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SBA OHA: In Three-Factor Test to Determine Small Business Manufacturers, No Single Factor is Determinative

In Size Appeal of NMC/Wollard Inc., SBA No. SIZ-5668, the Small Business Administration Office of Hearings and Appeals (“OHA”) clarified the three factor test used to determine whether a small business qualifies as a manufacturer of the end item being procured.  The decision confirmed that no single factor has greater weight than the others, and that a small business can be a manufacturer despite contributing a small percentage of the value of the end item if the contribution was essential to the end item’s function.

Under applicable SBA regulations, a small business manufacturer “is the concern which, with its own facilities, performs the primary activities in transforming inorganic or organic substances, including the assembly of parts and components, into the end item being acquired.”  13 C.F.R. § 121.406(b)(2).  The regulations set forth a three factor test to determine whether a small business is the manufacturer of the end item:

  1. The proportion of total value in the end item added by the efforts of the concern, excluding costs of overhead, testing, quality control, and profit;
  2. The importance of the elements added by the concern to the function of the end item, regardless of their relative value; and
  3. The concern’s technical capabilities; plant, facilities and equipment; production or assembly line processes; packaging and boxing operations; labeling of products; and product warranties.

13 C.F.R. § 121.406(b)(2)(i)(A)-(C).

NMC/Wollard arose from the Army’s contract for Aviation Light Utility Mobile Maintenance Carts (“ALUMMCs”), which was set-aside entirely for small businesses.  The Army identified specific capabilities for the ALUMMCs, including capabilities related to mobility, occupancy, fuel compatibility, and cargo bed payload.  In particular, the ALUMMC had to comply with certain military standards, including MIL-STD-209K, which required military-grade lifting and tie-down provisions.

After the Army announced the award to International Automated Systems, Inc. (“IAS”), NMC filed a size protest alleging that IAS was not the manufacturer of its offered product and instead was proposing a product manufactured by John Deere, an other-than-small business.  IAS acknowledged that it used a John Deere product as the basis of its offered product, but explained that it performed a number of necessary modifications that qualified IAS as a manufacturer of the product.

Throughout the proceedings, which included two size determinations by the SBA Area Office and two appeals to OHA, NMC alleged that IAS did not meet the three factor test.  NMC repeatedly stressed that, because the value of IAS’s modifications was less than 30% of the total value of the ALUMMC, IAS did not satisfy the first factor of the test.  With respect to the second factor, NMC alleged that IAS’s modifications were not “functionally important.”

In response, IAS explained that the modifications it would make to the John Deere product were necessary to comply with MIL-STD-209K, among other criteria.  Absent the modifications, the John Deere product would not meet the required criteria, particularly those relating to lifting and tie-down.

On appeal, OHA considered the regulatory history of the three factor test.  That history revealed that the SBA intended that none of the factors necessarily had more weight than the others, and that circumstances would dictate which factor was more important in each case.  The SBA used the example of a solicitation that required a widget with a safety switch, where an other-than-small business made the widget without a switch and a small business installed the switch.  The regulatory history explained that “[e]ven though the value added by [the small business] to the end product may be a very small proportion of its total value, [the small business] may still be the ‘manufacturer’ of the end product . . . because the safety switch is so important to the function of the end product.”

In light of the regulatory history, OHA rejected NMC’s argument that IAS did not contribute enough of the total value of the ALUMMC, measured by the percentage of total value, to be considered the manufacturer.  While NMC argued that OHA had never affirmed a finding that a firm is a manufacturer where it contributed less than 30% of the end item’s total value, OHA countered that NMC was unable to identify a case in which OHA had reversed such a finding either.  Accordingly, OHA found that “a small business may be considered the manufacturer of an end item if it purchases that item from another company and adds significant functionality unavailable from the original manufacturer.”

OHA further noted that IAS’s modifications to the John Deere product to meet the ALUMMC cargo bed payload requirements were critical to the functioning of the ALUMMC.  Accordingly, OHA concluded, “IAS is properly viewed as the manufacturer notwithstanding the dollar value of IAS’s contributions.”

The case confirmed that none of the three factors in the test is determinative and that they all should be considered in determining whether a small business is a manufacturer.  And while OHA stopped short of setting a minimum threshold for what value expressed as a percentage a small business must contribute to be considered a manufacturer, it made clear that the value added could be relatively low so long as the contribution was essential to the function of the end item.

© 2021 Covington & Burling LLPNational Law Review, Volume V, Number 238

About this Author

E. Sanderson Hoe, Covington Burling, Contracts Lawyer, Negotiations Attorney
Senior Of Counsel

Sandy Hoe has practiced government contracts law for more than 40 years.  His expertise includes issues of contract formation, negotiation of subcontracts, bid protests, the structuring of complex private financing of government contracts, preparation of complex claims, and the resolution of post-award contract disputes through litigation or alternative dispute resolution.  His clients include major companies in the defense, telecommunications, information technology, financial, construction, and health care industries.

Daniel Johnson, Litigation attorney, Covington

Dan Johnson has more than 30 years of experience helping government contractors and other clients successfully resolve litigation and employment disputes.

Mr. Johnson has extensive trial experience, resulting in bench and jury verdicts in favor of his clients. These include trial victories in multi-million dollar trade secret cases, complex business litigation arising from prime-sub, and other business disputes.

John Sorrenti, litigation lawyer, Covington

John Sorrenti advises clients across a broad range of complex government contracts law matters.

Mr. Sorrenti has experience representing contractors at all stages of litigation involving contract claims against the United States under the Contract Disputes Act. He also has litigated a number of bid protests at the Court of Federal Claims, the Government Accountability Office, and at the state and local level, and successfully represented contractors in size protests before the Small Business Administration Area Offices and the Office of Hearings and Appeals.