WASHINGTON ― To build targeting displays for the U.S. Army’s Abrams tanks, Palomar Tactical Products used to pay $13 apiece for a certain circuit. Now the Carlsbad, California-based company says the global semiconductor shortage has made it so scarce that the part fetches 100 times that on the open market.

Hammered by rising costs and longer lead times from suppliers, Palomar CEO Mike Pattison said he asked his Army contracting officer for a 4% adjustment to a fixed-price contract they signed in 2018. The Pentagon has yet to issue guidance to contracting officers on such adjustments, leaving the two sides at an impasse, he said on the sidelines of the Association of the U.S. Army’s annual tradeshow in Washington, D.C.

“I’m stiff-arming them, and they’re mad at me,” Pattison said of the Army. “I can’t bankrupt the company. We’re 20-something people. If I give you that [original] price, you’re not going to be talking to me, you’ll be talking to the landlord of the building we just left.”

Palomar has also seen prices rise for the aluminum chassis that house the optics for the company’s displays that are about the size of an old 14-inch television, with periscope-like eye outlets. Pattison said he showed his costs to the Army, but it wasn’t swayed.

Defense firms are grappling with the economic fallout from the pandemic — a perfect storm of inflation, supply chain bottlenecks and labor shortages. Rising costs hit small businesses particularly hard because those firms may not have the cash reserves to survive the long price adjustment process or absorb losses until the end of a contract, the National Defense Industrial Association said in a recent whitepaper.

“Of course large businesses are thinking about all these things too, but they have more resources to look at all these things and mitigate them,” said ML Mackey, chair of NDIA’s small business division and chief executive of the defense IT contractor Beacon Interactive Systems.

NDIA is among the defense trade groups encouraging Congress to authorize the Pentagon to adjust existing contracts for inflation. The effort comes as the Pentagon issued an advisory to contracting officials that “extraordinary contractual relief” is available in “extraordinary circumstances.”

Some of the sector’s smallest firms, grappling with smaller profits and onerous defense contracting requirements, are deciding to leave the defense business, Mackey said. That’s a loss not just because small businesses are an economic engine but because the Pentagon is striving to forge partnerships with small, innovative companies.

“You get these folks interested because they feel it’s a great honor taking care of our warfighter, addressing national security needs,” she said. “But at a certain point it’s not viable anymore; it’s not the right business model when [I’m] responsible for my company and my employees.”

Surveys of small business sentiment more broadly show it’s taken a markedly pessimistic turn in recent months, as owners worry about the impacts of inflation. The U.S. Chamber of Commerce’s Small Business Index for the third quarter showed that inflation concerns shot to the top of small businesses concerns more broadly. Four out of five owners said they could weather a recession but that inflation had cut their profits by 4%, according to an American Express survey.

Roughly half of all owners reported job openings that they could not fill, and half reported rising compensation for workers — a historic high — according to a June survey by the National Federation of Independent Business.

The pandemic-fueled telework boom has been a boost for Triitus, a software company that provides secure communications for Pentagon and intelligence community clients. However, a shortage of software engineers is complicating plans to expand the business, according to Chief Operating Officer Kevin Kuhns.

“I would say we’re still seeing growth as a company just because of what we sell and what we offer, but pushing that envelope as fast as we want to is the challenge,” Kuhns said on the floor of AUSA.

Kencoa Aerospace’s U.S. division, which builds detailed components like camera housings and rocket engine forgings for defense giants Lockheed Martin and Boeing, saw its aluminum prices shoot up 30% in recent months. The Korean firm’s global sales and marketing director, Will Beutjer, said the latest supply chain challenge is getting parts painted.

“From a small business standpoint, your cash flow is strung out,” said Beutjer, who’s based in Eastman, Georgia. “When you get the raw material, then you manufacture the parts, and when it goes out for special processing, there’s no paint ― and there’s a labor shortage. It’s just very difficult to streamline.”

To avoid delivering late, the company is sending some of its 100 U.S.-based workers to the factories of its vendors; that lets Kencoa’s parts continue to move through production and is something the company never had to do before.

“It’s very unusual,” Beutjer said.

Eugene, Oregon-based Deployed Logix, which makes disaster shelters, weathered the economic headwinds fairly well, but it still faces supply chain issues and skyrocketing fuel prices, said sales director Jean-Louis Gomes. Gas prices have eaten into the company’s bottom line given the need to transport its products from the West Coast to the East Coast.

“We are definitely meeting some challenges, especially when it comes to trailers: axles and stuff like that,” Gomes said. “One of the biggest issues of course is generators because everybody needs those.”

Supply chain fluctuations created a whipsaw effect at Dark Energy, a Provo, Utah-based manufacturer of lightweight power products for military use. CEO Garrett Aida said that because his company bought too many components when it was anticipating supply chain shortages, the company is now sitting on excess inventory, and high prices for some components have endured.

“Things are much more expensive to make,” Aida said. “High-functioning chip technology and access to that technology, that got crunched really, really hard. Since we have some complex power management systems, obviously chips are going to be part of that, but also some select raw materials as well — things like lithium for battery minerals — and some select elements that go into the making of high-tech solar panels.”

Joe Gould is the senior Pentagon reporter for Defense News, covering the intersection of national security policy, politics and the defense industry. He served previously as Congress reporter.

Bryant Harris is the Congress reporter for Defense News. He has covered U.S. foreign policy, national security, international affairs and politics in Washington since 2014. He has also written for Foreign Policy, Al-Monitor, Al Jazeera English and IPS News.

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