- Briefing Room
Public-private Partnerships (P3s) are contractual agreements between public agencies and private entities that provide greater private participation in the delivery and financing of transportation projects compared to the traditional design-bid-build public procurement model. Under the traditional approach, project sponsors execute separate contracts for the design of projects and then for their construction, and then they operate and maintain the infrastructure following construction.
There are many different forms of P3s. Transportation P3 arrangements range from design-build procurements, where design and construction services are grouped into a single, fixed-price contract, to concessions, where a private investor/operator is responsible for financing, designing, constructing, operating, and maintaining new highway projects in exchange for the right to collect the revenues generated by the project or availability payments from the public sponsor for the duration of the concession period. As shown in Figure 2-1, the primary distinction between them is the specific responsibilities and level of risk that is assumed by the private partner.
The following discussions provide brief overviews of the four P3 typologies shown in Figure 2-1. However, the focus of FHWA's Report on P3s is on design-build-finance-operate-maintain (DBFOM) P3 arrangements, which are also known as "concessions."
Figure 2-1: Spectrum of P3 Procurement Options and Risk Exposure
Design-build is a project delivery method that combines design and construction functions into a single contract, rather than as two independent services performed consecutively by separate entities. With design-build procurements, owners execute a single, fixed-fee contract for both architectural/engineering services and construction. The design-build entity - also known as the "constructor" - may be a single firm, a consortium, joint venture or other organization assembled for a particular project. With design-build delivery, the design-builder assumes responsibility for completing a final design for projects and undertaking construction activities for a fixed fee. As such, the design-builder also assumed the financial risks associated with possible cost overruns. Most design-build contracts also include penalties for schedule delays and bonuses for the early completion of construction. The project sponsor remains responsible for financing the project, and operates and maintains it after construction is complete.
Design-build procurements are often used with large and complex projects. Because they are fixed price agreements, design-build contracts incentivize the design-builder to innovate and identify strategies to streamline construction costs. Project completion can also be accelerated by undertaking some design and construction activities concurrently rather than sequentially, as is the case with design-bid-build projects. This has the potential to result in further cost reductions by shielding projects from the risk of inflation and commodity cost escalations. Project designs are generally 10 to 30 percent complete at the time most design-build procurements are let, and design-build procurements contain comprehensive performance requirements that the bidder's final design must meet. This structure provides the design-builder with the flexibility to innovate and find the most cost-effective solutions both in terms of project design and construction techniques.
The award of design-build contracts is made on a best value basis that takes price and technical quality as well as the qualifications of the bidding teams into consideration. Under the right conditions, design-build procurements can result in cost reductions compared to the traditional design-bid-build approach and can accelerate the completion of projects.
With the design-build-finance (DBF) procurement model, one contract is awarded for the design, construction, and full or partial financing of a facility. Responsibility for the long-term maintenance and operation of the facility remains with the project sponsor. This approach takes advantage of the efficiencies of design-build procurements and also allows the project sponsor to defer paying all or a part of the cost of the project during construction.
With DBF procurements, the constructor agrees to provide all or some of the construction financing. The design-builder is repaid with milestone and/or completion payments made by the project sponsor. These arrangements are typically short term and extend no more than a few years beyond the construction period. Responsibility for the long-term maintenance and operation of the facility remains with the project sponsor.
Project sponsors generally use DBF procurements to overcome cash flow constraints or out of a desire to defer paying for projects. With some DBF procurements, the owner identifies the current amount of available project funding and requires the design-builder to finance any development costs in excess of that amount for a specified period of time. In other cases, an owner may specify the maximum amount that it can pay a design-builder each year for a project. That specified amount and the cost of the project would determine the length of the repayment period.
Private sector design-builders may provide self-financing and front their own implementation costs until the sponsor is able to pay them. They may also borrow money using existing commercial credit liens, or arrange project-specific financing. In addition to all the potential benefits of design-build procurements, the DBF approach allows project sponsors to accelerate the construction of projects that they would otherwise have to wait to procure until they had amassed the required funding. DBF procurements are being used with increased frequency to deliver a broad range of projects.
The design-build-operate-maintain (DBOM) model is an integrated partnership that combines the design and construction responsibilities of design-build procurements with operations and maintenance. These project components are procured from the private sector in a single contract with financing secured by the public sector. DBOM procurements provide project sponsors with all the potential benefits of the design-build project delivery method. In addition, by bundling the operation of projects with their design and construction, these procurements incentivize the private partner to apply cost-saving, life-cycle costing principles to align the design of the project with long-term maintenance needs.
DBOM procurements require private sector bidders to prepare cost estimates that include maintenance activities for the duration of the contract. To do so, bidders must develop tailored maintenance plans that anticipate needs and streamlines long-term maintenance costs. This process may result in developing a more robust and costly design, in order to reduce ongoing maintenance costs throughout the operations period. For owners, the lifecycle cost approach also shields important maintenance needs from the uncertainties of future budget cycles.
The DBOM project delivery approach is also known by a number of different names, including "turnkey" procurement and build-operate-transfer.
