- Briefing Room
There are many approaches to the delivery of roadway projects. Though discussed extensively elsewhere (FHWA, 2010), the fundamental difference among these approaches is the type of services provided by the private sector through a single contract. Under the traditional design-bid-build (D-B-B) model, an agency procures only construction services (or design and construction services separately) from the private sector, whereas in a public private partnership (P3), the agency procures additional services, including combinations of design, financing, maintenance and operations, under a single contract from the P3 private partner. Figure 1 illustrates these differences among various delivery approaches. In essence, the P3 concept extends beyond the procurement of assets to delivering services mutually agreed upon by the parties involved. In other words, the P3 is a delivery of services and assets rather than a simple procurement like D-B-B.
Figure 1. Range of Potential Project/Service Delivery Methods and Private-Sector Responsibilities
Source: WSP | Parsons Brinckerhoff
Having a single point of responsibility for an integrated delivery of design, construction, maintenance and financing of a highway facility generates opportunities for effective risk management and efficiency gains in terms of cost, schedule and lifecycle performance. A potential outcome from this arrangement is a reduction of total cost of ownership. However, these benefits are not guaranteed, especially when the private sector does not have adequate opportunities to innovate and integrate operational and maintenance responsibilities with design and construction, or are constrained by the public agency's mandatory requirements on means and methods. Therefore, critical to the success of the P3 project delivery is the use of performance requirements.
Specific to performance requirements, the P3 approaches that are of most interest are Design-Build-Finance-Maintain (D-B-F-M) and Design-Build-Finance-Operate-Maintain (D-B-F-O-M). Under these two approaches, the private sector has the responsibility to maintain constructed assets at a desired performance level during the operational period, which typically is for a period of 30 to 50 years or even longer. (The same is true of outright privatization; however, since there is no ongoing relationship or contract between the private and public sectors that is not considered a P3.)
In the case of Design-Build (D-B) and Design-Build-Finance (D-B-F), performance criteria are still of interest. However, since the private sector does not have responsibilities for future maintenance and operations of the constructed facility, the performance requirements can only be part of acceptance or completion testing in D-B and D-B-F, which limits their usefulness. Design-Build-Operate-Maintain (D-B-O-M) has similar challenges as, even with large retentions, the construction contractor has limited incentives to maintain operational performance, as there is no private finance to provide material "skin in the game." As a result, this discussion on performance requirements will focus on the use of D-B-F-M and D-B-F-O-M models of P3.
Figure 2 illustrates the arrangement of D-B-F-M and D-B-F-O-M through a typical P3 contractual structure. The contractual agreement is between the agency and the P3 private partner's P3 Special Purpose Vehicle (SPV), while the D-B and O&M contractors are most typically subcontractors to the SPV. The P3 private partner is responsible for integrating all those parts, i.e. design, construction, financing, operations, maintenance and renewal, to deliver the service to the users during the concession period.
Figure 2. Typical P3/D-B-F-O-M Contract Structure
Source: WSP | Parsons Brinckerhoff
The P3 is more than the sum of its parts, as the P3 private partner optimizes all of the elements, from design through maintenance and operations, to deliver the service for the lowest cost over the life of the project in order to have a winning proposal. Furthermore, the P3 private partner has a strong focus on repaying the financing used to pay for the initial construction and earning a return on its equity contribution through its payment mechanisms, i.e., direct or shadow toll revenues, or availability payments (AP) from the agency. Regardless of the payment mechanism type, the P3 private partner's net income is linked intrinsically to performance of service delivery. In essence, the P3 private partner assumes the risks to ensure that the constructed asset will operate at a level of performance in the future and will last at least a given minimum period before needing maintenance or renewal. In contrast, under a D-B-B delivery, the contractor has no incentive to ensure that the construction does anything other than match the agency-provided design and the quality meets applicable standards upon completion.
The ability to bring in upfront private financing is a key reason for selecting P3 as the preferred alternative method. In addition, from the project delivery perspective, the typical reasons for selecting P3s include the factors discussed in this subsection.
P3 delivery can be a lower cost option than a D-B-B delivery from both short-term and long-term perspectives. In the short-term, P3s can result in limited or no payments until the facility is operational; because of its integrated service delivery arrangement, there is much lower potential for change in requirements and expensive change orders than in D-B-B, while most design and construction cost overrun risks are transferred to the private sector. In the longer horizon, the private sector has the incentive to undertake timely maintenance of the facility to mitigate cost risks, which can result in lower costs of facility ownership. In contrast, there is a greater potential for deferred maintenance on facilities that rely on a constrained source of public funding which may often lead to interventions that are more expensive.
For many resource-constrained agencies, having a single point of responsibility is attractive to alleviate the concerns caused by any gaps between contracts and the need to coordinate various subcontractors. The P3 private partner can harness the strengths and streamline the responsibilities of each subcontractor. The single-point interface or integration of responsibilities is particularly attractive for managing complex systems, such as ITS and tolling.
Including operational requirements in the design process brings in lifecycle perspectives and has the potential to reduce the total cost of ownership during and beyond the P3 concession period. Taking cognizance of future maintenance and rehabilitation needs, the choices made during design and construction have the potential to optimize between initial expenditure and future investments. Finally, the handback requirements in a P3 give a secured residual value or life of the project assets.
