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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 2 - Overview of Value for Money Assessment

Value for Money (VfM) analyses are prepared at multiple stages of project development and procurement, serving as a decision tool to ensure that the choice of a P3 procurement alternative is the best value proposition for the public sector at a given point in time based on the best information available.

Creating a Benchmark: The Public Sector Comparator
To understand the costs of a traditional public-sector approach, VfM analysts use a Public Sector Comparator (PSC). A PSC is developed as a baseline against which any P3 project, either hypothetical or as proposed by a private bidder, will be compared. A favorable comparison, in which the P3 achieves the same outcome for lower overall costs than the PSC, shows the P3's ability to generate value for money. An unfavorable comparison is evidence that the P3, as imagined or proposed, is unwarranted.

The PSC estimates the hypothetical risk-adjusted cost if a project were to be financed, owned and implemented by the public sector. It is generally divided into five elements: the raw PSC, financing costs, retained risk, transferable risk, and competitive neutrality, each of which is discussed below.

The Raw PSC accounts for all life-cycle costs including public procurement costs, public oversight costs, and both capital and operating costs associated with building and maintaining the project and delivering the service over the pre-determined time. Chapter 4 discusses these costs in more detail.

Financing costs are the costs associated with arranging financing for a project, generally with bonds for a traditional procurement. Financing costs are discussed in Chapter 4.

Retained risk refers to the value of any risk that is not transferable to the bidder, and transferable risk refers to the value of any risk that is transferable to the bidder. Some risks may be shared, i.e., borne partly by the public agency and partly by the private entity equally or in some other proportion. Valuation of these risks and optimal allocation of risks between the public and private sectors is discussed in Chapter 5.

Competitive neutrality adjusts the PSC for any competitive advantages or disadvantages that accrue to a public sector agency by virtue of its public ownership.  These adjustments are discussed in Chapter 7.

For toll-based projects, toll revenues reduce the net costs to government in pursuing the project through a conventional procurement. These revenues are deducted from the total costs. Chapter 6 discusses how toll revenues are forecasted and accounted for in VfM analyses.

Assessing the P3 Option
A VfM analysis typically consists of two major components:

  • Quantitative Assessment - a comparison of estimated, risk-adjusted costs, as discussed above; and
  • Qualitative Assessment - an assessment of key considerations that cannot be easily quantified (discussed in Chapter 8).

Once the cost of a PSC is determined, the public agency must estimate the total costs of the P3 option to the government over the life of the project. The estimate of the P3 option is called a Shadow Bid. It is important to assess the P3 option to determine whether beginning a P3 procurement process is advantageous, because the transaction costs of a P3 procurement are relatively high for the public agency as well as bidders. Therefore the public agency's intent to pursue P3 procurement must be fairly certain.

Armed with estimates of the whole-life costs and revenues for the PSC and the Shadow Bid (or actual bids), procuring agencies can compare them side by side. Discounting of cash flows (i.e., project costs and revenues over the proposed term of the P3 concession) is a key step in the process and is discussed in Chapter 3. Given that P3 and PSC scenarios often differ by small margins, small changes in the discount rates used in these analyses can tip the balance in the comparison. Figure 2-1 graphically shows a hypothetical comparison between a PSC and a Shadow Bid. Note that the public agency's procurement and oversight costs, which would not be borne by the private entity, would need to be included as a separate item for a fair comparison.

The PSC and the Shadow Bid are developed as part of the quantitative assessment of the VfM analysis conducted at the pre-procurement stage. They are typically developed using cost estimates developed early in the project lifecycle, and are continually updated and refined throughout the project assessment and the procurement process. Chapter 7 discusses the development of the PSC and the Shadow Bid and how they are compared for quantitative assessment of VfM.

After bids are received, the procuring agency is able to assess whether or not a private sector entity may be able to deliver the project with additional efficiencies and benefits relative to traditional procurement by conducting an updated VfM analysis using the bids received. There are other benefits of completing a VfM analysis at this stage, such as helping in contract negotiations and in the development of contractual documents once a preferred bid is selected.

Figure 2-1

Figure 2-1: Calculating Quantitative VFM

 

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