Fahad Alarfaj, Sam Anastasiou, Tim Burbury, Almiro Clere, Dan Feldman, Dan Giemajner, Matt Hardwick, Brendan Hundt, Phil Loynes, Sam Muir and Hanit Zedan | King & Spalding
Introduction
Public-private partnerships (PPPs) are an attractive option for public procurers seeking to deliver large-scale infrastructure projects. They offer a number of potential benefits over traditional procurement strategies if implemented successfully.1 In some jurisdictions, particularly the UK, they have fallen out of favor, partly as a result of the public perception that they do not deliver value for money for taxpayers. However, PPPs can and do offer value for money. Provided public procurers are judicious in selecting suitable projects and provided these projects are structured correctly, PPPs can foster efficiency gains that make them more attractive than traditional procurement.
In this article we explore some potential challenges that public procurers may encounter in developing and delivering PPP projects and suggest some strategies to ensure success at each stage of the PPP project life cycle.
1. Project Inception
a. Unclear project objectives and lack of planning
As with any project, if there are no clear objectives or if the objectives are not communicated to all relevant stakeholders, often those stakeholders can find themselves pulling in different directions without a clear path forward.
The objectives for procuring a PPP project should be clearly identified and communicated. These objectives could include one or more of the following:
- procuring private sector expertise in a particular area (e.g., new engineering techniques for a bridge or deploying AI in data center development)
- reducing overspend and delays by passing risks to the private sector
- reducing up-front costs due to budget constraints or leveraging private finance to increase the number of projects able to be procured
- inviting foreign direct investment into infrastructure
- mobilizing additional sources of debt funding both domestically and internationally
One option we have used successfully with procurer clients is to help prepare a procurement plan or “blueprint” at the outset that includes the relevant objectives for the procurement.
All stakeholders can refer to the blueprint at any stage of the procurement to guide them through the entire tendering process. The blueprint should address the following:
- an overview of the project including a description of the assets and services required (both core and non-core)
- the key objectives and any commitments by government
- structuring and procurement options for the project
- an overview of the recommended contractual arrangements for the project based on the optimal procurement option
- an implementation plan for the project
This last point is critical. The blueprint should include all gateways or approval steps and other protocols so these can be included in the planning. This plan should also map out the selected procurement steps (market sounding, prequalification expression of interest (EOI), request for proposals (RFP), etc.) and address the procurement time frames. Procurement processes are invariably driven by time. PPPs take longer than traditional procurement. An unrealistic or expedited time frame risks leading to mistakes or receiving rushed and inaccurate bid submissions and, potentially, retendering.
The consequences of not developing a procurement plan include project delays, increased costs and a greater potential for bidders to withdraw. This is even more critical for pathfinder projects.
b. Procurement team structures
Running a PPP procurement will require additional expertise in staffing. Bringing in temporary consultants or hiring permanent staff (if there is a pipeline of years of PPP projects) is recommended. Competitive PPP projects require commitments in terms of time and resources. Given the inherent complexity of these projects, procurers will need to engage external legal, technical and financial advisers early in the process as well as identify an internal team (often across several departments) who will act as the client stakeholders. Team leads should be appointed early and have defined responsibilities.
Some jurisdictions will have a centralized PPP unit to run aspects of the PPP tender process, rather than leave each procurement up to the relevant department procuring the infrastructure. Still, the sponsoring procuring department will need to ensure it has relevant PPP expertise to liaise with the centralized unit to convey its requirements and objectives. Therefore, staff familiar with traditional procurement still have a very important role to play. They will be critical in all phases, particularly the planning phase. For example, even if their experience is in developing input specifications for traditional procurements (e.g., a road or bridge), they will still be critical in helping refine this into an output specification for the PPP project, as well as monitoring the bidders’ technical submissions and the winning bidders’ performance.
c. Regulatory challenges and unfamiliar processes
PPP projects require a different approach to procurement. In most GCC countries, governments have sought to address this through implementing primary legislation, establishing central PPP units and issuing guidance documents.2 While these provide a framework for PPP implementation, in some jurisdictions there have been very few PPPs delivered under them. In places where experience in delivering PPP projects is limited, navigating unfamiliar processes and engaging with additional stakeholders tend to add time to the procurement process and in some cases ultimately lead to procurements being abandoned.
Although not unique to PPPs, the increased diligence that accompanies PPP projects and the novelty of some projects can throw up additional regulatory hurdles such as land rights, licenses and permitting issues.
