PUBLIC-PRIVATE PARTNERSHIPS:
IN PURSUIT OF RISK SHARING AND
VALUE FOR MONEY
Philippe Burger
University of the Free State
OECD Workshop
Amman – April 2008
Overview



Session 1: General overview of PPPs,
definition and rationale, affordability and risk.
Session 2: Value for money and the need for
competition.
Session 3: Institutional and accounting
aspects: PPPs units and the main regulatory
and accounting issues.
Session 1: General overview of PPPs,
definition and rationale, affordability and risk
1.
2.
3.
4.
5.
Overview of the day
Trend towards PPPs and the rationale for
PPPs
Definition
Affordability
Risk
Session 2: Value for money and the need for
competition
6.
7.
8.
9.
Competition and Value for Money
PPPs and the nature of the service
The Public Sector Comparator (PSC)
PPPs and the measurement of performance
Session 3: Institutional and accounting
aspects: PPPs units and the main regulatory
and accounting issues
10.
11.
12.
PPPs, budgets and government accounting
Institutional setup and issues: PPP units
and legislation
Transparency and accountability
2. The trend towards PPPs and
the rationale for PPPs


Really took off during the last two decades.
Majority of the projects in OECD countries:


Transportation infrastructure: airports, railroads,
roads, bridges and tunnels.
Other projects: waste and water management,
educational and hospital facilities, care for the
elderly, and prisons.


European Investment Bank (2004) reports
that transportation is the most prominent
sector (followed by schools and hospitals).
Regional breakdown shows that road and rail
projects dominate in all continents except
Middle East and North Africa, where water
projects dominate (AECOM 2005).




AECOM (2005): between 1985-2004, globally
public-private financing in 2096 projects = nearly
$887 billion.
Of this total, $325 billion went to 656 transportation
projects.
Of the 2096 projects 1121 projects were completed
by 2004. Total value of 1121 projects = $451 billion.
PPPs will not largely replace public procurement. In
UK PFI deals constitute a mere 12-15% of total
annual public investment expenditure.
Table 2.2. The capital value of United Kingdom PFI deals up to April 2007
(GBP million)
Including London
Underground projects
Total capital
value
Health
Excluding London
Underground projects
% of total
Total capital
value
% of total
8 290
16
8 290
23
22 496
42
4 902
14
Defence
5 644
11
5 644
16
Education
4 388
8
4 388
12
Others
7 203
13
7 203
20
Scotland, Wales and
Northern Ireland
5 380
10
5 380
15
53 404
100
35 807
100
Transportation
Total
Source: HM Treasury, 2007.
Table 2.1. Top ten countries with the largest PPP/PFI project finance deals, 2003
and 2004
Rank
2004
Country
Value
USD
millions
Deals
%
share
13 212
81
32.6
Rank
2003
Value
USD
millions
Deals
%
share
1
14 694
59
56.7
1
United
Kingdom
2
Korea
9 745
9
24.1
3
3 010
3
11.6
3
Australia
4 648
9
11.5
7
611
4
2.4
4
Spain
2 597
7
6.4
2
3 275
8
12.6
5
United States
2 202
3
5.4
4
927
2
3.6
6
Hungary
1 521
2
3.8
11
251
1
1.0
7
Japan
1 473
15
3.6
10
274
5
1.1
8
Italy
1 269
2
3.1
5
714
3
2.8
9
Portugal
1 095
2
2.7
n.a.
n.a.
n.a.
n.a.
10
Canada
746
3
1.8
n.a.
n.a.
n.a.
n.a.
Source: Dealogic, quoted in OECD, 2006a:57.



UK: substantial number of road and bridge projects,
as well as light railways.
South Korea: Recently accelerated PPP/PFI.
Followed similar path to other OECD countries,
starting with transportation infrastructure projects.
Spain: Focus very much on transportation. Private
sector key element in 2005-2020 transportation plan
of government.

€248 billion over the fifteen year period, of which the
private sector is said to contribute approximately 20%

France:





A 62-year contract with ALIS in 2001 to design, build,
finance and operate a 125km motorway in the Northwest of
France (total cost: €900 million). Motorway opened in
October 2005.
Other French projects include part of TGV Rhine-Rhone
line.
Greece: Airport projects.
Portugal: Vasco da Gama bridge and toll roads.
Other OECD countries with large transportation
projects: Ireland and Italy.


What is the rationale for having PPPs?
Pursuit of higher levels of Value for Money (VFM).


Tapping into the perceived higher levels of efficiency
of the private sector.



VFM represents an optimal combination of quality, features
and price, calculated over the whole of the project’s life.
Private sector skills and capability.
Government keeps control over output quality and
quantity.
Access to private finance.

