The Primrose Path to Profits

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The Primrose Path to Profits

Executives at the nation's leading federal information technology services companies are bullish about the next few years with good reason: outsourcing, the overseas government market, and state and local business will generate growing revenues for the nation's government systems integrators.

Federal Sources Inc. of McLean, Va., has identified $26 billion in potential government outsourcing contracts made necessary by the daunting year 2000 software conversion problem and pressures to balance the federal budget.

As any contractor will tell you, outsourcing is not a new idea, but it has been slow to catch on in the federal government. Why? Union resistance and congressional concerns have been the biggest obstacles.

Nonetheless, more than half of 92 federal government executives recently surveyed by Federal Sources felt that outsourcing was gaining momentum in their agencies and that the economic advantages outweighed the disadvantages.

Predicting the future is a dicey business, but there's got to be billions in the government outsourcing market for some alert contractors.

Officials at Computer Sciences Corp.'s government division in Falls Church, Va., are aggressively seeking outsourcing dollars from the federal government as government bureaucrats warm up to the idea.

Says Pat Ways, vice president of business development in CSC's systems group: "In a year or so, we are going to be in the midst of a wave of federal outsourcing."

CSC, which is ranked No. 4 in Washington Technology's Top 100, had no revenues from outsourcing contracts just five years ago. Officials at No. 6 ranked Boeing Co. are eyeing federal outsourcing as a business opportunity.

No. 11 ranked Litton Industries, which purchased PRC last April, plans to attack the year 2000 market, as does No. 5 Raytheon E-Systems. Science Applications International Corp. is busily pursuing year 2000 work along with a host of other leading federal contractors.

It is also clear from Washington Technology's Top 100 list that federal contractors are bolstering their federal units' expertise through acquisitions and partnerships.

Besides assigning managers to chase year 2000 contracts, integrator executives are striking partnerships with other firms in pursuit of state and local cash and building alliances with foreign firms in search of international government contracts. About 25 percent of Hughes Information Systems' revenues in 1996 were from international government business. Parent company Hughes Electronics Corp. took the No. 15 spot on the WT list.

There are threats that could diminish revenues for some systems integrators, however. Stagnant defense budgets have helped propel a dramatic consolidation among the nation's largest defense contractors. That, in turn, creates a much tougher climate for the medium-sized defense contractors.

Such contractors face being shut out of the prime and subcontracting business as defense giants like Bethesda's Lockheed Martin Corp. and the 800-pound gorilla that could emerge from the proposed merger of Boeing and McDonnell Douglas, snare all the work.

Moreover, the government's growing use of General Services Administration schedules and emphasis on commercial procurement practices, along with pressure for continuous competition through the lifetime of often smaller contracts, is cutting profit margins for all contractors.

Those pressures will be felt most sharply by medium-sized contractors on our Top 100 list, making them easy targets for takeovers or markdowns. It is these contractors that are least able to deal with high bid costs, contract bundling, newer indefinite-delivery, indefinite-quantity contracts and corporate consolidation.

Then there's the more subtle threat; being left out of the future. Witness this week's mega outsourcing contract between Farmland Industries Inc. and Ernst & Young LLP, billed by company officials as a first-of-its-kind venture to manage information technology for the $9.8 billion agricultural cooperative.

Farmland Industries Inc. and Ernst & Young LLP have formed OneSystem Group LLC, a joint venture to provide business process and information technology solutions to Farmland and its member cooperatives.

Farmland's burgeoning IT requirements will thus be supported by "an inventive joint venture that aligns the incentives, risks and business objectives of OneSystem Group, Farmland and Ernst & Young," company officials said.

Under this model, Farmland and Ernst & Young will provide equal financing for the start-up of OneSystem Group, as well as staff and management. Farmland will pay OneSystem Group a set fee for core services and will compensate the joint venture on a fee basis for additional services or special projects. OneSystem Group anticipates revenues of $300 million to $500 million for the first five years of a 15-year agreement. This marked departure from traditional outsourcing, in which companies establish agreements with suppliers who provide a commodity service and then increase their profits by cutting costs, may hold some parallels for the government.

That outsourcing deal was overshadowed by Microsoft's move into television technology. If government systems integrators aren't careful, they may find themselves in a backwater without the glamour, people, technology, revenue or stock price to continue growing or avoid predatory mergers.

The prospect of being ignored while the commercial systems integrators wire the world pressures top industry management to look beyond their growing revenue and to stay on the cutting edge of systems integration.

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