THE PRACTICE OF CONTRACTING IN PUBLIC PRIVATE
PARTNERSHIPS:
TRANSACTION
COSTS
AND
RELATIONAL
CONTRACTING IN THE IRISH SCHOOLS SECTOR
Eoin Reeves
Department of Economics
University of Limerick
Limerick
Ireland
Abstract
This paper explores the practice of contracting in public private partnerships.
Focusing on the first Irish PPP to provide secondary schools, it draws on perspectives
from transaction cost economics and socio-legal theory. It finds that the ex ante
contractual setting was undermined by pushing forward with the PPP before
conducting an adequate level of project appraisal. It explores the experiences of key
stakeholders in the ex post contracting stage and concludes that the conduct of
contracting practice was not characterized by the shift to relational contracting
expected under PPP. Whereas, this approach to contractual governance did not hinder
the development of broadly trusting relations between the client and contractor, this
was not manifest in terms of relations between the contractor and schools. A
significant degree of conflict was evident in some schools-contractor relations, which
can be attributed to sources of transaction costs including incomplete information,
bounded rationality and uncertainty.
Forthcoming in Public Administration
Key Words: Public Private Partnerships, Contracting, Schools, Ireland.
THE PRACTICE OF CONTRACTING IN PUBLIC PRIVATE
PARTNERSHIPS: TRANSACTION COSTS AND RELATIONAL
CONTRACTING IN THE IRISH SCHOOLS SECTOR
INTRODUCTION
In 1999 the Irish government launched a pilot programme of Public Private
Partnerships (PPPs) as part of the effort to address the country’s severe deficit of
physical infrastructure. In simplest terms the case for PPP over traditional forms of
public procurement was articulated in terms of speedier delivery of projects and better
value for money (VFM) (Department of Finance 2001). These arguments proved
persuasive and the proposed PPP programme expanded rapidly. This was recognised
in a review of worldwide PPP activity by global consultancy firm Deloitte (2007) that
categorised Ireland along with Australia and the UK as the countries with the most
mature PPP markets.
Against the claims in favour of PPP there is a growing body of critical literature,
which provides grounds for questioning the rationale for adopting this procurement
model (for example, Quiggin 2001; Ball et al 2001). The basic VFM case has been
questioned on the basis that it can only be achieved if financial savings under PPP
outweigh the relatively higher borrowing costs faced by the private sector. Also,
there is increased recognition that new institutional arrangements such as PPP involve
significant transaction costs, which are in addition to those costs that are measurable
in financial terms. As the PPP model of procuring infrastructure and services
typically involves features such as lengthy procurement processes and the
management of relations over periods as long as 30 years, the resultant demands on
1
the resources of both buyers and sellers must be considered when assessing the
appropriateness, or otherwise, of institutional arrangements such as PPP.
The focus of this paper is on the practice of contracting under PPP. The research
explores whether or not PPP involves relational contracting? Such a practice of
contracting would involve high levels of co-operation and trust and reduced
transaction costs thereby improving the prospects for economic efficiency. The paper
is structured as follows. It begins with a general discussion on the case for PPPs and
the development of the PPP programme in Ireland. It proceeds to develop a
theoretical framework for analysing PPP projects. The framework is based on
transaction cost economics, supplemented by socio-legal theory and perspectives on
contractual governance. The framework is then applied for the purpose of analysing
the first PPP project in Ireland to reach the stage of operation. As the procurement of
the contract to design, build, operate and finance five secondary schools was
completed in 2003 the analysis in this paper covers both the ex ante and ex post stages
of this PPP.
PPPs IN IRELAND
In June 1999 the Irish Minister for Finance, Mr. Charlie McCreevy announced the
decision to experiment with PPPs as a method for procuring public infrastructure and
services. Initially eight pilot PPP projects were announced in the roads (4), schools
(2) environment (1) and public transport (1) sectors and the number of PPP projects
has subsequently increased on a steady basis. By the end of 2005 PPP projects were
2
under procurement in sectors including roads, environment (waste and water), health
(nursing homes), schools, prisons, courts services and social housing.
Despite this expansion, the implementation of the PPP programme has encountered
difficulties. By mid-2003, four years after the announcement of the pilot projects, the
procurement process had been completed in just three cases, two of which were in the
schools sector (Reeves, 2003). At this point the PPP programme was the subject of
strong criticism from the private sector with respect to aspects such as the extent of
deal flow, the level of public sector skills in the context of procuring PPPs and the
costs involved in bidding for PPP contracts.
The fiscal treatment of PPP expenditures presented a significant obstacle in terms of
mobilising the PPP programme. The potential for PPP as a means of keeping capital
expenditures off-balance sheet had undoubted appeal for the Irish government which
was committed to keeping within the fiscal constraints imposed by membership of the
single European currency. Uncertainty in relation to this issue was exemplified in the
case of the PPP to build the Cork Music School. Although a preferred bidder had
been selected, the Department of Finance would not recommend approval of the
project on the grounds that the full capital cost would be counted in the General
Government Balance (GGB) figures and treated as Gross Fixed Capital Formation of
general government spread across the period of construction. Approval for the project
was only granted after Eurostat issued a clarification about the accounting treatment
of PPP expenditures in February 2004. In its clarification Eurostat recommended that
“the assets involved in a public-private partnership should be classified as nongovernment assets, and therefore recorded off balance sheet for government, if both of
3
the following conditions are met: (1) the private partner bears the construction risk,
and (2) the private partner bears at least one of either availability or demand risk”
(Eurostat 2004, p.1).
Despite these problems the government has demonstrated continued faith in the PPP
model. Buoyed by the fact that two PPP roads projects in addition to the PPP to build
five secondary schools were completed ahead of schedule, the government announced
a number of significant PPP projects in late 2005. These include an expansion of the
PPP programme in the education (buildings at primary, secondary and University
levels) and health (national radiotherapy network) sectors and the announcement of
the PPP to provide a national conference centre. In November 2005 the government
unveiled a transport plan, which commits to invest over €34 billion by 2015 with €8
billion coming from the private sector.