Regulatory issues are best addressed at a project’s outset through comprehensive scoping and engagement with relevant regulators and legislators so that any additional approval processes required do not delay negotiations. If this is not possible, private sector bidders will often require the public procurer to assume the risks associated with obtaining relevant approvals and licenses and/or any law changes.
d. Deviating from proven models
The success of PPP projects depends partly on the appetite of private sector developers, construction contractors and lenders to commit to the project. In the UAE and in Saudi Arabia, the water and power sectors have a proven track record of PPP project implementation. Bidders and lenders are familiar with the procurement processes, the regulatory and contractual frameworks, and the behaviors of the relevant public procurers.
In contrast, if a public procurer does not have a proven history and/or if the PPP project varies from the proven model, bidders and lenders will see this as a riskier investment. This will likely have an effect on the cost of the PPP project (with bidders typically pricing in the risk premium) and reduce the number of bidders prepared to submit tenders. In extreme cases, it may result in no bids being received. Bidders and lenders can also be hesitant to participate in projects when the regulatory framework is untested. This often results in a lag between the implementation of PPP regulatory frameworks and the award of the first project of a particular type. There is a clear contrast between the high number of bidders and record low rates being achieved on solar PPPs, which are frequently used and well understood across the GCC,3 and the much lower turnout of bidders on projects where PPP models are being deployed for the first time.4 Public procurers seeking to implement their first PPP project, or the first project of a particular type, may wish to consider a “pioneer project” — a relatively small project that will be more manageable to test and deliver and build momentum. This ought to be coupled with a risk profile that will be familiar to bidders and lenders, but it may also require additional guarantees or adjustments to the risk profile to build investor confidence. The award and completion of the pioneer project will demonstrate to the market that the model is viable, which, in turn, will promote the flow of future projects.
2. Challenges During Procurement and Negotiation
a. Being output- versus input-focused
Part of the mindset shift from traditional procurement to PPP project procurement is changing from prescribing inputs (detailed designs and materials) to being output-focused (e.g., service availability, client satisfaction, price per output). Input-focused specifications constrain bidders, whereas output-focused specifications enable private sector bidders to innovate in order to deliver the benefits the public procurer desires. An example of an output-focused scope for a toll bridge would be one that specifies the start and end points and the number of lanes but not the bridge type or the construction materials.
a. Creditworthiness challenges
If the PPP project is not self-financing, bidders and lenders will need confidence that the public procurer will be able to pay the concession fees for the duration of the term. In this regard, public procurers face two typical challenges: (i) they often operate on annual budgets; and (ii) where the public procurer is a corporate entity, their credit rating may not be sufficient to give requisite comfort to lenders. This can be overcome through the provision of credit support from parent companies/finance ministries in the short term. Mechanisms can be included in the contracts to remove that credit support where the public procurer achieves sufficient credit strength on its own.
b. Inefficient risk allocation
The story of PPP contracts is the quest to achieve value for money for the public purse. Contracts play a key role in this endeavor by allocating risks to the party best placed to manage each risk. This is a universally accepted principle, but often some risks are inherently difficult to quantify, which means that the private sector is either reluctant to take them on or prices them at a premium.5 Further, a concession that is too one-sided in favor of the public procurer will cause bidders to inflate their prices to accommodate risks, which has the potential to undermine the business case for the PPP project and adversely impact the value for money equation.
Engaging the right legal and financial advisers will help mitigate this risk. Experienced advisers know what the market will bear and what has been banked on comparable transactions in the region.
c. Inaccurate models
In assessing value for money and risk allocation, accurate modeling is critical. Toll road PPPs provide a cautionary tale for public procurers on the dangers of inaccurate models. For example, inaccurate traffic forecasts on an airport toll road in Brisbane, Australia, ultimately led to the bankruptcy of the project company and the consultant being sued by receivers for an estimated AUD 1.7 billion.6 Studies of PPPs across multiple sectors have shown that public procurers are more likely to overestimate the value of a particular PPP project — the result of “optimism bias.” This will be exacerbated if some of the other challenges noted in this article are evident (see, for example, Section b above). In the context of a toll road, modeling may overestimate the number of users or underestimate the impact of the new road in easing congestion. Depending on how revenue risk has been assigned under the concession agreement, this could result in the public procurer having to find more money in its budget to pay concession fees or the private operator facing financial strain and, in extreme circumstances, becoming insolvent.
