Outsourcing Evolves

WHEN STATE CIOs GATHERED for a conference of the National Association of State CIOs (NASCIO) in San Diego last October, they were asked to answer a simple survey question: “Is outsourcing a viable alternative in your state?” Seventy-one percent said “yes.”

When the survey was opened up to a wider group that included private-sector vendors and IT service providers, 80 percent of respondents said outsourcing was a viable alternative. And 78 percent said that the private sector is better prepared than the public sector to provide IT services.

Outsourcing has been on the rise for more than a decade. Enthusiasm for it continues to grow, even as state and local IT leaders recognize that a simple wave of the outsourcing wand will not magically improve government services and save money.

State of Wisconsin CIO Matt Miszewski, who is also the president of NASCIO, acknowledges that outsourcing solutions are always under consideration. “Are you providing a service efficiently in-house?” he asks. “If you are, then everything is fine. But if you’re not, then you have to look at something different.” And IT leaders have been doing just that.

Spending on state and local government IT outsourcing should grow at a compound annual growth rate of 12.4 percent during the next four years, from $11.1 billion in fiscal 2005 to $17.7 billion in fiscal 2009, according to an Outsourcing MarketView report from market analyst INPUT in Reston, Va. With 93 percent of the attendees at NASCIO’s conference saying state outsourcing will increase in the next three to five years, it’s no surprise that the numbers are trending upward.

A Sustainable Trend?

INPUT’s report suggests that outsourcing is increasing as the gap between gross domestic product and tax revenues has started to narrow as the economy grows. INPUT sees that trend continuing into fiscal year 2007 and beyond, even accelerating, as employee retirements increase and more legacy systems are replaced.

Despite those optimistic predictions, Miszewski senses caution among his fellow CIOs. “I usually describe it as a ‘settling effect,’” he says. “There’s a large surge in outsourcing at the start, and then you start to think a little more critically about it.

“We have to be careful and make sure it makes sense from a fiscal perspective, as well as a strategic perspective. We’ve seen a little bit of pulling back from the kinds of promises made early on about how much you could get out of outsourcing either pieces of IT or IT in general.”

Today, Miszewski adds, state CIOs are much more careful about what they will attempt to outsource. “We’re much more [selective] about how we do it now, rather than just assuming that if cost is an issue, outsourcing will always solve that problem,” he says. “We must ensure that government concentrates on our strategic core competencies.”

Outsourcing projects face numerous hurdles: opposition from government employees and legislators, flawed justifications of real savings and a lack of metrics with which to judge success. Failed projects can damage the reputations of IT decision-makers. Without an overall understanding of IT’s vital role in government, communicating the need for infrastructure improvements can be a challenge.

However, as Jim Krouse, INPUT’s manager, state and local market analysis, explains it, “Where economics meets politics, economics is going to win in the end.” The need for outsourcing will increase, he believes, even if it’s only to replace a retiring workforce and create compelling IT jobs with competitive pay scales.

The Virginia Alternative

One way to address resistance to outsourcing is simply to reinvent the concept altogether. Last November, the Commonwealth of Virginia approved a 10-year, $2 billion contract with Northrop Grumman of McLean, Va., to modernize the state’s aging IT infrastructure. But don’t call it outsourcing. It’s the result of the 2002 Public-Private Education Facilities and Infrastructure Act, a Virginia law designed to change the bidding process and the relationship between the public and private sectors when it comes to new IT initiatives.

As the largest such plan approved so far, it touches 90 state executive-branch agencies and up to 6,000 state workers. Why do it? To save money, for one thing. Virginia spends about $900 million a year on IT.

“Doing nothing would end up costing the state an additional $200 million over the next 10 years to support an increasingly outdated and expensive infrastructure,” said James F. McGuirk II, chairman of the state’s Information Technology Investment Board in an official statement.

Virginia Secretary of Technology Eugene Huang is quick to point out how this sweeping plan differs from traditional outsourcing. “In this case, the private sector offers its best ideas, and the government can negotiate in crafting those ideas,” he explains. “There is no pressure to actually get a deal done, and throughout the process, the plug can be pulled at any time.”

Even more important, the vendor must have a financial stake in the project’s success. “It requires risk sharing on the part of the private-sector entity,” Huang says. “Although many of the deals include some upside for the private sector, there’s also a significant amount of risk.”

Huang says his friends in the private sector have always enjoyed telling him how they would run things. “We’re happy to run state government, but if businesses or entities have some innovative ideas, we take a look at them,” he says. “If we’re interested in pursuing them, we post the ideas online, letting other companies respond to the initial ideas. The state requires a $50,000 deposit with each proposal, creating a co-dependent financial relationship from the very start.

“We shy away from the term ‘outsourcing,’” adds Huang, “because there are economic development components and caps on what can be paid to Northrop Grumman. And there are other terms and conditions that don’t fit with the traditional model of outsourcing, which was to hand over the keys to the kingdom and absolve yourself of responsibility for governance.”

The deal stipulates that Northrop Grumman will, among other things, build a large data center in an economically challenged region of southwestern Virginia and create jobs there. It may, in turn, use up to 75 percent of that facility’s capacity for its own private work. Even in facilities it will build in the state capital, Northrop Grumman will be able to use a portion of the infrastructure for its own projects. Eventually, approximately 1,000 state workers are scheduled to leave the state payroll and join the Northrop Grumman workforce.

There’s more to come in Virginia, possibly including enterprise resource planning, human resources and other functions. “We’re currently looking at a public-private proposal to overhaul ERP, HR, and financial and accounting systems,” says Huang. “That project will be in the range of $200 million to $300 million.”

While Huang says that he doesn’t know whether the Virginia initiative will stand alone or serve as a model for other states, Wisconsin’s Miszewski notes that state CIOs have been watching its progress for more than two years. In his view, it sets a precedent.

“It has caused discussions to pop up in all of our states,” Miszewski says. “It’s very different from what we used to do, which was simply to hire someone, pay no attention until they were done, and then just go on to the next project.”

INPUT’s Krouse says Virginia is doing an “excellent job,” and adds that the Northrop deal is “one of the big dominoes that might start a ripple effect” for public-private projects.

Beyond Politics

Wisconsin’s Miszewski says that despite the comments that sometimes come out of state legislatures, successful outsourcing is more about budgets than politics. “Fiscal responsibility is a core value of both parties,” Miszewski says. “When the discussion was more along the lines of ‘let’s outsource because we have a problem with how the public sector works,’ that would have been a different case. However, now that we’re talking about creative solutions to building a sustainable government, it doesn’t depend on Democrats or Republicans. It depends on progressive-thinking folks.”

Virginia’s Huang agrees. “IT reform legislation has worked to eliminate stovepipes, spark management reforms and develop best-in-class in IT management,” he says. “If you don’t act to fix the environment you’re in, you’re shirking from the responsibility that the taxpayers have given you in this position of public trust.”