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Deloitte Research Partnering or value

Partnering or valueStructuring eective

public-private partnershipsor inrastructure

A Deloitte Research study


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34 Deloitte Research Partnering or value

1 Introduction

3 The need or innovation in inrastructure partnerships

14 Conclusion

15 Appendix A: Estimated U.S. inrastructure decit

16 Appendix B: Applying the Value or Money test

18 Appendix C: Applying the bottom-up approach to a hypothetical case

25 Endnotes

26 About the authors

28 Contacts

Contents

Disclaimer

This publication contains general inormation only and Deloitte Services LP is not, by

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LP, its aliates and related entities shall not be responsible or any loss sustained by any

person who relies on this publication.

About Deloitte Research

Deloitte Research, a part o Deloitte Services LP, identies, analyzes and explains

the major issues driving todays business dynamics and shaping tomorrows global

marketplace. From provocative points o view about strategy and organizational

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In boardrooms and business journals, Deloitte Research is known or bringing new

perspective to real-world concerns. For more inormation, please contact William

Eggers, Deloitte Services LP, at +1 202 246 9684 or [email protected].


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Table 1. 2009 global stimulus programs with a signicant inrastructure component

Ater decades o neglect, and despite many other

distractions in the global economy, inrastructure has

nally made it to the top o the political agenda.

According to a recent survey, 77 percent o senior

business executives believe that the current level o public

inrastructure is inadequate to support their companies

long-term growth. These executives believe that over

the next ve years, inrastructure will become a more

important actor in determining where they locate their

operations.1

The public also has awakened to the consequences o

neglecting our roads, bridges, public transit, electricity

grid and other social inrastructure (such as hospitals

and schools). According to a recent poll, 94 percent o

Americans are concerned about the condition o the

nations inrastructure. Remarkably, 81 percent said they

are willing to pay 1 percent more on their ederal income

tax to improve Americas inrastructure.2

Introduction

Thanks to the stimulus packages unveiled in many

countries during 2009 (see table 1), public inrastructure

is receiving both long overdue attention and a signicant

inusion o public unds. While these are welcome

developments, the level o direct government unding

proposed will meet only a tiny raction o inrastructure

needs around the world. In the United States, according

to the American Society o Civil Engineers, there is a

$2.2 trillion gap between the supply o and demand or

roads and bridges, water and sewage systems, publictransit systems and other public inrastructure (see

appendix A).3 The inrastructure stimulus money rom the

2009 American Recovery and Reinvestment Act (ARRA)

addresses less than 5 percent o these inrastructure

needs.

That said, the current confuence o events does present

government leaders with a once-in-a-lietime opportunity

to make a timely and economically productive down-

payment on closing the global inrastructure gap.

Funding is not the only challenge. A business-as-usual

approach by the public sector will waste an importantopportunity to make our inrastructure saer, more

ecient and more eective. The inadequate, and in some

cases dangerous, state o certain inrastructure demands

new thinking to speed its improvement. This means

using the ull complement o innovative inrastructure

nancing and delivery solutions that are available, while

also developing new approaches to address todays

challenging credit markets.

a Gemma Daley, Australian Senate Passes Rudds A$42 Billion Stimulus, Bloomberg News, February 13, 2009 .

b $12B or Inrastructure Forms Key Pillar o Stimulus Package, CBC News, January 27, 2009 .

c Bill Powell, Should China and the U.S. Swap Stimulus Packages?, Time, March 05, 2009 .

d International Federation o Consulting Engineers, Fiscal Stimulus Package Survey 2009 .

e Sarkozy Outlines 26 billion French Stimulus Plan, New York Times, November 4, 2008 .

Daniel Schmachtenberg, German Inrastructure Stimulus Packages: Necessity Is the Mother o Invention, January 2009.

g Japan Unveils New Economic Stimulus o 15.4 Trln Yen, Reuters, April 10, 2009 .

h International Federation o Consulting Engineers, Fiscal Stimulus Package Survey 2009.i Worldwide Inventory o Inrastructure Spending Plans, Foreign Aairs and International Trade Canada, January 21, 2009

.j Ibid.k Inrastructure and the American Recovery and Reinvestment Act o 2009, Deloitte, March 12, 2009.

Country

Australia

Canada

China

European Union

France

Germany

Japan

India

Sweden

United Kingdom

United States

Spending on inrastructure

Around AUD 28 billiona

CAD 12 billionb

Around USD 438 billionc

Around EUR 173 billiond

Upward o EUR 10.5 billione

Around EUR 19 billion

Around JPY 2.6 trilliong

Around USD 33.5 billionh

SEK 1 billioni

GBP 3 billion (in capital spending brought orward)j

Around USD 113 billionk


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To be sure, the landscape or public and private

inrastructure nancing has changed dramatically since

the nancial crisis began in 2008. Just as governments

are strapped or cash, some private rms have and may

continue to ace diculty raising capital in constricted

nancial markets. This does not mean, however, that

private involvement is now o the table. Among other

things, this study explores how governments can make

limited public dollars go urther by leveraging the $180

billion in private equity that has reportedly been raised byinrastructure unds over the past ew years (which could

theoretically translate to over $300 billion o incremental

leveraged purchasing power).4

To eectively capitalize on this rare window o

opportunity, governments need to look beyond the

short-term infux o stimulus dollars and articulate a

much broader vision or enhancing inrastructure as

measured not just by jobs, but by enhanced productive

capacity or the uture. The purpose o this study is to

help government leaders address the longer-term issues

associated with pursuing their inrastructure objectives

in todays environment. Specically, this study will helpgovernment leaders answer the ollowing question:

How can the optimal mix of public and private sector

involvement for any given project be determined so that

limited public dollars can create maximum public value?


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With a greater number o priorities (and industries)competing or public unds in the wake o the credit crisis,

governments are under more pressure than ever beore

to be creative about how inrastructure needs are met.

I inrastructure gaps are to be narrowed, the traditional

models o nancing and delivering inrastructure must give

way to new, innovative models and a portolio o hybrid

approaches. The structure and nancing o inrastructure

projects involving both the public and private sectors

(public-private partnerships, PPPs or P3s) will need to

evolve in response to changing conditions in the nancial

markets. In countries around the world, we are starting to

see the outlines o what such innovations may entail.

Te need or innovation ininrastructure partnerships

We need to have an open mind aboutthis.We need to think outside of thebox.

U.S. Department o Transportation Secretary Ray LaHood.5

Inearly2009,theFloridaDepartmentofTransportation

entered into a $1.8 billion 35-year concession with a

private consortium, headed by the Spanish rm ACS

Inrastructure Development, to build and operate high-

occupancy toll lanes near Fort Lauderdale. The nancing

includes more than $200 million in equity, $750 million

in commercial bank debt and a $603 million loan rom

the ederal Transportation Inrastructure Finance and

Innovation Act (TIFIA) program.6 In this PPP, the Florida

DOT will set toll rates, retain all revenues and makeavailability payments to the private concessionaire

annually out o all o its revenues (including state

appropriations, tax revenues and tolls). The project is

the rst U.S. toll road PPP structured with perormance-

based availability payments (see gure 1).

TheUnitedKingdomisinthemidstofthenations

largest-ever school buildings investment program,

with a goal o rebuilding or renewing nearly every

secondary school in England. To realize this ambitious

goal, the central government has created a PPP model

called a Local Education Partnership (LEP), a private

Figure 1. The availability payment model

Ownsandretainsstrategiccontrolofassetsleased to concessionaire

Designsoutputspecicationandpayment/penalty regime

Makesregularlyscheduledpaymentsforperormance

Monitorscompliancewithconcessionagreement on an ongoing basis

Holdsconcessionagreementinaspecialpurpose vehicle

Raisescapitalagainstperformancebasedpayment system

Designs,builds,operatesandmaintainsfacilitiesthrough competitively tendered subcontracts

Concessionagreement

Equity

Debt

Public sector grantor Private sector concessionaire

Privatesectorcosts

Publicsectorcosts

Year

Year

0

0

5

5

40

40

Construction costs

Milestone payments, i any

Source: Deloitte

Long-term maintenance and operations costs

Perormance based payments


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sector consortium working in ormal partnership with

local authorities and the central government. Certain

LEP projects are being delivered through conventional

capital unding and design-build contracts, while

others employ PPP models. The program is designed

to capture economies o scale in delivery by bundling

multiple acilities into a single procurement.

