IT Handoff: State And Local Governments Warm Up To Outsourcing

High-profile failures in outsourcnig have left many state and local governments gun-shy about handing over business processes to the private sector. And who can blame them? Failure often translates to financial loss in the millions, a disruption in citizen services and political fallout. In other words, state and local governments have a lot to lose.

But with every success story, skepticism slowly begins to fade. And success stories are indeed starting to emerge as solution providers win over government customers by thinking outside the box about ways to eliminate risk and increase the return associated with outsourcing initiatives.

"Given the right environment and the right partner, [government] can save money and improve services for citizens by outsourcing particular initiatives," says Ed Burns, president of the state and local government practice at Greenwood Village, Colo.-based solution provider Ciber (GovernmentVAR 100 No. 33). "Outsourcing allows government to do what they do best, and IT, which may not be a core competency, to be managed by IT contractors that have the skills and expertise."

Reston, Va.-based research firm Input defines outsourcing as a long-term contract whereby the customer delegates all, or a majority, of the operations or functions performed by an organization to an industry partner. According to a recent study, Input predicts that the state and local outsourcing market will grow nearly 8 percent from 2006 to 2007, accelerating to double-digit annual growth starting in 2008, and reaching about $22 billion by 2011.

Driving such growth is the increasing significance of a few key internal challenges.

Similar to the federal market, state and local governments face a shrinking workforce as baby boomers approach retirement. A survey released by the New York State CIO Council's Human Resources Committee, for example, showed that nearly 25 percent of IT managers and 33 percent of CIOs are planning to retire within the next three years.

And in the city of Falls Church, Va., the IT department was outsourced when about half of the positions fell vacant. Such a reduction in internal resources makes management of IT processes and the ability to drive new initiatives far more challenging. At the same time, legacy systems and applications restrict agencies from moving forward on more sophisticated IT projects and become more costly to maintain.

"This area is going to grow because it has to," says Tom Burlin, executive vice president and COO of Affiliated Computer Services (ACS, No.14). Business process outsourcing is a primary focus for the Dallas-based systems integrator, which reports about $2 billion in annual state and local government revenue. "It's simply a response to demands of the market. Outsourcing was a difficult start-up, but the suppliers and clients are now becoming more sophisticated and learning how to make it work for everyone involved," Burlin says.

Rebounding From Failures

If history is any indication, state governments have a reason to be gun-shy about outsourcing. In 2000, San Diego awarded a seven-year, $644 million contract to Computer Sciences Corp. (CSC, No. 8) for the outsourcing of IT processes, only to be left with a mess to deal with a few years later. The contract was recently rebid to Northrop Grumman (GovernmentVAR 100 No. 1). And Texas stands as a more recent example of a state that attempted an ambitious outsourcing initiative, only to fail because of a badly developed business model.

"States can't afford to buy and replace hardware, so leveraging capital by outsourcing is an attractive option," says Celia Hagert, senior policy analyst at the Center for Public Policy Priorities. "But lawmakers don't always know enough about how complicated it is to build [complex] systems, underfund projects and set deadline expectations that are too lofty."

In the case of Texas, the state launched a new system for enrolling Texans in public benefits programs, called Texas Integrated Eligibility Services (TIERS). Theoretically, the system was a good one, providing online applications for such benefits as food stamps, Medicaid, children's health insurance and temporary assistance for needy families. A team of contractors led by Accenture (No. 13) was awarded a five-year, $899 million contract to develop and administer the new system. But since its launch in January 2006, the system hasn't saved the state a penny in administrative costs, and the number of children receiving health care through state funds dropped by more than 127,000, or 6 percent, between December 2005, when the new contractors took over, and April 2006. The contract was stalled in May 2006, audits were initiated by the State Comptroller of Public Accounts, and last month, the contract was canceled.

"There are certain types of government functions that are just not conducive to IT outsourcing," Hagert says. "The challenge is figuring out where to draw the line, and I think [Texas] crossed the line in this project and is now paying the price."