A FRAMEWORK FOR ANALYSING PPPs
From the outset, the case for adopting PPPs in Ireland has been largely predicated on
the basis that PPPs would deliver better VFM compared to traditional procurement.
This has been explained in terms of features of PPP including: competition for
contracts; bundling the elements of the project life-cycle; risk transfer and superior
private sector innovation (Department of Finance 2001). In theoretical terms, the
proposition of better VFM under PPP is broadly in accordance with the neo-classical
view of markets where firms are assumed to maximize profits, individuals are
assumed to be self-seeking and rational, and there is perfect information. Although
the neo-classical view of markets provides theoretical support for market-based
4
reforms such as PPP it is open to criticism on the basis that it focuses entirely on
production costs. Such costs however constitute just one element of economic
efficiency. A wider perspective on economic efficiency embraces transaction costs.
These are the costs that arise in organising a competitive tendering process as well as
writing, monitoring and enforcing contracts. As the central plank of ‘new institutional
economics’ transaction cost economics represents an important contribution to
understanding issues such as contracting practice and choices concerning the coordination of economic activity (e.g. market, hierarchy, outsourcing, strategic
alliances). Nevertheless, the limitations of adopting a purely economic perspective
need to be recognized. Investigations of how economic activity is organized have
engaged the attention of those across a host of disciplines including law, psychology
and sociology. With this in mind, the analysis of PPP presented in this paper goes
beyond the transaction cost framework and is primarily supplemented by aspects of
socio-legal theory. This approach facilitates an analysis of aspects of contracting
practice such as the quality of contractual relations under PPP. It also addresses
questions such as the degree to which the contracting process is co-operative or
conflictual and the role of contract and other mechanisms in co-ordinating economic
activity in a PPP context.
Economic and socio-legal perspectives of contracting
As PPPs entail contracting between the private sector and government under
conditions of imperfect information, the literature on the ‘economics of contracting’
provides useful insights into the practice of contracting under PPP. The theory of
transaction costs, initially developed by Ronald Coase (1937) and built upon and
5
popularized by Oliver Williamson (1975; 1985; 1996), is fundamental to the
‘economics of contracting’. Transaction costs are essentially the costs of using the
market and include “costs of negotiation and writing contingent contracts; costs of
monitoring contractual performance; costs of enforcing contractual promises; and
costs associated with breaches of contractual promises” (Rahman and Kumaraswamy,
2002:46). Consideration of transaction costs sheds light on issues including the
choice of procurement method (for example, PPP) and the practice of contracting
after contracts are signed.
Central to the theory of transaction costs is imperfect information. The theory of
transaction costs recognizes that agreement and exchange frequently occurs in the
context of parties possessing imperfect information about all aspects of the exchange.
Moreover, in some cases, exchange is characterized by information asymmetries with
one party to the transaction possessing knowledge that other parties do not.
The concept of bounded rationality recognizes the limits on human foresight and
cognition and how these limits give rise to transaction costs, especially in the context
of imperfect information and uncertainty. Opportunism refers to ‘the incomplete or
distorted disclosure of information, especially to calculated efforts to mislead, distort,
disguise, obfuscate or otherwise confuse’ (Williamson 1985, pp. 47-48). Taken
together, bounded rationality and opportunism give rise to the possibility that one or
other of the parties to exchange will exploit their information advantage at either the
pre- or post-contractual stages.
6
The danger of opportunism is increased where there is asset specificity. This refers to
the degree to which investments associated with the transaction are specific to the
parties involved. Specific investments have little or no use outside the transaction in
question and can lead to a situation of bilateral monopoly where both parties are
confined to exchange with each other (Walsh 1995). In other words, both parties are
‘locked-in’ to the exchange. Asymmetric lock-in occurs where one party has made
the majority of specific investments. Any resultant shift in the balance of power
creates scope for opportunistic behaviour or ‘hold-up’ whereby one party attempts to
exploit the dependency of the other party which has been brought about by the latter’s
specific investment. The danger of hold-up is increased where there are few
alternative parties with whom to contract (i.e. small numbers exchange).
As uncertainty and asset specificity together with repeat trading become more
significant features of the exchange, transaction cost analysis predicts the emergence
of ‘relational contracting’. Williamson (1985) describes relational contracting as a
means of displacing neo-classical contracting due to progressively increasing duration
and complexity of contract. The reference point for effecting adaptations is not the
original agreement. Instead the reference point under a relational agreement is the
‘entire relation as it has developed [through] time. This may or may not include an
original agreement and if it does, may or may not result in great deference being given
it’ (Williamson 1985, p.72). Relational contracting is closely associated with
partnerships and strategic alliances and involves long-term social exchange between
parties, mutual trust, interpersonal attachment, and commitment to specific partners,
altruism and problem solving (Darwin et al 2000).
7
The relational contracting context, which characterizes arrangements expected under
PPP, leads parties to supplement formal contractual clauses with more informal
mechanisms. Insights into these dimensions of the practice of contracting have been
illuminated by socio-legal theorists (for example, Vincent-Jones and Harries 1995a;
1995b; Deakin and Wilkinson 1995, Campbell, 2001, Vincent-Jones 2006) who have
drawn on perspectives including transaction cost analysis to explore the quality of
transaction processes considered with reference to how conflict and co-operation in
the management and adjustment of various kinds of exchange are related to the uses
made of different forms of governance structure, both contractual and extracontractual.
This approach owes much to Macaulay (1963) who found that the contractual process
in business relationships has relatively little connection with traditional contract law.
