Advances in new business assignment

Introduction

Public private partnerships (PPPs) are a key element in the Government's strategy for delivering modern, high quality public services and promoting the UK's competitiveness. They cover a range of business structures and partnership arrangements, from the Private Finance Initiative (PFI) to joint ventures and concessions, to outsourcing, and to the sale of equity stakes in state-owned businesses.

Discussion

The Government took action to enhance PPPs within days of taking office in May 1997, starting by overhauling the PFI. The flow of investment from PFI deals is set to rise rapidly as a result: contracts with an estimated capital value of over £8 billion have been signed since the election in areas as diverse as hospitals, schools, military helicopter training and water treatment services; in addition, in June 1998 the Government renegotiated the Channel Tunnel Rail Link project, with a capital value of over £4 billion; the Government's other PPP plans are expected to generate at least a further £20 billion of investment. This includes PFI projects currently out to tender and the Government's plans for PPPs for London Underground and National Air Traffic services (see below). All this compares with less than £4 billion of private finance contracts signed during the whole of the last Parliament.

The Government announced plans in July 1999 to build on this success by establishing Partnerships UK - a private company with a public interest mission, which will enhance the public sector's ability to use public private partnerships to achieve its objectives. The Government is also using PPPs to help state-owned businesses to compete and to provide improved services to their customers, while retaining responsibility for public interest issues in the public sector. These include:a PPP for London Underground in which private sector partners will be granted long-term concessions to upgrade and modernise the tube infrastructure, including some £8 billion of new investment in the first 15 years, backed by a rigorous performance regime to ensure that this investment leads to better services; the introduction of a private sector strategic partner into National Air Traffic services (NATs) to fund and manage more effectively the company's large, modernising investment projects, while separate, public regulation will ensure NATs maintains its high safety standards and offers value for money for airlines and their passengers.

In addition, the Government is extending the partnership approach to an ever widening range of public sector activities, drawing on business skills to develop and implement policy, and using the expertise of private sector partners to make better use of public sector assets. PPPs are not only vital for the modernisation of the UK. There is huge international interest in the UK's approach to developing partnerships between the public and the private sectors. It is an area of public policy where the UK leads the world. Over 50 countries have consulted the Treasury about the PFI. some, like Italy, Ireland, Japan and the Netherlands are following us in the way we organise within government to deliver partnerships. some are legislating to enable them to happen. PPPs also offer British companies the opportunity to use the skills and expertise they have developed in providing services within the UK to enter new export markets.

This paper sets out the underlying principles and themes which apply to all the various forms of PPP, and which are central to the way in which the Government goes about designing new partnerships with the private sector. By applying these principles in each case, and learning the lessons from the privatisation programme and the early years of the Private Finance Initiative, the Government will deliver partnerships with the private sector that will provide better public services for customers and local communities, greater opportunities for staff and better value for the taxpayer.

What are Public Private Partnerships (Ppps)s

Public Private Partnerships bring public and private sectors together in long term partnership for mutual benefit. The PPP label covers a wide range of different types of partnership, including: the introduction of private sector ownership into state-owned businesses, using the full range of possible structures (whether by flotation or the introduction of a strategic partner), with sales of either a majority or a minority stake; the Private Finance Initiative (PFI) and other arrangements where the public sector contracts to purchase quality services on a long-term basis so as to take advantage of private sector management skills incentivised by having private finance at risk. This includes concessions and franchises, where a private sector partner takes on the responsibility for providing a public service, including maintaining, enhancing or constructing the necessary infrastructure; and selling Government services into wider markets and other partnership arrangements where private sector expertise and finance are used to exploit the commercial potential of Government assets.

Drawing Out The Best From The Public And Private sectors

The Government recognises that there are some things which the private sector does best and others where the public sector has more to offer. The old argument, as to whether public ownership was always best or whether privatisation was the only answer, is simply outdated. The Government firmly believes it will only deliver the modern, high quality public services that the public want and increasingly expect if it draws on the best of both public and private sectors. The starting point is, therefore, a recognition of the contribution that the public and private sectors can each bring to the partnership.

The fundamental role for Government

First and foremost, while the best way to deliver the Government's objectives may be through some combination of public and private sectors, Government retains the responsibility and democratic accountability for:

  • deciding between competing objectives;
  • defining the chosen objectives, and then seeing that they are delivered to the standards required; and
  • ensuring that wider public interests are safeguarded.

