Outside In

Governments have long used outsourcing to shed certain functions, but jurisdictions now turn over entire business areas to the private sector.

by / October 4, 2004
In 1997, former Connecticut CIO Rock Regan received orders from then-Gov. John Rowland to privatize the state's technology infrastructure in the executive branch. The state awarded a $1.35 billion, seven-year contract to EDS in late 1998 for the project, and the company -- with a group of subcontractors -- was to assume responsibility for Connecticut's desktop computers, mainframes and telecommunications operations.

The bellwether initiative got substantial press because the state was among the first to consider such large-scale outsourcing and publicly commit to making it work.

The following summer, however, the project was killed.

Spirited opposition from several fronts -- including labor unions, legislators, the state comptroller and a handful of state agencies -- created enough fear, uncertainty and doubt to derail the privatization project, Regan told Information Week in late 1999. He said he wished he had better articulated his project plans because that might have saved the project.

"Instead, we allowed the issue to be framed by other people," Regan told the magazine.

That Was Then. This Is Now.
In 2004, a scant seven years later, huge outsourcing projects like Connecticut's aren't a novelty anymore. Some governments have upped the ante by outsourcing whole business areas, including HR or public welfare, and now let private companies do the government's daily work.

Because of the unbelievably tight budgets in which governments find themselves working, outsourcing has become an attractive way to shave costs. A new rank of governors with private-sector backgrounds also has spurred governments to actively search for opportunities to privatize services. These governors' familiarity with ruthless, bottom-line thinking has rubbed off on other branches of government.

Add a looming work force crisis -- the coming retirement wave -- and it's easy to see why outsourcing and privatization suddenly appear to be the answers to a number of problems.

That's reflected in the steady growth of outsourcing spending in state and local governments, said Shawn McCarthy, IDC's program manager who covers IT opportunities in U.S. government and education.

"In general, I expect to see contract IT services spending increase an average of about 6.9 percent each year between now and 2008," McCarthy said. "This will differ by state and municipality, but the overall trend is noticeable."

Solutions that state and local governments typically outsource fall into two categories, he said: business process outsourcing, which includes accounting, logistics systems and HR systems; and IT services, which includes network management, support, and hosted Web sites and applications.

Still, reliance on outside parties can cause trouble for governments learning to manage complex contracts associated with large-scale outsourcing.

As with any recipe, the wrong blend of ingredients can turn a pleasant dish into a foul mess. Turning over your entire enterprise computing operation to somebody else is an intricate undertaking, and structuring and managing that sort of contract is a skill not mastered quickly or easily. Governments have had varying success with these monster outsourcing projects, but the efforts can work and promise enough payback to make it all worthwhile.

Bring It On
Large-scale outsourcing is nothing new in San Diego County, though at one point, the county nearly scrapped a huge outsourcing deal.

In October 1999, the county signed a landmark, seven-year $644 million contract with the Pennant Alliance -- a group of companies including Computer Sciences Corp. (CSC), which leads the consortium; Science Applications International Corp. (SAIC); SBC (formerly Pacific Bell) and Lucent Technologies -- to outsource all county IT operations.

The first few years of the contract weren't pleasant.

CSC was fined for failing to meet service goals during the contract's first year and for not migrating county employees to a common e-mail platform, according to Michael Moore, CIO of San Diego County. In all, the alliance paid almost $2.4 million in fines in 2000, he said.

Moore is unusually well versed in the Pennant Alliance contract.

He worked for SAIC for 11 years, serving as an operations manager and corporate vice president responsible for state and local information technology outsourcing from October 1999 until November 2002, when he became CIO of San Diego County.

Moore served as SAIC's lead executive on the contract during the contract's first three years, then took over as the county's lead when he became CIO in 2002. He's in the unusual category of being on both sides of a messy contractual relationship between a vendor and a government.

"We came very close to what I call 'getting divorced,'" he said of San Diego county and the Pennant Alliance. "We were headed down the path of default."

The county listed approximately 50 major disputes on a default letter drafted by county staff in summer 2002.

The companies and the county had to acknowledge the possibility of going to court if the working relationship didn't improve.

This made everybody apprehensive, Moore said. The county, as part of the contract, gave all its IT assets and staff to the Pennant Alliance, and the specter of a protracted court battle had the county worried about what it would do for service. The Pennant Alliance stood to lose millions of dollars if the contract went into default, not to mention serious face in a marketplace the alliance believed could generate significant revenue for the companies.

The two sides sat down in summer 2002, reviewed the 50 disputes, and at the end of August, signed a complete restatement of the original 1999 contract because of the number and complexity of amendments to the original contract.

