Compendium of Successful Practices, Strategies, and Resources in the U.S. DOT Disadvantaged Business Enterprise Program (2019)

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77 This appendix explores two concepts: DBE “success” and DBE “graduation.” This appendix was submitted as a project deliverable and reviewed by NCHRP project panel members prior to launch of survey tasks. The Need for Definitions Many of the tasks in the study work plan require identification of “successful” DBEs as well as “graduated” DBEs. For example, the study team asked state DOTs for a list of “successful” DBEs and therefore needed to communicate what constitutes “being successful” when making the request. To prepare this memorandum on potential definitions of DBE success and graduation, the study team reviewed federal regulations and related background materials, examined relevant existing research (including disparity studies) and discussed the concepts with a small number of business owners. The study team then discussed the concepts with the NCHRP project panel and other experts before adopting working definitions for the next steps in the research. Definitions of “Success” In the financial world, business success is most often measured by how well the business creates economic value for the owners of those businesses, often based on earnings per share and growth in earnings per share (Mauboussin 2012). However, there were only 4,381 publicly traded U.S. companies in 2016 (The World Bank 2016). More than 99.9% of the 27.6 million businesses in the United States are not publicly traded (counting companies in 2012 with at least $1,000 in revenue) (U.S. Department of Commerce 2012). The literature on financial success of publicly traded companies does not directly apply to businesses that are closely held. Further, most of the non-publicly traded businesses are owned by individuals or family members. Of U.S. businesses, 74% were owned by one individual plus another 19% owned by family members. Only 7% of businesses were owned by two or more individuals who were not family members (U.S. Department of Commerce 2012). One conclusion is that business and personal success are highly intertwined for most U.S. businesses and are not limited to financial measures. In fact, researchers in this field have found that starting a business might not be economically rational and that being a business owner can decrease one’s earnings from work. (Levine and Rubinstein 2016, 968-1018) Business-oriented journals are filled with articles about how business owners define success beyond monetary gain. Representative examples include “achieving goals” and “having an engaged workforce” as opposed to tangible measures such as money. (Mielach 2013; Baer 2014) A P P E N D I X B Defining Success and Graduation

78 Compendium of Successful Practices, Strategies, and Resources in the U.S. DOT Disadvantaged Business Enterprise Program The study team’s disparity study experience confirms this point as many of the business owners in the transportation contracting industry the study team has interviewed over many years bring up non-financial factors when discussing success. For example, many business owners and managers discuss reputation, providing quality work, and relationships in the industry as measures of success (see the 2016 Disparity Study for the Oregon Department of Transportation as an example) (Keen Independent Research LLC 2016). One interview con- ducted as part of preparing this memo illustrates this finding: the owner mentioned customer satisfaction, quality suppliers, employee satisfaction, and quality personnel as how he defines success before he brought up any aspects of financial performance. The multifaceted nature of how small business owners might think about firm success, includ- ing many non-financial factors, makes it difficult to develop a consistent, measurable definition for purposes of this study. However, a common theme across each of the dimensions is whether the business is “competitive,” a concept also supported when examining regulatory indices of success. Regulatory Indices of “Success” The study team next explored what could be learned from regulations and related back- ground materials about definitions of success. Mention of “Success” in the Objectives for the Federal DBE Program Federal regulations in 49 CFR Part 26 govern the federal DBE Program. The only mention of the word “success” in the statement of objectives for the program is, “To assist in the devel- opment of firms that can compete successfully in the marketplace outside the DBE program” (49 CFR Section 26.1(g)). Therefore, one regulatory measure of success is whether an indi- vidual DBE is “competitive” as measured by winning work on an agency’s contracts or in the broader marketplace when DBE contract goals do not apply. • For many transportation agencies operating the federal DBE Program, this would mean the DBE is winning subcontracts on state- or locally funded contracts if the agency does not apply MBE/WBE goals or other race- and gender-conscious programs for those contracts. • Some state DOTs and other transportation agencies operate the federal DBE Program through 100% neutral means. Therefore, any DBE winning work with those agencies or in the market- place might meet this definition of success. • Other state DOTs also operate MBE/WBE programs on state-funded contracts. Competing successfully for work outside the program would typically mean winning state DOT prime contracts or other work in the marketplace not affected by the program. Definition of Economic Disadvantage in the Federal DBE Program The federal DBE Program assists firms that are socially and economically disadvantaged. Although it does not explicitly define “success,” it gives concrete measures to use when deter- mining whether or not a firm is economically disadvantaged. Primary criteria are (a) average annual business revenue, (b) personal net worth for the business owner, and (c) the business owner’s ability to accumulate substantial wealth (49 CFR Section 26.67). This third criterion can include factors such as the profitability of the business and the total value of the owner’s assets. By necessity, these criteria mix the concepts of economic disadvantage for the “business” and the “business owner.”

