Two years ago, San Diego County was supposed to be the proving ground for wholesale IT outsourcing of local and state government functions. Its seven-year, $644 million pact with a vendor consortium led by Computer Sciences Corp. (CSC) was said to be the first wave of a flood of new public sector outsourcing deals?all of them aimed at making government faster, more efficient, more e-businesslike for everyone. As the deal unfolded, government CIOs nationwide had one eye on San Diego and the other on their own preliminary outsourcing plans. The top outsourcing vendors, fresh from Y2K, promoted the state and local government marketplace as their Next Big Thing (see "High Anxiety," at www.cio.com\/printlinks).But today, San Diego is a mess. After some initial successes, the two principal executives who struck the deal have moved elsewhere (never a good thing in an outsourcing relationship). The new day-to-day managers are embroiled in such a bitter behind-the-scenes dispute over costs, service levels and a late ERP rollout that CSC has imposed a gag order on the account, for fear of igniting a public war of words. And the lucrative state and local government outsourcing bonanza that was supposed to develop right after San Diego\u2019s ink dried has never materialized.CIOs who remain committed to outsourcing?but are wary of following San Diego\u2019s lead?are trying different tacks, such as breaking out smaller pieces for vendors. But by and large, across-the-board outsourcing of state and local government has become a prospect that never quite got off the ground?and, because of several intractable hurdles, it probably never will.Even Rock Regan, the state of Connecticut CIO who has long been the poster boy for state and local government outsourcing (see "Connecticut Antes Up," at www.cio.com\/printlinks), now says if he had the chance to outsource all over again, he\u2019d take a very different tack. "Knowing what I know now, if we outsourced we\u2019d do it in chunks?not all at once," says Regan, who is the current president of the National Association of State CIOs (NASCIO). As he surveys the national landscape, Regan sees little new outsourcing activity in the public sector. He attributes part of the stall to the recession. But mostly he cites what he now sees as the fatal flaw of wholesale outsourcing in local government: too much, too soon. "Too much change, too much politics, too many battles," he says.Why Can\u2019t We All Just Get Along?Outsourcing is a proven business strategy in the private sector, so why can\u2019t it work in City Hall?Part of the problem, says Howard Lackow, senior vice president at The Outsourcing Institute in Jericho, N.Y., is the fundamental disconnect between big business (which wants to move fast) and municipal government (which traditionally moves slow). "Government is so archaic and cumbersome," Lackow says. "The whole objective [of outsourcing] is to try to streamline government, but that doesn\u2019t seem to happen."Although outsourcing might at first seem cost-effective for CIOs and lucrative for vendors, once projects are under way both parties find themselves spending a lot more time, money and energy than expected. Just ask CSC, the $10.5 billion IT services provider based in El Segundo, Calif., whose Pennant Alliance consortium has already exceeded its projected investments in San Diego County by about $10 million and 300 extra people. "Government takes a lot more hand-holding, care and feeding than people expect," Lackow says, and as a result there are fewer clients or vendors willing to take the risk.But beyond unforeseen expenses, which can dog any IT project, public sector outsourcing poses some unique challenges?any one of which could kill a deal.The scope of work. Frankly, state and local government IT is in worse shape than one might think. Because IT investments have been spotty at best in most agencies, the equipment is old, the networks are patched together, and the information silos are unbreached. It being the public sector, political turf is fiercely protected. Even though both sides in the San Diego contract did their due diligence before inking the pact, the county never really knew what it had for IT assets?much less what shape they were in. And no amount of homework prepared CSC\u2019s Pennant Alliance for the amount of work that needed to be done just to get the county\u2019s creaky infrastructure ready for upgrading. "We knew the triage work was going to be complex and difficult, but it was more than we expected," says CSC\u2019s Richard Jennings, the former project manager of the San Diego contract. To complicate matters, all the work has had to be done while maintaining high levels of public service. "We\u2019re changing the engine in a car that\u2019s moving," Jennings says.The publicity. Even though most private sector outsourcing deals are conducted between publicly held companies, the negotiations are still held in private. Not so in government, where every bid is a public document. The government executives are used to this transparency (not that they like it), but the vendors aren\u2019t. "It\u2019s a turnoff," Lackow says. "From the vendor\u2019s perspective, even if you lose the contract, suddenly your pricing structure is public." And from the CIO\u2019s perspective...well, would you want all your dirty data aired in public?The unions. Organized labor is rarely a great obstacle in industry anymore, but in government the unions are still powerful enough to kill an outsourcing project. That is what happened in Connecticut, where from day one CIO Regan was outgunned by two employee unions that controlled his IT staff and lobbied hard against his plans. Ultimately, Regan and the governor were the ones who made the final call, but it\u2019s safe to say that the unions had the last laugh after Regan pulled the plug on his outsourcing proposal in June 1999.Organized labor was less of an obstacle in San Diego, where fewer IT staffers were union members. But after the deal was done, the union kept the county busy with requests for sensitive documents and even audits. "We want them to do an internal audit [of the outsourcing initiative] and prove they\u2019re good managers," says Mary Grillo, executive director of the local 2028 Service Employees International Union, which had 50 members in county IT before it was outsourced. "I think they\u2019re afraid of what they\u2019re going to find." Again, government people are used to this politicking, but the vendors find the constant tug-of-war taxing. "The union does not advocate privatization of services," says Jennings, "so they want to use us as a poster child for \u2019don\u2019t outsource\u2019 in general."San Diego: What Went Wrong?San Diego started out with promise. In the first 18 months of the outsourcing deal, which kicked off in December 1999, the Pennant Alliance replaced nearly 22,000 telephones, installed 7,200 new desktop PCs, replaced the county\u2019s LAN and WAN, and