His empirical studies confirmed Weber’s observations on the importance of the noncontractual elements of business relationships including loyalty, co-operation and
trust (Deakin and Michie 1997, pp.19-20). Frankel (1977) describes trust as the
'binding cement of all relationships' (Quoted in Davis and Walker 1997, p.3). It
provides the basis for confidence that the obligations and commitments undertaken in
incomplete contracts will be met. Its presence can promote co-operation and reduce
transaction costs in relationships based on long term or repeated exchange. The great
benefit of trust is that it is efficient; the more there is trust the less necessary it is to
engage in detailed and expensive monitoring of performance (Walsh 1995).
As the threat of opportunism increases there are strong incentives for cementing
relations. Co-operative utility maximisation is viewed as the basis for efficient long
8
term contracting (Campbell and Harris 1993). It should be noted however that the
concept of efficiency referred to here is ‘dynamic’ rather than static (technical or
allocative). Dynamic efficiency is enhanced by innovation and the introduction of
new goods and new processes and takes time to accrue. The concept of dynamic
efficiency is of particular relevance to PPPs, which are typically promoted on the
basis of features such as output-specification and risk transfer which are viewed as
drivers of superior private sector innovation.
PPPs constitute a significant change in public procurement practice and proponents
commonly make claims for the PPP model on the basis of the benefits derived from
establishing collaborative relationships based on ‘shared vision, authority,
information, planning, decision making, financial risk, responsibility and
accountability’ (Langford 2001, p.3). The framework described in this paper is
designed to examine the quality of the transaction processes in the case of PPP. Its
particular focus is on the transaction cost features of the relationship. The starting
point of the analysis is the recognition that whilst the high costs of managing and
adjusting conflictual transactions might be outweighed by financial savings in some
cases, there is likely to be a strong association between co-operation and dynamic
efficiency (Deakin and Wilkinson 1995). Moreover this analysis is mindful of the
distinctive challenges that arise in the case of PPPs as illuminated by Vincent-Jones
(2006) who argues in his extensive socio-legal analysis of ‘new public contracting’
that economic contracting regimes such PPP
‘Tend to be particularly cumbersome, complex, and convoluted in operation. The
question is whether these regimes are capable of succeeding where bureaucracies and
9
markets have failed; or rather, given all governance arrangements are imperfect,
whether in any particular case this mode of economic coordination is better that the
next best alternative’ (2006, pp.357-358).
With these views in mind, this paper examines the practice of contracting in the case
of a PPP to build and operate five secondary schools. First, the ex ante contractual
setting is examined in terms of factors that present potential obstacles to co-operative
contracting. These are identified with reference to the theoretical considerations
discussed above as well as literature on public procurement practice. This is followed
by analysis of the conduct of exchange after the schools were constructed and in
operation.
Factors affecting the quality of contractual exchange
A number of writers (e.g. Parker and Hartley 2003; Vincent-Jones and Harries 1995a;
and Lonsdale 2005) have examined the practice of public-private sector contracting in
the context of market-based reforms such as contracting-out and PPPs. These writers
have drawn attention to the following factors, which potentially hinder the
achievement of co-operative exchange and dynamic efficiency:

Un-developed and unstable markets resulting in insufficient competition for
contracts;

Over-emphasis on price and insufficient regard to quality at the stage of
contract award;
10

Loss-leading behaviour and lack of contracting experience on the part of
clients;

The nature of the pre-contractual power relations;

The relative commercial resources of the two parties to the transaction;

The relative importance of the transaction to the two parties and

The relative switching costs faced by the two parties to the transaction.
Uncompetitive markets, loss-leading and over-emphasis on contract price
A fundamental requirement for successful procurement is effective competition for
contracts and the benefits of competitive tendering in terms of improvements in
productive efficiency (cost reduction) are well documented (see Domberger and
Jensen 1997 for a review). A number of factors can however condition the degree of
competition required to meet contracting objectives. These include the problem of
small numbers exchange at the initial tendering or re-tendering stage and loss-leading
behaviour by bidders. Vincent-Jones and Harries (1995a) draw attention to the strong
possibility of ‘transaction problems due to underbidding, whether deliberate or
inadvertent, and the “winners curse” according to which a winning bidder is likely to
have over-estimated the value of the object and hence be unable to perform to the
specification without cutting corners’ (1995a, p.6). The probability of such outcomes
is increased where public sector clients attach disproportionate weighting to contract
price.
11
Asymmetric power relations and the importance of the transaction to both parties
Lonsdale (2005) examines the issue of asymmetric lock-in whereby one party
becomes dependent on the other thereby empowering the latter to engage in the
relationship on the terms of its own choosing. He emphasizes the case where the
buyer is the party in a position of dependency. In a PPP context this can result in the
supplier passing back the risk transferred in the original agreement. Contrary to the
thrust of orthodox (Williamsonian) transaction cost analysis which sees the protection
of contractor’s reputation as a safeguard against exploiting contractual power,
Lonsdale views any imbalance of power relations at the pre-contractual stage, as a
threat to efficient exchange. In such circumstances the supplier may wish to
‘perpetuate its dominance’ at later stages of the relationship (Lonsdale 2005 p.74). In
addition, asymmetric lock-in is possible when the importance of the transaction to a
buyer is greater than it is to the supplier. If the supplier recognizes that the public
sector is constrained by its statutory obligations to provide for key services they can
exploit this knowledge as leverage when negotiating at the post-contractual stage.
Unequal resources
Grimshaw et al (2002) and Lonsdale (2005) draw attention to the lack of expertise,
experience, or resources on the part of public sector clients as an obstacle to cooperative exchange. It is widely recognized that the procurement process under PPP
is longer and significantly more complex compared to traditional procurement. In
cases where “the purchasing function of the buying organization possesses inferior
resources, in terms of capacities and capabilities, to the sales team of the supplier….
