Share-in-savings (SIS) is a concept that has become increasingly popular over the past few years because it appears to offer a win/win solution to a recognized public sector acquisition and funding problem. Government seeks to modernize a system or offer a new service, but—as always—is fiscally constrained. At the same time, industry, seeking a better than average ROI, is willing to accept some risk for a higher profit. These desires merge in SIS as the vendor is able offer a lower price for its services in return for a portion of additional revenue generated or cost savings realized by the government.

Federal, state, and local governments are discovering that they can stretch the taxpayers’ dollars further in their purchasing by using an SIS approach, also sometimes called benefits funded or shared benefits. However, pursuing SIS projects makes sense only if the downstream benefits are large enough to offset the risk that the vendor incurs up front, and if the relationship between government and vendor is good enough to enter into a closer than normal partnership. The vendor and the government both need to do a risk-reward calculation when considering shared benefits. However, this approach strongly incents the vendor to do a great job and to get the system up and operational as quickly as possible.

The January 2003 GAO Report 03-327 describes the management climate for a successful SIS effort. Agencies must clearly specify expected outcomes, define incentives, establish performance measures, and secure top management commitment. Good planning and expert program management are vital for SIS projects. The best venues for SIS are when government is seeking:

• revenue enhancement
• systems consolidation
• reverse auctioning
• audit recovery

The E-Government Act of 2002 (Sections 210 and 317) and the Clinger-Cohen Act (Section 5311) allow federal agencies to use this form of performance based contracting. It’s easy to see why it’s popular in theory since it shifts risk from government to industry and also allows agencies to retain some of their savings for other internal investment purposes. In practice, federal agencies are just beginning to work with GSA to take advantage of SIS and hope to have positive results to point to before the authorizing act expires in September 2005. In August 2004, GSA awarded blanket purchase agreements to six companies, certifying their ability to provide SIS work:

• Computer Sciences Corporation
• Accenture Ltd.
• CGI Group Inc.
• IBM Corporation.
• Science Applications International Corporation, and
• SRA International Inc.

GSA has created a decision tool that helps agencies develop a business case, define the cost baseline and savings potential, and rate the potential success of the project.

Federal executives could look to state governments for guidance in the “how to’s” of SIS, as state governments have been more aggressive in adopting it. Here’s an example of how SIS can work. A state has an antiquated automated tax system that was designed and implemented in the early 1980s using mainframe technology. Because its tax software is obsolete, the state is under-collecting revenue by $1 billion to $1.5 billion dollars per year, and additional revenue could be captured by a better system and procedures. A software provider proposes to install new, modern software that costs $200 million. The state cannot afford an investment of that size. This is where SIS can come into play.

Rather than the state paying the vendor $200 million, the state and the vendor negotiate an agreement that pays the vendor only $100 million for the software, but provides a share of the increased tax revenue if the benefits promised by the system actually occur. The state might offer 5% of additional revenues collected in the first year of system operation and 10% in the next three years. Of course, for shared benefits to be attractive to the vendor, the revenue numbers need to be baselined to a relatively stable economy and the revenue recognition numbers for the state need to be transparent. If all the details can be worked out and the system performs as promised, the vendor could make substantially more than the original $200 million (over a longer term), while the state would not have to pay full price for a system unless it received the benefits that were promised. The table below shows how SIS works to each party’s advantage.

It’s an unfortunate fact of life in government that many large projects, and particularly big technology projects fail. Below is a model of a project that isn’t as successful as anticipated.

The state would not have to pay the full amount for the work done, but would still reap some significant tangible benefits and realize a savings equal to the opportunity cost of nearly $100 million in capital on the project.

Of course, the project could fail completely. In that case, the government will seek redress from the vendor for any funds paid under the terms of their contract.

There are only a handful of completed SIS projects at the federal level today. For example, DOE realized savings in energy consumption through the Federal Energy Management Program that shared the benefits of cost reductions with commercial vendors who were able to cut energy bills by installing more efficient equipment.

Several projects also have been completed at the state level. Working with the CGI Group, the Commonwealth of Virginia and the States of Kansas, California, and Hawaii replaced their tax systems using the SIS approach, and have collectively realized almost a billion dollars of new revenue. An important aspect of many of these SIS efforts was to completely reengineer the customer relationship management process to make it easier for citizens to determine what and how much needed to be paid in tax. As with any large change effort, the process reengineering aspects of the project were at least as critical as the changes to software and databases—and probably more so.

Applying SIS to situations that are not directly tied to revenue is more complex. Government and the vendor need to find a different basis for recognizing success, usually in the form of cost savings rather than increased income. Managing against a cost savings goal requires that a clear mechanism for cost-based accounting is in place so that the government (and the vendor) can see whether or not the government is actually saving money relative to some pre-established baseline.

Governments that have used SIS on large contracts have occasionally taken some political flak because of the perceived exorbitant bonuses they have paid successful vendors. It’s important for government executives to make sure that legislators understand what they are doing when they enter into an SIS arrangement and the numerous ways that change efforts can fail. When projects turn sour or under-perform, shared benefits offer a softer landing for governments that are willing to take the risk of rewarding the vendor for very effective performance. When they succeed, both the government and the vendor are rewarded.

SIS is an idea whose time has come, and government should take advantage of this tool to accelerate the introduction of new services or the replacement of obsolescent infrastructure.