New Government Report for Improving PFI Value: 7 steps to get a better PFI deal

By Allan Watton on

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Leading government efficiency-focused think tank IfG (Institute for Government) and US project management association PMI (Project Management Institute) recently released a new report titled ‘How to get better private finance deals for infrastructure’.

The report took an interesting view of the way government makes its decisions between public and private sector funding on major national projects. And with the unfortunate circumstances surrounding the Carillion situation, funding these major project relationships is very much in the spotlight.

The report had three primary messages for the government on how it could be doing more to get a better deal for the public purse when handling PFIs. In turn, we have added a few of the key lessons we have learned through decades of experience working on hundreds of public sector project relationships with private sector involvement.

The report throws down the gauntlet in just its second paragraph: ‘The current Government has repeatedly said it wants to secure more private investment in UK infrastructure, at a good price. However, our research shows it is failing to take the necessary steps to meet these twin objectives.’ It seems the research is an analysis of relevant literature, interviews with a select group of 20 individuals and a round-table discussion with experts from the worlds of public sector, private sector and academia. The report then lays the blame on ministers for failings in the PFI system, citing three key barriers that need to be addressed before improvements can be expected:

  1. Limitations in civil service commercial capability
  2. Their own understanding of investor perspectives
  3. The quality of the infrastructure project pipeline.

1. Limitations in civil service commercial capability

The report indicates that negotiation and renegotiation seem to be at the core of this barrier. It asserts that while practices have improved from the early days of PFI contract negotiation (although due to the nature of these relationships and the length of their term the effects of poorly negotiated agreements made many years ago can still be felt on the public purse today), and states there are still two primary issues to address:

  1. Private organisations earning excessive profits from PFI agreements. Poorly negotiated agreements, it says, can lead to the private sector organisation in the deal achieving its primary objective of maximising profits for its growth and shareholders. This, not unnaturally, goes against the principles of the public sector. Again, such practice is increasingly under the media spotlight as it does nothing to help the flagging reputation of PFI agreements.The report further implies that in reality, this is a double-edged sword, as often to gain the best expertise to give the project its best chance of success you need to look outside of the public sector. In a capitalist leaning society that means paying them a profit. But it goes on to say that profit should not be the focus; it’s a necessary by-product of the process of involving the private sector. The key point everyone should be concentrating on is ‘value’, and whether the private contractors are providing sufficient value to warrant the fees they charge. It makes the further point that this is where negotiation skills are so important.
  2. Renegotiation and the art of the deal. The report goes into some detail about the lack of sufficient client-side negotiation skills and foresight that could result in a contractor pushing for a renegotiated deal. If the right in-house skills are not available, this could see the public-sector client accepting additional risks and costs as a result.A further observation is that it is often considered that achieving the lowest price is an indication of a good negotiator. a fee is so low that the contractor may get into financial difficulties in servicing the contract, it is likely to have trouble motivating its workforce, or it may have to cut corners on innovation and other areas, resulting in unsustainable service delivery and a bad deal for both parties. The report makes the point that the art of good negotiation is not to get the lowest price, but to achieve the best results from the right supplier in a deal that achieves the dual goal of giving them enough incentive to meet your targets and does this at the lowest possible fee.

Numerous National Audit Office and Public Accounts Committee reports have detailed contract shortcomings that emerged when public bodies lacked the necessary skills, or did not involve public sector commercial specialists early enough, to challenge their external advisers and contractors.’

The report goes onto imply that having sufficient in-house commercial skills in this area is vital to the public sector acting as an ‘intelligent client’ and to the long-term success of any PFI agreement.

It states: ‘Given the Government’s objective of substantially increasing private investment in infrastructure, the project finance specialism in the Infrastructure and Projects Authority (IPA) should increase the number of specialists available to manage private finance-specific contractual issues.’

Over and above the initial negotiation of the contract, the report also highlighted public sector failings in managing these contracts due to a lack of experience when compared with the suppliers they are dealing with, stating ‘Previous Institute for Government, and National Audit Office research suggests that government does not always invest adequately in managing contracts – particularly monitoring and challenging supplier performance.’ And that: ‘Public sector interviewees told us that contract management still plays a secondary role compared with agreeing contracts.’

2. Their own understanding of investor perspectives

The report goes on to suggest that commercial expertise on what policies might ‘unlock private investment’ is often siloed and as a result, policies are being implemented by those without a good enough understanding of what private investors are looking for. For this situation to improve, policymakers need to have more direct contact with private investors and the civil servants who more regularly engage with them.

