The Rational for the Implementation of the Private Finance
The Private Finance Initiative (PFI) is the name given to the policies announced by the Chancellor of the Exchequer in the autumn of statement 1992 with the aim of achieving closer partnerships between the public and private sectors. It utilises private sector competition to reduce the cost of delivering public service and improve the quality of service delivery.
It was one of a range of policies introduced by the Conservative Government to increase the involvement of the private sector in the provision of public services.
PFI entails transferring the risks associated with public service projects to the private sector in part or in full. Where a private sector contractor is judged best able to deal with risk, e.g. construction risk, then these responsibilities will be transferred to the private contractor. Where the private sector is deemed less able to manage the project’s risks, some of the responsibility will remain within the public sector. The main reason behind the push for more PFI type projects is that it delivers value for money (VfM), where VfM is the optimum combination of whole life cost and quality to meet the user’s requirement, and does not always mean choosing the lowest cost bid.
The introduction of PFI within the UK has meant that more capital projects have been undertaken for a given level of public expenditure and public service capital projects have been brought on stream earlier. As at the 1st December 2004 there has been almost 758 PFI deals signed with a total capital value more than ï¿½61.5
billion. This increased level of activity will be paid for by higher public expenditure in the future, as the stream of payments to the private sector grows. PFI projects signed to date have committed the Government to a stream of revenue payments to private sector contractors between 2000/01 and 2025/26 of almost ï¿½100 billion.
First and foremost the authors would like to thank the members of staff of Sheffield Hallam University School of Development and Society, and in particular Dr. Paul Stephenson, for their constant guidance throughout this project.
Finally the authors would like to thank all those who took the time out to participate in the survey and allowed us accesses to their places of business.
CSF Critical Success Factor
CIOB Chartered Institute of Building
DBFO Design Building Financing and Operation
FIPA Farquharson Institute of Public Affairs
GDP Gross Domestic Product
GOJ Government of Jamaica
ICE Institution of Civil Engineer
IMF International Monetary Fund
KM knowledge management
NAO National Audit Office
NLF National Loans Fund
NHS National Health Service
NROCC National Road Operating and Constructing Company
OBC Outline Business Case
OCG Office of Government Commerce
ODPM Office of the Deputy Prime Minister
PFI Private Finance Initiative
PPP Public Private Partnerships
PSC Public Sector Comparator
RICS Royal Institution of Chartered Surveyors
SPC Special Purpose Company
TJH Trans Jamaican Highway
VfM Value for Money
List of Figures
Figure 1: Methodological Model 11
Figure 2: Triangulation 19
Figure 3: Timing of payments under the PFI & conventional procurement 28
Figure 4: Attractions of PFI 32
Figure 5: Tender cost as a percentage of project cost 33
Figure 6: Typical PFI Structure 34
Figure 7: contractual arrangements 35
Figure 8: Business Case Guide 47
Figure 9: Quality of service and public sector borrowing 57
Figure 10: Private sector competition and VfM 58
Figure 11: Procurement and bidding cost 59
Figure 12: Balance of risk 60
Figure 13: The future of PFI 61
Figure 14: Value for money 65
Figure 15: Benefits to clients and contractors 66
This research examines the rational for the implementation of the Private Finance Initiative (PFI) in the United Kingdom (UK) as it relates to time, cost and quality. PFI refers to a strictly services defined legal contract for involving private companies in the provision of public services (Fryer 2004, p.229), which were traditionally provided by Government e.g. schools, prison, hospitals, etc.
Another feature of PFI is the transferring of risks associated with public service projects to the private sector in part or in full. Where a private sector contractor is judged best able to deal with risk, such as construction risk, then these responsibilities are transferred to the private sector contractor.
The authors specifically chose this area of study based upon past experience and primarily to further enhance their understanding of the concept as PFI was only introduced in their home country (Jamaica), three years ago.
The scheme when introduced was widely criticized by media practitioners and members of the Opposition party. Their main criticism was that PFI would not give value for money and the private sector should not be involved in the devilry of public service. This came about largely because of the misunderstanding of the concept and benefits if any to the public. This is also the case in the UK, though the criticism might not be the same, PIF is constantly under the micro scope.
A common argument generally put forward against the UK’s PFI, is the claim that it does not give value for money. The research work presented here is aimed at examining the rational for the implementation of PFI. This research will establish the views of the various stakeholders in a PFI project as it relates to time, cost and quality. However, due to the long length of PFI contracts it will be a number of years before a complete analysis is possible and the true picture painted.
It is the authors’ intention to investigate within the time constraint and to further enhance their appreciation of PFI as an alternative procurement route in order to achieve best value.
1.1.1 Rational for selected Topic
The basic theory is that public institution should wherever possible have their new infrastructure investment funded and to some extent managed by the private sector. The principle being that the government does not have to increase its public sector borrowing requirement. This can be very beneficial to third world countries if managed appropriately, that are deeply in debited to organisations such as the World Bank and International Monetary Fund (IMF)
PFI could become the new vehicle for Third World countries to improve their infrastructure and provide badly needed public services without having to go through the traditional methods of borrowing form multinational agencies mentioned above.
1.2 Research Aims and Objectives
The general aim of this research is to examine the rational for the implementation of the Private Finance Initiative (PFI) in the United Kingdom (UK) as it relates to time, cost and quality. Listed below are the aims and objective of the study.
1. The rationale for the development of PFI
2. The perceived views of the parties involve
1. Establish the views of client as it relates to value for money (VfM).
2. Establish the views of contractors in relation to time, cost and quality.
3. The perceived benefits of PFI
4. Examine the critical success factor for PFI implementation
The above aims and objectives will be achieved using the methodological model presented in figure one and shows the specific data collection technique that will be employed.
Figure 1: Methodological Model
1.3 Structure of the Research
Chapter two describes the research methodology used in this research. Chapters three presents a review of current literature on PFI, outlining the history and background of PFI and also examine the rational for its implementation and justification. Chapters 4 and 5 examine the procurement process and the critical
success factors for the implementation of PFI. Chapters 6 and 7 present the analysis of results from questionnaires and interviews and the conclusion and recommendations, followed by a list of references, a bibliography, and an appendix consisting a list of relevant documents.
