1.55 The Spreadsheet needs to account for the impact of uncertainty, which leads to Optimism Bias. There is a demonstrated and systematic tendency for project appraisers to be optimistic. Many project parameters are affected by optimism7. For example, appraisers tend to overstate benefits and understate the timings and level of both capital and operating costs. To redress this tendency, the new Green Book requires appraisers to make explicit adjustments for this bias.
1.56 One underlying cause of Optimism Bias is uncertainty. As appraisers are uncertain about the future, they naturally tend to ignore the objectives, requirements and risks that they cannot envisage. However, experience suggests that new objectives, requirements and risks do typically emerge during the course of a project and therefore this tendency should be expected and planned for. Certainty will tend to be lower at the Outline Business Case (OBC) stage than at the Full Business Case (FBC) stage. Equally, certainty tends to increase progressively through the tender submission to the construction stages of a project. In general, therefore, Optimism Bias is greater earlier on in a project's development.
1.57 Optimism Bias can also be influenced by the methods chosen by Procuring Authorities to manage project risks, particularly those deployed following the completion of the OBC. One of the most significant of these risk management strategies is method of procurement and, subsequently, from the different contractual arrangements that arise.
1.58 The distinction between Optimism Bias arising from, on the one hand, uncertainty and, on the other, methods chosen to manage that uncertainty, is important for the purposes of the Spreadsheet. Whilst, for example, uncertainty in relation to project scope or to the Procuring Authority's service requirements can lead to significant levels of Optimism Bias, there is currently little, if any, evidence to suggest that either conventional or PFI-type procurement methods deal any more or less efficiently with this type of Optimism Bias. There is however, better evidence that the allocation of risks achieved under a PFI contract, once awarded, reduces the impact on the Procuring Authority of those uncertainties that remain inherent in a project, when compared with the contractual arrangements that typically result from the Conventional Procurement Option.
1.59 Evidence is based on two features of the PFI Option:
• The level of project development completed prior to the completion of the FBC tends to be greater under the PFI Option than under conventional procurement. The transfer of significant performance risk to the private sector and, in particular, the involvement of third-party funders, typically leads Procuring Authorities and PFI partners to reach much more detailed levels of design and service definition and encourages third parties to complete a much greater level of technical due diligence before contracts are entered into. Confidence in estimates made at the FBC stage for PFI procurements tends therefore, to be higher than is typically found in conventional procurements.
• The level of risks transferred from the Procuring Authority to the contractor under the PFI Option exceeds that typically achieved under conventional procurement methods with third party funders usually demonstrating a harder budget constraint.
1.60 As the Spreadsheet needs to be able to account for any difference between the two procurement methods, sponsoring Departments are encouraged to build and add to evidence for optimism bias in their sectors, as well as including cross-sectoral information where appropriate.
7 See Section 5.61 to 5.64 of The Green Book (www.hm-treasury.gov.uk/greenbook)