Outsourcing: Look Who's Out Of Sorts

Strapped government agencies are making budget and time demands on their contractors

When Electronic Data Systems Corp. (EDS ) blew a Dec. 1 deadline to turn on a new Medicaid claims-processing system in Tennessee, state officials decided to fight back. They had outsourced such work to EDS for nearly a decade without a blip. But now the budget had tightened, Medicaid costs were skyrocketing, and the creaky mainframes EDS was supposed to replace were partly to blame. Besides, state officials say, EDS was already two months behind schedule. So for each day of delay, Tennessee is levying a $32,000 fine. An EDS spokesman says the system is expected to go live in a few weeks, but one state official says "the governor is not happy."

He's not the only one. Across the country, public-sector customers are putting the screws to information-technology outsourcers and systems integrators who they don't think are measuring up. Never mind that these companies were once hailed as partners in modernizing government and saving taxpayers money. With government spending on IT services set to rise at double-digit rates this year and competition heating up, public officials "know they have leverage," says Gartner Inc. analyst Lorrie Scardino.

The pressure comes as many IT companies continue to count on government work to replace weak demand from the private sector. Like corporate customers, however, state and federal agencies have been eyeing contracts granted tech outfits during the boom. In many cases, they're scaling them back or demanding more favorable pricing. "Government's a lot smarter now," says Mark Forman, who was chief investment officer of the federal government from 2001-03.

WITHHOLDING $1.6 BILLION

If the bureaucrats don't get what they want, they are prepared to play hardball. Take Computer Sciences Corp.'s (CSC ) $8 billion contract to overhaul the Internal Revenue Service's 40-year-old computer systems. The IRS says parts of the project are more than two years behind schedule and running over budget. CSC, which generates 42% of its revenue from government contracts, says it's "confident the project will be in place during 2004." But an IRS oversight board is recommending firing CSC if its performance doesn't improve by the end of this year. "It would be a very difficult decision," says Fred Forman, IRS associate commissioner of business systems modernization. "But believe me, we're very much thinking about it."

The U.S. Navy, meanwhile, has delayed $1.6 billion in payments, saying that EDS has missed key milestones on a project to install a new communications network. The state of Georgia, citing failure to meet expectations, has terminated part of Affiliated Computer Services Inc.'s (ACS ) $350 million contract to upgrade a health-claims processing system. ACS says it's now working.

MISSION ACCOUNTABLE

As the Feds and states put out new projects for bid, they're ratcheting up demands, making contractors give up fees and bonuses if they don't meet performance targets. Some are going even further. The Transportation Security Administration, which oversees airport screening, aims to hold its contractor Unisys Corp. (UIS ) responsible not just for the new computer system it is installing, but for TSA meeting its overall mission.

How will IT contractors deal with suddenly impecunious governments? What they'd love to do is send such tasks as software development, paper processing, and help-desk support to India and China. But while small pieces of government work now quietly go abroad -- to call centers for some state welfare programs, for example -- several state legislatures are considering banning the practice to protect U.S. jobs.

The upshot: Tech contractors will have to find ways to reduce their costs at home -- and keep their newly assertive government customers happy.

By Andrew Park, with Dean Foust in Atlanta, and Paul Magnusson in Washington

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