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Definition And Types Of Public Private Partnerships Construction Essay

Public Private Partnership (PPP) is a procurement method where the public and private sector connect forces to deliver a public facility. In this arrangement generally both public and private sector will put in their adeptness and resources to the project and allocate the risks involved. The definition of PPP might vary negligibly between diverse jurisdictions, depending on which part of understanding the significance is focused on.

According to Partnerships British Columbia PPP is defined as a “lawfully binding agreement between government and business for the provision of possessions and the delivery of services that assigns responsibilities and business risks with the various partners.” (Partnerships British Columbia 2003)

Whereas according to Indian Government the term PPP is defined as a “venture based on a concession agreement, between a Government on the one side and a private sector firm on the other side, for delivering an infrastructure facility on disbursement of user charges.”(Infrastructure section, 2005)

In the above two definitions there is an importance that both the public and private sector share a great amount of risks in a PPP project. In truth it is not always that an identical split of risks is experienced. In fact each party want to pass on more risks to the other party. It is observed that this happening is more frequent in developing countries wherein the government has less awareness in this alternative procurement process.

2.2 Background of PPP

Akintola et al. (2003) are of the opinion that PPP in services development involve private troupes in the design, funding, construction, possession and/or operation of public sector facility. Such partnerships amongst the public and private sector are now an acknowledged alternative to the traditional state stipulation of public services and facilities.

PPP projects can be dated as distant back as the 1600’s, during the railway construction rapid evolution in the United Kingdom. PPP is a comparatively new term for this arrangement used more frequently in the last decade. Earlier dissimilar differences of the arrangement incorporated Private Finance Initiative (PFI), which is more well-known term to many citizens due to its well-liked development in the United Kingdom during the early nineties (Grimsey and Lewis, 2004).

It would not be false to say that the PFI developed in the United Kingdom lifted the world’s attention to this alternative choice for delivering public infrastructure and services. Since 1992, approximately 630 PFI projects delivering infrastructure expenditure of above £63 billion have been signed (PPP forum, UK).

Due to extensive history of PFI/PPP projects in United Kingdom, Partnerships UK has a very inclusive compilation of policies and guidelines on employing PPP projects for all sectors in many features. Amongst the projects carried out by Partnerships UK it was also observed that the majority projects included are schools, hospitals and transportation. Other projects which were executed comprise environment ones, prisons, detention centres and leisure facilities etc. (Partnerships UK, 2010). The level to which PPP could be utilized and the advantages produced were the major drivers attracting other countries to start espousing their practice in PPP.

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2.2.2 Types of PPP’s

PPPs come in various types and no two PPP projects are precisely equal. Most of them will be similar, but the name is varied depending on the country it is used in, whereas in some cases there are major variations to the method. Some of the commonly mentioned diverse types of PPP have been listed as follows:

Design Build Finance Operate (DBFO): In this approach the duties for designing, constructing, financing, and operating are collected together and reassigned to private sector partners. Here the government will retain title of the land and lease it to the private group over the life of the concessionary agreement (Levy, 1996).

Build Own Operate (BOO): In this type the contractor constructs and operates a facility without reassigning ownership to the public sector. Lawful title to the facility remains in the private sector, and there is no compulsion for the public sector to procure the facility (Denton, 2006).

Build Own Operate Transfer (BOOT) : It is a form of project financing, where a private entity obtains a concession from the private or public sector to design, construct, finance and operate the facility stated in the concession agreement (Tony and Cyrus, 2002). This facilitates the project promoter to recover its outlay, operating and maintenance expenses in the project.

Build Transfer Operate (BTO): Under this approach the private sector design and constructs a facility on the turn key basis. When the facility is completed, the name for the new facility is reassigned to the public sector and the private sector operates the facility for a particular period. (Yescombe, 2007).

Leasing: In this approach the considerable part of all the risks allied with, developing, funding and operating the facility are assumed by the private sector, with the public sector entity obtaining the facility on lease (Denton, 2006).

