Analysing Public Private Partnership - Master Thesis Msc In Finance And International Business

DEPART MENT OF BUSINESS ADMINISTRAT ION
BUSINESS AND SOCIAL SCIENCES
AARHUS UNIVERSIT Y

Analysing Public-Private Partnership

Master thesis
MSc in Finance and International Business

Author: Jurgita Jakutyte
Student ID: JJ91185
Academic supervisor: Jingkun Li

September, 2012


T ABLE

OF

C ONTE NTS

Introduction .................................................................................................................. 5
Problem statement ...................................................................................................... 6
Structure ...................................................................................................................... 7
Delimitations ................................................................................................................ 9
1.

2.

Literature review ................................................................................................. 11

1.1.

Definition ................................................................................................... 11

1.2.

Types of PPPs .......................................................................................... 16

1.3.

Reasons for implementing PPPs ............................................................. 19

1.4.

value for money ........................................................................................ 21

1.5.

Advantages and disadvantages of PPP .................................................. 26

1.6.

Criticism of PPPs ...................................................................................... 29

Analysis ............................................................................................................... 32
2.1.

The project ................................................................................................ 32

2.2.

Alternatives for project implementation ................................................... 32

2.3.

Identifying an appropriate PPP scheme .................................................. 34

2.3.1.

Overview of Lithuania’s legal PPP environment .................................. 34

2.3.2.

Choosing a PPP scheme ...................................................................... 38

2.4.

Cost and benefit analysis ......................................................................... 39

2.4.1.

Assumptions overview ....................................................................... 40

2.4.2.

Data overview .................................................................................... 46

2.4.3.

Financial analysis .............................................................................. 48

2.4.4.

Socio-economic analysis ................................................................... 49

2.4.5.

Sensitivity analysis ............................................................................ 52

2.4.6.

Overview and the discussion of the CBA results.............................. 56

2.5.

Factors not covered by CBA .................................................................... 58

3.

Conclusions ........................................................................................................ 63

4.

Bibliography ........................................................................................................ 66

5.

Appendices ......................................................................................................... 73

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C ONTE NT

OF

F IGURES

Figure 1. European PPP trend, 1990-2009 ................................................................ 6
Figure 2. Cash flows in PPP and traditional procurement mode ............................. 16
Figure 3. Structure of Public Sector Comparator ..................................................... 22
Figure 4. Optimal risk allocation point ...................................................................... 23
Figure 5. Model for risk allocation ............................................................................. 24
Figure 6. Identifying Value for Money ....................................................................... 26
Figure 7. PPP scheme under economic activity....................................................... 37
Figure 8. PPP scheme under social activities .......................................................... 38
Figure 9. Sensitivity analysis – FNPV on investment............................................... 53
Figure 10. Sensitivity analysis – FNPV on capital .................................................... 54
Figure 11. Sensitivity analysis - Socio-economic results ......................................... 55

C ONTE NT

OF

T ABLE S

Table 1. Distribution of investment costs, % ............................................................ 46
Table 2. Financial return on the investment costs –PPP and traditional
procurement approach .............................................................................................. 48
Table 3. The structure of financing in PPP and traditional procurement approach 48

Table 4. Financial return on capital – PPP and traditional procurement approach 49
Table 5. Assumptions for the socio-economic analysis ........................................... 51
Table 6. Net benefits of non-market impact ............................................................. 51
Table 7. Socio-economic analysis results ................................................................ 52
Table 8. Sensitivity analysis – change in demand ................................................... 55

Page | 3


L IST

OF

A BBRE V IAT IONS

BBO

Buy-Build-Operate

BOOT

Build-Own-Operate-Transfer

BOT

Build-Operate-Transfer

CBA

Cost-Benefit Analysis

CO2

Carbon dioxide

CPVA

Central Project Management Agency

DBFO

Design-Build-Finance-Operate

DBOM

Design-Build-Operate-Maintain

EPEC

European Public-Private Partnership Expertise Centre

EIB

European Investment Bank

ENPV

Economic net present value of investment

EU15

European Union of 15 member states

FNPV/C

Financial Net Present Value of the Investment

FNPV/K

Financial Net Present Value of Capital

FRR/C

Financial Rate of Return of the Investment

FRR/K

Financial Rate of Return of Capital

IMF

International Monetary Fund

Kg

Kilogram

Km

Kilometre

OECD

Organization for Economic Co-operation and Development

PPP (3P)