This chapter outlines the authors rational for undertaking this research topic and the methodology used to collect information relevant to the topic. It also satisfies the reader curiosity as to the methods and the source from which the information was gathered to meet the aims and objectives of this project.
This research employs both quantitative and qualitative techniques to investigate the rational for the implementation of the PFI. The first part of this study was conducted via a literature review.
The second part of the study involved the collection and analysis of qualitative data through document reviews and interviews, to seek additional support for the findings of the quantitative data analysis (questionnaires) and to identify additional factors that were not discovered in the quantitative section.
This chapter provides an overview of the approach employed to research methodology selection and describes the above-mentioned studies that are utilized to address the research question.
2.1.1 Quantitative and Qualitative Research
Quantitative and qualitative methods are widely used to carry out the different research; both methods provide a balanced and in-depth analysis of the chosen topic. Quantitative research involves the researcher collecting adequate numerical data in order to apply a statistical analysis.
Creswell (1994), cited Naoum (1998, p.38) definition;
“Quantitative research is ‘objective’ in nature. It is defined as an inquiry into a social or human problem, based on testing a hypothesis or a theory composed of variables, measured with numbers, and analyzed with statistical procedures in order to determine whether the hypothesis or theory hold true.”
Qualitative research involves the researcher collecting a sufficient base of material to enable observation, description and review to take place. Qualitative data is open to interpretation enabling comparisons and arguments to be formed. In comparison Naoum (1998, p.40) states;
“Qualitative research is ‘subjective’ in nature. It emphasizes meanings, experiences [often verbally described], and description and so on.”
PFI procurement route was only introduced in 1992; hence the collection of quantitative research on PFI was not easily obtained, owing to the long Project Life Cycle (PLC) of PFI projects. As a result qualitative research methods were mainly used in meeting the aims and objectives of this research.
2.2 Primary and Secondary Data Collection
Naoum (1999, p.44) states: “there are two approaches to data collection, namely fieldwork [primary data collection] and desk study [secondary data collection].”
Primary data is gathered form questionnaires and interviews while Secondary data is data collected from previous work in the subject area, such as textbooks and journals.
A combination of primary and secondary research methods was adopted in order to meet the aims and objectives. The methodology model (see figure one) shows how the data collection methods was used to meet the aims and objectives of this project.
The information will be gathered through the following research methods.
1. Literature review
2. Questionnaire and
3. Personal interview
2.2.1 Literature Review
A literature review is the complication and assimilation of as much information as can be discovered with respect to a given topic (Holt 1998, p.80) i.e. material published on the topic by news papers, journals, accredited scholars and government bodies, will be gathered through a desktop study. This will give the researcher a wider spectrum of knowledge about the topic being research.
The disadvantages of using this method are: author’s review skills, author’s bias and the time constraint in collecting the data. This problem can be minimised by ‘thinning’ i.e. researching and analysing material from a wide spectrum (Naoum, 1998).
A literature review whatever the scale will necessitate reading what has been written on the subject and gathering it together in a critical review which demonstrates some awareness of the current state of knowledge on the subject (Gill and Johnson 1991, p.21). This would be carried out through a desktop study looking mainly at journals and conference papers as they will be most likely to address the authors concerns and would be keeping in line with the latest developments on information systems in construction. Such articles will include publications from bodies such as the Chartered Institute of Building (CIOB), Royal Institution of Chartered Surveyors (RICS), Institution of Civil Engineers (ICE) etc. as these are very reputable sources within the construction industry.
The authors are aware that this topic has already been researched and conclusions reached. However as Marshall and Rossman (0000, p.0) argues, their may be gaps that needs to be filled within existing literature.
Generally, a desktop study (secondary data) was used to collect the most of the information because of the time constraint.
2.2.2 Postal Questionnaires
Postal questionnaires are one of the most reliable research methods because it is easy for the researcher to standardize questions. Questionnaires also add external validity to the literature review (Hall and Hall 1996, p.43).
A combination of open and closed questions were asked, the length of the questionnaire was kept as short as possible with precise instruction to the respondent (see appendix ‘A’ copy of questionnaire). This was a good way to gain access to important company individuals who had very valuable information to share with the authors. A total of (20) organisations where targeted; government and private alike with the latter including cost consultants, contractors and clients. The researchers chose this wide spectrum of individual organisations to avoid bias in the research. All the organisations targeted have specialist PFI teams serving as managers and consultants that possess the general technical competence and experience required to manage a PFI project.
A total of (12) respondent replied to the questionnaire. This was enough to maintain the validity and reliability of the research and represents a 65% rate of return. Stephenson (2005) states that “…research is reliable if the rate of response is over 20%…”
2.2.3 Personal Interview
Interviews like questionnaires are a form of quantitative surveying technique (Gummesson 2000, p.35). Interviews can either be structured or unstructured
The disadvantage with this form of research includes the author inexperience interviewing techniques, time limitation and restricted travel resources and the willingness of relevant interviewers.
After collecting preliminary data, the authors conducted semi-structured interviews with key informants. Although the primary focus of this study was project participants, it was necessary to interview knowledgeable individuals on the subject to get their views on the rational for implementing PFI.
All the informants interviewed in this study were chosen on the basis of their willingness to participate in the research and geographical location within the city limits in an effort to minimize costs. A total of four (4) persons were interviewed from the following (3) different types of organizations; educational, health and transport. The authors considered these individuals to be secondary stakeholders. Turner and Simister (1994, p.166) defines stakeholders as, “anybody having an interest in the outcome of a project and not just constrain to those having a financial interest.”
Triangulation is the use of several research methods to examine the same problem as it would balance the weakness of one method on the strengths of the others (Hall & Hall 1996, pp.44-71). Therefore it would be appropriate to use triangulation to validate this research and to narrow any gaps or limitations that may exist in present literature see figure two.
Source adapted from: Gill and Johnson (1991)
Figure 2: Triangulation
This chapter outlines the research methodology used by the authors in the writing of this research. It also satisfies the readers’ curiosity as to the methods and the source from which information was gathered to meet the aims and objectives of the study.
PFI is a fundamental change to the way government in the United Kingdom has hitherto produced much of its capital expenditure, especially in the field of transport, health and prisons spending (Simon 1999). It is generally accepted by major political parties in the UK, as a means of procurement. PFI utilises private sector competition to reduce the cost of delivering public services and improve the quality of service delivered; essential PFI substitute private management expertise and funding for those of the public sector that provide services.
