IT Outsourcing and the Rise of the Virtual State

The new trend in government outsourcing: spinning off big IT projects to corporations. But does the private-sector tool work with the people's property?

by / August 31, 1997
More and more, governments are asking the private sector to become involved in managing and operating government technology through outsourcing -- a distinct form of privatization where functions of a public institution are transferred to the private sector. The trend has staunch proponents and growing political and public opposition, partly due to increased sensitivity to loss of government jobs through downsizing.

Arguments in favor of outsourcing IT projects generally include controlling and reducing the rising costs of information technology, achieving greater efficiency, and making technological solutions more responsive to change.

Yet there is concern that when some government functions are transferred to for-profit companies, service might ultimately suffer; that contractors who must focus on profit and loss cannot share the vision of local government leaders; and that outsourcing may prove to be a one-way street. "Few local governments have taken a previously outsourced information shop and brought it back in as an internal function," pointed out Michael Humphrey, business director of Public Technology Inc.

National Trend

A great deal of national attention was recently focused on a nearly $2 billion systems integration and reengineering project in Texas -- the Texas Integrated Enrollment System (TIES) -- which had been cited in some press reports as the largest single IT procurement in state government to date.

This initiative started when the Texas Legislature opened the door for privatization of some functions of the state Health and Human Services Commission (HHSC) -- a possibility which was only being explored. Nevertheless, various public/private consortia involving companies like Lockheed Martin IMS, IBM Corp., Andersen Consulting Inc., Electronic Data Systems Corp. and Unisys Corp. began preparing to bid on the job of overhauling Texas' human services infrastructure -- a sweeping project that would replace the hodgepodge of more than 12 independent entitlement programs with a single, integrated database to qualify applicants for a wide range of human services including food stamps, Temporary Aid to Needy Families, job opportunities and basic skills, and even medical services.

The goal was not only to reduce the state's administrative costs by 25 percent to 40 percent, but also to greatly improve the speed and accuracy of the eligibility determination process -- a process which currently involves scattered mainframe legacy databases and is still largely paper-based.

Public outcry from groups opposed to privatization of HHSC, especially the unions, led the White House to step in and disapprove the RFO that would allow the Texas HHSC to even begin asking the questions which might or might not lead to eventual privatization.

New legislation has now been enacted in Texas replacing the TIES program. HHSC is now the lead agency charged with formulating a new plan to reengineer the work processes in the state and to develop a new automation system to support this. As this new bill calls for automation of eligibility determination and service delivery, the scope of the new project may even be greater than the earlier TIES approach. The role that outsourcing will play in this new plan remains to be determined. Charles Stuart, HHSC associate commissioner for external affairs, emphasized that the new legislation (House Bill 2777) is very different from TIES because "the competitive element as been removed." The various government agencies involved are now working together rather than competing to develop a plan of action.

The bill also authorizes a new bond to finance the automation. "Under the TIES proposal, we would have been looking at the vendor community to in effect finance the automation," explained Stuart. "But that is no longer the case, so the state has to finance that itself -- anywhere from $150 to $200 million."

Once a new plan has been developed in consultation with a new legislative oversight committee, it still requires the final approval of both the Legislative Budget Board and the governor.

However, large outsourcing initiatives certainly are not dead. Recently, Pennsylvania Secretary of Administration Tom Paese announced his state will outsource the management of state agency data centers in an initiative to make the government "more customer-driven and cost-effective." In this case, the decision to outsource followed a study evaluating a range of options for data center reorganization, such as in-house consolidation, amalgamation under an outside vendor, and maintaining the current operational basis.

By opting for outsourcing, the state administration expects to save $127 million over the next five years. "By outsourcing, we don't have to buy a big new Unisys platform and a big new IBM platform," said Paese. "That is going to be the responsibility of ensuring we have the latest technology and people skills are kept up-to-date. Then we can focus more on desktop, distributed network and the like -- where we think people need the money spent as opposed to the big data centers."

By carefully involving all the "big players" over the year the plan was being developed, it has gone ahead smoothly. "We have involved, as much as we could, every single department," said Paese. "And before the announcement, I met with the union and told them what we were going to do and that we were going to spend money on retraining their people so that we had as little job loss as possible.