The report stated ‘Unfortunately, investors told us that ministerial engagement had been superficial and infrequent, and tended to occur only when new chancellors came to office.’ And: ‘While officials, particularly those in the Infrastructure and Projects Authority (IPA), have engaged extensively with investors, their insights are not always heeded by ministers.

The recommendations in the report, included:

  • Ministers must consult earlier, and more frequently, with investors when making policy designed to effect change in the infrastructure finance market.
  • This consultation must have balanced representation of incumbents and emerging companies, and maintain focus on a small set of issues, drawing on the principles we set out in Creating and Sustaining an Effective Strategic Dialogue with Business.

3. The quality of the infrastructure project pipeline

The report put quite a lot of focus on the private sector not having clear and reliable visibility of the infrastructure project pipeline. It implied that uncertainty is a barrier to more private investment in infrastructure. The ‘absence of a detailed project pipeline’ increases the perception of risk and, therefore, limits the number of investors interested in the prospects of investment. This in turn reduces competitive tension and, therefore, the public sector’s ability to achieve the best PFI deals. All this can be addressed with greater clarity, detail and transparency on a project pipeline, opening up the possibility of greater dialogue and collaboration between public and private sector, and allowing more investors to make informed decisions, reducing their need to demand terms and fees that cover this perceived risk.

To say that there is no published pipeline would be incorrect, as the NICP (National Infrastructure and Construction Pipeline) was published in 2013, but the report concluded that there is simply not enough detail about the upcoming projects in this pipeline and its replacement, PF2 (Private Finance 2). Despite this being proposed in 2016, it is still unpublished.

The problem is the competition chasing private investor money: ‘For the investors we spoke to, the main problem with the Government’s current approach is the dearth of upcoming bankable projects: projects that are well defined and attractive enough for them to finance.

The report also highlighted that: ‘In 2013, the Treasury Select Committee concluded that only a large number of competing investors would drive the cost of private finance down, and only a clear pipeline would attract a large number of investors.

Four additional lessons learned for achieving a better PFI deal

The three areas the report highlighted are important for the government to develop. However, in terms of dealing with the ‘coalface’, when implementing the complexities of these relationships, there are a number of key additional factors to consider, four of which have been included below:

4. ‘Intelligent’ Commercial Awareness

From the report, it seems that an understanding of the key motives of both civil service and the larger suppliers it selects are not clear enough. A structured approach to identify what these underlying interests and key motives are, do not appear to be addressed appropriately. As a result, it is difficult to see how any negotiation (and/or renegotiation) is likely to be effective for both sides without knowing what these underlying interests (as opposed to starting/ending positions) are.

As an example, when an organisation goes for the lowest price and ends up with a ‘bad deal’, it could be argued that if the contractor accepts a deal that is priced too low, then that is their problem. This is, of course, true – but who pays the consequences? You will. While there is case law to help hold suppliers to account for poor service (almost irrespective of the price), where the contract terms are ambiguous over accountability, a bad deal is always a bad deal.

Our experience, and lessons learned from hundreds of these relationships, tells us how important it is to ensure your own due diligence is structured in a manner to find out what the underlying interests are from the contractor and to evidence how they could in turn service your interests. This extends also to how their commercial model will evidence the manner in which they will do that. Once these interests are clear, the art of good negotiation is not to simply get the lowest price, but to leverage these interests in the right way to align them so as to meet the objectives of all parties at a charge level that can evidence best value.

5. Relationship management

Touched on earlier under negotiation, relationship management starts with identifying the need for change, moving through to the business case and engaging early with the market to start building external relationships. This will demonstrate the maturity with which you are operating and using the market to sense check your expectations and commercial modelling. In turn, the market is likely to lower its risk pricing when you eventually move through to the procurement process. Such maturity from both yourselves and the suppliers will usually continue throughout the relationship.

It’s about understanding your contract partners, identifying what motivates them (hint: believe it or not, it isn’t always just the money), what their goals are and what language they will respond to. By having an appropriate ongoing diligence process in place and having already established strong ‘Commercial Trust’ (pages 18–31 in this free white paper), if your supplier does have commercial challenges on the horizon, then clearly you want to be the first to know.

In turn, there are likely to be ways you can encourage greater performance, shift direction to correct or change and/or prevent issues before they arise, and so on. But it’s about getting early visibility. The closer and deeper levels of Commercial Trust you have with your suppliers, the easier it will be to work as a collaborative unit with shared goals and aspiration for the relationship. The further you are from this state, the easier it is to inadvertently be surprised when your supplier does fall into financial distress and the resulting consequences this is likely to have on your service provision.