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Joint Ventures (JV): In this approach Public and private sector jointly finance, own and operate the facility, so as to deliver long term- growth in value for both partners (Akintola et al, 2003).

Buy-Build-Operate (BBO): In this the publicly-owned asset is lawfully reassigned to a private-sector partner for a designated phase of time (Yescombe, 2007).

2.2.3 The parties in a PPP project

There are a number of key parties to any PPP project and all of them have particular motives to be involved in the task. The contractual arrangements involving those parties and the allotment of risks can be complex.

Denton (2006) explains about the major parties in a PPP project, which include:

Government Agency: A government department is a crucial party. It grants sponsor the concession, i.e. the right to construct, own and operate the service, grant a long term lease of or vend the site to the sponsor and frequently obtain most of the service offered by the facility. It also initiates the project, conduct the tendering procedure and assessment of tenderers.

Sponsor: The sponsor is the party, typically an association of interested groups (usually including a construction team, a financing organization, an operator and other diverse groups) which, in response to the request by the Government Department, organizes the plan to construct, operate, and finance the project.

Construction Contractor: The construction company can also be one of the sponsors. It takes the construction and completion risks, i.e. the risk of carrying out the project on time, within resources and to the specifications.

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Operation and Maintenance Contractor: The operator is expected to sign a long-term agreement with the sponsor for the operation and maintenance of the service. Operator can also infuse equity into the project.

Financiers: In a big project there is likely to be a group of banks providing the debt finances to the sponsor. The banks will need a security over the infrastructure constructed. The same or dissimilar banks offer a stand-by loan service for any cost overruns which are not cover by the construction contract.

Other Parties: Other parties such as design consultants, insurers and equipment suppliers were also involved. Most of the parties involve their lawyers, monetary and tax consultants.

2.2.4 Typical structure of PPP

A typical PPP structure is fairly intricate involving contractual arrangements between a number of parties including the government, project operator, project sponsor, suppliers, financiers, engineers, contractors, third parties and consumers. The formation of a separate entity called a Special Purpose/Project Vehicle (SPV) is an important feature of most PPPs. The SPV is a lawful entity that carries out a project with all contractual agreements between various parties. SPVs are also a chosen mode of PPP project implementation in non-recourse situations, where the lenders depend on the project’s cash flow and security over its possessions as the only means to pay back the debts. Figure 1 shows a simplified PPP structure (Yescombe, 2007).

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Figure 1. Typical structure of a PPP Project

2.3 Procurement Process and Management

In a typical PPP project the government invites private consortia to bid by submitting a project proposal. The successful bidder will need to design, build and operate the facility for the agreed concessionary period which is normally 10 to 30 years.

In general the typical procurement process for delivering PPP project in India includes the following two steps (Infrastructure section, 2005):

The Private Sector firm is selected through a visible and open competitive bidding method. The decisive factor for bidding is the amount of viability gap funding required by a private Sector firm for employing the project where all other factors are equal.

The Government proposing the project certifies the bidding process that conforms to the requirements of the proposal and communicate the same to the empowered organization prior to payment of the grant.

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In view of the fact that Promotion of PPP is essential, several initiatives have been taken by the Indian Government to make possible a better PPP framework in order to exterminate the constraints. Various foreign and private investments were promoted by waving off their charges. Framing of homogenized contractual documents for putting down the provisions related to risks, responsibilities, and functioning standards have been formulated. Approval proposals for PPPs have been rationalized through Public Private Partnership Appraisal Committee (Public Private Partnerships in India, 2010)

2.4 Positive aspects of adopting PPP

The positive aspects of PPP have been examined by previous researchers. This section looks in brief at some of these. The very first PPP project that selected for this approach was merely to take in private outlay for public services. These services were often vital for the public as the facilities were provided without using government’s capital thus the fiscal status of the government will not be affected.

