Private Finance Initiatives: Advantages and Disadvantages

PFI Principles

The PFI, known as Private Finance Initiative, is a type of Public Private Partnership procurement method implemented in UK construction industry in 1992. (Chinyio and Gameson, 2009) As an important part of Government’s strategy for delivering high quality public services, Private Finance Initiative requires the private financers to put its own capital at risk to deliver clear defined public projects for a long term period, ensuring the quality of the work delivered within the time and budget. (HM Treasury, 2009) OGC (2007, p.6) defined PFI as “Where the public sector contracts to purchase quality services, with defined outputs from the private sector on long term basis, and including maintaining or constructing the necessary infrastructure so as to take advantage of private management skills incentivised by having private finance at risk.”

PFI has now covered most of public services such as health, education, defence, prisons and transportations. Typically, PFI procurement involves contracting the entire project package including design, construction, finance, operation and maintenance, to a group of private companies which consists of a reasonably skilled construction firm and a facility management firm, for a long period of 20 – 30 years. The government also provides specifications indicating the services and standards it requests, and leave the control right of design and construction and operation solely to the private group for the contract period. (Bennett and Iossa, 2006) It is only recommended for projects to take PFI route when the capital cost is likely to exceed £20m. (OGC, 2007) Bennett and Iossa (2009) say that it’s more likely to use PFI procurement if the externality is positive and the innovation on residual value is large.

Advantages

Long-Term Relationship

PFI is not only focusing on the value for money, it also stressed the development of long term relationship between public sector and private sector. Robinson and Scott (2009) indicates that long-term relationships in PFI projects can provide a powerful incentive in order to learn from each other, share the knowledge, innovate and continuously improve the performance between private sector and public sector in project delivery. Partnering is a crucial key of PFI procurement, the good performance of which will lead to the success of the project. Spackman (2002, pp.283-301) addresses “Success can be achieved only if the public authority and the contractor approach the project in a spirit of partnership, wit understanding of each other’s business and a common vision of how best they can work together.”

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Public Saving

PFI/PPP procurement has the potential to reduce the cost, and deliver better quality work with the same cost in other procurements. (Bing and Akintoye, 2003) Research shows that the government’s investment using PFI procurement in the UK is now about 10-14% in its total investment. (Grimsey and Lewis, 2005) Local authorities are keen to use PFI to deliver a project via partnership as they do not need to borrow money from the banks. Spackman (2002) finds the government constrains its borrowing because it concerns about future taxation, economic demand, costs of the borrowing, and flexibility responding to future economy shocks. The interest cost of public debit in UK is at 2-2.5 percent, however for the cost of private one is only about 1 percent. (Spackman, 2002) Anon (2009, p.3) declares that “In the UK, lack of cash is forcing the government to look at using PPPs for more broadly.” The saving for the government is not only from the borrowing tax aspect, but also in total value of the projects compared with traditional procurement. Parker and Hartley, 2003 (in Grimsey and Lewis, 2005) claim that PPP contracts for UK defence services save cost range from 5-40 percent compared traditional public procurement.

Private Profit

One of the benefits for private sectors to take PFI is that under the long term ownership, they can gain incomes and profits under their management and operation, or exchange benefits with the local authorities. Carrillo at el. (2008) indentifies that one of the key drivers for the motivation of the PFI is the steady and long term income stream and higher returns and profitability. Spackman (2002, pp.283-301) also mentions ” it’s easier to increase charges to meet a contract with a private operator than by voting in local or national government, and private financiers might regard income from users as a less risky source of revenue.”

Better Management Skills

As private financers are more capable for management in business in various fields, the government believes that the private sector has a better role to offer project management skills, innovative design and facility and risk management. (Carrillo at el., 2008) Spackman (2002) stresses that the monitoring pressures on contractors from private sectors may be stronger than those from the public sector which is leading to a quality work.