In the case of PPPs introduced into public services, this means that, while responsibility for many elements of service delivery may transfer to the private sector, the public sector remains responsible for: deciding, as the collective purchaser of public services, on the level of services that are required, and the public sector resources which are available to pay for them; setting and monitoring safety, quality and performance standards for those services; and enforcing those standards, taking action if they are not delivered.

Similarly, in the case of state-owned businesses, while PPPs bring the private sector into the ownership and management of the business, the Government remains responsible for safeguarding public interest issues. This includes, in particular, putting in place independent regulatory bodies, remaining in the public sector, whose role is to ensure that high safety standards are maintained, and that any monopoly power is not abused.

The potential of the public sector

second, the Government recognises that in many ways the public sector represents a reservoir of potential, including: dedicated and professional staff, who are motivated by a desire to improve Britain's public services, and more generally to raise the quality of life of people in this country and beyond; a portfolio of assets and businesses, which are often central to the delivery of key public services; a unique source of data, and a wealth of ideas and intellectual property which are the product of top class scientific research; a range of trusted brands and marques, which may have unique commercial potential.

The contribution of the private sector

But third, PPPs recognise that this potential is only partially released in the absence of the private sector. The private sector can expand opportunity through the following disciplines and skills.

Commercial Incentives

Private sector organisations operate in a fluid and fast moving environment. If they do not generate profitable business, they will not survive. The realities of the private sector market-place exert a powerful discipline on private sector management and employees to maximise efficiency and take full advantage of business opportunities as they arise.

These disciplines can never be fully replicated in the public sector, since there are a multiplicity of policy objectives, and a more risk averse culture driven in part by the desire to safeguard taxpayers' money. Compared to the private sector, therefore, the public sector can be less equipped to challenge inefficiency and outdated working practices, and to develop imaginative approaches to delivering public services and managing state-owned assets.

Focus On Customer Requirements

The need for private sector businesses to generate a return means that they are forced to look for ways to enhance the service they offer their customers, and to adapt to their changing requirements and expectations. Unless they do, customers will go elsewhere. such incentives tend to be less clear for public sector providers, so they can tend to respond more slowly to customer demands.

New And Innovative Approaches

Similarly, the search for new opportunities to develop profitable business provides the private sector with an incentive to innovate and try out new ideas - this in turn can lead to better value services, delivered more flexibly and to a higher standard.

Business And Management Expertise

The private sector is normally far more skilled in running business activities and some elements of service delivery, including managing complex investment projects to time and budget, and assessing the commercial opportunities of potential new business ventures. In summary therefore:

  • PPPs enable the Government to tap into the disciplines, incentives, skills and expertise which private sector firms have developed in the course of their normal everyday business
  • and so release the full potential of the people, knowledge and assets in the public sector
  • so enabling the Government to deliver its objectives better and to focus on those activities, fundamental to the role of Government, which are best performed by the public sector - procuring services, enforcing standards and protecting the public interest.

Investing for modern, quality public services

A key priority for this Government is to increase investment in Britain's public services after many years in which the public sector asset stock was allowed to deteriorate. The Government announced in its Comprehensive spending Review in July 1998 a significant increase in public sector investment with over £10 billion being made available over three years. The Departmental Investment strategies published in April 1999 set out details of departments' plans for using this additional investment, and how these plans link to their overall objectives. They also outline the procedures and systems which will ensure that value for money is obtained.

The Departmental Investment strategies also show how the Government is using private finance and other types of public private partnerships to add to and complement this additional public sector investment, or in some cases using public sector investment to leverage in private sector funds. This can relieve the pressure on public finances, allowing Government to concentrate resources on other public services. Reforms already made to the PFI will lead to a significant increase in the contribution made by private finance to public-sponsored total gross investment, growing from 10% in 1998-99 to an average of 15% in 1999-2000 to 2001-02, in particular as PFI projects are brought on stream more quickly, and PFI is expected to generate some £11 billion worth of new investment over the period 1999-2000 to 2001-02. The contribution of private finance should continue to grow as further reforms help to extend the range of public sector activities into which PPPs can be introduced.

Central to the Government's approach is to use PPPs where they provide better value compared to public sector investment. Under PPPs, the public sector specifies the outputs required from the investment, but the responsibility for, and many risks associated with, delivering those outputs is transferred to the private sector partner. This can offer better services, delivered more efficiently and providing better value for money for the taxpayer than public sector investment, provided the outputs can be clearly specified from the outset and that both parties fully understand the risks they are taking on. In addition, PPPs encourage innovative approaches, as the private sector partner is given flexibility over the design of the assets and operational procedures.

