Delivering value-for-money in PPPs? Risks and insights in change management

Abstract

A fundamental benefit sought from Public Private Partnerships is risk transfer – or more explicit allocation of risks between the public and private partners. However, not all operating risks can be transferred or eliminated. The public partner retains residual risk and remains ultimately accountable for the delivery of public services. Sub-standard management of major change events can lead to poor value-for-money outcomes. In-depth insights are provided in this article into how the actual management of Public Private Partnerships may be carried out and dealt with by governments at critical junctures during the concession period. Key risks, issues and critical success factors are identified that can have profound effects on the achievement of intended outcomes. These considerations build upon existing knowledge, policy and guidance for Public Private Partnerships, both nationally and internationally, making this essay tangible and grounded for both academics and practitioners.

Introduction

Public Private Partnerships (PPPs) are a growing global phenomenon. Limited availability of government funding and rising public expectations for social and economic infrastructure, including increasing demand for high quality public services, is likely to continue well into the future. It is reported by both the OECD (Organisation for Economic Co-operation and Development) and the National Council for Public Private Partnerships (USA) that at the early part of this millennium there were 1747 projects worth a combined US$645 billion (OECD, 2011: 6). More recently, it was disclosed by the IBRD (International Bank for Reconstruction and Development), and the World Bank, that investment commitments valued at US$1.5 trillion had been made by low and middle income economies for PPP-procured infrastructure projects (IBRD and World Bank, 2016: 14), and it has been speculated that the new Federal Government of the United States, under President Trump, will use private finance to introduce US$1 trillion in infrastructure investment (Ballantyne, 2017). With such significant levels of investment at stake across the globe, governments must ensure that intended value-for-money outcomes are achieved. ¹

These procurement mechanisms are often characterised as endeavours involving public and private partners, developed through the expertise of each partner in order to meet identified public needs through appropriate resource, risk and reward allocation (Canadian Council for Public Private Partnerships, 2009). A ‘private partner’ can be defined as a group of private sector companies that are contracted-in by government to fulfil a particular role or obligation (Savas, 2000: 248; Greve and Hodge, in Osborne, 2010: 157) for a defined period of time (typically lasting 20 years or more). During operations, such consortia typically extend to bankers, investment bankers and asset/facility managers. It is often considered to be a partnership because the companies are bound together as a legal entity. Failure of any one company can have an effect on the consortium as a whole (UK National Audit Office, 2003: 7).

For government, a key benefit sought from PPP is risk transfer – or more explicit allocation of risks between the public and private partners. However, not all operating risks can be transferred or eliminated (for those risks that the public partner opts to retain) (McCann et al., 2014a). The private partner’s ability to manage operating risk is limited to its share of the equity and may therefore be illusory (HM Treasury, 2011b). This means that the public partner retains residual risk because its private partner cannot guarantee that it will fulfil its legal obligations for the life of the contract (Partnerships Victoria, 2001: 68) and, because of this, government remains ultimately accountable for the delivery of public services (HM Treasury, 2011b). Governments should therefore manage their risk positions (Victorian Department of Treasury and Finance, 2016b: 20).

With PPPs there is generally limited scope for identification and exploitation of opportunity risk during operations, although there are exceptions – for example, potential skill and technology transfers (Baker and McKenzie Solicitors, 2006). From a public sector perspective, risk management can be beneficial for standardising training opportunities and sharing knowledge across government agencies, derived through real experiences of managing performance risk, by drawing on specific situations where different decisions could have led to better results (Victorian Department of Treasury and Finance, 2007: 4). However, even if opportunity risks are identified, the potential for risk realisation is likely to be tempered with incentive levels as set out under concession deeds, as well as risk appetite for taking on additional risk. Such opportunities may arise infrequently and make substantial demands on the operational management resources of public partners in PPP (McCann et al., 2014a).

Public partner management of risk during operations thus tends to be mainly concerned with the threat risk perspective, given that the public partner’s objective is primarily to defend and protect value-for-money outcomes that have been agreed, and which should be delivered, by its private partner (McCann, 2014: 48). Threat risk arises from uncertainty (ISO, 2009: 1) associated with events that could prevent services from being delivered as planned.

