The 2017-18 Budget: California State Payroll System

The 2017-18 Budget: California State Payroll System MAC TAYLOR • LEGISLATIVE ANALYST • FEBRUARY 28, 2017 Summary The State Controller’s Office (SCO) is responsible for issuing pay to the state workforce, including employees of the state, California State University (CSU), and judicial council. The SCO has recently renewed its effort to replace the state’s payroll system. In this year’s budget, the Governor proposes $3 million to begin an analysis of proposed alternatives for replacing the system. At this time, we agree it makes sense for the state to assess the potential problems, both in terms of functionality and stability, to the state’s payroll system and explore potential solutions to these problems. Nonetheless, the appropriate selection of a project alternative will be critical to the success of the future project. Substantial delays and cost overruns are particularly acute risks for a project of this complexity. As such, we recommend the Legislature require the SCO to present its full findings from the alternatives analysis before it is granted additional funding. This would provide the Legislature with a clear opportunity to provide meaningful input and weigh in with its own priorities for the payroll system before a solution is procured. Background problems during its pilot stage, the SCO terminated its contract with the project’s primary vendor, SAP Recent Unsuccessful Attempt to Replace Public Services, Inc. (SAP). Since then, the SCO Legacy Payroll Systems. The SCO is responsible has entered into a settlement agreement with SAP for issuing pay to the state workforce, including for its lawsuit related to the TFC project, resolved employees of the state, CSU, and judicial council. the various payroll errors produced by the system In 2004, the SCO proposed the Twenty-First while it was in use during the pilot, and closed out Century (TFC) project, the information technology the project. For a full history of the TFC project (IT) replacement for its existing human resources through the settlement agreement in June 2016, management and payroll systems. In February please see the Appendix. 2013, after the project experienced various 2017-18 BUDGET Still May Be Necessary to Update the State’s Stage 2 alternatives analysis, Stage 3 procurement Payroll System. In the 2016-17 budget, the SCO analysis, and Stage 4 bid analysis and finalization of received funding for eight positions to restart the project details. Each stage: (1) requires sponsoring replacement of the state’s payroll system (now departments to conduct specific planning-related renamed the California State Payroll System, or analyses and submit an associated planning CSPS). When the TFC project was first proposed document to CDT, and (2) provides CDT with in 2004, the SCO justified the project by noting a discrete decision point in its approval process. there were functionality and stability issues that Departments cannot begin their projects without warranted pursuit of an updated payroll system. receiving approval from CDT for each of the four For example, the SCO believed there would be stages. (Please refer to our February 2017 report, ongoing challenges with maintenance as the The 2017-18 Budget: The New IT Project Approval legacy systems are technically challenging and and Funding Process, to learn more about the PAL labor-intensive to update. They also noted that process.) a new system would reduce the likelihood of Governor’s Proposal significant payroll disruptions in future years. However, the department has now suggested that Budget Request the primary reason to replace the state’s payroll system is to improve functionality, not to address Governor’s Budget Proposes $3 Million to potential future stability issues. For example, Begin Stage 2 of the PAL. The Governor’s 2017-18 functionality improvements in a new system would Budget includes nearly $3 million to begin Stage 2 allow the SCO to respond more quickly to payroll of the PAL process and continue internal efforts changes, issue reports to other state agencies and to replace the state’s payroll system. (The SCO stakeholders, and allow employees online access to anticipates it will complete Stage 1 of PAL in payroll and tax information. April 2017 using currently authorized resources.) New State IT Project Approval Process This proposal includes $1.1 million in one-year Aims to Improve Success of State IT Projects. limited-term funding to support 11 positions Historically, when departments proposed IT (in addition to the 8 positions authorized in the projects, the California Department of Technology 2016-17 budget package). These positions would (CDT) required them to prepare Feasibility Study provide information on existing payroll policies Reports (FSRs). Various shortcomings with the and procedures, provide technical expertise on the FSR approval process meant that projects often legacy