Will Sam Be VARs' Favorite Uncle In 2007?

In the midst of an expensive war and a change of leadership, IT contracting marches on. Some might go so far as to say it prospers, even as contracting and legislative challenges burden even the savviest solution providers.

Why the optimism? While 2006 didn't break any records, most in the public-sector channel saw their revenue grow in excess of government IT spending.

In GovernmentVAR's second annual State of the Government Market survey, 227 solution providers reflected their optimism for the public-sector channel in the coming year. The results show a lot of promise, as reported in 2006 revenue growth across all government segments. Many solution providers anticipate that the good times will keep rolling.

A More Level Playing Field
Large systems integrators once focused mostly on the federal market--dedicating most of their resources to the bundled contracts--particularly the multibillion-dollar defense and homeland-security engagements that carry enormous payouts. On the same note, small solution providers tended to focus more on the neighborly opportunities at the state and local government levels. That's changed, however, as those neighborly opportunities are swallowed up by city- and statewide-contracting vehicles. With that, the distinction among channel companies is narrowing.

The State of the Government Market survey results show an increasingly level playing field across all government segments. In all, 65 percent of respondents target local government with IT goods and services, compared to 58 percent that target state government and 57 percent federal government.

While large solution providers are significantly more likely to focus on federal agencies than those that report annual revenue of $1 million or less, they're nearly as likely to target state and local governments--something that would have been surprising only a few years ago.

At the same time, federal integrators experienced increases in growth--63 percent--compared to state and local VARs who witnessed growth--56 percent and 52 percent, in their respective public sectors. Most estimated the degree of growth at 5 percent to 14 percent across all segments.

Does this mean that the federal market carries more opportunity for the channel? Not necessarily.

In some cases, growth could be directly related to experience, given that respondents, on the average, had two more years of experience selling to the federal market than selling to state and local governments. That translates to additional understanding of the market and ability to focus on opportunities. And while two years' less experience may not seem terribly significant, each state and local municipality brings its own learning curve, particularly as the lower end of the public-sector market consolidates purchasing.

As noted by one respondent, some states are far more difficult to work with than others, and just trying to figure that out is the first challenge. Others noted difficulty tracking down decision-makers as a major hurdle. Respondents that said they no longer sell to state and local governments blamed their exodus on disruptive changes in strategy that came with frequent changes in leadership, combined with excessive red tape and prolonged approval processes.

"We've been doing this for 27 years, but the biggest challenge remains the contracts," says Rick Cadiz, director of sales for Custom Computer Specialists. The Hauppauge, N.Y.-based solution provider primarily focuses on state and local opportunities, recently providing project-management and quality-assurance services to the city of New York.

"Government is trying to make it better for the end user by saving money with state- and citywide contracts," he says. "But really, all it does is kill the value of services to the end user. We get squeezed out by these national providers that don't provide the hand-holding that customers require. Fortunately, we've been in this market for a while and built relationships with customers that stick with us. I don't know how a new company trying to come in can be successful; it's such an obstacle."

NEXT: Placing all eggs in the federal basket

But just as centralization of procurement at the state and local levels increases the complexity of the public-sector market, contract values grow exponentially. That creates a welcome alternative to the Beltway for solution providers that question the stability of the federal IT market. And smaller solution providers that may not be thrilled by changes in state and local government still recognize the advantage of their experience with agencies. With less than a quarter of small and midsize respondents holding their own GSA Schedule, the federal space can be tough to crack.

The state and local governments are still growing at a faster rate than at the federal level," says Alan Webber, senior government analyst at Forrester Research. "There's been a lot of uncertainty about how the war could impact non-DoD budgets and where the government is most likely to head next. There have been a higher number of contract protests, which means that companies are getting more aggressive in trying to carve out their section of the government pie. Add to this the continuing number of mergers and acquisitions, and that translates to a very challenging year [for the federal market], with a more challenging year coming up."

