Fed IT Spending Prospects Dimmer This Year

The twin effects of a general economic slowdown and the change in administration have clouded business prospects for government information technology companies in the upcoming fiscal year.

The Bush administration, which has proposed a 2002 federal budget that increases IT spending just 1 percent over this year's expenditures, is sending mixed signals about its support for electronic government and other technology initiatives, said industry officials.

For example, although the ad-ministration has said it wants to beef up information security, "there are some real questions whether the dollars are there to match the rhetoric," said Harris Miller, president of the Information Technology Association of America, Arlington, Va.

The president views tax cuts, not technology, as a top priority, Miller said.

Adding to the uncertainty about federal IT spending, the secretary of Defense has initiated a strategic review of the military, which could alter dramatically the budget sent in April by the administration to Congress.

But Dan Chenok of the Office of Management and Budget has noted that federal spending on information technology has exceeded budgetary levels for the past two years.

In fiscal 2000, the government planned to spend $34.2 billion but actually spent $41.2 billion; for fiscal 2001, the budget was set at $39.7 billion, but expenditures to date indicate the government will spend about $44.4 billion, said Chenok, the branch chief for information policy and technology in OMB's Office of Information and Regulatory Affairs.

While many industry and government officials are hopeful the president's proposed IT budget of $44.8 billion for 2002 will experience similar increases, they foresee greater competition among IT companies scrambling for scarce government dollars.

"This is going to be a tough year," said Jim Kane, president of Federal Sources Inc., McLean, Va. "From the standpoint of the budget [and] because of the slowdown, we see increased price competition, while differentiation is more of a challenge."

Kane, Chenok and Miller offered their views at a May 10 conference examining upcoming trends in government IT. The conference, Federal Outlook 2002, was sponsored by Federal Sources, a research and consulting firm.

The federal IT market will be driven more by administration policy than by legislative initiatives in the upcoming year, said Kane. He cited directives issued by Mitch Daniels, the new OMB director, calling for more accurate and easy-to-use inventories of federal employees under the Federal Activities Inventory Reform Act and the streamlining of the A-76 public-private competitive process. The General Accounting Office also has formed the Commercial Activities Panel to review outsourcing policies and practices.

After the conference, Kane said he wouldn't be surprised if new budget numbers for defense spending are not available until at least July, but he downplayed any significance in the lack of detailed information about the Pentagon's plans. "There's a lot of stuff already in place," he said.

The president's defense budget for 2002 proposes a lump sum of $21.5 billion for IT, just under current spending levels.


width="250">
<>
class="storywhite">IT Plans vs. Reality
Federal IT Budget Proposal vs. Actual Spending (In $ Billions)

 
Proposed
Actual
Percentage
Increase


FY2000
$34.2
$41.2
20.5


FY2001
$39.7
$44.4*
11.8

FY2002
$44.8
 
 
*Projected
Source: OMB, Federal Sources, Inc.




Even if overall federal IT spending remains flat, there are pockets of good opportunities in the federal marketplace, particularly in the areas of outsourcing, e-government and information assurance, Kane said.

Outsourcing is projected to grow 30 percent in fiscal year 2002, reaching more than $6 billion, he said. But he said the proposed Truthfulness, Responsibility and Accountability in Contracting Act, union-backed legislation to block outsourcing unless benefits can be proven, would hamper the administration's push for more outsourcing if approved by Congress.

Another factor is the wait-and-see attitude in other agencies toward the Navy-Marine Corps Intranet project, Kane said. NMCI is the eight-year, $6.9 billion dollar seat management program to provide services for up to 360,000 sailors, Marines and civilian employees. The project is so large, complicated and innovative, both civilian and military agencies want to see if it is a success before they take a similar plunge.

E-government is expected to reach $2.2 billion in fiscal 2002, Kane said, an increase of 30 percent. This is an area that could benefit from the administration's desire to hold down costs and trim federal payrolls. "It's sort of a classic capital-labor substitution," he said.

Information assurance, on the other hand, is getting a lot of attention, though Federal Sources estimated it would grow somewhat more slowly ? 15 percent in fiscal 2002 to almost $2 billion.

The challenge in identifying opportunities in information assurance and security is that it's usually included as an element of IT projects rather than as a project in itself, Kane said.

The government IT market continues to provide a source of long-term, stable opportunities for high-tech companies, according to financial analysts, but they also said a variety of competitive pressures are going to put the squeeze on some companies, particularly small and midsized firms.

It's "the death of the middle," said Robert St. Jean, vice president of e-business and IT services research with JPMorgan H&Q, a subsidiary of New York-based JPMorgan Chase & Co.

Both economies of scale and the technological trend of convergence demonstrate that size matters in this industry, he said. Pursuing a niche strategy, developing critical expertise in a narrowly defined area, only works so long, because sooner or later the niche disappears, he said.

Jerry Grossman, managing director for Los Angeles-based investment banking services firm Houlihan Lokey Howard & Zukin Inc., said that Wall Street is developing a greater appreciation for companies that do business in the federal sector, but it's not all rosy.

The good news is federal spending on IT is rising, he said, but not as fast as Wall Street financiers would like. This puts pressure on companies in the federal market.

"If there is pressure to have 15 percent growth in a segment growing just 1 percent, [that] forces rationalization," Grossman said.

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