payroll systems, and respond to the PAL experienced challenges once they were underway. documentation requirements. These challenges were frequently associated with Proposal Includes Funding for Consulting significant cost increases and schedule extensions Services. The proposal also includes $1.8 million for IT projects. The CDT has begun implementing in 2017-18 for consulting and professional services. a new IT project approval process—known as the These services include an interagency agreement Project Approval Lifecycle (PAL)—with the goal of with the Department of Human Resources (CalHR) helping to bolster project planning and reduce the to ensure the new system appropriately applies likelihood of project challenges or failure. legal and regulatory requirements and supports PAL Divides Approval Process Into Four statewide human resources and labor relations Stages. The stages are: Stage 1 business analysis, policies and practices. The SCO also includes 2 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET external consulting services to: (1) help the state • Decentralized Payroll Systems. rethink its payroll process so they are more efficient Payroll practices can vary significantly (known as business process re-engineering), across state departments, and some (2) improve its project management, and departments—such as the Department (3) support a procurement support vendor. of Forestry and Fire Protection (CalFire) Tentative Proposed Timeline for Completion and the Department of Corrections and of PAL. With these (and other previously Rehabilitation (CDCR)—have particularly authorized) resources, SCO anticipates it will complex payroll needs that complicate the complete Stage 1 of the PAL process in April 2017. state’s ability to integrate these systems. The SCO plans to complete Stage 2 by August 2018, (Employees in these departments, for Stage 3 by May 2019, and Stage 4 by December example, work unusual hours or receive 2019 (with the resources requested in this proposal variable compensation based on a variety of and additional requests in future years). The SCO conditions.) This alternative would assess anticipates project work would begin in 2020-21. updating payroll systems in a decentralized fashion that integrates less complex payroll Initial Alternatives Under Consideration departments together and considers SCO Has Identified an Initial List of alternative approaches for modernizing the Alternatives to Consider. The SCO has identified payroll systems of complex departments. the initial list of alternatives it will evaluate during • Using Commercial Off-the-Shelf (COTS) Stage 2 of the PAL process. Below, we summarize Software. This alternative would assess these alternatives: modifying existing software—known as • Modular Approach Toward Centralized COTS software—as necessary to address Payroll System. Largely as a means of the state’s payroll needs. The SCO would reducing IT project risk, departments contract with a vendor to make the across the state are beginning to consider necessary software modifications. The developing and deploying their IT projects SCO anticipates evaluating the viability of in modules rather than all at once, which several COTS applications, including SAP has been the traditional approach. The software and the Financial Information modular approach works by breaking System for California’s (FI$Cal’s) People projects down into multiple discrete Soft application. The TFC project also relied units of functionality, prioritizing them, on SAP COTS software and contracted and then deploying them over relatively with SAP to modify the software for use short periods of time. In the case of the by the state. FI$Cal is a state IT project CSPS, modules would likely focus on that, when fully built, would integrate the discrete aspects of the state’s payrolling state’s financial management systems in processes, such as benefits administration the areas of budgeting, accounting, cash or deductions. Collectively, the modules management, and procurement. would create a centralized payroll system for the state. • Internally Custom-Built System. Rather than rely on existing software and vendors, this alternative would assess building www.lao.ca.gov Legislative Analyst’s Office 3 2017-18 BUDGET a custom system primarily using SCO The Legislature should note that these employees. Under this approach the state alternatives are not mutually exclusive. For example, would not have to conform its payroll the SCO could evaluate using a COTS application process to accommodate the particular to modernize the payroll systems for less complex functions of a COTS software. According departments. Meanwhile, to address the needs of to SCO, this would position it to effectively departments with complex payroll processes, the maintain and operate the system without SCO could evaluate using a modular approach. the reliance of a vendor. This could LAO Comments allow the