Otherinnovativestructuresemergingaroundtheworld

include the combining o multiple public authorities(such as neighboring local government entities) to

procure a single project or service. The our local

authorities covering the city o Dublin, or example,

were keen to move away rom their traditional reliance

on landlls and together procured a large-scale

waste-to-energy acility to meet the needs o all our

authorities. The improved project economics attracted

a broader array o bidders to the procurement,

resulting in cost eciencies or the local authorities.

An agreement to purchase the generated power at a

reduced cost is an added benet to the authorities.

These projects, each with its own distinct mix o public

and private participation, demonstrate the diversity o

delivery models available today. There is no longer a binary

decision between public and private. In reality, nearly every

public inrastructure project involves a large degree o

private sector participation through the normal channels

o a market economy. Most PPP models simply represent a

way o deepening and/or broadening the private sectors

engagement in delivery in exchange or sharing in the

associated risks and rewards.

The question policymakers in the United States, the

United Kingdom and Ireland had to answer in the above

examples was not whether to involve the private sector in

inrastructure projects, but rather:

What is the optimal mixture of public and private

sector participation in the project to maximize

public value?

This is the central question acing inrastructure

policymakers today. And theres no one-size-ts-all answer

or every situation.

Most inrastructure projects are composed o ve elements

or which responsibility must be assigned: design,

construction, service operation, ongoing maintenance

and nance (see nearby box). Theoretically, any o these

elements and their related risks can be allocated to either

the public sector or the private sector. The shape o that

allocation determines the structure o the partnership.

Dividing up these responsibilities in the best possible

way or any given project is not easy. It requires careul

qualitative and quantitative analysis. Short-cutting this

process could result in suboptimal allocation and lostvalue. How then can public sector entities decide which

project responsibilities they are best suited to retain, and

which they are better o shiting to the private sector?

The decision making process is depicted in the schematic

(see gure 2).

The ve components o an inrastructure project

Design. Under virtually any partnership structure the responsibility or design will be

shared. For instance, even in partnership structures with high degrees o private responsi-

bility, the public sectors articulation o perormance specications will limit the range o

design options. In many projects, the need to ensure compliance with broader planning and

environmental guidelines results in a signicant degree o public sector design.

Construction. This component includes the construction o the physical asset(s) over a

prescribed period o time, generally at a prescribed cost. Deciding which party assumes the

impact o construction cost overruns and time delays must be considered.

Service operation. Operating the asset may include various activities rom general

management o service provision and revenue collection to perorming sot (or non-core)

services associated with an asset, such as laundry services within a hospital. Operation

typically begins at the end o construction, upon agreement that the construction has been

satisactory. In PPPs, the private partners compensation is dependent on the achievement

o perormance standards.

Ongoing maintenance. Generally, there are two principal types o maintenance to be

considered in any inrastructure project: ongoing regular maintenance (or operating mainte-

nance), and major reurbishment, oten called lie-cycle or capital maintenance.

Finance. This component generally includes nancing or the capital costs o construction,

as well as working capital requirements.


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Figure 2. Determining the right mix o public and private involvement ininrastructure nancing and delivery

Whocanandshoulddowhat? Capabilities Financial Risk transer

WhatdoIwanttodo?

Whataremyobjectives? Speed Eciency

WhatamIallowedtodo? Legal ramework Political realities

Project components

Determine bestowner or each

project component

Dene project needsand objectives

Determine public authority

Design Build Finance Operate Maintain

Desiredpartnership

structure

Source: Deloitte Research

Degree o certainty Innovation

Step 1: Determine public authority

What am I allowed to do?

What laws and policies exist regarding the delivery oinrastructure and the potential involvement o private

nance? Are there political, legal or policy constraints

that would make it dicult to use certain partnership

structures?

These questions are among the rst that need to be

answered beore a public sector entity gets too ar ahead

o itsel. The legal and policy ramework in place in

addition to the temperament o the electorate will

automatically narrow the pool o possible partnership

options. Most public sector entities ace restricted choice

in partnership arrangements. For example, U.S. state

legislation in this area runs the gamut, rom prohibitingeven design-build contracts to permitting ully fedged

concession arrangements.

O those governments with laws on the books, some are

nding that the enabling legislation does not provide the

fexibility necessary to support the range o possible deals

in which political leaders are interested. The presence o

a legal structure that is more or less in line with market

norms or PPP-type projects in more mature markets will

be o assistance. With governments worldwide competing

to attract private investment, a poor legal ramework will

stymie a jurisdictions eorts to increase the degree o

private sector participation in inrastructure development.

Recently, several governments have improved upon their

existing legislation. The State o Caliornia has adopted

a new legal ramework or transportation PPPs that

authorizes regional transportation agencies and Caltrans

to enter into an unlimited number o PPPs through 2017,

removing earlier restrictions on the number and type o

projects they may undertake. The legislation establishes an

independent Public Inrastructure Advisory Commission to

advise state and local agencies on PPP best practices, and

it allows or solicited and unsolicited proposals rom the

private sector.

In addition to legislative constraints, political actors

oten determine the extent or nature o private sector

involvement. For instance, the Commonwealth o

Pennsylvania was unable to garner sucient legislative

support to enter into a concession agreement or the

Pennsylvania Turnpike that would have raised $12.8 billionto meet other pressing transportation needs. In Canada

and elsewhere, core services (such as teaching, health

care and prison guards) are distinguished rom non-core

services (such as janitorial services, ood services and

transportation), and the public sector generally retains the

ormer.

Step 2: Dene project needs and objectives

What do you want to do?

Once a public sector entity has determined what it is

permitted to do, the next step is to dene the project

goals. First, dene the need. For instance, it could be

congestion in a certain corridor must be reduced by 15percent over the next three years. The next step is to

dene the service solution and associated assets to meet

that need. In this case, the solution might be to deliver

a new toll road with specic capacity within a specied

time period. Lastly, policy makers must determine how

the solution will be delivered and unded. Can tolls or

congestion charges be introduced, or must public unds

rom general (or special) taxation be made available?


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Four o the most common variables that governments

should consider when dening the need that must be

ullled are speed, eciency, degree o certainty about

needs and innovation.

Speed

How quickly does the asset or improvement to the

asset need to be delivered?

There are two important dimensions to speed when

it comes to inrastructure: procurement and delivery.

Delays in either mean that the public waits or needed

improvements or added capacity, and that the expected

benets rom the project are delayed, adding to the

indirect costs o the project.

Pure public approaches can oten be characterized as

speedy procurement ollowed by lengthy execution.

Partnership approaches with reliance on value-based

selection can oten be characterized as the reverse. While

empirical data in this area are limited, studies rom the

United Kingdom and Australia suggest that PPPs rarely

experience the types o signicant time overruns that

are all too common in public inrastructure delivery.

7

Thus, when evaluating the speed o delivery, the total

potential time period should include a realistic view o

both procurement and construction periods or all o the

options being considered.

There are several actors to take into account at the

outset o a project that can substantially compress delivery

time, starting with the procurement approach. Can the

project be designed in-house? I the answer is no, and the

public sector must look to a private contractor to do the

majority o the design work, then it may be useul to link

the design and build components o a project, thereby

reducing the overall procurement time line. Doing so

avoids the need to run sequential procurement processes

or design and construction.

