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Why Software Companies Must Consider the Government Market

By David S. Bloch, McDermott Will & Emery LLP, and James G. McEwen, Stein, McEwen & Bui LLP

Let's discusses why more software companies should consider selling to local, state, and federal governments. Part I identifies the government as a potentially lucrative market for software companies — a market that too often is neglected for reasons having more to do with myth than reality. Part II briefly outlines the process of finding and winning a government contract. Part III touches on specific rules for licensing software to the U.S. Government.

Part I
Government: A Neglected Market
Software companies typically sell to other companies and individual consumers. Left out of this mix is another very large potential market: local, state, and federal governments. Yet by most accounts the U.S. government is the world’s largest consumer of goods and services, and the aggregate spending of the 50 states is not far behind. i In telecommunications alone, the U.S. government will spend approximately $27 billion in fiscal year 2006. ii

Some small software companies — Arxan and Spyrus for example — focus substantial resources on the government marketplace. But they are in the minority. Most businesses focus on the more familiar world of business-to-business and business-to-consumer transactions. Why is this so? The failure of software companies — particularly smaller software ventures — to take advantage of the government market springs primarily from three related factors: difficulties in accessing the market, the complexity of the government procurement process, and risks to intellectual property rights. But the benefits of contracting with the government may outweigh those risks — especially when some persistent myths are dispelled. Consider the facts:

It's Not That Hard
It is true that public contracting is subject to some arcane rules, mostly embodied in the Federal Acquisition Regulations (the FAR) iii. But the Office of Federal Procurement Policy has helped streamline government contracts, creating standard contract terms and regulations. As a consequence, there are relaxed and simplified rules for acquiring commercial software of a type “customarily used” by non-government consumers.iv

Governments have come a long way in improving access to contract opportunities. Traditionally, companies interested in contracting with the government had to peruse a wide range of official publications. Federal government contract opportunities were published in the Commerce Business Daily, and each state (plus many municipalities) had similar paper-publication systems. Though it remains true that connecting buyer and seller is harder in the government market than in the private sector, the internet has made bidding much easier than in years past. The Commerce Business Daily and its state and local counterparts now can be searched online.

Moreover, governments are actively trying to make the process easier. For example, all federal government procurement opportunities over $25,000 are now posted online, in searchable form, at http://fedbizopps.gov: “Through one portal - FedBizOpps (FBO) - commercial vendors seeking Federal markets for their products and services can search, monitor and retrieve opportunities solicited by the entire Federal contracting community.” Many states — including North Carolina,v South Carolina,vi and Texasvii — and forward-looking foreign countries like Australia viii have followed suit and partially or fully enabled e-procurement systems. Some agencies go further still, circulating requests for proposals and invitations to bid via email to interested subscribers, free of charge, based on user-defined profiles.

That said, there are certainly some drawbacks to the process. For example, companies may need to “qualify” before becoming eligible for certain government contracts. Some foreign companies may be excluded from contracts relating to national security. Advertising is less effective when directed to a governmental agency. And client-development is more difficult in an environment where a business lunch or a round of golf could be interpreted as a bribe or kickback. Lastly, there is the ever-present need to understand that the government, generally, cannot participate in a “battle of the forms,” and is required by law to stipulate to certain processes.

No Stealing of Your IP
For years, private contractors were wary of dealing with the government because they were afraid the government would take or compromise the company’s intellectual property rights. This was a legitimate — if sometimes overstated — concern. Modern government procurement law developed chiefly in the Department of Defense. But the Department of Defense primarily purchased goods for which there was no “civilian” uses, and needed the ability to second-source replacement parts. So the general rule was that the government would acquire all rights (including all intellectual property rights) in goods or services purchased under a government contract. Companies interested in pursuing commercial opportunities could not risk losing their intellectual property to the government, and understandably stayed away from the field.

That all changed with the passage of the Bayh-Dole Act during the Reagan Administration. In the wake of Bayh-Dole, the Competition In Contracting Act, and various other contracting innovations over the last 20 years, the government now has the flexibility to contract (almost) like a commercial consumer. And this shift in rules has been accompanied by an increased awareness and recognition of the need to keep intellectual property rights with their developers. Thus, the government now only seeks intellectual property rights consistent with its actual needs. If a company has appropriate protections and good legal counsel, it usually can deal with the government just as it would with any private customer — preserving in full the company’s intellectual property rights.