To some large extent a fallacious argument.
3. Defining PPPs




What are PPPs?
How do PPPs differ from traditional
procurement?
How do PPPs differ from privatization?
What is the difference between PPPs and
concessions?



Lack of definitional clarity.
Grimsey and Lewis (2005:346), “…fill a space
between traditionally procured government
projects and full privatization”
Need to distinguish them clearly from
traditional procurement and privatisation, but
also from concessions.


IMF: PPPs refer to arrangements where the private
sector supplies infrastructure assets and services
that traditionally have been provided by the
government.
European Investment Bank: PPPs are
relationships formed between the private sector and
public bodies often with the aim of introducing
private sector resources and/or expertise in order to
help provide and deliver public sector assets and
services.


European Commission: PPPs refer to forms of cooperation between public authorities and the world
of business which aim to ensure the funding,
construction, renovation, management and
maintenance of an infrastructure of the provision of
a service.
Standard and Poor’s: Any medium- to long-term
relationship between the public and private sectors,
involving the sharing of risks and rewards of multisector skills, expertise and finance to deliver desired
policy outcomes.



Distinct from traditional procurement: role of
risk.
Distinct from privatisation: define what is a
partner.
Distinct from concessions: demand risk and
source of revenue.

OECD:



PPP is an agreement between the government
and one or more private partners (which may
include the operators and the financers)
according to which the private partners deliver the
service in such a manner that the service delivery
objectives of the government are aligned with the
profit objectives of the private partners
and where the effectiveness of the alignment
depends on a sufficient transfer of risk to the
private partners.




The private partners usually design, build,
finance, operate and manage the capital asset,
and then deliver the service either to government
or directly to the end users.
The private partners will receive as reward a
stream of payments from government, or user
charges levied directly on the end users, or both
(Concessions vs PPPs).
Government specifies the quality and quantity of
the service it requires from the private partners.
There is a sufficient transfer of risk to the private
partners to ensure that they operate efficiently.
Figure 1.1. The spectrum of combinations of public and private participation,
classified according to risk and mode of delivery
4. Affordability

Do PPPs create more space in the budget?



Affordability and VFM: Relative vs. absolute
affordability.


Affordability in principle terms.
Affordability in practical terms.
Efficiency and the cost of capital.
Affordability, limited budget allocations,
legally imposed budgetary limits and fiscal
rules.
4.1 Affordability in principle terms




Affordability and VFM are the benchmarks for PPP
viability.
Affordability and VFM determines whether the PPP
route is the best alternative.
Because of the off-balance sheet nature of PPPs,
their use has led to some misconceptions regarding
their impact on the affordability of projects.
Confusion stems from the impression that because
government not responsible for the acquisition of the
asset, that PPPs are cheaper than traditional
procurement – this is a fallacy.


Though PPPs may enable some projects to
become affordable, this does not stem from
their off-balance sheet nature.
The point is: Affordability not only relates to
PPPs, but to government expenditure items
in general.


In principle affordability is about whether or not a
project falls within the long-term (intertemporal)
budget constraint of government.
 If it does not, then the project is unaffordable.
However, because the cash flows and balance
sheet treatment of PPPs differ significantly from that
of traditional procurement, some confusion exists
about the effect of PPPs on affordability.

In principle terms, a traditionally procured
project is affordable if the present value of the
expected future revenue stream of
government:


equals or exceeds the present value of expected
future capital and current expenditure of
government,
while a portion of such future expenditure
streams is allocated to such a traditionally
procured project.

In principle terms, a PPP is affordable if the
present value of the expected future revenue
stream of government:


equals or exceeds the present value of expected
future capital and current expenditure of
government,
while a portion of such future expenditure streams
is allocated to such a PPP.


In both cases the positive net worth of
government depends on whether or not the
present value of expected future primary
surpluses (i.e. surpluses that exclude interest
payments) equal or exceed the value of
existing public debt.
The only essential difference between the
two cases is between the timing of the flows.
4.2 Affordability in practical terms

Even though the above is technically correct, it has
one shortcoming:



Although PPPs and the PSC used in PPPs involve detailed
present value calculations over the whole life of a PPP
contract, governments rarely use present value
calculations for the rest of their activities.
Governments also rarely budget for a longer horizon than
the upcoming year (although some use medium term fiscal
forecast).
This raises the question: how should affordability of
a PPP be assessed within an environment where
the planning horizon is not very long?