Under the DBFOM procurement approach, the responsibilities for designing, building, financing, maintaining and operating are bundled together and transferred to private sector partners. Also known as "concessions," DBFOM procurements provide project sponsors with the cost and acceleration benefits of design-build procurements and the added lifecycle benefits of the DBOM approach. In addition, they transfer financial risk to the private sector partner and provide owners with access to new sources of financing, including private sector equity.
There is a great deal of variety in DBFOM arrangements in the United States, especially the degree to which financial responsibilities are actually transferred to the private sector. One commonality that cuts across all DBFOM projects is that they are financed by debt leveraging revenue streams dedicated to the project. The following section provides additional information on the different DBFOM concession models.
Two different revenue sources have been used to leverage financing for DBFOM concessions. The majority of existing DBFOM concessions use toll revenues to raise project financing. Since 2009, a growing number of DBFOM concessions have been financed using annual availability payments paid by the project sponsor to the private partner. The financing raised from both of these revenue streams is also often supplemented by grants from project sponsors and other contributions, such as right-of-way or complementary construction projects. These two concession models are discussed in further detail in the following sections.
DBFOM projects leveraging toll proceeds are commonly referred to as "real toll" concessions. With these arrangements, the private sector partner maintains the right to collect toll revenues during the concession period but bears the risk that toll proceeds may not meet forecasted levels. With real toll concessions, the private sector partner assumes the risk that the funds generated by the project may not be adequate to pay the underlying project loans and interest and make a fair return on its investments of time, expertise and equity. To protect the public sector interest in the event of robust revenue generation, some concession agreements include a revenue-sharing provision between the private partner and public sector if revenues exceed certain specified thresholds.
The real toll concession model has been used to develop three different types of projects in the U.S.
With availability payment DBFOM concessions, the project sponsor retains all toll revenue risk if the facility is tolled. The sponsor pledges availability payments to compensate the concessionaire for its role in designing, constructing, operating, and maintaining the facility for a set time period during which it receives fixed annual payments. Availability payments are often used for projects that are not tolled. Owners make the availability payments to their private partners from public funds and they must be prioritized ahead of other needs throughout the concession period. The availability payments may be secured from a revenue pledge or subject to appropriations. When they involve the construction of toll facilities, the public sponsor may apply the toll proceeds to the cost of the annual availability payments.
The ongoing annual availability payments are dependent on the private partner's meeting operational performance standards, including lane closures, incident management, or snow removal. If the private partner does not meet the required standards, the amount of the availability payment is reduced. Availability payments transactions may also include milestone payments during construction or a one-time completion payment when construction is finished.
In addition to the construction of new facilities, project owners can also use the concession approach to lease existing toll facilities to a private partner. Known as long-term lease concessions, these arrangements involve the lease of existing, publicly financed toll facilities to a private sector concessionaire for a prescribed concession period in exchange for an upfront lease payment (i.e., a concession fee). The private partner then has the right to collect tolls on the facility for a specified concession period. The private partner must operate and maintain the facility over the life of the concession period and in some cases make improvements to it. Much like the financing structure of DBFOM transactions, private investors raise financing for these sizeable concession fees by leveraging future toll proceeds generated by the leased facilities.
Long-term leases are procured on a competitive basis, with awards going to the qualified bidder making the most attractive offer to the sponsoring agency. The most important criterion for the award of a long-term lease concession generally is the amount of the concession fee. Other criteria may include the length of the concession period and the credit worthiness and professional qualifications of the bidders.
Interest in using P3 approaches to develop and finance transportation improvements has increased in recent years due to the convergence of a number of key issues. They include growing travel demand, rising capital costs, constrained funding, aging infrastructure, and increased pressure on shrinking budgets. These trends reinforce the need for innovative solutions to meet transportation investment needs. Alternative delivery strategies are attractive to public agencies, particularly when resistance to new or increased taxes persists. P3's provide project sponsors with a number of potential benefits, including access to new sources of financing, reduced capital and life cycle costs, and the potential to accelerate the completion of needed projects.
Although financial capacity is often what initially motivates consideration of P3 concessions, the incentives created by concessions can also lead to greater overall value for the public sector through improved asset management and on-time and on-budget delivery.
The most important potential benefits of using P3 to deliver transportation projects include:
P3s are complex arrangements and require careful deliberation before agreements are executed. While P3 strategies can provide significant benefits as described above, they are not appropriate for all transportation projects. Some of the potential challenges in implementing P3s include:
The successful use of P3 strategies requires the definition of clear policies and evaluation and decision-making procedures that advance these procurements in a way that serves the public interest.
P3 projects have been less prevalent in the U.S. than in many other countries in part due to historic public policies that have led to large Federal investments via grants-in-aid for highways discouraging the construction of toll roads. Federal regulations that prohibit tolling of the Federal-aid highway system and constraints on Federal tax exemption for financing and long-term leases have the potential to limit the use of P3s. Similarly, State policies on tolling and private financing of public infrastructure may also limit public agencies in use of P3s. Crafting and attaining approval of policies that allow equal consideration of tolling as a method to help pay for transportation projects can help facilitate fair consideration of P3 strategies.
When contemplating the possible use of P3 procurements policymakers should consider a number of strategic issues: