Risky Business: Redefining Value for Money in PPPs 1

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Tuesday, December 1st, 2015
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The public-private partnership (PPP) has often been viewed as a ‘dumping ground’ for risk, with the heavy-handed transfer of risk seen by governments as key to achieving value for money. In reality, a more collaborative approach would create optimal value.

In some ways, public-private partnerships have become increasingly sophisticated over the past two decades. In other ways, the approaches taken to PPPs are stale, foster mistrust and deliver sub-optimal value to governments, private partners, investors, citizens and taxpayers.

A constant challenge is the ever changing definition of what value for money is. Often there is a bias in the contracting world toward ‘hard dollar’ approaches where risks are clearly allocated in a black-and-white manner between parties.

The fault with this approach is that some things will go wrong. Risks will be realised.

The best projects are often the ones where each party genuinely acknowledges who is best placed to manage a risk and then the parties agree upon ways to address any changes. In the transaction world this is called risk sharing, or the ability to turn unplanned risk into a contracted method of dealing with change.

Framers of true PPPs have delivered many projects under this model but unfortunately modern procurement practices have defined PPPs as simply being arrangements whereby private sector capital is repaid for the public sector having access to services (availability payments). A highly transactional approach is used, which belies the idea of a true public-private ‘partnership’.

A classic PPP example is the toll road, outlined in the example below:

Project A: A hypothetical example

A government is looking to build an inner city toll road or tunnel in order to address congestion issues, remove an identified bottleneck and unlock growth potential. A traditional procurement process for Project A is launched.

Being a toll road or tunnel, there are ample examples of previous public-private partnerships to draw upon. On the surface, Project A seems to fit the usual mould.

Government procurement advisers therefore apply generic risk allocation tables and a run-of-the-mill evaluation model to the tender process. This means the private party is expected to assume most risks, including exogenous risks. The tender evaluation process is weighted very heavily toward the lowest priced bid. After all, this will achieve the best value for money for taxpayers, right?

Thrifty Consortium – the lowest priced bidder – wins the contract to build, own and operate the toll road.

During the construction of Project A, they encounter a number of hurdles as risks are realised. Because they bid at such a low price with low contingencies, they apply for a variation to their contract. Understandably, the government is not receptive; after all, they are the custodians of taxpayers’ money. The matter ends up in court.

A relationship of mistrust and resentment forms between the government and Thrifty Consortium. The project runs over time and over budget, financially weakening the consortium members and reflecting badly on the government. Congestion issues worsen. Citizens are furious. Investors and banks are nervous.

The toll road is finally completed. The consortium charges the agreed toll fees. Citizen uptake of the toll road is slower than expected, as the toll road has taken so long that it doesn’t deliver the travel time cuts that were originally touted. Citizens also have low trust in Thrifty Consortium, as they have been hearing about all the troubles surrounding the project in the media.

Eventually, the already weakened consortium folds. Receivers are appointed.

While the failed project is embarrassing for the government, some within government hail the project as a success because it was delivered at such a low cost that it caused Thrifty Consortium to go broke.

Surely this represents good value for money for taxpayers?

While I admit that the above scenario is over simplified, it is an approach to PPPs that has been becoming more prevalent.

Increasing adversarialism, a growing lack of trust between private parties and governments, a transactional approach and a lack of collaboration when it comes to fair risk apportionment are all characteristics of many modern PPPs.

These characteristics, however, could drive out private investment in public projects in the long term.

Furthermore, the approach outlined in the above scenario doesn’t actually create optimal value, even in the short term.

Here’s a few reasons why:

  • Governments are left to ‘mop up the mess’ and to find a solution if the private consortium goes broke. This can involve pouring further public funds into the project.
  • Funds spent ‘fixing’ the project (or on contract variations) can far outweigh what would have been spent on a project that optimally apportioned risk from the outset, meaning taxpayers lose in the long term.
  • Private consortiums and governments face public and industry scrutiny – some warranted, some not – for poorly handing the project, delivery delays, toll hikes, and so on.
  • Government advisors who equate lowest price with highest value and that use generic risk apportionment tools are creating a recipe for disaster, particularly when big risks like construction risks are not examined in detail (i.e. contaminated land in urban environments or the potential for repeated weather events during construction).
  • Innovation that could have non-monetary (e.g. environmental or social) benefits is discouraged. Bidders realise that the standard evaluation processes used by governments will almost always favour the lowest price bidder. Innovative products, practices and processes are simply not considered.

Redefining value for money

A more collaborative, tailored approach to risk sharing needs to be implemented so that PPP projects drive true value for money for governments and society.

A mixture of competitive behaviour, along with a meaningful understanding of the risks of the owner and government, needs to be employed.

When transactions push risk to one party solely for items such as trying to predict the absolute position of a sewer pipeline buried 100 years ago, the project is destined for disaster.

The interesting outcome is that the transaction team is long gone by the time a risk event happens. It is the political leaders who need to stand on the community corner, explain the problem and cop criticism when the project is delayed.

A genuine discussion on risk sharing models is required to drive greater service outcomes for our communities. This should include deeper discussions around probability models, risk identification and how contracting culture can become less adversarial in order to can drive successful outcomes and create optimal value.

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  1. Barry

    Interesting take on the potential pitfalls of PPP's, but some concrete examples as opposed to a pure hypothetical would have been appreciated.