Cost Planning of PFI and PPP Building Projects

Abdelhalim Boussabaine

• Publisher: Routledge
• Year: 2013
• eBook ISBN:
  9781134224876
• Topic: Architecture
• Subtopic: Architecture Methods & Materials

This topical and timely book presents and innovative approach to dealing with the complexities of cost planning in PFI.

PFI/PPP projects have a significantly different costing environment from conventionally procured projects, requiring cost analysts to use their expertise and innovative thinking to develop whole-life cost solutions that deliver value for money to the client, thus improving public building assets performance.

Abdelhalim Boussabaine provides a thorough grounding in the theory of PFI, from its early evolution through to examples of current projects. In particular, the rationale for private financing of public services, arguments for and against PFI and 'value for money' mechanisms are discussed. The book presents an innovative framework for whole-life value and calls for changes in the way whole life cycle value is perceived, created and exchanged.

Cost Planning of PFI and PPP Building Projects provides the reader with existing knowledge as well as present innovative thinking for future development and management of PFI/PPP cost planning processes. Given the importance and novelty of this book, academics, professionals, undergraduate and postgraduate students will find this book valuable.

Part I PFI/PPP and VFM Rationale

DOI: 10.4324/9780203018842-1

Chapter 1 The Rationale Behind the Private Financing of Public Projects

DOI: 10.4324/9780203018842-2

Introduction

The UK Government introduced the Private Finance Initiative (PFI) as a policy to allow and regulate privately financed public projects. The private sector playing a part in the financing, creation and operation of public services and built assets is not a new idea, as this initiative can be traced back over several decades. This chapter outlines the rise of PFI/PPP (public–private partnerships) in the UK construction economy. It puts into perspective the rationale for and against the PFI procurement method and sets out some basic definitions and clarifies the difference between PPP and PFI terminology. It points out the benefits of public–private partnerships, it discusses the value of cost planning PFI/PPP projects and explains the challenges that are facing cost analysis in pricing long-term contracts. The chapter hopes to lay the ground for the subsequent chapters where the real in-depth analysis of the issues surrounding the cost planning of PFI/PPP projects lies.

What is PFI/PPP?

Lack of uniform agreement on the meaning of PFI/PPP creates confusion, introduces ambiguity and may lead to contractual disputes. If a precise definition is not agreed, it will be very difficult to measure the success or otherwise of this mode of project procurement and financing. Hence, this section presents the definition of PFI and PPP. Public–private partnerships (PPP) were introduced by the UK Government to deliver modern, high-quality public services and to promote the UK's competitiveness. Any collaboration between the public authorities and the private sector is referred to as a partnership. Partnering is defined by the National Audit Office (NAO 1999a) as: ‘The situation where a public organisation and a private one work together to provide a service with some sharing of risk and reward, usually over a period of time.’

According to the Treasury (HMT 2000a) PPPs are a form of long-term relationship between the public and private sector for the benefit of both parties and cover a wide range of business partnership arrangements including joint ventures, concessions, sale of equity stakes in state-owned businesses, PFIs, franchises and outsourcing of public services. 4Ps (2006) defined and explained the purpose of PPP as follows:

Public–private partnerships (PPPs) are a generic term for the relationships formed between the private sector and public bodies often with the aim of introducing private sector resources and/or expertise in order to help provide and deliver public sector assets and services. The term PPP is used to describe a wide variety of working arrangements from loose, informal and strategic partnerships to design, build, finance and operate (DBFO) type service contracts and formal joint venture companies.

It is clear from the above that PPP is broader in concept than PFI. But PFI is considered as a form of PPP. The House of Commons Select Committee on Treasury (2002) defined PFI as follows:

The principle of PFI is that a public sector body (central or local government or part of the health service, generically called ‘the authority’) obtains a service rather than an asset. A private sector contractor (often specially created for the purpose) funds any asset required and is then paid for the service provided. Usually payments will be made by the commissioning authority, but in some projects (e.g. a toll bridge) they are made by the public. There is also the possibility of charges to the public being subsidised by payments by the commissioning authority (e.g. a railway where the fares are subsidised for public benefit reasons). Normally, therefore, the commissioning authority will avoid the need for capital expenditure at the beginning of the project in exchange for making payments for the service as it is delivered, often over a period of up to thirty years. The private finance is temporary: the public sector still pays in the end. Because the contractor is paid for the service provided, it should be possible to arrange that he is taking the risks inherent in the construction of the asset.

