Public Private Partnerships Analysis Construction Essay

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Public-Private-Partnership (PPP) is long term contractual arrangements between public and private sector bodies for provision of public infrastructure facilities. This arrangement involves private investment to design, construct, operate, and maintain an infrastructure project for the use of community on behalf of public sector entity. Private sector should be able to collect revenue from the project within specified period of contractual time to recapture its investment and turning a profit on that as well. This type of partnerships are collaboration in broadest sense where public and private sector work together and share all kind of risks and rewards in delivering infrastructure services.

The main attraction for which governments desire to enter into PPP arrangements is reducing public debts and sharing financial and project risks and rewards between public and private sectors. Also, for the state, the major benefit is that part of heavy financial burden of investing in infrastructure is borne by the private sector. While privatizations are take-over of a publicly owned entity, PPPs are much like mergers where both public and private sector enjoy sharing the project risks and benefits.

PPPs are expected to be more efficient due to private involvement because they are considered to be in better capacity to run certain concerns than state. Also, they are likely to reduce the burden of subsidies by charging actual cost of services from the consumer. Other advantage for governments is that their resources can be available for the provision of other important projects of socio-economic uplift and standard of living improvement.

This idea of public and private sector entering into partnership is not new and many names and terminologies (BOT, BOOT, DBOT, PFI, PPP etc.) have been used for the same policy of providing public services and infrastructure facilities which had formerly been delivered by public sector alone. "In the UK the Private Finance Initiative (PFI) has offered a solution to the problem of securing the necessary investment at a time of severe public expenditure restraint" (Akintola et al, 2003).

In Public Private Partnerships, public sector is looking for private sector's skills and innovations in delivering the project and their expertise in managing the risks at minimum cost. The private sector is more interested in business opportunities,

availability of funds and generating revenues on its investment. The success of partnership lies in running a good and long term relationship in which each party recognize the objectives of other and of the project and manage the risks in pursuit of achieving these objectives.

"The trend of private provision of infrastructure has been strengthened because of the change in thinking and practices on these matters. There has been the perception that a move from 'taxpayer pays' to 'user pays' (i.e. from the ability-to-pay to benefit principle) in the provision of infrastructure services is likely to be associated with a better economic use of the services" (Grimsy & Lewis; 2000).

3.2 Conventional procurement

The public sector conventional procurement for the delivery of public services has generally been constituted by input-based specifications which involve funding from public sector. Such projects involve short-term contracts in which the contract structures are arranged in a way to fit certain definite circumstances. For the delivery of complex and large infrastructure projects, different approaches are used by combining different elements. Pricing of conventional procurement is characterized in different ways, e.g. fixed price, target-cost price, and guaranteed maximum price etc (HM Treasury; 2008).

The approaches for conventional procurement include (HM Treasury; 2008):

For building an asset or building, first the public sector procures the design and then arranges another procurement to build the asset by hiring the contractor. The price of work is usually fixed and is decided by a contracting authority. Finally the risks of cost over run and delay due to the change order or any other factor is retained with public sector. After the due delivery of project, usually limited contractual arrangements are considered at maintenance and operation phase.

Generally a design and build (DB) type of contract is adopted in which the provision of both design and construction of project is through one integrated project team. In such arrangements, the risk of late delivery might be transferred to the contractor.

3.3 Key Features of PPP

PPP exhibits the following key features:

A collaborative arrangement in which public and private sector work together to deliver infrastructure services. This collaboration can be through a contractual arrangement or a joint venture which may also include the operation and maintenance of the infrastructure assets and delivering the associated services;

Risks are allocated between the parties on the basis of which party is best able to manage the risk at the least cost while benefiting both the parties in partnership;

Generally PPPs are considered long term (25-30 years) contractual arrangements between the parties but they can be short term, e.g when maintenance and delivery of associated services of the infrastructure assets are excluded;

During the life of contractual arrangement, the public sector may pay the private sector for using complete or a part of the infrastructure facility when the operation and maintenance and delivery of associated services are also included in the contractual arrangement;

While ensuring the required level of delivering the services or the obligations agreed in the arrangement, payment to the private sector is to be made in a way to reward the sector;

Usually the authority arranging PPP, is responsible for the payments but they can be generated through end user e.g. in the form of toll for using a toll road;

The public sector is looking for value for money by utilizing private sector management and expertise;

Financing of the projects is often through private sector either in part or in full;

Governments more focus in policy delivery and monitoring the projects instead of delivering the services, in a PPP arrangement.