Walker and Smith (1995) recommended three main causes for using the PPP approach:

Generally the private sector owns better mobility than the public sector. For example, the private sector is not only saves the expenses of project in planning, design, building and operation, but also evades the administration and diminishes the managerial burden.

The private sector can provide superior service to the public sector and institute a good quality partnership so that a balanced risk-return structure can be sustained.

The government lacks the capability of raising substantial funds for the major infrastructure projects; however private participation can diminish the government’s fiscal burden.

Besides, Walker et al. (1995) supported that PPP is a win-win solution and a number of benefits to the general public and government are recognised:

Relief of fiscal burden.

Relief of managerial burden.

Reduction in size of (incompetent) organisation.

Government can focus and finance societal issue such as an education, health pensions and arts.

Better service to the public.

Technology transfer and development of national capital.

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Askar and Gab-Allah (2002) reviewed six advantages of PPP in his paper:

The use of private-sector investment, proposal, and know-how to lessen project building costs and plans and to improve operating competence.

The allotment of project risk and saddle to the private sector that would otherwise have to be take on by the public sector.

The use of private sector funding to provide new sources of resources thus reducing public borrowing and developing the host government’s credit ranking.

The participation of private sponsors and skilled commercial lenders, providing an in-depth reassess and added assurance of project viability.

The opportunity to institute a private benchmark to determine the effectiveness of similar public sector projects and thus offer chances for the enhancement of public supervision of infrastructure facilities.

In contrast to privatisation, the government’s retention of planned control over the project, which is reassigned back at the closing stages of the contractual period.

Time conviction is found to be more simply accomplished in PPP projects. The alliance is often waged according to milestones of the project programme and any hindrance might be subject to liquidated damages. Thus the association is often stimulated to reach these milestones on time, if not earlier. This is a general behaviour observed in the private sector but it could not be the case in the public sector (Chan et al. 2006).

2.5 Negative aspects of adopting PPP

Likewise the negative aspects of PPP were also re-examined and an outline has been given in this section. Berg et al. (2002) recapitulated some disadvantages of PPP projects:

Lengthy bidding procedure - from the preliminary stage of public sector evaluation to signing of indenture takes up to two years. The procedure of inviting, organizing, evaluating and refining bids and negotiating contracts is difficult and practical.

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Cost overruns - substantial scope for cost increase through the bidding procedure.

High bidding costs - the comprehensive and extensive nature of the bidding procedure means augmented transaction costs.

Intense risks - not obvious to what level the government can reallocate the risk.

The impact of project risks to task goals in carrying out a PPP project is typically important and these risks come up from numerous sources including the social, political economic, technical, and environmental factors, mainly due to the complexity and nature of the regulations, public groups and stakeholders involved. Both the private and public sectors need to have a healthier understanding of these risks in order to attain a reasonable risk distribution and facilitate the project to make better results (Chan et al., 2006; Mustafa, 1999; Satpathy and Das, 2007; Xenidis and Angelides, 2005; Zhang and AbouRisk, 2006).

PPP projects could fall to one side due to failure on the part of the private sector contributors. In contracting out the PPP projects, the government have to ensure that the parties in the private sector group are adequately skilled and fiscally proficient of taking up the projects. Due to a lack of pertinent ability and knowledge of project partners, PPP projects are intricate to procure and put into practice.

One cause for failure is the stakeholders’ hostility and general public disagreement. Whether the planned project is steady with the interest of the public is imperative as public opposition can unfavourably affect the financial support for the project from the public sector (El-Gohary et al., 2006; Grimsey and Lewis, 2002). PPP in public projects normally incur social and political issues like town planning, land resumption, employment, and ecological protection. These could result in public conflict, extravagant costs and delays to the projects.

