Has the budget announcement signalled the end of PFI? 6 ways to improve your own PFI
Byon December 4, 2018
Is this the end for PFI (private finance initiatives)? Brought in by John Major in 1992, extensively utilised by the Blair government and every occupant of No. 10 since, no matter their political stripes, PFIs have, in recent years, become very unpopular.
In the court of public opinion, it is perceived that PFIs can be a lose-lose. If the relationship fails, it is often the view the procurement system is broken. And, anyway, the perception continues, it probably could have been done far more cost-effectively in-house where all public sector projects belong.
If the relationship succeeds, then common views are usually that the government is squandering our hard-earned taxes on contracts with fat-cat private suppliers who sit pretty on the profits they’re making.
So, with Chancellor Philip Hammond announcing in the October budget: “I have never signed off a PFI contract as chancellor and I can confirm today that I never will”, does this signal the end of PFI once and for all?
What was actually said in the budget speech?
The BBC headline read: “Budget 2018: Chancellor abolishes PFI for future projects.” Hammond made it clear that while they would not create any new PFI agreements, the government was committed to honouring its existing contracts.
“In financing public infrastructure, I remain committed to the use of public-private partnership, where it delivers value for the taxpayer and genuinely transfers risk to the private sector. But, there is compelling evidence that the private finance initiative does neither.”
And in a swipe at Labour, whose policy it is to end PFIs and bring those contracts back in-house, Hammond pointed out that the vast majority of PFIs were in fact brought in under previous Labour governments, saying: “The shadow chancellor, of course, rages against PFI at every opportunity yet, curiously, forgets to mention that nearly 90 per cent of those contracts were agreed by the last Labour government, leaving the nation with a bill of more than £200bn to pay off...”
So, if there is this massive commitment still to pay for existing PFIs, what can the government do to minimise its impact on the public purse? The answer is to attempt to improve effectiveness and look for opportunities to optimise it. Hammond’s words on this were that: “… the days of the public sector being a pushover must end.” He further stated: “We will establish a centre of excellence to actively manage these contracts in the taxpayer’s interests, starting in the health sector.”
And, just in case there was any misunderstanding of his fundamental point, the chancellor finished by saying: “I can announce that the government will abolish the use of PFI and PF2 for future projects.”
But what does that mean in real terms – is it the end of PFI?
If Labour come to power and make good on their promise, it would mean a significant amount of borrowing to add to the national debt in order to buy back PFI contracts. In that same budget speech Hammond stated: “Labour’s policy is to terminate all these contracts, triggering the ruinous penalty clauses that they themselves agreed to in the first place, adding tens of billions more to an already enormous bill … Pouring good money after bad.”
It’s all well and good for some to talk of taking back PFI contracts. But even if it were financially plausible for a government to do this, they would be missing two fundamental points:
1. Why PFIs were created in the first place
People tend to forget that PFIs weren’t created purely to keep the large, costly infrastructure debt off the government balance sheet. They were also to achieve a true transfer of an appropriate amount of the project risk to the private sector partners, ensuring that these partners are properly ‘invested’ in the success of the project.
2. Where would all the in-house expertise come from to manage these projects?
At the inception of PFI, the public sector did not have an impeccable reputation for managing large infrastructure projects. Part of the reason why public-private partnerships work well in some cases is because of the commercial expertise of specialist outsourced contractors. If you bring these contracts back in-house, does the government have an appropriately assured plan to identify where all of this specialist knowledge and expertise will appear from?
It’s also important to remember that many of these contracts still have tens of years left to run. Those involved in PFI contracts must probably be feeling more than a little unnerved by this announcement, no matter how expected it may have been, because it adds a new level of uncertainty to their future. And with this perception of uncertainly, there will be many that are likely to be adversely impacted by this.
However, there are ways in which savings and much greater effectiveness can be achieved on existing PFI contracts should parties be willing to work together to achieve this goal.
6 ways existing PFIs can be run more effectively
It may seem implausible for savings to be made, schedules be improved upon or innovations encouraged when you’re already working at full pelt on an existing PFI. But often it’s not just a case of working harder, but also working smarter that can make all the difference.
