August 3, 2005 By Frank McDonough
The deal was a huge winner for both parties. By the end of 1995, Chicago collected $336 million in parking fines and EDS earned more than $50 million as part of its cut, with more to come. Not a bad return on investment.
Since then, several states, most notably California and Virginia, have followed suit, signing contracts that required private firms to invest upfront in technology and manpower in return for a portion of the savings, or in some cases, a cut of the revenue generated by the technology investment. Once called benefits-based, these contracts are often referred to as share-in-savings (SiS) agreements. Now the federal sector is the latest government entity to test the waters.
As federal agencies use SiS procurement agreements for IT projects, concerns have been raised about the cost-effectiveness of such deals for government, as well as the quality of the outcome when complex IT systems are implemented using these performance-based contracts. Cultural issues can also negate a government's ability to execute an SiS contract.
The good news is, first of all, that numerous other government entities -- both in the United States and abroad -- have already experimented with SiS procurements and found winning ways to make SiS agreements work. Second, the lessons they learned can apply almost universally to SiS contracts. Third, champions in government, most notably the U.S. General Services Administration (GSA), have accumulated and organized information about SiS, and developed case decision and evaluation tools that can walk governments through the process. Finally, the market is more receptive than ever to SiS procurement, creating healthy competition to the public sector's benefit.
Despite the often glowing remarks by backers of the SiS procurement approach, not all of these contracts save money. In Capital Financing: Partnerships and Energy Savings Performance Contracts Raise Budgeting and Monitoring Concerns, the Government Accountability Office recently reported that SiS contracts (when used in the energy-related field) can cost significantly more money -- 8 percent to 56 percent -- than traditional financing through the government appropriations process.
Most of the studies and literature highlight the benefits of using public-private partnerships for government procurement, but as in any change, there are new issues to address. A study done for the U.S. Department of Transportation identifies the following issues that can crop up in SiS programs:
An example is the Dulles Greenway toll road in Virginia near Washington Dulles International Airport. A private firm built the Greenway using private funds, with the contract allowing the firm to reap profits from the toll revenue. When the toll road opened to traffic in 1995, tolls were $1.75 each way, but when traffic fell short of projected levels, the toll was reduced to $1. This attracted more users but did not increase revenue. Eventually as traffic increased along with growth in the area, the toll road was widened.
States Make Case
Concerns of government agencies and the private sector are all legitimate. As actual programs begin using SiS, however, the issues will change and become more focused.
Outside the federal government, many SiS initiatives in other countries and in state and local governments have flourished. The California Franchise Tax Board initiative from the early 1990s is probably the granddaddy of SiS initiatives. AccessIndiana and TexasOnline are two examples of statewide portals in which government and industry shared the risk and reward using industry funding. Kansas and Virginia use similar SiS-based programs. The Arizona Department of Revenue's integrated tax system, the North Carolina e-procurement system and Iowa's Child Welfare System are other examples of the wide-ranging SiS systems in which the private-sector partner pays for development and is reimbursed from the savings after implementation.
As an example of how these systems work, look at the TexasOnline portal. In 1999, the Texas Legislature mandated the Department of Information Resources to create an e-government portal for all government agencies. The portal has become a best practice in government. Built without general revenue funds, TexasOnline is based on a self-supporting model.
Private partner BearingPoint paid for the estimated $26 million portal infrastructure costs, and is recovering its investment through a combination of user, subscription and premium service fees. The state receives 10 percent of the gross revenue generated by applications. After initial costs are recovered, the state's share will jump to an additional 50 percent of net revenues. Funding online applications with fees enables governments to implement online initiatives without major impact to internal budgets.
Five Examples, Two Leading Countries
SiS procurement initiatives have also increased internationally as practitioners grow more comfortable with the model.
The Canadian government plans to launch the Marketplace Program, an electronic catalog that all ministries and agencies will use to purchase goods and services. Government organizations spend about $6.5 billion annually on goods and services. The system will cost about $25 million and will be funded by the private partner on the condition that use of the Marketplace Program will be mandatory for all agencies. Currently in the final approval stage, the private partner, IBM, is requesting 2 percent of the transaction fees for the first five years to recoup its investment and make a reasonable profit. Later, its cut of the fees will drop to 1 percent and eventually to zero.
Ontario, Canada, deployed the Welfare Reform Re-engineering Program to save money while placing the benefits in the right hands at the right time. This program had a benefits sharing model based on resources the government and the private partner put into the program. Accenture invested about $41 million and has its return on investment capped at $148 million. The program was successful but auditors and the press questioned Accenture's significant profits from its investment.