12
[T]his can lead to the purchasing organisation signing an inappropriate contract –
through sheer pressure of time as much as anything else” (Lonsdale 2005, p.74). A
similar outcome can occur where a procurement model is imposed on the public
sector client by government. The Institute for Public Policy Research (IPPR) (2001)
warn of the inappropriateness of adopting the PPP model of procurement as the ‘only
game in town’ or where there is political pressure to urgently complete the project
subject to tight deadlines.
Switching costs
Failed business relationships, particularly under long-term contractual arrangements
for the delivery of important public services, impose significant costs on all parties.
One set of costs involves switching an organisation’s resources from one contract to
another. The potential of high switching costs (including the political embarrassment
of failing to secure satisfactory service delivery) is higher in cases where one party
has made most of the required specific investments. Consequent asymmetric lock-in
can become manifest in terms of failure to impose penalties or negotiate hard when
the need arises.
The factors discussed above create the wider setting for contracting under PPP.
Moreover, they influence the conduct of exchange once contracts are signed and
services are being provided. Among the main factors that have a direct bearing on the
quality of exchange is the balance between strict adherence to the terms of the
contract and reliance on non-contractual mechanisms such as flexibility, goodwill and
trust. The socio-legal and relational contracting literature suggests that over-referral
13
to the precise terms of the contract by either party, particularly with respect to factors
such as mechanisms for dealing with poor performance (e.g. penalty points and
deductions in payment) can damage the conduct of exchange and impact negatively
on dynamic efficiency. On the other hand, it must be noted that loose, informal
contracting may lead to a business relationship that is ‘too cosy’ and may not prove
acceptable when ‘set against accepted and expected standards for the conduct of
public life’ (Davis and Walker 1997, p.52). The following sections seek to bear these
considerations in mind when examining the nature of contracting practice in the case
of Ireland’s first PPP.
ANALYSING THE FIVE SCHOOLS PPP
Ex ante analysis: the contractual setting and procurement process
The contract for a group of five schools was announced as one of the original group of
pilot projects in June 1999. In 2001, the private sector consortium led by Jarvis
Projects Limited (Jarvis) was contracted to design, build, operate and finance the five
schools over a 25-year period. Construction of the five schools was completed in
approximately one year, which compares favourably with an average of two years for
schools constructed using conventional procurement (Dail Eireann, Committee of
Public Accounts 2005). All five schools were opened in January 2003.
A number of factors relevant to dimensions of the pre-contractual setting discussed
above served to shape the procurement process for this PPP. The experience with this
pilot project suggests a robust degree of competition for contracts in the schools
14
sector. Following the issue of initial notice in the Official Journal of the European
Community in June 2000, a total of twelve expressions of interest were received. Six
pre-qualification bids were invited and a final shortlist of three detailed tenders was
completed. The preferred bidder, Jarvis, was selected in February 2001 and the
contract documents were signed in November 2001. When interviewed in February
2006, the official in the PPP unit at the Department of Education and Science (DoES)
with chief responsibility for the PPP expressed satisfaction with the degree of
competition for the contract and stressed that the pitfalls associated with
overemphasis on the criterion of contract price (i.e. winners curse) were avoided as
the lowest bid was rejected on the basis of inferior design.
The question of risk allocation, which is a key feature of the PPP model, was
negotiated between the client and contractor on the basis of a risk transfer matrix used
by the DoES. The private sector takes full responsibility for risk in relation to school
design, construction, and operation of the contract whereas the public sector assumes
demand risk and residual value risk. Risks in relation to project finance, planning and
business regulation risks are shared. Normal business regulation risk is mainly
carried by the private sector whereas industry specific regulation is solely carried by
the public sector. It is worth noting that in its assessment of the procurement process
the Comptroller and Auditor General (C&AG) concluded that risks were
appropriately retained by the public sector but that the level of risk transferred to
Jarvis was ‘limited’ (2004: 52) accounting for 6.9% of the overall estimated cost of
procuring the schools by conventional means.
15
The C&AG’s report also highlighted a number of relevant shortcomings in the
procurement process. Whereas the DoES estimated that the PPP would yield cost
savings of 6%, the C&AG found that this estimate was subject to error and that the
PPP would be between 8% and 13% more expensive than under traditional
procurement. In addition the C&AG was critical of the decision to appoint the
preferred bidder prior to conducting the VFM test and the failure to establish an
affordability cap. As this project was the first of eight pilot projects announced in
1999 there was a significant degree of prestige attached to this PPP. This raised the
relative importance of the project to the public sector and provides a plausible
explanation for the push to complete the procurement process and build the five
schools.
The resources provided for procuring this PPP also deserve mention. The dedicated
PPP Unit within the DoES, which handled the procurement process, consists of just
two civil servants. As a consequence the DoES relied heavily on external advisers to
carry out project evaluation and management functions necessary to develop the
project. According to the C&AG, fees paid to these external advisers amounted to
€401,200. The evident inexperience of the public sector client can be viewed in
contrast to knowledge accumulated by the private contractor, Jarvis, which had been
successful in a number of PFI schools projects in the UK.
Ex post analysis: the practice of contracting
The principal objective of the analysis of ex-post contractual exchange in this paper is
to determine whether it possesses the features required for the achievement of
16
dynamic efficiency. It therefore probes whether high levels of trust and co-operation
characterize the PPP relationship. For this purpose the study adopts a framework
developed by Macneil (1978; 1985), which conceptualizes contractual relationships in
terms of two extreme types. The first, a transactional approach to governance,
‘involves a formal adversarial relationship between brokers and participants
characterized by economic exchange, short-termism and zero conflict of interest in
which integration and control are achieved through the implementation of contractual
specifications and the discipline of (quasi-) market forces’ (Darwin et al 2000, p.40).
At the other extreme is relational contracting which is associated with forms of
contracting such as partnerships and alliances and is characterized by features such as
informality, shared problem solving, co-operation and mutual trust.
