It’s the best of times. It’s the worst of times.

That sums up the outlook for state, local and education (SLED) public-sector IT spending as many states struggle with falling tax revenues and growing budget deficits. But the spending patterns are definitely mixed. States riding high on record energy and natural resource prices have largely escaped the growing economic malaise that has hammered regions hit hardest by the housing and credit crises.

In July, for example, the National Conference of State Legislatures (NCSL) issued its State Budget Update and reported that state budget shortfalls more than tripled this fiscal year compared with last year’s gap. The report, based on data collected from state legislative fiscal directors in June and early July, showed that state budget gaps for fiscal 2009 are projected to grow to more than $40 billion compared with about $13 billion for fiscal year 2008.

The report includes information on budget gaps for fiscal year 2008, revenue performance through May and budget gap projections for fiscal year 2009.

California, for example, faces a $15.2 billion deficit for its current fiscal year, which began July 1. Not only has California been hard hit by declining tax revenues tied to the mortgage crisis, but also an unprecedented number of wildfires has overwhelmed the state budget for emergency services.

The deficit prompted Gov. Arnold Schwarzenegger late last month to eliminate 22,000 part-time and temporary state positions and ordered 200,000 state workers to be paid only the federal minimum wage.

Kevin McDonald, executive vice president of Alvaka Networks Inc., an advanced network services solution provider in Irvine, Calif., said solution providers selling IT products to the state should proceed with caution.

“You may not get paid,” he warned. “Or you may get paid, but you are not going to get paid on time. If you look at the margins for many companies that are carrying a line of credit to support your sale, then a 60-, 90- or 120-day delay could put people out of business. You certainly will lose your margins.”

McDonald said that because of difficulties small businesses have dealing with the state, Alvaka chooses to do no business with California. Rather, it concentrates on offering advanced network managed services to municipalities, a business that continues to be robust.

“Cities aren’t adding anything new, but because we are a managed service maintaining their status quo, cities have to run,” McDonald said. “We are a better return on investment than having internal staff. For the City of Industry and Huntington Park, we run those cities entirely. We are not going to see new hardware acquisitions and I think there will be substantial cutbacks for anybody that is selling stuff. We don’t and we are doing just fine.”

Safety First

Ironically, even in the midst of the state’s worst budget crisis, Schwarzenegger’s executive order spared public safety agencies. Solution providers active in the SLED market say that while overall IT spending is tightening up, IT money for essential services is still available.

State CIOs attending last month’s Emergency Management Information Technology, and Archives and Records Management conference in Atlanta indicated that spending on records management and security remains a top priority.

“Iowa has just experienced record-breaking flooding,” Iowa CIO John Gillispie said in a statement from the conference. “Access to public records was critical during the response efforts and will be invaluable during recovery.”

He said strong interest in the conference on the part of state CIOs confirms the significant impact states see from loss of essential records and their willingness to address the security and preservation of that critical data.

All of these factors highlight both the danger and the opportunity awaiting solution providers active in the SLED market.

Solution providers in states pummeled by the mortgage crisis say state IT contracts are being scaled back or scrapped.

“In Florida, we’ve seen a huge cutback [in state IT spending]; everybody’s budget just got slashed,” said Dave Gilden, a partner in Acuity Solutions Inc., a Tampa, Fla.-based security and networking consulting solution provider. “Our year-over-year state business has seen a substantial slowdown; it’s off by 50 percent. Product purchases and new projects have been put on hold.”

By contrast, Gilden said his higher education business is holding up nicely.

“We’re not seeing the same impact in education. There is some trickle-down impact from the state on local government, but anything that is ‘Florida Department of’ is getting hit the hardest,” he explained.

Meanwhile, in the Rocky Mountain West and Texas, there is no discouraging word in SLED spending.

“We’re energy rich and have a lot of tax dollars available and [business] is really no different than we’ve seen over the past three to five years,” said John Palley, general manager of business development at ISC Corp., a solution provider in Casper, Wyo., which generates more than 60 percent of its business from the SLED market.

And Jay Uribe, president and co-founder of Mobius Partners, San Antonio, said his local government and education business is up about 50 percent so far this year over last. “I’ve seen more strength in the local governments than anything, but education has been up as well,” he said.

Uribe says that booming energy prices have helped Texas dodge any economic bullets and he sees no slowdown on the horizon for his government and education business.