This chapter outlines the origin and rationale for the implementation of PFI and outline details concerning the set up and financing of PFI project.
3.1.1 The History of the PFI
The Private Finance Initiative (PFI) was introduced by Chancellor of the Exchequer Norman Lamont (now Lord) in 1992 against the backdrop of privatisation promoted by the Thatcher government of the 1980s.
It’s an innovative means of financing social infrastructure by inducing private capital to invest in infrastructure projects such as hospital, schools, roads and housing. However during this period (1992) the UK economy was in recession; that part of the trade cycle characterized by falling levels of demand, very little
investment, low business confidence and rising levels of unemployment Marcouse and Martin (2000, p.240).
PFI was brought in when government borrowing was high, the aim being to shift the funding of public buildings and infrastructure onto the private sector so the costs would not appear on the government balance sheet.
As a result investment in public services, such as schools hospitals, and transport was becoming an issue for the government of the day. Hence the introduction of PFI provided a solution to deliver new capital projects using the knowledge and expertise of the private sector.
The history of PFI has been less than smooth. Since its launch in November 1992, the procurement method has been the brunt of many criticisms namely from groups such as UNISON, the trade union for people delivering public services and other commentators.
The scheme got off to a poor start with long hold-ups being suffered at the tendering and government approval stage. This resulted in contractors losing vast sums of money through unnecessary delays.
3.1.2 The Background of PFI
The UK public services have been subjected to long years of under-investment (Anon 0000, p.0) It is under this notion that the Government and other supporters of PFI see it as an important investment for public services.
Research has shown that when the labor Government came to power in 1997 public service buildings and the transport infrastructure were in shambles (Anon 0000, p.0). This has caused public funded investment to expand dramatically.
The nature of a PFI project is generic across all sectors. This led to a number of definitions been formed. However the authors are only concerned with PFI as it relates to construction of social and civil structures. The Royal Institution of Chartered Surveyors (1996, p.7) defines PFI as;
“The Private Finance Initiative (PFI) is the name given to the policies announced by the Chancellor of the Exchequer in the Autumn Statement of 1992. His intention was to bring the private sector into the provision of services and infrastructure which, formerly has always been regarded as primarily public.”
The Construction Industry Council (1998, p.3) also defines PFI as;
“The PFI is a new way of working with those involved in procuring public services and for those delivering the buildings and capital assets that deliver these projects. It is about restoring the link between the design and construction of built assets and their life time cost and performance so that those responsible for providing an asset are also responsible for its long-term operation.”
More recently, the acronym PPP (Public Private Partnerships) has entered the public arena with both Government and private sector endorsement.
This came about as a result of the Bates and Gershon reports; as a direct result of these reports, the Government announced in mid 1999, that it is planning:
“…to create a new private sector led body to help increase and improve investment in the UK’s public services from private sources. Partnerships UK, the new body, will employ City experts to help the public sector get the best deal from the PFI and other forms of public-private partnerships. A new Office of Government Commerce is also being set up as part of a shake up in how Whitehall goes about managing its ï¿½13 billion a year procurement budget. In announcing Partnerships UK (PUK for short and already being referred to as PUKE) the Government says it will not operate as a bank, instead it will be able to provide development funding to get PFI deals off the ground, where existing forms of private finance are not available. In these cases it will, where necessary, provide a range of financial products, tailored to the needs of the public sector bodies in the early stages of the procurement process, which enhance, rather than undermine, existing flows of private finance. PUK will act as a project manager for PFI deals, providing public sector organizations with expert advisory and implementation skills.”
(Turner and Simister 2000, pp.170-171)
The total investment in public services stand at ï¿½23 billion in 1997 and is expected to be much greater (at least ï¿½48 billion) by the end of 2006. PFI is a limited but important part of these increases in investment, making up around 15% of total investment each year. (Anon 0000, p.0)
3.1.3 The Aims and Objective of PFI
The aim of PFI is to provide badly needed social facilities schools, roads and hospitals etc. without the government having to resort to borrowing in order to fund these projects. However this is not always so, as some PFI projects have failed and ended up on the public purse. In recent times, Jarvis a major PFI contractor had to sell its PFI portfolio due to massive debt and falling share prices. In 2002 Jarvis was valued at ï¿½827m; today it’s ï¿½39.2m (UNISON, 2005a).
Despite this and other numerous setbacks beyond the scope of this research, PFI continue to foster greater corporation between the private and public sector (PPP) and perused by consecutive governments in the UK.
3.2 The Case for PFI
There are two major arguments traditionally put forward for the advantages of PFI; both revolve around the belief that private service is often superior (efficient) to public service. The first argument regards PFI as an improved form of government contracting or outsourcing, which under the right circumstances
could yield even greater efficiency savings and ‘VfM’ (Keen and Forrer 2002).
Where VfM is the optimum combination of whole life cost and quality to meet the user’s requirement, and does not always mean choosing the lowest cost bid.
In a report by Arthur Andersen and Enterprise LSE for the OCG ‘Value for Money Drivers in the Private Finance Initiative 2000,’ they identified six key drivers of value for money in PFI:
1) Risk transfer from public sector to private sector including construction and operation costs, technological change, and the long-term fit between a facility and its public purpose.
2) The long-term nature of contracts enables the private investment to be recovered over a reasonably long period and leads to lower costs to government for public services.
3) The use of an output-based service specification; PFI is based on delivery of a certain level of service-the output desired-rather than on the inputs used to provide the service, e.g., the building or other assets involved in producing the output.
4) Competition in the bidding process lowers cost of capital and services over the long-term.
5) Performance measurement and incentives are developed and used as the basis for holding the PFI provider accountable for results and can be used to create financial incentives for superior performance.
Private sector management skills increase operating efficiencies including economies of scale and the delivery of the services requiring skills that are non-core to government.
The second argument is that PFI helps government respond to the need for greater capital spending on public infrastructure in an era when public support for these expenditures can be difficult to sustain (Keen and Forrer, 2002).
