Money in the middle: Analyst claims midsize states are at cutting edge of IT

Jim Krouse

Systems integrators and IT companies that want to keep abreast of the latest trends and innovations in state and local contracting need look no further than midsize states.

"Follow what the tier-two states are doing for the next few years if you want to gaze into a crystal ball," said Jim Krouse, manager of state and local market analysis for Input Inc., Reston, Va. "They are the laboratories for change."

Focusing on states such as Arizona, Maryland and Virginia runs counter to conventional wisdom. But contractors that concentrate on large states such as California, Florida and Texas may miss where the market is headed, Krouse said at Input's March 30 MarketView 2005 Conference in Falls Church, Va.

For example, Arizona implemented a self-funded tax system and also embarked this year on a groundbreaking, statewide, voice over IP outsourcing initiative. Both Maryland and Virginia have used IT governance boards to oversee enterprise initiatives, and Virginia also is pursuing a statewide IT outsourcing project in the wake of the recent failed effort by Florida.

Input defines large states as those with a population of more than 8 million, and midsize states as those with a population between 3 million and 8 million. It defines small states as those with a population of fewer than 3 million. Local governments operate similar to the governments of small states.

Other midsize states worth watching this year are Massachusetts, Oregon and Washington, Krouse said.  

MARKET WILL GROW

State and local IT spending is expected to grow by a compound annual rate of 8 percent over the next five years, from $47.7 billion in fiscal 2005 to $70 billion by fiscal 2010, according to Input's State and Local IT Market Forecast released this month.

The state and local market will experience moderate growth in IT investments this year with the market accelerating through 2006, the report said. Beginning in 2007, the need for outsourced IT services will drive significant spending through 2010.

Professional services will continue to lead state and local IT spending, followed by telecommunications and networks and then software. Professional services is expected to grow at a compound annual rate of 14.2 percent from $11.1 billion in 2005 to $21.6 billion in 2010.

The second fastest growing area is telecommunications and networks. Initiatives for advanced, interoperable communications systems for coordinating law enforcement, border security and homeland security will fuel growth there.

The state and local market had a turnaround last year following its largest gap in 30 years between tax revenue and gross domestic product. The GDP grew at an average rate of 4.4 percent in fiscal 2004 and is expected to level off at 3.5 percent in fiscal 2005, according to Input. State budgets are growing parallel with the GDP as part of an overall national economic recovery, Krouse said.

Budget returns for fiscal 2004 showed 35 states where revenue projections were outstripping forecasts, 10 states where projections were meeting forecasts, and five states where projections were below forecasts.

Still, integrators shouldn't expect to see an immediate increase in new opportunities, Krouse said.

"Government spending is improving, but there will be no windfall over the next couple of years following the flush budgets," he said.

 

MONEY STILL TIGHT

Doug Robinson, executive director of the National Association of State Chief Information Officers in Lexington, Ky., said that states are in "a permanent state of fiscal constraint."

State CIOs are wondering whether state budgets will continue to rise and are worried that there will be a "mad rush" by agencies to embark on large IT projects as a result, he said. They continue to be interested in IT consolidation and reorganization across state government, Robinson said.

But the number of IT outsourcing opportunities should increase substantially from 2007 to 2009 as the political backlash against it dies down, and workforce shortages force governments to embark on outsourcing strategies, the report said.

Some governments will be more willing to consider IT outsourcing than others, said Michael Moore, San Diego County's CIO, who oversees the largest local government outsourcing project in the nation. CIOs often are reluctant to consider outsourcing as an option, because it can mean a reduction in their authority, he said.

Outsourcing is risky to the private sector, said Michael Kerr, director of the enterprise solutions division of the Information Technology Association of America in Arlington, Va. He said outsourcing requires a large investment by contractors and often involves terms and conditions that pose high risk.

Vendors should be patient for the next couple years while agencies continue working in a risk-averse mode, Krouse said.

"In about three years, we will see that trend end as state and local agencies are forced to find outside expertise to replace a retiring workforce," he said. "The only choice many of these agencies will have will be to outsource non-competencies, such as IT services, which will open vast opportunities to IT contractors."

Senior Writer William Welsh can be reached at wwelsh@postnewsweektech.com.

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