Public sector comparator methods in public-private partnership evaluation

Public Private Comparator

Public Sector Comparator (PSC) in the Public-private partnership (PPP) Process

Increased global financial pressures have caused many government entities to cut costs in any way possible. One way is to outsource services or projects to private companies. However, when comparing costs, the public sector frequently bases its cost calculations for a project by omitting certain types of factors. These can include employee benefits, utilities, or total administrative costs. As result, public sector services may erroneously appear to be less expensive than private services. The public cost comparator (PSC) provides a better comparison of the costs of public and private services. If the private sector can provide services cheaper than the public sector, then the public sector may choose to engage in a public -- private partnership (PPP). This allows them to share the costs, benefits, and risks of the project.

More than one method exists for comparing public and private job costs. Several factors that must be considered in the comparison are the discount rate, risk factors, and total costs of the project. In many cases, the discount rate will be lower for the public sector because they already have the infrastructure in place. This research will discuss various methods for calculating the public cost comparator and the effect of public-private partnership framework on the ability to lower costs through outsourcing public services.

Defining Concept: PPP

What is PPP?

The public-private partnership is a funding method whereby private companies and government entities form a partnership to carry out infrastructure improvement projects. The PPP offers several advantages over traditional funding methods. The PPP avoids the need to raise taxes. PPP projects do not raise government debt. They transfer some of the risk away from the government and the use of public funds (Nisar 2007). PPPs offer many options that are not available under traditional infrastructure improvement models. It has been found that private companies are often not interested in low-dollar projects. They are interested in larger projects. For instance, they will often be interested in building a new building, but they will not be interested in the upgrade of an existing building (Nisar 2007). The PPP arrangement can deliver better services through combining the best that the public and private sectors have to offer (Nisar 2007).

It is important to understand that PPPs differ from privatization. The distinguishing difference between these two terms is that the PPP focuses on partnership. However, some disagree with the use of the term "partnership" as they argue that partnerships usually share the same objectives. In the PPP both the private and public sector do not share the same objective. The objective of the private sector is to turn a profit, while the objective of the public entity is to provide a service (OECD 2008). Utilizing the PPP, the realization of the objectives of one party leads to the accomplishment of the objectives of the other party, but the two are not the same. This contrasts with traditional procurement means, where the objectives of both the supplier and other government entities are the same. In this case, the objectives of both parties are to provide a public service.

The PPP is an agreement between a government agency and one or more private partners. In order to be of benefit to both partners the planned project must meet both objectives of profit for the private partner and service delivery for the government entity. The government has the responsibility of stewardship of public funds and must accomplish service delivery in the most effective and efficient manner possible, regardless of the procurement process chosen (OECD 2008). The public-private partnership can only occur if the criteria for each entity are met in the project plan and design.

The most typical form of PPP is where the private partners designed, build, finance, operate, and manage the capital asset. They may deliver the final service either to the government or to the end users (OECD 2008). The private partner may receive a stream of payments from the government, or charges levied directly to end users. The government sets the standard for the quality and quantity of the end product. Payments may depend on the ability of the private partner to deliver the quality and quantity of services requested. Private partners assume a considerable amount of risk, in that they must ensure that the project operates smoothly and efficiently according to government standards. The public-private partnership can develop in many different forms. These include the build-own-maintain, build-own-operate, build-develop-operate, design-construct-manage-finance, design-build-operate, buy-build-operate, build-rent-own-transfer, build-transfer-operate, and many others (OECD 2008).

The significance of these different forms of the PPP are important in an understanding of the Public Sector Comparator. If each of these different forms of the PPP will have an affect on the accuracy of the public sector comparator and its ability to provide a realistic comparison between public and private funding of a project. The most important aspect to understand about the Public Sector Comparator is that many variables will have an affect on its accuracy and reliability. There is no single answer as to which of the factors should be included in the public sector comparator and how much weight they should be given. The public sector comparator has both quantitative and qualitative aspects, each of which must be considered for the proposed partnership. There is no "magic formula" that represents the best answer for the public sector comparator to utilize. Each project is different and has different parameters. Choosing the proper form of the public sector comparator can be a daunting task, but it is one of the most important factors if government entities wish to maintain efficient and effective use of public funds.

