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 different implementation options. It also examines public and private sector capabilities and conducts a relative risk assessment to determine the merits of bundling additional components of a project. We consider each of these in turn.
Who can and should do what?
The first step is to determine the various elements of the project and consider the relative complexity of each. Is the project overly complex (in terms of the number of stakeholders or in the nature of the project itself, for
Table C.2. Project needs considered for the wastewater treatment plant
Project needs | Question | Reason for inclusion | Answer |
Efficiency | • Would the private sector be able to exploit any economies of scale that may bring efficiencies to the project? | • The ability for the private sector to exploit efficiencies not otherwise available to the public sector is a quick way to achieve Value for Money on a project. | • It is not known at this time whether partnering with the private sector will bring substantive opportunities to increase efficiency. |
Degree of certainty | • Is there a high likelihood of technological change? • How far into the future can the need for services be reasonably predicted? • What is the expected life of the asset? | • Projects containing significant IT elements are generally not appropriate for PPP, as typical IT projects have a lifespan of 3-5 years, and it is difficult to predict technological advances beyond 5 years. Also, integrating different IT systems increases the complexity of the project significantly. • The services derived from the asset must reasonably be demanded over the long term to justify a PPP • PPPs, by nature, are long term projects. So the asset should have a long expected life. | • There is low likelihood of technological change. • The need for services is long term • The expected life of the asset is long term |
Innovation | • Is there scope for innovation in either the design of the solution or in the provision of services? Does some degree of flexibility remain in the nature of the technical solution/ service or the scope of the project? | • If bids can include innovative ideas, that increases the chance of realizing Value for Money. | • There is some scope for innovation, but this could be captured through design-build or design-build-operate partnership structures without bundling the finance component into the structure. |
example) - and does it thus exceed existing internal capacity to procure or to execute? Similarly, if the project is too complex or requires significant upgrade over the life of the project, it may be too difficult 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 effectively either in-house with existing capabilities or by the private sector.
The Authority will define the technology solution for the new treatment plant, which is relatively easy to operate and will not require a lot of operator training. Thus, the public sector will not incur large additional costs for staff training if plant operations are kept in-house. That said, the organization should consider whether operating the plant may be considered a core or strategic function. By transferring operations to a private partner, would the public sector lose a core skill that may have strategic or long-term importance? In this case, facility 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 staffing under a private sector operations model may bring additional cost savings to the Authority if the structure is acceptable.
The next step is to determine whether it is possible to put an effective performance monitoring program in place. If the contract bundles private finance, operations and maintenance responsibilities, staff at the public organization will need to monitor performance, ensuring that the partner delivers services as the contract defines in clear, objective, output-based terms. Without effective performance monitoring, the project is less likely to deliver Value for Money. In this case, the staff currently managing the wastewater facility would have to undergo a major transformation in order to manage the performance agreement over the long term. The Authority has not conducted a similar project (one that bundles design, build, finance, operations, and maintenance components) in the past, so it has no internal experience to rely on. In addition, future opportunities to manage this type of partnership approach for other projects are unlikely, which means these performance management skills would be of benefit only on one project. However, in a PPP context, the performance monitoring and penalty deductions can be introduced and managed quite efficiently with "self-monitoring" by the private sector along with Authority check up. Performance monitoring should therefore not prevent the use of PPP; however, the use of PPP should be based on the financial and risk assessment.
Next, the organization examines whether the private sector is capable of delivering the required outcome. This step primarily involves surveying the market for similar projects and talking to known market participants to gauge interest in this project. An existing market for similar projects is likely to improve competition in the bidding process, thereby delivering additional Value for Money. In this case, there is an existing market, and known market participants have confirmed 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 for it?
In this example, while sufficient capital is available from the public sector to finance the new treatment plant, the organization's primary financial objective is to consider which structure offers best Value for Money, including weighing the benefit of long-term annual payments against up-front construction costs and ongoing operational costs.
To assess the best partnership structure for meeting this objective, a financial analysis is conducted to determine the expected cash flows during the construction and operations phases of the project (usually considered over 20- 25 years). This analysis makes it possible to compare the relative cost for each partnership structure.
Once cost values have been calculated, they are converted to net present value (NPV) to facilitate an apples-to-apples comparison of total costs incurred (in today's dollar value). For the wastewater treatment plant in this example, we have included the financial analysis based on estimated outcomes under different procurement structures. This is typical of the analysis that should be completed by any procuring Authority when considering potential structures in advance of actual procurement. These of course can be compared with actual results when detailed bids are received.
Different private operators might use different operations models that would result in cost savings, but to avoid disorting the analysis, those potential savings have not been included. Similarly, except for 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 significant way. The NPV calculation assumes a long-term cost of funds for the Authority of 6 percent, which has been used as the discount rate on all procurement options considered.
Table C.3 sets out the results of the financial analysis of each procurement option. Based on this analysis, it would appear that in NPV terms, either of the design-build-operate-maintain options, including and excluding private finance, offers the lowest NPV. It should be noted that some of the differential relates to the levels of risk retained by the Authority, particularly in the traditional and design-build options where only limited elements of the project are covered by fixed price contracts and performance-level requirements.
