Economic factors drive gov’t outsourcing to state and local levels

The phrase “government outsourcing” usually conjures up images of Washington, D.C., federal agencies and defense contracts. But a recent study suggests that the heaviest near-term growth in IT outsourcing may be set to occur at a more regional level: in state and local governments.

A report published last week by market research firm Input predicts that state and local governments will increase their IT outsourcing spending by a whopping 17% annually over the next five years, growing the sector from $10 billion in 2003 to more than $23 billion in 2008. This growth rate far outpaces the commercial outsourcing sector, which has been expanding at about 5% to 7%, and even the federal sector, which has shown growth of as much as 10%.

Why are state and local governments expanding their IT outsourcing efforts so rapidly? Some of the issues are economic. The economic downturn has had a devastating effect on most local tax revenues, creating real deficits in government budgets, Input points out. This budget shortage has sent many local governments looking to save money, and outsourcing is one way to help achieve those savings.

But the problem goes deeper. With low tax revenue, many local governments are losing their most skilled IT employees to retirement or to the commercial sector, yet they have very little available budget to replace those employees. The situation is causing a slow “brain drain” from local government IT shops, and the missing skills often must be acquired via outsourcing, Input notes.

Finally, many state and local governments are faced with antiquated IT systems that are becoming increasingly difficult to operate because of the shrinking base of employees with the training to run them. To control costs, state and local governments must upgrade their systems to more cost-effective technology that can be operated by a broader base of technicians. Yet, making those upgrades requires additional help and expertise – and is another driver for outsourcing.

State and local governments likely will put outsourcing providers to work doing repetitive administrative tasks, such as operations of local Medicare and Welfare systems, Input said. Increasing costs associated with new regulations, such as the Health Insurance Portability and Accountability Act (HIPAA), also are driving many state and local governments to outsource.

IT outsourcing at the state and local level previously was frowned on by local politicians, who feared that such contracts might be viewed as costing local jobs, Input observed. However, recent shifts in the economy, combined with the need to control costs, have helped many politicians to eliminate the stigma around outsourcing and make it a viable alternative.

While state and local outsourcing is set for rapid growth, outsourcing service providers should be careful about which contracts they bid on, Input warned. State and local governments have historically used the outsourcing request for proposal (RFP) process as a method of re-evaluating their own internal processes, and ended up keeping the work in-house. The RFP discussion essentially ends up being free consulting on how to re-tool the local government’s IT infrastructure and processes, Input said.

Despite these warnings, however, it does appear that state and local government contracts will be a strong opportunity for outsourcing service providers over the next several years. Expect to see IT outsourcing providers expanding their services regionally, and building relationships with local subcontractors in the weeks and months ahead.