside regulations. From 15% in the early 1960s, the Department of Defense had gradually increased the proportion of its apparel business reserved exculsively for small-company bids to nearly 95%. For practical purposes, every article of clothing the military bought had to be made by a small business. There were no more big companies in the military-clothing industry, only small companies with a keen interest in staying small. Suddenly, to be a big business in this industry, says Forman, was to be out of business. There was nothing left for a big business to bid on.
So Gibraltar, like some of its competitors, elected to stay in the industry by staying small. It reduced its operations in the highly labor-intensive cut-and-sew end of the business, contracting much of that work out to small mom-and-pop shops that typically operated with fewer than 150 workers. When Gibraltar's employment did begin to creep close to the 500 level, Forman says, he would sell off something, perhaps a sewing plant. "None of our major competitors would be a major competitor if they hadn't done the same thing," he says.
What set Gibraltar apart from its competitors, however, was the Formans' decision to take the company public. Having to keep the business small, by SBA standards, had created an estate problem. In the absence of family successors, who could Forman, or the owner of any other company in the industry, sell his company to? Anyone interested in buying would likely already be in the business, and the employees of both companies added together would surely exceed the 500-worker limit. Selling shares to the public, however, gave Forman a market for his own equity and a way, eventually, to cash out.
But in solving one problem, Forman stirred up a different batch of troubles. In an industry in which the key to staying in business is to stay small, the easiest way to eliminate a competitor is not to underbid him, but to get him declared "other than a small business concern," the phrase used by the bureaucrats who make those determinations to describe a business that, one way or another, fails to comply with their size standards.
Gibraltar's qualifications as a small company had been challenged before. "Everybody in my industry who does a substantial amount of business is under challenge frequently," says Forman. But as a public company, it was subject to financial reporting and disclosure requirements that, Forman says, created a "treasure-trove" for a few Washington, D.C., lawyers.
A business in the military-apparel market is small, by SBA standards, if it has 500 or fewer full- or part-time employees. That is pretty clear, but what if the company subcontracts some of its work? And, what if one of the subcontractors is a former company employee? What i f the subcontractor acctually bought his plant from Gibraltar? What if Gibraltar holds a mortgage on the subcontractor's plant or on some of its equipment? Is the subcontractor actually an affiliate of Gibraltar, and should its employees be added to Gibraltar's in making the size determination?
Since all the major companies in the industry do a substantial amount of subcontracting, this question of affiliation becomes a key one in the industry's competition -- not competition to innovate, to improve product or process technology, or to increase productivity, but competition to win the legal-technical squabble over which company is and which company is not a small business.
In the past three years, Forman estimates, he has spent at least $1 million on legal and consultant fees to maintain his certification as a small business in the face of challenges from competitors. "I've had to run my company in my spare time," he says, because no single business problem is as potentially damaging as the loss of that certification. "Every attack is a matter of life or death for the company." No certification, no business.
In September 1982, for example, a losing bidder on a large contract protested the award to Gibraltar. Gibraltar was a large company, the protestor claimed, because ti was affiliated with three other companies. In what was by now a familiar routine, the protest went first to the New York regional office of the SBA. There it was denied, and the protestor filed an appeal with the Size Appeals Board, consisting of several senior SBA officials from the agency's Washington, D.C., headquarters. The board agreed with the regional office on two of the three allegations. Gibraltar was not affiliated with Case Manufacturing Inc. of Olive Hill, Ky., the board found, because Gibraltar had assigned the lease it held on Case's plant to an independent trustee. Gibraltar, therefore, exercised no control over Case, in the board's view.
For similar reasons, the board also dicided that Gibraltar wasn't affiliated with Amertex Enterprises Ltd., a Puerto Rican company purchased from Gibraltar five years earlier by a Gibraltar employee, Leo Jacobson. Forman pointed out to the board that Amertex had actually brought suit and extensive arbitration proceedings against Gibraltar since becoming independent, which is not the usual way that affiliated companies resolve their internal disputes.