Global Perspective: UK, Australia, USA, Germany, Korea

Australia and the United Kingdom were among the first to adopt PPP strategies. However, France, Germany, Ireland, Italy, Japan, Korea, Portugal, Spain, Turkey, Argentina, Brazil, South Africa and others soon began to see PPP as a viable strategy for funding public projects (OECD 2008). The introduction of PPP into the government infrastructure raised several questions, one of which was whether the introduction of private entities into the public sector would create political problems. Those countries who wished to engage in the PPP process saw a need to develop clear legal framework and policies to ensure that sufficient capacity existed to manage the projects and that private entities did not gain control of some portion of the government (OECD 2008).

Many government agencies set up dedicated public-private partnership units to help with organization, set up or to help the government ensure that all provisions necessary are provided to the private entity to complete their task (OECD 2010). Seventeen OECD countries have dedicated public-private partnership units at a national level. The 17 countries are Australia, Belgium, Canada, Czech Republic, Denmark, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Korea, Netherlands, Poland, Portugal, and the United Kingdom. However, not all countries choose to have this type of unit at a national level. Tthe 12 countries that do not have a public-private partnership unit on a national level are Austria, Finland, Iceland, Luxembourg, Mexico, New Zealand, Norway, Slovak Republic, Spain, Sweden, Switzerland, and the United States (OECD 2010).

In addition to different methods of managing public-private partnerships, countries also have different definitions of public-private partnerships. For instance, Korea defines a public-private partnership project as a project to build and operate infrastructure which has been traditionally constructed and run by government funding (OECD 2010). The United Kingdom defines a public-private partnership as "typified by joint working between the public and private sectors" (OECD 2010: 22). They further define the PPP by the types of projects that they can cover. The most common definition is that it must be one involving an investment of assets in a public project on a long-term basis between 15 and 30 years (OECD 2010). In this State of Victoria, Australia, a public-private partnership relates to the provision of any ancillary service that involves private investment or financing of more than a minimal monetary amount.

Throughout the world, PPPs account for varying percentages of infrastructure investment. Mexico and Chile utilize the greatest percentage of PPP infrastructure projects at >20%. Korea and New South Wales utilize between 10-15%. The UK, Czech Republic, Slovak Republic, Greece, Italy, South Africa, and Ireland utilize between 5-10%. The lowest usage of PPP infrastructure projects are undertaken by Austria, Germany, Canada, Denmark, France, Netherlands, Hungary, Norway and Spain at less than 5% (Burger & Hawkesworth 2010). Traditional procurement (TIP) is still the most widely utilized method for funding public projects and it is also the default mode of procurement. Many countries lack criteria to identify how projects are chosen as PPP or TIP candidates (Burger & Hawkesworth 2010).

In the State of Victoria, Australia the public-private partnership relates to the provision of infrastructure and related services which involve private investment or financing with a present value of payments for service to be made of more than AUD 10 million (OECD 2010). South Africa defines the public-private partnership as a commercial transaction between the government and a private partner in which the private party performs an institutional function on behalf of the governmental institution for a specified or indefinite period of time (OECD 2010).

As one can see, a variety of factors affect the public-private partnership. Not all countries treat public-private partnerships in the same way. They have different agencies for administering public-private partnerships, different ways of dividing risk and different ways of defining the public-private partnership. There are many differences in the types of transactions, payment methods, and rules that govern the public-private partnership. In order to understand the public sector comparator, one must first understand the various factors that influence the public-private partnership in its many forms.

Economic Effectiveness Analysis on PPP

The main reason for considering a PPP is a lack of government funding available (ESCAP, 2011). However, this is not a good reason to undertake a PPP. Several factors can make the PPP project more expensive than conventional funding. For instance, the cost of borrowing money can be more expensive for private companies than for the government. There also administrative costs for managing the contractual obligations of the PPP (ESCAP, 2011). Transaction costs a PPP projects can be high. The government can also expose themselves to greater risk through implicit and explicit liabilities (ESCAP, 2011). These factors must be considered for determining the economic effectiveness of the PPP.

Under Eurostat rules, PPP ease are classified as private investment if the private partner bears most of the construction risk, and either availability or demand risk (Ted-Minassian, 2006). Low deficits can result in some projects being classified as PPPs just to classify them as private, even though the government still has sizable risks. In addition, some projects that are well suited for PPPs are not being designed optimally in order to classify them as private (Ted-Minassian, 2006). Both of these scenarios represent economic inefficiency in the use of PPPs. The economic effectiveness of the PPP depends on the ability to properly classify it based on the economic situation in the host country.

