ppp_advantages & disadvantages

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PUBLIC PRIVATE PARTNERSHIPS, THE ADVANTAGES AND DISADVANTAGESEXAMINED

G.W.E.B. van HerpenDutch Ministry of Transport, Public Works and Water Management

Directorate-General of Public Works and Water ManagementAVV Transport Research Centre

1. Introduction

This essay is written as part of my study of the Economics of Transport and Logistics at theErasmus University Rotterdam in the Netherlands. The aim of this essay is to analyse theadvantages and disadvantages of public private partnerships (PPPs), particularly in theinfrastructure sector. At first a desk research had been carried out. After this literature studya questionnaire had been sent out to different public and private actors, mainly in the UnitedKingdom as well as in the Netherlands. The responses have been processed in this essayand cited in italics.

Important to note is that the aim of this paper isn't the promotion of public privatepartnership, nor the opposite; PPPs neither imply nor exclude the private ownership ofinfrastructure or the use of (shadow) tolls. In contrast, there can be no PPP without risk-sharing and an approach that takes overall account of the infrastructure and services in atransparent and stable contract drawn up within the framework of stable, appropriate andrespected legislation.


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widened to embrace all aspects of public services, managed by both the public and privatesector1.

Infrastructure services exist out of two service-levels:1) The first-level services represent the private use that is made of the second level.

These services belong to the private domain, thus are marketable. They cannot beused without the complementary service on the second level. Example: physicalinfrastructure.

2) The second-level services are non-marketable services and originally belong tothe public domain. Example: performance measurement, political decision-making

process.

Public private partnerships can take many forms, from simple commercialisation to fullprivatisation, but in general PPP's can be considered as long term agreements between thepublic and the private sector to provide and operate transport infrastructure and / or service.These new forms of agreements are aimed at optimising the input of knowledge from bothsectors. Most of these agreements aren't based on equality, but on a principle-agentrelationship. The principal is the public infrastructure agency and the agent is theinfrastructure operator.

PPP arrangements display three essential characteristics:1) A significant level of responsibility and risk that is transferred from the public

sector to the private sector.2) Contractual arrangements are built around performance-based outcomes, rather

than work specifications.

3) Long term contractual arrangements


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The approval process is the key step between project development and implementation.Once the project has been approved, the planning phase can commence if the planning

risk is retained by the public sector. A fair, open and accountable competition for host governments is of extreme importance

in the implementation phase.

In the post-transaction phase, the public sector is responsible for ensuring that theprivate sector contractors meet statutory standards, such as safety, design andconstruction standards. These should be contractually enforced by a requirement of thecontractor to submit design, construction and safety plans for approval and by therequirement that the infrastructure will not be opened until all necessary approvals have

been satisfied.

The allocation of risk is often seen as the defining quality of a PPP arrangement. Thegeneral rule regarding risk transfer is that it should be allocated to the party which is bestable to manage it and at the least cost. The following categories of risk can be identified:political, planning, design, construction, maintenance, operational, usage, legal & regulatoryand financial risk.

Public

Public/

Private

Private

Private

Private

Private

Private

Public/

Private

Public

Identification

Option Analysis

Planning & Approval


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the least cost. Risk transfer ensures that the parties involved will use conservativeassumptions in developing their expectations of benefits and costs.

A detailed project risk analysis promotes a shared understanding of the projectby all parties involved in order to communicate the complexity and detail of ascheme.

Output based specificationSpecifying the project result as outputs allows innovation to take place. Outputsare the products of a service. In the conventional procurement, an input

specification is used, therefore describing the asset used to provide a service.

"Many clients (public sector) find it difficult to articulate precisely which outputsthey want. They can have whatever they want, but at a price. Our skill inbidding (private sector) is to offer alternatives that reduce the price, but stilldeliver reasonable outputs.

Long-term nature of contracts (including whole life costing)

Investments in the capital assets used to be based upon buying the cheapest.After a short period of time, the maintenance of the assets began to cost a lot andin extreme cases had to be replaced.The long-term nature of contracts allows the service provider more time to recoverthe cost of the investment, enabling the supplier to reduce annual charges. It alsogives the supplier greater depth of experience in running the business which couldbe a source of efficiency gain. It also makes it easier to transfer technology risk to

th li b bli th li t k b tt j d t b t h


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monitoring the contracts.

"The payment mechanism is usually a payment deduction if the private partyfails to perform. This leads contractors to give a higher price than theyotherwise would, so that they can afford to get it wrong on occasions. A targetcost arrangement would be better, where all costs are agreed on an open-bookbasis and the contractor and client share the pain / gain when the target cost isexceeded or beaten".