SCO to relatively easily modify the system as payroll practices change, State IT Projects Are Expensive and such as when a new memorandum of Carry a Great Deal of Risk. The state has a understanding (MOU) is ratified between history of significant challenges in successfully the state and bargaining units. implementing IT projects. In some cases, projects have experienced significant cost overruns and • Implementing a New Front-End System multiyear delays. In other cases, the IT projects on Top of Existing Technology. The have failed altogether, resulting in either project existing payroll systems rely on mainframe suspension or termination and receiving significant technology. This alternative would assess legislative and media attention. While the PAL building a new “front-end” system (the should increase the quality of up-front planning interface a user sees) using modern and result in more accurate cost and schedule technology while continuing to rely on estimates than the prior FSR process, it does not the current mainframe technology in ultimately guarantee success. the “back-end” (the code and software Replacing Payroll System Will Be that support the system). Despite SCO’s Challenging . . . The CSPS would be a huge concerns with the stability of the existing undertaking. The state’s human resource systems when the TFC project was first management and payroll systems are very proposed in 2004, SCO now believes the complex and updating those systems (even if it is existing mainframe technology is stable through a decentralized or modular approach) and reliable well into the future. However, carries significant risk. As we have noted, some SCO has identified some challenges with departments, like CalFire and CDCR, have hiring employees with the technical particularly complex payroll needs that complicate expertise to maintain and operate the state’s ability to integrate these systems. The mainframe technology. state’s payroll needs are also continually evolving as new MOUs institute different compensation • Initiating “Software as a Service.” This schemes. As such, a new payroll system may be met alternative would assess establishing a with significant, and unforeseen, challenges. While subscription for an online application to we do think there is merit to the state pursuing process the state’s payroll. This option is an updated payroll system, we would caution the similar to the COTS alternative. However, Legislature that the risks common to IT projects a third-party would own and operate the are particularly acute in the case of CSPS. As a software, rather than state. 4 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET result, substantial delays and cost overruns are even No Concerns With the Governor’s Current more likely than usual. Proposal. At this point, we have no concerns . . . But Rigorous Planning May Result in with the Governor’s proposal to provide one-year a More Favorable Outcome. While unforeseen limited-term funding to the SCO for the PAL challenges surely will arise, we are cautiously alternatives analysis. We agree it makes sense for optimistic about the SCO’s current effort to replace the state to assess the potential risks, both in terms the state’s payroll system. In particular, the new of functionality and stability, to the state’s payroll PAL process, while still relatively untested, has system and explore potential solutions to these the potential to reduce the likelihood of project problems. challenges or failure through a more rigorous Recommend SCO Report to the Legislature planning process. Through the PAL, the SCO is With Analysis and Preferred Alternative. The currently collaborating with CDT and, through PAL process presents the Legislature with an this year’s proposal, would formally institute its early opportunity to weigh in on its own priorities ongoing collaboration with CalHR. The SCO’s for IT projects. However, the SCO’s anticipated initial list of alternatives suggests it is exploring timeline for completing the PAL does not neatly a wide range of possible project types. These align with the budget cycle. In particular, the SCO developments are encouraging. anticipates it will complete Stage 2 and move on to State Should Give Alternative Selection Stage 3 (which initiates the procurement process Careful Consideration. The alternative selected based on the solution selected in Stage 2) in August at the end of Stage 2 by SCO and CDT will have 2018, just after the adoption of the 2018-19 state significant consequences for the future of the state’s budget. If so, the Legislature may not have an payroll processes. Once an alternative is selected, opportunity to evaluate SCO’s alternatives analysis it could be years or decades before the state would and express its preferences in the selection of a implement a different system. (We would note project alternative. We recommend the Legislature the SCO proposed the TFC project in 2004, over