The data used for this stage of the research was gathered during interviews with the
private contractor, the official in the DoES with chief responsibility for the PPP and
each of the five school principals. As part of the semi-structured interviews (which
were conducted over the period January-March 2006), interviewees were also asked
to complete a pro forma questionnaire concerning dimensions of the client-contractor
relationship. The questionnaire was based on the contractual governance framework
developed by Macneil. Interviewees were asked, where feasible and appropriate, to
apply scores to ten dimensions of the client-contractor relationship that are intended to
distinguish between those relationships that are mainly transactional and those that are
more relational in nature. For example, one of the dimensions drawn from Macneil’s
framework concerns the extent to which the written contract binds the parties. This
17
dimension of the relationship is considered transactional if the contract agreement
binds the parties totally. Alternatively, this dimension is considered to be relational if
the agreement is tentative. A scale of 1-10 was adopted with 1 representing the
transactional pole and 10 representing the relational pole. This follows the approach
adopted in studies of competitive tendering in the UK public sector by Walker and
Davis (1999) and Darwin et al (2000).
It should be noted that prominent socio-legal scholars (Campbell, 2001, VincentJones, 2001) have been critical of analysis based on the transactional-relational
spectrum. For example Vincent-Jones (2001) argues that these studies demonstrate
the
‘importance of trust and co-operation in exchange relationships, and have contributed
to our overall understanding of relational contracting. However, in comparison with
the potential scope of relational theory as set out in Macneil’s recent clarification, the
analyses appear unduly limited by an ideal-type methodology based on the polar
opposition of discrete and relational contracts’ (2001, p.78).
While recognizing the wider debate that covers these limitations as well as exploring
how Macneil’s ideas might be applied more productively, it should be noted that the
ex post analysis of contractual relations in this paper recognizes that the contract is
unlikely to be entirely relational or entirely transactional. Rather it is likely to have
elements of both. In this context the transactional-relational spectrum is adopted on
the grounds that it serves as a useful basis for describing the differing relationships,
18
which have developed in this PPP, and proceeding to explore why they have
developed in these ways.
Details of the ten aspects of contractual governance examined are provided in table 1.
The respondents were also asked to provide an overall assessment of the relationship
in terms of the degree to which it was characterized by co-operation, flexibility and
trust. These were also presented in terms of extremes (e.g. low-trust to high-trust) and
respondents were requested to score these aspects on a scale of 1-10. Whereas this
subjective scaling helped identify the differing relationships developing under PPP,
the research also sought to identify the key factors shaping the development of
relationships by posing open-ended questions concerning important issues and events
which arose in the course of the contract, how they arose, how they were resolved and
the approaches of relevant stakeholders.
Findings
PPP contracts are characterized by complexity in relation to aspects such as the
number of parties involved (e.g. contractors, sub-contractors, financiers and service
users) and the extensive documentation in PPP contracts. These complexities must be
taken into account when seeking to examine the quality of the contracting relationship
under PPP. In this case study it is recognised that while the formal contractual
arrangement is between the DoES and the private contractor, a full analysis of
contractual governance also requires an assessment of the relationship between the
contractor and the schools. As a consequence this examination of the public-private
19
sector relationship under PPP focuses specifically on the relationship between (1) the
DoES and Jarvis and (2) the schools and Jarvis.
TABLE 1: THE POLES OF TRANSACTIONAL AND RELATIONAL CONTRACT
RELATIONSHIPS
Transactional Pole
Relational Pole
Communication
Communication is limited and formal.
Communication
Communication is extensive and both formal
and informal
Contract
The contract document plays little or no role
in terms of dealing with issues as they arise.
Contract
The contract document is referred to
extensively for the purpose of dealing with
issues as they arise.
Planning
Initial planning is complete and specific –
only remote contingencies are not covered.
Bargaining
There is little or no bargaining as the
contract proceeds.
Binding
The contract agreement binds the parties
totally.
Cooperation
Almost no cooperation is required after the
start of the contract.
Planning
There is limited specific planning at the
beginning.
Bargaining
The contract involves extended mutual
planning – a ‘joint creative effort’.
Binding
The agreement is tentative.
Cooperation
The success of the contract is entirely
dependent on further cooperation in both
performance and planning.
Benefits and Burdens
There is unspecified sharing of both benefits
and burdens.
Rules and Rights
Rules and benefits are non-specific and nonmeasurable.
Altruism
There is significant expectation of altruistic
behaviour.
Problems
The possibility of trouble is anticipated and
dealt with by co-operation.
Benefits and Burdens
Each particular benefit and burden is
specifically assigned to one party.
Rules and Rights
Specific rules and rights are applicable,
usually measured in monetary terms.
Altruism
No altruistic behaviour is expected or
occurs.
Problems
Unplanned problems in performance or
among participants are not expected. If
they occur, they are covered by specific
rules.
Source: Adapted from Walker and Davis (1999), Darwin et al (2000).
DoES and contractor relations
20
The results in table 2 indicate that both the DoES and Jarvis see the current exchange
as distinctly transactional. It is particularly noteworthy that this view was held more
strongly by the public sector client. The only aspect of the relationship that was
viewed as strongly relational by both parties was the role of co-operation as a basis
for ensuring successful exchange. There was a significant difference in the views
regarding the use of the contract when contingencies arose. Whereas the client
expressed the view that the contract played a strong role in dealing with
contingencies, the contractor asserted that they frequently handled contingencies by
working flexibly outside the terms of the contract. This assessment was reflected in
the contractor’s view that the relationship was characterized by an appreciable degree
of altruism on their part.