But there are still some technical traps for the unwary, and a company should be careful when entering a deal with the government involving intellectual property. For example, where non-commercial software is being provided, there are extensive notice and reporting provisions. Certain of these notices must be made prior to contracting, and for non-Department of Defense contracts, care must be taken to ensure that the proper clauses are used to allow delivery of trade secret-protected software. All intellectual property must be prominently marked, and the government needs to know precisely what materials the company considers proprietary. If a company does not follow these provisions, it runs the risk of losing title or rights to its intellectual property, whether existing or developed after contract. By way of example, in Campbell Plastics Engineering & Mfg., Inc. v. Army, 389 F.3d 1243 (Fed. Cir. 2004), the U.S. Army took title to a patent for an invention created by Campbell Plastics Engineering during the research conducted under a government contract precisely because Campbell failed to comply with notice-and-reporting rules.

In summary, the government sector is a very large consumer of goods and services, including software, software modifications, and customized applications. Though some barriers remain, it is increasingly easy to find and enter government contracts. Thus, government is a potentially lucrative market that is often overlooked by software companies.

Part II
Process of Government Contracting
In Part I, “Government: A Neglected Market,” we discussed the reasons that software companies should consider marketing to local, state, and federal governments. Despite the unusual nature of the government market, there are several good reasons for companies — especially emerging ones — to take advantage of the possibilities offered by contracting with the government. Assuming we have persuaded the reader to consider entering the market, in this section we outline the process of obtaining a government contract.

The process of winning a government contract or subcontract is very different from entering into a private-sector contract. A company often must go through a complex process of bidding before being awarded a contract; or else it will need to wait while the government seeks an authorization for “sole source” procurement. These rules vary depending on if the contract is local, state, or federal in nature. We will focus here on the Federal system, which has the best-developed body of procurement law and serves generally as a model for public contracting at the state and local levels.

Registering with the Government
Before a company can contract with the government, it needs to become part of the procurement system. This entails registering with various governmental bodies. For Federal contractors, a company needs to obtain its DUNS number from Dun & Bradstreet, and typically also must obtain a Commercial And Government Entity (CAGE) number from the Defense Logistics Agency. These numbers plug into the government’s accounting and oversight system, allowing companies to get paid for contracts they win.

Though registration may involve a non-trivial up-front investment of time and resources, it can clear the path to lucrative future contracts. And the government is doing a decent job of standardizing and streamlining the process. For example, the Department of Defense’s Central Contractor Registration program allows a company to complete a single registration form in order to contract with any organization falling under the Department’s aegis.

Finding Contracts
As we discussed in Part I, the process of finding a government contract to bid on has never been easier. All federal contract opportunities — plus a broad spectrum of local, state, and international requests for proposal — are available online in searchable form, free of charge. And companies geared toward facilitating business-to-government transactions have also sprung up. For example, companies like B2GMarket (http://www.b2gmarket.com) and Onvia (http://www.onvia.com) operate subscriber-based internet clearinghouses of international and domestic government-contracting opportunities. Moreover, the variety of contract types available can allow for substantial flexibility, depending on the work requested. For instance, while generally the government is constrained to follow general procurement rules, certain contract types allow for substantial deviations. Commercial item procurement allows for the purchase of commercial software, even with minor modifications, under the greatly simplified regulations of FARs Part 12. Additionally, the entire structure of the Federal Acquisition Regulation is not applicable to Other Transactions, ix venture funding, x and some other special types of research and prototyping agreements that can be used as vehicles for software development or sales.

Small software companies should also bear in mind their potential advantages in seeking government work. In addition to policies favoring competition, most governments have affirmative-action and small-business mandates or set-asides. Companies that are minority or woman-owned, or that satisfy Small Business Administration guidelines for size, xi may have an advantage when competing for government work with software giants like Microsoft or Oracle under such programs as the Small Business Innovative Research (SBIR) program.

Additionally, even where software giants are awarded contracts, these giants are often required to subcontract and team with smaller contractors, such that substantial sub-contract opportunities typically exist that are not always immediately apparent. One advantage of these sub-contracting opportunities is that the procurement laws and regulations often provide protections not normally provided to a subcontractor in the commercial context. xii


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