Known risks should be continually monitored and managed (IBRD et al., 2014: 209) during operations because risk appetite can change over time and existing risk positions may be neither properly quantifiable nor static. Moreover, it is crucial to identify the source of new risks, their drivers, and to whom the benefits or consequences flow. New threat risks, or changes in the severity of previously identified risks, can quickly and adversely have an impact on value propositions (McCann et al., 2014a).

The traditionally long-term nature of PPPs means that effective oversight management of the concession deed, beyond the development and delivery phases, is likely to be important to the success of these projects. In order to attain intended value-for-money outcomes, developing the right organisational culture (UK National Audit Office, 2009: 55) is vitally important because failure to establish and then maintain effective relationships can undermine trust or manifest in intractable difficulties between the partners. There is also potential for the public partner to be unduly influenced by its private partner – arising from power/information asymmetries (Loxley and Loxley, 2010: 36; Garvin 2010) – which might have far-reaching consequences, including setting of informal legal precedent.

The importance of effective contract administration is acknowledged here as an essential feature for monitoring and managing private partner adherence to contracted obligations (including contributing to the assessment of overall sustainability of the concession deed). However, it can be viewed, in the current operating environment, largely as a compliance function. It is also acknowledged that although under-performance and acts of non-compliance have the potential to undermine sustainability of contract by eroding value, the ability to manage large-scale change events successfully is more likely to have a direct effect on the attainment of strategic outcomes and, therefore, value-for-money propositions.

Value-for-money challenges

It was claimed by the IBRD et al. (2014: 203) that there are differences between managing traditional government contracts and PPPs, where the latter are described as ‘long-term and complex’ and, by necessity, incomplete. This means that for practical reasons the spectrum of requirements and rules for all scenarios that relate to PPP mechanisms cannot be fully specified in these types of contracts. Because of this, uncertainty can give rise to risk.

When governments take decisions to deliver infrastructure through PPPs, policy-makers and other influential stakeholders (Kasperson et al., in Slovic, 2010: 318) often direct public attention towards the assets – such as hospitals, schools, prisons – that will be created to deliver services. The design of these buildings, particularly those that result in innovative practices to reduce costs, or improve efficiency or user experiences, are often central themes for selling PPPs as value-for-money investments. The significance of these benefits is not easily disputed – there are many examples of stylish and fit-for-purpose buildings procured through PPPs.

Value-for-money, however, is not realised once construction is completed; it trickles into communities over long periods of time, depending on the length of individual concession agreements. In this context, PPPs and attainment of value-for-money should be recognised as a long game, where the real return on investment will be known only at projects-end (McCann, 2016). Such ‘realisation’ is not easily quantifiable at the outset despite arguments to the contrary (Perraudin, 2017; Carrell, 2017).

Stated differently, across the globe, poorly managed PPPs are resulting in governments paying private partners hundreds of millions of dollars – and even billions – for services that do not fully address intended social needs, and from failing to manage under-performing public services (McCann, 2016). If genuine value-for-money outcomes are to be achieved, suitable resources must be allocated to PPPs to which governments are already committed in order to increase the likelihood that services will be delivered as intended, and that expectations, as set out in those business cases, are met (McCann, 2016). Such decision-making in PPPs can have far reaching consequences and there will be many risks and challenges that governments face – frequently and over a long period of time – during service delivery, not least because services are delivered non-competitively for the duration of the concession period.

Risks are social phenomena. They are constructs that are developed in the minds of individuals (Renn, in Bouder et al., 2009: 21) and structures are built from observations and experiences which are experienced both individually and collectively in groups and by society more generally. Risk is thus a social construct. Different perceptions can lead to complexity when different views are formed by individuals and groups about what risks are (to them) and, correspondingly, how they should be managed and communicated (Renn, in Bouder et al., 2009: 16–17; Kasperson et al., 1988). In understanding risk, PPP decision-makers should consider organisational and institutional capabilities, including available resources and the opportunity cost of implementing risk management plans.

Government can be viewed as the ‘customer-by-proxy’ for PPP in terms of service delivery arrangements secured and rendered on behalf of the state; however, it is acknowledged that end users (for example) are intended beneficiaries of these services. The public partner therefore acts as an agent on behalf of certain stakeholder interests in pursuing value-for-money outcomes for them. Effective risk assessment may allow a greater degree of control to be applied to certain aspects of the risk, which then makes risk targets less vulnerable to potential loss (Renn, in Bouder et al., 2009: 15–16). This builds upon the notion that risk is subject to the belief that human action can prevent or at least mitigate harm or loss from occurring (Renn, in Bouder et al., 2009: 21).