Another consideration in gauging the potential speed

o delivery is unding/nance. In some circumstances,

particularly those in which public unding is available only

on a pay-as-you-go basis, partnership approaches can

accelerate delivery o inrastructure improvements simply

by creating the possibility o nancing.

Eciency

How can the asset be delivered and maintained as

efciently and cost-eectively as possible?

This concept o bundling certain project components to

shorten procurement time lines can be urther extended

to reduce the overall cost o ownership or a new asset.

Traditional procurement models tend to reward the lowest

cost bidder, thereby devaluing quality and innovation

on the part o contractors. In addition, such models can

incentivize change orders that increase the cost and

delay the delivery o projects.

Properly structured partnerships, on the other hand,

bundle elements o the design, build and maintenance

components o a project and ocus the contractors

attention on delivering the lowest overall lie-cycle cost.

The result is a better product up ront, delivered more

eciently and more systematic maintenance o assets(that meet specied perormance standards) something

that most governments, aced with eciently allocating

limited resources, have ound challenging.


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Built in the 1920s, James F. Oyster Bilingual Elementary

School was on its last legs by the early 1990s. The schools

strong academic record stood in contrast to a structural

crisisleaking roos, building code violations and

accompanying shutdowns, lack o computer hookups and

limited space. Yet the District o Columbia didnt have the

$11 million required to build a new school, nor did it have

the borrowing power. The District had to make a hard

decision: shut down the decrepit building and relocatestudents, or nd another way to bring the school up to

code.

What the District lacked in nancial assets, it made up or

in physical assets: the school sat on 1.67 acres o prime

real estate within walking distance o the National Zoo.

The District converted its underused physical assets into

a nancial asset by dividing the property, hal or a new

school and hal or a new apartment buildingboth

designed and built by the private sector. In exchange

or giving the private sector partner the development,

operation and maintenance rights or the new apartment

building, the District got its rst new school in 20yearsa state-o-the-art acility with double the space.

The bond issue that nanced construction is backed by

the incremental revenue generated by the project, which

consists o the taxes and other payments by the private

partner generated rom the operation o the apartment

building.

In 1996 the Houston Independent School District used

a lease-leaseback arrangement with a private developer

to obtain two new schools or $20 million less than

the budget and a year earlier than originally planned.

Besides solving the nancial problem, potential benets

o increased private sector participation in school

modernization include aster construction, innovative

design and more time or school administrators to

ocus on core educational goals rather than acilities

management.

In 2006 the Rensselaer, NY, school district, lacking

sucient public borrowing capacity, executed an

innovative land swap transaction to build a new

school to replace its old, overcrowded acilities. The

old school sat on prime waterront property, and a

private developer held land in another location that

was not as desirable or residential or commercial

purposes but was appropriate or the school. Through

a nancing vehicle that raised tax-exempt debtsecured by lease payments, the parcels were swapped,

and the new school was constructed by the developer

who in turn received development rights on the

waterront parcel. In addition to a new, modern and

larger school, the city o Rensselaer will also have a

redeveloped commercial and residential section on

its highly desirable waterront, urther contributing to

its economic recovery. Essentially a design-build PPP,

this project demonstrates how innovative thinking

between the public and private sector can meet

multiple goals o both parties and create win-win

situations.

These examples point to an important and growing

strategy or meeting school inrastructure needs:

innovative partnerships with the private sector. PPPs

can be structured in a number o ways to meet

school modernization objectives. Private rms typically

nance, design, construct, and operate a public school

under a contract with the government or a given

time period, usually 20 to 30 years. Businesses usually

provide non-core services such as school transport,

ood services and cleaning, while the government

assumes responsibility or teaching. Common PPP

models can include the sale o development rights on

unused property, and sale-leaseback or lease-leaseback

arrangements. In these solutions, school districts

can sell or lease surplus land to a developer who

then builds a school and leases it back to the school

district.8

Source: William D. Eggers and Tiany Dovey, Rebuilding AmericasSchools Education Week, January 24, 2008.

Using Innovative Financing and Delivery or School Modernization


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Degree o Certainty

Will changes in technology, policy or demand aect

how the needs o tomorrow are met?

In many situations, the public sector must maintain a

degree o fexibility to meet likely, or even unanticipated,

evolution in inrastructure and service needs. Some

partnership models are ill-suited to inrastructure systems

that are likely to be recast over time to meet changing

demand, particularly growth. I the public sector is not

certain about the perormance requirements underlying

the partnership, then it will be dicult to achieve a air

contract price and to ensure that the inrastructure will

continue to meet uture demands.

Uncertainties might result rom latent deects (faws in

the existing inrastructure that are not apparent until

work begins), policy changes (implying a change in

service requirements), demand risks (resulting rom the

introduction o user choice, or example), changes in

public needs or rapid changes in technology. For projects

that are especially vulnerable to these uncertainties,

partnership models with increased fexibility and shorter

contract periods can improve the likelihood o achieving

inrastructure objectives.

How inrastructure needs are dened and met will change

with advances in technology. New technology can make

the unexpected and, at times, the seemingly impossible,

possible. One example is the tunnel constructed to add

the missing link to the A86 ring road around Greater Paris.

A problem that had perplexed urban planners or more

than 30 years was resolved thanks to rapid advances

in technology, such as made-to-measure tunnel boring

machines that could simultaneously drill, excavate and

provide structural nishing.

InnovationIs there an opportunity to incorporate private sector

innovation?

Is there scope or innovation in either the design o

the solution or the provision o services? Does some

degree o fexibility remain in the technical solution/

service or the scope o the project? The partnership

that created the CityLink private tollway in Melbourne,

Australia, or example, introduced a number o customer-

riendly innovations to make paying tolls a more positive

experience. CityLink delivers alerts to customers mobile

devices when their accounts run low, and it makes

house calls to install toll tags on customers vehicles. An

independent body, the CityLink Ombudsman, resolves

disputes, and the organization provides transparency

and accountability via customer charters and scorecards.

Hence, the level o innovation and fexibility desired may

aect the method o procurement selected.

Step 3: Determine the best owner or each

project component

Who can and should do what?

Determining what you have authority to do and then

what you want to do will begin to narrow the options or

structuring the relationship with the private sector. The

next step is sorting out who can and should do what.

The sorting process has three principal components:

capabilities, nance and risk.

Capabilities

What capabilities do we have in house to deliver and/

or manage the project?

In what areas o project delivery does the public sector

project sponsor excel: design, operations, maintenance,

nancing? What capabilities are present in the market? For

example, i a government excels at road maintenance but

is weak on construction (cost or timing), it might decide

to bear responsibility or long-term asset condition, but

allow a private partner to add value at the ront end o the

project.

The same goes or management. Large capital projects are

complex and require a great deal o experience to manage

successully. Partnerships add another layer o complexity,

and institutional capacity building must be a core elemento any PPP program. Eective project management is

essential to limit risk and cost overruns and streamline

delivery, so the presence o competent sta is o particular

importance when unding is tight. The need or strong

project management may necessitate training or shits in

internal sta. It may also mean that certain projects are

not worthy o pursuit in light o the associated risks.


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Financial

How are we going to pay or the inrastructure?

An important, but oten conused, distinction to

draw when considering the nancial elements o an

inrastructure project is that between unding and

nancing. The unding or a project is its long-term source

o support. In the case o public inrastructure, this may

be revenues generated by the project, dedicated tax

revenues or general resources o the sponsoring public

sector entity. The nancing o a project is the means by

which the unding is leveraged to provide enough up-

ront cash to purchase, construct or adapt the project.

It is important to note that, while there may be many

creative nancing vehicles available, once the unding

structure is established, all o these nancing vehicles will

be securitizing the same project economics.

