State, local and education agencies in the US are rapidly adopting hybrid cloud managed services to replace costly outdated systems, using AI, automation and data-driven strategies to improve citizen services despite ongoing fiscal and talent shortages, ISG research finds.
Across the US public sector, agencies are ramping up hybrid cloud adoption to address a pressing problem: outdated, costly legacy systems that drain budgets and hamper service delivery. According to the 2025 ISG Provider Lens Private/Hybrid Cloud – Data Center Services report for the US Public Sector, state, local and education (SLED) organizations are focusing their technology spending on modernization, cybersecurity and hybrid cloud infrastructure, even as overall IT market growth slows due to limited resources and political shifts at the federal level.
The report finds that nearly 90% of SLED agencies are expected to embrace hybrid cloud models, a move driven by the urgent need for measurable modernization outcomes supported by AI-powered tools and automation.
“US public agencies are looking for IT modernization projects with measurable outcomes, provided through AI-powered tools and automation,” said Nathan Frey, ISG Partner and Lead, US Public Sector. “They are relying on managed service providers to administer their IT assets and supply the skills necessary for Digital Transformation.”
From aging systems to agile architectures
The report identifies legacy systems – some in operation for decades – as representing a significant barrier to public sector efficiency. These platforms are costly to maintain, prone to inefficiencies and often incapable of meeting the evolving expectations of constituents. In many cases, legacy infrastructures are patched together with outdated code and hard-to-replace hardware, creating fragile environments that are prone to outages.
Agencies aspire to replace these systems with secure, scalable, cloud-based solutions but face a chronic shortage of in-house expertise. Many IT leaders in the public sector are caught in a balancing act: maintaining critical citizen services while simultaneously planning for long-term modernization.
Managed service providers (MSPs) are identified in the report as stepping in to fill this gap. By overseeing infrastructure upgrades, MSPs not only improve IT performance but also ensure regulatory compliance and bolster security. Their role extends to optimizing applications for hybrid cloud environments, where flexibility and scalability are essential.
Some states, for example, have turned to MSPs to migrate decades-old unemployment benefit systems into hybrid cloud models that scale on demand, reducing backlogs and improving response times during economic downturns. These transformations demonstrate the potential for hybrid models to directly improve citizen outcomes.
Automation and AIOps reshape public sector IT
As agencies transition to complex, modern architectures, automation and AI for IT operations (AIOps) are becoming essential, the report says. These tools proactively identify and address issues before they escalate, automate repetitive tasks and help organizations sift through massive volumes of public sector data to extract actionable insights.
By using predictive analytics and AI-driven monitoring, AIOps allows agencies to anticipate system failures, improve incident response and free up skilled staff for higher-value tasks. This not only reduces downtime but also improves the speed and quality of services offered to citizens.
An education department, for instance, might use AIOps to monitor online learning platforms, predicting when surges in traffic could overwhelm systems and automatically reallocating resources to maintain availability. This type of automation has direct implications for students and families, reducing frustration and improving accessibility.
The cost equation: FinOps and pay-as-you-go models
Budget constraints remain one of the most significant obstacles to modernization. To stretch limited resources, many agencies are deploying FinOps strategies to control cloud costs, the report says.
FinOps is more than just accounting – it is a cultural practice that brings together finance, technology and operations teams to ensure transparency in cloud spending.
Pay-as-you-go service contracts are increasingly popular, allowing agencies to align IT spending directly with usage and avoid the waste associated with overprovisioned systems. This approach resonates with public administrators under pressure to show taxpayers a clear return on investment.
Automation is also delivering cost savings by streamlining workflows, improving workforce efficiency and reducing manual intervention in routine processes. In a resource-constrained environment, these efficiencies are crucial.
“Advanced cloud service models enable public agencies to improve operations despite significant, ongoing resource limitations,” said Shashank Rajmane, Senior Manager and Principal Analyst, ISG Provider Lens Research, and author of the report. “Ultimately, technology improvements allow them to make government processes quicker and more intuitive for users, fostering greater engagement with citizens.”
Data management emerges as a critical capability
The ability to manage and leverage data is now central to public sector performance.
Comprehensive data solutions from MSPs – covering storage, advanced analytics and security – are enabling agencies to organize and protect sensitive information while deriving actionable insights, the report says.
For SLED organizations, effective data management underpins more informed policy decisions and enables evidence-based governance. By integrating analytics into daily operations, agencies can forecast needs, measure program effectiveness and deliver services more effectively.
One municipal agency, for example, has applied advanced analytics to transportation data, identifying patterns of congestion and improving public transit scheduling. These insights not only improve efficiency but also reduce costs and environmental impact.