Another general grievance by the public is the high tax charged for the services offered. More frequently, the private sector would face political uphill in increasing tax to a level adequate to cover its expenses and earn rational income and returns on outlay. The involvement of the private sector to provide public facility will certainly bring improvements and efficiencies in the function, but can create a fear of rationalizing in the public sector. To a

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certain extent, there would be less employment prospects if no dictatorial measures were employed (Li et al., 2005b; Zhang and AbouRisk, 2006).

Private sector financiers bear fiscal risks in funding of the outlay. Seeking fiscally sturdy partners in a PPP project is considered as complicated. In most PPP arrangements, the debt is limited –recourse, where investors have to to bear risks. In truth, most stakeholders are not prepared to accept extreme risks. The lack of mature fiscal engineering practices on the part of the host countries can also be another setback (Grimsey and Lewis, 2002). Unappealing fiscal is often s negative aspect to PPP success. Thus, a conducive fiscal market is vital for the private parties to impel PPP projects.

2.6 Ensuring Value for money in PPP Projects

One of the foremost reasons that projects are procured by PPP is to augment Value for money (VFM) by inviting the private sector to handle public projects. Consequently there has been much literature on how VFM in PPP projects can be achieved. This section gives brief explanation on how VFM can be achieved in PPP projects.

VFM is the final test for a project. When considering a PPP method and one plan versus another, the comparison of imminent cash flows is the primary fiscal analysis required in assessing VFM. Other aspects to consider include a dedication to ensure that government's funds are managed with due regard for financial system, competence and effectiveness.

Grimsey and Lewis (2004) defined VFM as the best possible combination of whole life cycle costs, risks, achievement time and quality in order to meet public needs and it is another significant thought when deciding whether to go on with the PPP choice, particularly for the public sector.

‘Public sector comparator’ (PSC) is the most common tool used by the public to illustrate how much it would cost the Government to construct the asset through public money, which is then used to evaluate with how much it would cost to construct it as a PPP (Andy, 2006).

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Cost savings refer to the diminution to the price as a result of carrying out a project by PPP instead of traditional methods. The saving could be an outcome of the private sector’s originality and competence which the public sector may not be able to attain (Grim and Lewis 2004; Akintola et al. 2003; So et al. 2007). Private sector normally attains higher operational competence in asset procurement and service delivery by employing their proficiency, knowledge, new ideas and improvements. By and large cost savings to the project can be attained by striving for the least possible total life cycle costs while exploiting earnings.

Tahir (2007) stated that the private sector can offer services more professionally and cost-effectively than the public sector, which is supposed as extremely bureaucratic and thus high-priced. The same service could be provided at less cost, or a better-quality service would result for the same cash expenses and private agents’ involvement will guarantee VFM gains. It is therefore argued that VFM can be estimated against a number of options, including the business case, the PSC and by benchmarking costs (Heald, 2003).

Nisar (2007) mentioned that a vital characteristic of PPP is the integration between the partners’ .PPP project arrangements are intricate and engage many parties with differing objectives and interests. Consequently, PPP projects often need wide expertise contribution and high expenses and take protracted time in deal intercession. The high transaction costs and lengthy time may not signify importance to all parties and thus the deal may not appear in the beginning or could flatter in the end. PPP projects could incur high transaction costs than those under the conservative public sector procurement.

The lawful and recommended fees would be integrated as lawyers are involved in all phases of a PPP project. The possible high transaction costs might have a pessimistic impact on the object of securing the finest value (Corbett and Smith 2006; Grimsey and Lewis 2004; Zhang and AbouRisk, 2006). Complex PPP projects need inputs from many parties of dissimilar expertise. Hence, the projects should be reasonably feasible to cover such expenses.

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Yuan et al. (2009) identified the Key Performance Indicators (KPIs) used in performance administration, which are: physical characteristics of projects, stakeholders and project processes, modernization and learning, financing and advertising These indicators are imperative for permitting both public and private sectors to make proper decisions during the project life cycle in order to develop the value of PPP efforts. This level of complexity is essential owing to the presence of complex macro and micro economic, fiscal and political conditions during the life cycle of a project (Abdel, 2007). Appropriate understanding of these performance indicators is of equal importance for both public and private sectors. Therefore to achieve VFM, the Special Project Vehicle (SPV) should ensure that it has the correct processes and abilities in place.