This is attractive to the Government, in part because many of the contracts take debt off the Government’s balance sheet. Hiding the true level of debt helps to comply with one of the Treasury’s fiscal rules, not borrowing in excess of 40% of
Gross Domestic Product (GDP), and in conforming to European Union rules on fiscal deficits (UNISON, 2004).
3.2.1 Value for Money
According to the ODPM (2004), there are several ways in which PFI projects can offer better value for money than the traditional option of buying the asset and being responsible for running and maintaining it in terms of risk and efficiencies coupled with good asset management (ODPM, 2004).
However there are some weaknesses in that line of argument been put forward by the various government bodies and other supporters of PFI, namely UNISON. Firstly it is true that PFI transfers majority or the risk involved during construction to the private sector but at what cost. Under standard tendering
procedures a contractor will quote is price based on the level of risk involved, hence the high cost of PFI contracts. UNISON reported that the private sector borrows at higher rates than the public sector since governments can borrow at much lower rates and calculated these costs as adding ï¿½0.2 – ï¿½0.3 million each year for every ï¿½10 million invested (UNISON, 2005).
As it relates to efficiencies and asset management, failed PFI contracts, had been rescued by the public sector meeting additional costs. Whatever the terms of the contract may say, with essential public services it is the government which remains the guarantor of last resort (UNISON, 2005).
3.2.2 PFI v Traditional Procurement
Procuring a new asset under PFI differs form the traditional approach because the local authority enters into a contract for services and not just the facility. Under traditional procurement, the local authority pays for the new facility by using its own resource or borrowed funds approved by central government.
Another key feature of PFI is the amount of initial capital needed to be injected into the project at the initial stages when compared with traditional procurement,
i.e. the public sector does not have to find the money up-front to meet the initial capital costs. But the cash payments thereafter will generally be higher than in an equivalent conventionally-financed project see figure three.
Source: House of Commons, (2002-3)
Figure 3: Timing of payments under the PFI & conventional procurement
In conventional contracts the private sector is paid for the construction of the asset and the public sector makes separate arrangements for the ongoing maintenance and operation of the asset. In PFI contracts the private sector is paid on the basis of the service provided over the lifetime of the contract. The regular unitary charge paid to the contractor is intended to cover the cost of construction, maintenance and operation of the asset (HC, 2002-3).
3.3 Characteristic of a PFI Schemes
Strictly speaking, a PFI projects should be structured to provide incentives for the private sector to perform efficiently and effectively without returning to the public purse for a bailout. However it would appear that the private sector is more profit oriented in its endeavors. This lead Gosling (2003) to remark in the Guardian “Construction companies engaged in the UK’s Private Finance Initiative expect to make between 3 to 10 times as much money as they do on traditional contracts, the industry admitted” (see figure four key attractions of PFI, pg.0).
According to a publication by the Office of the Deputy Prime Minister, ‘Local Government Finance Public Private Partnerships: Private Finance Initiative 2004,’ there are four inter-related principles at the heart of this approach:
* Genuine risk transfer
* Output specification
* Whole life asset performance
* Performance-related reward
3.3.1 Genuine risk transfer
Risks should be allocated between the private and public sectors to the party best able to manage them to ensure best value for money. Typically, PFI projects transfer to the private sector risks relating to the design, building, financing and operation (DBFO) of an asset. This would see the contractor
absorbing any loss encountered due to delays and cost overruns (ODPM, 2004).
However this is not always the case, as the government had been known to bailout PFI project that has fallen into problems and refuse to cancel those that provide substandard services to the public (NAO, 2003).
3.3.2 Output specification
The contracts should specify the service outputs required by the public sector client i.e. how the service is to be delivered. E.g., in the case of a facility open to the public, the level of service required in terms of capacity, hours of service and fitness for purpose (NAO, 2004). Essentially is about defining the type of service and performance standards required this is discussed further in chapter five (section, 5.1.2 p.0).
3.3.3 Whole life asset performance
PFI contracts require the contractor to take responsibility and assume risk for the performance of the asset over the length a specific period usually 25 to 30 years (NAO, 2004). Some PFI supporters will argue that this encourages innovative thinking and good asset management. This may not always be the case as it is likely that the asset delivered under a PFI scheme will last as long as the concession period, hence upon handing over to the government they will be faced with massive refurbishment cost.
3.3.4 Performance-related reward
Payments to the contractor under a PFI contract are characterized as a regular “unitary” fee for services (a periodic payment covering all fees payable under the contract). Payment will be subject to performance in relation to specific and quantified criteria in the contract. These will be derived from the specification of the standard of service required (NAO, 2004). Because of the strict nature of PFI contracts as it relates to the devilry of services, it could be argued that some aspect of a PFI contracts lack a ‘duty of care’ one example cited by Walsh (2005), is that under a PFI contract in the National Health Service (NHS) the ancillary staff will not empty overflowing bins until the prescribed time stated in the contract. This is in light of the fact that the super bug ‘MRSA’ is still present in many hospitals and PFI was supposed to have delivered cleaner hospitals.
Key Attractions of PFI
Source: Serco Group plc (2003)
Figure 4: Attractions of PFI
3.4 High bidding cost
High bidding costs continues to be a major deterrent to PFI contractors and there seems to be no near solution to the problem. A 1996 report from the Adam Smith Institute found average tender costs expressed as a percentage of expected total costs, across projects of all sizes, to be higher for PFI public services projects than for traditionally procured projects, as can be seen in the figure 5 below.
Source: BEC and Sir Michael Latham, Constructing the team (1994)
Figure 5: Tender cost as a percentage of project cost
It is argued that contractors who tender for PFI project bids have to cover higher ‘front-loaded’ costs when drawing up detailed specifications and contract terms than when preparing bids for public service projects under conventionally tendered contracts. This was not surprising to the researchers because of the high level of risk involved. Balfour Beatty reported that it may cost up to ï¿½0.9m before actual construction commence (Balfour Beatty, 2005).
3.5 The Structure of PFI
A PFI project can be structured in many different ways; however there are four key elements: Design, Finance, Build and Operate. Typically a consortium or special purpose company (SPC) will be formed by a construction company and a
facilities management (see figure 6). They will be responsible for designing, constructing and managing the facility. The SPC will fund construction through a mixture of long-term debt raised from banking or privately placed bond.