Long Term Contract

In PFI, contractors are tied into a long-term commitment, so that it reduces that a contractor can walk away during the project if no sufficient funding is in place. Even though contracts might restrict this from happening, but it is difficult to design and impose broad articles and clauses in the contract for a long contractual period. (Spackman, 2002)

Risk Transfer

Risk transfer is also an important element for delivering a good PFI project. Carrillo at el. (2008) claim that PFI will reduce the risk level carried by the government and transfer it to the contractors. Grimsey and Lewis (2005, pp.345-378) concludes that “The transferred risk is often a key determinant of value for money in PPPs, and one that may need to be updated as negotiations processed, to allow for variations in risk allocation.” Apart from public procurement cost risk, there are also other risks such as site use, site operation and access, building standards, operations and management, financial conditions, maintenances and services, residual value and revenue etc. (Grimsey and Lewis, 2005) Those risks can all be considered and transferred to private side. In UK, there is a long list of samples for public funded projects being delayed or finished with over budget. Such risks being transferred from public sector to private sector through a PPP route is considered to be adding value for money for public project, as private sector will solely manage the project cost, time and quality. (Grimsey and Lewis, 2005)

Less Construction Time

PFI is considered to be one of the procurements which can deliver project under or on time. MacDonald, 2002 (in Grimsey and Lewis, 2005) reviewed 50 large UK public procurement projects in the past 20 years, and found 11 were using PFI/PPP, average of which were completed under-time. HM Treasury, 2003b (in Grimsey and Lewis, 2005) reviewed 61 PFI projects, 89 percent of which were completed under or on time. Compared with traditional procured projects, 30 percent of which delivered on time, PFI projects could be completed on time with a 76 percent. (UK National Audit Office, 2003, in Grimsey and Lewis, 2005)

Delivery against Budget

PFI is also considered to be one of the procurements which can deliver project under or on budget. HM Treasury, 2003b (in Grimsey and Lewis, 2005) reviewed 61 PFI projects, all of which were all finished within the budget. Compared with traditional procured projects finished with 27 percent on budget, PFI projects completed on budget with a 78 percent. (UK National Audit Office, 2003, in Grimsey and Lewis, 2005)

Innovation Approach

PFI schemes allow the private bidders to explore their appetite to develop creational and unique projects which can also meet the required standards from the government. (Bing and Akintoye, 2003) When the project is under the ownership of public sector, renegotiation between the private financiers and the public clients must be carried out before the innovation is applied. However, when the project is the ownership of private sector, following government’s specifications, private financiers has own power and freedom to implement an innovative approach to meet its own requirements. (Bennett and Iossa, 2006)

Disadvantages

Time Taking

Research shows that most suppliers complain that during the procurement, the PFI process takes too long for management decisions. (Spackman, 2002) Li (in Bing et al., 2005a, pp.25-35) claims that the most negative factor associated with PFI/PPP procurement is “a lot of management time spent in the contract transaction, length delays in negotiation and high participation cost”. Furthermore, Carrillo at el. (2008, pp.138-145) state that PFI projects are complex than traditional procurement taking longer lead-in time before the start of the construction. It also adds “It is unsustainable for a private company to have staff involved on a project for a 5 years period without a positive outcome”.

Risk Allocation

It is an advantage for public sector that their risks during PFI have been allocated away to private sections. However, it would be a shortcoming for private bidders to carry the risks somehow. OGC (2007, p.10) indicates that: “construction projects are undertaken by the private sector, which are incentivised by having private finance at risk.”

High Cost

According to research from Bing et al. (2005b), PPP/PFI procurement has problems such as high tender cost, complicated negotiation, innovation cost restrains and conflicting in objectives between stakeholders. Carrillo at el. (2008) also find complain from both of client and contractors that the costs for the bidding, design and construction are higher than the traditional procurements.

