High Hopes, Top-Level Talks Fail To Save Billion-Dollar Deal

High Hopes, Top-Level Talks Fail To Save Billion-Dollar Deal<@VM>No Cakewalk<@VM>So What Killed the Deal?<@VM>The CEO's Role<@VM>Tenacious Union Opposition<@VM>Dwindling Support<@VM>Looking to the Future

Moira Lyons

By Steve LeSueur, Staff Writer

Chief negotiators for Electronic Data Systems Corp. and the state of Connecticut thought until the very end that they would hammer out a multibillion-dollar deal to hand the job of running the state's computer services to the company.

But six months of ticklish negotiations between representatives of the state and the Plano, Texas-based integrator, punctuated by phone calls between the governor and EDS' top executive, failed to save the billion-dollar outsourcing deal.

"This makes so much business sense that it was hard not to imagine it being signed," said Bill Dvoranchik, EDS' managing director of the Connecticut project.

While the intense negotiations produced its "good days and bad days," said Rock Regan, Connecticut's chief information officer, "I was pretty confident all along" that the deal would be struck.

But in late June, after the two sides had settled on a price of $1.35 billion over seven years for EDS to run the Connecticut's information technology services, negotiators could not agree on another price tag: the amount Connecticut would pay if its computer processing needs increased over time, company and state officials said.

Connecticut Gov. John Rowland and Richard Brown, EDS' new chairman and chief executive officer, spoke for the last time June 23.

"Both men wanted this to happen," said Regan.

After that call failed to move the talks along, Regan decided it was time to quit.

On June 28, Regan recommended to Rowland that the state terminate negotiations. Rowland concurred and called Brown the morning of June 29 to tell him of the decision.

At a hastily called press conference later that morning, Rowland announced that Connecticut was canceling the project. What's more, he said, the state would modernize its IT systems in-house and rely on outside vendors only for smaller, more focused projects.

With that, the most widely watched outsourcing project by a state government came to an abrupt, quiet end.

When Rowland announced in December 1996 his plan to make Connecticut the first state to outsource its IT services to a single vendor, he envisioned the state becoming a model of innovation and efficiency. The governor predicted his state could save as much as $50 million a year by using modern technology to transform government.

Elated EDS officials said the project would showcase the company's outsourcing expertise and help open the door to similar projects throughout the country. EDS was selected over IBM Corp., Computer Sciences Corp. and the state's employees union for the job in December 1998.

"This is a major step in changing the landscape of government outsourcing," George Newstrom, group executive of the EDS Government Services Group in Herndon, Va., said at the time.

Contract negotiations between EDS and Connecticut were expected to last no longer than the end of April. But Connecticut and EDS officials also recognized many land mines lay ahead.

The deal was opposed fervently by the state's roughly 700 IT employees whose jobs would be privatized by the deal.

After a contract was negotiated and signed, state auditors would review it for the state legislature, which could veto the deal with a three-fifths vote in either the House or Senate. The House vote was worrisome particularly because Democrats outnumbered Republicans 96-55; they needed only 91 votes to defeat the Republican governor's planned deal.

While no one involved in the project regarded the negotiations as a cakewalk, few thought they would be the place where the project died. Indeed, there was a strong desire among Connecticut and EDS officials to strike a deal.
In announcing the project's termination, Rowland said there was too much uncertainty about the state's costs in the last years of the contract. An escalating price would eat away at expected savings, and this posed an unacceptable risk to the taxpayers.

"EDS wouldn't commit to the price," Regan said. "That was the heart of why we pulled the plug."

The $1.35 billion contract the two sides initially agreed upon was based on expectations about Connecticut's IT requirements, especially forecasts of utilization rates, or raw data processing, over the next several years. Connecticut officials were confident of their utilization forecasts for the first several years, but "it was anyone's guess after that," Regan said.

EDS calculated a price for the potential increases in volume, but state officials considered that price too high. Regan said he was afraid the state "would be paying more than it should when things changed downstream."

EDS officials saw things differently: Connecticut wanted the company to provide virtually unlimited increases in processing volume for free.

"This was a fair deal for EDS, but not a great deal," Dvoranchik said. "We weren't out to make a killing."

It will cost Connecticut about $1.48 billion to run its own computer services over the same seven-year period, according to state estimates. This is only about $18.5 million more per year than the proposed EDS contract.

But Dvoranchik said that EDS would have achieved Connecticut's goal of saving an average of $50 million annually by modernizing its IT systems and by streamlining government operations. The state will spend hundreds of millions more to reach the same outcome, he said.

"It was a political decision to kill the project," Dvoranchik said.
The willingness of EDS to walk away from this prestigious contract, probably the most coveted IT outsourcing deal for a state government, has prompted speculation among analysts that Brown had a strong hand in the deal. Brown became chairman earlier this year with the expectation that he would cuts costs and pump up earnings for the $16.9 billion systems integrator.

Some analysts wondered whether a pre-Brown EDS might have given in to Connecticut's demands, foregoing profits on this deal to use it as a lever to land future contracts. One analyst noted that the contract would have almost certainly "blown up" under this scenario a year or two down the road.