Singapore, always a leader in public-sector IT, has three initiatives under way. As in most countries, these are called public-private partnership programs.
The Integrated Land Information Service co-shares investment capital and recurrent costs between the government and the industry partner. Singapore pays for development, maintenance and enhancement of the application software -- and it owns the data, application software and intellectual property rights. The industry partner pays for hosting, marketing and operating the system.
To recover its costs, the government receives royalties from the industry partner for data sold. The partner recovers its costs from transaction-based revenue sharing and a fixed-based maintenance fee.
Singapore's National Electronic Bills Payment Hub system lets the private-sector company bid to participate either in a joint venture with an equity stake or as an outsourcing service. In either case, the private-sector company must meet performance targets. These include the number of consumers and billing organizations signed up, the number of active consumers, and the number of bills paid and presented within the first five and eight years. The company receives revenue by charging a fee for each payment transacted through the hub system
Co-sharing of investment is the feature built into the Integrated Platform for Trade and Logistics Program. Singapore's government will pay for the software applications and own the software, business processing rules, designs and data. The private-sector partner, under a 10-year contract, will be responsible for the costs of all operations, maintenance and acquisition of all required hardware and infrastructure. The fee paid to the private-sector partner will consist of both fixed and variable components, and will be performance-based.
Watching Profits, Minding Deep Pockets
As the previous examples show, types of share-in-savings contracts can vary greatly. Certain universal lessons, however, can be drawn from what other governments experience.
Strong IT management is key.
Wu Choy Peng, Singapore's CIO and vice chairwoman of the International Council for Technology in Government Administration, said the government outsources everything to help build up its domestic IT industry. "We have been at it for eight years, learning how to manage these SiS programs, and we are getting very good at it," she said.
As a result, Peng has a keen understanding of how and why certain SiS contracts succeed for government. For example, she said everything must be nailed down before the contract is signed. Any circumstance that could occur afterward must be addressed in the contract. Experience will identify these issues to those new to the field. Peng said the SiS projects are managed very tightly, providing performance scores to private partners each month.
"Depending on the conditions, penalties may be assigned monthly, although we only do this in severe cases." But, she emphasized, it has taken eight years and a lot of experience to reach this point.
The windfall profits charge, however unfair, may surface in public debate.
If the industry partner seeks and obtains a "windfall" profit, it is highly likely that sustained criticism will come from auditors and the media. Even if a windfall is not sought or the project is considered a success, continuous criticisms may occur. Like the Ontario-Accenture case, criticism about SiS profits occurred after the erection of the Skye Bridge in Scotland. In this case, a consortium of banks invested about $36 million and they receive about $6 million return each year. The bridge successfully provides a service to the public, but critics say the revenue to the consortium is excessive. Seeking a firm's "normal" and documentable profit may be the best target for industry in SiS programs.
Projected usage of the new system by government agencies must be based on something other than advocates' subjective estimates.
SiS programs often disintegrate after implementation because the government advocates can be too optimistic when predicting the system's future use. There must be some assurance that the estimated use is valid, and that agencies will actually use the system and generate the transactions necessary to produce revenue for the industry partner. The best assurance is legislation that requires agency usage after implementation. Canada's Marketplace Program is one approach. It's driven by a governmentwide policy requiring mandatory usage, as requested by IBM.
There is no single best approach.
SiS examples in other governments -- including those discussed here -- reveal many variations for sharing in risk and reward programs. There is no one best approach to meeting the respective needs of government and industry organizations in SiS programs. Even in a single government, there can be numerous approaches depending on the circumstances. And in Singapore, both the government and the industry partner share in the investments needed to make the program work.
Private partners need deep pockets.
In some scenarios, the contractor will need to work for a few years before receiving any income. Remember though, all things are negotiable. One incentive for companies to hang in there can be seen in the state government examples. Awards are sometimes made at the end of the acquisition cycle without competition because not all companies can spend two years without income while waiting for a contract to be signed.
The SiS approach can be an opportunity for government and industry organizations to profitably join forces and develop advanced systems to run government. While the federal sector has almost no experience in using this approach, plenty can be learned from states and other national governments. Both sectors have been active in SiS for more than a decade. If asked, they have things to teach both federal CIOs and their peers in other levels of government who might be considering an SiS contract.
For one thing, managing SiS programs brings different issues to the forefront. These are layered on top of the traditional challenges of complex IT system management. One key is to learn from those who have been down the road before and know what lies around the next corner.
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