SAN FRANCISCO (CNN/Money) - Thanks to the recall election, California's financial woes are national news. But the state is hardly alone in searching for solutions that won't decimate already-thin education budgets or destroy social services.

One concept currently gaining favor among state and local governments is IT outsourcing. Rather than purchasing and maintaining the massive technology infrastructure necessary to run certain government operations, states and cities can reap some cost-cutting advantages through outsourcing.

For IT companies, the financial squeeze presents a golden sales opportunity. Last week, government technology research firm Input announced that nonfederal spending on IT outsourcing will grow by more than 130 percent during the next five years, reaching $23 billion by fiscal 2008. With general business IT spending still depressed, the IT-services firms -- and their investors -- are desperate for a growth market.

Three key factors have aligned to make IT outsourcing a more attractive and viable option for government agencies.

First, the budget crunch is forcing states and municipalities to seek alternatives to the standard procedure in which technology is purchased and a staff is hired to maintain it.

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Second, the IT professionals currently in place across the country are growing long in the tooth. With the public sector unable to match the salaries of the private sector, filling government positions remains a challenge, and one that's not expected to lessen.

"Retirements will outpace the ability of governments to staff important technical functional areas," says James Krouse, manager of state and local market analysis for Input.

Third, the concept of outsourcing has finally come of age. The idea of farming out an area that is not part of your core competency is no longer cutting-edge. And the government sector relies on all kinds of skill sets that are ideally suited for outsourcing, namely repetitive task processes like managing and dispensing welfare allotments or keeping track of Medicaid reimbursements.

Already the governments of California, Delaware, Georgia, Indiana, Kansas, New Jersey, and other states have outsourced some of their technology functions to IT-services companies. Cities such as Baltimore, Dallas, and Nashville, Tenn., have gone this route as well.

While many observers immediately think of giants like IBM, Lockheed Martin, and Oracle when it comes to outsourcing and IT services, these companies have a long way to go before they become market leaders in the government segment.

According to Input, the leading company in the state and local government IT-outsourcing market is the relatively small (with about $3.1 billion in annual revenue vs. IBM's nearly $90 billion) Dallas-based Affiliated Computer Services, which has a 29 percent market share of state and local government IT-outsourcing contracts. Rounding out the top five, according to Input, are EDS, Unisys, Accenture, and IBM.

John Engler, president of EDS's state and local government division and former governor of Michigan, says the government sector is very different from other markets.

"There's a great risk in the public sector that any project that doesn't work becomes a headline and the subject of an investigation," he says. "Government projects are just as successful as private-sector projects, but when they fail, they're more public."

Even though EDS has more than 40 years of experience in fulfilling state and local government technology needs, the ascendancy of IBM is something many observers here are watching.

According to Krouse, IBM first started making a concerted effort to secure state and local government work a couple of years ago. "They've been increasing their activity in this area," he says. "They bring with them a noteworthy reputation, which is significant in scoring government contracts."

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Research firm IDC ranks IBM No. 1 in IT outsourcing in nongovernment markets, and No. 2 behind Computer Sciences Corp. in federal government outsourcing. IBM representatives could not be reached for comment by press time.

Thankfully for companies struggling to get into this market, and their investors, the window of opportunity hasn't closed just yet. Although the sector is poised for significant growth, Krouse says it likely won't skyrocket until after 2004, giving interested companies time to cement their strategies and partner with other firms.

Asked why the growth in state and local government outsourcing wouldn't kick in until 2005, Krouse gives an appropriate answer: Politics. "2004 is an election year," he says. "No one wants to be seen as being responsible for potentially cutting jobs [through outsourcing]."

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