Theme3: Value for Money

The third theme of this discussion is regarding Value for Money.

1. Drivers of VFM

We could list some of the key drivers as:

Output based contracts
Whole life-of-asset costings
Single point responsibility ? integration / scope
Innovation
Competition
Economies of scale
Capital at risk to long term performance
Risk transfer
(Competition is also believed in the UK to be a very important driverto VFM and the critical element during the procurement phase.)

And our suggested questions to consider are these two below:

What has been the experience in different PPP markets of these drivers?
What is other potential policy drivers to PPP, which might or might not always be compatible with VFMas the policy driver?

[1] Author: Edward Farquharson

Organization:: Project Director, Partnerships UK

To help start off the discussion on vfm, I have the following comments:

VfM assessment is a continuous process and should start at an early stage, if possible, at the programme level when procuring authorities might be considering portfolios of projects. It then proceeds through the project preparation phase when project specific details are better defined just prior to engagement with the market and typically involves some form of quantitative comparator with the alternative of conventional procurement combined with a qualitative assessment. During the subsequent procurement stage the quality of the competition will then be a key element of the analysis prior to any decision to sign the contract.

The practice of VfM should of course continue into the operational phase where the importance of good contract management is key to ensuring that VfM continues to be delivered by the project. Preparing contract managers properly to manage these contracts well in advance is a key lesson from UK experience where we now have over 550 of these contracts in the operational phase.

Procuring services that can have clearly defined outputs that are not likely to change significantly is important for VfM hence PFI is not considered suitable for projects where there is rapid technological or other change which makes it difficult for procuring authorities and bidders to predict service delivery requirements and include sufficient contract flexibility at a reasonable price. Accordingly PFI is not for example considered to deliver VfM in ICT procurements. One might draw this wider and say that VfM is unlikely to be achieved for any projects in sectors that are subject to significant policy instability i.e. where policy and hence requirements are likely to change significantly.

We have also found that the upfront costs of this complex form of procurement make it difficult to make the case for VfM for smaller discrete projects hence our cut off of £20m capex project size in the UK. But we have found that programme approaches, where a number of factors working together to achieve economies of scale, simplified procurement and better project management can enhance VfM such as the LIFT and BSF programmes.

Achieving capital at risk to performance is one of the key VfM drivers as it underpins the risk allocation. This has occasionally been tested in the UK market when some projects have got into difficulty: where, for example a contractor has encountered financial problems that threaten completion of a project or its operation, the incentive of having equity and debt capital exposed to potential loss has ensured that the capital providers have addressed the problem. Getting lenders to accept performance risk is one of the key challenges to developing any PPP market but without this, the VfM benefits of PFI will be much less pronounced.

Competition between policy drivers

VfM and balance sheet treatment - there are many instances where VfM and accounting treatment are complimentary but there are also areas where they can conflict. Usually the conflict arises where risk is transferred simply to achieve an off balance sheet result rather than being allocated to the party best able to manage or assess the risk. In this case it is important to have a clear priority: in the UK we accept that VfM is the overriding factor.

VfM and affordability - there may also be instances where a long contract length can reduce the monthly unitary charge making the project appear more affordable (e.g. through longer loan periods) but the contract length is not optimal is relation to the asset life or likely changes and therefore unlikely to achieve VfM. To help ensure this, contract lengths in the UK are likely to be established for different sectors and with a maximum cap of 30 years.

VfM and soft services - evidence from the recent examination of operational PFI procured projects, shows that soft services are seen as performing less well on average than the very high scores given to other elements of the PFI framework. The evidence on satisfaction with soft services does not therefore demonstrate VfM as consistently as other elements of the framework, and the analysis of service outcomes suggests that, while standards are no worse than in non-PFI structures, PFI has not led to a step change in soft service delivery. Accordingly, recent VfM guidance requires that public authorities now rigorously prove the case for including soft services in PFI projects.

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[2] Author: Gary Sturgess

Organization:: Serco Institute, UK

There is a great deal that could be said on the subject of value for money - but to start, let me take issue with one of Edward´s observations - the record on soft services. The claim that contracting for soft services in PPP/PFI does not deliver as much value for money as construction and hard FM is based on a UK Treasury report published last year.

Treasury provided very little evidence to support this claim, and what little there was, was based on a small sample and a questionable methodology. But if it were true that contracting for soft services had not delivered the same benefits under PFI/PPP, then there are a number of logical explanations. To give just three:

* in a number of sectors, most notably in hospitals, competition and contracting for soft services such as cleaning and catering had been going on for many years prior to PFI/PPP being introduced. The result was that many of the easy value for money savings had already been extracted some years before. Unless there was a significant change in the scope of services being put to the market, then there is little reason to believe that significant additional savings would be secured, particularly where the terms and conditions of transferred workers are protected by law, as they are in the UK.
* in many sectors, those involved in letting PFI/PPP contracts have been capital works specialists, and they have tended to specify requirements according to their own understanding of the requirements. Moreover, the consortia that have won PFI/PPP contracts have tended to be led by construction firms and hard FM specialists. It would be unsurprising under those circumstances, if the solutions offered by the private sector tended to focus on innovation in construction and hard FM.