Public-Private Partnership

PSC

Public Sector Comparator

PwC

PricewaterhouseCoopers

SPV

Special Purpose Vehicle

STPR

Social Time Preference Rate

t

tonne

tkm

tonne-kilometre

VAT

Value Added Tax

VFM

Value for Money

WACC

Weighted Average Cost of Capital
Page | 4


I NT RODUCTION
PPP (3P) – public-private partnership – a concept used widely in the public
procurement that lacks both clarity and united definition (Meidute & Paliulis, 2011).
The concept has no clear boundaries for distinguishing what kind of private and
public partnership is assumed to be a form of PPP or a form of a traditional
procurement. This results in some confusion, both in the academic literature, as
well as within the international experiences. Nevertheless, PPP, in general terms,
could be defined as a long term contractual relationship between a public and
private sectors, which is usually characterised by having features such as bundling
of functions, exchange of resources, shared responsibility, risks and rewards, and
is arranged with the aim to provide a public service/asset.
PPP is not a new phenomenon even though it is perceived as such due to its
recent popularity. Growing interest is a result of changing attitudes as well as

expectations of the society towards the government and public services (Grimsey
& Lewis, 2004). Today society expects to see the government more as a governor
and regulator rather than the direct provider of public services. In addition, it
requires infrastructure of better quality, more efficient provision of public services,
as well as better use of public money. Considering all this, PPPs are seen as a
procurement mode that may satisfy these changing needs. Nevertheless, PPPs
are not a ‘miracle’ solution (European Commission, 2003; Harris, 2004; Meidute &
Paliulis, 2011) to the problems of the conventional procurement; they are complex
and expensive and, as a result, only certain projects qualify for the use of publicprivate partnerships.
The figure below shows the trend of growing interest in the use of PPP within
Europe for the period of 1990 – 2009. It is important to note that between 1990 and
2004 from all PPP projects more than half were arranged in the United Kingdom.
Only recently the trend has changed and other European countries have
experienced increased use of PPPs (EIB, 2010).

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35.000

160

30.000

140

25.000

120
100

20.000

80

15.000

60

10.000

40

5.000

20

0

Number of projects

Value of projects, mln. €

Figure 1. European PPP trend, 1990-2009

0

Years
Value of projects

Nuber of projects

Source: Adopted from EIB (2010, p. 7)

Even though, the numbers are increasing, the portion of PPP projects in the overall
public procurement is still not that significant (Appendix 1). For example, in the
United Kingdom, the biggest producer of PPP projects, public private partnerships
represent only 10-13% of all public infrastructure projects (Deloitte Research,
2006).
Having this in mind, the question rises, why PPPs represent such a small fraction
of all public projects if they deliver benefits such as greater efficiency, timely
delivery of public projects, better quality of service provision, etc.? In order to try to
answer this, the paper examines the concept of public-private partnership and
reviews the advantages, disadvantages, and the reasons why PPPs are
implemented. In addition, the case study is perf ormed where the conventional
procurement approach is compared to public-private partnership. The paper
investigates what PPPs are, what they deliver and when they prevail over the
conventional procurement approach.

P ROBLE M

ST ATE ME NT

The aim of the paper is to analyse the concept of public private partnership and its
suitability for a procurement of a public project. The objectives of the thesis are
achieved by reviewing the relevant literature and performing an analysis on the
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case study by examining the different procurement approaches available for the

project: PPP and conventional procurement. The analysis will answer which
procurement approach should be the appropriate one for the case study
concerned.

S T RUCTURE
The paper is divided into two main parts. The thesis is structured in the way that
from the very beginning an understanding of the concept of PPP could be
developed, which is used for the second part of the thesis, where the analysis is
performed.
The first part of the thesis provides an extensive discussion on the theoretical
foundations of public private partnerships. It focuses on the discussion of the
relevant concepts, characteristics, types, advantages and disadvantages of the
PPP. The first part of the paper answers questions, such as: what PPPs are, why
such a procurement mode is practiced and how it differs from other procurement
approaches, such as conventional procurement and privatisation.
The second part of the thesis is the analysis of the case study. It is divided into two
main sections. The first section includes an overview of the project’s background
and its adequacy for a PPP. It further includes a review of the Lithuanian
environment regarding PPP law and provides a discussion on the suitable PPP
form for the infrastructure project concerned. The second section of part two
consists of the cost and benefit analysis, which involves the following steps:


Data overview (identification of costs and benefits, assumptions);



Financial analysis;



Socio-economic analysis;



Sensitivity analysis;



Overview of the results.

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In addition, the second part of the thesis is expanded with a discussion on other
factors that are not covered by CBA, however, factors that are relevant when a
PPP approach is considered.
The last part of the paper concludes the discussion on public-private partnerships
and the analysis performed.

