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ConcessionFinancial regulationInfrastructurePublic private partnershipPrivatizationSource selection

(Pre dto better serve the public needs. However, in worldwide practices, there are

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IATSS Research 36 (2013) 8897

Contents lists available at SciVerse ScienceDirect

IATSS Reexploring innovative means for improved infrastructure development,and consequently different types of publicprivate partnerships(PPPs) have been practiced. PPPs are contractual relationshipsgoverning a long-term public sector acquisition and private sector pro-vision of public works and services [2]. PPP projects have the following

publicmonopolies in infrastructure development and service provision,and inmerging the resources of both public and private sectors to betterserve the public needs that otherwise would not be met. A great num-ber of infrastructure projects have been successfully developed throughPPPs with signicantly increased value and substantial cost savings [4].In addition, the public sector often lacks the technologies, skills and ex-pertise required for efcient infrastructure development. Furthermore,civil servants often have less incentive to invest wisely than private pro-ject managers [1]. Facing these problems, governments worldwide are

manage them through better utilization of resources and improved pro-ject control; and (3) PPP projects are usually based on a long-termcontract to encourage innovations and low life cycle costs.

PPPs play an important role in bringing private sector competition to Corresponding author.E-mail address: zhangxq@ust.hk (X. Zhang).

Peer reviewunder responsibility of International Associati

0386-1112/$ see front matter 2012 International Ahttp://dx.doi.org/10.1016/j.iatssr.2012.11.001cture and services world-ountry is always limited.

construction, nancing and operation of the infrastructure, in returnfor payments either from the users of the infrastructure or from thepublic client itself; (2) public and private partners share risks and jointlyThere is a huge demand on public infrastruwide whereas the government budget of any c1. Introductionpractices and lessons from unsuccessful projects, this framework integrates the four broadly divided stagesthat repeat over time: (1) design of a workable concession, (2) competitive concessionaire selection, (3) -nancial regulation, and (4) periodic reconcession and rebidding. The four-stage framework takes into accountthe requirements of public services, realignment of responsibility and reward among multiple participants inPPPs, the monopolistic rights of the concessionaire, and the wide range of risks and uncertainties in the longconcession period. Varying competition elements are incorporated in each of the four stages for continuousperformance improvement in the delivery of public works and services. The design of the right concessionforms the base on which other stages are implemented in addition to planning the project and allocatingrisks for enhanced efciency. The nancial regulation allows the government to address changing conditionsand to regulate the concession for efcient operation with due discretion, whereas the competitive conces-sionaire selection and periodic reconcession and rebidding play critical roles in achieving innovation, efcien-cy and cost effectiveness through direct competition rather than government discretionary intervention.

2012 International Association of Trafc and Safety Sciences. Production and hosting by Elsevier Ltd.All rights reserved.

common characteristics [3]: (1) a private partner provides the design,on of

ssociaework for the delivery of public works and services through PPPs in general. Justied by publicurement principles, aimed at a publicprivate winwin solution, and based on worldwide best industrialKeywords:mixed results, substantial controversy, criticism and conict over PPPs. This paper proposes a systematicframReceived in revised form 30 October 2012Accepted 2 November 2012

public and private sectorsA systematic framework for infrastructureprivate partnerships

Xueqing Zhang , Shu ChenDepartment of Civil and Environmental Engineering, The Hong Kong University of Science a

a b s t r a c ta r t i c l e i n f o

Article history:Received 13 June 2012

Publicprivate partnershipsmonopolies in infrastructuTrafc and Safety Sciences.

tion of Trafc and Safety Scienevelopment through public

Technology, Clear Water Bay, Kowloon, Hong Kong

PPs) play an important role in bringing private sector competition to publicevelopment and service provision and in merging the resources of both

searchFor example, it is reported that U.S. state and local governments haveroutinely experienced 1040% cost savings and improvements in ser-vice quality and asset management through PPPs [5]. On the otherhand, many privatized projects suffered disastrous consequences be-cause of construction cost/duration overruns, changing market de-mand, depreciation of local currencies and/or reduction in tolls/tariffsby utilities. Some of them had been postponed or abandoned by thesponsors, and others had to be bailed out by host governments [68].

ces. Production and hosting by Elsevier Ltd. All rights reserved.

Accompanying the mixed results mentioned above, substantialcontroversy, criticism and conict exist over PPPs. The division inthinking over PPPs is as wide as the world itself. Opponents arguethat (1) the prot-making objective of the private sector motivatesthem to seek cost savings at the expense of quality services, and there-fore, is antithetical to the public's well-being; and (2) the involvementof private sector in public services results in loss of jobs of public em-ployees and consequently a counterproductive relationshipwith unionsof public employees [9]. In contrast, proponents contend that the protmotive of the private sector does not necessarily comprise service qual-ity or reduce public jobs. Instead, improved level of service via cost ef-fective solutions are possible as the private sector can become moreaccountable to the public through well-designed PPPs, which providethe public sector sufcient control over the works and services beingprovided by the private sector while allowing the management skills,technologies and nancial resources of the private sector to come intoplay. The National Council for PublicPrivate Partnerships (NCPPP) ofthe United States provides successful PPP examples in transportation,urban development, schools, water/wastewater and other infrastruc-ture sectors to support these contentions [5].

The worldwide interest in PPPs, problems encountered in manycountries and the substantial controversy over PPPs call for animproved methodology for improved infrastructure and servicedelivery through PPPs. The writers have thus conducted researchcorresponding to this call. This research results in a better under-standing of PPPs and the development of a framework that inte-grates different stages in the delivery of public works and servicesand systematically addresses the key issues in each stage in orderto achieve continuous efciency improvement. This framework is

based on worldwide best industrial practices and lesions from un-successful projects, aimed at publicprivate winwin outcomes,and justied by public procurement principles. Details of the re-search outputs are provided in the following sections.