Lack of Expertise

There are still many public professionals not experienced with PFI as it is so complex to cope with. Carrillo at el. (2008) indicates that lack of expertise in public sector in terms of experience is one of the issues for PFI process. It adds further that the lack of expertise has negative impacts on the PFI projects, and the local authorities who are limited with the experience are also struggling to keep up the private partners, which influences the partnering development.

Government Influence

The government is somehow bombarded that it is trying to show positive sides of PFI as much as it can in order to encourage implementation of PFI. The research and studies carried out so far by the government have been using a limited amount of projects with certain focus. It is recommended to call for more independent and third party studies for a wide range of project research and collect feedback from the clients in all types of projects to analysis the PFI performance. (Carrillo at el., 2008)

Procurement Comparison

In order to procure the project of residential development for Wulfruna University in UK, PFI and Design and Build are taken into account for the project procurement. Comparison and analysis are carried out as following.

Design & Build

Design & Build is one of the popular procurement methods implemented in the construction industry. Since April 2000, D&B has been nominated as one of the procurement recommendations along with PFI and Prime Contracting by the government body. (OGC, 2007) The basic principle of D&B procurement is, as fig.1 shown, the client sets up the requirements and standards, and then forwards them to the D&B contractor for the delivery of the work. There is always possible option for client to consult other design professionals for initial innovations and design concepts. Once, the client is contracted with the D&B contractor, its responsibility of design involvement is totally reduced. Risks shifts to the D&B project team, consisting of designers, suppliers and subcontractors, who will take full responsibility to carry out the design and construction of the projects. (OGC, 2007)

Brief Analysis

With the intention of analysis the brief, following key points have been indentified:

1. Existing 12,500 students with 800 hall of residence and 450 on proposal
2. Existing 65% males and 60% full timers
3. Proposed 450 bed hall of residence
4. Proposed building with comprised different types of accommodation
5. Proposed building with a modern standard
6. Proposed building to hire out to tourists or public members during holidays

Analysis:

1. The current student number is 12, 500, and full time student is about 7,500. But the number of the halls is only 1,250 (including the one on proposal). This figure is only about 16.7% of the current full time student number, if 1,2500 rooms are all counted as single units. There is a possibility of future development of more student halls of residence.
2. If current full time student number is about 7,500 who need student accommodation, there could be about 4,875 male students. It is common that the maintenance and cleaning for the rooms rented out for male students are more likely harder and difficult than the ones for female students. So that the proposed building should be quality ensured with good maintenance scheme in place.
3. 450 bed hall of residence with modern standard and mixed types of rooms could increase the project cost, and it is likely to over the £20m limit. Such a number of student’s accommodation also needs a good management and administration.
4. The requirement of different types of accommodation might involve variation during design stage of the project.
5. A modern standard might involve client into the design for its appetite of innovation approach and standard.
6. Renting out tourists and other public members could increase extra income for the owner. Good management and operation are required from experience management firms to provide professional services.

PFI versus Design & Build

Project Time

It is clearly indentified in the previous section that the majority of PFI project delivered under or on time. D&B comes with 2 options for competing projects normally. One is fixed price project; therefore, the project will be delivered definitely within the budget or no extra costs for the clients if it’s over. But the time of the project is uncertain. The other option is fixed time project, which can guarantee the project time, but the cost of the work could be more than what clients expects. Therefore, in terms of project time, both PFI and D&B are all suitable for the project.

Project Cost

PFI is considered to be cost efficient delivery, and it always meets the budget or even under the budget. But it may cost more for the bidding cost for the contractors. D&B can apply fixed price option so that both procurement methods can meet the requirement of cost even though the cost requirement is not clear in this brief. However, and again, the time will not be guaranteed.

Project Quality

Due to PFI is involved a long term contract for the contractor and private financiers, it guarantee the quality and maintenance of the project. However, D&B is somehow has more chance to deliver a less quality work depending on the morale and motivation of the contractor, contractor might reduce the quality of the work in terms of material or skilled labour etc to save a profit for its own. According to the analysis b, PFI is more favourable for the quality work in this project.

