Under a Public-Private Partnership (P3) for highway projects, a private partner may participate in some combination of design, construction, financing, operations and maintenance, including collection of toll revenues. Value for Money (VfM) analysis is a process used to compare the financial impacts of a P3 project against those for the traditional public delivery alternative. The methodology for carrying out a VfM analysis involves:
The PSC estimates the hypothetical risk-adjusted cost if a project were to be financed, built and operated by the public sector using its traditional procurement approach. It includes the baseline PSC cost, ancillary costs, financing costs, retained risk, transferable risk and competitive neutrality.
The baseline PSC includes all capital and operating costs associated with building, owning, maintaining and delivering the service over the pre-determined period of time. Ancillary costs include other costs such as right-of-way and procurement costs. Financing costs are those associated with interest costs on public debt and issuance fees. 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. Competitive neutrality adjustments remove any competitive advantages and disadvantages that accrue to a public agency by virtue of its public ownership, such as its freedom from taxes. The present value of forecasted toll revenue is generally subtracted from total PSC costs to get net present cost (NPC).
The cost elements of a P3 option are: (1) the present value of payments to be made to the private partner, which account for transferred risks and financing costs; (2) the value of any risks retained by the public sector; and (3) any ancillary costs borne by the public agency. At the pre-procurement stage, a "shadow bid" is constructed to estimate what the private sector would bid in response to a P3 Request for Proposals (RFP).
Generally, a P3 proposal must cost less than the PSC in order to be preferable to a traditional procurement approach. However, even if P3 costs are higher, qualitative factors not included in the quantitative analysis may still make the P3 approach preferable. When a P3 presents overall savings, it is said to provide "value for money." This value is usually expressed as the percent difference by which the PSC cost exceeds the P3 cost. Small changes in the assumptions underlying the analysis can tip the balance. So it is important to undertake a sensitivity analysis to understand the critical assumptions.
The example depicted in the bar chart 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 1. Comparison Between a Public Procurement and a P3 Shadow Bid.
PSC = Public Sector Comparator, P3 = public-private partnership
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