Despite the mounting pressure of ever more limited budgets and strict HM directives to actively pursue savings in PFI contracts, it is surprising how few organisations have completed a thorough review of their PFI-related costs.
Recent discussions with senior managers within organisations administering multiple PFIs have unearthed a number of worrying and enduring ‘myths’ which seem to be acting as barriers to change. These myths, around what can and cannot be done to reduce PFI costs, could well be standing in the way of significant savings.
This article will concentrate on the three main ‘myths’ relating to PFI contract savings, aiming to dispel common misconceptions and act as an enabler for PFI managers and finance directors to kick-start a PFI-related cost reduction programme.
Myth 1: There is no point generating PFI contract savings because HM Treasury will claw them back
Although this is the most enduring PFI-related ‘myth’, it is untrue. While the Treasury was indeed entitled to claw back PFI savings achieved through improved efficiencies prior to July 2011, this is no longer the case.
In fact, HM Treasury instigated a major PFI savings initiative in summer 2011, followed up by ‘Lessons learned’ and further guidance, in July 2013. In this latest guidance, the Treasury clearly summarises its position on PFI savings thus: “It is for public and private sector contracting bodies to come to an agreement on how best to realise savings in their contracts, but even now it is clear that opportunities for savings to the public and private sector outweigh the costs of delivering them. These savings will not be ‘clawed back’ centrally but will be for contracting bodies to recycle back into front-line services.”
Therefore, there is now a clear incentive for finance directors and PFI managers to instigate a PFI cost savings review, as any reduction in PFI costs will result in a direct benefit to their organisation’s balance sheet.
Myth 2: Benchmarking is the only time that saving initiatives can be instigated and this process can only be led by the PFI contractor
This is not the case. There is a widespread misconception that organisations have to wait for the benchmarking/market testing date to carry out any cost-saving changes to their PFI contracts.
While using the market testing mechanism does make the instigation and implementation of PFI-related savings easier, this is not the only time such an exercise can be carried out. And, as benchmarking dates can be up to six years apart, it is not always possible or economically advantageous to wait for the next date before commencing a PFI savings review. In addition, in many PFIs only a proportion of the services included in the contract are subject to benchmarking review, which may unnecessarily limit the scope of the savings programme.
There is also a common perception within the public sector that it should be the PFI contractor that has to come up with options for possible contract-related savings. However, although on the face of it this may seem like an easier solution, such an approach will inevitably lead to a far greater risk transferring back to the contracting authority, while leaving other options, which may be much more advantageous to the client, unexplored.
To maximise the potential for savings, public sector organisations need to consider their current needs and priorities against the existing scope of their PFI project, and conduct a consultation with key stakeholders on the scope and nature of proposed cost-saving changes. This will ensure that the changed contract will have a ‘better fit’ for the client it serves, without stripping away too many of the contractor’s responsibilities. It will also ensure that the inevitable up-front cost of such changes will be justified by long-term benefits.
Myth 3: PFI savings initiatives are too costly and complex to implement, and likely to be opposed by the PFI contractor, so why bother?
While it is true that changing a PFI contract is somewhat more complicated than removing a site from a cleaning contract or reducing the volume of toilet consumables procured by your organisation, this challenge is not insurmountable and can often afford significant savings.
Before instigating a cost saving review of all of your PFI contracts, you should first assess what costs are related to assets that have already been delivered, and are therefore fixed. It is also important to determine at the outset which contractual provisions must be retained, because their removal would pass too much risk to the contracting organisation (such as the removal of life-cycle costs for the PFI asset). This will allow the officers involved to concentrate on the elements which are most likely to generate VFM savings, with the least opposition from the PFI contractor.
And there are other ways of generating PFI contract savings…
Other ways of generating PFI contract cost reductions can involve focusing on the savings which can be achieved from making internal client monitoring systems more efficient. As these do not require approval from the PFI contractor, they won’t cost anything to implement.
Beyond this there are other measures, such as the review and enforcement of profit share arrangements, which can also generate savings without any related contractor costs and which should be investigated before moving on to making full scale contractual changes.
Finally, there are changes to the scope and specification of a PFI contract. While they are likely to generate the highest levels of long term savings, they will also require use of the formal change process and negotiation with the PFI contractor. To get most value for money from such complex contractual changes requires an in-depth understanding of the commercial drivers dictating the PFI contractor’s response to such change requests, as well as a comprehensive understanding of the structure and performance mechanisms of the PFI contracts themselves. This will allow the changes to be structured in a way most likely to align the contract to current client needs, without giving an incentive to the contractor to veto the proposals or impose exuberant implementation/compensation fees. Therefore, it is prudent to seek support from advisers that specialise in implementing such complex contractual changes, before the issue of any formal change notices. With PFI experts directing the process, the client is likely to be able to gain a considerably higher reduction in their variable and even fixed elements of the PFI unitary charge, without having to take back an excessive amount of risk or paying exuberant implementation fees to the PFI contractor and legal advisers.
Implementing a PFI contract savings initiative is a worthwhile undertaking
In summary, implementing a PFI savings initiative:
- Can deliver direct savings to the contracting organisation, without any claw back from central government
- Is possible at any point during the life cycle of the contract
- Can be delivered through a variety of methods, many of which won’t cost the client anything
- And, if selected and managed properly, formal PFI re-scoping changes can:
- Align the contract to client needs
- Achieve significant savings
- Be implemented quickly and efficiently
- Will not be opposed by the PFI contractor.
This is the first of a series of PFI-related articles Best Practice Group (BPG) will be publishing to assist local authorities, NHS organisations, police forces and educational establishments, to name but a few, to tackle the thorniest of issues relating to PFI costs and governance at a time when the public sector is expected to be seeking cost reductions in line with their ever dwindling resources.
If you, or your colleagues, would be interested in receiving further information on how you can instigate your PFI contract savings initiative, please contact us or visit our PFI support page for further information.