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Value for Money for Public-Private Partnerships: A Primer

September 11, 2012

DRAFT
For review by P3 Evaluation Toolkit Beta-Testers

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Chapter 1 - Introduction

This primer addresses Value for Money Assessment for public-private partnerships (P3s). Companion primers on Financial Assessment and Risk Assessment for P3s are also available as part of this series of primers.

What are Public-Private Partnerships?

Public-private partnerships (P3s) for transportation projects are drawing much interest in the United States for their ability to ease traditional financing constraints and transfer certain project risks. P3s differ from traditional procurements where the public sponsor controls each phase of the infrastructure development process – design, construction, finance, operations and maintenance. With a P3, a single private entity (which may be a consortium of several private companies) assumes responsibility for more than one development phase, accepting risks and seeking rewards.

Design-Build procurement – under which private contractors are responsible for both designing and building projects for a fixed price – represents the most basic form of P3. Further along the P3 spectrum, the private sector may also assume responsibility for finance, operations, and maintenance, typically via a long-term (e.g., 30 years or more) concession from the public sponsor. With a Design-Build-Finance (DBF) structure, the private sector entity is in charge of financing and building the project, but leaves the O&M of the facility to the public agency. Design-Build-Finance-Operate-Maintain (DBFOM) adds private financing to the design, construction, and O&M of the project. The public agency may have to provide a public subsidy to the project which may require use of bond proceeds or budgetary authority, but the public agency will not usually finance the entire project under this P3 structure.

This document, as well as the series of FHWA primers on P3s, is concerned primarily with forms of P3s where the private sector partner (called the "concessionaire") enters into a long-term concession to perform most or all the roles traditionally filled by the government.

Public agencies pursue P3s for a variety of reasons, including access to private capital, reduced upfront costs, accelerated project delivery, transfer of risk to the private sector, design innovation, and improved levels of service. However, P3s – like traditional projects – require revenue in order to pay back the upfront investment.

P3s are complex transactions, and determining that a P3 is likely to provide a better result than a traditional approach is not simple. There are many factors that must be considered when determining the best procurement approach for a given project, including long-term costs, myriad uncertainties, risks both now and in the future, and complicated funding and financing approaches.

For more information the reader is encouraged to refer to FHWA's primer on Public-Private Partnerships, available at: http://www.fhwa.dot.gov/ipd/p3/index.htm.

Using Value for Money Analysis to Evaluate Public-Private Partnerships

Value for money is defined as the optimum combination of life-cycle costs and quality (or fitness for purpose) of a good or service to meet the user's requirement. For example, in the case of highways, the user's requirement might be mobility and safety on a specific roadway. Value for Money (VfM) processes have been designed and utilized in many countries to help government officials determine if, when entering into a P3 agreement, they are likely to obtain a better deal compared to traditional approaches to procure the same project. A basic assumption is that a public procurement is possible with public financing. Also, benefits to users from earlier delivery of the project are generally not quantified, although they may be considered in a qualitative evaluation.

The VfM analysis process is utilized on a case-by-case basis to compare the aggregate benefits and the aggregate costs of a P3 procurement against those of the traditional public alternative. Risks are present from the early development of a highway project through construction and operation. At the core of a P3 agreement is the allocation of project risks between the public and private partners in order to minimize the overall costs of risk by improving the management of risk. The VfM analysis may be used to assist in:

  • Development of the transportation investment program, by indicating which projects are potentially suitable for P3 delivery;
  • Selection of a project's preferred procurement option, i.e., traditional procurement or P3, and assessment of its affordability; and
  • Selection of the preferred bidder and negotiations with the selected bidder (if negotiations become necessary) prior to finalizing the P3 agreement.

The methodology for carrying out a VfM analysis varies, but its major elements generally involve:

  • Creating a Public Sector Comparator (PSC) which estimates the whole-life cost of procuring the project through the traditional approach, including operating costs and costs of risks, which are not typically considered in traditionally procured projects;
  • Estimating the whole-life cost of the P3 alternative, either as proposed by a private bidder or a hypothetical Shadow Bid (SB) at the pre-procurement stage which attempts to predict the bidder's costs, financing structure and other assumptions; and
  • Completing an "apples-to-apples" risk-adjusted cost comparison, with appropriate consideration of qualitative factors.

The PSC not only assists in analyzing VfM, but also promotes an understanding of full life-cycle costs at an early stage in project development and encourages bidding competition by creating confidence in the rigor of the evaluation process.

Figure 1-1

Figure 1-1. How a PSC and P3 alternative are compared at different stages of project development

What Value for Money Analysis Does Not Evaluate

It is important to clarify that VfM assessment of P3s is distinct from the process of establishing whether a public sector project is a good use of society's resources, which is done through a full benefit-cost analysis. Benefit-cost analysis involves a comprehensive assessment of the full range of economic costs, risks and benefits and takes into account less quantifiable impacts including external costs and benefits. In contrast, VfM analysis assumes that the decision has been made that a project is a good use of societal resources, and that the question that remains to be answered is which procurement method will deliver the greatest value.

VfM assessment of P3s is also distinct from the process of establishing whether or not a project is actually affordable to the government. There is no reason to presume that a project that represents good value for money will be affordable or that an affordable project will represent good value for money. Financial assessment of a given project is more likely to address affordability. A separate primer in this series addresses Financial Structuring and Assessment of P3 projects.

Structure of this Primer

This primer is structured as follows. Chapter 2 provides an overview of the VfM analysis process. Chapter 3 discusses discounting of future costs and revenues to facilitate comparison of the procurement alternatives in terms of present value. Two key components of the PSC are life-cycle costs and the costs or risks. They are discussed in Chapters 4 and 5 respectively. Toll revenue risk is discussed separately in Chapter 6. Chapter 7 discusses quantitative assessment of VfM and Chapter 8 discusses qualitative assessment. Finally, Chapter 9 presents a summary with cautionary notes based on experience to date.

 

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