One sector where PFI/PPP procurement has been dominated by the providers of ´soft services´ from the outset, is prisons, and in that case, there have been significant value for money gains made on the services side - not only in cost savings (around 15%) but also in the delivery of more decent regimes for the management of prisoners. Even there, however, innovation has been constrained by public sector commissioners who have been inclined to impose their own models of offender management on the private sector. There is an active debate going on in the UK at present over the establishment of a system of end-to-end offender management (including community service as well as custodial service), and this promises to place service innovation rather than the construction of physical facilities at the heart of the offender management market.

More recently, we have begun to see some public hospitals procured in a way that permitted greater service innovation, and PPP bidders have been coming up with innovative new solutions for the soft services, involving (for example) the use of robotics for the delivery of food and linen to wards, and increased focus on patient service by porters and other support staff.

Unsurprisingly, when public sector commissioners encourage service innovation, then service design is placed at the heart of the solutions offered to government. And when service design lies at the heart of PPP design, then we will begin to see very different kinds of facilities, and significant value for money improvements in soft services.

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[3] Author: Richard Foster

Organization:: Acting Head, Partnerships Victoria Unit
Commercial & Infrastructure Risk Management Group
Department of Treasury and Finance

For the most part, our experiences in Australia are consistent with Edward´s observations. Gary´s comments in relation to soft services are interesting - while the evidence in Australia is more limited due to the much smaller number of projects we have undertaken, there is no doubt that the roles that different consortium members play impacts upon how the consortium seeks to deliver value for money. Some consortia will aim for a simple, low risk offering that meets government´s requirements and (due to the low risk nature of their construction/maintenance solution) enables them to put together a low cost financing package - this approach might be taken by an investor-led consortium. Others may seek to deliver value for money by striving for more innovation in construction, taking more risks but hoping to lower overall construction and maintenance costs - as Gary indicates, this is more likely where the consortium is constructor-led.

Whole of life considerations: Whole of life considerations can be a strong driver of value for money. We often see bids that have higher capital costs than would be the case if government delivered the project using traditional procurement methods. The additional capital is not "gold plating" - typically it is a result of the contractor incorporating higher quality into the project up front, anticipating lower maintenance, soft service and/or lifecycle costs over the contract term. The PPP model drives bidders to identify the optimal balance between capital costs and operational expenditure.

Innovation: A PPP will rarely contain a large and obvious piece of innovation that all can see. More often, there are numerous small examples of innovation in a project. Many of these will not be obvious to a layperson not involved in the construction or operation of similar facilities. Nevertheless, these innovations are significant contributors to value for money.

Asset Utilisation / Access to third party revenues: Another driver of value for money in some projects is improved asset utilisation, often through allowing contractors to access third party revenue streams to the extent that these don´t compromise the outputs required by government. For example, in some jurisdictions undertaking schools PPPs, allowing the contractor to hire out school facilities outside of school hours has provided the contractor with an alternative revenue stream which has lowered the overall cost of the project to government. Similarly, there may be significant synergies between the project and potential commercial development. If there are significant interfaces between the project and the potential commercial development, bundling those two elements together may offer value for money, as bidders will offset the value of the commercial development opportunity against the required payment stream from government, lowering the overall cost to government of the project.

Competition: Whatever the means by which bidders deliver value for money, the competitive bidding process plays a vital role in ensuring they invest significant effort in taking up these opportunities.

Competition between Policy Drivers: Here in Victoria we have a policy that there are certain "core" services that should be delivered by the public sector, and therefore not bundled into the PPP contract. Examples include the provision of clinical services in PPP hospitals and correctional services in PPP prisons. Theoretically, bundling these core services into the PPP contract and having the contractor deliver them would potentially offer better value for money. However, through "asking the right questions" in the tender documents, it is possible to obtain bids that enable government to drive efficiencies in the delivery of the core services, as well as securing value for money delivery of the contracted services. Perhaps greater efficiencies could be obtained through bundling the core services into the PPP contract, but this would only be achieved by non-compliance with the policy that "core" services be delivered by the public sector.

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[4] Author: Edward Farquharson

Thanks Richard and Gary for some very useful points on this large subject. I think, inter alia, an important point that they both draw out is this issue the asset/service combination as a driver to VfM. As Gary rightly points out, in the prisons sector where we have perhaps gone further than in most other sectors with the inclusion of the service, VfM gains have been significant. Where outputs (for either policy or contractible reasons or both) can allow for a comprehensive combination of asset and service inputs then service and design innovation (not to mention long termism) are given fertile ground and therefore likely to drive VfM.

One other point of a practical nature, one must not lose sight of overall deliverability in the project analysis stage. VfM needs to be examined in the light of other factors. A project that potentially shows very good VfM also needs to be affordable and the capacity of the public sector to manage the procurement and contract phases needs to be in place. A good quality control process for project preparation, a well informed project review team and well prepared procurement and contract management teams are therefore key to ensure that projects actually deliver VfM.

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