Profit or revenue sharing is common for PPPs in other countries where the contractor takes the demand risk, such as for example toll roads. Typically, the contracts provide that if revenue or profit rises above a predefined level in any year, then the excess revenue or profit is shared between the government and the contractor. In shadow-tolled17 projects, a similar result is obtained by setting the shadow toll in bands, whereby the toll reduces for higher traffic bands.
Because traffic levels are difficult to forecast, a contractor that has taken demand risk is exposed to a significant risk of making large losses or large profits. Since profit/revenue sharing without symmetrical loss sharing reduces the overall expected profitability of a project, the contractor will bid a higher price. There is therefore no net financial advantage for the government. Instead, profit sharing reduces the contractor's incentives to incur expenditure to maximise traffic flows. It detracts, therefore, from the advantages that PPPs have over conventional forms of procurement.
Profit/revenue sharing, however, reduces the political risk for government that arises when a contractor is lucky and makes very large profits. The political risk arises because the public tends to overlook the considerable risk the contractor took18.
In each instance the need for profit sharing should be tested with the government.
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17 A shadow toll exists where a toll is payable for each vehicle using a road, but the government pays the toll instead of the motorist.
18 For a discussion of the economics of optimising the profit or revenue sharing threshold, see Engel, E., R. Fischer & A. Galetovic, The Basic Public Finance of Public-Private Partnerships, NBER Working Paper 13284, http://www.nber.org/papers/w13284