"I called every legislator in the affected area and explained what we had done for the last year and that we were not going to start the migration for another nine months to a year, a reasonable time frame to retrain people and get them refocused.

"It did help to make sure that they knew we looked at different angles and touched all the bases. A lot of people weren't happy with it, but they knew we really worked it pretty hard considering all the options."

Citing Michigan, Connecticut and Arkansas as other states where outsourcing solutions to data-center operations are being developed, Paese argued that there is a national trend toward increased outsourcing both in government and in private industry.

The Virtual State

The outsourcing trend in the private sector has gone hand in hand with the rise of the virtual corporation. Increasing global competition in the last decade has led corporations to downsize in an effort to maintain or increase output using less labor.

Beyond just increased efficiency, many Silicon Valley companies discovered cost-cutting, productivity and competitiveness could be enhanced by using the production lines of another company -- and the idea of the virtual corporation was born. Firms are keeping "headquarter functions" like research, development, design, marketing, finance and legal. But they are, more and more, outsourcing manufacturing activities, as well as building strategic alliances with other firms with increased specialization.

Richard Rosecrance, professor of political science and director of the Center for International Relations at the University of California, Los Angeles, suggested that we are now witnessing the development of the political counterpart of the virtual corporation -- the virtual state.

"The model of the virtual state suggests that political as well as economic strategy push toward a downsizing and relocation of production capabilities," said Rosecrance. "Outsourcing of government functions is part of the trend."

"That view is one which is hard to argue with," said Michael Moss, a partner with Gordon & Glickson, which provides legal services exclusively to the information technology marketplace. "Of course, the private sector is the model for having worked out outsourcing in a competitive environment. If outsourcing did not produce benefit for the company outsourcing, then the practice would not have stood the test of time and companies would not be doing it. It would seem pretty clear that while it might not be suitable for every governmental agency, there certainly are many situations where outsourcing is the smart thing to do. It works in the private sector, so there is likely to be similar benefits possible in the public sector."

However, Mark L. Gordon of Gordon & Glickson said government sector outsourcing involves a completely different set of dynamics. "The recipe of influence is just not the same," he said. "The assets of the government belong to the people. The way job structures are established is different in the public sector than in the private sector. And while politics influences many things, both private and public, politics is at the very core of the key elements of government. So its influence is going to be substantially greater and different than in the private sector."

The rules associated with how government enters into a relationship are also much more stringent and regulated than those a private-sector company must follow. Private-sector companies are free to develop a set of rules by which they want to do business. And they can change the rules to accommodate any given moment. The public sector is not afforded that kind of flexibility. It needs defined rules of how to do business and then it must arduously follow them.

Nothing New Under the Sun

This is not a new dawn in the modern trend of outsourcing. In fact, the public sector has always had business relationships with the private sector to provide goods, services, people and support operations. Gordon suggested the substantial difference in the current trend may be that the large scale of modern outsourcing deals puts them in a magnified light.

"There is no doubt that there is a focus on these issues that is new or different," said Gordon. "The reason for this, as best as I can conclude, is that the size is so significant. Also, services now being outsourced are the most critical [for] government -- information flow and control that frequently involves confidentiality and privacy. So outsourcing is occurring now on the most sensitive nerve-endings of the business of government. And I think a third factor that enters the mix is that these deals have a much more significant influence on the workforce than might have been true in past deals. Because of those three factors, outsourcing deals today are more complicated to achieve."

People tend to think of outsourcing and downsizing as going hand in hand, something which may or may not be true in any given deal. Sometimes outsourcing simply means a job shift, not a job loss. However, these transactions are very frequently viewed as reducing the workforce, and thus outsourcing projects has become a more complicated process.

There is also concern about certain government functions passing to the for-profit sector. Yet government has always had an interest in providing service at lower cost. And it has had an equally valid goal of providing service more efficiently. If in that context government provides profit to someone, that in itself does not violate any government policy. The private sector has been providing profitable work to the public sector for a long time. People who work for government in the private sector frequently make a profit. The government's goal is not to have its suppliers operate non-profitably. Here again, current public perceptions perhaps reflect more an increased sensitivity to these issues rather than an actual sudden shift.