The SPC will be remunerated, once the facility is available for use, by receipt of regular payments, indexed to inflation, over the 25 or 30 year period to cover operating, maintenance and ancillary service costs.
Source: Serco Group plc (2003)
Figure 6: Typical PFI Structure
With reference to the above figure, the private sector takes on those risks it is best able to manage, design, construction and maintenance. At the centre of the project is the SPC, a concession which has the actual contract with the public authority (see figure 7). This contract specifies the output that is required by the
public authority and the basis of payment for those outputs. Also contained within a PFI contract is a performance regime which outlines how service delivery levels against the public sector’s desired outputs i.e. supported hospital beds, pupil places or prison accommodation. Deductions are also made for poor performance by the private sector or lack of availability.
Source: Serco Group plc (2003)
Figure 7: contractual arrangements
In a publication by HM Treasury (2003), PFI Meeting the Investment Challenges, the process of setting performance measurement and penalty mechanisms in the PFI contract ensures that the private sector delivers the specific outputs the
public sector intends to purchase. It also means the public sector only pays if those services are delivered. For example:
* if an operating theatre in a PFI hospital were unavailable, a deduction would be made from the unitary charge paid to the private sector until that theatre was again in full working order;
* if the pipes in a school burst, flooding it and causing damage to its fabric, the private sector would be responsible for fixing the pipes and returning the school to its proper condition, and in the meantime it would not be paid unitary charges for those parts of the school that were unavailable;
* if there is an electrical fault in an office’s lighting, and the conditions in the office therefore fail to meet the project’s output requirements, then the private sector and in this case typically a specialised facilities management firm that was a part of the private sector consortium would have a set time period to remedy the fault. If it failed to do so, it would incur a financial penalty until the fault was remedied.
(HM Treasury, 2003)
A PFI scheme is expected to ensure that the taxpayer gets a better long-term provision of service in terms of overall cost and quality than the conventional alternatives. Departments will generate a public sector comparator (PSC) before initiating a PFI. This would be based on what the project would cost were the
project to be dealt with using public finance such as a direct Government let (Illidge and Cicmil, 2000).
A public sector comparator is a costing of a conventionally financed project delivering the same outputs as those of the PFI deal under examination. It is just one of a number of ways of evaluating a proposed PFI deal. It is directly relevant only when the publicly financed option on which it is based is a genuine alternative to the PFI deal (HC, 2002-3).
3.5.1 Payment structures
The payment mechanism is at the center of any PFI project, giving financial effect to the allocation of risk between the public sector client and the private sector provider. From the public sector’s perspective the key elements of the payment mechanism are:
* that payments commence only upon the provision of services by the private sector (to incentives timely completion)
* that it is constructed in such a way that the private sector earns payments only to the extent that services are provided which meet the service requirements set out in the contract.
In contrast, the private sector will be keen for payments to be as certain as possible, and will seek to limit the right of the client to make deductions from its anticipated payments as a result of substandard performance.
The Jamaican PFI/PPP Experience
During the 1999 general elections, the then government made a set of promises in their election manifesto. The promise construction of a new super highway was one of the key features of their campaign strategy to further modernise the countries road network. The proposed highway would span some 230-km across the island. This would be the largest civil project the island has ever seen for the last 60 years. This led to numerous questions as to how they plan to finance such a massive project without going to the Jamaican tax payer, hence PFI/PPP was proposed as a possible solution.
4.2 The Scope and Background of Jamaica’s first PFI/PPP Project
Highway 2000, Jamaica’s first PFI/PPP project, is the centrepiece of a multi-year Millennium Projects Programme initiated by the Government of Jamaica (GOJ) announced by Prime Minister P.J. Patterson in September 1999. The main objective of these projects is to upgrade the country’s infrastructure and assist in providing economic opportunities for growth and the creation of jobs.
These Millennium Projects include the establishment of a new Sports complex, a new international airport and the construction of Highway 2000 (NROCC, 2000).
The highway is a four to six lane controlled-access, tolled motorway with fully grade separated interchanges and intersections built according to modern international standards. The Highway connects the capital Kingston with eight other parishes.
4.2.1 Short Listing of Bidders
From a field of seven (7) pre-qualified bidders, three of the world’s largest and most experienced construction companies where short-listed to submit bids for the project. The three finalists were:
* Bouygues of France
* Dragados of Spain
* A Consortium led by LTA Construction Ltd. of South Africa
The discussions with all three company lasted for nearly twelve month with the final decision going to Bouygues of France. During these discussions, the GOJ employed Halcrow Consultants; specialist in planning, design and management for infrastructure development worldwide (Halcrow, 2005).
4.2.2 Key Features of the Project
Apart from being the largest project for the past 60 years, it would also be the first of its kind to be delivered by PFI/PPP; design, build, operate, maintain and transfer under a 35 year concession agreement with the charging of a toll for the
use of the highway. The project has a capital value of US$390 million and was finance by Local Bond issue, guaranteed by GOJ equity and commercial banks (Halcrow, 2005). This debt is paid back from the project cash flow. The government established the National Road Operating and Constructing Company Limited (NROCC), to represent the local authority and Trans Jamaican Highway Limited (TJH) set up by the contractor Bouygues Travaux Publics as the SPC (see figure four). The project is divided into three phases 1A, 1B and 2. Phase 1B is completed while phase 1A is currently under construction.
4.2.3 Public Perception
The scheme was widely criticized by media practitioners and members of the Opposition party. Their main criticism was that PFI/PPP would not give value for money and the private sector should not be involved in the devilry of public service (Anon, 2003). This came about largely to the misunderstanding of the concept and benefits if any to the public and the poor public information campaign. This led the Prime Minister P.J. Patterson, meeting with a government team to examine the issue and propose a solution as to how the situation could be resolved (JIS, 2005). By far, the experience has been parallel with those experienced in the UK. Local pressure groups such as the Farquharson Institute of Public Affairs (FIPA), a non-partisan and non-advocacy body has constantly called on the government to disclose its strategy and halt further development of
the project until a detailed analysis of the process has been done (NROCC, 2002). PIF/PPP is constantly under the microscope.
