Washington Technology Online - Eye on the States

Performance-Based Contracts Create New Opportunities

By Thomas R. Davies
Contributing Writer

New methods of financing information technology projects are changing the ground rules of the state and local government market. States, cities and counties are beginning to free themselves from the constraints of traditional approaches to financing IT projects.

Once limited to just a few revenue sources for IT projects - primarily property taxes, income taxes and sales taxes - state and local governments found it very difficult to find the budget to make significant commitments to new IT initiatives. Now, however, these buyers are turning to grants, user fees, bonds, court settlements, surcharges, and even citizen contributions, to finance investments. This is resulting in rapid growth in the IT market for state and local government - by some estimates over 10 percent annually - that is outpacing the overall growth in state and local government tax revenues.

Of all the new approaches to financing IT projects, performance-based contracting offers the greatest promise of fundamentally changing the game of how buyers buy and how sellers sell.

Going by a variety of labels - shared benefits, shared risks, performance based - this innovation in business practices has met with tremendous success. It has not only opened up the market for exciting new opportunities, it gives new meaning to the frequently heard marketing pronouncement, "We want to be your partner."

The California Franchise Tax Board has established a strong track record in implementing performance-based purchasing. And it is now moving across the country with the state of Virginia entering into contract negotiations for a performance-based contract that is expected to exceed $100 million. Initially focused on revenue-generating programs, such as tax collections, state and local governments are now considering how to migrate the practice to other areas such as reducing costs and improving the efficiency of government services.

Under performance-based contracting, buyers no longer need up-front capital to make new IT investments. They simply need to have a business problem and a willingness to enter into business partnerships with companies. The latter, in turn, must be a firm commitment to delivering improvements in the performance of government or risk losing some, or all, of the expected revenues and profits from the project. The risk exists because payments to contractors are generated from measurable improvements in the performance of the government program; no performance benefits means no payments.

Where will this new approach take state and local government? Almost anywhere policy makers and the industry want to take it. Ideally suited for large, complex systems integration projects, this new buying model is potentially attractive to all types and levels of government. IT companies are considering adopting a "Field of Dreams" marketing model in exchange for long-term contracts. They are actively planning how to proactively market IT-based business partnerships that are not dependent upon funding from traditional government appropriations.

Companies with pre-existing capabilities, technologies and resources - such as subject-matter expertise, consulting skills, networks, data centers, software and financing - benefit significantly from this new model. By assembling these capabilities and resources, either through alliances or under one company umbrella, these companies are positioned to uniquely deliver on the value proposition of improving performance. IT companies are also finding themselves in the position of having to develop deep pockets of expertise in the performance of state and local government programs. It is no longer adequate to simply understand the latest technology, assist government officials in implementing and using it, and then walking away. Companies are now staying around and taking responsibility for delivering actual performance improvements in programs and services.

This new trend gives IT companies that have built government consulting capabilities a distinct advantage. They are able to create their future by working with customers to discover where performance improvements can be captured. Government officials are increasingly looking to IT companies to proactively identify opportunities for performance improvements. This requires knowledge of the best practices in the industry. It also requires tremendous insight into how government programs compare to one another in their relative performance. Targeting of attractive partnership opportunities needs to take into account not only the IT but also other factors that facilitate or inhibit government performance.

The trend to performance-based government is accelerating the movement to this type of buying and selling. As all levels of government respond to citizen pressures to improve the performance of government, they are seeking ways to do so without increasing taxes. This is resulting in significant constraints on the availability of new funding for improved operations. Therefore, government officials can be expected to continue to look to private industry for these funds.

By turning to performance-based contracting, and relying more on nontraditional sources of financing, the state and local government IT market is becoming much more commercial-like. Companies that can actually deliver on the promise of using technology to reduce costs, improve productivity and enhance services will be the winners.

Thomas R. Davies is vice president of Federal Sources State and Local Government Consulting practice in McLean, Va.