In 1995, the UK Chancellor of the Exchequer gave the following description of PFI in his Budget speech:

Under the PFI the public sector does not simply sign a contract to buy a prison, a train or a computer system. It pays to have specific services supplied at guaranteed levels of performance. The government chooses the quality services the public require, and then goes out and acquires those services from private companies with the finance and expertise to deliver.

The Private Finance Panel (1995) defined PFI as follows:

PFI has become one of the government's main instruments for the delivery of high quality and cost effective public services. It enables value for money and improvements to be obtained by requiring the private sector in competition to be innovative in the design and operation of asset-based services, manage an appropriate level of risk and adequately maintain assets on a long-term basis.

The NAO definition emphasises the issues of procurement, management of public services and lack of funding for public projects:

A policy introduced by the Government in 1992 to harness private sector management and expertise in the delivery of public services …

The PFI approach can enable departments to undertake projects which they would be unable to finance conventionally.

(NAO 1999a)

PFI is now established as a major form of Government procurement … PFI has introduced changes in the way public services are procured and managed.

(NAO 2001)

Broadbent and Laughlim (2003) explained:

PFI, in its purest form, is a design build finance and operate (DBFO) system. It usually involves the provision, by a private sector consortium, of property-based services for a period of a minimum 30, and, more usually, 60 years, to a public sector ‘purchaser’. In exchange for these services over this 30/60-year time horizon, the public sector pays a monthly, in effect, lease cost to the private sector supplier. This monthly cost is revised periodically as the contract progresses.

It is apparent from the above quotations that PFI evolved from the development of public–private partnerships. Hence, hereafter, in this book, PFI and PPP are treated synonymously.

In examining the above quotations on PFI and PPP, one can identify the following key concepts that lead to the emergence of PFI/PPP:

• sharing risk and reward;
• introduction of the resources and expertise of the private sector into the public sector;
• delivery of public services by the private sector at a guaranteed level of performance;
• delivery of high quality and cost-effective public services;
• innovation in the design and operation of assets;
• risk transfer;
• introduction of a new form of managing and procuring public services and projects;
• long-term contractual agreements between private and public sectors;
• a substitute for public expenditure control;
• value for money in the delivery of public services.

The rationale for PFI/PPP has evolved over time to address these issues. While some of these concepts were instrumental in the materialisation of PFI/PPP, more recently the emphasis has shifted towards the theory that PFI/PPP is a public procurement system that can deliver value for money and manage risk transfer to the benefit of the public sector. Hence, this chapter seeks to provide an overview of PFI/PPP and the arguments relating to it.

The rise of PFI/PPP in the UK construction economy

The rise of PFI/PPP in the Western construction economy is not a new phenomenon. Many Western countries have used this procurement method to build motorways, prisons and hospitals. For example, in France, private financing for motorways was introduced in the late 1960s and early 1970s. Similar initiatives were also undertaken in Spain and Italy in the early 1970s. The following subsection will map out the process of PFI/PPP emergence in the UK. The development of PFI over the past 25 years is mapped out in Figure 1.1.

PFI/PPP post-1980

During the 1980s, the provision of private finance for public projects was governed by the Ryrie Rules (Ryrie was a Treasury official). The Ryrie Rules set two main criteria for the use of private finance in the procurement of public sector capital projects. These are:

1. Public sector capital projects can only be financed by the private sector if it is proved to be more cost–effective than a comparable publicly funded project.
2. The investment or asset must be part of the planned public sector schemes and not in addition to (in some cases, this rule is ignored by decision-makers). The consequences of this second rule are that public expenditures ought to be reduced by the same value as private investments.