2.7 Critical Success Factors in a PPP Project

In order to achieve victorious PPP projects, some success factors have previously been reported in literature. This section reports few instances of how victorious PPP projects can be achieved by using the critical success factors (CSFs).

In PPP contracts the government must be concerned that the properties are obtained and facilities are delivered on-time with superior quality and meet the pre-agreed facility requirements during the life of the contract. Nevertheless, the government should be less concerned with how these are attained and should not compel undue restrictions on the private sector participants. The government must be demoted to the principal role of industry and service guideline and should provide sturdy support and make incentive payments to the private sector. On the other hand, government have to keep hold of controls in case of non-payment and be geared up to step in and re-provide the facility if required (Corbett and Smith 2006; El-Gohary et al. 2006; Li et al. 2005; Tam,1999; Tiong, 1996).

A translucent and well-organized procurement process is vital in lowering the transaction expenses and curbing the time in intercession and finishing the deal. Understandable project brief and client needs should help to attain these in the bidding procedure. In most cases, competitive bidding only on price cannot help to secure a strong private group and acquire value for money for the public. The government have to take a

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long term observation in seeking the correct partner (Corbett and Smith 2006; Jefferies 2006; Li et al. 2005c; Qiao et al. 2001; Zhang 2005).

Successful PPP functioning requires a steady social and political environment, which in turn relies on the constancy and ability of the host government. Social and Political issues that go beyond private sector’s area must be handled by the government. If overly victimised, it is valid that the private sector participants should be sufficiently remunerated (Hassan, 2010)

Chua et al. (1999) identified the key success factors in a construction project, where success is determined by a range of factors pertaining to four key project factors, namely:, contractual arrangements, project characteristics interactive processes and project participants The identification of these CSFs would facilitate limited resources of time, money and manpower to be distributed aptly.

Bing et al. (2005) argued that CSFs would improve project value with enhanced quality of outcome, augment administration success, economic viability, favourable investment environment and proper risk allotment. The plausibility of project achievement can be augmented if intrinsic characteristics of the project could be thoroughly understood, proper contractual arrangements are implemented, knowledgeable management team is assigned, and sound supervising and control system is instituted (Ward et al.1991).

Many researchers (Corbett and Smith 2006; Jeffieries et al. 2002; Zhang 2005) have come across that project financing is a most important success aspect for private sector outlay in public infrastructure projects. The accessibility of a competent and grown-up fiscal market with the advantages of low financing costs and diversified range of fiscal products would be an inducement for private sector taking up PPP projects.

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2.8 Risks in PPP

Infrastructure projects carry many risks that are distinctive to the type of delivery method in addition to the risks allied with more usual tasks. These risks are widespread to any project-financing activity, and pertain with some force depending on the project concerned. This section looks at the risks that are associated with the PPP project.

Grimsey and Lewis (2002) explain some of the risks in PPP projects, which are:

Design Risks: This risk relates to any imperfection in the design of the infrastructure service stipulated for the project. This is an intrinsic risk in the project as it is very hard to decisively determine that damage to the service is actually caused due to the imperfection in the design parameters. Normally it is the design contractor who is accountable for the design characteristics of the project.

Construction Risks: The construction risks are fundamentally a bundle of diverse individual risk aspects that unfavourably influence the construction of a project within the time frame and costs planned and at the standard specified for the service. Construction risks are allied with PPP projects, more usual construction projects and the design/build projects.

Operating Risks: The operating risks arise when the operations and maintenance (O&M) services are being provided in a project. Apart from for termination of the contract by the concession company, these risks run openly to the concession company.

