At the outset of a small business set-aside procurement, the contracting officer (CO) assigns the procurement a North American Industry Classification System (NAICS) code, which has a corresponding size standard. The CO is also responsible for structuring the procurement as one for manufactured products or supply items, or for services. When a contract for manufactured products or supply items is set aside for small business, the prime contractor must either manufacture the end item or qualify under the nonmanufacturer rule. Entities may qualify as a manufacturer if they manufacture the end item in the United States. Under the relevant regulations, a manufacturing entity utilizes its own facilities to perform the primary activities in transforming inorganic or organic substances, including the assembly of parts and components, into the end item being procured. Notably, there can only be one manufacturer of an end item for size purposes. The Small Business Administration (SBA) conducts an analysis under three factors enumerated in 13 C.F.R. § 121.406(b)(2)(i) to determine whether an entity is the manufacturer. These factors are:
- (A) The proportion of total value in the end item added by the efforts of the entity, excluding costs of overhead, testing, quality control, and profit.
- (B) The importance of the elements added by the entity to the function of the end item, regardless of their relative value.
- (C) The entity’s technical capabilities; plant, facilities and equipment; production or assembly line processes; packaging and boxing operations; labeling of products; and product warranties.
If an entity does not qualify as a manufacturer of the end item, it may nevertheless qualify under the nonmanufacturer rule. The nonmanufacturer rule applies to businesses that do not manufacture their own products as relevant to a particular procurement but instead supply the products of another company. Significantly, the nonmanufacturer rule is only applicable to procurements that have been assigned a manufacturing or supply NAICS code or the ITVAR exception to NAICS 541519. The rule does not apply to contracts that have been assigned services NAICS codes. To qualify under the nonmanufacturer rule, the entity must meet the requirements of 13 C.F.R. § 121.406(b)(1). Specifically, the entity:
- (i) Must not exceed 500 employees (or 150 employees for the Information Technology Value Added Reseller (ITVAR) exception to NAICS code 541519).
- (ii) Must be primarily engaged in the retail or wholesale trade and normally sell the type of item being supplied.
- (iii) Take ownership or possession of the procured item(s) with its personnel, equipment or facilities in a manner consistent with industry practice.
- (iv) Supply the end item of a small business manufacturer, processor or producer made in the United States or obtain a waiver of such requirement.
Notably, under the requirements of 13 C.F.R. § 121.406(b)(1)(iv) above, a non-manufacturing entity may only qualify for a small business set-aside procurement if it supplies the U.S.-manufactured end item of another small business. Consequently, if a small business entity supplies the end item manufactured by a large business or supplies an end item not manufactured in the U.S., the entity will not qualify under the nonmanufacturer rule. The SBA may waive the requirements at 13 C.F.R. § 121.406(b)(1)(iv) at the request of the procuring agency. In such procurements, the procuring agency must obtain the SBA waiver in advance and identify the applicable waiver in the solicitation at the time the solicitation is issued. Pursuant to 13 C.F.R. § 121.406(b)(5), the SBA may grant an individual or class waiver to the nonmanufacturer rule under the following two circumstances:
- (i) Individual Waiver: CO has determined that no small business manufacturer or processor reasonably can be expected to offer a product meeting the specifications (including period for performance) required by a particular solicitation and SBA reviews and accepts that determination, or
- (ii) Class Waiver: SBA determines that no small business manufacturer or processor of the product or class of products is available to participate in the Federal procurement market.
Under the size regulations, when a contract for manufactured products or supply items is set aside for small business, the prime contractor must either manufacture the end item being procured or qualify under the nonmanufacturer rule. To determine whether an entity is the manufacturer of an end item, the SBA conducts an evaluation based on three factors listed in 13 C.F.R. § 121.406(b)(2)(i). If the entity does not qualify as a manufacturer, it must meet the requirements of the nonmanufacturer rule, as provided in 13 C.F.R. § 121.406(b)(1). The SBA may grant an individual or class waiver to the nonmanufacturer rule requirements at 13 C.F.R. § 121.406(b)(1)(iv). However, contractors should be mindful that under SBA regulations, it is the procuring agency, not the prime contractor, that is responsible for requesting a waiver of the nonmanufacturer rule for a particular procurement. The procuring agency must identify any applicable SBA waivers to the nonmanufacturer rule in the solicitation at the time of its issuance. Once a waiver is granted, contractors may supply the product of any size business without regard to the place of manufacture. Finally, it is worth noting that the SBA’s waiver of the nonmanufacturer rule, as provided in 13 C.F.R. § 121.1204, has no impact on requirements external to the Small Business Act, such as the Buy American Act or the Trade Agreements Act.
This Federal Procurement Insight is provided as a general summary of the applicable law in the practice area and does not constitute legal advice. Contractors wishing to learn more are encouraged to consult the TILLIT LAW PLLC Client Portal or Contact Us to determine how the law would apply in a specific situation.