In managing risk from a public sector perspective in PPP, McCann (2014: 123) proposed that there is a set of generic risk management propositions which may contribute towards achieving value-for-money outcomes during operations. This involves:

Identifying risks that may prevent business case or other defined strategic objectives from being appropriately managed;

Ensuring service delivery is periodically aligned/re-aligned with business case/project brief objectives, the concession deed, service specifications and subsequent contract variations, amendments, etc.;

Ensuring service delivery is perceived by users and the wider community to represent value-for-money; and

Where appropriate, identifying and implementing opportunity risk leading to improved value-for-money outcomes.

These factors can potentially be used as a foundation upon which to build risk management evidence-bases, in order to assess whether value-for-money outcomes are being progressively achieved and to assist with effective planning and implementation of change management events.

Impact of change initiatives on value-for-money

This article identifies a range of change initiatives that should be effectively managed to achieve desired outcomes. Mobilisation, contract variation and end of concession handover are factors that are managed as part of all PPP agreements between government and its private partner: some will involve managed termination.

These mechanisms exist to improve or maintain performance levels in delivering specified services. Taking contract variation as an example, a private partner may propose a variation because it, the partner, seeks a different level or form of performance than that currently provided. Change of consortium members can occur due to poor performance; and changes to a public partner’s agency authority may result from machinery of government changes, where resources are re-allocated to another public entity considered best placed to manage the PPP arrangements effectively.

The issues raised here are not necessarily exclusive to PPPs: any strategic procurement approach is likely to be affected. However, each – including its potential consequences on PPP operations – is outlined separately, and presented mainly from the perspective of threat risk.

Technical completion/contract mobilisation

Demanding timescales can impinge upon successful transition from project delivery to operational management for the public partner. For PPPs, successful mobilisation may be constrained by schedule overruns due to the volume of commission testing (which in some cases can amount to hundreds or thousands of tests for a large and complex project). Timely completion may also be affected by non-conformance of the project/output specification; or from defects (e.g. those that have quality, health and safety or environmental implications) which arise from issues not anticipated or properly dealt with during the planning and construction stages.

Typically, for social infrastructure projects, delays mean that the public partner will not authorise defined service payment for its private partner until PPP facilities are properly commissioned (McCann, 2014: 188). This can inadvertently put both parties under a great deal of pressure to finalise technical completion. Delays may also decrease opportunities for the public partner to influence service implementation (4 ps, 2007: 8) which can result in a loss of public partner control, costly disputes and long-term relationship difficulties.

There are likely to be many factors on which the public and private partners will have different views and which will ultimately require agreement: for example, those arising from audit findings, risk and asset register assessments (which, for instance, could otherwise be manifested in wrong-doing, fraud or theft of assets); the focus of compliance and performance reporting regimes (which, for instance, could lead to collection of inaccurate operational data or difficulties with Key Performance Indicator measurement and trend reporting); training for site-based employees (staff not being adequately trained, resulting in failure to disclose and/or manage hazardous situations); and so on (Victorian Auditor-General, 2007). This may be exacerbated by specific wording in contractual clauses that are open to interpretation – different perceptions may have a profound effect on achieving intended outcomes (McCann et al., 2014a). The public partner must therefore be mindful not to set legal precedent(s) which could result in services being provided that do not fully address intended public needs.

A recent example involving Miller Construction as part of the Edinburgh Schools Partnership (a private sector consortium) demonstrates, however, that failure to satisfy technical requirements may result not merely in a delay to commencement of service delivery; defects or poor construction quality can potentially have an effect on the provision of services well into the operating phase. In April 2016 (approximately 10 years after technical completion), serious structural problems relating to wall and header ties led to the emergency closure of 17 PPP schools in Scotland, affecting more than 7000 students (Carrell and Brooks, 2016).

Contract variation

For these long-term agreements, it is not unreasonable to expect that contract clauses will be varied from time-to-time. Variations (including re-allocating risks) can potentially result from technical obsolescence – for example, ICT systems; new legislative/political requirements – for example, health and safety; changes in service user demand (Partnerships Victoria, 2001: 135; Edwards et al., 2004: 122); service provider under-performance (Partnerships Victoria, 2001: 161); and from decisions to modify the length of concession deeds.