2. Framework for a systematic approach

2.1. Four-stage systematic framework

A systematic approach is taken in the proposed framework forinfrastructure development through PPPs in general. Basically, theproposed framework (please see Fig. 1) integrates four broadly divid-ed stages in the infrastructure and service delivery process, including(1) design of a workable concession, (2) competitive concessionaireselection, (3) nancial regulation of the selected concessionaireduring the concession period, and (4) periodic reconcession andrebidding to allow changes and adjustments of the concession, andnew entry for the concession. This general framework is proposedon the realization that although there are many aspects that areproject, sector, and/or country-specic, the concept, process and keyprinciples in infrastructure and service delivery through PPPs areessentially identical, which is supported by the World Bank and theInter-American Development Bank [1].

A validation process had been conducted to justify the proposedframework and evaluate its potential application in the industry. Inthis regard, opinions of experts and practitioners in PPPs from Canada,China and United Kingdom had been solicited. Sixteen professionalsparticipated in this validation process. In general, most of them agreedthat this framework was well-developed and that it included key issues

Concession or Free Competition

Separation of Monopolistic and Competitive Sectors

Public Sector Comparator

Integrated Project Plan

sign

Multiple Objectives

Tradeoff of Cost/ Noncost CriteriaEvaluation Methods

(1) Simple scoring method

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89X. Zhang, S. Chen / IATSS Research 36 (2013) 8897Projections of Market Demand

Risk Allocation andGovernment Support

Partnership Evaluation

Technical Innovations

Public Affordability

Performance-Based Contracting

Certainty vs Flexibility

Con

cess

ion

De

Strengthening Competition periodically

Changes in operation conditions and service requirements

Scheduled and Unscheduled Concession

Reducing regulatory discretion

Valuation of Unamortized Assets

Concession Specific and Nonspecific Assts

Concession Rebidding Interval

Biased Rebidding FavoringIncumbent Concessionaire

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PrincWSoFig. 1. Four-stage systematic framework foChallenges to Best Value Selection

(1) Financial(2) Technical

(3) Safety/ health/environmental(4) Managerial

Competitive Process

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Maintaining CompetitionReflecting Changes/Risks

Balancing Efficiency Incentiveand Earning Insurance

Types of Regulation(1) Rate of return

(2) Price cap(3) Intermediate scheme

Price Setting and Adjustment

Overcoming Regulatory Weaknesses

(1) Efficient level of cost(2) Regulatory lag(3) Prudence test of capital

investment (4) Pass-through of exogenous

costs(5) Sliding scale (6) Public/private profit/loss

sharing(7) Floating rate of return(8) Reducing regulatory

burden and transaction costs(9) Efficient information

management system

Fina

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Participation Constraint andEfficiency Requirement

lic ment

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onsr PPPs in infrastructure development.

90 X. Zhang, S. Chen / IATSS Research 36 (2013) 8897to be dealt with in a systematic approach to infrastructure developmentthrough PPPs, although some suggested that some aspects of the frame-work need to be modied or improved.

2.2. Public procurement principles

The acquisition of public works and services should follow relevantprocurement principles, mainly including accountability, transparency,value for money and fair competition [10]. Accountability requiresclarity in assigning responsibilities to project participants and answer-ability of the concessionaire to the government, regulator, and the gen-eral public. Transparency necessitates an open approach to decision-making, which enables the establishment of a mutual trust betweenpublic and private sectors. In this regard, the government must makeexplicit (1) its objective and requirements in a business transaction,(2) key assumptions about risk denition, assessment and allocation,(3) the format of the tender proposal and the denition of anon-responsive proposal, (4) the tender evaluation criteria and theirrelative importance, (5) contracting monitoring methods, (6) paymentmethods, and (7) incentive schemes. Value for money requires thatcosts associated with the acquisition of a public work and/or serviceshould be justied by the value generated from such a business transac-tion. Measures should be taken to ensure that the prot motive of theprivate enterprise does not lead to an undermining of the public good.

2.3. Publicprivate winwin solution

Successful infrastructure development through PPPs necessitatesthe adoption of a publicprivate winwin solution that adequately ad-dresses the concerns of both sectors and guarantees the interests ofeach of them. This winwin solution means that the PPP project agree-ment should be designed in away that on the onehand it allows the pri-vate partner to make adequate returns to its capital investments whichare usually sunk and subject to social, political, economic, technical andenvironmental risks and that on the other hand it allows the publicpartner to achieve social objectives, and productive and allocative ef-ciency, and to maintain appropriate quality, environmental, and healthstandards. The requirement of a winwin solution is conrmed byLaffont and Tirole [11], who maintain that the regulator should designa contract that is (a) acceptable to the regulated rm and (b) as goodas possible for society as a whole. This equivalently means that a con-cession agreement should satisfy the participation constraint to pre-vent the concessionaire from bankrupting and to provide it withincentives to be efcient [12].

2.4. Rationale of the framework

The public procurement principles and publicprivate winwinsolution act somewhat as guidelines or constraints for decisionsmade in each of the four stages of the framework, which repeatover time possibly as long as the service is needed. The four-stageframework takes into account the requirements of public services, re-alignment of responsibility and reward among multiple project par-ticipants in PPPs, the monopolistic rights of the concessionaire, andthe wide range of risks and uncertainties in the long concession peri-od. The design of the right concession forms the base on which otherstages are implemented in addition to planning the project and allo-cating risks for enhanced efciency. The nancial regulation allowsthe government to address changing conditions and regulate the con-cession for efcient operation with due discretion, whereas the com-petitive concessionaire selection and periodic reconcession andrebidding play an important role in achieving innovation, efciencyand cost effectiveness through direct competition which extracts mo-nopoly rents without government discretionary intervention.

Varying competition elements are incorporated in each of the four

stages for continuous performance improvement in the delivery ofinfrastructure and services. In the concession design stage, risks areeffectively controlled through appropriate risk allocation and rightselection of a PPP model. In the concessionaire selection stage, themost competent consortium available is chosen through competitivebidding, which would offer cost-effective services at required qualitystandards. During the concession, the nancial regulation maintains acompetition environment to address potential efciency problemsrelated to the incumbent concessionaire's monopolistic rights and toensure its continuous efciency improvement. By periodic reconcessionand rebidding at the end of each concession, a new entrant is allowed tocompete for the concession and this enhances competitive efciency forthe following concession by choosing a new concessionaire that ismorecompetent than the incumbent. Periodic rebidding also keeps the in-cumbent concessionaire under pressure to improve performance dur-ing the term of the current concession in order to raise its chances ofkeeping the following concession, and to offer competitive service inthe following concession if selected.