As with other government activities in such an
environment a PPP project is affordable if:



the expenditure it implies for government can be
accommodated within current levels of government
expenditure and revenue (as captured in the current
budget and medium term forecasts)
and if it can also be assumed that such levels will be and
can be sustained into the future.
This working definition of affordability allows for the
use of present value calculations when estimating
cost of a PPP vs that of traditional procurement
(using a PSC), but to do so in an environment with a
short planning horizon.
4.3 Affordability and VFM


Relative affordability: affordability of PPP compared
to that of traditional procurement.
 Interest rate and efficiency differentials main
determinants (of relative affordability and VFM).
Absolute affordability: Can the project (delivered
either trough a PPP or traditional procurement) be
accommodated within the budget without violating
the budget constraint.

UK:


Procuring authorities must complete affordability
model for any planned PFI (it includes sensitivity
analysis).
The models based on agreed upon departmental
figures for the years available and cautious
assumptions about future dept spending
envelopes.

Victoria:



Decision about how a project is funded is
separate from the decision about how it is to be
delivered.
Potential PPP compete with other capital projects
for limited budget funding to ensure that they fall
within what is considered affordable.
Funding is approved on the preliminary PSC.

Brazil:


Project studies must include a fiscal analysis for
the next ten years. In addition, the commitment of
the federal budget to PPP projects is limited by
law to 1% of the net current revenue of the
government.
Hungary:

From 2007 a limit on the amount of expenditure
on PPPs within the budget, so that each program
has to fit within this limit.
4.4 Affordability, limited budget allocations
and legally imposed budgetary limits


Distinction between affordability, limited budget
allocations and legally imposed budgetary limits
In many countries there are:



Limits on second- and third-tier government borrowing.
Fiscal rules that limit government expenditure, deficits or
debt.
Thus, project might be affordable, but legally
imposed budgetary limit prohibits borrowing.

In some cases the opposite is also possible.


In addition: budgetary allocations of government
departments and authorities that are done from a
central budget and within which expenditure plans
must be fitted.
Even if a traditionally procured project would not
violate the long-term budget constraint of
government, a project may still exceed the future
expected budgetary allocations of a specific
government department.

Danger: less of a focus on VFM and create an

incentive to get project off the books of government.
Three specific cases when there is an incentive to
get project of the books of government.

The first case is one where a project cannot be
delivered through either traditional procurement or a
PPP within budgetary limits.

1.
2.
3.
Has 3 features, but a short-run focus on 1st and
disregard for the 2nd and 3rd by gov creates incentive
to go PPP route:
Should gov use traditional procurement: Large initial
capital outlay will cause a gov entity to exceed its
allocated budget.
Should entity then decide to go PPP route: May not be
able to make future fee payments to private partners
without exceeding expected future allocated budgets.
In addition, private partner also cannot levy user
charge on direct consumers of the service.



Second case shares the same features with the first
with the exception that instead of receiving a fee
from gov, the priv partner can impose a user charge
directly on the consumers of the service.
As a result, the project might fit within the budget
allocation of the government entity.
Additional question: Is the higher tax-plus-usercharge burden of those individuals benefiting from
the good or services acceptable?




Third case occurs when gov operates under a fiscal
rule that sets a limit on the overall fiscal balance of
gov (or a dept operates under a budget allocation).
Results from cash-flow vs accruals accounting.
Traditional procurement: Capital outlays may
contribute to breaking the budgetary limit in the year
in which government undertakes outlays.
PPP: Private sector responsible for initial capital
outlay and government might be able to fit future
payment of fees to private partner into its budget
without exceeding the budget limit.

In all three cases the budgetary limit may be
main reason why government might want to
get projects off its books.


However, main reason should be higher VFM.
This is not an argument against budgetary
limits and rules – rather it is an argument in
favour of emphasising VFM as the main
rationale for going the PPP route.
5. VFM and risk transfer







Reason for going the PPP route: Value for money, but
effective risk transfer to the private partner prerequisite
to ensure VFM.
What do we mean by risk?
 Risk vs. uncertainty.
Categories of risk.
Endogenous and exogenous risk.
Degree of risk transferred and the type of PPP project.
Who should carry risk in a PPP?
Responses to risk.



Governments interested in PPP route: Value for
money.
UK National Audit Office (2003): 22% of UK PFI
deals experienced cost overruns and 24% delays;
compared to 73% and 70% of public sector projects.
Scottish Executive and CEPA study (HM Treasury
2006):


Authorities: 50% received good VFM, 28% reported
satisfactory VFM.
KPMG survey (2007) among private project
managers in the UK:

59% of respondents said performance of their projects in
2006 was very good, compared to 49% in 2005.