The empirical evidence suggests that, in modeling any potential project, public procurers should account for optimism bias. Some jurisdictions have now released guidance for public sector procurers on how to do this.7 The risk of inaccuracies and optimism bias creeping in can be further mitigated by engaging experienced technical advisers to prepare, benchmark, test and/or audit project models.
e. Too many/too few bidders
Competition drives value. Too few bidders and the public procurer loses leverage in negotiations; too many bidders and the procurement process becomes unwieldy, lengthy and costly. Some of the other challenges identified in this article will have a bearing on the number of bidders (e.g., the contract terms, size and complexity of the deal, and perceived credit risk). Public procurers can also directly influence numbers through screening during the EOI and RFP processes, guided by technical, financial and legal advisers (to control the number of bids received) and through soft market testing and careful project structuring (to encourage more bids).
f. Strategic bidding by tenderers
Compared to traditional public sector procurements, PPP project bids are more expensive for bidders to produce for several reasons (e.g., increased complexity, required modeling, number of agreements/advisers involved), but the “prize” of a 20- to 30-year revenue stream under a concession is also much larger than that for a typical procurement. This has led several commentators to suggest that bidders may seek to “game” the system — bidding low to win a contract, then renegotiating a few years later when they have a stronger position as the incumbent operator. A perceived willingness of international public procurers to engage in contract renegotiations may exacerbate this risk.8
Evidence suggests that failure to run an adequate procurement process increases the likelihood that the terms of the PPP project will be renegotiated following award of a concession (usually to the benefit of the private sector rather than the public procurer).9 Examples of procurement strategies to counter this risk might include stress-testing bid models, conducting thorough diligence on bidders (which can be enhanced by data sharing between public procurers), and scrutinizing or rejecting bids that are significant price outliers.
In the implementation phase, carefully monitoring the project company can give the public procurer early warning of financial difficulties, the visibility of which can be enhanced if the public procurer has a stake in the project company.
3. Challenges During Implementation
a. Inflexible long-term lock-ins providing poor value for money
A feature of PPP projects is the long duration of the concession term. This is intended to ensure that bidders consider the whole-of-life consequences of their bid and to spread capital costs over a longer duration. Experience in jurisdictions that have pioneered PPP models (and have therefore seen the consequences pan out over the course of concession terms) suggests that long concession terms pose challenges when circumstances change in the future. If contract risk allocation is inefficient, public procurers will also find themselves locked into expensive contracts with an inability to effect change.
The UK’s review of the PFI contracting model recommended that these risks be mitigated by excluding some services from the scope of long-term PPP contracts and awarding them on shorter-term contracts instead.10 The review also recommended that public procurers take a stake in the SPV or use contractual mechanisms to ensure that the public sector shares in the benefit of any windfall profits.11
b. New projects’ strain on public resources
Public procurers should consider the impact a new project may have on their existing operations. While one of the benefits of using the PPP model is the potential to deliver more projects at once, this can lead to a surge in demand for critical resources. New hospitals and schools, for example, will create competition with existing facilities for doctors and teachers. Where those talents are “homegrown,” consideration should be given to scaling training programs to coincide with the projected PPP project completion dates.
In the GCC region, similar dynamics are being witnessed in the competition for construction materials and workers as a result of the pace and scale of construction projects (as well as various international supply-side shocks). This has two consequences for public procurers considering implementing PPP projects: (i) the inflationary effect on construction costs caused by increased demand coupled with constrained supply; and (ii) the potential for fewer bids due to contractor unavailability.
c. Lack of public procurer capacity for appropriate oversight/management
Another critique of the first wave of PPP projects in the UK and elsewhere is that the public procurers failed to reap the full benefits of their projects because they did not have the capacity — both in terms of raw numbers and relevant skills — to monitor them and react quickly to performance issues. Also, lack of visibility into the finances and management of the project companies delivering the projects contributed to the public perception that the private sector was making excessive profits from taxpayer money.12
Transparency issues can be addressed to a degree through contractual disclosure requirements and/or public sector equity stakes in the project company and rights to monitor and verify KPI data rather than rely on the project company’s data. These tools require public procurers to maintain a suitably skilled and diligent workforce to oversee project implementation.
d. Disincentives to maintain assets
One of the benefits of PPP projects is the incentive effect they have on bidders to design and build the project facilities (be they roads, power stations or hospitals) in such a manner that they are cost-effective to operate and maintain for the duration of the concession. On the other hand, unless there are robust handover requirements, the operator will be incentivized to run down facilities toward the end of the concession in order to reduce their costs and maximize their returns. If public procurers intend to utilize assets after the end of the concession term, it is important to include in the concession contract handover standards as well as mechanisms for inspecting the assets and enforcing those handover requirements through, for example, withholding of payments or delivery of bonds to cover the cost of any repair work required.
Conclusion
PPP projects present an exciting opportunity for the acceleration of infrastructure development across the Middle East. The lessons learned from successful PPP projects in the region and around the globe demonstrate that, when implemented correctly, PPPs can provide considerable benefits to both the public and private sectors and remain a valuable alternative to complement traditional procurement strategies.
While PPPs are not without their complexities, public procurers that are appropriately advised and prepared to invest time up-front in identifying suitable projects and allocating risk appropriately can realize the benefits of this procurement model and achieve good value for money on their infrastructure investments.
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