Defining Success and Graduation 79 Business Size Limits in 49 CFR Part 26 To be economically disadvantaged, a firm must meet both of the following criteria related to annual revenue (or in some cases, number of employees): • Over a 3-year period, the business has average annual revenue below the ceiling set in the federal DBE Program, which was $23.98 million per year at the time of the study (49 CFR Section 26.65 (b)). • Meets the definition of a small business as defined by the U.S. Small Business Administration (SBA) standards. These ceilings are specific to the subindustry in which the firm operates and pertain to average annual gross receipts over a 3-year period (49 CFR Section 26.65(a)). Federal regulations governing establishment of small business size standards are provided in 13 CFR Section 121.402. As an example, the small business size standard was $15 million for engineering firms and $36.5 million for highway, street, and bridge construction companies at the time of this study. (For manufacturing and wholesale trade, the size measure is based on average number of employees.) Measure of Firm Profitability Mentioned in 49 CFR Part 26 Regulations in 49 CFR Section 26.67(b)(ii)(A) provide a specific dollar value of firm profits that might indicate whether a company is no longer economically disadvantaged: “Whether the average adjusted gross income of the owner over the most recent 3-year period exceeds $350,000.” The regulations in this section also outline exceptions to this ceiling. Personal Net Worth and Total Assets Two measures within 49 CFR Section 26.67 pertain to the net worth and the total assets of the business owner: • Regulations in 49 CFR Section 26.67(a)(2) state that personal net worth exceeding $1.32 mil- lion (not including the individual’s equity in the business and equity in the personal residence) indicates that the individual is no longer economically disadvantaged. • Regulations in 49 CFR Section 26.67(b)(2)(A)(6) state that assets exceeding $6 million may indicate ability to accumulate substantial wealth (which indicates that the business owner is not economically disadvantaged). Small Business Act As the U.S. Small Business Administration (SBA) sets the size limits for what constitutes a small business under the authority of the Small Business Act, it is instructive to review the provi- sions of the Act and how the SBA sets those size limits. Purpose The Small Business Act encourages “full and free competition” within the American economic system by developing the capacity of small businesses. The Act did not provide precise defini- tions of small business, other than to state that they be “independently owned and operated and . . . not dominant in its field of operation” (Section 3(a)(1) of the Small Business Act (Public Law 85-536, as amended)). The Act recognized that annual revenue, annual net income, number of employees, and net worth might be factors, but did not set ceilings for non-agricultural busi- nesses in the Act. Instead, Congress gave the U.S. Small Business Administration authority to set small business size standards for federal programs.

80 Compendium of Successful Practices, Strategies, and Resources in the U.S. DOT Disadvantaged Business Enterprise Program According to the discussion of the legislative history in SBA Size Standards Methodology, the Act’s purpose was to encourage competitiveness of small businesses, and that Congress intended to exclude firms from the definition of small business that dominate an entire industry, nation- ally (U.S. Small Business Administration 2009). SBA Development of Size Limits Depending upon industry, the SBA defines ceilings for what constitutes a small business using (a) annual revenue or (b) number of employees. Most of the industries involved in transporta- tion contracting fall under revenue-based size standards, but manufacturers and suppliers are typically under employment-based measures. SBA starts with an “anchor size standard” across industries: $7 million in revenues or, if an employment-based industry, 500 employees (or 100 employees if in wholesale trade). It varies those limits among subindustries by considering five primary factors: • Average gross receipts or average number of employees per firm (when the standard is employment-based). The smaller the average firm, the lower the size standard for a subindustry. • Average business assets (the higher the average assets, the higher the size standard). • Degree to which the industry is dominated by a few large firms, using the four-firm con- centration ratio (defined as the total receipts of the four largest firms in an industry divided by total receipts for that industry, and the more concentration in few firms, the higher the size standard). • Size distribution of firms (the more inequality in the distribution of firm revenue the higher the size standard). • Percentage of federal purchases in the subindustry that go to small businesses (the lower the percentage, the more likely SBA will increase the size standard for the subindustry). SBA considers secondary factors as well. Taken together, these factors are intended to identify the level at which a firm is “competitive” in its industry. Other Measures of “Competitiveness” or “Success” Considered by the SBA The SBA has stated that its measures of economically viable businesses are necessarily simpli- fied and that other financial measures might provide an alternative way of establishing small business size standards. Return on capital, gross margins, and net worth are three mentioned in the SBA Size Standards Methodology. Graduation The federal DBE Program does not have a “graduation” component. Firms are no longer eligible for DBE certification if they exceed one of the measures of economic disadvantage. Infor- mally, the DBE community and state DOT staff use “graduation” as shorthand for when a DBE grows so large in terms of revenue or personal net worth that they no longer meet the definition of economic disadvantage. Potential Definitions of “Success” and “Graduation” in the Study The Keen Independent study team recommends use of competitiveness-based measures of business success for this study and a concept of “graduation” that reflects exceeding the revenue, net worth, annual profits, or total assets size standards.