However, having private partner is not in itself sufficient
to ensure VFM: need transfer of risk.
VFM: optimal combination of quality, features and price,
calculated over the whole of the project’s life.
Studies confirmed importance of risk transfer.
Risk: The measurable probability that the actual outcome
will deviate from the expected (or most likely) outcome.
Private partner carries risk if its income and profit is
linked to the extent that its actual performance complies
or deviates from expected (and contractually agreed)
performance.
Figure 3.4. The categorising of risk





Many factors that may affect its actual performance
Some can be managed, others not.
Thus, need to distinguish between endogenous and
exogenous risk.
Transfer endogenous risk: Company can influence
the extent to which actual outcome deviates from
expected outcome.
Key question: Is whether the adverse outcome is
foreseeable and if it is, can it be managed?

Examples of endogenous risk:




Equipment and physical structure (e.g. buildings, roads)
deterioration.
Wasteful use of inputs (i.e. x-inefficiency) – includes
wasteful use of raw materials, appointment of too many
personnel.
Failure to manage risk related to input prices (e.g. failure to
negotiate best price of raw materials and labour services;
failure to use hedge prices through use of future and
forward contract).
Failure to implement accounting and auditing procedures
that leads to theft, fraud and corruption.

Examples of exogenous risk:






Unforeseen technological redundancy (e.g. ICT).
Unforeseen demographic changes (e.g. migration,
changes in labour force participation, changes in
population composition).
Unforeseen changes in preferences (e.g. high-speed trains
vs. airplanes).
Unforeseen environmental changes (e.g. costs arising from
pollution management and pursuit of cleaner energy use).
Unforeseen natural and manmade disasters (e.g. costs
arising from floods, wildfires or political acts).
Unforeseen exchange rate movements driven by
speculation.

1.
2.
3.
4.
5.
There are five major types of response:
Risk avoidance, whereby the source of risk is
eliminated or is altogether bypassed by avoiding
projects that are exposed to it.
Risk prevention, whereby actors work to reduce the
probability of risk or mute its impact.
Risk insurance, whereby an actor buys an insurance
plan – a common form of financial risk transfer.
Risk transfer, whereby actors relocate risks to parties
who can best manage them.
Risk retention, whereby risk is retained because risk
management costs are greater.


Transfer of risk in PPP does not imply the
maximum transfer of risk to the private
partner.
It means that the party best able to carry the
risk, should do so.
Principles of Optimal Risk Transfer
VFM
VFMmax
σoptimal
Risk transferred




Confusion about what ‘best able to carry risk’ means
Leiringer (2005): Is this the party with largest influence
on the probability of an adverse occurrence
happening, or the party that can best deal with the
consequence after an adverse occurrence?
Corner (2006): To best manage risk means to manage
it at least cost.
If cost of preventing an adverse occurrence is less
than cost of dealing with consequences of the adverse
occurrence, then risk should be allocated to the party
best able to influence the probability of occurrence.

Cases where cost of preventing occurrence
(incurred by private partner) is lower than cost
dealing with fallout (incurred by both private partner
and government):



Example 1: Cost of road maintenance vs. rebuilding
sections of road once it degraded and damages paid
because of accidents – probably cheaper to maintain road.
Example 2: Cost of maintaining hospital equipment vs. cost
of dealing with the consequences of broken equipment
(financial cost including damages paid, loss of life).
Example 3: Cost of keeping prisoners in prison (including
cost of rehabilitation) vs. cost of escapees and
unrehabilitated felons.

Cases where cost of preventing occurrence
(incurred by private partner) is higher than
cost dealing with the consequences (incurred
by both private partner and government):

Example 4: Cost of maintaining some types of ICT
equipment vs. cost of dealing with the
consequences of broken equipment – cost of
dealing with broken equipment is cheaper than to
maintain it.

Cases where cost of preventing occurrence
(incurred by government) is lower than cost
dealing with the consequences (incurred by
both private partner and government):

Example 5: Cost of leaving arrangements
unchanged vs. cost of nationalisation – Cheaper
for gov to leave arrangements, if it also carries the
risk of paying damages in case it nationalises the
private partner.
Figure 3.3. Degrees of risk sharing by project type
6. Competition and Value for
Money

Why is competition important?




Competition for the market.
Competition in the market.
Contestability and competition.
Foreign firms.


Benefits.
Possible problems and pitfalls.
6.1 Why is competition
important?





Monopolistic behaviour and lack of competition: no
VFM.
Competition important in pre- and post-contract
phases.
Pre-contract phase competition occurs in the bidding
process.
Zitron: 86 recent UK PPPs at tender stage: on average
3 bidders for each contract. However, 20% of 86 PPPs
less than 3 bidders.
Few bidders increase danger of opportunistic
(monopolistic) behaviour by the bidders.


Too few bidders: VFM is not attained.
How does government end up with too few bidders?
1.
Paradox of many potential and few actual bidders.


2.