Private sector management skills

Private sector management skills allow the project to be delivered ahead or ontime. By using public private partnerships for infrastructure investments thegovernment will have access to new skills. The public sector can get bothsignificant R&D and the testing of different approaches at private sector risk.Lower or stable rates over the long-term, equal or improved service levels, betterunderstanding of the utility, lower taxes and improved technology are benefits thatcan be directly transferred to the customer from an effective PPP.

CompetitionGenerally, the benefits of introduction of competition to an area which is normallydominated by public sector monopolies are: lower prices, greater innovation,increased investment and better service.Governments have a wide range of options for creating competitive procurement:service contracting, management contracting, leasing and concessions. Theconstruction and maintenance of public assets have always been done by the

i t t th diff PFI h b ht i th t it i t t ll th ti iti


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and the delivery of services (i.e. servicing the asset), because maintenance will beconsidered when the asset is designed to maximise efficiency. Another reason for thecreation of cost efficiencies is the departure from standards (thus innovation).

Time-to-delivery savingsPublic private partnerships can also lead to time-to-delivery savings, caused by a greaterprivate incentive to generate revenue as soon as possible and the increasing experiencewith public private partnerships. Another reason for these time-to-delivery savings is theexistence of a learning curve for all parties involved. The private sector is driven by profitmotives and is accountable to shareholders to ensure that the profit isn't diminished by

higher interest charges and revenue losses from delays in project completion. In thepublic sector, project completion delays might not have the same perceived directfinancial impacts.

"PPP-projects can be delivered quicker than under conventional procurementbecause of better project management, better management of project risks andbecause the service provider is not paid until the facility becomes operational".

However, the advantage of a quicker delivery of the project has to be shaded a bit more.The design and construction itself can be realised quicker than under the conventionalmethod, for the reasons mentioned above.

"PPP-processes take longer than conventional procurements because the contractsare for long periods (25-30 years) and therefore the financial assumptions underlyingbids have to be looked at in depth. Negotiations with bidders are also lengthy. ( )

Th l t i d f ti i th j t d li i ll th l


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sector ownership. The government will probably have to pay for this transfer. Even if thistransfer is free, the government will have additional costs, compared to the concessionperiod before the transfer. For example maintenance costs. There are also aspects ofshadow tolls to consider.

"It is a clever mechanism that enables public sector schemes to be funded withouthaving to raise taxation levels.

Improved response to market forcesIn case of user-fees, an improved response to market forces will be created, resulting in

greater efficiency. Traditionally, transportation facilities are publicly-funded. While usersdo pay for the facilities they use, price signals aren't available to guide demand or supply.These improvements in incentives to market forces are the improved profit margins, thelong term business, the whole life costing, the payment for performance and the mergingof design, build, finance and operation.

Broad supportIn common, public private partnerships are broadly supported by the European

government, the national, regional and local government and by the private sectorbecause of the creation of value for money and because of the new source of income.

'Attitudes to the Private Finance Initiative', a survey carried out byPricewaterhouseCoopers, confirms that participants in the PFI believe it has been asuccess in the UK. In the survey, 71% of senior decision makers in the public and privatesectors agree that 'PFI has been good for both the public and private sector'. Another

73% b li th t 'PFI j t d li i l f f th bli t ' Th


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Higher transaction costWilliamson defines transaction costs as: "the ex ante costs of drafting, negotiatingand safeguarding an agreement, and more especially, the ex post costs of mal-adaptation and adjustment that arises when contract execution is misaligned as aresult of gaps, errors, omissions and unanticipated disturbanc."

PPPs represent opportunities to reduce total project cost. However, tenderingcosts and developing costs are usually much higher than under conventionalprocurement.The procurement costs appear to be higher because PPP projects are often

unique and have to anticipate up to 30 years of external events andcircumstances. PPP contracts are much more complicated to negotiate andadminister than the traditional construction contracts, partly because there aremore actors involved. Thats why they require more time, effort, complexity ofcontract forms and additional experts.Public-sector finance costs are lower than private-sector finance costs, becausethe public sector can spread risk the widest by making the taxpayer an involuntaryrisk-taker in government projects. The advantage of public financing is that it

allows to tax-exempt debt and government grants, thereby reducing project costs.However, in contrast to the capital cost of the public sector, the cost of the projectsrisks are calculated into the capital cost of the private sector. The profit required byprivate developers as compensation for undertaking project risks adds to the costsof a franchised project. That's why profit is a function of project risk.