But with Brown's attention to the bottom line, EDS would not agree to a contract whose costs easily could spiral out of control.

Dvoranchik said EDS' negotiating position "was consistent with the direction that Brown has set for the company." And Brown "has been intimately involved with the deal for the last several months," he said.

But Dvoranchik disagreed with the notion that EDS might have signed an unprofitable contract in the past. "Why would any business want to do that?" he said.
Rick Melita, a spokesman for the Connecticut State Employees Association, said it is telling that Rowland did not blame the unions or Democrats in the state legislature for the failed project.

Rowland said EDS could not guarantee the savings, and that the state "didn't have enough flexibility," said Melita, whose union represents Connecticut's IT workers.

"This is what we've been saying from the beginning, that it's a bad idea and that they should have been insourcing all along," he said.

By all accounts, Melita and his union were tenacious opponents of the outsourcing deal, adopting an in-your-face campaign that helped stretch the outsourcing project by challenging nearly every aspect of the governor's plan.

The union also took the governor's basic justification for outsourcing and turned it on its head. While Rowland contended that the state's IT employees lacked the skills or expertise that private-sector companies could bring to the table, the union asserted that, in reality, it was the large systems integrators that have performed poorly on IT projects.

"The vendors in the state of Connecticut have ripped us off," said Melita.

EDS was a favorite target of the union, which attacked the company's performance in modernizing computer operations for the state's Department of Social Services. The union found an ally in Democratic State Comptroller Nancy Wyman, who, after investigating EDS' work with the department, labeled the 1994 project a boondoggle.

"If EDS couldn't handle this single project, how can the administration consider them the front-runner for the biggest contract in state history?" she said.

EDS officials contended that these attacks were misleading and often inaccurate.

"Our performance on past contracts was outstanding," said Dvoranchik. "People went back 15 years to harp on our performance."

A Department of Social Services spokesman supported Dvoranchik's claim, stating that despite problems with the one project, EDS has performed satisfactorily for 18 years processing Medicaid claims and providing other services.

"If we were not happy with EDS, we wouldn't have continued in this ongoing relationship for all these years," said Claudette Beaulieu, a spokesman for the department.

Although EDS has a long history of bringing IT workers into the company when it takes on outsourcing projects, Connecticut's employees strongly resisted the signing bonuses and other enticements to join the company.

Partly as an effort to gain union support, EDS and state officials in late May said union members would be given the choice of joining EDS or remaining as state employees after outsourcing began.

"I knew the deal was in trouble when they offered us that concession," said Melita. "They needed to get us off their backs."

Nevertheless, union members remained staunchly opposed, and Melita estimated that little more than 5 percent would have joined EDS had the outsourcing project gone forward.

This last-minute concession, giving employees the option of remaining with the state, introduced another level of complication into the already shaky negotiations.

Although both Regan and Dvoranchik insisted they were able to work through this new contract wrinkle, industry observers said the option reduced EDS' flexibility in performing the work, because it lost some control over a key asset: the people.

"Giving employees the option of remaining with the government significantly changes the economics of an outsourcing deal for vendors. It typically results in lower margins and increases risk," said Thomas Davies, a senior vice president with Federal Sources Inc. of McLean, Va.

"Allowing employees to stay with the buyer has always been one of the downsides for outsourcing vendors in the public sector, compared to the commercial market," he said.
After four months of negotiations failed to produce agreement on a contract, a new goal was set: June 15. But as this day approached, rumors circulated about the new offer to state employees.

There were also press reports that the seven-year contract had risen to $1.5 billion from slightly more than $1 billion.

The actual price under discussion was $1.35 billion, said EDS and state officials. The increase resulted from re-estimates of Connecticut's inventory and expected IT requirements and were not based on any increase in EDS' rates.

But "the rising cost was a concern to everybody, to the executive branch, too," said Moira Lyons, Democratic speaker of the Connecticut House. "We thought there were going to be certain cost savings, but it appeared we weren't going to save money."

While Lyons and many others remained noncommittal, saying they wanted to see the contract before making a decision, support for the project appeared to be slipping.

"We had more opposition in the legislature now than in 1997," said a state official.

While Rowland never offered this as an explanation for terminating the project, many observers believe that he added up the votes and saw they were not there.
When speaking about Connecticut's ambitious outsourcing effort, Rowland once said: "Failure is not an option." Although this bold statement has been ridiculed by opponents of the deal, Regan insists that the state has not failed.

"Our goals are still the same, to modernize information technology and use it to transform government," he said.

The state's information technology department already is laying plans to create a management oversight team to provide strategic planning to begin the work.

Regan said the state will apply what it learned from EDS and other companies to improve government services.

Connecticut's employees are happy with the new plan, which will make them an integral part of the state's modernization efforts. The legislature likely will be receptive to this approach.

"The final decision was the right one," said Lyons. "We all realize that we have a problem. The question is what's the best way to solve it."

Regan said he still thinks EDS is a good company, and that Connecticut intends to use EDS and other companies for smaller outsourcing projects to complement the state' own resources.

"We've only failed if we don't act on our goals," he said. "We're going to continue moving forward."

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