While the NPV values of the two design-build-operate-maintain options are very close, the nominal value of the option including finance is much higher. The decision to be made involves considering whether funding is available to pay for project costs as they are incurred or whether it is preferable to defer these expenditures by selecting the option including finance. Even if the required funding is
Table C.3. Nominal and NPV outputs of the financial analysis
Option | Build Costs | Operations | Finance | Risk Value | Total | NPV |
Traditional | 99.5 | 52.5 | - | 15.2 | 167.2 | 126.6 |
Design-build | 99.3 | 52.5 | - | 15.2 | 167.0 | 126.4 |
Design-build- | 97.7 | 50.0 | - | 9.6 | 157.3 | 119.6 |
Design-build-finance- | 97.7 | 50.0 | 109.9 | 3.0 | 260.5 | 119.7 |
available, the Authority should also consider whether this funding would be better used on other projects, allowing a greater level of project development based on the funds currently available.
Who should bear what risks?
The main reason for pursuing a greater role for the private sector is to achieve greater Value for Money (that is, greater economic and social benefits with lower overall risk). Value for Money is achieved principally by allocating and managing risk. That means making each party responsible for managing risk (and potentially giving that party a revenue source) through obligations in a contract or a specific piece of legislation.
In this project, several risks were identified as key, meaning they were likely to occur, and if they did, they would bring severe consequences (see table C.4).
After identifying 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 total cost of the project if it does occur.
A risk plot methodology might yield the following list, with the lowest-risk model at the top and the highest at the bottom.
• Design-build-finance-operate-maintain
• Design-build-operate-maintain
• Design-build
• Design-bid-build (traditional delivery).
In this case, the design-build-operate-maintain model is only slightly riskier than the design-build-finance-operate-maintain model. The other two models carry considerably more risk.
Service providers in this sector will generally accept the risks in areas over which they have full control, for example in:
• Design
• Construction cost
• Operations
• Maintenance
Table C.4. Key risks identified for wastewater treatment plant
| Description |
Government policy changes | A change in law, government policy or protocols modifies or terminates the process. |
Wastewater treatment technology selection | The treatment technology proves inadequate to meet effluent requirements, requiring costly mitigating measures. |
Design risk | The designed system (including all equipment) fails to deliver services at the required levels of performance and quality, because the partners failed to translate the requirements into the design. This produces additional design and system development costs. |
Construction/ decommissioning activity results in contamination | Construction/decommissioning activity results in contamination of the site. This could close the site temporarily and delay contract completion. |
Construction delays | The facility is handed over late and/or is late in achieving its performance goals because of delays in construction. |
Failure to build to design or quality level | The project is not constructed according to the design documents (or quality requirements). This could impair performance, safety, longevity and the like. |
Construction cost | Construction costs are higher than the construction contractor estimated. |
Latent defects | Latent defects in new work are discovered after substantial completion and/or after warranty period. |
Change order risk | Change orders are issued during construction due to design coordination/design completion/design gaps. This risk may be compounded if the contract does not fully specify the method of pricing for change orders and change order costs exceed estimated amounts. |
Life-cycle maintenance - residual value | Capital and life-cycle maintenance to the structure and systems of the building is not performed when appropriate to sustain the capital value of the property and meet handover specifications. |
Life-cycle maintenance costs | Life-cycle maintenance costs are higher than projected. |
Effluent quality | Effluent fails to meet regulatory requirements. |
Biosolids management | Risk is associated with management of biosolids, including long-term liability. |
Unanticipated operating costs | Operating costs are higher than projected because of inflation or inaccurate estimates and assumptions, affecting utility and maintenance costs. |
Labor supply risk | The operator may encounter labor disputes or trouble attracting and retaining staff who are suitably trained and certified. |
Professional and legal liability | Key operating facility staff may be subject to litigation and claims related to negligence. Risk may affect operation of the facility, causing delays in services to the public and damage to the owner's reputation. |
Site security | Site security may be breached during operations, receiving, maintenance or renewal. |
Loss of operational flexibility /control (if operations risk is transferred) | Operating processes, procedures and standards may lack the flexibility required to operate plant optimally. |
Default of operating contractor (if operations are bundled into the contract) | The operating company may default or go bankrupt. |
Experience to date indicates that the private sector can easily manage these risks. Private sector partners will not take full responsibility for risks in areas where they do not have control, for example:
• Latent defects in existing infrastructure
• Regulation
Latent defect risk probably will not be significant for the project, as little of the existing plant will be used in the new plant.
Results of the bottom-up analysis
After analyzing the relative risks and costs of the different delivery models, determining potential market interest in the project and surveying internal and external capabilities, the organization reaches the following conclusions:
• Design-build-finance-operate-maintain is the lowest-risk option (although only marginally lower than design-build-operate-maintain);
• Design-build-finance-operate-maintain is the most expensive option in nominal terms due to financing costs; however, it is in line with the lowest cost in NPV terms; and
• Potential private sector efficiencies for construction and operations along with competitive price pressures could be achieved when detailed bids are received that would further reduce the overall cost.
Because a properly structured design-build-finance-operate-maintain structure puts the private sector service provider's capital at risk (that is, non-performance penalties can prevent it from recovering its capital investment), this model can provide a stronger performance incentive than a design-build-operate-maintain structure. Given the small difference between the two "full service" options, the use of the option including finance may provide the greatest overall benefit.
If the organization is not able to manage and monitor a long-term performance arrangement with a private partner, the project is less likely to achieve Value for Money. The government must acquire the skills necessary to manage performance. This should be achievable, and improved performance monitoring should result in better service provision.
Thus, in this instance, a partnership approach that bundles the design, build, operate, finance and maintain components of the project appears to best meet the public sector organization's needs and to offer the greatest Value for Money.