In the case of under-performance, this means the public partner has the right to intervene if the quality of services provided by the operator fails to meet its obligations (Partnerships Victoria, 2001: 161; APMG-International, 2016: 31). This could arise from a breach of contract such as default (through continued acts of non-compliance) (Partnerships Victoria, 2001: 148), a major default, or in an emergency situation where the public partner may assume operational control for a period of time because the situation may be beyond the capability of the private partner to deal with it effectively (Partnerships Victoria, 2001: 161) – for example, major flooding. That said, force majeure events are uninsurable. The public partner may, however, provide for contract variations in these instances to give relief to its private partner because of unexpectedly high financial consequences (Partnerships Victoria, 2001: 28). The public partner should be aware of and plan for this possibility (APMG-International, 2016: 26).

For the public partner, regardless of the driver of a variation, a crucial factor in achieving value-for-money is the ability of its employees to effectively assess and select the best course of action, and not unintentionally (through failing to understand the commercial and legal underpinnings of the concession deed) give away something which undermines value for the state over the longer-term, or leads to an adverse change in its risk profile (McCann et al., 2014b). For example, inadequate levels of skills and experience (Boyer and Newcomer, 2015) can have a detrimental effect on achieving desired outcomes through planning for and administering contract variations. This can be further compounded by dealing with uncertainty (e.g. ‘unknowns’) when trying to future-proof assets; for instance, those arising from unexpected changes or a rapid pace in technological advancement or population growth.

According to McCann’s research (2014: 189), risk re-allocation between partners did not at that time appear to be a significant concern for Australian PPP decision-makers, for example (even though there are numerous examples of ‘failed’ ventures – most notably toll roads – arguably stemming from the use of contemporary risk allocation and forecasting models). For social infrastructure projects, a likely scenario involving the state taking back risk (APMG-International, 2016: 8) or altering the concession deed during operations would be due to mispricing facility management services; that is, soft services, where the public partner is faced with a choice between renegotiating the deal or permitting the operator to walk away from the concession deed (or go into voluntary administration or liquidation).

However, anecdotal evidence from the United Kingdom (McCann, 2014: 189) suggested that in some instances, public partners had decided to take-back risks associated with the provision of soft services, whilst allowing the private partner to continue to maintain and operate the assets. This is occurring in some PPP schools, for instance, due to above-market costs of facility management and over-servicing school assets. Furthermore, it was stated by HM Treasury (2011a) that some PPP consortia may have purposely de-scoped or introduced value testing for underpriced services as a way to transfer risk back to government.

Change to public partner’s agency authority/change of consortium members

In Australia, PPPs tend to be established under state government law (as distinct from Australian Commonwealth or Federal law). Typically, for economic infrastructure projects, statutory authorities are established to enforce legislation in order to achieve government objectives. This includes managing PPP contracts on behalf of the state. Although largely dependent upon the structures and specific arrangements of each PPP, once projects move from procurement and delivery to operations, statutory authorities can be restructured to incorporate other projects or functions under a single governance framework (e.g. to expand the scope of responsibility, create efficiencies of scale, etc.). This differs from most social infrastructure projects which are aligned with the government entity (the public partner) considered to have the greatest level of expertise in providing management oversight throughout the asset’s lifecycle (McCann, 2014: 72).

For example, the responsibilities and powers of the Southern and Eastern Integrated Transport Authority for the EastLink toll road were enacted during 2003 to oversee and manage the procurement phase and the initial operational stage (Southern and Eastern Integrated Transport Authority, 2009: 5) on behalf of the Government of Victoria. In 2009, its accountabilities were transferred to Linking Melbourne Authority in order to ‘better reflect [the latter’s] ongoing role in delivering projects which link communities, jobs and opportunities’ (Linking Melbourne Authority, 2010: 6), thus incorporating the statutory role for EastLink into its existing portfolio of projects. However, the following year, the obligations were again transferred to another statutory body – VicRoads – due to the introduction of Victoria’s Transport Integration Act 2010 (Linking Melbourne Authority, 2010: 5).