Public Sector Comparator

Relationship between PPP & PSC

Public-private partnerships (P3) are a growing trend throughout the United States and Canada. The Province of British Columbia has invested more than $9 billion in 25 P3 projects since 2002 (Naim 2009). PSC projects have many benefits to the public. These include lower costs, higher levels of services, and reduced risk through risk transference or sharing (Naim 2009). P3 projects also give the public sector access to capital that they would not otherwise have.

The PSC is used to determine the value for money (VFM) of a project using the P3 model. The PSC helps to determine whether the public will receive a sufficient return from the project if they use a public-private partnership. Value for money is the driving force behind PPPs and traditionally procured projects (TIP) (Burger & Hawkesworth 2010).

Value for Money

Value for Money (VFM) tests come in many different forms which give different results. Choosing the correct VFM methodology is one of the most difficult tasks faced by PPP cost analysts. Simple cost tests and full cost-benefits tests give approximately the same answers and are considered to be acceptable substitutes for each other (Grout, 2005). Choice of discount rate and certain types of risk are different for various VFM methods.

Several types of risks are involved in each project and different VFM methods treat them differently. Specific risks are those that are only involved with the project under consideration. They are different for every project. Specific risks can be categorized and priced accordingly (Grout 2005). Systematic risks differ from specific risks. Systematic risks are closely related to a correlation between the risk of a particular asset as compared to the risks associated with a set of all assets (Grout 2005).

Differences exist in the way various countries approach VFM tests. In Victoria, Australia the VFM is calculated through the net present cost to the government. It takes into account the public sector method of providing preferred output. The comparison considers the specific costs and risks the public procurement is likely to face. The method also takes into account the value of risks allocated to private parties in the PPP. This method attempts to remove advantages that are inherent with the government entity, simply as a result of their position. The PSC is used as a benchmark to assess bids. The method takes into account innovation that will make it more or less costly for the government to deliver services to the public. The method also has a qualitative aspect such as the bidder's reputation, references and performance on past projects (Grout 2005).

VFM tests in British Columbia, Canada include both quantitative and qualitative elements. The method includes a qualitative assessment of the VFM under different procurement methods, a PSC calculation and a procurement test. Like the Victoria, Australia model competition neutrality is assumed (Grout 2005). The Canadian method also considers many factors that are difficult to quantify in monetary terms. One such example of this type of factor is indirect jobs that will be created by the project. Macroeconomic effects such as economic stimulus and environmental benefits also fall into this category.

In Ireland the VFM method focuses on the appraisal process and the capacity of the private sector to deliver in terms of monetary value. The Irish method takes into account the potential for the project to be procured as a PPP and the form of PPP that will offer the best value for money. The Irish method takes into account the result of similar projects in the past and the capacity of the private sector to provide quality service should they be chosen. In the case where there is doubt about the ability of the PPP to deliver the services that are promised, the contracting agency will develop a shadow bid. This allows the contracting agency to compare the costs of the provision of services through the PPP and through traditional procurement channels (Grout 2005).

In the Netherlands, the process contains four primary steps. The first is the inception report which outlines the various procurement options. The second portion is the qualitative analysis to provide insight into the financial difference between the various options. The third is the quantitative analysis of the various procurement options. The final report concludes whether the PPP represents the best VFM or whether the traditional procurement methods will be utilized (Grout 2005).

This comparison of various VFM methods demonstrates the diversity in methods that can be utilized to accomplish the same task and to arrive at the same decision. These methods use a mix of quantitative and qualitative methods to arrive at their conclusions. Some of the methods, such as that of Ireland use almost entirely quantitative methods. However, others such as that of Canada, rely more on qualitative methods. This comparison demonstrates the variability in the methods used and the lack of standardization that exists. The VFM method chosen is a matter of preference, economic conditions in the country and preference. VFM methods utilize a hybrid of quantitative and qualitative methods in various degrees.

The Processes of PSC in PPP

The PSC has several components. Inflation rates are determined by projections provided by the state government. Direct capital costs include items such as construction and commissioning, raw materials, design and planning, upfront consultancy costs, and contingencies. Capital receipts include the residual value of the project once complete. Maintenance and lifecycle costs include capital and maintenance costs, lifecycle costing, and labor required for maintenance (Government of Western Australia 2011). Direct operating costs include the cost of inputs, employee costs that are directly related to the service provision, and insurance. Indirect costs include corporate overhead. Third party project revenues include third party demand for infrastructure and government allowed third party utilization (Government of Western Australia 2011). These items are common to many PSC calculations and are not unique to the Australian PSC.