But with those kinds of failures come lessons learned for both the government customer and the channel community. While many states remain reluctant to move forward on outsourcing initiatives, more and more are coming around, with state officials trying to take a business approach to government processes and demanding more of their private-sector partners. At the same time, contractors are responding with proposals that offer tangible cost savings and returns on investment.

A New Approach

Before, outsourcing initiatives were often treated like any other IT contract, with a set value and deadline, and awards often going to the lowest bidder. That's changing, with states investing more time in the planning stages of outsourcing initiatives and even requiring contractors to minimize risk by investing more in initiatives.

The Commonwealth of Virginia is certainly among the most innovative states in terms of its approach to outsourcing. Functioning in what Lemuel Stewart, CIO of the Virginia Information Technologies Agency (VITA), defined as a 1980s IT environment, Virginia set out to modernize legacy systems about six years ago. After a full assessment, the office determined that the price of such an initiative would be in excess of $300 million.

"That was not an option--end of story," Stewart says. "So we set out to invite the commercial sector into Virginia government for an evaluation from the standpoint of 'look at our total infrastructure, evaluate its efficiencies, and then determine if you can effectively put together a business case that would involve you making an investment in Virginia's IT program.'"

After evaluating four proposals, Virginia awarded the contract to Northrop in July 2006 and the integrator took over the operational responsibility of the entire IT infrastructure that supports Virginia's 92 agencies.

As a stipulation of the contract, Northrop agreed to invest $270 million in up-front capital for the modernization project, with the understanding that Virginia wouldn't spend any more money on IT than it had in 2006, and payment for investment and services would be made to Northrop only when efficiencies and cost savings are realized. The state is counting on annual expenses dropping by several million, as the number of servers in use is cut in half--from 3,000 to 1,500, at most--and applications are updated and more efficiently managed to improve processes. At the same time, Northrop was expected to contribute to the community.

"We did more than look for dollars," Stewart says. "We saw an opportunity to use technology to advance economic development in distressed areas of the state."

Northrop is building two new data centers--one just south of Richmond and another in the southwestern corner of Virginia--creating 450 jobs throughout nine counties. The first will be occupied this month, the second four months later. With a contract commitment to refresh all technology within the state in the first 36 months, Northrop is rapidly replacing hardware and will begin consolidation this summer.

Obviously, these kinds of opportunities emerge only when states have structures and policies in place to support such partnerships with the private sector. In Virginia's case, the Public-Private Education Facilities and Infrastructure Act offers a mechanism that supports such large-scale outsourcing initiatives. In addition, VITA is independent of the administration, with Stewart reporting to a 10-member board, eight of whom are citizens of Virginia.

Start Small And Specialize

Even if states support outsourcing initiatives, however, not all solution providers have the capital to support programs such as Virginia's VITA. Small and midsize businesses may have to seek subcontracts for a piece of those mega opportunities. Another option is to think smaller--that is, to seek opportunities at the city, town and county levels, and offer outsourcing services for a single IT function or component at a time.

Manassas, Va.-based Integrated Digital Systems (IDS), for example, targets traditionally neglected municipalities in remote areas of Virginia with outsourced scanning capabilities, backup and recovery services, and networking support. Oftentimes, after IDS provides one function, the customer then opts to outsource others.

"When we go in and present a system, we really push that, regardless of what we do on the front end. We need to do a business process review," says Larry Hunt, CEO of IDS. "We shock them with the money that can be saved by outsourcing just a piece of business processes. This area is going to grow, especially at the city and county levels," he says.

And as proven by the situation in Texas, solution providers need to go beyond the technology to become subject-matter experts. Understand the policies and requirements associated with the specific process targeted, and develop an outsourced solution that meets the expectations of both the government customer and, when a factor, the citizens affected.

ACS, for example, launched the e-Childcare Solution for the State of Oklahoma's Department of Human Services (OKDHS) in 2003, and has saved the state about $1 million a month in direct program costs--or about 10 percent--in verifying eligibility for subsidized care, determining required co-payments and performing automated attendance and invoicing. The program is currently being used for almost 50,000 children in 4,800 daycare centers throughout the state, with associated savings being used to reward quality providers with higher pay.

