- Converging internal and external forces are heightening government demand for modern IT solutions to replace outdated, inefficient, and costly systems and help government entities more effectively carry out their missions.
- This demand is translating into growing opportunities for technology providers—especially those of cloud-based solutions—as well as for strategic buyers and financial investors interested in the government technology sector.
- The payments sub-segment is especially attractive, as a wide range of interactions between the public and government revolve around paying for some form of government service.
Members of Harris Williams’ Technology, Media & Telecom Group will be at the Money2020 Conference in Las Vegas from October 27-30 if you’re interested in meeting the team or learning more about software and payments technology.
When it comes to adopting technology, many government entities have lagged private industry. That’s beginning to change, particularly at the state and local levels, with a confluence of factors creating a ripe environment for more rapid change. With that push for modernization comes significant potential for providers, and for strategic buyers and financial investors who understand the space and how to participate in it.
In this Insight, Managing Director Tyler Dewing and Vice President Scott Reinig, both of the Harris Williams Technology, Media & Telecom (TMT) Group, explain the key drivers of this shift and reveal one specific area creating noteworthy growth opportunities.
A $93 Billion Opportunity
The U.S. state and local government landscape is vast, encompassing more than 90,000 entities with nearly 20 million employees. Collectively, these entities run 450,000 IT systems across operations, asset and resource management, civic engagement, and public safety. A full one-third of these systems are 16 years old or older.1
With a renewed emphasis on modernization and innovation, U.S. state and local governments are forecast to spend more than $80 billion on technology in 2019, a figure that is expected to exceed $93 billion in 2022 (Figure 1). Spending on software alone has a CAGR of more than 7% since 2016.2 Many politicians are making technology modernization a key part of their platforms, while emphasizing the potential for both improved experiences and lower costs.
Figure 1: Steady growth in government technology spending
Two Key Trends Driving Growth
Two long-term trends are powering the rapid modernization of government technology: the internal pressure to modernize and improve efficiency, and external consumer demands for better digital experiences.
Trend One: Growing internal pressure to modernize antiquated legacy systems
Government entities have long favored building their own highly customized solutions—often in collaboration with costly consultants, IT services providers, and large systems integrators—over buying traditional enterprise software suites, with the rationale being that each government entity’s needs are too unique for out-of-the-box offerings.
Today, government entities are paying in several ways for choosing this route. Their initial cash outlay for these systems was massive, often costing entities tens of millions of dollars. Just as significant, these systems have required substantial infusions of money every year to keep running, which gets more expensive and difficult as the systems age—and age is a real problem. For instance, the 10 oldest systems still operating at the federal level are over 40 years old, with the top six exceeding 50 years in service.3
Beyond the purely financial aspect, these disparate, antiquated, and static on-premise systems can also impede an entity’s ability to execute its mission. Such systems can keep employees from efficiently completing workflows. Perhaps more importantly, they can also prevent government agencies from effectively analyzing the treasure troves of data they often possess. Outdated systems can also create an information gap between the public and government that contributes to the ineffective delivery of services, diminished collection of revenue, and exacerbated public dissatisfaction.
The California DMV offers, perhaps, one of the most extreme examples. The state’s governor, Gavin Newsom, has launched an overhaul of the agency, which includes appointing its third leader in a year, amid ongoing and pervasive complaints among the public about long lines and poor service. Newsom put the blame squarely on the agency’s technology: “I recognize that people are outraged by their experience at the DMV. I am not naive about the challenges at the DMV. The technology is byzantine.”4
Trend Two: External demand from tech-savvy consumers to interact with government the same way they do with private companies
Spoiled by digital disruptors in the private sector, many consumers want highly personal and contextual digital experiences across all platforms, including those provided by the government.
Unfortunately, many government entities lack the digital options that people have come to expect. Instead, people have to visit, call, or communicate by mail, which can be time-consuming, error-prone, and expensive.