With many bidders: probability of being preferred bidder is
small.
Given bidding cost, this may cause strong potential private
partners not to bid, even if the project itself and the risks
that it entails are acceptable to them.
Few specialist companies.
Danger is that just a small group of companies may
bid for every project that comes along.



Distinction should be made between bidding risk
and the risk of the project itself.
Can address this by having government cover the
bidding cost.
However:


Government will have to enter this subsidy as as part of the
total project cost.
Before agreeing to pay a private company’s bidding cost,
that company must first demonstrate that they have the
capacity to bid and to deliver the service in the event that
they should get the contract.




Competition in the post-contract phase also a
complex issue.
Once preferred bidder is announced and the
contract is signed, the unsuccessful bidders
move on, some leaving the industry.
Thus, once the contract is signed, the
preferred private partner becomes a
monopolist supplier.
Exception if the market is contestable.


While risk transfer is the driver of efficiency
and VFM, competition and contestability
ensures effective risk transfer.
In the absence of competition or potential
entry it will be difficult to attain higher
efficiency and VFM.
6.2 Foreign firms

Benefits:




Skills and know-how of foreign firms.
May be able to get credit cheaper than
developing/emerging market governments.
Size of contract (may have capital to undertake very large
contracts).
Possible problems and pitfalls:



Size of contract (not interested in relatively smaller
contracts).
Differences in national, institutional (i.e. public vs. private)
and corporate cultures.
Government may lack skills and capacity to match
negotiating skills of foreign firms.
7. PPPs and the nature of the
service


General interest goods.
Contractual flexibility and renegotiation.
7.1 General interest goods

Public goods and goods with externalities.





The free-rider problem of goods characterised by nonrivalry and non-excludability
Textbook examples: lighthouse vs. food
PPP relevant examples: inner-city vs. inter-city roads,
correctional facilities
Goods suffering from free-rider problem: because demand
is not fully revealed; private companies unable to estimate
the future demand
If government then defines/poses that demand, demand
risk disappears. Sufficient risk transfer will then depend on
whether there is enough supply risk.




Goods with an ‘inelastic social demand’ and basic
(private) goods and services delivered to the poor
Healthcare one example where government
historically played a large role – particularly with the
advent of the modern welfare state (education another
example)
Traditional procurement, i.e. state-run hospitals and
clinics, but also state-run medical aid schemes
Given that it is health, emphasis often more on
effectiveness (i.e. delivery of desired quantity and
quality), than on efficiency (i.e. minimising cost;
maximising output relative to input)




Has potential to be a very sensitive political issue
Political sensitivity linked to the confusion about the
difference between a health PPP and privatised
healthcare
Confusion heightened particularly when user
charges are involved
In this setting ensuring good communication to the
public as to how the role of government differs
between PPPs, concessions and privatisation
becomes important

Also a distinction between PPPs:




where priv partner delivers capital goods, admin &
management, but gov delivers medical service (same for
schools),
and the case where private partner also delivers medical
(or education) service, though in accordance with PPP
contract
For gov issue is Value for money (VFM): Balance
between interests of the ill vs. interests of taxpayers
VFM: combining quality and features that closely fit
client’s (i.e. gov’s, but ultimately the patient’s)
specifications and at the best price possible (i.e for
gov, but ultimately for taxpayer)
7.2 Contractual flexibility and
renegotiation
Contract flexibility
 PPP contracts usually long-term contracts (25-30
years)




Even a 62-year French road contract mentioned above
Gov specifies quality & quantity and payment depends
on delivery of specified quantity & quality
As such, PPP contracts can be very inflexible.
Example: Toll road that is best option today, but with
new technology and higher petroleum prices, a highspeed train might represent more VFM in ten year’s
time

Design, standards and forecasted demand
may prove inadequate or irrelevant to shifting
societal needs
 Given the continuous change in ICT and
medical science, PPPs involving ICT, schools
and healthcare might be more exposed to this
than, say, a water purification and toll roads
 In ICT there might be fast technological
redundancy that changes the type and unit
cost of services required


Even education (schools) is affected as
modern teaching methods are increasingly
more ICT intensive
In healthcare there might also be
technological redundancy or changing
demographic health features that changes the
demand for services




Government might miss out on cost-saving effect of
new technology if it has to pay private partner to
deliver service, while new technology causes
technology that partner uses to become obsolete
With traditional procurement government would
have been able to switch to the new technology
Inflexibility together and long-term nature of
contracts: major weaknesses of PPPs
Thus, contractual commitment might result in
government buying a relatively expensive service:
destroys relative VFM of PPP


This raises the question: Who should bear the risk of
technological redundancy?
The allocation of this risk will depend on the degree
of rigidity (as opposed to flexibility) of contracts:


The more rigid the contract, the more risk government
carries, while the more flexible the contract, the more risk
the private partner carries
The private partner, though, will probably only be
willing to carry the additional risk if government pays
it to do so.