Much of the success of the program can be attributed to its simplicity, says ACS' Burlin, and the investment made in subject-matter experts.

"The more you can keep homogenous processes, the more the chances of success," he says.

Outsourcing human resources payroll processing and benefits, for example, is very different than outsourcing HR payroll, benefits and recruiting, given that the latter requires an entirely different set of resources and skillsets.

"Every time you add a tower to the service level, it becomes more complex," Burlin adds. "IT is still a big part of business process outsourcing." n

Outsourcing: Sizing Up the Competition

The following companies have made outsourcing a significant focus of their state and local government strategies:

ACS
58,000 employees
Total Revenue: $5.3B
StateLocal Revenue: $2B+
Outsourcing Focus Areas: Claims processing, Medicaid Management Information Systems (MMIS), child support enforcement
Significant Outsourcing Contracts by Customer: Ariz., Calif., Colo., Fla., Ga., Ill., Ind., La., Mass., Mont., N.J., N.C., Ohio, S.C., Texas, Va.


EDS
140,000 employees
Total Revenue: $21.5B
StateLocal Revenue: >$1B
Outsourcing Focus Areas: MMIS Systems
Significant Outsourcing Contracts by Customer: Calif., Del., Ga., Ind., Kan., Pa., R.I., Wis.


IBM
307,000 employees
Total Revenue: $85.9B
StateLocal Revenue: >$1B
Outsourcing Focus Areas: Fiscal management, satellite broadband services, e-government
Significant Outsourcing Contracts by Customer: Ariz., Calif., Pa.


Accenture
75,000 employees
Total Revenue: $11.6B
StateLocal Revenue: >$1B
Outsourcing Focus Areas: E-government, child support enforcement, e-procurement
Significant Outsourcing Contracts by Customer: Fla., Md., Mich., N.M., N.C., Pa., Tenn., Texas


Northrop Grumman
125,400 employees
Total Revenue: $29.9B
StateLocal Revenue: NA
Outsourcing Focus Areas: MMIS, welfare system management, IT infrastructure management
Significant Outsourcing Contracts by Customer: Va., Calif.


Unisys
39,000 employees
Total Revenue: $6B
StateLocal Revenue: >$1B
Outsourcing Focus Areas: CRM, e-commerce, e-procurement
Significant Outsourcing Contracts by Customer: Ill., La., Minn., Pa, Va., W.Va.

BearingPoint
10,000 employees
Total Revenue: >$3B
StateLocal Revenue: >$1B
Outsourcing Focus Areas: Finance and administrative support, public employees' retirement systems
Significant Outsourcing Contracts by Customer: Fla., Ga., Md., Mass.

Source: Input State Outsourcing Trailblazers

According to Input, the following states lead the way in outsourcing initiatives:

California
Outsourced Services: Child-support enforcement, Medicaid management, comprehensive IT management and support

Florida
Outsourced Services: HR, Web portal, e-procurement, online motor-vehicle processing and Medicaid

Georgia
Outsourced Services: Health-claims processing, pension administration, communications convergence and police information access

Illinois
Outsourced Services: Child-support enforcement, IT management and support, IT infrastructure and network taxation

Maryland
Outsourced Services: Child-support enforcement, e-procurement, desktop services

Michigan
Outsourced Services: Financial institution data-matching initiative, pharmacy benefits management and claims system

North Carolina
Outsourced Services: Department of Corrections electronic monitoring services, Medicaid management and e-procurement

Pennsylvania
Outsourced Services: Medicaid management, comprehensive data center, e-procurement and electronic bill payment

Texas
Outsourced Services: State data centers, Medicaid management, HR and payroll, Web portal and targeted software applications

Virginia
Outsourced Services: Comprehensive IT infrastructure, desktop services and e-procurement

Source: Input