require SCO to present its full findings from the 12 years ago.) The appropriate selection of a project Stage 2 alternatives analysis, alongside its preferred alternative will be critical to the success of the alternative, before it receives funding for Stage 3. future project. This would provide the Legislature with a clear opportunity to provide meaningful input and weigh in with its own priorities for the CSPS before a solution is procured. www.lao.ca.gov Legislative Analyst’s Office 5 2017-18 BUDGET 6 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET Appendix delays, SCO issued a breach-of-contract notice to BearingPoint. The vendor and SCO then reached History of the TFC Project a plan to address project failures and integration continued. These delays extended the schedule by Modernization of State’s Human Resources two years and raised estimated total costs to about and Payroll Management Systems. In 2004, $180 million. the State Controller’s Office (SCO) proposed Vendor Contract Terminated. After several the Twenty-First Century (TFC) Project, the months, BearingPoint once again fell behind information technology (IT) effort to replace the schedule, unable to complete project activities existing statewide human resources management and provide deliverables on time. With the and payroll systems used to pay approximately project’s schedule and development in jeopardy, 260,000 state employees. The new system, also the Department of General Services (DGS) issued called MyCalPAYS, was intended to allow the a default notice to the vendor on December 3, state to improve management processes such as 2008. The notice stated that the vendor failed payroll, benefits administration, and timekeeping to: (1) properly manage the project, (2) complete and include self-service access for employees and designs in a timely manner, and (3) make progress managers, among other capabilities. The SCO noted toward development. On January 6, 2009, SCO that the existing systems, commonly referred to formally terminated the contract, and primary as “legacy systems,” were developed more than 30 work on the TFC project stopped. years ago and are inflexible, fragmented, and costly Strategy to Move Project Forward Developed. to maintain. In 2005, the Legislature approved the Following the termination of the primary vendor project with an estimated total cost of $130 million contract, SCO developed a new strategy. In with full implementation scheduled for July 2009. particular, the project scope was narrowed by Two-Phase Procurement. In conjunction excluding California State University (CSU) from the with state IT oversight officials, SCO decided to project. The CSU has different payroll requirements pursue a two-phase, or “unbundled,” procurement from those applicable to state civil service employees. approach. This meant the state sought two vendors The legacy system would continue to process payroll and undertook two procurements. The first vendor for CSU until a revised system for CSU employees would supply the software package, and the second was completed as a separate project. The SCO also vendor (the primary vendor) would integrate the decided to select a new system integrator using a software to the state’s business requirements. In two-stage procurement approach, discussed below. April 2005, SAP Public Services, Inc. (SAP) was The new strategy was documented in Special Project selected to supply the software package. The system Report (SPR) 3. integrator contract was awarded to BearingPoint in New Contract Procured. In March 2009, DGS June 2006. released a request for proposal for a new system Early Issues Delayed Project Development. integrator. The procurement was conducted as During 2006 and 2007, SCO asserted that a two-stage procurement approach. Stage I was multiple problems had emerged with the work of the selection of contractors to evaluate the work BearingPoint. The vendor asserted that issues with completed to date and its possible reuse, and to the software package and with SCO caused delays. better understand the requirements of the project. In October 2007, following multiple schedule Accenture, LLP, and SAP were selected in Stage I. www.lao.ca.gov Legislative Analyst’s Office 7 2017-18 BUDGET Both companies submitted Stage II proposals, calculated, and medical benefits were denied for which detailed the approach, cost, and schedule some employees and their dependents. In one for completing the project. In February 2010, case, employees that took vacation time during the SAP was awarded the contract, at which point payroll cycle received compensation in addition to the project costs and schedule were revised. The their base salary. Attempts to correct these errors project schedule was extended to October 2012, created further problems in the following payroll and estimated total costs rose to $283 million. cycle. In early August, project staff determined Implementation