Of course, government can take steps to improve
flexibility of PPPs. Examples:
UK: The right to modify specifications (of course at a
cost to government) and the right to set out a tender
for modifications.
France: Contracts between local authorities and
private operators are administrative contracts. Thus,
authorities have the right to change specifications
once contracts are signed.
 Of course, the authority must justify the changes and
compensate the private operators for the changes





The question, though, remains: Who should bear
the risk technological redundancy?
Ex ante a private partner can probably agree to
carry this risk, but only if it is paid to do so
Technological redundancy is an exogenous risk (i.e.
private partner cannot prevent the actual outcome
from deviating from the expected outcome)
Thus, having the private partner carry it, will not
improve the efficiency with which it delivers the good
As such, it makes sense for government to carry this
risk, or to at least share it with the private partner



What about changing demographics that
change the level and composition of demand
(e.g. modern lifestyles that increase heart
disease relative to other diseases)?
If risk is endogenous, i.e. if private partner
can manage demand risk, it should also carry
it. Otherwise, government can carry it or
share it with private partner.
Most demand for health services, not
endogenous.

Above explains why PPPs more common in infrastructure
development (e.g. roads and water works), followed by education
and health projects and lastly ICT


In the UK ICT projects deemed unsuitable for PPP option
In short:



Complex goods usually do not make for good PPPs
Countries new to PPP game: start with infrastructure (i.e.
simpler) projects
Standardised contracts

Source: See example of UK defense contract

http://www.hmtreasury.gov.uk/documents/public_private_partnerships/ppp_index.cfm
Renegotiation of the terms of contract
 Wish to renegotiate may come from either
government or the private partner
 May deal with costs incurred by private
partner

Though strictly speaking, if cost increase was part
of the initial risk that the private partner took and if
the private partner has been remunerated for that
risk, the scope for renegotiation is less

Areas of contract negotiations and renegotiations
may include the following:





project agreement: establishing the rights and obligations
of both parties;
performance specifications: technical, financial, and service
requirements;
collateral warranties: establishing direct links between the
public authority and all the contracting parties;
direct agreements: regulating the relationship between all
parties and financers
Table 3.1 sets out more specific areas of negotiation
and renegotiation
8. The public sector comparator
(PSC)


What is a Public Sector Comparator (PSC)?
What do countries do?



Rigorous use of PSC: UK, Australia and South
Africa.
Not all use PSC: France.
Furthermore, all those who use PSC, do not
use it in same manner.

From the most to the least complex methods.
Figure 3.5. The spectrum of methods to assess value for money
Source: Grimsey and Lewis, 2005:347 and 351.



PSC construction enables government prior to concluding the
contract to:
 assess the affordability of a PPP by ensuring full life-cycle
costing
 be sure that compared to traditional procurement PPP will deliver
better VFM
PSC also helps to:
 manage discussions with private partners on critical issues such
as risk allocation and output specifications;
 stimulate bidding competition by building greater transparency
and trust in the bidding process.
Importance of PSC when competition is limited
 In the past, if there is only one bidder: compete against PSC; but
this is increasingly not done in the UK and Australia
The use, abuse and pitfalls of
PSCs

The use, abuse and pitfalls of PSCs






Efficiency and the cost of capital revisited
Choice of discount rate
Dating of cash flows
Weighting of risks
Danger of point estimates
Need to carry out sensitivity analysis




The UK and South African examples
Websites and sources:
HM Treasury (2006c), “Value for money quantitative
evaluation spreadsheet”:

www.hm-treasury.gov.uk/documents/public_private_ partnerships/
additional_guidance/ppp_vfm_index.cfm.

HM Treasury (2006b), Value for Money Assessment
Guidance, The Stationery Office, London.
National Treasury (2004), National Treasury PPP
Manual, South African National Treasury, Pretoria:

www.ppp.gov.za
9. Measuring performance

PSC to measure relative VFM of a PPP prior to
contract





Helps to set a performance benchmark
However: not sufficient to ensure that actual performance
will yield the expected VFM.
PPP contract needs to state Key Performance
Indicators (KPIs)
These have to be measured and monitored during
the lifetime of the contract
Key element: Private partner remuneration
dependent on actual, measured performance
relative to contractually agreed performance


What do countries do?
UK: monitoring in form of both formal and informal
analysis to assess VFM




Formal analysis: Market-testing and benchmarking
exercises for soft services as set out in the original contract
Informal analysis: Compare outturn data to original
assessments.
Government uses target benchmarks for Key
Performance Indicators (KPIs).
KPI targets often specified in terms of acceptable
range of performance rather than single-point
measures of performance.




