3.54 Where the contract has an above-market service cost but there is no value testing regime to flow cost reductions through to the Authority, this will enhance equity returns and/or profit at the subcontract level. Conversely, PFI providers have an incentive to de-scope or introduce value testing for services they have underpriced as a means of transferring the risk back to the authority.
3.55 As such, authorities should be watchful of PFI providers steering de-scoping / value testing towards services they have underpriced. If there is evidence that the service is already being provided at or below the market pricing then value testing for the service should not be introduced and de-scoping should be carefully considered9. Advice should be sought from authorities with similar contracts, departmental PFUs or technical advisors regarding the current costs of services to determine whether it is likely to be worthwhile.
3.56 When comparing costs across alternative providers (either in-house or outsourced), authorities should take care to ensure that costs are compared on a like-for-like basis (i.e. overheads are treated appropriately). Senior lenders will generally need to consent to a change in service provider, removal of a service from the contract or the introduction of value testing.
3.57 Especially for older contracts, it is quite possible that a market test might lead to an increase in the costs of services as wells as introducing administrative costs for undertaking the market test.
3.58 It can be difficult to determine VfM when de-scoping private sector risks, especially those which are not explicitly costed in the project's Financial Model. For example, if a given risk is costed as part of the required return on risk capital rather than through separately identifiable cashflows, it can be difficult10 to determine how much the cost of risk capital should come down by if the risk is de-scoped. A similar issue applies to risks that are costed in the cashflows but where the level of detail is insufficient to isolate the cost relating to just the risk being de-scoped.
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9 This can be particularly difficult for risks taken by the private sector but not explicitly costed in the project's financial model. See paragraph 3.58.
10 Outside of competition.