M ET HODOLOGY
The paper is written by following the deductive, in other words, a “top-down”
approach. The paper begins with the general overview of the theory and then
narrows down to the analysis of a specific case study. In addition, the paper is
based on the secondary sources.
The first part of the paper emphasises on the literature review. The literature
review is based on the European Commission, EPEC, Hong Kong Efficient unit,
Victoria Partnership guidance on PPPs, reports of OECD, IMF, PwC, Deloitte, and
views provided by a variety of PPP researchers – such as Grimsey and Lewis,
Akintoye, Hodge, etc. The articles, books and reports used in the paper were

accessed through a variety of research databases, such as OECD iLibrary,
Science Direct, Business Source Complete, etc.
The second part of the paper emphasises on analysing a particular public-private
partnership project. The analysis is carried out by performing a cost-benefits
analysis (CBA) while employing guidance of the European Commission: “Guide to
Cost Benefit Analysis of Investment projects: Structural Funds, Cohesion Fund and
Instrument for Pre-Accession” (2008) and “Guide to cost benefit analysis of
investment projects” (2002). Some additional insights for the application of CBA
have been adopted from OECD (2006), Boardman, Greenberg, and Vining (2011)
and Campbell and Brown (2003).
Cost and benefit analysis is a technique used to identify, measure and compare
benefits and costs of an investment project and it is used to assist the decision
maker in choosing the most beneficial project from the alternatives available
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(Campbell & Brown, 2003). In this paper cost and benefit analysis is used as a tool
to determine the main differences between procuring a project through a traditional
procurement mode and a PPP. It should be noted that the CBA used in this paper
does not try to compare different project implementation alternatives 1. The idea of
the analysis is to compare the same project financed by public and private funds.
Therefore, it could be said that the aim the cost and benefit analysis performed in
this paper is to understand whether the inclusion of the private partner in the public
procurement influences the investment decision rule – whether to proceed with the
project or abandon it instead.
The addition to CBA is an overview of other factors that are not incorporated in the
aforementioned analysis, which, however, are influential when the choice of
procurement approach is considered. The discussion on these factors is performed
in accordance to the theory overview of the first part of the thesis.

D ELIMIT AT IONS
The concept of public-private partnership encompasses a variety of different
partnerships and relationships, which are not covered fully in the thesis. The paper
focuses on one particular PPP infrastructure approach, within which the topic is
analysed.
What concerns the second part of the paper, due to time constraints and size
limitations, the CBA is performed only to the level that is enough to identify the
most important points regarding the differences between procuring a project
through PPP and conventional procurement approach. In addition, due to the
complexity and extent of the project, the analysis has been simplified and only
most important impacts taken into account. As a result, there is possibility for some
divergence between results presented in the paper and the reality. Further
development on the CBA could be made if more specific studies were conducted:
for example, a detailed market demand analysis or more specific environmental
1

The paper does not intend to compare the usual cost and benefit analysis’ alternatives: “Business as usual”,
“Do minimum”, “Do something”, “Do something else” (European Commission, 2008).

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studies examining the CO 2 emission, air pollution, etc. Moreover, due to the lack of
relevant information, which is a consequence of the absence of the analogues
projects in Lithuania, most of the assumptions are based on the foreign countries’
experience, especially of the more developed Western economies, which might be
highly inaccurate when situation in Lithuania is considered. With addition to this, it
is a nature of CBA to use a variety of assumptions, which might sometimes appear
to be imprecise, in particularly, when a long term project is analysed.

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1.

L ITE RATURE

REV IE W

1.1. D EF I N I T I ON
Public private partnership (PPP), in simple terms, is a form of private-sector
involvement (PSI) 2 in which a private partner brings its skills, capital, commercial
innovation into the provision of the services the government is responsible for. It
should be noted, however, that such an explanation covers only a part of this broad
concept. It is widely acknowledged within the relevant literature that there is no
clear definition for PPP which would cover all aspects of different relationships that
these partnerships encompass (Daube, Vollrath, & Alfen, 2007; Hodge & Greve,
2007; OECD, 2008) and at the same time restricting it to a more narrow
description. As Weihe (2006) argues, the concept of PPP is nebulous – it “allows
for great variance across parameters such as time, closeness of cooperation, types
of products/services, costs, complexity, level of institutionalization as well as
number of actors involved”, as a result, nearly any type of the relationships that
include both the private and the public sector (whether it is a service contract or a
joint venture) may be called a public-private partnership (PwC, 2005). In order to
make some distinction between the variety of definitions present, Weihe (2006)
attempted to classify them into 5 categories: local regeneration, policy,
infrastructure3, development and governance approaches. The local regeneration
and the policy approaches are similar due to perceiving PPP concept as a very
wide definition that covers changes in policies of environment, economic renewal,
development, and institutional set up. The difference between the two is that the

local regeneration approach focuses on the local level while policy approach – on
the national. The third approach – the infrastructure approach – covers the
cooperation of private and public sector in order to create and maintain
2

Private-sector involvement is a new focus of EU which has been created in order to “assist the government in
meeting its priorities, building on the clear recognition that public funds are limited” (Tanga, Shena, & Chengb,
2010, p. 684).
3
In order to define infrastructure, we use the definition provided by Grimsey and Lewis (2004, p. 20):
“investment in infrastructure on some definitions is said to provide ’basic services to industry and households ’,
‘key inputs into the economy and ‘a crucial input to economic activity and growth’”. Infrastructure approach in
PPP does not cover such infrastructure as “coal or steel or motor vehicles”, it concerns infrastructure like
roads, motorways, ports, airports, telecommunication, prisons, schools, etc.