was to occur in five phases— that the severity of these issues warranted the known as pilots and waves—where Pilots 1 and 2 delay of Pilot 2, an expansion of the new system to would bring a small number of employees into the 15,000 employees across numerous departments. new system in order to test it prior to Waves 3, 4, Pilot 2 was initially delayed from September 2012 and 5, which would fully implement the system in to March 2013. As a result of continued challenges, three large and roughly proportional stages. (SPR 4 discussed below, Pilot 2 was not implemented. documented these changes.) Cure Notice Issued to SAP. On October 25, Subsequent challenges occurred when the 2012, SCO issued a cure notice to the system project began converting data from the legacy integrator, SAP, expressing serious concern system to the new system. Project management regarding SAP’s ability to successfully implement issued a cure notice to the primary vendor, the new system. According to SCO, SAP’s lack of which then subcontracted with a data migration expertise and strategic planning lead to inadequate vendor, BackOffice Associates, to improve the data scheduling, staffing, knowledge transfer, deliverable conversion process. SPR 5 accounted for these management, and quality assurance. The SCO delays, increased the estimated total project costs also identified concerns regarding design, testing, to $373 million, and extended the final wave of the organizational change management, and training project, Wave 5, by one year—from October 2012 to weaknesses. In total, the cure notice cited 13 September 2013. grievances and prompted SAP to correct these Pilot 1 Test. On June 11, 2012, the first major problems by November 30, 2012, so that the project test of the state’s new payroll system took place. The could move forward. test, known as Pilot 1, produced payroll, benefits, SAP Responds to Notice. The SAP submitted a timekeeping, and position management activities response to the cure notice on November 30, 2012. for about 1,500 SCO employees. This pilot program In its response, SAP did not assume responsibility tested the new system’s functionality with a small for the grievances outlined by SCO and took no number of employees in an effort to identify and action to resolve the issues. correct potential problems before expanding the Contract Terminated in Early 2013. On number of employees covered by the new system. February 8, 2013, SCO terminated its vendor Problems Encountered During Pilot 1. contract with SAP, citing inaction regarding issues Although SCO expected minor discrepancies listed in the cure notice and a lack of confidence in during Pilot 1, significant errors surfaced during the vendor to implement the project successfully. the first payroll cycle and persisted through each At the same time, the Technology Agency—now of the subsequent seven monthly payroll cycles. the California Department of Technology (CDT)— In particular, incorrect paycheck deductions were suspended further work on the project until a new made, payroll and pension wages were erroneously plan could be established. 8 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET State Payroll Reverted to Legacy Systems. legacy systems in order to identify inaccuracies and Beginning in March 2013, SCO returned the ensure that no pay or benefits discrepancies were payroll processing for its Pilot 1 employees to left unresolved. As a result of this precaution, SCO the existing legacy systems. According to project indicated the return to the legacy payroll systems staff, SCO began running parallel payrolls on the for these employees should not pose a problem. Figure A1 Twenty-First Century Project Timeline • May 2004—The Department of Finance approves the TFC project FSR and the project begins. • April 2005—The TFC project procures the SAP Public Services, Inc. (SAP) software solution for a new system and begins a second procurement for an integration vendor to design, develop, and deploy the solution. • June 2006—The TFC project contracts with BearingPoint, the winning system integration vendor. • January 2009—After experiencing multiple serious problems, the state issues a notice of default to BearingPoint and terminates the contract. • February 2010—After completing a second vendor procurement, the TFC project contracts with SAP to complete the new system. With the start of the SAP system integration contract, the TFC project updates its costs and schedule with SPR 4. • Spring 2011—Initial data conversion tests between the state’s existing payroll system and the new system are problematic. The TFC project staff identify additional implementation issues. • August 2011—The TFC project issues a cure notice to the system integrator, SAP, requiring SAP to improve data conversion, among other requests. The SAP subcontracts with BackOffice Associates in order to remedy the cure notice, and the project continues. • November 2011—Project