As the cost of providing information technology services escalates and IT budgets shrink, local governments are increasingly turning to outside contractors to achieve the efficiency and cost controls they have been unable to produce on their own.

In fact, state and local governments outsourced some $2 billion worth of IT and services last year, according to Linda Cohen, a research director with the Gartner Group, Cambridge, Mass. By the Year 2000, she says, that figure should hit $3 billion, much of it spurred by states' new responsibilities for welfare and other areas.

"In order to get block grant funding, [states] are going to have to have mechanisms to share data at the federal level and across states and counties," something they weren't able to do before in their traditional "siloed" IT environments, Cohen said. Because states "don't have the capacity to build these new systems," they will turn more and more to outsiders.

Added Jack Winters, vice president of IBM Global Services, Somers, N.Y., which is capitalizing on the outsourcing trend: "Government wants to leverage IT as a tool and productivity aid." Because governments are not expert at running power plants or data centers, he said, "they can get better service and technology at a better price" by going outside.

Although outsourcing may be a move of last resort, it seems to be working. Indianapolis, which a little more than a year ago outsourced nearly all of the city's IT processing to Systems and Computer Technology (SCT), Malvern, Pa., is seeing the benefits, said Michael Yoder, director of the city's Department of Administration. (The Indianapolis area has a "unigov," combining authorities from the traditional metro area and the surrounding county and townships.)

SCT has taken over the city's data center, local-area network and PC support, help desk, training and "all nonpublic safety application development and maintenance," Yoder explained. In turn, the government retains control of public safety application maintenance and development, and several small offices continue to provide their own IT support.

The county of Westchester, N.Y., has taken a similar tack, hiring IBM Global Services to provide IT infrastructure services, including data center operations and desktop application development and support as well as phone installation. The county maintains strategic planning, capital development and program control, explains Susan Egginton, administrator of general services.

The Westchester contract is a seven-year, fixed-price agreement worth more than $100 million, including anticipated CPI adjustments, Egginton says. The county reviews prices and performance annually and "can separately bid components at any time that we're interested." The government hopes to save $26 million over 10 years, if the contract's three one-year options are exercised.

When governments outsource IT functions, one of the key issues they face is the welfare of incumbent employees. In Indianapolis, the government insisted on "equal or better wages and benefits," Yoder said. SCT hired the incumbents, although the workforce had shrunk significantly through attrition by that time. SCT also brought in its own managers and recruited and hired other employees.

"Figuring out the right way to approach the people situation is the most challenging thing," IBM's Winters said. "You have to handle assimilation very sensitively." Such staff transfers are typical in outsourcing situations, Cohen says.

The shape of outsourcing contracts is also important. The Indianapolis contract contains 32 pages of service-level agreements, Yoder said. Specified performance levels must be met to avoid cash payments of "liquidated damages." The seven-year, fixed-price, $81 million pact, with three one-year options, aims at saving the city $26 million. A savings of $2 million was achieved in the first year.

Service-level requirements with penalties for below-par performance are typical. "State chief financial officers like to know what their costs and outcomes will be," Cohen said. "That's what performance-based pricing is all about." Performance assessment involves items such as uptime for mainframe and midsize computer operations and LAN operations, according to Richard Cappelletti, SCT's executive director in Indianapolis. Although that sounds tough, SCT will be able to turn a profit by bringing about efficiencies, Yoder predicts.

"The way you save is [to achieve] economies of scale," Egginton said, and put in place more efficient application development. She expects IBM will be involved in developing managed care and other applications for Westchester County. "The whole point of outsourcing is to aggregate infrastructure services across a number of entities to get economies of scale," Cohen said.

SCT is making a profit, Cappelletti says. The company "bid on a cost-plus-margin basis" and can also "renegotiate contracts" with its vendors and suppliers. Outsourcing can be a win-win situation for governments, he said. "When they bring in competitive private companies," they can see increasing levels of service and decreasing costs.

Data center operations can often be made more efficient, Cappelletti explains, by consolidating software being used and changing out hardware. In business for 26 years, SCT is also able "to leverage alliances" with leading hardware, software and service vendors to get the best prices.

Overall, companies such as SCT also set up an IT plan-something that may have been lacking before. This involves "setting up standards, advancing a consistent IT architecture and management, and consolidating development activities," Cappelletti said. In software development, moreover, SCT applies a "more structured, life-cycle approach."

Just keeping up with the latest technology seems to be practically beyond the means of all but the richest localities. "How can government keep pace with technology that's changing every 12 months?" Egginton asked. "We were always probably four years behind."

If one needs to maintain effective service levels and reduce costs, "that's not something we were able to do in-house without a massive infusion of investing," Egginton said.

Lessons Learned

Be sure to retain "competent counsel," Yoder advises governments eyeing the outsourcing option. Indianapolis went not only out of town but out of state to an experienced Washington, D.C., firm, Shaw Pittman Potts&Trowbridge, in order to get a "good, private-sector contract."

Municipalities will also want "to be all-inclusive" in their process, Yoder adds. Because the city/county council was convinced at every stage that the existing IT workforce would be taken care of and that there would be true savings, the contract was approved by a unanimous vote.

Cohen sees high growth in "program-focused" outsourcing, to the point that there will be more "vertical" activity than the "horizontal," infrastructure-oriented outsourcing common now. The implications of such a trend are worth considering. As governments move from infrastructure to programmatic outsourcing, "government is giving up programmatic control," Cohen contends. "They're leaving it up to the vendors to administer programs," supplying services directly to the citizen.

Cohen cites several examples to illustrate the trend, including emergency dispatch 911 service, parking-ticket fine collection in Chicago and tax collection in California.

The days when states went to the vendors with money for new programs are fading, Cohen argues. "Now vendors are going to have to build these systems on their own nickel and sell them to the states in replicated situations."


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