Historically, U.S. public sector entities have supported

inrastructure development through pay-as-you-go cash

unding or debt nancing through a myriad o credit

structures and instruments. Given already overstretched

budgets, dismal scal outlooks or the near to medium

term, and a general reluctance to raise taxes and imposenew ees in the current economic climate, most public

sector entities will be challenged to und a slate o new

projects to rehabilitate existing assets and enhance current

capacity on a pay-as-you-go basis. Likewise, borrowing

capacity or many public sector entities is constrained,

and credit positions have been weakened by scal stress,

making access to credit-sensitive nancial markets more

dicult.

In this atmosphere, partnership structures may prove

appealing or many public sector entities. They may

consider partnership structures that reduce the public

sectors capital payments over the lietime o the asset (orcontract), monetize existing assets to pay or new ones

or allow or nancing by the private sector that does not

eat into public debt capacity. Using PPPs to raise private

capital or public projects can help to spur job creation

when projects would otherwise be put on hold. This,

in turn, can enhance public sector revenues through

associated tax revenue.

Risk Transer

How much risk should be transerred?

Answering this question correctly and allocating risks

accordingly maximizes public value. There are several risk

allocation conventions (or example, a private contractor

is naturally positioned to eciently manage construction

risks, a government is better positioned to control and

absorb regulatory risk), but every partnership is unique and

careully negotiated. Beyond the conventional wisdom

o placing the various risks with the party best able to

manage them lies the reality o competing public policy

goals, the nite risk capacity o the marketplace and the

diculty o holding a risk allocation xed throughout

a negotiation. In short, risk allocation is the search or

optimality.

As partnership models prolierate around the world,

risk allocation principles are becoming increasingly

sophisticated and the parties are becoming more adept

at crating structural solutions to risk capacity constraints.

For example, many PPPs have been structured to isolate

discrete and identiable chunks o risk (such as

tunneling) to avoid contaminating the overall risk-sharingapproach with inecient pricing. The public sector has

discovered ecient ways to write down those elements

and still achieve value. The key is to optimize, rather than

maximize, the level o risk transer.

One o the core tools being used in international P3

that is now gaining ground in the United States is Public

Sector Comparator/Value or Money analysis. The term

Public Sector Comparator (PSC) reers to the risk-adjusted

whole-o-lie cost o procuring an asset or service

through whatever is considered the conventional public

procurement method. The term Value or Money (VFM)

reers to the result o a comparison between the PSC andthe risk-adjusted whole-o-lie cost o procuring the same

asset or service rom a private party.


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The PSC/VFM analysis is used to describe the dierence

in risk-adjusted cost to the public sector between

conventional procurement and PPP procurement. In a

direct comparison, whichever model produces a lower

cost is said to provide Value or Money (see appendix B

or a schematic o the analytical process). The practice

in many countries is to perorm this analysis as part o

the approval process or undertaking a project as a PPP.

In those cases, unless VFM can be proven, the project is

either aborted or pursued by conventional procurementmeans.

A key rst step in developing a PSC/VFM ramework is

to dene conventional public procurement. For U.S.

public sector entities, that is likely to be a marrying o

the best-practice contracting method (design-bid-build

or design-build) with some orm o bond nancing. In

countries where this analysis has been widely practiced,

the sovereign cost o capital is used as the benchmark.

That concept is irrelevant or the United States, where

inrastructure is conventionally nanced in the tax-exempt

long-term debt capital markets.

Accurately assessing the value created by partnership

structures in todays turbulent nancial markets requires

complete transparency in both the public and private

sectors costs. An accurate assessment also requires

realistic assumptions about whether a project could

actually proceed through traditional means i Value or

Money is not demonstrated using PPP. With public unds

less available and being used to nance an expanded

number and degree o activities (social welare needs,

economic stimulus spending and nancial systemrecovery), the validity o this assumption should be

conrmed. I the project would not proceed unless a PPP

is used to deliver it, then the benets o expedited delivery

should be actored into the analysis.


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Figure 3. Optimizing risk transer to maximize Value or

Money

Value or

Money Optimal risk transer

Signicant benet o risktranser as private sectordiscipline ensureseective perormance

Source: Deloitte.

Value declines ascosts o risk transeroutweigh benets

Cumulative risk transer

Common risk allocation mistakes

Several common mistakes can occur when governments

set the risk terms o a partnership structure.

1. Goldilocks syndrome. There can be a tendency in

partnership structures to transer either too much or too

little risk. Because the public sector can be risk averse,

with public sponsors oten looking to PPPs to save up-

ront or total project costs, there are times when too

much risk is transerred to the private sector. The result is

a project that is dicult to nance, which in turn reduces

the quality o partners willing to bid on it and ultimately

increases costs o delivery. While the public sector must

be vigilant in protecting its own interests, the point o risk

transer that will cause private partners to walk away rom

a deal can oten be dicult to predict. Consequently, the

public sector should be cognizant o the private sectors

risk capacity constraints when structuring the initial bid

documents, and be open to urther negotiations on some

items when the preerred bidder is selected. Optimal risk

transer ensures that there are enough high-quality bidders

to reap the benets o robust competition and that the

public sector does not overpay to transer risk that it isbetter suited to retain (see gure 3).

2. The Beetle vs. the Ferrari. The public sector

oten views partnering as a way to achieve higher

service levels rom the private sector. Private partners

are more than willing to provide high-quality service

levels, but they expect to be paid or doing so. The

public sector cannot expect to get a Ferrari or the

price o a Beetle. Understanding this at the outset will

help to establish more realistic perormance standards

in the project agreement and mitigate sticker shock

once the bids come in. PSC/VFM analysis seeks to

create an apples-to-apples comparison that enables

the public sector sponsor to make a best value choice.

Once the project agreement is signed, the public sector

is aware o the quality o service that will be provided

or the term o the contract. This approach contrasts

with conventional procurement models, where the

quality o service has been shown to decrease over the

length o the contract as maintenance requirements

become more costly.

3. Buy or Lease? Leasing a car might cost you less

per month than making payments on a car you buy.But when the lease is up, i you want to purchase

the car, theres a balance to pay. Depending on the

cars eatures or service level, on top o anything else

that may have changed since the lease was initially

signed, the amount owed might be higher than the

current value o the car. Consequently, beore decid ing

whether to buy or lease, it is important to careully

evaluate what your needs are at the outset, and how

advances in technology may aect those needs over

time. The same is true o entering into partnership

agreements. Making a realistic determination o

actual needs up ront, assessing how those needs

may change over time and identiying the acceptablelevels o risk associated with each o those needs are

important steps in preventing surprises down the road.


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4. Optimism Bias. Several studies have ound that

during inrastructure procurements, public sector

entities tend to be overly optimistic about a projects

costs and time lines and about its potential to generate

revenue. Separately, bidders optimism is particularly

pronounced when it comes to orecasting demand or

a product or service, given the desire to provide the

best bid possible. Governments use several approaches

to mitigate demand optimism bias. These include

setting a range o revenue returns in the contractterms; allowing or a renegotiation o the contract

i the returns are below the set range and limiting

the private partners prots i returns are above the

desired range; providing nancial payments to the

private partner i demand is below a certain level; and

setting the duration o the total project concession to

a targeted revenue amount (that is, once the private

partner has hit the specied revenue ceiling, the

concession ends).


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Table 2. Integrated map or inrastructure modernization

Step

Determinepublic authority(What do I havepermission to do?)

Dene projectneeds andobjectives(What do I wantto do?)

Determine thebest owneror each projectcomponent(Who can andshould do what?)

Considerations

Laws andstatutes

Political

Speed

Eciency

Innovation

Degree ocertainty

Financial

Capabilities

Risk

Key questions to ask

What laws and policies existregarding private nancing anddelivery o inrastructure?