But the board did find that Gibraltar was affiliated with Edcar Industries inc., another Puerto Rican company, whose owner, also a former Gibraltar employee, had bought the plant and equipment from Gibraltar less than two years before the date of the bid protest. Gibraltar, as with Case and Amertex, had assigned all outstanding leases with Edcar to an independent trustee, but, in this case, that was not enough to satisy the board. It finally decided, on June 2, 1983, that because Edcar's owner, Enrique Arsuaga, was a former "key employee" of Gibraltar operating a "newly organized concern," and because more than 80% of the dollar value of Edcar's contracts during 1982 has been subcontracts from Gibraltar, Gibraltar was affiliated with Edcar. Gibraltar thus exceeded the small-business size standard and was therefore "other than a small business."
As a big business, Gibraltar was out of business. But so was Edcar.
"They had to find me affiliated with Edcar in order to find me large," Forman says, "but in so doing, they deprived Enrique of all of his due-process rights, of all his constitutional rights. He was completely unaware that he was even under attack.
"At that point we had gone into court to overturn this whole thing, and the SBA, represented by the Justice Department, had to take the following position: 'We believe,' the attorney told the judge, 'that our decision with respect to Gibraltar is correct and that it is affiliated with Edcar Industries, and on that ground we declare Gibraltar to be large. However, we agree that [for the purposes of this appeal] Edcar is not affiliated with Gibraltar, and therefore Edcar remains a small business.'
"And the judge said something like, 'Wait a minute. Are you saying that Gibraltar is affiliated with Edcar, but Edcar is not affiliated with Gibraltar?' And the Justice Department attorney said, 'I know that it seems to fly in the face of reason, but that is our official position.'
"That," says Forman, "is the kind of idiocy that has been going on."
A staff attorney at the SBA says that Forman has applied his own interpretation to the facts of the case, but, the attorney says, his facts are roughly correct.
The court rejected Gibraltar's appeal on jurisdictional grounds, but the company was back in business the following month anyway. The New York regional office of the SBA recertified Gibraltar on the basis that, lately, a much smaller proportion of Edcar's production w as subcontracted from Gibraltar and also that Edcar, which may have been "a newly organized concern" when the protest was filed in September, was, by July 1983, almost a year older. Thus, Gibraltar was no longer affiliated with Edcar, the SBA decided, and Forman was once again running a small company.
"What haunts you in this business," says Forman, "is that you can never know what decision [the Size Appeals Board] will make next time."
If it is such an absurd industry to be in, why didn't Forman get Gibraltar out of it, or at least diversify into some nongovernment work? Why stay in a business in which competitive success only leads to more troubles?
"Say," Forman postulates, "that I wanted to slice the company in half -- half government work and half not. Well, a 250-person production line won't allow me to bid on most large government jobs, and you have to understand that I need more than one contract at a time anyway so that I can survive the troughs between contracts. The same thing applies to the nongovernment business. Who can I go to with a production line of 250 people? K mart? They'll give me an opening order requiring me to have 500 ot 1,000 people.
"Why don't we just get out of the government business entirely? Who could survive the transition? In our industry, what we've got are very efficient production capacity, very specialized quality control, specialized laboratory facilities, special administrative skills that you must have to work with the government. We don't have, however, design facilities, marketing facilities. We don't have sales facilities. We don't have the background to go into the nongovernment textile and apparel business. To make the change would take two or three years, and the day after we started we couldn't take any more government business."
When 95% of a company's potential market is reserved for small business, Forman says, the set-aside program creates a class of companies that have to behave like welfare recipients. "When you're on welfare and you try to get off, they tell you the day you get a job is the day the welfare checks stop coming in. So, you don't get a job. We couldn't get off set-asides."
But what Forman says is true only if you think like a manufacturer, which he was. His dream, his love, was the new plant in Pennsylvania. Gibraltar's competitive advantage, he insisted repeatedly, was the excellence it brought to the textile-manufacturing process -- the dyeing, finishing, and coating of the raw fabric.
If, on the other hand, you don't think lika a manufacturer, there is a way out of the set-aside trap, and Forman's partners in PER, the parent corporation, took it.