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infrastructure, as well as deal with the financial and legal aspects of such projects.
The fourth approach – the development approach – concentrates on the
development of infrastructure in developing countries where corruption, social
deprivation, global disasters are present. This approach includes many forms of
cooperation between the public and private sectors such as strategic or
entrepreneurial partnerships. The last approach is the governance approach which
does not specify any context or policy as it emphasizes on organizational and
management side, as well as new ways of cooperation and governing. For the
purpose of this thesis, the concept of PPP will be limited to the infrastructure
approach.
Even thought the concept has been narrowed down, there are still many definitions
explaining what a PPP is under the approach chosen. For example, the European

Commission (2004, p. 3) defines PPPs as “forms of cooperation between public
authorities and the world of business which aim to ensure the funding,
construction, renovation, management or maintenance of an infrastructure or the
provision of a service”; whereas OECD (2008, p. 12) defines it as “an arrangement
between the government and one or more private partners (which may include the
operators and the financers) according to which the private partners deliver the
service in such a manner that the service delivery objectives of the government are
aligned with the profit objectives of the private partners and where the
effectiveness of the alignment depends on a sufficient transfer of risk to the private
partners”. Further examples of definition include the one proposed by IMF (2006, p.
1) that explains the concept as the “arrangements where the private sector
supplies infrastructure assets and infrastructure-based services that traditionally
have been provided by the government”, and EIB (2004, p. 2) that views PPP as a
relationship of the two sectors which has an aim “of introducing private sector
resources and/or expertise in order to help provide and deliver public sector assets
and services…<it is> used to describe a wide variety of working arrangements
from loose, informal and strategic partnerships, to design build finance and operate
(DBFO) type service contracts and formal joint venture companies”. An overview of
the PPP definitions under the variety of international organizations draws some
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conclusions on the basic set of features that characterise PPP under the
infrastructure approach:


long term contractual arrangement between the public and private sector;



functions are bundled;



responsibility for the provision of the services is shared;



resources are shared:
o the private sector brings in capital, skills, experience, commercial
innovation, etc.;
o the public sector delivers skills, political authority, access to publicly
run services, assets, etc.;



risks and rewards are shared.

In order to understand the PPP concept fully, it is also useful to distinguish it from
the traditional procurement mode. The reason for this is that the boundaries
between the two modes are ambiguous. In order to remove this ambiguity the main
differences between the two modes are identified and explained.
First of all, the main differentiating point between PPP and traditional procurement
is that in PPPs risks are shared between the private and public partners whereas in
a conventional procurement most of the risks are retained by the government 4
(European Commission, 2005; OECD, 2008) . This is in line with the functions
included in the contracts. In a PPP different tasks are bundled together and, as a
result, private partner takes responsibility for the whole package of the associated
risks. In the conventional procurement, on the other hand, the government usually
purchases a single function from a private partner and, as a result, the private

partner is responsible only for the risks associated with this function. Consequently,
in the traditional procurement the private partner has no incentives to incorporate
decisions that may favour future operations as after completion of the task, the
private partner is no longer involved in the operations of the asset/service. For
4

Because there is no single clear definition for PPP, the most important factor that distinguishes the
procurement mode and the type of PPP used is the amount of risk and responsibility transferred to the private
partner (European Commission, 2005, p. 1).

Page | 13


instance, if the government proposed a tender to deliver a package of services,
such as design, build and maintain a facility, the private partner involved would be
incentivized from the very beginning to make decision that could minimize the
future risks associated with cost overruns. Such an example has been identified in
the international experience by Grimsey and Lewis (2004, p. 135), where an
innovative decision to construct 45-degrees windowsills in UK hospital was
proposed with an intention to save future cleaning costs. It is hardly likely that such
a decision would have been made in the conventional procurement case. A
government would propose a tender to design a facility with input requirements
already specified. The specific requirements can be seen as a frame from the
private partner’s point of view as these requirements restrict private partner to
innovate and come up with more efficient solutions. The aim of the private partner
responsible for a design function is to design a facility while incorporating all the
details required and within the budget stated. The review of function bundling and
risk allocation in both procurement cases help to determine what defines a PPP
and a traditional procurement approach.
Secondly, the two modes differ between each other when the function specification

is considered. What this means is that, in a PPP, government states what it
expects from the private partner in output terms, whereas in the conventional
procurement

it

does

that

through

input

specification.