22.214.171.124 Public Opinion Polls
In opinion polls conducted between April 2001 and April 2002 by Johnson’s Research, Market Research Services and The Stone Team they found that:
* 47% of the adults in Jamaica say they have heard of Highway 2000. Of these, 70% have a favourable opinion of the proposed highway, 19% an unfavourable opinion and 11% don’t know enough about the highway to have an opinion at this time.
* The majority of Jamaicans share the opinion that the Highway 2000 project is a good idea.
* Most persons also consider the new highway to be a priority at this time although the incidence of persons who think so is 30% less than the incidence that believe that the project is a good idea.
* The vast majority of Jamaicans (84%) expect the new highway to bring improvement to the road system generally.
* The most common view among the Jamaican people is that funding for the Highway 2000 project will be provided by the Government, suggesting that there is a fair amount of misinformation among the Jamaican people about the funding of the project.
The authors are keen to point out that these polls where commissioned by various government bodies as they were unable to access any independent surveys due to time constraint.
4.2.4 The Future of PFI/PPP in Jamaica
During the launch of the Highway 2000 project the Prime Minister announced that the government is committed to a number of future projects dubbed the ‘Millennium Projects.’ These Millennium Projects include the establishment of a new population center in mid-island, a Sports complex, the Milk River Spa [a public leisure center], a major cargo facility, and the construction of Highway 2000 the first to get off the ground (NROCC 1999). Also in recent time the revamp of the national railway is been considered as a possible PFI/PPP project (Caribbean Net News, 2005). This is in line with a statement by the then Minister of and Works Dr Peter Philips; “We are committed to the maintenance of our infrastructure and the development of new infrastructure development as we enter into the 21st century” (NROCC, 2000).
Small island states like Jamaica are always looking for creative ways to solve their infrastructure problems and provide well needed social services. However they should be cautious in their approach as is still room for improvement in the process. Nonetheless PFI will always look attractive, as it appears to offer value for money. Some authors also argue that it is not suitable for every project.
The Critical Success Factors of a PFI Project
For any project to be successful there must be a clear process for achieving the desired project goals in the most efficient manner in order to achieve best value. These factors are considered to be critical to the success of any project; critical success factors (CSFs) i.e. those factors or characteristics which are critical to the success of the project.
This chapter discusses the arrangements required to deliver a successful project under a PFI scheme and the barriers that may hinder this process. The authors have identified several factors which are considered critical to the success of a PFI project:
* Good business case
* Relevant performance measures / Bench Marking
* Good output specification
* Continuity of project team / Knowledge management
5.1.1 Good Business Case
The outline business case (OBC) for PFI includes specific technique to justify its use and to establish the financial feasibility of the business case, will depend on the scale of the project. According to Kee and Forrer (2002), the main criteria used to justify a PFI scheme are the following:
* Funding is to be predominantly (usually fully) from the private sector and the contractual relationship relates to the consumption of services not the assets itself;
* A ‘substantial’ amount of risk is transferred into the private sector; and
* The project must be shown to offer value for money to the taxpayer.
A business case links the proposed investment to the achievement of the department’s objectives; it documents the policy, business and project objectives and options that will affect both the decision and the investment itself (OCG, 2005). Additionally the business case guide shown in figure eight proposed by the CPFA, Consultant can be used as a guide to access the business case for the project. The process involved nine key steps leading up to final approval.
Source: Capital Investment Manual (2005)
Figure 8: Business Case Guide
5.1.3 Relevant performance measures / Benchmarking
Every PFI scheme should have a Public Sector Comparator (PSC) [benchmarking] to demonstrate that the PFI scheme is value for money (UNISON 2005b).
In principle, the best alternative available to the public sector should be used as
the comparator. A point is being reached where in certain sectors it will be more valuable to compare a proposed PFI deal with the terms of previous PFI deals, or an alternative benchmark based upon relevant private sector data and practice to delivering the service, rather than to a PSC. To assure continuing value for money, public sector project managers will need to make full use of the provisions that now commonly feature in PFI contracts for periodic benchmarking of project costs (Andersen, 2000).
5.1.2 Good output specification
Over the course of a 25-30 year contract, it is inevitable that the use of a school will change and hence the income flow (UNISON, 2004). This could be a simple change in technology or the upgrading of the school to meet new legislation.
One of the most frequent complaints about schools and hospitals under PFI are that there is not enough storage space in the schools and specialist clinic are almost never included (Walsh, 2005).
5.1.4 Continuity of project team / Knowledge management
Building a successful and thriving skills base in the right areas is vital if project managers are to become active in PFI (Hosken, 2003).
Skyrme (1999) define knowledge management as;
“…the explicit and systematic management of vital knowledge and its associated processes of creating, gathering, organizing, diffusion, use and exploitation. It requires turning personal knowledge into corporate knowledge than can be widely shared throughout an organization and appropriately applied.”
The purpose of knowledge management (KM) is to gather, categorize, store and spread all knowledge that is needed to make the organization both grow and prosper. In the building industry it is traditionally an accepted fact that you learn by your mistakes.
According to Mc Andrew (2004), In PFI contracts this will have significant impact in design, planning and pricing of new projects since the contractor will need to finance the biding stage out of the companies coffers, and there is a likely hood of losing at least 1 out of every 3 jobs they bid for, the cost of which could be running into hundreds of thousands and in some cases escalate into millions of pounds.
5.2 Barriers and Critical Success Factors
The Private Finance Initiative (PFI) is the Government’s preferred method of public infrastructure procurement in the UK. The expertise and capital required to engage in the bidding process and to deliver a multitude of services under long-term contracts are new skills set that raise barrier to entry.
The construction industry is often characterised has having low entry and exit barriers (Seymour 1987; Flemming 1998). Male & Stock (1991) agrees that barriers do exist but argues that they tend to vary in accordance with the size and complexity of the project. For small, simple projects, entry is relatively easy because capital requirements are low, as are the managerial and technical skills require to complete these projects. However, for bigger, complex projects, entry is more difficult since the capital and financial requirements are considerable higher. The technological and managerial capabilities required are such that only the larger companies are able to carry out these projects.
According to Hosken; key barriers to PFI work include the fact that many firms are still not involved or interested in PFI work, and that people do not specialize in PFI. This is intensified by lack of opportunities to gain PFI skills.
Since PFI work is increasingly substituting for public sector work, many contractors are left with no option but to consider the PFI market.