Client’s Involvement

When the private financier claims the ownership, involvement of design is more likely to happen in order to input innovation approach to achieve the appetite of financier’s own. Therefore variation is allowed to occur within the PFI. However, D&B contractor process the project from design to construction, there is not involvement for the client. Any variation for the project will lead an extra fee to be implemented by the contractor. According to the brief analysis d and e, PFI is definitely better for D&B in this case.

Risk Allocation

In PFI, risks will be transferred to the private financier for the development. In D&B, client only have a single contractual link with the contractor, shown as in fig. 1. The risk the client carried is little and passes most of it to the contractor.

Project Nature

PFI procurement is suitable for complex project, in which the project cost is more than £20m according to the introduction from OGC. D&B, however, is also suitable for the complex project. As in the brief analysis c, it indicates complex types of accommodation requirement, both PFI and D&B can procure this project.

Partnering Approach

It is no doubt that PFI is the only one procurement which required partnering for project compared with D&B. Good partnering can lead to exchange of learning, knowledge sharing and improvement of delivery. In the brief analysis a, there is a potential development of student halls in the future if the number of students keeps increasing. Good partnering and relationship are the keys for quality delivery. PFI is then better than D&B to be selected.

Management Operation & Maintenance

PFI is a long term contractual practice which involves design, construction, management, operation and maintenance for a period of 20 to 30 years. Private sector sometimes has better management skills than public sector. Analysis f stresses the need of good Management and Operation, and also analysis b again claims the importance of maintenance. PFI, therefore, is once again the only option for this requirement contrasted with D&B

Selection Recommendation

According to HM Treasury’s Central Unit on Purchasing, 1992 (in Masterman, J.W.E., 2002), selection of an appropriate procurement method can be achieved following the following steps:

• Review of contract strategy
• Analysis
• Options
• Selection of best strategy
• Implementation

The document suggests clients or project managers to score how each procurement method meet the requirement of the objectives in various aspects, in which way the evaluation of the procurement is carried out. (Masterman, J.W.E., 2002) As fig. 2 shown, each standard criterion has its own requirement’s relative weighting range from 1 to 4. A satisfaction score range from 1 to10 should then be given to the procurement matching with the standard criteria. After the scoring, a calculation should be done by using the procurement score on one of the criteria multiplied by the weighing for the matched criteria. Then add up all the results to get a total score. For instance, in fig. 2, the underlined figures show the timing weighing for the project and traditional procurement’s score on this aspect for the project, so it should be calculated as: 4 X 4 = 16, and 16 is the total score for the traditional procurement’s performance on timing. Then add the rest scores for variation, project nature etc. The more the score is, the more suitable the procurement will be.

It is recommended that the client, the Wulfruna University, should firstly analysis and identify the importance of each objective for the entire project, and provide the scale weighing on the object criteria according to the importance level. Then follow the sample shown above to list common procurement methods and give a score to each one. In the end, to choose the most scored procurement for the student hall of residence project. However, there are also other types of selection, but the main principles are all similar to each other.

Conclusion

In this report, it has reviewed PFI procurement. The review has recognized PFI can provide quality project within the time and budget scale, freedom of innovation, long term relationship, risk transfer from public sector to private sector etc, but has also underlined some drawbacks such as long decision making, high bid cost and lack of experience for both side etc. Meanwhile, it has compared two chosen procurement types PFI and Design & Build, both of which are recommended by the government body. According to the brief analysis, it has listed some key points and requirements for the projects and comparison against each requirement between PFI and D&B are carried out. It is clearly that PFI can provide more to meet the requirement of the project brief. Furthermore, a recommendation for procurement selection is also provided with an example of how the procurement is selected is also presented. The recommendation stressed the importance of the analysis and identification of important requirement of the objectives and standards for the project.

References

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