It is always dangerous to compare two types of procurement when the subject cases involve complex facilities but the following conclusions can be drawn.
The nature of the PFI route requires an exhaustive study of requirements to take place before contracts are agreed and the user is pressurised to consider all aspects of the facility in terms of its performance output. When the PFI project is agreed, there is little scope for the public sector to seek changes to the specification and this should result in additional cost being contained.
With the case study project, design development continued until late in the briefing process, and this resulted in an unclear brief and extra cost.
In the PFI project the public sector was concerned that design risk should remain with the private sector contractor. A real transfer of risk will only take place if this process produces the required performance. If this is not the case, cost reductions will result not from greater efficiency but an inferior specification, and the risk can never be transferred absolutely in the case of contractor failure. The failed contractor in the PFI project was compensated to the amount of £75m but this did not save any equity investment in view of the large outstanding bank loans. In the case study project, design problems came to light some time before a start on site and before the pre-tender estimate. In both the cases, considerable sums were expended in solving or attempting to solve the design problems but with the PFI project the public sector client did not become involved with the solution of the problems to ensure that risk and design responsibility remained with the contractor. When the contractor failed, the risk immediately rebounded to the public sector client as the PFI contract contained compensation clauses if the contract was terminated. With the case study, there was considerable expenditure of design team fees and a new services consultant had to start the design from first principles, which resulted in further delay. In theory, the earlier a design mistake is discovered in a project, the lesser the cost will be. If the case study project had proceeded to contract and contractor mobilisation, the cost would have been greater than it was. The PFI project used a procurement route that placed all of the design risk on the contractor so long as there was no change of instruction, and this type of procurement attempts to provide the client with a detailed input by way of a performance specification with the added cost certainty of design and build.
That the route chosen failed in this instance was in part due to the stringent requirements of the performance brief that proved impossible to satisfy completely.
In the case study project, the user client found that financial and time pressures resulted in some areas of specification being changed for non-operational reasons, although this, perhaps, would not have been necessary
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if the briefing process had been more thorough early in the project. With conventional projects, and the case study is a good example, the user is not motivated to think in detail about commissioning until late in the programme and this adds to the risk of increased costs and time. Conversely, there is a loss of flexibility in the project if the scheme is effectively frozen when contracts are agreed with a PFI contractor.
PFI contractors are used to taking on responsibility for design and con-struction risk and have a direct incentive to proceed quickly and smoothly.
At the time of incurring expenditure on design development, the PFI con-tractor will have achieved preferred bidder status and there will be a strong incentive for all parties to complete the scheme. There may be some risk that design solutions may not provide the same performance that would have been achieved by a conventional route, but the risk of major cost overruns should be reduced. In essence, what is assumed to be achieved with a PFI scheme is project management by a private contrac-tor rather than by civil servants. When the public seccontrac-tor has agreed upon the performance specification, the development of the design becomes the responsibility of the PFI contractor. Theoretically, the risk of cost increases over and above the budget should be reduced as cost control of build-ing projects is a risk well understood by contractors. Government should be provided with increased cost and time certainty but as Gaffney and Pollock seek to show, other factors such as funding requirements tend to cloud the picture. With the PFI project the design problems associ-ated with the stringent technical requirements of the laboratory modules were insurmountable and eventually the public sector relaxed the specifi-cation. This was too late, however, for the contractor to stay financially viable.
It should be remembered that a consultant project manager from the private sector managed the case study project, and this was a feature of most DHSS-funded projects at the time. Those commentators who write about PFI sometimes assume that civil servants commonly took on the project management role and this was and is not the case. The NAO states, ‘Traditionally many departments have themselves been managers or providers of services and directly responsible for the construction of capital assets’ (1999, p. 6). The problems associated with the case study project stemmed from an indistinct development of the brief with considerable delays from the original programme resulting from technical work involved with satisfying the user client. Yet, the NAO acknowledges that ‘value for money will be compromised if the public sector’s requirements take second place to providing an attractive opportunity for the private sector’ (1999, p. 3). There is little doubt that with the case study, progress would have been quicker and budgets more robust if the user client had been restricted to performance criteria only. In this situation, however, the PFI contractor would have a direct incentive to provide the cheapest possible solution to meet the public sector requirement and this may have led to a design that fell below the optimum. The comparison between the case study project and the PFI project is summarised as follows.