Victoria: VFM as part of the contract. Agreement on fixed price
for delivery of services that meet specified financial and nonfinancial KPIs.
After conclusion of contract, focus not on whether government is
getting better VFM than was agreed upon in contract.
Rather, government assesses
1. whether or not the contractor is actually delivering the VFM
agreed upon in the contract and
2. whether or not the financial and non-financial investment benefits
of the project (identified as part of the business case / investment
logic map in the pre-contract phase) are being delivered.
The government of Victoria expects all KPIs to have specified
target levels that contractors are expected to deliver on.



France: Where performance is measurable,
PPP contracts contain key performance
benchmarks, i.e. target levels for
performance benchmarks.
Brazil: Contracts generally establish
standards or target levels that must be
followed by the private partner
Hungary: Contracts also contain performance
indicators

PPP performance measured using basket of
performance indicators. These indicators include:





Efficiency measures defined in terms of inputs and
outputs (e.g. the provision of a health service at the fee (if
government pays) / user charge (if client pays) agreed
upon with government)
Effectiveness measures in terms of outcomes (e.g.
quantity, level of coverage of area or population.)
Service quality measures
Financial performance measures
Process and activity measures
Table 3.2. Performance indicators used by selected governments to measure the
performance of public-private partnerships
Victoria,
Australia
Brazil
Efficiency measures defined in
terms of inputs and outputs


Effectiveness measures in terms
of outcomes


Service quality measures


Financial performance measures
(1)
Process and activity measures

France
Hungary
United
Kingdom












1. Although contracts in Victoria do not typically include financial performance measures, the
government does monitor the financial performance of a concessionaire and its principal contractors
(private parties must submit their financial documents to the government).





The frequency with which governments measure the
performance of private partners also differs between
countries.
UK: Performance is measured continuously.
France: Private parties must report annually their
results to government.
Brazil: It depends on the indicator and the of type of
project (highway, railroad, etc).
Hungary: Private parties must report their results on
a quarterly basis to government.

Victoria:





Private party must prepare and deliver to government a
regular periodic performance report (usually monthly).
The private party must (on an annual basis) also provide
government with:
 a copy of its business plan for the following year and
 its budget for the next two financial years.
It must also provide unaudited financial documents on a
six-monthly basis and
audited financial documents on an annual basis.
At any time up to six months after the end of the contract
term, government may (at its own cost) require an
independent audit of any financial statements or accounts
provided.



If in case where government pays a fee, the private
partner falls short on a KPI, effective performance
management requires that the fee is reduced to the
extent to which they fall short.
Threat of a fee reduction: Incentive to the private
partner to ensure that its performance matches the
target defined in terms of the performance indicator.
Thus, fee reductions ensure the effective transfer of
risk to the private partner.

UK:




Increasingly punitive deductions are involved where KPIs
are missed.
Small one-off miss may not incur a payment deduction
A continuous small miss or large one-off miss will have
proportionally higher payment deductions.
Victoria:

A similar regime in place, with a distinction between a
'major' and 'minor' default regime is considered
appropriate.

France:



Fee component linked to the operation may be affected if
performance falls short;
Fee component relating to the investment is not
necessarily affected.
Brazil:


PPP Law requires that any payment by government must
be linked to service provision.
If the private partner does not meet service level
parameters, there can be deductions from the agreed fee.
10. PPPs, budgets and
government accounting







What are the basic points of departure?
Problem: Different sets of books
Potential problems:
 Capital and current financial flows may not be captured in either
government or private sector books
 Capital and current financial flows may be captured in both
government or private sector books
IMF solution: Who carries most of the risk?
IPSASB: Who controls the asset?
Risk disclosure, recording of guarantees and contingent liabilities
Sources: See discussion documents from IPSASB and SAASB
(note that these are currently only discussion documents)
11. Institutional setup and issues:
PPP units and legislation



What is the role of the PPP unit?
The main function of most PPP units is to
ensure that all PPP agreements comply with
the legal requirements of affordability, value
for money and sufficient risk transfer.
By providing technical assistance PPP unit
can guide government departments and
provinces to follow international good practice
that will ensure the successful creation of
PPPs.