Considering

the

aforementioned example, in a PPP case, government might require a hospital to
be big enough to accommodate 300 people and to be kept in a good condition by
clarifying what good condition means, whereas in the conventional procurement
option, a government would request a certain size, with a certain number of rooms,
with specific materials used, etc. In the PPP case, private partner is free to use its
skills and innovation in order to provide the outputs required in a most efficient
way, whereas the latter case does not allow such a freedom as a private sector is
restricted to the requirements specified.
Thirdly, in a PPP approach, returns to the private partner are linked to the
performance of their functions, i.e. the provision of outputs specified by the

Page | 14


government, whereas in a conventional procurement approach, private partner is
remunerated for the completion of a specific function. This contributes to the level
of incentives attached to the private partner: in a PPP case, if a private partner
does not operate as expected, it might incur some sort of penalties (Harris, 2004),
if it operates better than expected, it may be awarded by, for example, receiving
higher portion of additional profits. In a traditional procurement case, on the other
hand, private partner is not awarded for an extra value added to the task it was
responsible for, however, it might be penalized f or the uncompleted function.
Considering all this, the private partner in a traditional procurement is not
encouraged to provide more than the government requested for, which means
some possible gains might be overlooked.
Fourthly, the relationships involved in both of the procurement modes differ
(OECD, 2008). In the traditional procurement, in order to deliver the services and
infrastructure required, the government acts as an intermediary – on the one side it
deals with direct users of the services, taxpayers, and financial markets, and on the
other side – with other private companies. The idea behind such a relationship
structure is that the government gathers financing directly from the users of the
service, taxpayers and financial markets, and uses it to remunerate the other side
– the private companies for the capital goods provided to deliver the public service
and develope the infrastructure. If the project is handled through a public-private
partnership, the intermediary role of the government is decreased – public authority
deals with the taxpayers and the single private operator only. The role of the
private operator, on the other hand, is enhanced: private operator becomes
responsible for the intermediary role – it collects financing from the direct users of
the service and financial markets and remunerates the other side – other private
companies for the capital goods provided. If the private operator acts in
accordance to the performance standard specified, in some of the cases 5, it

receives additional payment from the government (Maski & Tirole, 2008). The
relationship structures of the two schemes are represented in the Appendix 2.
5

The private operator may be remunerated through: the collection of direct user charges only, through the
government payment only, or through a combination of both (Grimsey & Lewis, 2004).

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Finally, a crucial advantage of PPP from a government’s point of view is the
financing. In a PPP case capital is provided by the private partner. This means that
the government does not incur immediate cash outflow due to the project, which
might be an impossible task when restricted public funds are considered. In a
traditional procurement mode, on the other hand, the government finances the
project from its own funds, that is it incurs large investment costs instantly. Figure 2
represents the comparison between the two financing options in the public
procurement.
Figure 2. Cash flows in PPP and traditional procurement mode

Source: Akbiyikli, Eaton, and Turner (2006, p. 71)

All in all, the two modes differ between each other when the following factors are
considered: amount of risks transferred and tasks bundled, the way requirements
for the service delivery are specified, characteristics of private partners returns,
relationship between the parties involved and the financing flows. Nevertheless, it
is clear that sometimes these differences may be too ambiguous or too subjecitve
to state clearly which procurement approach is adopted.

1.2. T Y PES OF PPP S

The spectrum of different PPPs range from the short term service contracts to
concessions. Nevertheless, as the focus of this thesis is the concept of PPP under
an infrastructure approach, the overview of different PPP modes will be limited to
the ones that are covered by the PPP approach chosen. These modes have

Page | 16


common characteristics, such as: being long term, involving risk transfer, shared
responsibility, resources and rewards.
In general, private partner involvement arrangements in PPPs differ between each
other depending on the level of responsibilities and risks transferred to the private
partner (Amekudzi & Morallos, 2008). The responsibilities concerned include
activities such as: designing, building, financing, maintaining, operating, and
owning the facilities. The allocation of risks will be discussed in more detail later in
the paper; however, what matters at this point is the amount of risks transferred
and retained by the government.
Most common forms in the infrastructure approaches are:


Turnkey procurement, which includes: BOT (build-operate-transfer), BBO
(buy-build-operate), etc. (European Commission, 2003, 2005);



DBFO (Design-Build-Finance-Operate), which includes: DBOM (designbuild-operate-maintain), BOOT (build-own-operate-transfer), concessions,
etc. (Deloitte Research, 2006; European Commission, 2005; IMF, 2004).