Why modernization is urgent
Market projections indicate the US SLED IT infrastructure services market will reach approximately US$150 billion by the end of 2025, with expectations to surpass US$170 billion by 2028. The report finds, however, that growth is moderating due to fiscal pressures and shifting political priorities.
Despite increased federal funding through initiatives like the Technology Modernization Fund, spending as a share of GDP remains below historical levels. This financial reality means agencies often must choose between maintaining essential services and investing in transformative IT projects.
In many cases, the decision to delay modernization perpetuates the risks associated with aging systems – security vulnerabilities, high maintenance costs and difficulty integrating with new platforms. Several high-profile system outages in recent years have highlighted the cost of inaction, reinforcing the urgency of cloud transformation.
Security: a top priority in the cloud shift
The report acknowledges older infrastructures lack the built-in security controls of modern systems, leaving agencies more vulnerable to cyberattacks. Public sector data includes sensitive citizen information and, in some cases, national security data. A breach could erode public trust and have far-reaching consequences.
Agencies must also comply with rigorous frameworks such as the Federal Information Security Modernization Act (FISMA) and the National Institute of Standards and Technology (NIST) guidelines. Meeting these requirements involves continuous monitoring, stringent controls and detailed reporting – activities that demand skilled resources and specialized tools.
This is where hybrid cloud models provide an advantage. Providers can offer layered defenses such as zero-trust security, encryption at rest and in transit, and continuous vulnerability scanning. Some also incorporate AI-driven threat detection, helping agencies stay ahead of increasingly sophisticated attacks.
Breaking down silos
The report recognizes one of the most persistent challenges in public sector IT is the existence of data silos. Disparate systems and isolated repositories make it difficult to gain a holistic view of operations or share information efficiently across departments.
Overcoming these silos requires both technical integration and political will. Improved interoperability can significantly enhance efficiency, reduce duplication and enable better citizen services. However, such projects often require extensive inter-agency co-operation and careful resource allocation.
For example, when state health departments integrate with education systems, agencies can respond more effectively to public health crises by understanding their impact on school attendance and community well-being. This type of cross-sector data sharing is made possible by modernized IT environments.
Shifting procurement and service models
The competitive landscape among service providers is evolving, the report says. Many now offer modular pricing, outcome-based contracts and on-demand engineering services. This shift away from one-size-fits-all models toward agile, tailored solutions reflects the public sector’s need for flexibility and rapid transformation.
Providers are investing selectively in capabilities that support hybrid operations, regulatory compliance and vertical-specific modernization. As large vendors consolidate or form global alliances, some public sector clients are seeking assurances on service continuity and long-term support.
Procurement models are also under review. Agencies increasingly prefer shorter contracts with built-in flexibility, reducing the risk of vendor lock-in and ensuring that services evolve alongside emerging technologies.
Key modernization trends
The report identifies several trends as shaping how the US public sector approaches IT transformation:
- Legacy replacement: Outdated systems are being replaced with cloud-based solutions designed for scalability, security and integration.
- Automation and AIOps: These technologies reduce manual workloads, detect issues early and enhance decision-making through advanced analytics.
- Cost optimization: Agencies are embracing FinOps practices, automation and consumption-based pricing to ensure sustainable IT spending.
- Data-driven operations: Comprehensive analytics tools enable agencies to derive insights, improve services and guide policy.
- Citizen-centric services: Investments aim to make interactions with government more intuitive, responsive and accessible.
Industry leaders and recognition
The report names Rackspace Technology as a Leader across all three evaluated quadrants: Managed Services, Managed Hosting and Colocation Services. Ensono, Kyndryl, NTT DATA and Unisys earned Leader status in two quadrants each, while Accenture, CGI, Equinix, HPE, IBM, Infosys, Iron Mountain and TierPoint were recognized in one quadrant.
Persistent Systems was named the global ISG CX Star Performer for 2025, achieving the highest customer satisfaction ratings in ISG’s Voice of the Customer survey. This recognition reflects growing demand for high-quality, user-focused cloud services.
Looking ahead
The report finds that while challenges such as budget limits, talent shortages and regulatory complexity persist, the momentum toward hybrid cloud adoption in the US public sector is undeniable. By leveraging managed services, AI, automation and data analytics, agencies are not only modernizing their IT infrastructures but also reshaping how they deliver services to citizens.
This transformation, the report says, is not only technological but cultural with the shift toward flexible, secure and data-driven systems marks a turning point in public sector operations, promising more transparent, efficient and citizen-focused governance for years to come.
As citizen expectations continue to rise, hybrid cloud models will become a linchpin of public trust and service innovation. The agencies that act decisively today stand to redefine how government works tomorrow, the report says.