Are there political constraints thatwould make it dicult to usecertain partnership structures?

How quickly does the asset needto be delivered?

How can the asset be deliveredand maintained as eciently aspossible?

Is there an opportunity to incorpo-rate private sector innovation?

Will changes in technology, policyor demand aect how we wouldmeet the need tomorrow?

Who is going to pay or theproject?

What capabilities are there in-house to deliver the project and/or manage the project? Whatcapabilities exist in the market?

How much risk should be trans-erred? Who is best able to bearwhat risks?

Impact on private involvement

A poor legislative and statutory environment will constraineorts to increase private sector participation in inrastruc-ture development.

Many jurisdictions ace limitations rom the public on thetype and level o responsibility that can be allocated to aprivate partner.

Traditionally procured projects typically begin sooner andhave shorter procurement cycles (provided nancing orcapital costs is available), while PPPs have a superior recordin timely completion.

Properly structured partnerships ocus the contractors at-tention on delivering the lowest overall lie-cycle cost.

The greater the scope or fexibility in the nature o thetechnical solution/service or the scope o the project, themore opportunity or private sector innovation.

The greater the uncertainty about the projects scope andscale, the more a hybrid PPP or traditional procurement islikely the best option.

Fiscal conditions can either widen or constrain the PPPoptions available.

I a PPP model is chosen, the public sector must create theinstitutional capacity to manage a complex set o contrac-tual arrangements.

Optimal risk allocation is critical to successul partnerships.

Optimal partnership structure

Completing these three stepsdetermining public

authority, dening project needs and objectives,

and determining the best owner or each project

componentshould yield the optimal partnership

structure or any given inrastructure project (see table

2 or an integrated guide to the steps). To see how

this might work in practice, appendix C lays out how

this approach is applied to the case o a hypothetical

wastewater treatment plant.


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Conclusion

In these challenging times, governments are coping with

the normal course o scal stress overlaid with a new set

o extraordinary demands on their resources. At the same

time, it is clear that reverting to a deault setting o earlier

times putting inrastructure investment on hold until the

economy has recovered will put economies in an ever

more precarious position going orward. I inrastructure

gaps are to be narrowed, the public sector must respond

with creative and fexible solutions that evolve with the

changing environment. The old models o nancing and

delivering inrastructure must give way to new, innovative

models and a portolio o hybrid approaches.

Too oten, public sector entities are unaware o the

alternatives available to them or o the considerations

involved in selecting the most appropriate delivery models

or their capital projects. This has resulted in less-than-ideal

outcomes rom traditional procurements and public-private

partnerships alike. By applying a bottom-up approach to

the development o a partnership structure, the public

sector can deliver projects in a way that most closely

approximates the optimal solution within the connes o

what is possible.

Careul, inormed analysis at the outset o a project will

help to ensure that limited resources are put to their best

possible use, while putting government organizations in

the best position to achieve their inrastructure objectives

in todays challenging climate. Used systematically, such a

disciplined approach to project structuring will also put the

public sector on a strong ooting or continued innovation

beyond the current crisis.


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Appendix A: EstimatedU.S. inrastructure defcit

Dened comprehensively

Transportation

(roads, bridges, transit and rail)

Education acilities

Energy transmission

Criminal justice acilities

Technology architecture

Water systems

(drinking water, wastewater, levees, inland waterways and dams)

Huge legacy needs

($Billions)

1,300+a

322+b

1,500+c

12.5+d

100+e

585+

a American Society o Civil Engineers: $1.3 trillion or roads, bridges, transit and rail over 5 years.b National Education Association: one-time investment.c American Association o Civil Engineers and the Brattle Group: or 2010-2030.d Pew Center or the States: or 20072011.e EDUCAUSE: $25 billion annually over our years. American Association o Civil Engineers and Association o State Dam Saety Ocials: $110 billion over 10 years or drinkingwater; $275 billion one-time investment or levees, inland waterways, and dams; $390 billion over 20 years or wastewater.


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Appendix B: Applying theValue or Money test

Irrespective o the procurement structure used, any

public sector authority should have a methodology

to demonstrate that Value or Money (VFM) has been

achieved. It is clear that this is not always easy to do,

however. Across the world, methodologies or assessing

whether PPP deals oer VFM have been developed and

used with some success. Overall, VFM testing considers

whether the procurement structure being considered

oers a lower overall cost ( in present value terms) relative

to an estimate o the risk-adjusted costs were the publicsector to deliver the project itsel (commonly reerred to as

the Public Sector Comparator, or PSC).

Developing the Public Sector Comparator

The PSC incorporates an assessment o all project

costs, revenues and risks projected or the project. The

PSC developed should be used as a VFM assessment

tool throughout the procurement process and as a

management tool or considering options during bidder

negotiations and consultation. The PSC should thereore

be developed using realistic costings or a realistic

alternative to the PPP model being considered.

Costs or inclusion in PSC

A detailed evaluation o project costs and revenues is

required (see nearby box). It is important that those costs

are considered, based on the same scope o services being

requested within the PPP structure. The PSC should also

consider all costs relating to the project, including costs

that will not be transerred to the private sector under any

structure.

Cost/revenue headings

Capital/constructioncosts

Construction period

Lie-cycle costs (operations period)

Operatingcosts

Core services

Non-core services

Maintenance

Insurance

Taxation

Third-partyincome(basedonpublicsector

ability to generate)

Cost and revenue should be estimated based on precedent

(construction and operating) methodologies used by the

public sector on similar projects. It is important that cost

estimates not be overly optimistic to avoid creating an

unair comparison. The key question or the public sector

when costs are being nalized is whether the project

could realistically be delivered within the budget proposedi required. I this is not the case, then the budget should

be adjusted to a more appropriate level.

Risk assessment

The PSC must consider the project as i the public sector

were to deliver it using the same scope, service levels, time

lines and build quality required o the private sector. The

PPP procurement structure will require a xed price deal

delivered within a dened period with various operating

risks being retained by the private sector. The PSC must

thereore include an assessment o the cost o these risks

to the public sector, or example, cost overruns or time

delays based on previous public sector experience.

While dicult to do, the PSC will involve the development

o a risk register that identies all o the project risks

involved. Ideally, each risk or each element o the project

over the entire lie o the project should be identied. In

turn, each o these individual risks should be considered,

valued and designated or transer to the private sector

under the PPP structure or or retention by the public

sector. Either way, they should be included in the PSC.


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VFM assessment

The VFM assessment involves comparing the net present

value o the PSC costs with the total public sector costs

o the proposed PPP structure as set out in the diagram

below (see gure B.1). In advance o receiving detailed

costings rom private sector bidders, private sector costs

under the PPP structure can be estimated by developing

a shadow bid. This allows an early assessment o VFM

to help to avoid spending time going to the market with

a transaction that could never be justied on a VFM basis.The net present value calculation should be based on the

discounted cash fow o revenues and costs over the lie

o the project. The discount rate used should be the long-

term cost o unds or the public sector authority.

It should be noted that in some cases, VFM cannot

always be quantied. Qualitative aspects should also be

considered including increased quality o service, speed o

delivery and the long-term nature o the contracts. Where

the dierential with the PSC is quite small, these issues

may result in the project VFM being viewed positively or

negatively.

Figure B.1. Value or Money assessment

PSC cost analysis PPP structure Public sector costs

Cost Cost

Cost overrun risks

Time Time

Construction ConstructionOperations Operations

In certain instances, the VFM assessment can be more

academic in nature given that without adequate

public sector unds, the project may not be deliverable

unless private sector unds are made available under a

PPP structure. In those cases, the PSC should still be

developed and the VFM analysis carried out to better

understand the potential dierential between the two

options were public unds available. The key decision will

depend on the aordability o the private sector option

relative to the level o public sector unds available.