Performance-based procurement, massive contracting vehicles and preferential treatment toward incumbents drove some out of the federal market, with one respondent saying that "federal-government customers don't understand that they need to be fully engaged with the services we provide; they want a magic bullet to solve all of their problems."

While Integrated Digital Systems, a Manassas, Va.-based solution provider, targets all segments of government, CEO Larry Hunt says that challenges associated with bundled contracts have caused federal revenue to make up an increasingly smaller piece of his business.

"We'll never get beyond the $500,000 mark; it's just not the nature of our business," Hunt says. "They say to [do team selling], but everyone has someone already. What do you do? Your hands are tied. We decided to focus on state and local government, where we found 8,000 opportunities in Virginia alone. State and local can be even worse than federal as far as finding money and getting projects approved, but we've managed to get good at working with them. The wheel just turns very slowly."

NEXT: Predicting growth

Despite the challenges associated with the federal market, the large solution pro-viders are holding out hope that Uncle Sam will offer the greatest opportunity in the new year. Of large government integrators (those who report annual revenue of $10 million or more), 53 percent believe that the federal government carries the greatest growth potential, compared to 35 percent and 30 percent that chose state and local governments, respectively.

In contrast, 36 percent of small solution providers believe that all segments of the public sector have equal growth opportunities--perhaps another indicator that state and local contracting is starting to mirror the federal market. Thirty percent and 28 percent of the same slice (small government solution providers) point to state and local government, respectively, as carrying the most potential, compared to 26 percent that chose the federal market.

Maybe more telling still is that the state government market, in particular, has sparked interest from solution providers that either don't currently target a particular segment of government or don't sell to the public sector at all. Of that group, 23 percent said they expect to make a play for opportunities in state government, compared to 20 percent and 18 percent that plan to go after local and federal contracts, respectively.

In the end, channel companies big and small seem to have met someplace in the middle in recognizing the newfound opportunity in state and local government. Smaller solution providers figure that diversifying across all segments will give them the greatest chance of growth. And with all of the uncertainty currently swirling around the market these days, that might be the safest approach of all.

"The shift in Congress from Republican to Democrat, along with the likelihood of a yearlong continuing resolution is only going to make things worse in 2007," Webber says.

"We also expect to see a larger gap between the numbers of needed [contracting officers] versus the number of available officers, as more retire or leave government faster than they can be replaced. The expected outcome is even longer sales cycles, more uncertainty around purchasing and a [lengthier] contracting process."

NEXT: Educating the customer

All challenges aside, government solution providers that know their customers, stay ahead of the trends and jump on new opportunities will fare well in this market, regardless of the segment they target.

For Custom Computer Specialists' Cadiz, that means educating the customer and pushing the envelope in terms of technology, for example, enabling handheld devices carried by parking-meter attendants to link back to headquarters in real-time, rather than to just log and print tickets, he says. And instead of selling a state agency on Microsoft's Active Directory, explain that the implementation will also enable collaboration through Windows SharePoint Services.

Often, government buyers aren't aware of the full scope of capabilities offered by IT solutions. Educating the customer, Cadiz says, opens the opportunity for more sales.

Above all, the key is to solve problems, says Linda Gooden, the recently appointed executive vice president of Lockheed Martin Information and Technology Services. Beyond that, it's about solving problems that could develop down the road.

"In government IT, we've seen an evolution in delivery," she says. "The first phase focused on automating manual processes to improve productivity; then, the second phase focused on integration--bringing together existing technologies and competencies to deliver solutions to a problem. What we're seeing now is a phase that I call 'business services aggregation.' Successful companies will deliver on-demand business services that allow customers to plug-and-play in their own architectures to serve changing requirements.

"From there, the best of the IT world [can combine] with processes to act as the mechanism for coping with mounting budget pressures, workforce shortfalls or any other [challenges] facing the customer," Gooden adds. "If the needs change, the architecture will allow them to efficiently adjust processes without a huge disruption. That's where the market is heading."