The NCSL acknowledged that the state fiscal crisis is spotty. “Not every state is facing challenges,” NCSL Executive Director William Pound said in a statement. “States that have significant portions of their tax bases tied to natural resources seem to have escaped major budget problems.”

Yet NCSL said the housing crisis is impacting budgets in 17 states, while natural resources were bolstering budgets in 10 states.

Mike Humke, vice president of Public Sector for Hewlett-Packard (NYSE:HPQ)’s Solution Partners Organization, said solution providers hoping to bid on new projects in the SLED space are in for tough times. “There are no big new projects,” Humke said. “It’s a market that people are looking at and saying, ‘I have to have uniform services. I have to continue to teach.’ They are just being prudent with their dollars.”

Humke said solution providers that can offer consulting services to SLED customers will do well. “If you are leading with hardware, it’s not the place to be,” he said. “What we’re hearing from people is it’s virtualization; it’s consolidation; it’s how can I do more with less. They are getting smarter about how they spend their money.”

Humke noted that despite the fact that everyone active in the SLED market is fighting state budget issues, HP is seeing low double-digit growth in the market. “We are seeing growth; we are not going backward,” he said. “As opposed to buying more printers, for example, people are asking how do I get better at document management.”

He said solution providers need to understand the business needs of SLED customers. “People aren’t going to throw incremental dollars to add on [to their IT infrastructure] as much as they are going to look to improve how they are currently doing something to maximize the spending that they have today.”

Rick Chernick, president of Camera Corner Connecting Point, a solution provider in Green Bay, Wis., said he’s seeing strength in his education business. “We are growing our education business with HP,” he said. “We are up 33 percent year to date for our year that ends Sept. 30. We’ve been able to win business away from competitors because of our face-to-face contact with the schools and some aggressive pricing from HP.”

Camera Corner Connecting Point recently won a deal for 450 new HP desktops and related services in a K-12 district and switched the University of Wisconsin Green Bay over to HP’s camp, selling the university blade servers, desktops and laptops, Chernick said.

But even within an overall robust education market, the solution provider is starting to see some weakness. Ryan Chernick, vice president, said education customers are trying to consolidate server farms with VMware. “They are trying to cut hardware costs and power consumption and better budget for the future,” Ryan Chernick said.

But he said the K-12 spending is mixed. “This year we will do well with prominent districts that are making big purchases, but smaller school districts are not buying much.”

He said that some of the smaller school districts couldn’t afford to complete some projects and have been forced to scale back their IT spending. “I’m a little nervous,” he admitted.

But as Rick Chernick noted, “Bigger districts are still buying, colleges are still buying and the world is moving forward.”

 

TAX REVENUE DECLINE USHERS IN OUTSOURCING SERVICES

Falling tax revenues could mean big opportunities for solution providers that offer outsourcing services.

That’s the upshot of EquaTerra’s 2Q08 Public Sector IT Business and Mission Support Service Provider Pulse Survey. The Houston-based consulting and research firm predicts that public-sector spending on externally provided IT support services will increase 5 percent annually over the next five years, growing from $66 billion in 2007 to approximately $90 billion in 2013.

The survey includes responses from IT service providers as well as data from the company’s client-facing advisers.

Glenn Davidson, EquaTerra’s managing director of public-sector practice, acknowledged that states are suffering from declining sales tax and property tax revenues from the mortgage crisis. What’s more, he said states, schools and local governments are under mounting pressure to comply with underfunded federal mandates.

The survey also cited the aging public- sector IT workforce. Stan Lepeak, EquaTerra’s managing director of research, noted that most public-sector managers are struggling to get the job done with outdated technology, cumbersome business processes and loss of institutional know-how as senior staff retires. He noted that many public-sector managers see outsourcing as the best way to cope.

But Davidson called the growing opportunity for IT outsourcing “countercyclical” to budget constraints, which impact IT infrastructure purchasing.

According to the survey, 46 percent of the service provider respondents said the key driver in public-service outsourcing was cost reduction or avoidance. Project-based work was the preferred means to engage third-party service providers, especially projects that deliver a near-term reduction in operating costs.

Among the hottest emerging services identified by survey respondents included overall IT modernization, such as adoption of a software-as-service model. Davidson, too, said that there is particularly strong demand for financial management and budgeting services, including risk management, accounts payable and general accounting.

—Craig Zarley