3.4 PPP Contract Types

Stakeholders' change in attitude to bear the project risks reflect in bringing more innovative ways for entering into PPP for infrastructure. These innovative modalities of PPP, give different preferences to control and own a project. This is how more complex modes of PPP come into practice, such as:

3.4.1 Service Contracts

Simplest of all, service contracts are not technically considered core form of PPP because of little risk transfer. This is a short term contract of public owned enterprise with private sector to perform some specified level of operational tasks. These types of contracts are commonly available in road and health sector and typically last for 1-3 years.

3.4.2 Management Contracts

This is a short-to-medium term contract, usually for 3-5 years long period, and covers performing certain operational tasks along with some management tasks. Operational risk still remains with government but if it's a shared risk then it will accompany a profit-sharing incentive as well. Such type of contracts may be followed by further private sector involvement in project. Private party does not involve in major project investments but contributes working capital.

3.4.3 Leases

In this type of contract private sector Leases government owned asset and pays a fee for a fixed period of time. This is similar to management contract in a way that operational risk is shifted to private sector and they generate income by using that asset. And during that lease period, private sector is also not necessarily responsible for significant investments in that asset.

3.4.4 DBO, BOT, BOO and DBFO

BOT is the type of PPP in which private sector build, operate and then transfer the asset to public authority after certain contractual time period. BOO refers to type of PPP in which private sector builds, operate and owns the asset after the end of contractual period. Both of these type of contracts involve heavy investments by private party. Duration of contract period is usually longer, often 20-30 years because private sector has to generate revenue for a return on investment. Design build operate (DBO) and Design Build Finance Operate (DBFO) are also such type

of contracts in which private sector does not retain ownership at the end of contractual period.

3.4.5 Concessions

Concessions are such type of PPP contracts in which private sector generate revenue by charging public consumer as user charges e.g. toll tax instead of having government as a buyer. Demand risk is transferred to private operator. These are considered to be the most complex form of PPP contract. Such type of arrangements may involve new investments or as a franchise PPP, extension to existing state-owned assets. Contract duration is usually considered to be 20-30 years.

3.5 Advantages and Disadvantages of PPP Arrangement

Advantages

Disadvantages

Government resources can be freed for other important socio-economic works in society and it will be able to focus more on its core competencies instead of involving its resources in unfamiliar projects.

Although PPP is perceived to provide public infrastructure at low cost, there is still a concept that many additional facilities are still beyond the public 'purse' (Kumaraswamy and Zhang, 2001).

According to Li and Akintoye (2003), PPP can be beneficial in reducing life cycle costs of a project as the capital is extended to the whole life of a project which guarantees the expected return on that investment.

Kumaraswamy and Zhang (2001) discussed about different BOT type projects that faced many problems due to different factors such as project cost overrun, unrealistic price and future income projects and legal disputes between public and private sector. In reality, the cost failure in all such cases had to be borne by government or the public sector and not the private operator. In the light of findings in this research, this has become crucial to focus on public point of view about the failure of PPP performance.

With the participation of private sector, government resources can be utilized with more productivity in providing public services with improved quality (Edkins and Smyth, 2006).

The PPP approach to deliver public services may not be implicit or well received by the government authorities that handle it. That is why sometime government agencies are reluctant to deliver/finance public facilities using this innovative approach (Tang, L et al, 2009).

More adequate delivery of public services can be done with the efficient and proper usage of private sector's expertise, innovation and technology (Shen et al., 2006).

While there is successful infrastructure delivery through PPP, public has to bear additional taxes for that utility also.

Another major advantage is sharing of risks between public and private sectors can be done at different levels of a project completion (Shen et al., 2006).

While PPP always need special legislations, it is mentioned by the practitioners that political influence hinders the way of using PPPs (Algarni et al., 2007).

Private sector brings commercial handling of the public project that radically reduces the risks of delay and cost overrun (Li and Akintoye, 2003; Ho, 2006).