Only a limited number of projects have been conceived under these two rules. Among these projects include the third crossing of the Thames at Dartford and the second Severn crossing. Many authors and politicians have commented that these rules have been a huge obstacle to encourage public authorities to seek private funding. This led to the abolishment of the second rule in 1989 by the UK Treasury which had the effect that privately funded projects no longer had to be substitutional. Finally, both rules were discarded in 1992 with the introduction of the PFI/PPP in the procurement of public services.

Figure 1.1 Map of PFI/PPP development.

PFI/PPP post-1990

In the early 1990s, the UK economy suffered a considerable slowdown. This reflected on the ability of the government to raise sufficient tax revenue to adequately improve the public sector's infrastructure and services. This directly or indirectly led to the creation of new legislation for the introduction of private finance to develop and operate public services and assets:

The cumulative effect of under-investment on the capital stock inevitably increases through time. It was the reality of this pressing infrastructure need, alongside the equally pressing requirement to keep public expenditure under control, which, when coupled with an ideological commitment to involve the private sector in the public sector, led the Conservative Government to launch PFI in 1992.

(Broadbent and Haslam 2000)

PFI was launched in 1992 by the Chancellor of the Exchequer. This launch was met with little enthusiasm by the private sector. As a result, in 1993, the Chancellor gave the PFI greater emphasis and momentum. He announced the creation of a Private Finance Panel. The main aim of this panel is:

To encourage greater participation in the initiative by both private and public sectors, to stimulate new ideas, to identify new areas of public sector activity where the private sector could get involved, and to seek solutions to problems which might impede progress.

(Private Finance Panel 1995)

In 1994, the Chancellor insisted that the Treasury would not approve any capital project unless the options to acquire private funding had been explored by the procuring department. This universal testing decision had the effect that public sector authorities are forced to engage with the private sector. This decision has played a pivotal role in securing private funding for the development of services and assets in the public sector. In 1996, the local association established the Public–Private Partnerships Programme (4Ps). The aim of 4Ps is to assist local authorities and encourage the growth of private investment in public services. Even with these initiatives, the uptake of PFI/PPP by the private sector fell short of the government's hopes. In 1997, after the general election, the new Labour Government re-affirmed its commitment to the PFI/PPP paradigm and appointed a committee to conduct a wide-ranging review of PFI/PPP. The new government also abandoned the universal testing of private sector financing in May 1997. The review committee made several key recommendations. Among these were:

• abolishment of the Private Finance Panel;
• control of PFI by the HM Treasury;
• compulsory not to shortlist more than four bidders;
• formation of a new private taskforce. The advice is that this entity should have a limited life and provide both strategic policies on PFI and technical advice on design and approval of specific projects.

These key recommendations led to centralisation and standardisation of practices across procuring departments. As a consequence of the review and formation of the Taskforce, the following have been achieved:

• 1998 The step-by-step guide to the PFI procurement process was launched.
• 1998 Development of a comprehensive approach to PFI training. A training programme on how to undertake PFI schemes was put in place.
• 1999 Standard contract guidance was issued.
• 1999 Agreement on accounting procedures for PFI schemes was reached.
• 1999 Establishment of a review group to sign off all local authority PFI schemes.

Other major developments in 1999 were the announcement and launch of a second review on PFI/PPP by the government. The main recommendations from the second review are:

• Formation of an advisery body composed of private sector experts to replace the technical advisery wing of the Treasury Taskforce.
• All PFI standard documentation ha...

Table of contents

• Cover Page
• Half-Title Page
• Other
• Title Page
• Copyright Page
• Dedication
• Contents
• List of figures
• List of tables
• Preface
• Acknowledgements
• List of abbreviations
• Part I PFI/PPP and VFM Rationale
• Part 2 Procuring Building Assets Under the PFI/PPP Model
• Part III The Process of Cost Planning of PFI/PPP Projects
• Part IV Cost Variations in PFI/PPP Projects
• Part V Risk in Costing PFI/PPP Projects
• Bibliography
• Index