“The fact is, government has a great opportunity today to adapt to better meet the needs of the public and to build positive sentiment,” Dewing notes. “Government entities recognize they need to deliver a modern consumer experience with the convenience and speed of an Amazon, for example, and that the only way they can accomplish this is by adopting modern technology. Continuing to throw dollars at maintaining and augmenting old systems won’t get them there.”
In addition, as the next generation of digital-native leaders enters the public sector, the internal and external drivers of demand for new technology within the government will converge—only accelerating the growth in technology adoption and spending.
A big chunk of that spend is likely to be focused on the cloud. Recently, government has awakened to the fact that there are robust cloud software offerings that can meet their needs at lower cost, with more features, constant updates and next-generation capabilities. Further, cloud technology providers, such as Amazon, provide instances specifically designed to meet government entities’ rigorous and complex compliance and security requirements, paving the way for migration to existing solutions and the development of new ones in the cloud.
Government entities also are beginning to realize the merits of leveraging unified, cloud-based platforms for mission-critical operations across departments, which can be managed in a more coordinated way and configured—not customized—for government workflows.
As shown in Figure 2, CIOs of U.S. states have aggressive plans to implement various forms of cloud computing. For instance, while just 15% currently use off-premises, public cloud computing, over 80% plan to do so in the future.5
Figure 2: Aggressive plans for cloud adoption across government entities
Source: 2018 Digital States Survey (Govtech Navigator)
Beyond boosting operational efficiency and providing a more engaging and easy-to-use face to the public, cloud solutions offer substantial potential costs savings. A single cloud application can reduce an entity’s annual IT costs by 25%. That figure grows to nearly 50% when two cloud applications are involved, and over 60% when four are used.6 For a sector that has been beset by high IT costs for decades, this would be welcome relief.
“In the early days of cloud solutions, government entities were reluctant to embrace them—mostly because of the pain associated with switching from the custom solutions that were ingrained in how these entities operated,” says Reinig. “It’s not easy to just flip a switch and abandon an established and expensive system for an external solution. But now we’re at a tipping point. The benefits of the cloud are so compelling, and those custom solutions have gotten so old, that government entities are much more open to moving to the cloud.”
“Plus, the latest cloud-based solutions are easier to implement without having to make major changes,” adds Dewing. “Many of them can simply sit on top of existing custom solutions to give them a modern interface and modern functionalities. It's far less disruptive to an entity’s operations, but still can have a transformative effect in terms of the service levels these entities can deliver.”
Investing in Next-Gen Government Technology Platforms
Not surprisingly, government’s push for modern software solutions is fueling significant M&A activity, as market participants compete for leadership and share. Since 2014, nearly 100 notable middle market transactions have closed in the government technology sector, collectively representing a median enterprise value of just under $200 million, and median multiples approaching 5 times revenue and 15 times EBITDA, with high-growth, cloud-based software companies garnering premium valuations.7 These transactions represent technology vendors that run the gamut of solutions, and serve clients across the spectrum of state and local government entities.
As Dewing explains, today’s environment regarding government technology is distinctly different from the past, when most investors avoided the public sector out of fear over long sales cycles, cumbersome procurement processes, tight budgets, and decentralized decision-making. “As those barriers become less prohibitive and government’s appetite for new solutions grows, the sector becomes increasingly attractive,” he says, “especially when considering technology providers with strong competitive ‘moats’ and innovative business models that help speed government decision-making.”
Where to Start: Payments
Payments is one specific area within government that highlights the need and potential for new technologies, and that provides an avenue for software companies and their potential buyers to increase their participation in this growing opportunity.
Payments is a great place to start, due to its ubiquity, visibility, and financial impact. For instance, many interactions between the public and government revolve around payments—for permits, licenses, citations, taxes, utilities, parking, and a wide range of other services (Figure 3).
Figure 3: Consumer-to-Government payments total more than $1.5 trillion annually
Sources: U.S. Census Bureau, Bureau of Transportation Statistics, Office of the Administration of Children and Families, United States Postal Service, Whitehouse.gov.