The transaction cost will increase with the complexity of relations and the duration

f h l ti Th ill d li ith d i ith PPP d


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limited and thereby reducing the competitiveness of the tender process.The quality of bids can be significantly improved through the payment of compensation tounsuccessful bidders and by keeping the number of pre-qualified bidders relatively low(from UK-, Greek- and Hungarian-experience, between two and five bidders).If the government has chosen to deliver an infrastructural investment by means of apublic private partnership, then the private parties have to be involved as soon aspossible. This way, the investment's quality will improve and the project will be multi-functional.Although the European Union strongly supports public private partnerships, the Europeantender-procedures may have a negative effect on the realisation of efficiency-gains. Early

contacts between the government and the private parties in a pre-mature phase may behampered due to the fact that favouring certain actors in case of granting a concession isout of the question under the general principles of competition and equality. This mayprevent private actors wishing to be involved in the early phases of a public privatepartnership.

InefficienciesLong-term operating contracts can lead to value for money. However, they can also lead

to inefficiencies due to a lack of contestability and competition. The tender-procedure atthe beginning of the process may have introduced competition, the developer who hassigned the contracts will have the exclusive rights to an infrastructure facility, thereforepractically enjoying a monopoly. During the operation phase inefficiencies may becreated due to a lack of contestability and competition.The terms of contract are very important. The public sector has to remain its position asclient and specify the services it requires. If the service provider defaults in the provision

f th t i d li b t d d i th h ld b t i th


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company thinking helps improve efficiency and effectiveness".

Short term rigidities

A public private partnership can be compared to a network. Durable networks createstability and lower the uncertainty of actors. At the same time this also means rigidities,dependencies and inability to adapt to changed conditions2. That's why PPP-contractsshould allow for changes to take place and prices benchmarked or market-tested fromtime to time.

"The only way to speed up the procurement process is to create stability and certainty

through the use of standardised contractual terms, etc. The flexibility should generallybe reserved for scheme specific issues".

Hold-up problemAnother disadvantage of public private partnerships is the existence of the hold-upproblem, whereby a party may be able to enforce a new cost-revenue-ratio thanpreviously agreed upon. This problem may take place when the negotiation-position ofthe parties involved change over time and when observance of the contract isn't perfectly

possible. The relative position of negotiation is influenced by the sunk cost aspect ofinvestments and the alternative possibilities of usage.

Public sector staff concernIf a public private partnership is intended to replace an existing public facility, this mayresult in concern about the public sector staff's terms and conditions of employment. Thisfear will have to be dealt with seriously, otherwise it could influence the output of the

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Arthur Andersen and Enterprise LSE (2000) Value for money drivers in the private financeinitiative.

Bartelsman, E.J., Canoy, M., Ewijk van, C., Vollaard, B.A. (1998) Economie van publiekprivate samenwerking, ESB Dossier.

Canadian Council for PPPs (2000) British and Australian experts discuss progress in p3sabroad.

Confrence Europenne des Ministres des Transport (1999) Conclusions and

recommendations on public-private partnerships, Transport Infrastructure Financing.

Corry, D., Le Grand, J., Radcliffe, R. (1997) Public-private partnerships.

Cowie, H. (1996) Private partnerships and public networks in Europe.

Dysard, J. (1999) Sharing the benefits of public-private partnerships, R.W. Beck Inc.

Farrel Grant Sparks and Goodbody Economic Consultants in association with ChestertonConsulting (2000) Report submitted to the Inter-Departmental Group in relation to PPP.

Fayard, M. (1999) Overview of the scope and limitations of public-private partnerships,Seminar on public-private partnerships in Transport Infrastructure Financing.

Federal-Provincial-Territorial Working Group on Public-Private Partnerships (1999) Public-

i hi d h i l i ibl N i l Hi h P


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Laan van de, G., Ruys, P., Talman, D. (2001) Optimal provision of infrastructure usingpublic-private partnership contracts, Tinbergen Institute, discussion paper.

Middleton, N. (1999) PPPs a natural successor to privatizations, PricewaterhouseCoopers,International Privatisation Review 1999/2000.

Montague, A. (1999) Public-private partnerships in the UK lessons for internationalprojects

Moore, A.T., Segal, G.F., McCormally, J. (2000) Infrastructure outsourcing: leveraging

concrete, steel and asphalt with public-private partnerships.

Private Finance Taskforce (1999) Great Brittain, DBFO value in roads, a case study on thefirst eight DBFO road contracts and their development.

Raad voor Verkeer en Waterstaat (2000) Meer markt, andere overheid, advies over deveranderende relatie tussen markt en overheid op terreinen van Verkeer en Waterstaat.

Savas, E.S. (2000) Privatization and public-private partnerships.

Spackman, M., Dijk van, Th. (1998) Ervaringen met publiek-private samenwerking in hetVerenigd Koninkrijk, ESB Dossier.

Treasury Committee (2000) Fourth report.