TABLE 2: CLIENT’S (DOES) AND CONTRACTOR’S VIEWS OF CURRENT CONTRACT
RELATIONSHIPS
Dimensions of Current
Relationship
Communication
Role of Contract
Planning
Bargaining
Binding
Co-operation
Benefits and Burdens
Rules and Rights
Altruism
Problems
Client
Contractor
2
2
1
1
1
6
1
1
2
3
5
8
3
4
1
8
3
3
5
3
Table 3 presents the data on actual and preferred aspects of the relationship. The data
indicates a salient preference for a mainly transactional relationship on the parts of
both client and contractor. While similar preferences were found in comparable
studies (e.g. Walker and Davis 1999; Darwin et al 2000) these were confined to
aspects such as complete initial planning, specification of rules and rights and the
binding character of the contract. It is striking that respondents in the case of this
21
study expressed a preference for a transactional approach to aspects such as
communication and the degree to which the contract document should be used to
regulate the exchange. This was notably true of the public sector client who revealed
a marked preference for referring to the contract document when problems arose – a
preference that is consistent with his initial expectation that the contract would cover
most contingencies.
TABLE 3: CLIENT’S (DOES) AND CONTRACTOR’S VIEWS OF CURRENT AND
PREFERRED CONTRACT RELATIONSHIPS
Dimensions of
Relationship
Communication
Role of Contract
Planning
Bargaining
Binding
Co-operation
Benefits and Burdens
Rules and Rights
Altruism
Problems
Average
Client
Current
2
2
1
1
1
6
1
1
2
3
2
Client
Preferred
3
2
2
8
1
8
2
2
8
2
3.8
Contractor
Current
5
8
3
4
1
8
3
3
5
3
4.3
Contractor
Preferred
3
5
3
3
3
10
3
3
1
8
4.2
TABLE 4: OVERALL ASSESSMENT OF THE QUALITY OF PPP RELATIONSHIP
Client
Contractor
Un-Cooperative (1) –
Cooperative (10)
8
6
Inflexible (1) –
Flexible (10)
5.5
6
Low Trust (1) –
High Trust (10)
8
8
Despite these views of the relationship as largely transactional it is important to note
that both client and contractor consider their relationship to be characterized by high
levels of cooperation and trust (see table 4). While a number of issues have proved
difficult to resolve, both parties consider the PPP contract to be working well and
expressed satisfaction with the approach adopted by their partners. The broadly
cooperative nature of the relationship has been evident in terms of the mutually
satisfactory handling of contingencies and variations arising in the course of the
22
contract and the non-application of formal sanctions in the case of poor performance
(i.e. default points or deductions).
Overall, the responses from both the public and private sector parties indicate an
approach to contractual governance that is neither strictly transactional nor strictly
relational. This is to be expected.
‘No real life co-operation will be found entirely transactional; it will involve at least
some whole personal relations, some diffuse communication and some non-economic
personal satisfaction. Nor will contractual relations be found entirely lacking in
transactional discreteness, if such lack of discreteness is indeed humanly possible’
(Rahman and Kumaraswamy 2002, p.47).
A question that naturally arises concerns the factors explaining the transactional and
relational aspects of the relationship. With respect to the former, it must be
recognized that the responses in terms of aspects derived from Macneil’s framework
present a picture that is at odds with the expectation that partnerships are associated
with a relational approach to contractual governance. However, it can be noted that
empirical studies of business practice (for example, Macaulay 1963; Beale and
Dugdale 1975; and Darwin et al 2000) generally find a transactional approach to
aspects such as planning the contract and its basic parameters (e.g. price,
specification, assignment of rules and rights and an expectation that the contract is
binding to a large degree). In addition, there are other factors specific to this PPP that
have shaped a transactional approach. First, the contract in question is a pilot project
and the first such arrangement in the Irish schools sector. Hence, the largely
23
transactional approach observed in the first three years of this contract is consistent
with the proposition advanced by Sako (1992) who proposed that new contracting
arrangements will engender a transactional approach, particularly in the early stages
of the relationship. Second, the belief expressed by the public sector that the contract
would deal with all eventualities offers a possible explanation for a preferred
transactional approach to the use of the contract document to deal with issues. In
addition, the expressed preference for a formal approach to communication (with a
particular emphasis on the helpdesk system of providing information) can, to a
degree, be attributed to public sector resource constraints (there are two civil servants
working in PPP Unit in the DoES) and a set of schools that is geographically
dispersed.
The factors lending to the view of a mainly transactional relationship must however
be set beside other aspects that have governed the relationship to date. These include
the long-term (25 year) nature of the PPP contract, which has provided incentives for
fostering a cooperative approach in the interest of sustaining the relationship. For
example, both parties provided examples of cooperative behaviour on the part of the
private contractor. These include the replacement of equipment and the provision of
some small-scale facilities outside the terms of the contract. In some cases these
issues arose due to incomplete specifications provided by the DoES. Whereas
incomplete specifications can provide scope for disagreement and conflict the
responses in this case suggest that the contractor was willing to demonstrate the
flexibility and goodwill expected in the context of relational contracting. In addition,
it has been noted that aspects associated with a low trust environment have not
characterized this public-private exchange. There was no evidence presented of
24
excessive monitoring such as extensive inspection. Moreover, problems that have
arisen to date have largely been resolved on the basis of negotiation and a degree of
reciprocity rather than immediate imposition of financial penalties. Although the nonimposition of financial penalties is consistent with a more relational approach to
contractual governance it does raise questions about the de facto extent of risk
transfer, which is an important feature of contracting under PPP. This issue is
addressed in the next section.
Schools and contractor relations
Although this PPP contract is formally agreed between the DoES and Jarvis, a
complete analysis of contractual governance in this context requires a focus on the
relationship between the private contractor and the service user (i.e. the schools). To
examine these contractual relationships, structured interviews were conducted with
each of the five school principals. These interviews (which were conducted over the
period January-March 2006) were structured along the same lines as those conducted
with the DoES and Jarvis. Interviewees were asked to complete the pro forma
questionnaire concerning dimensions of the client-contractor relationship in terms of
transactional and relational aspects as well as discussing issues concerning their
degree of satisfaction with the new school building and standard of service supplied
by the private contractor.