The government has several advantages over the private bidder. They do not have to pay land tax, payroll tax or stamp duty. These represent advantages that a government entity has that are not available to an outside bidder. These advantages would be different in other countries and under different tax schemes. Project specific risk would be different from project to project. This is risk that is associated with the outcome being better or worse. This risk is estimated as part of the PSC calculation. Not all risk is retained by the public entity. Some risk is transferred to the contracting party. Risk can be divided into transferred and retained risk (Government of Western Australia 2011). Sensitivity analysis is performed to determine the robustness of the PSC and potential changes in the assumptions used to calculate it (Government of Western Australia 2011). A calculated discount rate is applied to the PSC and to the bids received.

Partnerships Victoria also outlined several different risk categories. Quantifiable risks include retained risk and transferable risk. Transferable risk is that which can be transferred to the private party if the project proceeds. Retained risks are those that the government expects to incur if the project proceeds under Partnership Victoria (Partnerships Victoria 2003). Other components of the PSC that must be considered in a Partnerships Victoria Project are transaction costs, inflation, efficiency dividend, residual value, competitive neutrality, abatement and bonus adjustments. Calculating the PSC in a Partnerships Victoria project must take into account many factors. The goal is to transform as many factors as possible into quantifiable terms.

Australia's PSC guidelines and policy is an excellent example of a highly defined process for constructing an accurate PSC in the public-private partnership. Partnership Victoria projects require a PSC to be constructed for every project in the initial stage during the pre-market period. The PSC can be changed throughout the procurement process if circumstances change that reflect a more efficient delivery of services. The PSC allows an accurate estimate for the most efficient use of public funds. It is important that it be as accurate as possible and demonstrates the best estimation of value for money. In some cases, the PSC is disclosed to bidders to allow for a more efficient bidding process (Partnerships Victoria 2003). There are many variations of this process in other countries, but the Australian example is the most widely used for the development of PSC in the world.

Developing A Successful PPP

Several factors were found to be necessary for a successful P3 project. These are:

"• Clearly defined project scope;

• Clearly defined needs and objectives;

• Clearly defined process for project development and approval;

• Flexibility for the private sector in innovation and delivery;

• Allocation of risk to those parties best able to manage and mitigate risk elements;

• Clearly defined performance measurements and incentives;

• Private sector competition" (Naim, 2009).

One of the key errors in the implementation of PPP projects is that they are often implemented in a hurry, with a lack of adequate funding or advice from experts in the field (Delman, 2010).

Recent economic Crisis and PPP

The current financial crisis impacts governments all over the world. Many countries that did not consider public-private partnerships in the past are now beginning to explore the benefits of the public-private partnership to their economy. A majority of the literature that promotes the public-private partnership as the ultimate answer to the world's financial woes. However, the this research study addresses many issues that can jeopardize success of the public-private partnership in accomplishing its goals. One of the most important factors in the ability to establish a successful beneficiary partnership was the accuracy and ability to provide a meaningful public sector comparator.

The Futuristic role of PPP

Boundaries between the public and private sector are shifting and in some cases becoming blurred. Many governments now seek public-private partnerships as a way to balance struggling economies and improve their economic position. The face of public management is changing and public performance is now measured by output and efficiency more so than in the past (Bult-Spiering & Dewulf, 2006). As was found throughout this research study, the difference between public and private projects can take many different forms. This has been described as a spectrum according to the amount of autonomy that the private partner has in performing the duties required by the project. The spectrum ranges from complete public autonomy without the use of private partnerships to one where the private entity takes complete control of the project with very little government intervention (Bult-Spiering & Dewulf, 2006). Different countries take a different approach to public-private partnerships and in many cases differences can be found according to the project be undertaken. All of these factors have an affect on the ability to accurately calculate the PSC.

The public-private partnership represents a new revolution in infrastructure financing. The infrastructure benefits both public and private entities. Private entities benefit from improvements in infrastructure that are provided by public funds (Grimsey & Lewis 2007). One example of this is transportation infrastructure. Transport is a service which is used as an input into the production of products and services. Input by private entities into the infrastructure reduces the cost to all individuals that use it by lowering the capital needed to provide it (Grimsey & Lewis 2007). Governments need the private sector to reduce their debt and the burden on the public. As our infrastructure ages and deteriorates, it needs to be replaced. These factors, coupled with the growing demand on public sector services force a government to search for the most efficient means to provide the infrastructure for use to both individuals and businesses (Grimsey & Lewis 2007).