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PUBLIC PRIVATEPUBLIC PRIVATE

PARTNERSHIPSPARTNERSHIPSTHE ADVANTAGES AND DISADVANTAGESTHE ADVANTAGES AND DISADVANTAGES

EXAMINEDEXAMINED

BAS VAN HERPENBAS VAN HERPEN

AVV Transport Research CentreAVV Transport Research Centre

Dutch Ministry of Transport, PublicDutch Ministry of Transport, Public

Works and Water ManagementWorks and Water Management

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AET-Conference - September 9, 2002

Introduction intoIntroduction into PPP andPPP and

infrastructureinfrastructure

Case: N13 LeeuwardenCase: N13 Leeuwarden NijegaNijega

Main advantagesMain advantages

Main disadvantagesMain disadvantages

General advantagesGeneral advantages

General disadvantagesGeneral disadvantages

RecommendationsRecommendations

DiscussionDiscussion

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PUBLIC PRIVATE PARTNERSHIPSPUBLIC PRIVATE PARTNERSHIPS


Main characteristics:Main characteristics:

oo LongLong--term contractual arrangementsterm contractual arrangements

oo Risk transferRisk transfer

oo Own identity and responsibilitiesOwn identity and responsibilities

oo PerformancePerformance--based outcomesbased outcomes

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INFRASTRUCTUREINFRASTRUCTURE


First level servicesFirst level services

Second levelSecond level

servicesservices

PhysicalPhysicalinfrastructureinfrastructure

PoliticsPolitics

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N13 LEEUWARDENN13 LEEUWARDEN -- NIJEGANIJEGA


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N13 LEEUWARDENN13 LEEUWARDEN -- NIJEGANIJEGA


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MAIN ADVANTAGES N13MAIN ADVANTAGES N13

(1)(1)


oo Cost EconomiesCost Economies

oo Reduction on the public treasuryReduction on the public treasury

oo Value for money:Value for money:

o Risk transfer

o Output based specification

o Long-term contracts (incl. whole life costing)

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MAIN ADVANTAGES N13MAIN ADVANTAGES N13

(2)(2)


oo Value for money:Value for money:

oo Performance measurement and incentives

o Private sector management skills

o Competition

o Various

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MAIN DISADVANTAGES N13MAIN DISADVANTAGES N13


o Poor experience with PPP

o Public sector staff concern

o Poor value for money

o Higher transaction cost

o Higher capital cost

o Advantages turning into disadvantages

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General disadvantagesGeneral disadvantages



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GENERAL ADVANTAGESGENERAL ADVANTAGES


oo TimeTime--toto--delivery savingsdelivery savings

oo Improved response to market forcesImproved response to market forces

oo Broad supportBroad support

oo Improved cost calculationsImproved cost calculations

1111


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GENERAL DISADVANTAGESGENERAL DISADVANTAGES


o Insecurity

o Inefficiencies

o Culture gap

o Short term rigidities

o Hold-up problem

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GeneralGeneral disadvantagesdisadvantages



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RECOMMENDATIONS (1)


o Work transparent

o Risk transfer only to best parties

o Performance measurement necessary

o Government be clear

o Private sector involvement early in process

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RECOMMENDATIONS (2)


o Minimum and maximum amount of bidders

o Use standardised contracts

o Communicate early and honest

o Choice PPP or conventional is project-dependent

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GeneralGeneral disadvantagesdisadvantages



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ACTOR vs PHASE vs RISK


RISK

ACTOR

PHASE

Public Public /

Private

Private Private Private Private Private Public /

Private

Public

Identification

Option Analysis

Planning & Approval

Implementation

Post-Transaction

Politi-

cal

Plan-

ning

Design Con-

struc-

tion

Mainte-

nance

Opera-

tional

Finan-

cial

Usage Legal

&

Regu-latory

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2020


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Further InformationFurther Information

MinistryMinistry of Transport, Public Works and Water Managementof Transport, Public Works and Water Management

DirectorateDirectorate--GeneralGeneral of Public Works and Water Managementof Public Works and Water Management

AVV Transport ResearchAVV Transport Research CentreCentre

G.W.E.B. VAN HERPENG.W.E.B. VAN HERPEN (MA)(MA)

Consultant Passenger TransportConsultant Passenger Transport

Boompjes 200Boompjes 200

P.O. Box 1031P.O. Box 1031

3000 BA ROTTERDAM3000 BA ROTTERDAM

THE NETHERLANDSTHE NETHERLANDS

EmailEmail:: g.w.e.b.g.w.e.b.vherpenvherpen@@avvavv..rwsrws..minvenwminvenw.nl.nl

PhonePhone:: +31 10 282 57 78+31 10 282 57 78

Fax:Fax: +31 10 282 50 14+31 10 282 50 14

Internet:Internet: wwwwww..rwsrws--avvavv.nl.nl

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