3. Design of concession

3.1. Concession or not

Typically in a PPP project, the public client entrusts through a con-cession a private entity (i.e., the concessionaire) with predened rights(1) to implement a project, in which the concessionaire is responsiblefor and has some freedom to choose the means for achieving the spec-ied performance targets related to construction of infrastructure facil-ities, long-term operation and maintenance of these facilities, andprovision of relevant services; and (2) to collect fees for its services.Concessions are maneuvered to achieve one or both of the two mainpurposes: (1) bringing competition to government monopolies and(2) attracting private funds, technology, knowledge and expertise. Theconcession option should be evaluated against two other alternatives,i.e., one that completely relinquishes government monopoly andallowing direct competition in the market, and another that continuesgovernment self-provision through a traditional public procurementapproach. If it is determined that the concession is the best option,then the next step is to focus on designing an appropriate concessionthat reects the country and sector specic conditions and demon-strates the best value. Several key issues need to bedealtwith in conces-sion design, and these issues are discussed in detail in the followingsections of this part.

3.2. Separation of monopolistic sectors from competitive ones

A pure monopoly has the following characteristics: (1) a companyis a single provider of a product/service, (2) there are no close substi-tutes to the product/service of this company, (3) this company con-trols the total supply of the whole industry and is able to exert asignicant degree of control over the price by changing the quantityof supply, and (4) entry to the market is blocked by some economic,technological and/or legal barriers [13]. A monopolistic companyhas the power to limit production and raise the price above whatwould be a competitive price and/or to use price discrimination tomaximize its prots [14]. Natural monopoly refers to an industrywhere the provision of a product/service involves huge capital costsbut minimal variable costs, and consequently, it is more economicallyefcient for a single company to provide this product/service thanfree entry of many companies to compete for the provision of thisproduct/service [14,15].

PPP projects have been successfully developed in a wide range ofindustries, including both competitive sectors and naturally monopo-listic sectors. For a competitive industry, newcomers can enter the in-dustry freely and there is no monopolistic power associated with aPPP project in this industry. A PPP project is subject to competition

from other projects. For an industry that is naturally monopolistic,

91X. Zhang, S. Chen / IATSS Research 36 (2013) 8897competitive concessions create a certain degree of competition to theindustry by allowing companies to compete for themarket periodically.Concessions are most suitable for naturally monopolistic infrastructuresectors. Therefore, there is a need to differentiate monopolistic indus-tries from competitive ones. The natural reason for this industry tobe a monopoly is that it has large economies of scale: the averageproduction/service cost declines as the quantity of production or thenumber of users increases due to more intensive utilization ofresources. Natural monopoly arises typically in network industries. Itis often wasteful to have more than one provider in a specic area be-cause of the high costs of duplicating the infrastructure, e.g., parallelrailway systems or water/sewerage pipe networks. The World Bankand the Inter-AmericanDevelopment Bank [1] list (1) the following sec-tors as natural monopolies and therefore the most suitable candidatesfor concessions: water distribution, power transmission and distribu-tion, gas transmission and distribution, railway infrastructure, androads; and (2) the following sectors as potentially competitive andtherefore ordinary competition should be considered rst before usingconcessions: power generation and supply, gas production and supply,long-distance and mobile telecommunications and rail services.Furthermore, an infrastructure sector may contain potentially com-petitive and inherently monopolistic segments. Competitive seg-ments (e.g., power generation and retail supply) may be separatedfrom monopolistic ones (e.g., power transmission and distribution).In general, it is advisable that the government allow ordinary marketcompetition to play in the potentially competitive sectors/segmentsand design competitive concessions for sectors/segments that arenaturally monopolistic. However, please note that concessions maynot necessarily be the wrong option for potentially competitive sec-tors/segments. For example, if the industry is too small to support ef-fective competition, a competitively awarded concession may be anappropriate option. Nonetheless, before turning to a concession op-tion, the ordinary market competition alternative should be exam-ined to see whether it works or whether it can be made to work byreforming and restructuring the industry.

3.3. Projections of market demand

PPP projects are often based on a project-nancing principle, thatis, debt and equity used to nance the project are supposed to be paidback from revenues to be generated by the project, and lenders haveno recourse or only limited recourse to the general funds or assets ofthe project sponsors [16]. The selection of a PPP project to be devel-oped through project-nancing should be justied by a sound fore-cast of the future market demand of the product/service from theproject. The project scope needs to be realistic and exible to reectthe situations of future market demand, and different investment sce-narios should be carefully planned for alternative market possibilitiesso that they are adaptable to changes in the long concession period,instead of xing the milestones of investments. Inappropriate projectselection, overly ambitious project scope/size, or rigid investmentplan may cause serious problems [17].

3.4. Risk allocation and government support

The allocation of risks among project participants is at the core ofthe concession design. Public and private sectors have different capa-bilities and may deploy different measures to mitigate different typesof risks. In general, risks should be allocated to the party who is bestpositioned to manage them, for example, in terms of possession of in-formation and accessibility to necessary risk hedging instruments.The World Bank and the Inter-American Development Bank [1] havesummarized the main types of risks encountered in infrastructureprojects and the way in which they should normally be allocated,not only between the government and the concessionaire, but also

between other parties, such as contractors, suppliers, insurers, andusers. The government should only transfer risks that can be bettermanaged by the private sector, and retains risks that are beyond thecontrol of the private parties. Furthermore, private sector investorsare usually risk averse. The government may even share some of therisks that are supposed to be better managed by the private sectorto encourage more private parties to take part in the bidding process,thereby enhancing competition and consequently increasing thechance of obtaining the best offer. However, the government shouldlimit its contingent liabilities and ensure that the risk sharing mecha-nism should not result in the concessionaire's weak incentives to takemeasures to minimize risks or its adopting other types of uneconomicbehavior.