Defining Success and Graduation 81 Focus on Competitiveness as the Key Aspect of “Success” of DBEs When interviewing state DOTs and others, and when exploring data on DBEs, the study team needs a working definition of a “successful DBE” in order to accurately and consistently request information about such firms. The study team proposes to focus on “competitive- ness” as the working concept of “success” for purposes of this study. This definition is con- sistent with: • The multifaceted explanations of success one obtains from the literature and from discussions with business owners; • The only mention of “success” in the objectives portion of 29 CFR Part 26; • The concept of economic disadvantage and its measurement in the federal DBE Program; and • The underlying reason for the Small Business Act and how SBA sets thresholds for when busi- nesses no longer need assistance. For purposes of discussion, we propose several ways to define a “successful” DBE in our dis- cussions with state DOTs and others: 1. Obtaining a substantial volume of state DOT subcontracts without the benefit of a DBE contract goal (“state DOT contracts” include local public agency contracts using money flowing through the state DOT). 2. Winning a substantial volume of state DOT contracts as a prime contractor, consultant, or direct supplier to the state DOT. 3. Achieving a substantial amount of revenue from agencies and other customers that do not operate the federal DBE Program (or operate it on a race-conscious basis). The study team suggested that these firms be identified as potential “successes” as well: 4. Generating high revenue within the program compared with other DBEs in similar fields. The fifth category included firms that: 5a. Are on a growth path where they might exceed size standards for the business in the next few years; 5b. Have diversified their businesses and requested additional NAICS codes from the state DOT (which is required to be counted toward meeting a DBE contract goal); and 5c. The state DOT was working to prepare them for when they exit the program. The research included a sixth category of firms achieving success through the DBE Program: those firms that were certified as DBEs and through revenue growth, increases in personal net worth, or other reasons are no longer certified DBEs. This group of firms is synonymous with having “graduated” from the program, informally using that term. It can also include firms that were successful and were acquired by non-DBE firms. 6. A former DBE where growth in its revenue or assets was such that the firm is no longer certified (including any firms sold to non-DBEs). The study team did not quantify what is meant by “substantial” in the above definitions, because a monetary figure that is large in one state might be small in another. We measured success of DBEs relative to other firms from the perspective of the DBE Program Manager or similar staff member at each state DOT. Graduation As previously mentioned, there is no formal graduation as a DBE as there is from the SBA 8(a) program. “Graduating” is often temporary, with a firm that loses DBE certification able to re-enter the program once its revenue decreases (purposefully or not).

82 Compendium of Successful Practices, Strategies, and Resources in the U.S. DOT Disadvantaged Business Enterprise Program Even though it is not a term in the regulations, the study team used “a graduated DBE” to mean a former DBE that has been successful to the point where it was no longer certified because of its success. It is the same as the category #5 set of successful firms as described above. The above definitions reflect input from project panel for this study. References Baer, D. “How 9 Incredibly Successful People Define Success.” Business Insider. June 02, 2014. Accessed May 08, 2017. http://www.businessinsider.com/how-9-incredibly-successful-people-define-success-2014-5. Keen Independent Research LLC. Oregon Department of Transportation 2016 Availability and Disparity Study Final Report. 2016. Accessed May 14, 2017. www.keenindependent.com/wp-content/uploads/files/ keen-reports/2of4/Oregon/Keen%20Independent%202016%20ODOT%20Disparity.pdf. Levine, R., and Y. Rubinstein. “Smart and Illicit: Who Becomes an Entrepreneur and Do They Earn More?” The Quarterly Journal of Economics, 2016, 963–1018. doi:10.1093/qje/qjw044. Mauboussin, M. J. “The True Measures of Success.” Harvard Business Review, October 2012. Accessed May 13, 2017. https://hbr.org/2012/10/the-true-measures-of-success. Mielach, D. “Entrepreneurs Define the Meaning of ‘Success.’” Business News Daily. March 19, 2013. Accessed May 8, 2017. https://www.businessnewsdaily.com/4161-definition-business-success.html. U.S. Department of Commerce. Bureau of the Census. Survey of Business Owners (SBO)—Survey Results: 2012. 2012. Accessed May 13, 2017. https://www.census.gov/library/publications/2012/econ/2012-sbo.html#par_ reference_25. The World Bank Group. “Listed Domestic Companies, Total.” The World Bank Data. 2016. Accessed May 13, 2017. https://data.worldbank.org/indicator/CM.MKT.LDOM.NO.