Under both AP and toll risk P3 arrangements, the agency has an early and much higher level of certainty of future investment needs. In an AP P3 structure, the payments are fixed in the P3 agreement based on the commitments made in the proposal process and are not modified during the concession period (though a portion may be indexed at CPI). Contrastingly, the agency lacks this level of cost certainty in D-B-B arrangements due to uncertainties related to future asset performance.
The advantages of selecting P3 as the preferred project delivery method discussed in the section above can be ensured only when the transfer of risk from the agency to the P3 private partner is effective and the efficiency gains are realized.
The risk profiles and responsibilities in P3 contracts are significantly different from those of traditional D-B-B projects. Under a D-B-B, the public agency retains significant risks in design, construction and future asset and operational performance of the facility with an exception in regard to contractor's materials and workmanship. Examples of the agency's risks under D-B-B include differing site conditions, errors and omissions in design, performance of the finished product, interfacing with different job packages, latent defects and acceptance of non-performing construction. Under P3, on the other hand, the agency is ultimately only responsible for any variance from base line information provided to a P3 private partner at the time of proposal; any such variance provides the contractor with the basis to claim additional time and/or compensation.
In addition to these risks, large-scale infrastructure projects are subject to additional complex interface risks and scope changes that occur throughout the development and implementation phase of a project. The retention of these risks by the public sponsor under D-B-B often leads to cost overruns with project cost at completion of construction (including all the risk payments and change orders) on average ending up higher than the engineer's estimate developed at the time of project initiation and often exceeding the amounts set aside for contingencies.
When done correctly, some of these risks can be transferred to the P3 private partner to create potential efficiency gains related to cost, schedule, asset lifecycle and operational performance. Critical to such gains is the optimal allocation of risks and responsibilities in the P3 contract to the parties best able to manage them. With optimal risk structuring, the financial implications of risks are managed better through effective risk mitigation. For instance, many risks relating to facility construction, asset management and operational performance can be transferred to the P3 private partner, while many third-party interface risks (with the exception sometimes of utility relocation and site clearing), differing site conditions and force majeure may be retained by the public agency.
Typically, D-B contracts within a P3 are structured with a guaranteed maximum price (GMP) and offer very limited opportunities for claiming additional time or compensation. Such claims are generally restricted to unusual events that are outside of the P3 private partner's control (e.g., limited access to site, archeological discoveries, unknown hazardous material, or political unrest). In addition, within a P3, the D-B subcontractor accepts direct financial liabilities in case of cost overrun or schedule delay, including liquidated damages and recourse to D-B subcontractor's assets for failure to perform. Such contractual clauses are strictly enforced by the debt and equity providers within a P3 concession framework (in addition to performance bonds) providing several layers of protection for the public sponsor's budget and schedule.
While the P3 private partner is expected to carry additional risks, a D-B-F-O-M contract also provides the opportunity to create cost and schedule efficiencies (i.e., cost savings) by integrating design and construction activities with asset lifecycle and operational performance considerations under a single contract. The primary sources for such efficiencies include:
Because the P3 private partner is bidding a single price for the project -to either receive the lowest subsidy through an AP or pay the highest upfront concession fee (or receive the lowest subsidy) for a toll concession - it focuses design on minimizing the cost of the project over its whole life to be as competitive as possible. Choices of pavement and structural design all have impacts on routine maintenance costs and renewal frequencies.
Thus, reductions in lifecycle cost are a direct result of the optimization of design for specific construction means and methods (lowering upfront capital cost), long-term maintenance requirements, and operating requirements. Additional operating efficiencies can be gained, for large-enough operations, by eliminating interfaces among multiple parties (i.e. the P3 private partner is the single point of contact managing these parties), and efficient staff utilization.
To realize the full benefits of optimal risk transfer and efficiency gains, the P3 contractual arrangement must ensure that the P3 private partner has adequate opportunities and flexibility to innovate. When technical requirements of the public agency mandate the use of specific means and methods or highly specified designs, there is huge potential for conflict or incompatibility between the resulting constructed asset and operational requirements. Note that, as illustrated in Figure 3, the P3 private partner assumes the risks and responsibilities for facility design and construction, asset management and its operational performance.
Figure 3. Typical Lifecycle Stages of a Facility Under P3 Contracts
Source: WSP | Parsons Brinckerhoff
Therefore, so that the P3 private partner may execute its responsibilities effectively, it is prudent to provide the P3 private partner the flexibility to make and control design decisions that may affect performance. Without this flexibility, there is significant potential for dispute as the P3 private partner can claim to have adhered to the means and methods or detailed design, and is therefore not liable for poor performance or failure. While it is typical to set out a hierarchy of requirements in a P3 agreement, the use of prescriptive requirements is likely to build sufficient ambiguity to weaken the transfer of risk.
On the other hand, performance requirements remove the specific need to adhere to standard means and methods and are agnostic as to how the performance is achieved. Performance requirements allow the P3 agreement to specify outcomes only, while eliminating potential contradictions. With performance requirements, the P3 private partner assumes liability for its own design and construction methods to produce a product that achieves the operational requirements. This can result in the following innovations:
Life cycle perspective in design, to minimize whole life costs including those of future replacement and renewal, because the operator and D-B subcontractor frequently work together from the proposal stage of the project.