"We, today, are getting everything we expected to get out of this deal," Moore said. "We don't even think about infrastructure. We don't think about desktops. It's not a day-to-day issue with us. The Pennant Alliance owns the equipment."

At the end of the contract, San Diego County has the option of buying back the technology assets at net book value. If the contract is cancelled, he said, each asset has a depreciation schedule in the contract.

"The cost of maintenance of all the hardware is rolled into the monthly price points that we pay," he explained. "We estimate the total savings on the entire deal to be about 15 percent or $87 million over the seven-year life, based on an evaluation done at the point of approval for our contract."

Perhaps the biggest benefit? Moore said he's talking to different county agencies about what new IT services will be put in this year.

"We're not talking about cutting IT costs," he said. "We're talking about spending more on IT to help us relieve some of the budget cuts. That's not normally what happens in state and local government."

The Devil Is in the Details
Early this year, the city of San Diego discovered how messy outsourcing can get when not enough attention is paid to certain details in IT services contracts.

Since 1979, the city outsourced some IT operations to the San Diego Data Processing Corp. (DPC). The firm is a unique entity -- it's a 501(c)(3) nonprofit independent corporation wholly owned by the city.

In its early days, the DPC provided mainframe services to San Diego, and expanded its offerings over time to network management, integration services and software development, according to an April 2004 Manager's Report written by Rey Arellano, deputy city manager and CIO of San Diego.

In January, the city auditor released partial results of its ongoing DPC audit that identified inappropriate and excessive expenditures on travel and entertainment, and other indiscretions. The district attorney was asked to investigate DPC executives for possible criminal conduct.

Though the city auditor's findings cast a negative light on the DPC, San Diego was troubled by the corporation for some time, according to the city manager's April report, because the DPC's growth and unique relationship with the city created structural problems related to oversight and accountability.

"It was a relatively independent entity," Arellano said. "If city employees provided this type of function, arguably those folks would fall under the CIO, and certainly there's direct accountability there. If this was a more typical third-party outsource, the office of the CIO would have been intimately involved in negotiating, as well as managing the contract once it came to signature.

"In this particular case, since the DPC board of directors is appointed by the City Council, the office of the CIO has no direct, meaningful influence on DPC activities," he continued. "Since it is a nonprofit and we are 95 percent of its revenues, it's very difficult to have any meaningful contractual agreement in terms of financial penalties and so forth because we are only penalizing ourselves."

After the city auditor's report, the mayor issued a memorandum asking San Diego's city manager to evaluate whether to abolish the DPC and merge its responsibilities with San Diego's Department of Information Technology and Communications.

"We went through an internal process to take a look at that question, did some research and talked to some folks," Arellano said. "We came up with a recommendation to pursue dissolution of the DPC, take a look at insourcing some functions but then competitively sourcing the rest of the functions provided by the DPC."

The DPC Rules Committee did not approve that recommendation, he said, directing the city manager instead to create a city/DPC project team that would provide an unbiased and objective review of all IT outsourcing options for the city's short- and long-term IT needs.

Arellano said that review is happening now. He also said the City Council approved a resolution in early July to change the DPC's governance structure in several ways, including:

  • delegating the City Council's voting proxy, which includes the authority to appoint the board of directors, to the city manager;
  • changing the composition of the board of directors to include three city staff members: the CIO and two other staff members at the deputy city manager or department director level; and
  • adding financial reporting requirements.

    "Even if we said we were going to dissolve the DPC, it would take between 18 and 24 months to go through the process of bringing on a consultant to conduct a baseline to then determine which functions should be insourced or outsourced to then create the RFP ... and you see where I'm going," Arellano said, adding that it's not a simple matter of just shutting the DPC's doors.

    Tightening the Belt
    The focus now is on seeking the most cost-effective way the city can deliver IT services to agencies, he said, because the negative publicity surrounding the DPC's leadership and financial irregularities created the impression in the public's mind that the arrangement is not cost-effective for the city.

    "Cost-effective" is prime motivation for governments to consider outsourcing everything -- from IT services to maintaining shrubbery on traffic islands. A quick read of headlines in state capital newspapers shows that "cost-effective" is becoming a modern mantra for state and local governments. Curiously outsourcing isn't always about saving money. Sometimes it's just about doing things better.

    In California, Gov. Arnold Schwarzenegger created the California Performance Review (CPR) to "restructure, reorganize and reform state government to make it more responsive to the needs of its citizens and business community," said the CPR's Web site. The CPR has four major components: executive branch reorganization;
  • program performance assessment and budgeting; improved services and productivity; and acquisition reform.