3.5. Evaluation of partnership models

A concession is dened by the underlying contractual arrangementof the particular PPP model adopted. There is a spectrum of contractualmodels for PPPs with different scenarios of responsibility and risk allo-cation among project participants. For example, the United States Gen-eral Accounting Ofce [18] has dened the following models of PPPs:buildownoperate, buildoperatetransfer (BOT), buybuildoperate,designbuildoperate, and builddevelopoperate. However, pleasenote that these PPP models are not always used consistently acrosscountries or evenwithin a country.Whatmattersmost are the risk allo-cation and incentives built into a specic PPP scheme. Therefore, de-signing a scheme that strikes the right balance between the interestsof the public and private sectors and that ts the conditions of the in-dustrial sector and the country concerned is pivotal [19].

In partnership evaluation, the government compares different PPPmodels against its business missions and strategic needs, and conse-quently chooses an appropriate one for the project under consideration.In the United Kingdom, the following approaches are taken in partner-ship evaluation: (1) determining the need within the public client'sstrategic context, (2) formulating alternative PPP models, and identify-ing, quantifying and valuing the costs, benets, risks and uncertaintiesassociated with each model, (3) checking each PPP model against thepublic client's business needs, policy objectives and available resources,(4) estimating the potential cost savings and/or service quality im-provement of each PPP model, (5) examining the likelihood of success-ful development of each model in light of the particular conditions ofthe project, such as the operational needs, risk structure, the proposedscope of risk transfer to the private sector, and the interest and capacityof the private sector, and (6) presenting the results and recommenda-tions to the management for nal decisions [20,21].

3.6. Comparison with traditional procurement approaches

The chosen PPP model may need to be compared with a publicsector comparator (PSC) to demonstrate value for money and enhancethe partnership evaluation. This is practiced in the United Kingdom. ThePSC describes a traditional public procurement option for the projectunder consideration. However, the PSC does not necessarily mean thegovernment providing all assets and services directly, but assumingsome greater degree of involvement in project development. The keyissue of the PSC is to identify all the costs and benets to the public ifthe project were to be provided by a traditional means of the fullrange of services required under the chosen PPP model. In this regard,one point that needs to be paid attention is that the PSC should includethe quantied costs of risks being retained by the government such asconstruction cost overruns, and technological obsolescence in additionto the capital expenditure, operation andmaintenance costs. Such com-parison should be made over the whole contract life and reect all theconstituents of the contract. Alternative benchmarks may be used asthe PSC for nancial comparisons with the PPP approach. This may bea do nothing option, the costs and rates of return available in the

current market, a similar recent privately nanced project, or a quite

in operation since 1988, and the Yan'an Donglu 2nd Tunnel, which

sector usually lacks interest in developing a non or less protable

and in highway concessions in the United Kingdom, payments are

92 X. Zhang, S. Chen / IATSS Research 36 (2013) 8897linked to performancemeasures such as the availability of carriagewaysand footways, road accidents, operational standards, bus journey timeproject on their own.Without bundling, they would call on the govern-ment to provide part of the nance and/or charge prohibitive prices forservices provided by the project. In the former the governmentmay nothave money while in the latter strong public opposition may beincurred by the unaffordable price.

The practices of packaging and bundling projects allow for expan-sion and improvement of the network at a faster pace and produceseconomies of scale, reduce transaction costs, diversify risks, and provideexibility to the design of a concession. They enable projects that lackself-nancing ability due to low levels of usage and/or high constructioncosts to be developed without government nancial inputs. Thesepractices also increase the usage of infrastructure facilities due toreduced prices. However, please note that cross-subsidies may bedistortionary and anticompetitive, and measures should be taken tocounter this negative effect.

3.8. Competitive neutrality

Distortions often exist between private sector activities and those ofthe public sector. The government needs to set out necessary policies orlegal measures to ensure competitive neutrality, that is, public and pri-vate parties are treated objectively and uniformly in their competitionfor public works and services. A competitively neutral procurementprocess plays an important role in maintaining integrity of the procure-ment process, sustaining competition, enhancing technical and nan-cial innovations, improving resource allocation, increasing efciencyand reducing costs [27].

3.9. Performance-based contracting

Performance-based contracting (PBC) relates payments, bonusesand penalties to performance levels of the concessionaire in the currentconcession and even to future contract award decisions. It creates apowerful incentive for the concessionaire to achieve excellence andcustomer satisfaction [28]. For example, in the Argentine road conces-sions, the serviceability index was used to measure performance [17],is a new tunnel. The concessionaire is a joint venture of the Chinesestate-owned Shanghai Huangpujiang Tunnel Company and HongKong Jingli Company Ltd., with each company contributing 50% ofthe total investment in the project. The investment of the formerwas the asset value of the Yan'an Donglu 1st Tunnel while the latterinputs in cash [25]. The other is to bundle nonprotable and/or lessprotable projects to protable projects so that protable projectscross-subsidize less protable and/or nonprotable ones. For example,in Japan, a toll revenue pooling system is adopted, where tolls are setat equal levels for the entire national expressway network regardlessof the costs or trafc levels on the individual segment [26]. The privatedifferent way to achieve the same objectives as required under the PPPmodel [2224].

3.7. Integrated project plan

Two approaches may be taken to integrate projects for improvedconcession design and consequent better infrastructure developmentand management. One is to package a new project or projects to anexisting project or projects. The Yan'an Donglu tunnel project inShanghai, China provides an example. The 30-year long BOT projectincludes two tunnels, the Yan'an Donglu 1st Tunnel, which has beenreliability, junction delays, and queue lengths [29].3.10. Technical innovations

A PBC approach also encourages technical innovations by empha-sizing end results instead of the process or means to achieve theperceived end results. PBC requires that effective and efcient projectdevelopment functions be designed and structured around the mis-sion objective of the public client in order to maximize end outcomes.The public client may provide a preliminary design as a reference forthe private sector to add innovations. However, the client should notset out detailed design and technical specications. Otherwise, it maylose opportunities to explore the knowledge and expertise of the pri-vate sector for a potentially improved design that may signicantlyreduce project life-cycle costs and increase efciency. Furthermore,the public client may require the private sector to design the project,or initiate a design competition to solicit innovative designs. In eithercase, a value engineering process may be conducted in the early de-sign stage, where the government and the private sector participants(e.g., designer, contractor and operator) meet to generate innovativeideas to improve the constructability, operationability and maintain-ability of the project.