Seymour (1987) identifies a number of barriers to entry which was hindering small contractor’s involvement. These barriers are discussed below.
5.2.1 Lack of appropriate skills
Under the PFI, it is the responsibility of the private sector to tender for work on the premise that they will design, build, finance and operate the asset over a concession period. Traditionally, a contractor bidding for work is concerned with pricing a customized design that is prepared for a client by a consultant. Under PFI, financing, operating, maintaining and investing are mandatory. Although whole-life costing has been a long standing requirement in the public sector, it has not been widely adopted due to the fragmented nature of the industry and the practice of awarding separate contracts for design, construction, operation and maintenance. Financing, operating, maintaining and investing in a long term asset are not activities that contractors are used to performing.
Traditional construction work differs markedly from PFI work, both in the process involved and the skills required. PFI work require skills in project management, relationship building, risk assessment and allocation, operation and maintenance over long periods of time, and skills in creating and running businesses, other than contracting. These are skills which many contractors currently lack and which they consider outside the scope of their activities.
5.2.2 High participation cost
High bidding cost for contractors is the most prominent barrier to entry. When bidding for a PFI project, a consortium has to deal with a variety of issues relating to contracts, construction, design, finance, law operation, maintenance, and management. Many contractors and their consortia lack these specialists, external advisors are employed. It is the cost of employing these external advisors (financial and legal) that makes bidding for PFI projects so expensive. The PFI tender costs are over six times greater than the cost of alternative forms of procurement (BEC 1995). This is why it is extremely difficult for small contractors to bid on a PFI project. Although cost is an effective barrier to entry for the small contractors it did not seem to prevent the medium-size and large contractors bidding. Part of the reason why certain contractors are prepared to endure such high bid costs is because the returns that can be made from equity investments into PFI projects are much higher than those that can be achieved from ordinary construction work.
5.2.3 High project values
The majority of projects under the PFI are larger than those for which many small contractors can realistically aspire to bid. Many of the schemes that have been let to date have capital value in excess of ï¿½30m. For small contactors with turnover of between ï¿½50m and ï¿½200m, a project of that magnitude would
represent a large commercial exposure. The only realistic role small contractors can play in these type of contract is to be subcontractors to the larger contractors. Larger contractors, perhaps not surprisingly, seemed to be less concerned about project size.
5.2.4 High risks
One of the fundamental requirements of a PFI project is that the private sector must genuinely assume risk (HM Treasury 1993). In most PFI projects, a number of risks need to be considered: risk associated with design and construction; commissioning and operating; demand (or volume/usage); residual value; technology and obsolescence; regulation and project financing (HM Treasury and Private Finance Panel 1995). In PFI projects many of these risks are transferred
to the private sector. This is in stark contrast to conventional construction projects, where the construction risk, and in some special cases (such as design and build projects) the design risk, are the only one from this list to remain with the contractor. Whereas risk is an effective barrier to entry for the small contractors, it merely has influence on the sort of project the large and medium-size contractors chose to bid for.
5.2.5 Lack of credibility
The PFI invariably involve a contractor working in a consortium with partners from outside the construction industry. In a prison project, for example, a contractor might reasonably be expected to join with a prison operator, a facilities management company, a catering company, and a healthcare company. This is an effective barrier to smaller contractors, since they are less likely to have the external contacts necessary to assemble a PFI consortium.
In order to put together a PFI project, a consortium must be credible as a corporate entity if it is to secure finance and win a PFI bid. Banks are very conservative and very averse to risk, and are less likely to finance consortia containing small contractors. Even if they did, the finance would be at unfavourable rates which reflect the greater risk involved in lending to an organisation with limited expertise.
5.2.6 Demands on management time
Bidding for PFI projects is more intensive on management time, more so than for bidding for conventional construction projects. Most of these times are wasted negotiating with the client over commercial and legal issues. The bidding process under a PFI contract can last as long as one year. The small contractors, as well as most of the large and medium-size contractors, doubted whether they could afford the managerial time to bid for PFI projects. There is danger if too much
management time is spent on bidding on PFI projects, other parts of a contractor’s business activities might suffer as a consequence.
Analysis of Questionnaire
This section illustrate the results generated from the questionnaires and analysis of the data to establish enough evidence that may justify the views of the stakeholders in PFI as it related to value for money (VfM).
A total of twenty (20) questionnaires were distributed to various organizations that are involved in PFI. Of these a total twelve responses were received, this equates to a 65% response rate. Four (4) interviews were conducted to further strengthen the research findings; hence enhancing the validity of the research and keeping inline with Stephenson (2005) who states that “…research is reliable if the rate of response is over 20%…” The names of the organisations and identity of interviewee are kept confidential in order to protect their identity.
The findings of the research are summarized below.
6.2 Research Findings
The following is a graphical description of the response to each survey question. The graphs were generated using iMagic survey Pro. This software is used to analyze the results of field survey. The Y-axis results are given as per respondent and not as percentage of respondents. Additionally results from the interviews are also provided to support questionnaire findings.
Does PFI increase and improve the quality of public service and infrastructure without directly increasing the public sector borrowing requirement?
Figure 9: Quality of service and public sector borrowing
It can be concluded that there are still quite a number of persons who believe that PFI does not offer better quality of service even though the majority of respondents believe that it does. This could be as a result of groups such as UNISON and the number of PFI contracts that have failed.
Does PFI utilize private sector competition to create value for money to the tax payer? Yes no
Figure 10: Private sector competition and VfM
This has been one of the major selling points of PFI; Value for Money VfM. Eight (61.50%) of the thirteen respondents agrees that PFI utilizes private sector competition to achieve value for money for the tax payer. This is typical with any form of competitive process.
Does PFI procurement process results in higher bidding cost and delays?
Yes no not sure
Figure 11: Procurement and bidding cost
The response clearly indicates that majority of respondents 53.80%, agrees that PFI increases procurement cost and causes delays. While 30.80% does not agree and 15.40% of the respondents are not sure. This result was not surprising to the researchers as Sir Michael Latham in is report Constructing the Team (1994) highlighted this and it is still the case today with Balfour Beatty reporting that it may cost up to ï¿½0.9m before actual construction is started (see chapter three section 3.4, p.33).