staff and SAP review data conversion and revise timeline, delaying the first pilot test by nine months. SPR 5 includes new cost and schedule estimates. • June 2012—Pilot 1 goes live, processing payroll for about 1,500 SCO employees. • August 2012—The TFC project staff report significant errors during the go-live payroll, including overpayments, incorrect deductions, and leave balance discrepancies. Staff tentatively delay Pilot 2 from September 2012 to March 2013. • October 25, 2012—The SCO issues a second cure notice to the system integrator, SAP, requiring SAP to increase personnel on the project, reschedule project milestones, and stabilize the software so that Pilot 2 and Waves 3, 4, and 5 may go forward, among other requests. • November 30, 2012—SAP issues its response to SCO’s cure notice, denying responsibility for the Pilot 1 payroll inconsistencies and timeline delay. • February 8, 2013—The SCO terminates its vendor contract with SAP and returns Pilot 1 employee payroll to the existing legacy system. • February 8, 2013—The California Technology Agency (now the California Department of Technology) suspends the TFC project, citing the vendor’s failure to finish the project and unwillingness to remedy the issues SCO presented in the cure notice. • November 2013—The SCO files a lawsuit against SAP, seeking to recover payments made to the vendor, and SAP files a counter-claim against the SCO. • June 6, 2016—The SCO reaches a settlement agreement with SAP. Under the terms of the agreement, SAP pays the SCO $59 million and drops its own claims. • December 2016—The SCO closes out the TFC project and renames the renewed effort the California State Payroll System. TFC project = Twenty-First Century project (also known as MyCalPAYS system); FSR = Feasibility Study Report; SPR = Special Project Report; and SCO = State Controller’s Office. www.lao.ca.gov Legislative Analyst’s Office 9 2017-18 BUDGET Lawsuits Filed. In November 2013, the System/Software Assessment Released. In SCO filed a lawsuit against SAP for breach of late 2015, Grant Thornton, a contractor hired contract, seeking to recover payments made to on behalf of CDT, released the results of an SAP for system integration costs prior to project assessment of the TFC system and software. The termination. (The primary vendor payments made assessment detailed which system requirements to SAP totaled $50 million of the $90 million were satisfied, determined which of the delivered contract.) SAP later filed counter-claims against products could be leveraged to complete the the SCO for damages and declaratory relief in the project, and estimated the cost for a vendor to amount of $23 million. complete the system. CDT had planned to complete SCO Corrects System Errors Produced During two additional assessments of the TFC project—a Pilot 1. In 2014, SCO took on a “Do the Math” project management assessment and an alternatives reconciliation effort to identify and correct the assessment. However, these were later rolled into errors produced during Pilot 1. Of the 1,542 SCO the Project Approval Lifecycle (PAL), the state’s employees that participated in Pilot 1, the SCO new IT project approval process. corrected errors for 267 employees who were Post-Implementation Evaluation Report underpaid and 541 employees who were overpaid. (PIER) Completed. In November 2016, the SCO In addition, the SCO completed reconciliations submitted a PIER to the CDT. The PIER includes a for the 100 interfaces that connect with other detailed history of the TFC project, compares the payroll system payees, such as healthcare providers, project objectives to the actual project outcomes, retirement savings systems, and tax agencies. documents the failures and successes experienced Lawsuits Settled. The terms of a June 6, 2016, on the project, and describes the corrective actions settlement agreement resulted in SAP paying the the SCO will take to improve the chances of future SCO $59 million and abandoning its own claims success. The submittal of the PIER represents the against the SCO. The $59 million settlement was official end of the TFC project. For SCO, it also distributed to the state’s General Fund and special represents the start of a renewed effort to update funds, using the same proportions established the state’s human resources management and to support the TFC project. Figure A1 shows the payroll systems. In December 2016, the SCO named timeline of major events from the start of the the renewed effort the California State Payroll project in 2004 through the close of the project at System. the end of 2016. 10 Legislative Analyst’s Office www.lao.ca.gov 2017-18 BUDGET www.lao.ca.gov Legislative Analyst’s Office 11 2017-18 BUDGET LAO Publications This brief was prepared by Ann Hollingshead and Lourdes Morales, and reviewed by Jason Sisney. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 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