Turnkey procurement 6 is described as the scheme where the private partner takes
on the responsibility to design, construct and operate the asset, whereas the public

sector retains the responsibility for the financial risks involved. Using this
procurement mode, public sector sets the quality outputs required and by doing so
it ensures that the private sector brings the necessary efficiency gains as well as
the asset is maintained to the standards expected. This mode of procurement is
used in water and waste projects as it ensures incentivized management and
maintenance of the asset through the bundling of functions passed on to the
private partner (European Commission, 2005).
DBFO scheme 7 is characterized by involving a private partner with responsibilities
(financing, designing, building, constructing, and operating the asset/service)
attached to it. Public sector’s role is to set the specific output requirements for the
6
7

See Appendix 3 for illustration of the turnkey procurement’s scheme.
See Appendix 3 for illustration of the DBFO scheme.

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private partner, whereas private partner’s role is to fulfil those requirements. The
DBFO schemes are usually long term and involve bundling of functions in order to
provide private partners with the necessary incentives for it to operate in the most
efficient and innovative way. These schemes involve performance linked payment
mechanisms with an aim to ensure the presence of motivation for the private
partner to operate on its full capacity. The idea behind such schemes is that the
private partner designs, builds, operates and maintains the asset for the agreed
term. At the end of this term, the asset is either transferred back to the government
or is left under the ownership of the private partner – depending on the specific
structure of the scheme chosen. For example, one of the most common schemes
under DBFO is concession. Concession is described as a PPP scheme, where

exclusive rights to operate an asset or provide certain services are granted to a
private company (usually a SPV 8), which in return has to design, build, finance and
operate the asset/service for the time agreed upon. These exclusive rights usually
permit the private partners to collect the revenues from the direct users of the
asset/service. Concessionaires typically own the rights to the asset/service during
the time of concession, however, at the end of this period the ownership of the
asset/service is usually transferred back to the public sector (Deloitte Research,
2006; European Commission, 2005; IMF, 2006). Literature overview shows that
concession is usually assumed to be a form of PPP (Deloitte Research, 2006;
European Commission, 2004; IMF, 2006; Ng, Xie, Cheung, & Jefferies, 2007;
PwC, 2005), however, OECD (2008) argues the opposite. First of all, it states, that
the amount of risk transferred differs in PPPs and concessions: concessions
involve higher level of risks allocated to the private partner, compared to other
forms of PPPs. Secondly, it is usual for concessionaires to collect revenues from
the direct users of the asset/service and, according to OECD, this feature
differentiates concession from other PPP forms. As a result, OECD concludes that
concessions should not be treated as a PPP. Nevertheless, in this paper
concession is considered as a form of PPP.
8

SPV (special purpose vehicle) – “an organization that can be established as a distinct legal entity to bring
together the companies involved in a PPP in order to manage the project and share the risks and rewards”
(Grimsey & Lewis, 2004, p. xv).

Page | 18


The international experience shows that most of the time DBFO schemes are used
in transport sector for building highways, bridges, railways, whereas concessions
are chosen for mobile phone services, toll roads or provision of municipal water.

The similarities between the turnkey procurement and DBFO schemes are that the
activities involved are same in both of the schemes, differing only in the amount of
functions involved in the arrangements. What differentiates the two schemes is that
in the first one the majority of risks remains within the public sector, whereas in the
latter – risks are shared between the partners, allowing for the possibility to transfer
the optimal amount of risks to the private partner.

1.3. R E AS ON S F OR I M PL EM EN T ING PPP S
The main objective of procuring a public project through a PPP mechanism is to
achieve value for money (VFM) (Grimsey & Lewis, 2004; Harris, 2004; New South
Wales Government; Quiggin, 2004; Shaoul, 2005) which as Grimsey and Lewis
(2005, p. 347) argue is “the optimum combination of whole life cycle costs, risks,
completion time and quality in order to meet public requirements”. This definition
assents to the one implied by the European Commission (2003, p. 55) which
identifies a set of factors that determine value for money: life cycle costs, allocation
of risks, time required to implement a project, quality of a service, and ability to
generate additional revenues. Following this, a general principal used to determine
whether a project should be implemented through a PPP or a traditional
procurement is to evaluate which procurement mode ensures lower life cycle costs,
better allocation of risks, quicker implementation, higher quality and additional
profits. In other words, additional value for money represents additional efficiency
gains – delivering or maintaining the same service or asset in a more cost efficient
or a more qualitative way than it would have been if the government retained the
full responsibility for delivering/maintaining service/asset concerned (EIB, 2004, p.
4; Meidute & Paliulis, 2011; Nisar, 2006). EIB (2004) argues that the critical aspect
in order to reach value for money is the ability to share risks and rewards
appropriately. OECD (2008) confirms this view recognizing that main reasons for