Do you think the risk transfer from the public to private sector is balanced?
Figure 12: Balance of risk
This result came as a surprise to the researchers; 46.20% saying yes and the remaining 53.80% reporting that risk are not balanced. This may be due to the recent publications about failed PFI contracts and reports about government bailouts. In one of the interviews conducted, the informant was ask if they think that there is a balance of risk under a PFI contract to which they response that “if the government will bailout contractors then it is the taxpayers who eventually carry the risk.”
Do you think that PFI will continue as the government proffered method of procurement in the UK? Yes no
Figure 13: The future of PFI
This was not surprising to the researchers with 76.90% agreeing that will continue to be used as a method of procurement. This may be due to the fact that both major political parties have used PFI to procure public services. In one of our interviews the informant revealed that if the government discontinue the use of PFI it may reappear under a different name and cited ‘Procure 21’ as one such example.
What do you think could possible improve the performance of PFI as a procurement method?
What do you think are the critical success factors for a PFI contract?
Why is PFI attractive to a private organisation?
In your opinion, do you think that PFI is offering value for money?
Yes no not sure
Figure 14: Value for money
Again this is the major selling point of PFI, with reference to question two, it can be seen that though most persons agree that PFI utilize private sector competition to create value for money, 46.20% do not believe that it offers value for money, with 23.10% saying yes and 30.80% saying that they are not sure.
Would you agree that PFI offers equal benefits to clients and contactors?
Figure 15: Benefits to clients and contractors
The results indicate that 69.20% of the respondents believe that PFI does not offer equal benefits to clients and contractors, while 30.8% agree. This result is based on the notion that PFI contracts have transferred to the private sector a substantial degree of responsibility for some of the risks if not all, involved in constructing, operating and maintaining public services and financing the assets that support them. Where finance is concerned, the Government borrowing through the National loans fund (NFL) is backed by tax revenues and so is virtually risk free and hence the cheapest way of raising funds. Private sector companies are inherently riskier propositions and hence borrow on less advantageous terms. This response may be due to the latest reports of contractors making super profits and government bailouts.
In your opinion, what do you think are the main pitfall of PFI?
The results have shown that there are mix feelings where the pitfall of PFI is concerned. Most of the respondents believe that the main pitfall is caused from any of the three reasons.
a. Lack of experience people are in short supply
b. The changing nature of PFI
c. Procurement cost and the time it takes the contract to be ready
While lack of experience people and the changing nature of PFI can be considered as pitfalls to PFI, the bidding period and the procurement cost seems to be the major pitfall for contractors. This is confirmed from research,the PFI tender costs are over six times greater than the cost of alternative forms of procurement (BEC 1995).
The general findings of this research are supported by other commentators therefore the survey was reliable.
The time, cost and quality of projects developed under a PFI procurement scheme will remain under public scrutiny as long as some companies continue to make super profits, bailout been offered to those that have failed and poor specifications continue to daunt the scheme.
In order to over come this, a number of factors will need to be examined i.e. factors critical to the success of a PFI project. Knowledge management and a clear strategy was the main point put forward in order to improve the process.
Conclusion and Recommendations
The main aims of this research were to identify issues surrounding the introduction of PFI and weather or not it delivers value for money and to examine other countries experiences with PFI.
A total of twenty (20) questionnaires where distributed to various organizations and a total of four (4) persons were interviewed. The response level was way below the levels that the authors expected due to time constraints; however the authors where able to acquire valuable information from the interviews conducted. A combination of various research methodologies was adopted in order to meet the stated aims and objectives:
1. Establish the views of client as it relates to value for money (VfM).
2. Establish the views of contractors in relation to time, cost and quality.
3. The perceived benefits of PFI
4. Examine the critical success factor for PFI implementation
7.1.1 Establish the views of client as it relates to value for money (VfM)
Many of the persons surveyed did not believe PFI will deliver value for money. This may be attributed to the fact that PFI projects are constantly been bogged by claims of poor specifications in the schools and NHS. Some informants who were interviewed also claimed that this is an abuse of the public sector by the private sector effectively creating financial giants who will bleed the tax payer for 25 – 30 years and provide very little in return.
7.1.2 Establish the views of contractors in relation to time, cost and quality.
All the contracting organisations surveyed believed that PFI delivers value for money. However they all believed that there are still areas for improvement as it relates to the development of specifications and facility management for public asset.
7.1.3 The perceived benefits of PFI
Although there is constant critics of PFI, respondents do believe that PFI will deliver well needed public assets. This is also the general findings from the literature.
7.1.4 Examine the critical success factor for PFI implementation
The outline business case (OBC) for PFI includes specific technique to justify its use and to establish the financial feasibility of the business case, will depend on the scale of the project.
Every PFI scheme should have a Public Sector Comparator (PSC) [benchmarking] to demonstrate that the PFI scheme is value for money
7.2 Limitations to the Study
The researchers are mindful that this research represents a small fraction of the stakeholders within the UK’s construction industry and only twenty organizations were contacted with a response rate of 65%. Additionally was undertaken over a 12 weeks period; perhaps the results would have been different if the research was conducted over a wider spectrum and over a longer period, for example over a twelve months period.
7.3 Recommendations for Further Studies
There are many issues relating to PFI within the UK that would require further research, for instance:
1. Examine the development of standard PFI education.
2. Examine the development of a standard PFI contract.
3. Investigate the suitability of PFI as a procurement method in the delivery of various public assets.
7.4 Overall Conclusion
The primary argument for PFI remains the perception of “value for money.” The fundamental principle is the theoretical justification that private sector competition will create public services that are modern, superior and efficient than those that are presently provided by the public sector. These advantages arguably outweigh the likely increase in transaction costs involved in PFI (Kee and Forrer, 2002).
Critical to the success of PFI are four problematic concerns. First, there should be a good business case to justify establish the financial feasibility of the business case. Second, there should be a public sector comparator (benchmarking). In principle, the best alternative available to the public sector should be used as a comparator. Third, the public sector will need help to develop good output specifications. Forth, knowledge management, In PFI contracts this will have significant impact in design, planning and pricing of new projects. If these problems can be solved, PFI can provide the public sector with an optional approach to the procurement of public service and delivering value for money (Kee and Forrer, 2002).