While this is not ideal, it nonetheless is a reality in many

countries around the world.

Capital costs

Retained risks Retained risks

Retained operating risks

Retained operating risks

Retained operating costs Retained operating costs

Transerring operating risks

Transerring operating costs

Unitary change

Timedelayrisks


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Appendix C: Applying thebottom-up approach to ahypothetical case

Consider a public sector organization (the Authority)

that wants to adopt the best approach or upgrading its

decades-old wastewater treatment plant.

The water/wastewater PPP market has matured

considerably in recent years, with numerous deals

with various types o procurement structures having

been completed. The Authority wants to make sure

it understands all the options currently available or

designing, building, nancing, operating and maintaining

a new plantand o those, which is best suited to this

particular project at this point in time and or the uture.

The Authority wants to retain ownership and control o

the acility, which immediately rules out ully privatized

delivery options. So Authority ocials must conduct a

bottom-up analysis that looks exclusively at the ollowing

project components: design, nance, construction,

service operation and ongoing maintenance. It must also

look at which party might be best able to manage each

component.

The overarching goals that guide this analysis include theAuthoritys desire to achieve an optimal risk transer and

its wish to weigh the benet o paying construction costs

up ront or over the lie o a project.

Step 1: Determine public authority

The rst step is to survey the statutory landscape and

identiy any laws that may aect the types o partnership

structures the government can consider. In this case, the

public sector organization has the authority to involve the

private sector in part or all components o the project. The

public sector can involve the private sector in the nance,

design, construction, service operation and ongoing

maintenance components o the project i doing so

provides good Value or Money.

Next, the analysis considers public perception o dierent

partnership structures. It is possible that some special

interest groups will oppose private nance in the project.

But the Authority can easily mitigate potential opposition

by developing a sound business case and conducting

eective public outreach. In addition, the retention o

ownership at all times assists in dealing with this issue.

Thus, subsequent phases o the analysis ocus on the

ollowing partnership structures: design-build; design-

build-operate-maintain; and design-build-nance-operate-

maintain. In each case, each structure is compared to the

traditional procurement structure where each element isprocured separately.


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Step 2: Dene project needs and objectives

Ater determining what is possible rom a legislative and

statutory perspective, the next step is to dene the project

needs and the parameters or meeting those needs.

What does the plant need to do? What technology is

appropriate or accomplishing this? How can the asset be

delivered and maintained as eciently as possible?

To begin, the authority needs to answer some primary

questions: What does the plant need to do? What kind o

volume does it need to handle? Does it need to improve

on any o its existing processes? It then denes some

criteria by which waste treatment technologies will be

screened to determine the most appropriate one or the

project, and the associated construction, operating and

lie-cycle costs.

Table C.1. Partnership options under consideration

Traditionalprocurement

Design-build

Design-build-operate-maintain

Design-build-nance-operate-maintain

DescriptionPartnership structure

Thegovernmentownercontractswithadesignengineertodeveloptheprojectdesigndocuments(drawings,quantity

estimates and specications).

Theconstructioncontractorisselectedthroughacompetitivetender,withthecontractawardedtothelowestbidder.

Ongoing operations and maintenance are managed and provided either d irectly by the public sector or by subcontractors.

Designandconstructionarebundledtogetherandtenderedasawhole.

Contractsareusuallyawardedbasedonlowestprice,butbestvalueevaluationsarealsopossible.

Thetwokeyreasonstochoosethisapproachovertraditionalprocurementaretoreducecapitalcoststhroughinnovationin

a competitive process, and to gain certainty by transerring design and construction cost risk rom the public sector owner to

the private partner. Similar to traditional procurement, post construction services are provided separately by the public sector.

Theprivatepartnerisresponsiblefordesigning,building,operatingandmaintainingtheassetoveralongperiodoftime(such

as 25+ years).

Themotivationbehindthistypeofpartnershipstructureistotransferthefulllife-cycleandoperatingcostriskoftheassetto

the private partner. The operations element needs to be o an appropriate scale to drive a real perormance penalty regime

because all construction unding is provided by the Authority in advance o operations.

Similartoadesign-build-operate-maintainmodel,withtheadditionalprovisionthattheprivatepartnernanceallorpartof

the capital cost.

Therepaymentofthecapitalcost,nancingcostsandoperatingcostsarerolledintoaseriesofperformancepaymentsmade

by the public sector owner to the private partner over a long period o time.

Capitalcostsarenotpaidtotheprivatepartnerwhentheyareincurredbutratherarenancedandpaidbackovertime,

much like a lease payable based on perormance.

Fulllife-cyclecostriskisbornebytheprivatepartner.

It identies the ollowing evaluation criteria:

Hasasmallfootprint

Iscapableofreceivingseptage

Producesalowervolumeofsludge

Iseasytooperateanddoesnotrequireahighlevelof

operator training

Usesexistingbuilding

Isredundant(canbemaintainedandservicedwithoutprocess interruption)

Meetsmandatedefuentstandards

Ater ocials have screened existing technologies against

these criteria, a preerred technology emerges. When

considering the use o PPP as a procurement option, the

Authority must decide whether it wishes to dene the

required technology solution or allow the private sector to

propose technology alternatives. This depends on whether

or not the Authority wants to retain design or technology

risk in the project.


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The next step is to think through how project needs

may evolve over time and to identiy some parameters

that aect how the service might be delivered over the

long-term. For example, how ar into the uture is it

possible to predict the need or services? The answer

to this question will aect which delivery models the

organization can consider, since some o the partnership

approaches are easible only i demand or the new plants

services remains strong or quite some time or i the

service delivery model will not change signicantly. In thiscase, the organization has a long-term need or services.

(See table C.2 or additional parameters identied or the

project.)

Based on the project needs identied, all o the

partnership options outlined above remain in the running.

Table C.2. Project needs considered or the wastewater treatment plant

Project needs

Eciency

Degree o certainty

Innovation

Question

Wouldtheprivatesectorbe

able to exploit any economieso scale that may bringeciencies to the project?

Isthereahighlikelihoodoftechnological change?

Howfarintothefuturecanthe need or services bereasonably predicted?

Whatistheexpectedlifeofthe asset?

Istherescopeforinnovation

in either the design o thesolution or in the provision oservices? Does some degree ofexibility remain in the natureo the technical solution/service or the scope o theproject?

Reason or inclusion

Theabilityfortheprivatesectortoexploit

eciencies not otherwise available to thepublic sector is a quick way to achieveValue or Money on a project.

ProjectscontainingsignicantITelementsare generally not appropriate or PPP,as typical IT projects have a liespan o35 years, and it is dicult to predicttechnological advances beyond 5 years.Also, integrating dierent IT systemsincreases the complexity o the projectsignicantly.

Theservicesderivedfromtheassetmustreasonably be demanded over the longterm to justiy a PPP.

PPPs,bynature,arelongtermprojects.

So the asset should have a long expectedlie.

Ifbidscanincludeinnovativeideas,that

increases the chance o realizing Value orMoney.

Answer

Itisnotknownatthistimewhether

partnering with the private sectorwill bring substantive opportunitiesto increase eciency.

Thereislowlikelihoodoftechnological change.

Theneedforservicesislongterm. Theexpectedlifeoftheassetislong

term.

Thereissomescopeforinnovation,

but this could be captured throughdesign-build or design-build-operatepartnership structures withoutbundling the nance componentinto the structure.

Step 3: Determine the best owner or each

project component

The last step in the analysis involves understanding who is

best positioned to do what. In order to optimally allocate

project responsibilities, the Authority determines the

costs associated with dierent implementation options.

It also examines public and private sector capabilities and

conducts a relative risk assessment to determine the merits

o bundling additional components o a project. We

consider each o these in turn.

Who can and should do what?