Public-private partnerships bring benefits to their host governments, but there is mounting evidence that the implementation of PPPs creates many managerial, technical, and fiscal problems (Yescombe, 2007). The public-private partnership requires additional skills for those in the public sector. The appraisal methodology has many weaknesses, which were the topic of this research study. Accountability and transparency are another issue that plagues the success of PPP projects. Profitability represents an issue that is often troublesome, particularly when contracts have to be refinanced (Yescombe 2007). Yescombe points out that the PPP project can be an excellent tool for improving government efficiency and reducing waste. However, if proper attention is not paid to metrics and the appraisal system, the project can soon turn into a losing proposition for one or both parties (Hodge & Greve 2005).

In the transportation industry several key concerns were found in interviews regarding the public-private partnership process. These concerns echoed those found in other sources. They included a lack of ability a state's department of transportation to administer and provide oversight to P3 projects. There was a concern over who would have the final authority and decision-making ability of the end of the project. This is particularly troublesome when the issues involve public safety, homeland security, and other national interest issues. Authority and oversight are key concerns over public-private partnerships throughout the transportation department (Buxbaum & Ortiz 2009). The same concerns would be similar in other public-private partnership projects as well.

Many lessons have been learned about the public-private partnership over the past 30 years. A public-private partnerships have seen many successes and failures over the past 30 years. These provide an excellent reference upon which to build best practices in the public-private partnership to ensure the greatest chances of success for each party (Yong 2010). It is difficult to determine which form is best for any particular given situation. What works in industrialized nations may not necessarily work in developing nations. The economic status and profile of the country also helps to determine the best approach to ensure success of the public-private partnership.

Prospect of PPP

The growth of public-private partnerships continues to increase in many countries around the world, largely due to the need to provide greater efficiency in the expenditure and stewardship of public monies. This problem is compounded by the global financial crisis and its impact on government debt and stability. As this research found, the structure of the public-private partnership varies in different countries. The level of governance and involvement of the public entity in the project has an affect on the PSC and the accuracy of the value for money estimate.

Value for money tests and public sector comparator are utilized for determining if the project is viable. These analytics are also used to establish benchmarks throughout the life of the project. The criteria for these financial tests can change due to changing risk structures and differences in quantifiable factors. It was found that countries have different criteria for the reliability of the VFM and for the PSC. One cannot make general statements about these factors, except that the more reliable these factors are, the better the government and can estimate the cost benefits of the public-private partnership.

Conclusion

Much of this research focused on the framework and governing characteristics of the public-private partnership. It is difficult to enter into a discussion that specifically addresses the public sector comparator without first engaging in an extensive dialogue about the public-private partnership. The public-private partnership is the basis for the public sector comparator. The initial purpose of this research was to define and explore the differences in calculation of the public sector comparator. It was expected that the research would result in certain factors that would provide a closer estimation of costs than others.

Instead, the research found that no best method exists for developing a public sector comparator. What was discovered during the research is that many different factors influence the accuracy and reliability of the public sector comparator. The development of the public sector comparator algorithm must take into consideration many different influences. For instance, the public sector comparator must take into consideration economic factors, market stability, laws and regulations, tax schemes, and other elements that would influence the costs of a project. Due to the shifting nature of certain variables, it is possible that a public sector comparator may be developed at the beginning of a project that is no longer valid when the project begins.

This study found that not all public-private partnerships are cost effective. It found that the inability to establish a reliable and accurate PSC played a key role in the inability to foresee the cost of the project. At present, Australia has the most advanced system for establishing the PSC and for the conduct of public-private partnership projects. Australia serves as a prime model for the establishment of public-private partnership governance in other parts of the world. In countries such as Germany and the United States, little consistency exists in terms of the public-private partnership. This inconsistency translates into the inability to establish a reliable and accurate VFM and PSC.

Market pressures in the global economy will continue to make the public-private partnership play an important role in cost savings to government entities. However, at present there are many models available for calculating the VFM and PSC. There are also many discrepancies in the establishment of quantifiable terms in its calculation. These issues will remain a barrier in the use of the PSC in the establishment of public-private partnerships. The example of Australia emphasizes the importance of establishing clear guidelines and policies for public-private partnerships and the calculation of the public sector comparator. The most important outcome of this research is in establishing a need for more consistent policies and procedures for calculating the public sector comparator and in the governance of public-private partnerships. Establishing consistent rules and regulations will improve the ability of the public sector comparator to predict the outcome of public-private partnerships.