3.6 Risk Allocation

The contract is the medium that defines the roles and responsibilities of stakeholders and allocates the project risks. The optimal risk allocation aims at minimizing the total cost of a risk that need not be the cost borne by each party separately. This not only affects the total project cost, but also the quality and time for the completion of the project and the potential for disputes between the participating parties. Once the risks are carefully understood and their impact has been measured, decisions can be made to allocate them in a way to reduce the costs. For a more clear and knowledgeable understanding of project risks, risk identification, their assessment and analysis and the mitigation measures need to be determined at the earlier stage of a project in order to achieve project goals. The objectives of risk allocation process are in line with the project goal and follow the two basic principles (FHWA; 2006):

Allocate the risks to the party best able to manage them.

Allocate/share the risks in alignment with the project goals.

I. Allocate the Risks to the Party Best Able to Manage Them

A fundamental principle of risk management is to allocate the risks to the party best able to manage them. That party must be in best capacity to evaluate and control the risk at the least cost which will result in reducing the overall cost of project.

Inappropriate transfer of risk may lead to mistrust and disputes. If the risks are left to be borne by only private sector, reputable enterprises might avoid entering into a PPP or may ask very high price. On the other hand, if only public sector has to bear all the risks, the advantage of private participation will be gone.

II. Risk Allocation in Alignment with Project Objectives

It is necessary to clearly understand the project objectives in order to allocate the project risks effectively. Risk allocation is to be done in a manner that enhances project profitability. Therefore, the project objectives must be communicated with clarity to the contractor, consultant or the designing body. Prioritizing the project objectives is essential and a difficult process in case of complex, large infrastructure project.

In order to share the risks, the process is actually defining the point when the risk is to be transferred from one party to another following the same fundamental principle of risk allocation. Risk sharing should also be kept in alignment with project objectives. Also, the project stakeholders should be in alignment with the project objectives and must be in well communication in order to share the risks effectively.

3.6.1 Risk Management and Allocation Matrix

The aim of risk management is to achieve the project objectives. The mitigation measures include strategies to reduce the risk to an acceptable level in order to achieve the objectives and also to achieve the control over that risk. The strategy may change with the change of risk. So the target is always achieving the objectives and not the risks.

Generally a risk allocation table or matrix is used as a template in the contract provisions and is anticipated as a communication tool throughout the project life cycle for risk management. The list of project risks is complied in that matrix or table and risks are allocated to the party best able to manage along with the direction how to manage.

The party bearing the risk must be ready to bear the financial burden in managing that risk as well. The estimated cost to complete a project including the cost of unforeseen events can be determined using quantitative risk assessment techniques. The total cost of the project can be reduced for all parties entering into a PPP can be reduced by proper allocation of project risks.

3.7 Factors Influencing Risk Allocation Process

Factors influencing the process of risk allocation include:

Legal and regulatory environment of the host government

Status and structure of local financial market

Financial, institutional and technical capabilities of host government

Availability of information for conducting due diligence undertakings

Tendering process

Risk profile of the sector and project in question.

3.8 Previous Research into Risk Allocation

Research on risks related to PPP projects can be very helpful in managing them. The management process can be categorized as: risk identification, risk analysis and evaluation, and mitigation strategies. To improve mitigation strategies, it is very important to carefully identify the risk areas and analysing them properly. Research has been conducted to identify key risk areas and their possible affects on projects mainly through questionnaire surveys. Also to study the perception of client, contractor and financing institutions about these risk areas case studies of individual projects have been carried out. Risk factors affecting different stages of an individual project, have also been analysed to investigate their affects on different phases of procurement.

But there is still need of more comprehensive study to investigate the affect of country specific risks on an individual project success or failure and how do these risks trigger risks specific to a project. Also, there is need to investigate how effectively mitigation measures have been taken out to handle these risks with regard to individual country political, economical and social culture perspectives. No actual work has been done in developing countries in exploring the nature of public sector works and risks associated to them and how effectively they can be managed using PPP.

Below is an overview of previous research into risk allocation mostly in developed and some of the developing countries. Risk allocation has been done through questionnaire surveys or project case studies.

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