The rst step is to determine the various elements o

the project and consider the relative complexity o each.

Is the project overly complex (in terms o the number

o stakeholders or in the nature o the project itsel, or


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example) and does it thus exceed existing internal

capacity to procure or to execute? Similarly, i the project

is too complex or requires signicant upgrade over the

lie o the project, it may be too dicult to interest the

private sector in assuming long-term project risks. In this

case, the wastewater plant is not highly complex and

can be managed eectively either in-house with existing

capabilities or by the private sector.

The Authority will dene the technology solution or the

new treatment plant, which is relatively easy to operate

and will not require a lot o operator training. Thus, the

public sector will not incur large additional costs or sta

training i plant operations are kept in-house. That said,

the organization should consider whether operating the

plant may be considered a core or strategic unction. By

transerring operations to a private partner, would the

public sector lose a core skill that may have strategic or

long-term importance? In this case, acility maintenance

and operations are not considered core and thus may

be bundled into the partnership model without posing a

strategic loss to the organization. Reduced stang under

a private sector operations model may bring additionalcost savings to the Authority i the structure is acceptable.

The next step is to determine whether it is possible to

put an eective perormance monitoring program in

place. I the contract bundles private nance, operations

and maintenance responsibilities, sta at the public

organization will need to monitor perormance, ensuring

that the partner delivers services as the contract denes

in clear, objective, output-based terms. Without eective

perormance monitoring, the project is less likely to deliver

Value or Money. In this case, the sta currently managing

the wastewater acility would have to undergo a major

transormation in order to manage the perormanceagreement over the long term. The Authority has not

conducted a similar project (one that bundles design,

build, nance, operations, and maintenance components)

in the past, so it has no internal experience to rely on.

In addition, uture opportunities to manage this type o

partnership approach or other projects are unlikely, which

means these perormance management skills would be o

benet only on one project. However, in a PPP context,

the perormance monitoring and penalty deductions can

be introduced and managed quite eciently withsel-

monitoring by the private sector along with Authority

check up. Perormance monitoring should thereore not

prevent the use o PPP; however, the use o PPP should be

based on the nancial and risk assessment.

Next, the organization examines whether the private

sector is capable o delivering the required outcome. This

step primarily involves surveying the market or similar

projects and talking to known market participants to

gauge interest in this project. An existing market or similarprojects is likely to improve competition in the bidding

process, thereby delivering additional Value or Money. In

this case, there is an existing market, and known market

participants have conrmed their interest in the project.

Since the public sector organization is providing land, and

the project is essentially a new build, the procurement

process is not expected to be overly complicated

How to pay or it?

In this example, while sucient capital is available rom

the public sector to nance the new treatment plant, the

organizations primary nancial objective is to consider

which structure oers best Value or Money, includingweighing the benet o long-term annual payments

against up-ront construction costs and ongoing

operational costs.

To assess the best partnership structure or meeting this

objective, a nancial analysis is conducted to determine

the expected cash fows during the construction and

operations phases o the project (usually considered over

20 25 years). This analysis makes it possible to compare

the relative cost or each partnership structure.

Once cost values have been calculated, they are converted

to net present value (NPV) to acilitate an apples-to-applescomparison o total costs incurred (in todays dollar value).

For the wastewater treatment plant in this example, we

have included the nancial analysis based on estimated

outcomes under dierent procurement structures. This

is typical o the analysis that should be completed by any

procuring Authority when considering potential structures

in advance o actual procurement. These o course can

be compared with actual results when detailed bids are

received.


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Dierent private operators might use dierent operations

models that would result in cost savings, but to avoid

disorting the analysis, those potential savings have

not been included. Similarly, except or reductions

in procurement costs and synergies between the

construction and design team costs where services are

bundled, potential savings/synergies in various structures

due to bundling have not been included in any signicant

way. The NPV calculation assumes a long-term cost o

unds or the Authority o 6 percent, which has been

used as the discount rate on all procurement options

considered.

Table C.3 sets out the results o the nancial analysis o

each procurement option. Based on this analysis, it would

appear that in NPV terms, either o the design-build-

operate-maintain options, including and excluding private

nance, oers the lowest NPV. It should be noted that

some o the dierential relates to the levels o risk retained

by the Authority, particularly in the traditional and design-

build options where only limited elements o the project

are covered by xed price contracts and perormance-level

requirements.

While the NPV values o the two design-build-operate-

maintain options are very close, the nominal value o the

option including nance is much higher. The decision to

be made involves considering whether unding is available

to pay or project costs as they are incurred or whether it

is preerable to deer these expenditures by selecting the

option including nance. Even i the required unding is

Table C.3. Nominal and NPV outputs o the nancial analysis

available, the Authority should also consider whether this

unding would be better used on other projects, allowing

a greater level o project development based on the unds

currently available.

Who should bear what risks?

The main reason or pursuing a greater role or the private

sector is to achieve greater Value or Money (that is,

greater economic and social benets with lower overall

risk). Value or Money is achieved principally by allocating

and managing risk. That means making each party

responsible or managing risk (and potentially giving that

party a revenue source) through obligations in a contract

or a specic piece o legislation.

In this project, several risks were identied as key, meaning

they were likely to occur, and i they did, they would bring

severe consequences (see table C.4).

Ater identiying the key risks associated with the

project, the Authority conducts a probability and severity

assessment to estimate how likely it is that a particular

risk will materialize, and how that risk will impact the totalcost o the project i it does occur.

A risk plot methodology might yield the ollowing list, with

the lowest-risk model at the top and the highest at the

bottom.


Design-build-operate-maintain

Design-build

Design-bid-build(traditionaldelivery).

In this case, the design-build-operate-maintain model is

only slightly riskier than the design-build-nance-operate-

maintain model. The other two models carry considerablymore risk.

Service providers in this sector will generally accept

the risks in areas over which they have ull control, or

example in:

Design

Constructioncost

Operations

Maintenance

Recapitalization

Option

Traditionalprocurement

Design-build

Design-build-operate-maintan


Build Costs

$m

99.5

99.3

97.7

97.7

Operations

$m

52.5

52.5

50.0

50.0

Finance

$m

109.9

Risk Value

$m

15.2

15.2

9.6

3.0

Total

$m

167.2

167.0

157.3

260.5

NPV

$m

126.6

126.4

119.6

119.7


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Table C.4. Key risks identied or wastewater treatment plant

Government policychanges

Wastewater treatmenttechnology selection

Design risk

Construction/ decommis-sioning activity results incontamination

Construction delays

Failure to build to designor quality level

Construction cost

Latent deects

Change order risk

Lie-cycle maintenance residual value

Lie-cycle maintenancecosts

Efuent quality

Biosolids management

Unanticipated operatingcosts

Labor supply risk

Proessional and legalliability

Site security

Loss o operational fex-ibility/control (i opera-tions risk is transerred)

Deault o operatingcontractor (i operationsare bundled into thecontract)

Description

A change in law, government policy or protocols modies or terminates the process.

The treatment technology proves inadequate to meet efuent requirements, requiring costly mitigating measures.

The designed system (including all equipment) ails to deliver services at the required levels o perormance and quality,because the partners ailed to translate the requirements into the design. This produces additional design and systemdevelopment costs.

Construction/decommissioning activity results in contamination o the site. This could close the site temporarily and delaycontract completion.

The acility is handed over late and/or is late in achieving its perormance goals because o delays in construction.

The project is not constructed according to the design documents (or quality requirements). This could impair peror-mance, saety, longevity and the like.

Construction costs are higher than the construction contractor estimated.

Latent deects in new work are discovered ater substantial completion and/or ater warranty period.

Change orders are issued during construction due to design coordination/design completion/design gaps. This risk may becompounded i the contract does not ully speciy the method o pricing or change orders and change order costs exceedestimated amounts.

