Project management and the private finance initiative

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2.1 Introduction chapter two Managing the private finance initiative The Private Finance Initiative (PFI) is a method of procurement in which private sector finance and management skills are used to deliver public infrastructure and services. There is evidence to suggest that, when applied correctly, PFI has delivered benefits over traditional forms of public sector procurement (Arthur Anderson and Enterprise LSE, 2000; Ive et al., 2000). However, when it has been used incorrectly PFI has resulted in inefficiency and wasted resources (CBI, 1996). Given the scale of PFI, it is imperative that both the public and private sectors should look to manage PFI better, by (CBI, 1996): • Refining policy and processes; • Adapting culturally; and • Acquiring new skills. This section focuses on the last of these issues. Specifically, it examines the role of project management skills in the PFI process and the ways in which the management of PFI projects could be improved. In doing so, it discusses the background theory and rationale behind PFI, and the way in which PFI has performed in practice. It also examines the role of project management in the PFI process. 2.2 The Private Finance Initiative Originally conceived as a means of reducing government borrowing and increasing investment in public infrastructure, PFI has increasingly come to be seen as a way of achieving better value for money from government procurement. Public sector construction and infrastructure projects have traditionally had a reputation for being poorly managed, leading to cost and time overruns and long-term technical problems (Graves and Rowe, 1999; Hobson, 1999; Allen, 2001; Mott MacDonald, 2002). For instance, a survey of public sector procurement by Graves and Rowe (1999) revealed that two-thirds of projects exceeded their programme and 75% of projects finished over budget. Under PFI, private sector consortia bid to design, finance, build and operate infrastructure on behalf of the public sector for 3 chapter two Managing the private finance initiative Project management and the private finance initiative periods of around 30 years. Consortia may also be asked to provide ancillary services or services direct to the public as part of the contract. In return, the public sector pays the private sector consortium a unitary payment for using the infrastructure and services. Unitary payments are usually structured so that the public sector can incentivise the consortium to perform by making deductions for late completion, poor quality infrastructure or poor service provision. This way PFI projects are supposed to avoid many of the problems normally associated with conventional public sector procurement. PFI construction projects typically comprise three main parties (Figure 2.1). These are: • The awarding authority; • The special purpose vehicle (SPV); and • Third party funders. The awarding authority is the public sector client responsible for procuring the project. An awarding authority may be a central government department, local authority or government agency. The objective of the awarding authority is to achieve value from public money by transferring to the private sector the risks associated with providing infrastructure and services (Fox and Tott, 1999). It does this by specifying the output required from the project. The output specification is intended to be non-prescriptive, since responsibility for designing and delivering the desired outcomes lie with the SPV. Figure 2.1: PFI project structure Consultants and advisors Awarding authority Funders SPV Construction contractor Consortium Consultants and advisors Facility management contractor Sub-contractor(s) Investors Sub-contractor(s) Dixon et al, forthcoming
The SPV is a limited company that is set up for the sole purpose of delivering the PFI project. It comprises parties from the winning consortium, which will typically include a construction contractor, facility management provider, investors and other specialist contractors. The objectives of the SPV are to minimise the risks of delivering the project and to generate profits. In doing so it will pass down risks to sub-contractors, thereby limiting risk in the SPV. Limiting risk in the SPV is particularly important because consortia usually require access to third party funding, such as equity, bank loans or bonds. The objective of the third party funders is to make a profit from their investment (Fox and Tott, 1999). Although many of the risks associated with PFI projects lie with the SPV, the awarding authority still has a critical role to play in managing the procurement process. Amongst other things, the awarding authority is responsible for: • Establishing the business case; • Developing the public sector comparator 3 ; • Devising the output specification; • Inviting and evaluating bids; and • Awarding and managing the contract (Treasury Taskforce, 1998). In doing so the awarding authority may call on the expertise of external consultants and advisors. This is particularly important in projects where awarding authorities have little or no experience of the PFI process. As of April 2003, 569 PFI contracts had been signed, 418 of which were already operational (OGC, 2003a). The combined capital value of these contracts was £53 billion, although the value of individual projects ranged from under £1 million to over £1 billion (OGC, 2003a). In the construction and property sector, the scope of PFI has been wide-ranging, including roads, bridges, sewage treatment plants, waste incinerators, hospitals, schools, prisons and office accommodation. Research for Foundation for the Built Environment (Dixon et al, forthcoming) showed that in the early years of PFI (1992–1994) only 8 deals were signed, with a combined value of £630 million. PFI has grown in importance, however, with a peak in 2000, when 102 PFI contracts worth £4.3 billion were awarded. The research also showed that more than a third of PFI contracts awarded since 1992 were in the education or health sectors, comprising 19% of the total capital expenditure through PFI. A large number of PFI contracts have been awarded by the Ministry of Defence (MoD) and the Home Office (mainly prisons) (Figure 2.2). Although fewer in number than health and education projects, MoD and Home Office projects still comprise 17% of total PFI capital expenditure since 1992. The most valuable PFI contracts have been awarded by the Department for Transport, its 31 PFI projects comprising 39% of total capital expenditure on PFI. In contrast, more than half of all other departments have procured less than 10 PFI projects, constituting just 12% of total PFI spending, and five of these have procured only one project 4 . Despite the large number of projects procured to date, however, the effectiveness of PFI is still subject to considerable debate. A number of studies have suggested that PFI has delivered benefits over conventional public sector procurement (Arthur Andersen / Enterprise LSE, 2000; Ive et al., 2000; NAO, 2003a). For instance, a study of PFI projects by the National Audit Office revealed that only 22% of projects experienced increasing construction costs after the contract had been awarded (NAO, 2003a). Ive et al. (2000) found average total cost savings of between 5% and 10% compared with conventionally procured projects, and Arthur Anderson and Enterprise LSE (2000) identified average cost savings of 17%. Nevertheless, the use of PFI has not been without problems (Audit Commission, 2003; NAO, 2003b; Ive et al., 2000). A survey of PFI schools by the Audit Commission (2003) suggested that the quality of PFI schools was lower than those that had been procured conventionally. Similarly, a National Audit Office study of PFI prisons concluded that the operational performance of projects, as measured against the terms of contracts, had been mixed (NAO, 2003b). PFI has also been criticised for its high transaction costs, reflecting the complexity of the procurement process. For example, legal and advisory fees have, on average, been 10% to 20% higher than under conventional procurement (Ive et al., 2000). 3 The public sector comparator (PSC) is the benchmark project against which the PFI option and private sector bids are evaluated (Treasury Taskforce, 1998). 4 There have also been a number of large PFI IT projects, which have produced mixed results. Recent high profile cases which have run into problems include new IT systems for the child support agency and the criminal records bureau (Denny, 2003). The Government has decided to restrict PFI to large projects because in their view (HM Treasury, 2003), high legal and financial costs make projects less than £20m poor value. A more detailed review and analysis of such projects is expected from the Treasury in autumn 2003. Project management and the private finance initiative chapter two Managing the private finance initiative 4
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