The scores attributed to different aspects of the current relationship are detailed in
table 5. It can be seen that, on average, the five schools indicated a view of the
relationship that is largely transactional with average scores of less than five recorded
25
for seven of the ten aspects covered. Of particular note is the widely held view that
communication between the schools and contractor is transactional in nature. This is
explained by significant reliance on the helpdesk as a means of communicating issues
and the fact that face-to-face contact is mainly confined to scheduled meetings. In
this context one school principal described the relationship between the schools and
the contractor as “businesslike”.
TABLE 5: SCHOOL’S VIEWS OF CURRENT CONTRACT RELATIONSHIPS
Dimension of Contract
Relationship / School
Communication
Role of Contract
Planning
Bargaining
Binding
Co-operation
Benefits and Burdens
Rules and Rights
Altruism
Problems
A
3
5
7
3
3
7
4
3
5
4
B
1
2
2
2
2
2
2
2
2
2
C
3
3
1
2
5
3
1
4
D
2
2
2
1
3
8
2
9
9
E
8
9
2
2
2
9
2
2
9
9
Av.
3.40
4.20
2.80
2.00
2.50
6.20
2.60
2.33
5.20
5.60
Table 6 compares the school’s views of the current contractual relationship with how
they would prefer to see the relationship governed. The responses reveal a desire for
a more relational approach across all dimensions of the contractual relationship. It is
noteworthy that this consensus contrasts strongly with that of the DoES, which
expressed a preference for a mainly transactional approach (see table 3).
With regard to their overall assessment of the relationship, the data in table 7 shows
significant diversity of opinion across schools. For example, whereas schools D and
E see the relationship as characterized by high levels of trust, cooperation and
flexibility, the other three schools (in particular, school B) hold relatively negative
views. In this regard it is significant that the latter three schools view their
26
relationships with the contractor as characterized by relatively low levels of trust in
particular.
TABLE 6: SCHOOL’S VIEWS OF CURRENT VERSUS PREFERRED
CONTRACT RELATIONSHIP
Dimension of Contract
Relationship
Communication
Role of Contract
Planning
Bargaining
Binding
Co-operation
Benefits and Burdens
Rules and Rights
Altruism
Problems
Actual
Preferred
3.4
4.2
2.8
2
2.5
6.2
2.6
2.33
5.2
5.6
6
6.2
6.4
4.6
5.25
9
6
5.5
7.25
7.8
TABLE 7: OVERALL ASSESSMENT OF THE QUALITY OF PPP RELATIONSHIP:
SCHOOLS AND DOES
School
Characteristic
Relationship
Cooperation
Flexibility
Trust
A
B
C
D
E
AV
DoES
6
8
5
1
1
1
8
5
4
9
8
9
10
8
7
6.8
6.0
5.2
8.0
5.5
8.0
of
The striking differences in views expressed by schools was explored in follow-up
questions which shed light on a number of issues that shape the conduct of contractual
relations under PPP. First, the different views expressed highlight how the disposition
of school principals towards the question of private sector involvement in schools can
impact on the quality of exchange. For example, in the two schools with the most
negative views of PPP, both principals expressed fundamental problems with private
sector involvement in the provision of school services. To illustrate, the principal in
school C remarked that he “does not believe that a partnership can occur as public
and private sectors have different and irreconcilable objectives”. The principal in
27
school B expressed similar views. Moreover he asserted that PPP has failed to deliver
promised, “state of the art facilities and services”. In this case the school principal is
particularly dissatisfied with the standard of the school building in terms of features
such as structure and materials, remarking that “everything is driven by cost…they
couldn’t have done it cheaper”. As a consequence the contractual relationship
between school B and the private contractor has been characterized by a high degree
of conflict. This was illustrated in terms of examples such as (a) the principal’s
decision to install fixtures and fittings regardless of whether this was in accordance
with the contract or not and (b) alleged opportunistic behaviour by the contractor with
regard to quoting exorbitant rates for requested variations.
In contrast to this conflictual relationship, the principal in School E depicted a
relationship characterized by high levels of trust and cooperation. In this case the
principal expressed a strong degree of satisfaction with both the standard of the school
building (physical structure and architectural features) and the service provided by the
contractor. In his view the establishment of co-operative relations can be attributed to
high degrees of flexibility and reciprocity. He has always been positively disposed to
the PPP pilot project and has sought to establish good relations with the private
contractor from the outset. An illustrative example concerns the delivery of
equipment prior to the school opening. As in other schools, some of the equipment
was either unnecessary or failed to meet expected standards. Whereas this caused a
significant degree of tension in other schools, the principal in this case dealt with the
problem by securing credit notes from the main supplier and giving teachers the
discretion to purchase necessary items as they deemed fit.
28
The principal in School E has operated on the basis of managing most issues locally.
Whereas another school principal expressed frustration with the formality of the
helpdesk system and consequent delays in resolving straightforward issues, the
principal in school E asserted that he uses the system on his own terms. For example
if a replacement window is required he will work to deal with the issue promptly and
may log the issue with the helpdesk after the issue is resolved.
A number of factors shaping the conduct of contractual relations between the schools
and Jarvis, derive from the functioning of the DoES. A significant grievance on the
part of schools concerns uncertainty regarding the content of the contract. As the
schools have been provided with just excerpts of the contract, three of the five schools
referred to problems in dealing with the contractor in the light of this imperfect
information. To illustrate, one school principal referred to the problem of discerning
between items that were to be ‘supplied’ and items that were to be ‘supplied and
maintained’ by Jarvis. Due to this uncertainty, schools are in a weak bargaining
position if requests for replacement equipment are refused on the grounds that “they
are not provided for in the contract”. While there was scope for dealing with these
issues at scheduled monthly meetings between the schools, Jarvis and the DoEs, these
meetings were phased out. One school principal remarked, “that the DoES should
pay more visits to schools or have more contact”. Moreover, three principals
expressed concerns about the DoES’s reliance on the contractor for information
concerning the status of issues logged with the helpdesk, “how can it work when the
profit seeker is in effect the provider of information and the public sector is not
monitoring adequately?”. Three schools indicated that insufficient monitoring by the
DoES undermined the enforcement of risk transfer. One principal remarked, “in
29
effect the contract is not being monitored and so the private sector is not effectively
taking risks. As a consequence there has not been one payment deduction”. Three
schools expressed the opinion that the contract was poorly negotiated and was poorly
specified. These concerns were expressed in remarks including “most areas are
covered by the contract but they are not covered adequately…too many issues are not
bolted down” and “We would prefer more flexibility to deal with things outside the
contract. A number of issues are messy and there was a lack of clarity about who
should take care of them. We would like to control these rather than refer to the
contract”.