Such machinery of government changes has the potential to expose government to unintended risks which can disrupt the effectiveness of PPP oversight. These events may be further affected by uncertainty in decision-making and poor communication with employees and other stakeholders during change processes. These developments may also heighten the risk of failing to achieve intended value-for-money outcomes because of staff turn-over and/or the loss of critical knowledge, unless these risks are adequately managed (McCann et al., 2014b).

On the private sector-side, the composition of a private partner and the extent of involvement of particular stakeholder groups will depend upon the progress made at each PPP phase as well as the specific circumstances of individual projects. Sub-standard delivery of services or the failure to provide agreed services by a member of a consortium may lead to its contract being terminated (McCann, 2014: 58). Such situations may result in the replacement of that member in the existing consortium, or an amended concession deed if the provision of those services is no longer required. Consortia membership may not be fixed, therefore, for the full term of the concession.

A change to the composition of a consortium – for instance, the introduction of a new equity investor – can potentially present an opportunity to improve value-for-money outcomes, depending on appetite and tolerance to risk and the ability to manage change situations. Conversely, a new consortium member may be less receptive to the notion of taking on additional risk because it may have different organisational drivers and/or internal policies compared with those of its predecessor (McCann, 2014: 191). Typically, pension fund providers have a conservative risk profile and are attracted to PPPs that are likely to produce a stable return on investment over the long-term; for instance, regular income that can be generated from patient care and cleaning in hospitals. As a result, these providers are more likely to be passive investors and, generally speaking, less likely to seek higher exposures to risk (McCann, 2014: 191).

Managed termination

A key objective of contract management is to ensure that private obligations are met for the full term of the concession deed (Partnerships Victoria, 2001: 172). Although considered as a last resort (Partnerships Victoria, 2001: 172), contract termination can be enforced if a private partner fails to meet its responsibilities (Partnerships Victoria, 2001: 25; APMG-International, 2016: 25, 41). In such situations, long-term government funding commitments and priorities may be put at risk unless an alternative service provider is found; planned value-for-money outcomes can be severely compromised if government is left without what it set out to achieve.

Although the exact timing and nature of the arrangement has yet to be defined (Perchard, 2017), the Greater Manchester Waste Disposal Authority in England chose in April 2017 to terminate its concession deed with the Viridor Laing consortium (BBC Manchester, 2017). It is understood that the £3 billion waste recycle contract was axed after only eight years into the 25-year operating term. This is attributed to local council budgetary constraints (BBC Manchester, 2017) (local councils pay a levy to the Authority and is deemed by some to be unaffordable) and as a result of under-performance by its private partner – that is, facility repair delays and processing lower than expected volumes of waste (Perchard, 2017). It appears that poor value-for-money for tax payers will be exacerbated because Viridor Laing is seeking compensation for termination (BBC Manchester, 2017). This puts Government in a difficult position unless long-term cost savings and other efficiencies can be derived from an alternative approach.

Using a second example to illustrate the potential for poor value-for-money, after the new consortium, Cross City Motorway Pty Ltd in Australia took control of Sydney’s Cross City Tunnel (after the original consortium was put into receivership), a dispute arose during 2012 between the new consortium and the Office of State Revenue about whether or not stamp duty of AU$60 million should be paid on the purchase of the asset (Saulwick, 2012; Haynes, 2012). The new private partner stated that it purchased the Tunnel based on an understanding that it was not required to pay the tax (Haynes, 2012). It was claimed that by forcing the owner of the toll road to pay the debt the consortium could be tipped into receivership (Haynes, 2012). Because New South Wales’ tax payers are essentially unsecured creditors of the Cross City Tunnel, this meant the Tunnel’s shareholders would be given preference over taxpayer interests if the road was to be re-sold (Haynes, 2012).

During a managed termination, the public partner is ultimately accountable for the continued delivery of services. It can attempt to mitigate this risk by putting robust contingency plans in place (Partnerships Victoria, 2001: 35). Although this may seem obvious, particularly in light of examples where operators have been placed into receivership (due to the knock-on effects of over-optimistic traffic estimates, for instance), historical research from the United Kingdom has demonstrated that these types of plans were not always evident in practice (Edwards et al., 2004: 66). More recent anecdotal evidence obtained by McCann (2014: 58) suggested the same occurring for some Australian PPPs.