3.11. Affordability

PPP projects often involve large amounts of construction costs andlong-term service delivery. The government needs to specify its af-fordability threshold for a proposed PPP project. This affordabilitythreshold acts as a price target for the private sector bidders to devel-op innovative solutions. A bid exceeding the government's affordabil-ity will be dropped in the selection process [30]. The affordabilitycriterion works like a two-edged sword in maximizing the value ofthe proposed project. On the part of the public client, it moves the at-tention concerning consortium selection away from the lowest priceto other important issues, one of which is value for money. On thepart of the private sector consortium, criteria other than price areused to endear the client, of which innovative solutions are the keyto surpass competitors and meet the affordability threshold [31].

3.12. Certainty versus exibility

Although the concession can be designed in detailed and strictterms on the rights and responsibilities of both public and private sec-tors, there is a need for a certain degree of discretion for the govern-ment to address possible changes and new developments of theproject in the long concession period. Three main factors affect thelevel of government discretion: (1) level of country risk, (2) reputa-tion of the private parties involved in the project, and (3) characteris-tics of the infrastructure sector and the particular condition in whichthe project will operate. A high level of discretion is allowed when thecountry has a stable political, social, legal and economic environmentfor private investments, and the private parties involved have goodreputation. In a country without a sound legal system, a high levelof discretion may signicantly increase the private sector's perceptionof risks and, consequently the increase in the cost of capital. The pri-vate sector is usually concerned that the government's discretionarypower may be misused. To alleviate this concern, necessary recoursesmay be provided to the private sector against the government's pos-sible inappropriate discretionary decisions.

4. Best value concessionaire selection

4.1. Best value source selection and its challenges

The best value source selection (BVSS) is a multi-criterion evalua-tion methodology that allows tradeoffs among cost and non-costcriteria. The BVSS encourages creativity and innovation from interested

parties inmeeting the requirements of a public project and provides the

93X. Zhang, S. Chen / IATSS Research 36 (2013) 8897public client exibility to select a project proposal that offers the bestvalue. However, the BVSS is open towide criticism bymany contractingspecialists from both the private and public sectors who think that theprocess could be used with broad discretion to award public contractsand is often subjective [32]. For example, strong challenges to theBVSS have occurred from private sector participants, who (1) questionhow the government has made its decision based on price andnon-price criteria, and whether it has conducted a thorough analysisand fully documented the contract award decision, (2) doubt whetherthey have received fair evaluation during a BVSS process, (3) questionwhat are, and argue against, the discriminators that led to theirnonselection, (4) allege that the increased value of the chosen proposaldoes not merit its additional cost, and (5) criticize the government forusing the best value technique to ensure that the party of its choice re-ceives the contract.

4.2. Best value source selection methodology

The courts have considered the challenges to the BVSS and the legaldecision has upheld the BVSS as long as the government documents itsrationale for the tradeoff between cost and non-cost criteria [32]. There-fore, the public client should develop a sound BVSS methodology thatmeets the requirement of the legal decision in order to withstand anyprotest proceeding concerning a contract award in a BVSS. The essenceof a sound BVSS methodology lies in (1) the adoption of a competitivesource selection process that encourages innovative solutions, (2) theestablishment of a set of cost and non-cost evaluation criteria thateffectively predict the private sector participants' capability andtheir potential contributions to the public client's best value objectives,(3) the development of a sound evaluation method that ensures theright tradeoff between these criteria such that a defensible contractis awarded to the right private sector partner, whose proposal is per-ceived to be able to maximize the outcome of the project underconsideration.

4.3. Competitive source selection process

A competitive environment should be maintained throughout theBVSS process to motivate the private sector toward innovative andcost-effective solutions, efcient management of risks, and qualityservice. A competitive process has the potential to signicantly in-crease the outcomes of the acquisition. Governments should changetheir mind setting and encourage private sector competition, forwhich two measures may be taken. One measure is to invite the ex-press of interest from a wide range of industrial sectors by publishinga notice in newspapers and/or journals/magazines. For example, PPPprojects in the UK that are above a specied threshold project valueare required to advertise in the Ofcial Journal of the European Com-munity. The other measure is to compensate for an appropriate levelof the tendering costs of the private sector participants whose pro-posals are not successful. In view of the large amount of tenderingcosts, potential private sector participants may not be willing totake part in the competition and as a result the chance of the publicclient to get the best offer is reduced. However, while the compensa-tion should be adequate to cover the substantial design effort of pri-vate sector participants in preparing proposals, it should not be setso high that parties will offer proposals merely to make a prot onthe compensation. It is argued that a reimbursement at one-third ofthe auditable design hours of the party making an offer will offsetthe designers' actual costs without decreasing competition [31,33].

4.4. Transparent and valid evaluation criteria

The public client's best value objective should be translated into anappropriate set of effective evaluation criteria that measure a private

sector party's capability and predict its potential level of contributionsto the public client's best value objective. The criteria should be unam-biguous. This not only provides transparency in the selection process,but also avoids unnecessary complications resulting from tradeoffs be-tween offers on multiple criteria by competing bids [17]. The criteriaand their weighting should also be justied. Otherwise, the best valueobjective of the public clientmay be impaired in addition to the possibleprotests led by unsuccessful tenderers. Therefore, actual project dataneed to be collected and correlated to the completed project value,and sensitivity analysis needs to be conducted to determine the appro-priate value of technical weighting and the cost weighting in order toachieve the real best value through an equitable BVSS process [33].

Zhang [34] has developed a four-package evaluation criterion set forPPP projects in general. The four packages are (1) nancial, (2) techni-cal, (3) safety, health and environmental, and (4)managerial. Statisticalanalyses of the responses from a structured questionnaire survey of in-ternational experts on the relative weighting of the four packages andthe relative signicance of the criteria within each package have con-cluded that the four-package criterion set may be used as a commonset of evaluation criteria for PPP projects in general, and be tailoredfor a specic PPP project by making appropriate adjustments to reectthe uniqueness of the project, such as the type and scope of the project,the PPP model chosen, and the allocation of responsibilities and risksamong project participants.