It is (or should be) the ICF (Intelligent Client Function) team that handle this most important of roles. They may be known by a different name in your organisation, but they are the multidisciplined team tasked with encouraging your own organisation to be clear about the outcomes it needs to achieve through the use of external strategic suppliers. While many organisations have adopted this ‘better together’ concept, more still needs to be done to ensure that all PFIs include this element.

As well as the installation of a skilled ICF team, there are two other primary features of a quality relationship management effort:

  1. Periodic contract review and revision. What may have been analysed to the nth degree at the outset to determine the best contractual plan of action, when it’s 6 or 12 months or 2 years into the agreement, turn out to be far from the best option for its successful completion. All contracts should, therefore, contain a biannual review and revision session between contractors and clients to assess where improvements can be made that benefit the project with respect for the needs of all parties.
  2. Issues escalation/dispute management. Successful relationships are created when efforts are made to earn commercial trust from the outset, and to have a strong, agreed and understood process for achieving objectives that is underpinned by a flexible contract. Among its many facets, this should include an effective pathway for issues escalation and if necessary, dispute resolution.If not resolved early, simple misunderstandings can quickly escalate into something more serious for the relationship. Which is why an aspect of good relationship management is understanding the interests your supplier is looking to serve and how this knowledge can have a positive effect on issues resolution. It’s about following the contractual process while maintaining strong communication lines with your supplier, dealing with it in a professional, swift and decisive manner that will build trust and not damage it.

6. Roles and responsibilities

This follows on from relationship management. Implementing an appropriate commercial and operational due diligence process will ensure that the most suitable roles and responsibilities are allocated to the right parties.

In turn, these roles and responsibilities should be incorporated into the contract terms, and in line with the biannual review of your objectives and outcomes, appropriate adjustments should be made to ensure there is little room for any ongoing ambiguity.

Knowing, agreeing and understanding one another’s duties to the project helps in a number of ways.

  • It enables you to create a clear and unambiguous contractual agreement that can act as a benchmark against which actions can be measured.
  • If productivity dips, these clear and agreed roles and responsibilities can be reviewed to determine if and where deviations have occurred.
  • Should a disagreement ensue, then the time dedicated to clarity of these roles and responsibilities will make it easier to identify which party is in the right.
  • And finally, should things go down the legal route, the roles and responsibilities that have been agreed and set in the contract will be an element that will influence judgement.

Roles and responsibilities is such a vast subject, so to avoid going into detail that might overshadow the rest of the article, he is a free white paper that takes a deeper look into the duties each party to a relationship owe one another.

7. Expert responsibilities

‘Expert responsibilities’ are the focus of a specialist supplier’s obligation to ‘critical friend’ critique the requests that the client asks of them, from initial instructions to change requests and the biannual review and revision sessions. A supplier is often selected for their specific expertise and, therefore, this expertise must be properly utilised (and that the supplier is accountable for) to ensure that the client is always getting the best advice on what is and is not possible, and what does and does not assist in the achievement of their goals.

When a supplier represents themselves as a specialist in a particular field it has implied contractual obligations to always offer best advice; fundamental among these is its ‘duty to warn’, even if this is not in the written agreement – if some attempt has been made by the supplier in the contract to exclude this responsibility. The aim is to ensure that the possibility of misunderstandings and unexpected costs are minimised.

Conclusion

The subject of PFIs is currently at the forefront of any political discussion in the wake of the Carillion collapse. With the government still seemingly strongly behind increasing private sector investment, it’s now more important than ever that they be seen to do so in the most responsible of ways. Therefore, listening to the recommendations of reports such as the ‘How to get better private finance deals for infrastructure’ analysis would certainly make sense.

The report makes clear that the government has made significant progress in recent years to negotiate better PFI deals, better for all concerned, though there is no doubt that with private sector involvement and the profit they will naturally and rightly make from this, there will be some on the political left (in fairness, with some justification), who will always oppose them no matter how much they are reformed and refined.

While the ‘near perfect PFI deal’ is unlikely to ever be a reality, moving to achieve significantly better value and service levels can be. Attention to detail in uncovering the underlying key interests to leverage to the benefit of all parties in negotiations is key. Having in-house commercial talent to handle this is important, as is greater clarity on the upcoming project pipeline to instil investor confidence, and greater engagement between investors and policymaking ministers.

Photo credit: iStock, ogichobanov

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