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Value for Money Assessment for Public-Private Partnerships: A Primer

December 2012

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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 conventional 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. An unfavorable comparison may also be taken to suggest that there is a better way of structuring a transaction and a better way of allocating risks between the parties. This can therefore help to inform the decision-making process with regard to the optimum type of transaction. The process of performing the VfM analysis should help the public agency to focus on the key risks and opportunities and decide whether to look again at the project scope and key risk allocations before starting a procurement.

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 conventional 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 conventional 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 an agency to better understand the value of risks when considering changes to contract terms during contract negotiations once a preferred bid is selected.

The example depicted in the bar chart in Figure 2-1 portrays a comparison between a public procurement with a baseline present cost of $60 million and a P3 shadow bid for which the baseline present cost (net of financing costs) is $65 million. While the baseline P3 cost is $5 million more and imposes an additional $6 million in ancillary and financing costs, the $13 million reduction in the costs of risk due to transfer of some risks to the private sector and $8 million in competitive neutrality adjustments overcome these cost differences and result in a net savings to the government of $9 million overall, offering 7% in Value for Money. This example illustrates the central trade-offs that often characterize P3 procurement: the government trades away significant risks in exchange for higher baseline costs and financing costs in the P3 scenario.

Figure 2-1

Figure 2-1: Calculating Quantitative VFM

 

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