4.5. Suitable evaluation methods

Anumber of tender evaluationmethods for PPP projects are current-ly in use. These include the simple scoring method, net present value(NPV) method, multi-attribute analysis, KepnerTregoe decision analy-sis technique, two envelope method, NPV method+scoring method,and binary method+NPV method. Zhang [35] provides a brief discus-sion of these methods. The binary method, simple scoring method andtwo-envelope method may be more appropriate for small and simpleprojects. For projects in which technical issues are not a problem andthere exists proven construction technology, the NPV method may bemore suitable. For complex projects, the multi-attribute analysis andthe KepnerTregoe decision analysis technique may be more tting.Furthermore, nancial aspects are the most important issue thatneeds to be considered in concessionaire selection. Hence, the nancialpackage is usually assigned amuch higherweight than other evaluationpackages, and the NPV method is often used in conjunction with otherevaluation methods to enhance the appraisal of nancial aspects.

5. Financial regulation

5.1. Objective of nancial regulation

In general, the objective of nancial regulation is to maximize theincentive of the concessionaire to operate efciently while respectingthe participation constraint (discussed in detail in a following sec-tion) for continued provision of services in order to safeguard the in-terests of both public and private sectors. This objective is achievedthrough the following measures: (1) preventing the concessionairefrom abusing its monopoly rights associated with the concession torealize supra normal prots, (2) maintaining a fair competition envi-ronment to ensure cost-effective and quality services, (3) sustaining arelatively stable and public-affordable price regime, and (4) address-ing either ex ante or ex post the changes in the concession period toenable the concessionaire to achieve a reasonable but not excessivelevel of prots.

5.2. Types of nancial regulation

Financial regulation mechanisms may be broadly divided intothree categories: (1) rate of return, (2) price cap, and (3) intermedi-

ate scheme that lies in between (1) and (2) [36].

94 X. Zhang, S. Chen / IATSS Research 36 (2013) 88975.2.1. Rate of returnRate of return regulation is also called cost of service regulation in

that it essentially allows the concessionaire to pass through thosecosts which are deemed necessary for the concessionaire to providethe required services at the specied quality. A pure form of rate of re-turn regulation protects the concessionaire against any nancial lossand guarantees a predetermined rate of return to the investments ofthe concessionaire in each period of the concession. The rate of returnis determined in part based on the cost of capital to the industry towhich the project belongs. These necessary costs are the base onwhich to derive the required level of revenues, which in turn deter-mines the prices to be charged for services provided by the concession-aire. The price is regulated to ensure that the resultant revenues are justsufcient to cover the costs incurred. If the revenues are less than the re-quired amount, the price will be increased and/or the excessive reve-nues in previous years are used to compensate for the revenueshortage in the current year, and to ensure adequate revenues for futureyears. Conversely, revenues in excess of the required amount arereverted to the public sector and/or prices are frozen or even reducedfor the following years [1]. Therefore, as the price is regulated up ordown, uctuations in demand and costs will not affect the concession-aire's level of prot.

5.2.2. Price capThe price cap regulation limits the highest price the concession-

aire could possibly charge in each year of the concession for the ser-vices it provides at the minimum required standards, usually takinginto consideration ination (which is measured by the consumerprice index) and efciency improvement in that year. The WorldBank and the Inter-American Development Bank [1] provide the fol-lowing mathematical denition of the price cap regulation:

PtPt1 1 ItXt 1

where Pt = price in year t; It = ination in year t; and Xt = efciencyimprovement in year t.

As shown in Eq. (1), it is important to set an appropriate level ofprice for the rst year of the concession. This is usually done basedon the capital expenditure (actual or estimated), predicted values ofthe key components of the operation and maintenance costs, the pre-dicted average demand of services, the affordability of the users, thelength of the concession, and a reasonable level of return to the in-vestments of the concessionaire.

Except for the price cap and the requirements on service standards,the revenues of the concessionaire are unconstrained. The concession-aire can keep the prots resulting from reduced costs, improved ef-ciency and/or increased demand. Conversely, if these parameters go inthe opposite direction, the concessionaire assumes the consequentlosses no matter how severe these losses are. This is true even thoughat the beginning of the concession the price are set to a level highenough to cover the cost of service based on the estimates of key vari-ables that affect the project's protability (e.g., costs, efciency gainsand revenues) because the concessionaire is fully exposed to the vari-ability between the estimate and the actual value of these variables [12].

5.2.3. Intermediate schemeBoth advantages and disadvantages exist in either the rate of re-

turn or the price cap regulation. In practice, usually an intermediateregulatory scheme is adopted, which is a variant or hybrid of thetwo extremes designed to achieve a balance between efciency in-centives and earnings insurance. For example, an intermediatescheme may set the price at a level that enables the concessionaireto recover an efcient level of costs ex ante, but ex post the conces-sionaire is given incentives to improve efciency as the prices willnot be reviewed for a certain period. At the beginning of a following

price review period, the price is adjusted to reect the efciencyimprovement achieved in the previous period, but the benets ofthe concessionaire made in the previous period are not clawed back[12].

5.3. Price setting and adjustment mechanism

Central to a nancial regulation regime is the price setting and ad-justment mechanism, as all regulations must have regard to the par-ticipation constraint and implement it through price setting andadjustment. A workable price setting and adjustment mechanismshould (1) establish clear rules on dening the price structure of dif-ferent categories of users, the concessionaire's freedom to vary theprice structure such as surcharging tariffs and interrupting servicesto some types of users in times of high demand, and redistributingprots or losses between the concessionaire and the public client,and (2) develop a sound methodology to assess the impacts of themain factors that affect the cost structure/total costs, revenue struc-ture/total revenues, efciencies and protability of the project inorder to allow the concessionaire to achieve a reasonable but not ex-cessive level of return. These factors include project costs (capital ex-penditure, operation and maintenance costs, etc.), the reasonablelevel of return to private investments, concession period, types ofusers and their demand of services, efciency improvement, and inte-gration with the overall pricing system.

5.4. Balancing efciency incentive and earning insurance

The concession arrangement is a principalagent maximizationproblem [37], in which the principal is the public client and the agentis the concessionaire. In solving such a problem, various requirementshave to be met. In particular, there are two generic constraints thatshould be satised: participation constraint and incentive compatibilityconstraint [38]. A PPP model that satises the two constraints wouldhave a built-in mechanism, which ensures that the concessionaire ben-ets if it behaves in the public interest and suffers if it does not. The twoconstraints are also the necessary requirements of a publicprivatewinwin principle.