Despite the threat risks of contract termination – e.g. take-back of assets or services, or negotiating with another party to provide the services possibly at a higher cost to government or delivered to a lower standard – termination events may not always result in poor value-for-money outcomes if the asset can be secured at a discounted price by government (McCann, 2014: 193). A favourable outcome may, however, depend on a range of factors specific to each PPP, including the cost of financial settlement (itself including making an adjustment to employment conditions of staff under new pay awards, if applicable), and the amount of value left in the life of the concession deed.

There are two other notable risks identified for managed termination (Chartered Institute of Purchasing and Supply, 2013). The first relates to governance arrangements which require the outgoing private partner to co-operate with the new incumbent during handover. It is likely that during this period some interaction between consortia will be necessary. Interaction could extend to establishing an understanding of the outgoing partner’s capabilities, processes, assets, documentation, etc., that will not be transferred to the new consortium or public partner, and how these should be sourced to ensure the provision of public services are not disrupted. The second risk involves managing intellectual property. Issues or concerns may be raised by the outgoing private partner with regard to the new incumbent using the outgoing partner’s intellectual property in delivering services through accessing sensitive commercial documentation, etc. Such situations can, unless effectively managed, potentially result in costly legal action.

Although these two risks may be perceived primarily as a private sector matter (to be resolved between consortia with limited public partner involvement or interference), the public partner, as the PPP client, can be adversely affected (e.g. delays and/or costs) by non-cooperative behaviour that have an effect on public sector business and the delivery of services.

End of concession handover

If assets are not properly maintained over their entire lifecycles, they can deteriorate prematurely and be rendered unfit-for-purpose (Edwards et al., 2004: 123; Victorian Department of Treasury and Finance, 2016a). This can reduce value-for-money outcomes, particularly if the public partner is obliged to absorb the cost of major repairs or replacements soon after concession handover is complete. The public partner traditionally mitigates this type of risk by writing stipulations into concession deeds stating that assets must be appropriately maintained over the full life of the contract term (McCann, 2014: 59). It is often the case that these clauses restrict/regulate the distribution of profits to the private partner if assets are not appropriately maintained.

The commencement of asset monitoring by the public partner before concession handover will depend on specifics, but typically monitoring starts five years before the contract end-date (Edwards et al., 2004: 123). ² At the time of handover, if irregularities are uncovered, the public partner can penalise and/or abate the operator to cover its costs and the acceptance of asset transfer will then be subject to the approval of a final inspection undertaken by the public partner. An associated issue is the practicability of determining in advance what the hand-back condition of an asset should be, and what penalties for non-compliance would be appropriate, for an event that might occur decades in the future (McCann, 2014: 59).

There remains a possibility of cost being passed to the public partner after transfer takes place due, for instance, to the acquisition of technical expertise which may be required to monitor or solve highly complex technological matters – for example, the management of legacy systems. If competing views from experts arise, for instance, inexperienced public officials could be forced to take strategic decisions that have far-reaching consequences affecting the future viability of assets (McCann, 2014: 59). Moreover, hiring external expertise can be costly and, cumulatively, can have an effect on the achievement of value-for-money propositions.

Transition arrangements must therefore be effectively managed by the public partner (including maximising the use of these periods for developing detailed tender specifications, running procurement processes, obtaining government approvals, etc.). If planning is left too late (APMG-International, 2016: 25, 41) there will be a risk that the public partner will need to negotiate with the incumbent at least for an initial period to maintain service delivery. This may not be the most cost-effective option that would otherwise have been available to government, and the state is obligated to demonstrate that whatever decision is taken it represents the best value-for-money option (McCann, 2014: 194). Moreover, by going to tender under such circumstances it may increase the prospect that the incumbent will provide a less competitive price for delivering services, thus decreasing the public partner’s level of bargaining power (McCann, 2014: 194).

Conclusion: practitioner points

In adopting a practitioner-based focus, this article offers:

In-depth insights into how the actual management of PPPs is carried out and dealt with by government during the concession period. This is beneficial because there is limited empirical information and data available that relates to operational governance of PPPs both in established and emerging PPP markets;

Detailed insights on value-for-money in the operating phase of PPPs and how it relates to change management, thus making it more tangible and grounded for practice; and

Identification of critical success factors that can lead to the achievement of value-for-money outcomes, thus building upon existing knowledge, policy and guidance for PPPs, both nationally and internationally.