1. Closer financial monitoring
Assurance and oversight is sometimes seen as a negative thing; watching over performance and progress could have a malevolent Big Brother feel about it, but when implemented in a professional manner and reasoned for in a logical framework it can create impressive effectiveness.
Two minds are better than one, so they say, but many minds are better than two – by having all relevant stakeholders involved in conversations where their input may lead to greater insights, efficiencies and savings. One of the failings of all too many a complex service relationship is limiting both informal stakeholder management and formal meetings to a few senior members.
Atop this, it’s vital to know your numbers – when jobs need to be started and completed by, when milestones need to be achieved and when payments need to be made. It’s a complex web of information, but someone needs to be on top of it, driving the right skills to the right roles at the right time in identifying where significant cost savings can be made.
2. Knowing when to withhold payments
Once an infrastructure project has been completed, the maintenance portion of the contract will often begin, commencing many years of monthly payments to the contractors for their role in its management and maintenance. At this time it is vital to initiate an audit trail process to monitor the contractor’s performance, making specific mention of issues, when they arise, when they are resolved, and what the ramifications of those issues have been.
This will support your reasoning for withholding part or all of your payments in a particular month. While this can be a bit of a blunt instrument for a strong contractor relationship, it can assist to get better visibility and transparency of what you are paying for. You are also drawing a line in the sand and stating clearly that there are certain expectations, as identified in your agreement, that you are prepared to assert.
3. Renegotiation can work for both parties
As is mentioned often in any article we write about PFIs, they are a long-term commitment – often a very long-term one. As such, the reality is that what was once considered a reasonable cost for a service or supply, or a reasonable means of achieving a stated end, may no longer be so reasonable years later.
As practices evolve, efficiencies can improve, technology can advance parties to a PFI and they must adapt. It is perfectly reasonable to work with your contractor to consider and evidence the business case for adapting your agreement to take advantage of the many budget and time-saving strategies.
If you can collaborate and identify ways to improve operational effectiveness (there are often many), this works to the advantage of you both.
4. Know your contractor’s strengths and weaknesses
Truly ‘knowing’ your contractor has many advantages – in your communication with them, in your appreciation of what drives best behaviours and motivates innovation, and in understanding their strengths and weaknesses. If you can identify areas of responsibility that your contractor may not be as strongly skilled or efficient, you can identify areas where there may, in future, be opportunities for renegotiation.
Keep an eye on market rates for similar services and where opportunities for greater efficiency or cost savings are identified in the marketplace, bring them to your contractor’s attention. Proper benchmarking and market testing form part of the components that will supply you with the evidence you require to show good cause for renegotiation.
5. Leverage indexation
An extension of knowing and understanding your contractor is identifying their financial motivations. When your contractor takes advantage of indexation – the realignment of a proportion of its fees with the reality of inflation – you have an opportunity to negotiate a more efficient agreement with them. Are there provisions for this in your contract, what proportion of their invoices to you will be affected, are there checks to make sure no overcharging is occurring as a result, and is there an understanding of the indexation calculation to know whether this is happening in the first place?
6. Minimising the cost of change
Should you wish to change your agreement with your contractor there will doubtless be charges associated with this, as set out in your agreement. It is, therefore, vital that you know how these additional charges will be calculated and that you keep an eye on them at the finer detail level to ensure that they are no more than they should be. Benchmark them against other providers and challenge them when they do not align.
The world of politics is so unpredictable right now that it would be foolish to attempt to predict anything that this or the next government may do to existing PFI agreements, but Hammond has expressed the Conservative’s position on PFIs quite clearly.
They are to end, so it’s just ‘how’ is the question. Until the political powers-that-be get their act together on this, it’s important that all PFI clients look for ways to manage the status quo – through monitoring and renegotiation. While, subject to the performance, attitude and behaviour of your prime contractor, scrupulous adherence to contractual terms and mechanisms may work to keep your contractor in line, some creative thinking about the services that provide the greatest return on investment for you, versus the least cost for the contractor to provide, may point you in a better, more sustainable direction.
For support and advice on PFI financial issues, including how to achieve cost savings, contact us on T. 0845 345 0130 or email: firstname.lastname@example.org. Further information on driving maximum performance from PFI contracts can be found by downloading our free white paper.