It is an interesting side note that the outsourcing business first emerged in government, not in the private sector. The federal government had huge contracts with companies like EDS, CSC and SAIC, who were providing tremendous outside support services that would today be considered within the outsourcing market.

Making the Deal

Failing to be sensitive to all the factors at play in the public sector is perhaps the biggest mistake that can be made in outsourcing. "Whether it is the political part of the process, the rule part of the process or the workforce part of the process, if you fail to attend to those, you may have fatally flawed the ability to accomplish what you are trying to do," said Gordon.

"What do you do about it? A lot of it is educational. And a lot of it is engaging in the process in a consensus manner and not surprising the various stakeholders and constituents by permitting them to participate in a way that tries to get the blend of transaction that will satisfy all the stakeholders."

Putting together the outsourcing deal today is a participatory process. Gordon advises his clients to be patient. "It is not a rushable transaction," he said. "I think that most of the government deals which have progressed have done so over time. It is sometimes frustrating to people who see the opportunity and would like to move on it faster.

"I think an important element in the public sector in getting the deal done successfully is listening and providing forums for stakeholders so they can build consensus -- although not so much so that it is paralyzed. Someone needs to lead it and make it happen and you need to have the right folks who are sponsoring it at the highest levels of government to be successful. So the key to successfully outsourcing in the public sector today may be training, education, patience, the ability not only to talk but to listen.

"If you don't approach a project from that point of view, you make a mistake. I think a lot of people -- because outsourcing initiatives today are big and complicated -- are frequently intimidated by the process. Yes, they are big, they are complicated, but they are not unmanageable. And they have a lot of value if done correctly."

Private-Sector Lessons

There are also lessons which public outsourcing initiatives can draw upon from the private sector. Bob Forman is president of IMI, the IT services subsidiary of the Olsten Corp., which has provided IT outsource solutions to companies like British Telcom, Chase Manhattan Bank and Bell Atlantic. He says that his company is seeing a 50 percent increase in the level of business and that there is still dramatic growth of the outsourcing industry in the commercial sector. "I think companies see a lot of these functions as not core functions of their companies, and they want to focus on those things which they really see as the core value they can really deliver to their customers and clients," he said.

Forman said the key to putting together an outsourcing deal is ensuring that all parties have the same expectations of what's going to be done and how it is going to be accomplished. Equally important is a mechanism to allow the agreements to change as the world changes. "It is very difficult to predict what the requirements are going to be six to 18 months from here," he said. "Most of our agreements are structured so that we provide a base level of service and a way to do added things that come up which the user organizations request."

In drawing up a sound contract, each side lays out its duties and responsibilities and how they are going to work together. It also must be flexible enough to take into account emerging technology and changing social demands. "Once the process is done, if it is a really good contract, you put it in a drawer and you never have to pull it out again," said Forman.

Forman predicts that as state and local governments get more involved in outsourcing business models, there will be even broader opportunities and a reassessment of some of the players involved in this market. "From a government standpoint, if they are not outsourcing chunks of work, they are not really doing a lot to manage down their bottom line," he said.

One aspect of the outsourcing trend which local and state governments will increasingly grapple with has yet to become a pronounced political issue. "Once you establish a telecommunications link, you can be virtually anywhere," said Forman. "We are in fact doing work in the U.K. for U.S. clients. Or you can be in the States with ties into a data center in India."

This is one aspect of IT outsourcing -- and the rise of the virtual state -- which is likely to become a hot political issue in the years ahead. "The world's attention continues to be mistakenly focused on military and political struggles for territory," said Rosecrance. The virtual state, he suggested, represents an emancipation from the land and an increased orientation to the global marketplace. What impact this will ultimately have on state and local government remains to be seen.

For more information, contact Michael Moss of Gordon & Glickson at 312/321-1700 or on the Internet at .

"Services now being outsourced are the most critical of government ---- information flow and control that frequently involves confidentiality and privacy. So outsourcing is occurring now on the most sensitive nerve-endings of the business of government."

"Services now being outsourced are the most critical of government ---- information flow and control that frequently involves confidentiality and privacy. So outsourcing is occurring now on the most sensitive nerve-endings of the business of government."

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