Market Watch: Sizing up who will succeed in government IT market

The size and scope of the opportunity in this sector can differ from company to company, depending on the degree to which each company has aligned its thinking and organized its resources with market realities.

The continuing migration in government IT from staff augmentation to outsourcing shows no signs of abating. Historically, government agencies purchased support services to augment employee teams, managed by supervisors. Today, government executives are looking to buy solutions.

Government entities, faced with shrinking staffs and retirements of key people, want full-scope capabilities from their service providers, including situational analysis, alternatives identification and selection, solution architecture, implementation and -- increasingly -- operation.

There are other factors supporting these IT contracting trends. Military transformation has high-priority focus on interoperability. The communications element within and between organizations is paramount. And IT capability is the foundation, the platform upon which interoperable communications systems will be designed and implemented.

Systems modernizations at the Internal Revenue Service, Federal Aviation Administration and U.S. Customs Service, among others, will require complex, enterprise-scope solutions. Another factor is government reorganization, most particularly the creation of the Department of Homeland Security.

As a consequence of the number and scope of government IT projects, the emergence of Web-based systems and the goal of improved data sharing among agencies, the Office of Management and Budget set forth 24 e-government initiatives and placed a temporary hold on major projects pending OMB review.

Taken together, these government objectives, and the priorities attached to them, provide a target-rich market for well-positioned government IT companies.

For some IT businesses, the emerging environment is more of a threat than an opportunity. Segmentation of IT companies into four tiers helps in assessing the performance outlook. Based upon revenue size, the breakdown is: tier 1, more than $1 billion; tier 2, $250 million to $1 billion; tier 3, $30 million to $250 million; tier 4, under $30 million.

Successful companies will combine all elements of an effective solution into their offerings.

This is a very complex environment, requiring significant resource mobilization, pricing, costing, negotiating and project management skills. While staff augmentation has its place, it will capture a shrinking proportion of government budgets, generally, at lower margins.

Typically, tier 1 companies will lead on large, complex IT projects. In these circumstances, companies in tiers 3 and 4 will serve as subcontractors. For most of the smaller IT projects, companies in tiers 2 through 4 will be best cast in a prime contractor role.

Focus and depth in critical IT segments will increase in importance for all companies, but is most critical for tiers 2 and 3. Companies in tier 4 will continue to benefit from contract set asides under 8(a) and small business preference programs.

At the end of the day, the winners will be companies that can think in terms of problem-solving based upon available IT. The size and growth of government information management needs, considered in the context of ongoing upgrades in technology tools, suggest a long-term, robust market for government IT companies.

Well-managed companies can expect double-digit, organic revenue growth, profit margin expansion and acquisition opportunities.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hlhz.com.