To fulfil the abovementioned function the PPP unit has two broad
tasks:
 To provide technical assistance to government departments,
provinces and municipalities who want to set up and manage
PPPs, and
 To provide National Treasury approvals during the pre-contract
phases of a PPP agreement.
However:
 PPP unit should not be involved in post-contract management of
contract. That is responsibility of line department
 It does, nevertheless, need to approve major contractual
revisions that might result from renegotiation after the conclusion
of the contract
Examples of PPP units: Partnerships Victoria, SA PPP unit, PPP
Knowledge Centre (The Netherlands)

Empowerment of PPP units




Proper legislative framework
Political support
Location of PPP unit
Skilled staff

Proper legislative framework



If possible, steer clear from fragmented legislation
(e.g. separate legislation for PPPs in defense,
education, health, or for each PPP deal)
Thus, legislation should be encompassing
Legislation should ideally link up with other public
sector procurement legislation (e.g. a public
sector finance management act)


Though specific enough to ensure proper
regulation, legislation should allow room for
contractual flexibility and innovation in design
Without relaxing legislation to the point that it will
undermine the pursuit VFM, the legal
requirements on private partners and government
should not serves as a disincentive for bidders.
(Keep in mind: Bidders can always bid for nongovernment contracts, if government (PPP)
contracts are too cumbersome and costly)

Political support


Potential private partners (operators and
financers) need to know that next government will
not terminate support to PPPs
Location of PPP unit


In government there is a natural tension between
spending ministries and the treasury
Putting the PPP unit within the treasury
strengthens the regulatory position of the PPP
unit, as it can rely on the natural tension


Skilled staff
What type of staff do PPP units and government
departments wishing to create PPPs need?






Financial analysts: to assess affordability and value for
money
Legal experts: particularly experts in corporate and
contract law, as well as specific legislation on public
procurement and PPPs
HR and labour law experts: PPPs may involve the transfer
of public sector staff to a SPV
Economists: to assess economic impact of large projects
Experts to assess environmental impact studies
Skilled project managers in government departments

Typical HR issues that PPP units and government
departments wishing to create PPPs encounter:





Relative quality of private and public sector staff
Remuneration issues
Staff leaving government to go to private sector (cooling-off
clauses)
Use of ‘roving’ project managers
Require from departments who wish to create PPPs to first,
prior to anything else, demonstrate that they have the
capacity to manage project
12. Transparency and
accountability



Are PPPs in general and the private providers
specifically, less transparent and accountable than
government and its departments?
To answer, first ask what transparency and
accountability we require from government?
Transparency and accountability with regard to:




Policy objectives (equity and effectiveness)
Processes (e.g. procurement, operating and management
processes) through which government pursues these
objectives (equity (i.e. fair) and efficiency)
Honesty and the absence of corruption
Can (and should) require the same from a PPP

The PPP contract can and should ensure transparency
regarding PPP objectives



Also recall that government might prefer PPP to full
privatisation because it keeps control over the quantity and
quality of output
Transparency of processes
Potential for improved efficiency is already established
if:



Competition and effective risk transfer occurs
If private partner beats PSC and
Performance measurement (measured against KPIs) occurs
and penalties enforced

In addition, government can assess whether or not
private partners comply with legislation that ensure
they act fair and equitable



This ensures that there is no tension between accountability
and efficiency (i.e. ‘cannot cut corners to save on costs’)
Framework needed within which a PPP bids for contracts
are awarded that are clear, open and beyond dispute
However, that if good is complex, ensuring transparency
and accountability becomes more difficult (but also if
government should deliver the complex service)



Transparency regarding financial and other information. What
information should be in the public domain?
Essential details of contract, particularly information that has
implications for public expenditure and revenue (amount of
capital, payment structure of unitary charges and fees, user
charges, transaction costs etc.)
Financial statements of Special Purpose Vehicle and holding
companies can be put in public domain
 Similar to publicly listed companies
 Note that by doing this the private partner does, in fact, not
necessarily provide less information than government provides in
its statements on its public procurement activities



Financial statements should be audited by an
independent auditor
There should also be proper internal financial and
accounting controls to manage (i.e. prevent and
detect) corruption
Human resource issues regarding fair treatment of
staff who are transferred from government to SPVs:



Employment contracts,
Remuneration and benefits (e.g. transfer from government to
private pension fund)
Working conditions
Concluding remarks



PPPs are able to harness the capacity of the private sector to
produce VFM
In a setup where the debate about privatisation has become
ideologically highly divided and charged, PPPs provide an ideal
vehicle to pursue value for money through the participation of the
private sector, while government, nevertheless still keep control
over quantity, quality and cost
However, it is important to deal with PPPs on a case-by-case
basis and to acknowledge that PPPs are not a panacea to all
government’s problems. Indeed, as we have seen, there are
several prerequisites that need to be in place to ensure that a
PPP works.
Some valuable websites

HM Treasury (UK):


Partnerships Victoria (State of Victoria
(Australia)):


www.hm-treasury.gov.uk/documents/public_private_ partnerships
www.partnerships.vic.gov.au
PPP unit (South Africa):

www.ppp.gov.za