relocated all the major data centers. Service levels, which had never even been measured prior to outsourcing, started out shaky with more outages and dissatisfied customers than anyone anticipated. But by last August, satisfaction across the board ranged from 95 percent to 100 percent.Still, despite the high satisfaction levels, there were some major screwups in the first 18 months, the biggest being Pennant\u2019s inability to get all county employees on a common e-mail platform. The vendor paid a $250,000 penalty for that failure?the single highest fine it\u2019s faced in San Diego, so far. In all, Pennant shelled out between $2.1 million and $3.5 million in penalties in 2000 (the amount depends on which side you ask) mostly for missed service levels, but nothing in 2001.Then two things happened to send this already-rocky relationship into a spiral. First, in unrelated moves, the two principals in the deal, county CTO Tom Boardman and CSC Vice President Jennings, were reassigned in early 2001. Boardman was sent on an emergency assignment to the county district attorney\u2019s office to fix the faulty child support system. He was replaced by Lana Willingham, a 30-year county official coaxed out of retirement to temporarily manage the outsourcing team. Jennings, meanwhile, was promoted to other regional accounts and replaced by one of his deputies, Kristine Buitenhek. Typically, changes at the top mean an outsourcing deal is in trouble, but at the time these moves seemed innocuous. Then came ERP.ERP was to be the highlight of year two. By January 2002, CSC was scheduled to have rolled out two countywide ERP projects?PeopleSoft in HR and payroll, Oracle in finance?and then the county could start enjoying the information efficiencies that executives had promised all those months ago. But the project was taking longer than expected, and the two sides had become tangled in scope creep and disagreements over contract renegotiation. The result: a big dip in end user satisfaction and impatient saber rattling from the county?specifically from Willingham, a hardline negotiator who saw this delay as a clear example that the county wasn\u2019t getting its money\u2019s worth from CSC and the Pennant Alliance. "We negotiated service-level agreements that amount to us getting a Cadillac," Willingham says, "but we\u2019re actually getting a Volkswagen."Frustrated by the vendors\u2019 inability to even set a new, firm deadline for the ERP rollout, Willingham withheld $45 million in payments owed to CSC until the project\u2019s completion. Her message with this shot across the bow: Pennant should do what it signed on to do. Now. "In government, you expect everything in a service agreement to be provided," she says. "But in the private sector everything seems to be subject to constant rethinking. They must meet all the agreements, not just tell us which ones we\u2019ll get."CSC executives, sensitive to the glass-house effect of conducting business in public, won\u2019t discuss the ERP flap, confirming only that they\u2019ve slapped a gag order on all principals involved in the account, just so no one will say anything incendiary. What next? This mess could get messier. With five years left to go in the contract, and with finances and reputations at stake, both sides have every reason to want this marriage to work. Neither would benefit from the publicity or political fallout of an outright failure. But they also have termination clauses they can invoke. If this ERP confrontation escalates, then local government\u2019s first big outsourcing marriage might well become its first big divorce.Meanwhile, there have been more changes at the top. Willingham slipped back into retirement on April 1, to be replaced by a CTO-to-be-named-later (Boardman is staying put at the DA\u2019s office, for now). But she\u2019s not promising to stay away forever. "I have a great deal of loyalty and commitment to the county," Willingham says. "If the necessary things don\u2019t go well [with this deal], then I might just be the bad penny that keeps showing up."Outsourcing AlternativesSo, if not wholesale outsourcing, then what? Some municipalities have done very well without outsourcing. Phoenix, for example, has won global recognition for its efforts to create a wired, Web-friendly city government?and all of the IT is in-house. The differentiator, though, is that Phoenix recognized the importance of IT decades ago, and city leaders have consistently invested in technology projects and staff. "We\u2019ve never had to spend a zillion dollars to catch up," says Danny Murphy, CIO of the city of Phoenix. "Other places that haven\u2019t kept up, haven\u2019t invested, are the ones that are backed into a corner and having to play catch-up now."A few local governments have found success in partial outsourcing. The Commonwealth of Pennsylvania, for one, has successfully outsourced its data processing functions. The Georgia Technology Authority (GTA), the state\u2019s IT agency, is circulating an RFP to outsource its telecommunications infrastructure and services. But because IT outsourcing is so new to Georgia, in mid-March the state legislature introduced a bill to appoint a new GTA overview committee to keep a close eye on these developments. Was that shades of conflicts to come? Some public sector organizations have devised their own unique twists on outsourcing. In Chicago, the Public Housing Authority now outsources discrete projects, not processes, to prequalified bidders (see "Chicago: A Qualified Approach to Out-sourcing," Page 68). And in Connecticut, where wholesale outsourcing was rejected, CIO Regan is leading an IT transformation that\u2019s making his IT organization look and act increasingly like an outsourcing vendor. Regan has centralized IT across all 65 state agencies (see "Connecticut: Rebuilding a Dynasty or a Dinosaur?" Page 70).Clearly, for those state and local governments that haven\u2019t yet embarked on wholesale outsourcing initiatives, there are alternatives. But a caveat for those who might ignore the warnings and explore further down the privatization path: Once you go all the way, there might be no turning back. That is the situation in San Diego. As messy as the relationship has become, the county is stuck now that it has outsourced so many people and services. The county will not buy back the IT assets it sold to Pennant or hire back all 234 outsourced employees (who now are accustomed to better salaries and benefits) because it can\u2019t maintain all the new service levels and strategies. "It\u2019d be impossible," concedes San Diego\u2019s Board-man. "There\u2019s no way a government organization such as ours can supply the same level of service as an IT vendor."To his credit, Boardman still thinks the San Diego and Pennant relationship can be salvaged. But even if he\u2019s proved wrong, "there\u2019s no turning back for us," he says. "We\u2019re going to outsource forever."For better or for worse.