Capital and lie-cycle maintenance to the structure and systems o the building is not perormed when appropriate tosustain the capital value o the property and meet handover specications.

Lie-cycle maintenance costs are higher than projected.

Efuent ails to meet regulatory requirements.

Risk is associated with management o biosolids, including long-term liability.

Operating costs are higher than projected because o infation or inaccurate estimates and assumptions, aectingutility and maintenance costs.

The operator may encounter labor disputes or trouble attracting and retaining sta who are suitably trained and certied.

Key operating acility sta may be subject to litigation and claims related to negligence. Risk may aect operation o theacility, causing delays in services to the public and damage to the owners reputation.

Site security may be breached during operations, receiving, maintenance or renewal.

Operating processes, procedures and standards may lack the fexibility required to operate plant optimally.

The operating company may deault or go bankrupt.


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Experience to date indicates that the private sector can

easily manage these risks. Private sector partners will not

take ull responsibility or risks in areas where they do not

have control, or example:

Latentdefectsinexistinginfrastructure

Regulation

Latent deect risk probably will not be signicant or the

project, as little o the existing plant will be used in the

new plant.

Results o the bottom-up analysis

Ater analyzing the relative risks and costs o the dierent

delivery models, determining potential market interest in

the project and surveying internal and external capabilities,

the organization reaches the ollowing conclusions:

Design-build-nance-operate-maintainisthelowest-risk

option (although only marginally lower than design-

build-operate-maintain);

Design-build-nance-operate-maintainisthemost

expensive option in nominal terms due to nancing

costs; however, it is in line with the lowest cost in NPV

terms; and Potentialprivatesectorefcienciesforconstructionand

operations along with competitive price pressures could

be achieved when detailed bids are received that would

urther reduce the overall cost.

Because a properly structured design-build-nance-

operate-maintain structure puts the private sector service

providers capital at risk (that is, non-perormance

penalties can prevent it rom recovering its capital

investment), this model can provide a stronger

perormance incentive than a design-build-operate-

maintain structure. Given the small dierence between

the two ull service options, the use o the option

including nance may provide the greatest overall benet.

I the organization is not able to manage and monitor

a long-term perormance arrangement with a private

partner, the project is less likely to achieve Value or

Money. The government must acquire the skills necessary

to manage perormance. This should be achieveable, and

improved perormance monitoring should result in better

service provision.

Thus, in this instance, a partnership approach that

bundles the design, build, operate, nance and maintain

components o the project appears to best meet the

public sector organizations needs and to oer the

greatest Value or Money.


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1 Top Executives Say Current Inrastructure InvestmentWont Support Business Growth, Says KPMGStudy, PRNewswire, January 14, 2009 .

2 Building Americas Future, Building Americas FutureReleases New Poll: Majority o Americans Ready to Payor Better Inrastructure but Demand Accountability,press release issued on January 8, 2009 .

3 American Society o Civil Engineers, 2009 Report Cardor Americas Inrastructure, January 2009 .

4 Kearsarge Global Advisors (in coordination with Abertis,Babcock & Brown, Barclays Capital, Carlyle InrastructurePartners, Chadbourne & Parke LLP, Citi InrastructureInvestors (CII), Credit Suisse, Debevoise & Plimpton,Freshelds Bruckhaus Deringer, Fulbright & Jaworski,Mayer Brown, McKennaLong & Aldridge LLP, MerrillLynch, Morgan Stanley, RREEF, RBC Capital Markets,Scotia Capital, and UBS), Benets o Private Investmentin Inrastructure, January 21, 2009 .5 Christopher Conkey, Raising the Federal Gas Tax Is a

No-Go, Wall Street Journal, March 4, 2009 .

6 Federal Highway Administration, U.S. Department oTransportation, USDOT Approves $603 Million Loanto Build New Express Lanes In Florida: Sunshine StateLands Nations First TIFIA Loan o 2009, March 4, 2009.

7 Colin Dueld, National PPP Forum BenchmarkingStudy, Phase II: Report on the Perormance oPPP Projects in Australia When Compared with aRepresentative Sample o Traditionally ProcuredInrastructure Projects, Melbourne EngineeringResearch Institute, University o Melbourne, December17, 2008 .

8 The use o land and development opportunity as part othe consideration or services and inrastructure assetsgenerally requires a strong property market. In thecurrent economic climate, depending on the location,this may be challenging. However, as long as valuationexpectations are reasonable on all sides, then theseoptions may be considered.

Endnotes


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About the authors

Tiany Dovey

Deloitte Services LP

Tel: +1 571 882 6247

Email: [email protected]

Tiany Dovey is a research manager with Deloitte

Research where she has responsibility or public sector

research and thought leadership. She has written exten-

sively on a wide range o public policy and management

issues and is the co-author oStates of Transition (DeloitteResearch, 2006). Her work has appeared in a number o

publications, including Public CIO, Governing and Educa-

tion Week. Tiany holds a Bachelor o Arts in philosophy

and public health and community medicine rom Univer-

sity o Washington and a Masters in Public Policy rom The

George Washington University.

William D. Eggers

Deloitte Services LP

Tel: +1 202 378 5292


William D. Eggers is the Executive Director o DeloittesPublic Leadership Institute and the Global Director or

Deloitte Research-Public Sector where he leads the public

sector industry research program. A recognized expert on

government reorm, he is the author o numerous books

including: Governing by Network: The New Shape of the

Public Sector(Brookings, 2004), Government 2.0: Using

Technology to Improve Education, Cut Red Tape, Reduce

Gridlock, and Enhance Democracy(Rowman and Little-

eld, 2005) andStates of Transition (Deloitte Research

2006). He is the winner o the 2005 Louis Brownlow

award or best book on public management, the 2002

APEX award or excellence in business journalism, the

1996 Roe Award or leadership and innovation in publicpolicy research, and the 1995 Sir Antony Fisher award

or best book promoting an understanding o the ree

economy. A ormer manager o the Texas Perormance

Review, he has advised dozens o governments around the

world. His commentary has appeared in dozens o major

media outlets including the New York Times and Wall

Street Journal. His upcoming book, If We Can Put a Man

on the MoonGetting Big Things Done in Government,

will be published by Harvard Business School Press in the

all o 2009.

Michael Flynn

Deloitte Ireland

Tel: +353 1 4172515


Michael Flynn is a Corporate Finance Partner at Deloitte in

Ireland and leads the Specialised Finance Practice including

Government & Inrastructure, Debt Advisory and Financial

Modelling services. He advises the public, private and

banking sectors on inrastructure (including PPP) and pub-lic sector related transactions in Ireland and internation-

ally across a variety o sectors, including transport (roads

and rail), health, education, housing, justice, waste and

energy. Michael is a member o the Deloitte Global Inra-

structure Leaders Steering Group and supports Deloitte

teams on inrastructure projects around the world. He is

a regular contributor to industry publications and presents

to public and private sector organisations on inrastructure

and PPP related topics.

Irene Walsh

Deloitte Corporate Finance LLC

Tel: +1 212 436 4620


Irene Walsh is a Managing Director and leader o the U.S.

Inrastructure Advisory practice o Deloitte Corporate

Finance LLC. She provides strategic and transactional

advice to public and private sector sponsors o

inrastructure projects. Irene has more than twenty-ve

years o experience in inrastructure nance globally across

the spectrum o ratings, advisory, debt capital markets,

credit banking, project nance, and international develop-

ment banking. Commencing her career in the U.S. public

nance industry and then London-based or a decade, shehas worked in more than hal a dozen countries on many

precedent-setting projects, most notably in the transporta-

tion sector. Irene holds an MCRP rom Harvard Universitys

Kennedy School o Government, and a BA in Urban Aairs

rom George Washington University.

partnering for value.deloitte_090710

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