Another factor impacting negatively on the quality of contractual relations is the
quality of the interface between the contractor and the schools. The five schools are
widely dispersed around the country whereas the contractor is based in Dublin.
Although the contractor’s facilities manager visits the schools on a monthly basis,
four of the five schools indicated that this arrangement was inadequate: “We would
prefer more contact with Jarvis, or a person on the ground between the school and
Jarvis. Having them located in Dublin is a problem” and “I am happy with the
caretaker and the facilities manager who visits once a month…it works on that level
but the weaknesses in the contract prevents it working at higher levels… There is also
a problem of having a geographical spread of schools under one contract”.
With regard to the overall question of quality of relationships between schools and the
private contractor the evidence presents a picture of mixed experiences across
schools. It appears that the degree of cooperation or conflict depends to some degree
on the personalities involved. The evidence also indicates that schools are broadly
30
dissatisfied with the transactional nature of contractual governance and would prefer a
more relational approach that affords them greater discretion. Interestingly, four of
the five principals expressed the opinion that contrary to expectations, PPP has not
provided principals with more time to focus on educational matters rather than
administrative or facilities management duties. The evidence indicates that where
transaction cost issues arise, these relate to uncertainty in the context of imperfect
information. There appears to be scope for significantly improved communication
between the schools and the DoES, particularly in terms of clarification of rights and
responsibilities as specified in the contract.
CONCLUSIONS
The PPP model of procuring public infrastructure and services is growing in terms of
its adoption by policy makers worldwide. However the model is still in its infancy
and much of the evidence concerning its use concentrates on the procurement process
and ex-ante estimates of VFM (for example, Gaffney et al 1999; Shaoul 2002; 2003).
This paper seeks to add to the evidence on PPP by analysing the ex ante and ex post
stages of the PPP procurement process in the case of the contract to design, build,
operate and finance five secondary schools in Ireland.
The examination of this PPP project in terms of transactional/relational poles of
contractual governance indicates that the client-contractor relationship is largely
transactional in nature, a finding that is at odds with commonly accepted notions of
partnership. Moreover, the high level of satisfaction with these transactional aspects,
on the part of both client and contractor, highlights the complex nature of contractual
31
governance under PPP. It appears that a largely transactional approach does not
prevent the development of trusting and cooperative relations. In this case, mutual
satisfaction with the quality of the contractual relationship can be attributed to factors
such as the long-term nature of the PPP agreement, the constructive use of the
contract as a channel for cooperative dealing with problems that arise during
performance and a broad displacement of the contract with regard to monitoring and
sanctioning poor performance.
The findings in this paper indicate that the existence of trusting relations between
client and contractor is not necessarily mirrored in relations between schools and the
contractor. Whereas schools see the relationship as mainly transactional they express
a clear preference for a more relational approach. The relationship between some
schools and the contractor has been characterized by conflict. Where this has
occurred it has been attributable to factors including the dispositions of key players
towards PPP and the relationship between the schools and the DoES. The latter factor
has had a particularly important bearing on the operation of this PPP. Most schools
have faced difficulties due to incomplete information regarding contractual provisions
and have expressed concerns that the contract is not sufficiently monitored and
enforced.
The findings presented in this paper indicate that the practice of contracting in the
case of this PPP has, in some respects, been at odds with expectation of relational
contracting in the context of partnership arrangements. For example, Grimshaw et al
(2002) describe the adoption of partnerships in terms of a
32
‘shift from a system of atomistic, short-term market-based contracts, which are
designed to maximize the gain of each bounded entity, to the development of
medium-to-long ‘relational contracts’ where the emphasis is upon permeable
organising practices that are intended to yield mutually beneficial outcomes.
According to this view, notions of market structure and the organising principles of
the quasi-market are less important than the form of contractual relationships and the
nature of organisational form’ (2002, p.482).
In this particular case, any expected shift towards relational contracting has
encountered a number of fundamental obstacles. These include the practical reality of
procuring the project in the context of political pressure to get the schools up and
running. This led to sub-optimal decisions at the pre-contractual stage, in particular
the appointment of a preferred bidder prior to testing the scope for VFM under PPP.
In addition the ex post conduct of exchange has been impeded by fundamental
problems in communication between the DoES and the ultimate users of the
contracted service i.e. the schools. As a result, this PPP has been characterized by a
higher level of transaction costs than might be expected under relational forms of
contracting. While it is recognised that this analysis is based on the first three years
of a 25-year contract and that contractual relations may change over time, it is
concluded that the use of PPPs in the education sector will not necessarily lead to
improved economic efficiency unless considerable care is taken to quantify the costs
and benefits of PPP at the ex ante stage. In addition it is necessary to improve the
flow of information to all key stakeholders thereby securing a level of ‘buy in’ which
can underpin the development of long-term cooperation and mutual benefit.
33
ACKNOWLEDGEMENT
The author is grateful to the University of Limerick Foundation for funding the
research costs associated with this paper. The author also wishes to acknowledge the
helpful comments made by Jim Gleeson, Sarah Moore, Donal Palcic, Eoin
O’Sullivan, Sean O’Riain and the anonymous referees on earlier drafts of this paper.
The usual disclaimer applies.
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