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Comparison between conventional (case study) project and PFI project.
Item Conventional project PFI project Client contract As above PFI contract with SPV Payment Monthly stage payments
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Conclusion
In terms of procurement, cost savings on PFI schemes over the conventional route have been reported. Peter Coates (2000, p. 18) reports that before PFI
‘expensive cost and time overruns were the norm’ and he quotes the example of the Kensington and Chelsea hospital project, which had an estimated cost of £134m and eventually cost £236m. ‘Meeting the Investment Challenge’
makes similar points. Conversely, Gaffney and Pollock (1999, p. 59) provide figures to show that the differences between outturn and original approved tender sums on NHS capital construction projects over £1m show average cost increases of between 8.8 and 6.2% in the period 1990– 1997. In conclusions to the PFI laboratory case study described earlier, the NAO compared the cost of the procurement to the department with the value of the facilities produced. It is noticeable that in ‘Meeting the Investment Challenge’, the emphasis is on cost benefits of PFI in comparison with earlier pre-PFI public sector projects. If the concept of value is introduced, as it is in the NAO report on the failed National Physical Laboratory, a different picture may emerge.
The value of PFI projects as a percentage of Public Capital Spending (PCS) shows a distinctive upward trend. Yet, PFI in 2001 still accounted for less than 20% of PCS in 2001 (IPPR quoted in The Economist 30/6/01). The size of the overall PFI market is now in excess of £6000m and the projects are tending to become larger (PFI State of the Market 2006, p. 6). The average capital value of projects was £148.57m in 2006–2007 with the main sponsoring department being the Department of Health followed by the Ministry of Defence (ibid.). Supporters of PFI stress the efficiencies of private sector consortia and the advantages of risk transference, yet there is evidence that risk for PFI contractors is limited to those areas where it is most easily managed. Indeed, apologists for PFI see this as a logical step because risk should remain with the party best able to manage it. The case study provides the example of a publicly funded scheme before PFI and it may be inferred that some of the problems associated with its procurement may have been managed better had it been a PFI project. Fundamental questions remain, however. The case study project was managed, designed and built by private sector companies and this was not unusual before PFI. A PFI scheme would not allow the user client to influence the detailed design late in the project and therefore cost and time certainty should be improved. Whether or not the specification produced provides the optimum remains open to debate and there may be collateral benefits for the private sector with the release of development land. Refinancing as project risk declines may yield further benefits but if government seeks to claw these back, it runs the risk of making PFI less attractive to the private sector.
There is little doubt that an attractively structured PFI project is regarded as a sound investment for private sector funds. ‘Annual 30 year PFI payments from the Government to the private sector prove a lucrative and secure return on investment. This is a form of hypothecated tax that the public sector can only dream of’ (Pollock, Business The Observer 8/7/01, p. 5).
The IOD confirms the popularity of PFI schemes to the private sector. In a
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survey, 70% of a sample of IOD members who had been involved with PFI deals considered that PFI ‘provided the private sector with an investment opportunity with a reasonable return without unmanageable risk’ (Leach 2000). A PFI scheme is usually highly geared with bank finance providing over 90% of the development funding for schemes of a value of up to £250m (Partnerships UK 2007). Although it may be considered a strange statement in the current climate, banks are risk averse and a well-managed PFI scheme provides an excellent low-risk investment. Returns are guaranteed by the State and the State is funded by many millions of taxpayers. With such a diverse source of funds the risk of State default is minimal and the investment becomes safer than all others with the bonus of growth guaranteed by linking returns to the RPI. If, during the construction phase, the contractor runs into insurmountable difficulties and the public sector terminates the contract, as in the case of the National Physical Laboratory, the PFI contractor is compensated and all this compensation will go some way towards repaying outstanding bank debt.
The government remains committed to PFI and it appears that predictabil-ity of public capital expenditure and the timing of delivery are seen as major incentives. There is an implication in government policy that whatever the circumstances, private sector management will always be preferable to a more active public sector role. Although there are strong economic and prac-tical arguments against PFI, it appears likely that government will maintain its policy stance in the future.