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Market and revenue risks: Revenue risk is the improbability in relation to the revenue that a project would truly produce. The market and revenue risks that a PPP project might face can be divided into the three areas:

Insufficient revenue from fares: In the case of a PPP project functioning under a government concession, it would be anticipated that the concession company would ask for money compensation from the government for a shortage in revenue from fares.

Insufficient revenue from Other Operation: In this case, similar chances exist for requesting the government to give cash compensation for shortage and/or extending the concession period.

Insufficient Traffic: It is imperative for the PPP contractor to attain a commitment from the government, with respect to expected traffic levels and to negotiate an adequate compensation arrangement for shortages.

Financial Risks: Risks arising from inadequate hedging of income streams and financing costs are known as financial risks. These risks fall into the following categories:

Exchange rate risk: This risk relates to the likelihood that changes in foreign exchange rates change the exchange rate of cash flows from the project and this risk may be substantial, since exchange rates are mainly unstable in many developing countries whose financial system are in alteration.

Interest rate risk: This risk may be important in infrastructure projects given the typically large amounts borrowed and the lengthy duration of projects, with some loans extending over a period of many years.

Political Risks: The project company and the lenders face the risk that the project implementation might be pessimistically influenced by acts of the contracting authority or the host country’s legislature. Such risks are known as political risks.

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Environment Risks: These are risks relating to happening of environmental incidents during the execution of the project. These risks are usually within the control of the construction, and the operation and maintenance consortium. This risk has augmented due to the presence of stringent legal accountability in relation to such environmental incidents, which can result in unfavourable effects on the financials of a project.

2.9 Risk allocation in PPP

Efficient risk allocation is essential to bring up infrastructure projects to fiscal closure and to provide proper incentives during construction and operation. This section gives brief description on allocation of risks in a PPP project.

Risk allocation is the method of dividing and passing on the responsibility associated with a particular risk for a range of supposed circumstances and it is primarily challenging and essential in the background of PPPs. Hayford, (2004) considered that the private sector can handle risks better than the public sector by adopting PPP process and the truth that a value-for-money result for government in implementing the PPP process will repeatedly switch on the triumphant transfer to the private sector.

Akintola et al (2003) stated that the Risk allocation principle has two main purposes:

To diminish the acuity of risks and transaction costs

To promote rational and sensible demeanour of the parties involved in the project during its life span.

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In a PPP infrastructure project, the public sector partner retains site accessibility and political risks and the majority of the project risks, predominantly those at the macro risk level are allocated to the private sector partner. Risk allocation in PPP projects are viewed from a Transaction cost economics (TCE) perspective, since any issue can be formulated as a contracting problem and can be studied to the enhancement in transaction cost economizing terms.( Bing, et al. 2004; Xiao and Hemanta, 2008; Jin, et al. 2007).

Xiao and Hemanta, (2007) developed a theoretical model for effective risk allocation in PPP projects which is exemplified in Figure 3. The model consists of five constructs, which are environmental uncertainty, risk management commitment, risk management capability, risk allocation strategy, and risk management performance. ‘Opportunism’ is considered as a transitional variable between environmental uncertainty and ‘risk management commitment. The level of environmental uncertainty finds out the commitment level of a collaborator. Besides the collective effects of governance structure, organizational capabilities, and commitment to the management of a certain risk determines the risk management performance.

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2.10 Summary

This Chapter has provided the outcomes of a comprehensive literature review conducted to provide background understanding on the research theme. The traditional practice of procuring PPP projects and the process management by the Indian government was reviewed. It was found that there are understandable procedures prepared by the Indian government explaining the process of implementing PPP projects. A comprehensive review was carried out to study the positive aspects, negative aspects and ensuring value for money measures of PPP projects. In addition, a few of the peer-reviewed journal articles try to categorize the critical success factors and circumstances that make a project victorious. Subsequently, risks in PPP and their impact on infrastructure projects were reviewed. Finally the allocation of various risks and effective model for risk allocation were re-examined.

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