The participation constraint requires that a PPP project providethe concessionaire with a minimum level of compensatory return toits capital investments, under which investors and lenders will with-draw from the project and turn to other more protable opportunities[39]. The participation constraint requires that in setting the level ofprice the government needs to take into account the costs to be in-curred by the concessionaire or by an efcient benchmarked compa-ny that provides the same service. The incentive compatibilityconstraint requires that the concessionaire act in accordance with adened solution in the interest of the public sector. For example,this solution may require that the concessionaire continuously im-prove efciency and share the resultant benets with consumers.Without the incentive compatibility constraint, the solution mightbe economically meaningless for even though the solution could pro-duce an optimal outcome, the concessionaire might choose not to actin accord with it [38].

5.5. Further improvements in nancial regulation

The following points are useful in further improving nancial reg-ulatory practices. First, the regulatory framework should provide theright pressure and incentives for the concessionaire to continuouslyimprove efciency, cost-effectiveness, and service quality. Second, abalance should be achieved in granting essential discretion to the reg-ulator and providing the concessionaire certain necessary recoursesagainst the decisions of the regulator. Third, the regulatory processshould be protected from both industry and short-term political pres-sures. It is better to be conducted by a body that is politically and -

nancially independent from the government or the concessionaire.

95X. Zhang, S. Chen / IATSS Research 36 (2013) 8897This minimizes the negative effects of the government's role as regu-lator and as a project party, and protects customers from abuse ofpower by the monopolistic concessionaire. Fourth, the regulationshould be credible. Members of the regulatory body should be ac-knowledged professionals, who would benchmark performance, setprice levels and ensure the rationalization of the existing systemand improve the system if necessary [1,17,26].

6. Reconcession and rebidding

6.1. Scheduled/unscheduled reconcession

Reconcession refers to the contractual arrangements to terminatethe original concession and design a new concession to reectchanges and new needs. This may be classied into two categories:(1) scheduled reconcession, corresponding to the case in which thecurrent concession ends at the scheduled termination date as denedin the concession agreement and (2) unscheduled reconcession,which is deemed necessary to deal with signicant changes that hap-pened before the expiration of the current concession, for example,the concessionaire becomes bankrupt or fails to fulll its obligationsthat justies the government's termination of the concession, and aforce majeure risk makes it difcult to implement the initial conces-sion. The government usually reserves the right to terminate the con-cession before its scheduled end, and it may terminate the concessionin terms of the general interest of the public even though the conces-sionaire has fullled its contractual obligations.

6.2. Periodic rebidding of concession

Periodic rebidding allows new competitors to challenge the in-cumbent concessionaire for the concession periodically. Theoretically,there is no big difference between a rebidding and the initial biddingof the concession. Rebidding usually focuses on the unamortized as-sets of the current concessionaire, new construction, rehabilitationand maintenance of existing and newly built facilities, and the pricesoffered to consumers. Periodic rebidding is sometimes called a Chad-wickDemsetz auction, as Edwin Chadwick proposed this idea in1859 and Harold Demsetz resurrected it in 1968 [19]. Generally, peri-odic rebidding of concession is more economical than either freeentry or a long-lasting concession for an infrastructure sector that isnaturally monopolistic.

There are several specic reasons for periodic rebidding. First, theinitially chosen concessionaire may not still be the most competitiveat the end or even before the end of the current concession periodeven though nancial regulation is implemented over the concessionperiod tomaintain the incumbent concessionaire's operational efcien-cy. This is partly because the exclusive rights of the concessionaire toprovide relevant services may lead to its lack of incentive to improveefciency, and technical advancements result in the obsolescence ofthe technologies and the management practices of the incumbent con-cessionaire. Second, periodic rebidding serves as ameans to reduce reg-ulatory discretion of the government as it provides the governmentwith better information for price setting and adjustments. This mayalso reduce the premiums required by the private sector on regulatoryrisks [40]. Third, periodic rebidding forces the private companies to re-duce costs and charge the lowest protable price for the services pro-vided and maintains pressure on the concessionaire for continuousquality service. Fourth, periodical rebidding facilitates contract adjust-ments to signicant changes.

6.3. Valuation of the incumbent's unamortized capital

In addition to the initial construction costs, substantial capital in-vestments may also be needed for rehabilitation of existing facilities

and possible new construction during the concession period. Thesecapital costs cannot be adequately predicted at the beginning of theconcession. The initial construction costs and the capital investmentsmade during the concession, particularly those made toward the endof the concession, may not be fully amortized before the concessionexpiration date. If the incumbent loses the concession in rebidding,its unamortized assets should be reimbursed either by the govern-ment or the new concessionaire. The unamortized assets includeboth concession specic and non-specic assets. Concession specicassets refer to those that are difcult if not possible to be used for pur-poses other than the concession such as underground water systems,and assets that are not specic to the concession refers to those thatcan be easily transferred/sold to be used for other purposes otherthan the concession, for example, vehicles and equipment used tomaintain highways [40].

A sound asset valuation methodology including advanced measure-ment instruments is needed to reasonably determine the value of theunamortized assets and to factor them into the new concession beforeputting it out for bidding [40]. Appropriate valuation and compensationof unamortized assets provide incentives for the incumbent to makeproper capital investments for necessary new construction and rehabil-itation, and to maintain infrastructure facilities timely, which wouldlead to a low life cycle cost of services. This in essence ensures fair com-petition and long-run viability of the periodic concession rebidding,which aims to achieve continuous efciency improvement.

6.4. Concession rebidding interval

For simplicity, the public client may set equal interval for the con-cession to be rebid, for example, every ten years in power distributionin Argentina. However, the concessions to be rebid do not have to beof equal length. The suitable length of a concession depends on manyfactors, including:

1. Capital expenditure and project revenues. Normally, for a xed levelof projected revenues, the higher the capital expenditure is expectedfrom the new entrant (e.g., related to new construction, major reha-bilitation of existing facilities, and the unamortized assets of the in-cumbent), the longer the concession should be. A short concessionis usually advisable if the new concessionaire is only required to beresponsible for routine operation and maintenance.