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PPP establishment are the appropriate risk allocation and value for money gains 9.
Grimsey and Lewis (2005, p. 347), however, imply that the value for money gains
can only be achieved if the following conditions are present: a competitive
environment, optimal risk allocation and if the comparison between the financing
options is handled in a “fair, realistic and comprehensive” way. Furthermore, when
questioning PPP’s ability to deliver additional gains, one should consider the
qualitative benefits of PPPs – whether they are achievable and whether they really
provide the benefits expected. It is essential therefore to check whether the private
partner is capable of bringing in skills that the government lacks and whether it has
the expertise and know-how necessary to operate more efficiently compared to the
government (PwC, 2005).
According to the literature review, further reasons that lie behind the use of PPP as
a procurement mode differ between countries depending on the environment
present. For example, the main aim of a PPP at the early stage of its development
in the United Kingdom was to finance the public infrastructure projects (Grimsey &
Lewis, 2004; IMF, 2006; Meidute & Paliulis, 2011). The issue at that time consisted
of a growing need for public infrastructure development (as it also is the case in
Hong Kong (Cheung, Chan, & Kajewski, 2009)) and a lack of available public funds
to finance this need. As a result, a new initiative took place – Private Finance
Initiative (PFI) – with the purpose to provide additional funds for public
infrastructure projects. On the other hand, countries like Australia do not have
such an issue. They are capable of financing projects by themselves, however,
they still choose to involve the private sector for the possibility of achieving
additional value (Cheung et al., 2009). Moreover, Hong Kong and Australia involve
a private partner into the procurement of public services with the aim to ensure a
better quality of services. This, on the other hand, does not seem to be the
prioritized reason for the PPP development in the United Kingdom, which

9

The gains associated with the inclusion of the private partner are based on the assumption that the private
partner has more to offer than the public entity could realize by itself - it is assumed that the private partner will
bring more innovative and cost efficient solutions in addition to a better management. Nevertheless, caution
should be taken here that the mere inclusion of the private partner will not be sufficient to generate value for
money required (OECD, 2008, p. 18).

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emphasizes the point that reasons to implement PPP depend on the
circumstances surrounding countries’ economic and political environment.
In many of the countries the choice for PPPs, however, is due to financial reasons
(such as lack of public funds and restricted public investment). This reason is
amplified when “a tight fiscal environment following the development of European
Monetary Union” (EIB, 2004, p. 4) is considered as due to this European countries
experience difficulties in organizing large investment sums to finance public
infrastructure projects from the public funds only.
All in all, in theory, the main reason to develop PPPs lies behind the concept of
value for money, creating additional benefits due to private partner’s expertise,
know-how, ability to operate efficiently and generate additional revenues. Despite
the theoretical foundations, it is evident that PPPs are also often used in cases
when there is a lack of public funds for the growing need for public infrastructure.

1.4. V AL U E F OR M ON EY
The concept of value for money is ambiguous and in order to understand it better,
it is worth analysing the estimation procedure for it. When estimating the value for
money that a partnership creates, governments have to choose between four
methodologies: CBA of public and private partner proposals, PSC-PPP comparison
before the tender, PSC-PPP comparison after the bidding process, and

identification of value for money through the competitive bidding process (Grimsey
& Lewis, 2005; Sarmento, 2010). The literature review shows that the calculation of
PSC (public sector comparator) and comparison of it with the PPP option before
the tender is the most commonly used method. The purpose of public sector
comparator is to verify that value for money is generated (Harris, 2004; Quiggin,
2004) and in order to do this “the hypothetical risk-adjusted cost if a project were to
be financed, owned and implemented by the government” (Partnerships Victoria,
2001, p. 6) should be calculated. The calculation of such costs is done by
estimating four elements: raw PSC, competitive neutrality, transferable and
retained risks, all of which are represented in the figure below:
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Figure 3. Structure of Public Sector Comparator

Source: Partnerships Victoria (2001, p. 6)

To begin with, the first component – raw PSC – includes the calculation of project’s
base costs as if the government would procure the project through the
conventional method. It includes identifying and calculating project’s direct (capital,
maintenance, operating costs) and indirect costs (overheads, administrative costs)
as well as any revenues incurred (Amekudzi & Morallos, 2008). The next
component – competitive neutrality – involves adjusting the cash flows in order to
remove any competitive advantages or disadvantages that the government may
have over the private sector (Amekudzi & Morallos, 2008; Partnerships Victoria,
2001). The advantages and disadvantages concerned may be due to different
aspects of the taxing system applicable to the public and private sectors. For
example, land and income tax rates may differ as government authority may
receive exemption whereas bidder may not. In addition, competitive neutrality
adjustments may rise due to differing regulatory requirements for the partners

concerned. The third and fourth elements of PSC calculation concern the
estimation of transferrable and retainable risks, where risks are identified, allocated
and priced. The price of risks transferred to the private partner should be included
in PSC value. Transferrable risk element together with retained risk element ideally
should ensure the optimal allocation of risks between the partners involved in the
project.
The allocation and valuation of project’s risks is inherent in the value for money
concept (European Commission, 2003; Grimsey & Lewis, 2004; Nisar, 2006;
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Sarmento, 2010). The aim of the risk transfer is to transfer only those risks that the
private partner could offset in a most efficient and least costly way(Grimsey &
Lewis, 2004; Harris, 2004; Nisar, 2006). Risk allocation produces highest value for
money once the optimal risk transfer point is identified (Figure 4): transferring too
much or too little risks results in either procuring an inefficient project or procuring a
project with excess costs incurred by the government (for example, if risks are
transferred to the private partner that it does not have control over or cannot
control it at least-cost, then the private partner will require higher premium for these
additional risks assumed (Hodge, 2004)), consequently, producing lower value for
money (Amekudzi & Morallos, 2008).
Figure 4. Optimal risk allocation point