    There may be a role for outsourcing to play in the CPR, said J. Clark Kelso, California CIO and one of a few CPR directors, but outsourcing is not an overarching strategy or theme of the CPR. It's not that California is averse to outsourcing, he said. The state will seek outside assistance in certain areas, such as an enterprisewide budget/financial system.

    "We're not looking at outsourcing as some grand strategy for reducing government costs," he said. "We're simply looking at ways of improving productivity."

    California has no choice but to worry about productivity, Kelso said, because of an impending "human capital crisis."

    "We're in a position where 70,000 state employees are going to be at retirement age in five years -- out of 280,000 employees," he said. "Seventy thousand. We don't have the issue that a private-sector company does: 'I have to cut 20 percent of my work force, and I'm going to do that over the next year.'

    "We don't have to do that," he said. "We're going to have a downsizing, whether we like it or not. The problem we have is, how do you manage that wave of retirements so we can maintain services and improve productivity while, at the same time, government is very naturally reducing its size?"

    Kelso said the chief problem with outsourcing entire areas of government business, such as HR or child welfare services (two big Florida initiatives), is that it puts a government or government agency in an odd position of admitting a certain amount of weakness in running a program.

    "This is not an area where there's one clear approach that's as simple as 'focus on your core business and outsource the rest,'" he said. "When you start to get into the realities of business management, it's not quite as simple as that. In part, what you're doing from a management perspective is saying, 'Well, we can manage the contract better than we can manage the program.'

    "Sometimes, that's just not true," he said. "Sometimes, you're going to manage the contract worse than you would manage the program. Contract management is itself, particularly in services, quite an art. A lot depends on how well you've drafted your contract to give you the controls you need to keep your service levels up. It's not easy to outsource entire functions and do it in a way that guarantees the level of service you need and guarantees you performance."

    Wholesale Outsourcing
    Perhaps no other state has taken to outsourcing the way Florida has. Since January 1999, Florida outsourced 138 programs or services to private vendors, according to the state's Department of Management Services (DMS), a list that includes everything from food service delivery in state prisons to toll collections to the state's internal HR.

    Gov. Jeb Bush's administration clearly stated its belief that Florida's most efficient course of action is through contracting, and the DMS said Florida will continue to spend a significant portion of its budget on contracted services.

    The administration says many projects are outsourced because the state doesn't have a work force with specialized skills to perform a function or service; a project's up-front, capital investment makes the idea of a third-party vendor bearing those costs attractive; or that functions or services can be enhanced if performed by the private sector.

    The state's aggressive use of privatization has not been without problems. At the end of July, a report from the state inspector general was turned over to the Florida Department of Law Enforcement so it could be reviewed by the FDLE. The report covered a series of allegations that IT staff in several state agencies improperly accepted gifts
  • from companies bidding for state contracts. Two high-profile officials resigned from the Department of Children and Families in mid July as the media published accounts of the two men accepting gifts such as a ticket to the Masters golf tournament in Augusta, Ga., tickets to see Elton John and Alabama in concert, and expensive meals.

    The inspector general's report also noted that many of the improper gifts have been repaid.

    Gov. Bush created a Center for Efficient Government to evaluate the state's outsourcing efforts, identify opportunities for additional outsourcing initiatives and oversee execution of future outsourcing projects, DMS officials said.

    "We had engaged in many outsourcing activities previously and had a whole collection of learning -- some good and some not so good," said William Simon, DMS secretary and chairman of the center's Oversight Board. "The difficulty we were having was applying the learning consistently. The pain that one agency went through, we weren't really that good at transferring that knowledge to other agencies."

    The goal for the center is to serve as a clearing-house for successful enterprisewide outsourcing practices and principles. To that end, the center created a centralized "gate process" to determine the best source to deliver services.

    Any agency seeking to outsource a particular project must follow the gate process to get the project approved. The process ensures outsourcing projects are reviewed at critical stages before they advance to the next stage. It is also designed to make the outsourcing process more transparent and produce more predictable costs and outcomes.

    Outsourcing increases competition, and therefore boosts efficiency of government operations, Simon said.

    "We believe competition is critical to success, whether it be public or private sector," Simon said. "Governments, in general, have been immune to competition. There have been cases where we've reviewed projects for potential outsourcing, and for one reason or another, made the determination that they were not good candidates to be outsourced. But they went through the competitive process, and that's what's been missing. That's what outsourcing brings."
    Shane Peterson Associate Editor