2. Bidding costs to the industry. The bidding cost as a percentage ofthe total project development cost is different for different typesof projects. To save costs to the industry as a whole, the frequencyof concession rebidding needs to be reduced if it is perceived thathigh bidding costs will be involved, and vice versa.

3. The level of complexity in transferring concession from the incum-bent concessionaire to the new winner. A varying number of issuesneed to be addressed in the transfer of concession, depending onthe features of the specic industry and the concession model ofthe particular project. High transaction costsmay be incurred if com-plicated issues are involved, for example, the settlement of the pos-sibly large number of employees of the incumbent concessionaire.In addition, the concession transfer may interrupt services to thepublic. Therefore, more frequent concession rebidding may be prac-ticed if the transfer process is not complex, and vice versa.

6.5. Biased rebidding favoring the incumbent

Recognizing that it may lose the concession in the upcomingrebidding, the incumbent concessionaire tends to skimp on capital in-vestment and maintenance of assets whose quality is hard to measure,especially toward the endof the concession. In addition, any investmentor improvement by the incumbent in the concession's assets (includingboth human capital and physical assets)would benet the newwinner,further reducing the incumbent's interest in investing and maintaining

the assets. For example, the incumbent may have a weak incentive in

tive bidding, which also forces the chosen concessionaire to offercost-effective services at required quality standards. During the conces-

96 X. Zhang, S. Chen / IATSS Research 36 (2013) 8897sion, the nancial regulation maintains a competition environment toaddress potential efciency problems related to the incumbent conces-sionaire's monopolistic rights and to ensure its continuous efciencyimprovement. By periodic rebidding at the end of each concession, anew entrant is allowed to compete for the concession and this enhancescompetitive efciency for the following concession by choosing a newconcessionaire that is more competent than the incumbent. Periodicrebidding also keeps an incumbent concessionaire under pressure toimprove performance during the term of the current concession inorder to raise its chances of keeping the following concession, and totraining its employees as the winner in a concession rebidding is nor-mally required to hire the employees of the incumbent. Klein [40] ar-gues that a biased rebidding in favor of the incumbent is generallyadvisable to dealwith the incentive of the incumbent tomakenecessaryinvestments timely. This approach gives the incumbent a greaterchance to keep the concession as the concession is awarded to a com-petitor only if its bid beats the incumbent's by more than a speciedmargin. Such biased biddings have been used for traditional contractsfor equipment and civil works in the United States. However, this mar-gin should not be too large so that the competitive efciency is lost.

7. Conclusions

PPPs play an important role in bringing private sector competition topublic infrastructure monopolies and in merging the resources of bothpublic and private sectors to better serve the needs of the public thatotherwise would not be met. The worldwide interest in PPPs, problemsencountered in many countries and the substantial controversy overPPPs call for an improved methodology for improved infrastructureand service delivery through PPPs. This paper proposes a systematicframework for infrastructure development through PPPs in general,on the realization that although there aremany aspects that are project,sector, and/or country-specic, the concept, process and key principlesin infrastructure and service delivery through PPPs are essentially iden-tical. This framework integrates four broadly divided stages in the infra-structure and service delivery process, including (1) design of aworkable concession, (2) competitive concessionaire selection, (3) -nancial regulation of the selected concessionaire during the concessionperiod, and (4) periodic concession rebidding to allownewentry for theconcession.

The public procurement principles and publicprivate winwinsolution act somewhat as guidelines or constraints for decisionsmade in each of the four stages of the framework, which repeatover time possibly as long as the service is needed. The four-stageframework takes into account the requirements of public services, re-alignment of responsibility and reward among multiple participantsin PPPs, the monopolistic rights of the concessionaire, and the widerange of risks and uncertainties in the long concession period. The de-sign of the right concession forms the base on which other stages areimplemented in addition to planning the project and allocating risksfor enhanced efciency. The nancial regulation allows the govern-ment to address changing conditions and regulate the concessionfor efcient operation with due discretion, whereas the competitiveconcessionaire selection and periodic reconcession and rebiddingplay an important role in achieving innovation, efciency and cost ef-fectiveness through direct competition.

Varying competition elements are incorporated in each of the fourstages for continuous performance improvement of the concessionairein the delivery of infrastructure and services. In the concession designstage, risks are effectively controlled through appropriate risk allocationand right selection of a PPPmodel. In the concessionaire selection stage,the most competent consortium available is chosen through competi-offer competitive service in the following concession if selected.Acknowledgment

This study is nancially supported by the Research Grant Councilof the Government of Hong Kong Special Administrative Region (Pub-lic Policy Research, HKUST6002-PPR-11).

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97X. Zhang, S. Chen / IATSS Research 36 (2013) 8897

A systematic framework for infrastructure development through public private partnerships1. Introduction2. Framework for a systematic approach2.1. Four-stage systematic framework2.2. Public procurement principles2.3. Publicprivate winwin solution2.4. Rationale of the framework

3. Design of concession3.1. Concession or not3.2. Separation of monopolistic sectors from competitive ones3.3. Projections of market demand3.4. Risk allocation and government support3.5. Evaluation of partnership models3.6. Comparison with traditional procurement approaches3.7. Integrated project plan3.8. Competitive neutrality3.9. Performance-based contracting3.10. Technical innovations3.11. Affordability3.12. Certainty versus flexibility

4. Best value concessionaire selection4.1. Best value source selection and its challenges4.2. Best value source selection methodology4.3. Competitive source selection process4.4. Transparent and valid evaluation criteria4.5. Suitable evaluation methods

5. Financial regulation5.1. Objective of financial regulation5.2. Types of financial regulation5.2.1. Rate of return5.2.2. Price cap5.2.3. Intermediate scheme

5.3. Price setting and adjustment mechanism5.4. Balancing efficiency incentive and earning insurance5.5. Further improvements in financial regulation

6. Reconcession and rebidding6.1. Scheduled/unscheduled reconcession6.2. Periodic rebidding of concession6.3. Valuation of the incumbent's unamortized capital6.4. Concession rebidding interval6.5. Biased rebidding favoring the incumbent

7. ConclusionsAcknowledgmentReferences