In fact, with most state and local entities collecting some form of revenue, people make more than $1.5 trillion in payments to state and local governments every year.8 Therefore, payments represent a logical starting point for governments to modernize, as they are at the heart of an entity’s engagement with the public.
Modern digital payment channels can generate many benefits for government entities. These include higher satisfaction with government and more streamlined interactions, as well as increased revenue generation, faster collections, the ability to offer payment plans to those who need them, and greater compliance.
One of the biggest benefits from migrating payments online is that it represents sizable and highly tangible operating cost saving opportunities for government organizations. The IRS estimates that the cost of an online transaction can be as low as $0.20, a far cry from the $42 for a phone payment, and the $57 for payment via a mailed check.9
Even better, government entities can get these benefits with no upfront or monthly cost: Most vendors of cloud-based payments solutions offer a pricing model in which the vendors provide the solution free of charge and, instead, take a percentage of each payment the entity processes.
Even if there is a cost for the software, it’s often in the form of a monthly subscription, instead of a large upfront license fee or massive initial investment. Government entities also can offset some of their monthly costs by charging the public a small fee to use digital services—a fee many people are willing to pay to avoid the inconvenience of having to visit an office or mail a check.
“We’ve seen government entities experience substantial increases in consumer adoption of digital payments and revenue when launching modern and mobile-first payment solutions,” notes Dewing. He adds that for vendors of payments solutions that also have software for other areas of an entity’s operations, making such a measurable, highly visible impact on payments can open doors to their other offerings.
“Modernizing payments is a quick win for both government agencies and technology vendors,” says Dewing. “For agencies, it delivers an almost instant and significant operational efficiency boost for employees and service improvement for the general public—without requiring a big-budget purchase. For vendors, it creates an attractive revenue model and enables those with a broad suite of solutions to get a foot in the door.”
Strong tailwinds in the government technology space are driving demand for modern technology solutions. This demand will translate into substantial money being spent—approaching $100 billion in a few years at the state and local levels.10
Demand is especially strong for solutions that provide better experiences for the public, while helping government entities improve revenue and reduce costs, enabling providers to expand their coverage to more government entities and handle payments for an increasingly diverse group of services. Fragmentation in the segment creates the opportunity to consolidate smaller vendors offering point solutions into larger and more comprehensive platforms.
“The government technology space is changing rapidly, as government entities begin the task of moving on from their old legacy systems to modern cloud solutions,” says Dewing. “Companies that provide such solutions, and have experience with the needs and sales cycles that are unique to government entities, can be very attractive targets, and should offer significant upside for buyers over the next decade.”
Published September 2019
Recent Harris Williams transactions in the government technology sector include the sale of PayIt to Insight Venture Partners and the sale of nCourt to Providence Strategic Growth.
1. Tyler Technologies’ Investor Presentation (August 2019)
2. Gartner (Forecast Pivot Table: Enterprise IT Spending by Vertical Industry Market, Worldwide, 2016-2022)
3. “Here Are 10 of the Oldest IT Systems in the Federal Government,” Jack Moore, Nextgov, May 25, 2016,https://www.nextgov.com/cio-briefing/2016/05/10-oldest-it-systems-federa...
4. “California DMV Leadership Overhauled over Long Lines and Poor Service,” Patrick McGreevy, Los Angeles Times, July 23, 2019, https://www.latimes.com/california/story/2019-07-23/california-dmv-chang...
5. 2018 Digital States Survey (Govtech Navigator)
6. Center for Digital Government
7. CapitalIQ and Harris Williams proprietary information
8. U.S. Census Bureau, Bureau of Transportation Statistics, Office of the Administration of Children and Families, United States Postal Service, Whitehouse.gov.
10. Gartner (Forecast Pivot Table: Enterprise IT Spending by Vertical Industry Market, Worldwide, 2016-2022)