Source: Partnerships Victoria (2001, p. 52)

Unfortunately, there is no universal solution regarding risks allocation for every
single project, however, there is a general agreement on how different risks should
be allocated. To begin with, risks in general are allocated to different categories,
such as, for example, proposed by OECD (2008): legal and political risks in
addition to the commercial ones. Categories are differentiated on the basis of who

takes the responsibility for the risks concerned – private partner or the government
authority. For example, construction, supply and demand side risks lie under the
commercial risk category (market risk, project risk and internal risk) as they are
handled better by the private partner, whereas legal and political risks are assumed
to be handled better by the government. Other categorization is proposed by Li,
Akintoye, and Hardcastle (2001), who distribute risks into three levels: macro,
meso and micro. Macro level covers risks outside the project – environmental,
political, legal risks that are concerned with national or industry level. Meso level
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risks emerge within the project’s implementation phase – design, construction,
operation. Finally, the micro level risks concern risks that appear between the
partners involved, they rest on the idea that both of the parties have different
incentives and objectives, and therefore, risks due to power struggle, differences in
working

methods

and

environment

between

the partners

may

emerge.

Furthermore, Grimsey and Lewis (2004) argue for more detailed risk categorisation
– they divide risks into nine categories that are suitable for the infrastructure
approach: technical, construction, operating, revenue, financial, force majeure,
regulatory/political, environmental and project default risks. This distribution is
similar to the one proposed by Gray (2004), IMF (2004) and the European
Commission (2005).
Finding the most optimal risk allocation point requires identifying what risk is
handled best by which party. As mentioned above, there is no one optimal risk
allocation solution that fits every specific project, however, some general guidance
is present in the literature on PPPs (Bing, Akintoye, Edwards, & Hardcastle, 2005;
European Commission, 2003; Grimsey & Lewis, 2004; OECD, 2008; Quiggin,
2004). For example, if Harris (2004) risk allocation model was considered, the risks
would be assigned accordingly:
Figure 5. Model for risk allocation

Source: Harris (2004)

The proposed model identifies risks that should be passed on to the supplier
(transferable risks), that should be retained by the government and the ones that
do not belong to neither of the parties. As the figure shows, risks such as design,
construction, operating performance, technology obsolescence, etc. are usually

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assigned to the private partner. The reason for that is that the private partner
receives most of these risks implicitly with the responsibilities passed on to the
private partner (Harris, 2004). When, for example, DBFO is concerned, the
responsibilities of the private partner include designing, building, financing and

operating the asset, all of these tasks include associated risks, and by contractually
agreeing to handle these tasks, the private partner, consequently, agrees to handle
the risks concerned (Akintoye, Beck, & Hardcastle, 2003). The risks that are
retained by the government authority are risks that the private partner has no
influence over while the government does (Nisar, 2006). For example, the
discriminatory regulatory risk – government might decide to change certain
regulations that may influence the success of the private partner. In order to keep
private partner safe from such possible modifications, the government has to take
responsibility for the consequences of such certain change. Risks under the shared
risk group are those that cannot be controlled at least cost or in the best way by
neither of the party, for example, inflation, exchange and interest rate risks
(Akintoye et al., 2003). An example of a more detailed risk allocation matrix,
proposed by Chan, Yeung, Yu, Wang, and Ke (2011), is presented in the Appendix
4.
After identifying and allocating the risks, the next step is to place a value on them.
There are three factors determining the price of the risk – probability of the risk
occurring, consequence of the risk and the contingent factor 10. The value of the
transferable risk equals the contingent amount that the government would pay to
the private partner if a risk occurred under the conventional procurement approach
(Amekudzi & Morallos, 2008; Hodge, 2004).
Four elements: raw PSC, competitive neutrality, transferable risks as well as
retained risks, produces the value of PSC, which is then compared to the value
proposed by the private partner – estimate of PPP value. The value for money is
represented in net present value terms as a difference between the expected costs
of PSC and PPP (Amekudzi & Morallos, 2008), as shown in the figure below:
10

Value of risk = consequence * probability of occurrence + contingency factor (Partnerships Victoria, 2001)

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