As a textile converter, Putnam Mills, the other half of PER, was in much the same business as Gibraltar, but it did none of the work itself. Putnam Mills bought fabric from manufacturers, contracted with other companies for the processing, and sold the product to cut-and-sew operations that made the final garments. It was strictly a white-collar operation. When it was acquired by PER, Putnam Mills was producing revenues of nearly $100 million with just 39 employees.
The size-standard protests and the distraction and expense of fighting them were, Forman concedes, not helping the price of PER's stock, and after the acquisition of Putnam Mills the balance of thinking among PER's officers began to shift. "My brother and I wanted to fight the good fight," says Forman, "but when you've got partners that are accountants, not manufacturers, their attitude is, 'You got a problem? Get rid of the problem.' They started thinking, 'Who needs manufacturing? Who needs manufacturing problems? Who needs major capital investment? Who needs the responsibility of manufacturing? Who needs manufacturing employees?' That started to be the new view internally."
"If PER wants to move into nongovernment areas," Forman says, "it has to create depart ments or divisions to do that business. If Gibraltar is operating reasonably close to the 500-employee limit, there's no room to squeeze these new departments in. Something had to go, and the thing that went was our textile-manufacturing operation, the very area that my brother and I had spent our entire lives in."
Last November, PER's board voted to sell the Pennsylvania plant, and a buyer was quickly found. "Just when that plant was about to become the star of the industry," Forman sighs, "we sold it, which I found personally heartbreaking." The Forman brothers began winding up their affairs and cleaning out their desks at the company they had started 32 years earlier. PER made another acquisition almost immediately, an importer of sweaters that generates $30 million in sales with just a handful of office and sales personnel -- and no manufacturing headaches.
Forman is 54. His brother is 47. They, their children, and other Forman family members own a total of about 1 million shares of PER stock worth roughly $8 million on the market. They may have decided to leave their jobs, but the Formans could hardly be called losers in this absurd game PER decided to stop playing.
For a time, Forman says, the constant protests made it look to him like Gibraltar was up against the rest of the industry, not in business competition but in various protest forums. And, in one sense, the protestors won. They drove Forman out of the business. "But," he says, "they haven't accomplished anything. They're still in there eating each other alive. Somebody else will become the target . . . For the hundreds of thousands of dollars, maybe millions of dollars, they spent, they wound up winning very little . . . I think there are a lot of people who are tired of the fighting. The regulations are the disease. You're just seeing the symptoms."
The Defense Department, like other government agencies, must ensure that small companies get a fair proportion of its procurement contracts, but the law doesn't say where or how those contracts should be apportioned among industries.
"What happens," Forman says, "is that there are certain product areas where it's easy for [DoD] to set aside purchases for small business and other areas where it is not so easy. For example, the purchasing prople who are involved with aircraft carriers and nuclear submarines, fighter planes and cannons, tanks and super-duper electronic systems -- they do not want to be bothered by small-business set-asides. They want to go exactly where they want to go to do their purchasing. But, frankly, which general in the Defense Department gives a damn about who makes a sweater or who makes a pair of socks or who makes almost any textile product you can name? So, there were certain product areas, including mine, that were used as sacrificial lambs to take the heat off other areas."
If the intent of DoD in setting aside all of its apparel purchases for small companies, or of the SBA in endorsing the Pentagon's policy, is to ensure that these purchases are spread over a large niumber of small companies instead of being concentrated in a few large ones, the effect has been almost the opposite. According to Forman and to attorney Dennis Riley, frequently Forman's opponent in size-standard protests, five or six efficient, vertically integrated competitors (including Gibraltar before the sale of its production facility) grab as much as 70% of the business, leaving less than 30% to be fought over by as many as 400 really small companies.
"It's just a game, that's all," says Paul J. Seidman, another Washington lawyer specializing in procurement cases. "If I had a client on either side of the issue, I'd take the case. All it accomplishes is the generation of lawyers' fees."
Doesn't the near-total set-aside in the defense apparel industry strike the SBA as odd? "We don't consider at this point that there is a problem," says Gene Van Arsdale, SBA deputy associate administrator for procurement assistance. ," says Gene Van Arsdale, SBA deputy associate administrator for procurement assistance.