Federal IT market: More demand, but less growth

According to a report released Tuesday, a larger discretionary budget for information technology is proof of the federal government's demand for IT products and services. But at the same time, the report said, the overall annual growth rate of the IT budget has shrunk and agencies are feeling more pressure to justify their spending and prove they can manage their investments.

Those were the conclusions of an annual IT market outlook released by Federal Sources Inc. (FSI), a technology market research firm in McLean, Va. The group found that technology spending accounts for 7.2 percent of the fiscal 2004 discretionary budget, which amounts to $819 billion. That's a 0.5 percent rise over last year, and reflects a "shift in our national priorities toward information technology," said James Kane, the firm's president.

Shifts in priorities rather than dramatic increases in funding characterize the budget, Kane said. In particular, the Office of Management and Budget's demand that agencies write business cases to support spending requests has become "institutionalized," he said. Agencies that fail to make their cases may lose their IT funding.

In light of that enforcement, the rapid growth rate of the budget that fueled the IT market in the late 1990s has dissipated. FSI predicts a 4.7 percent compound annual growth rate from 2003 to 2005. In previous years, that rate fluctuated between 8 and 9 percent.

The slowdown also can be attributed to a decrease of new IT contracts. New contracts accounted for only about 12 percent of transactions worth $5 million or more in fiscal 2002, the analysis found. Kane also noted that money has been reallocated to support initiatives at the Homeland Security Department, which already has the second highest IT budget of any civilian agency, at more than $3.5 billion. Money has been funneled away from the Justice and Treasury Departments toward Homeland Security as components of those department move into the new organization, he said.

Rather than initiate many new deals, agencies are spending more money through task orders on governmentwide contracts. Those orders have become "the preferred method of government buying," Kane said. In fiscal 2002, task orders comprised about 55 percent of contract transactions over $5 million, FSI concluded.

One governmentwide contract set in place, the General Services Administration's schedules program, saw fiscal 2003 IT spending of $15.5 billion, FSI estimated. Fiscal 2004 will see an 8 percent growth in IT schedule sales, and services will account for two-thirds of transactions, the firm predicted.

INPUT, a competing research firm in Chantilly, Va., also released a study Tuesday that said schedules sales overall, not just for technology, increased 24 percent from 1997 to 2002.

INPUT's analysis "shows a notable trend of increased spending on [schedules] with a corresponding decrease in the use of full and open competitive procurements," an INPUT statement said. Schedule contracts are essentially precompeted: a company wins a schedule and may then sell to the government through task orders. Agencies are supposed to solicit offers from multiple companies when making a buy, but federal investigations have shown that some agencies just buy from one preferred company.

The FSI report also showed that the constricting market is dramatically impacting companies. The last 12 months saw more than 70 mergers and acquisitions among federal technology providers, the analysis found. Those transactions were all valued at $50 million or more, and most of the acquired firms were privately held, it said.

Companies that hoped to cash in on security spending have learned that bigger firms and those with more experience selling to the government win most contracts. Kane said that smaller firms or those that haven't distinguished themselves from the pack face two choices: "Get acquired or die."

So many companies are pitching themselves as one-stop providers for all the government's technology needs that traditional business sectors have become meaningless, Kane argued. Whereas in years past, companies characterized themselves as systems integrators or services firms, for example, now the ways in which those firms are all that different from each other have blurred, he said.