PPPs can also act as a value benchmark against which wholly public sector providers can be compared. In this way, they are helping to reinforce the pressure being applied across the public sector by the Government's Public service Agreements, ensuring that the additional investment announced in the Comprehensive spending Review delivers substantive improvements in public services.

Helping state-owned businesses and other public sector assets achieve their full potential

There are now relatively few large commercial organisations in the public sector, for example London Transport, BNFL, the Civil Aviation Authority and CDC. In most cases, the customers of these businesses are largely outside Government and pay for the services they receive along normal business lines. By introducing greater commercial disciplines, for example through private sector management and ownership, and through competition, the Government is looking to help these businesses fund and better manage their investment programmes, to operate more efficiently, to take advantage of new commercial opportunities to expand their businesses in the UK and beyond, and to improve the services they provide. This benefits their customers and the economy as a whole, and in turn will enhance their long-term commercial prospects and their value to the taxpayer.

Similarly, PPPs are contributing to the Government's drive to use publicly-owned assets more effectively and efficiently. The National Asset Register, published in November 1997, provided the first ever list of the assets owned by the Government. since then, Government departments have been encouraged to sell off assets they do not require, and make better use of irreducible assets that they do not use to full capacity, often by harnessing the expertise and finance of a private sector partner.

Sharing the benefits fairly between all stakeholders

PPPs should create genuine economic benefits for all involved. This means ensuring that the benefits of PPPs are shared fairly:

  • between public and private sectors. Private sector partners and investors benefit from the new and profitable business that PPPs represent. But it is for Government to ensure there is a fair deal for the public sector;
  • and within both public and private sectors, that all the stakeholders receive a fair share of the benefits. This includes the customer, the taxpayer, private sector investors and employees at every level of the organisation.

Why does PFI offer value for money when the private sector's cost of borrowing is higher than that of the public sectors

First, it is important to put this into perspective: the difference between the private sector's cost of borrowing and that of the public sector is down to some 1-3%2; and this additional margin applies only to a relatively small proportion of the total cost of each PFI contract- capital expenditure forms on average just 22%2 of the total cost of PFI projects.

second, and as a result, the value extracted from the use of the funds raised is normally more important than the price paid for these funds. The private sector can compensate for the higher price of its borrowing in a number of ways:

  • it can be more innovative in design, construction, maintenance and operation over the life of the contract;
  • create greater efficiencies and synergies between design and operation;
  • invest in the quality of the asset to improve long term maintenance and operating costs; and
  • underlying all this, the discipline of the market place ensures the private sector can manage risk better - it has better incentives and is better equipped to deliver on time and within budget. As the Institute of Civil Engineers and the Faculty and Institute of Actuaries in their publication on risk management state: "The Private Finance Initiative has heightened awareness of project risks in ways that traditional procurement has hitherto not been able to do, so that the identification, allocation and management of risks has grown to become an essential part of the PFI process."3

Third, in reaching a judgment on whether a PFI contract will offer value for money, and therefore whether to proceed, the Government compares the contract with an assessment of the cost of alternative public sector financing and management - the Public sector Comparator (PsC).

In July 1999, the Government commissioned Arthur Andersen and Enterprise LsE to carry out a study of Value for Money Drivers in the Private Finance Initiative. The report was published in January 2000, and submitted as evidence to the Treasury select Committee. It confirmed that PFI is delivering better value for money, and indicated that PFI projects are on average delivering savings of 17% over traditional forms of procurement. some examples of the better value obtained by PFI include the following:

  • In the National savings contract signed in January 1999 for the transfer of business operations, the PsC indicated that the traditional procurement option would be over 20% more expensive;
  • The Falkirk school PFI deals are estimated to offer 15% better value for money;
  • Defence projects average between 10 - 15% and in some cases up to 20% (for example, the project to train crew for the Medium support Helicopter);
  • Prisons averaged 10% for initial deals signed under the previous Government and an average 13% (assuming optimal public sector risk management) to 18% (assuming good public sector risk management) for recent contracts; and
  • The first four Design, Build, Finance and Operate (DBFO) road projects are likely to deliver savings of around 100 million (10%).

To make them affordable, don't PFI schemes lead to smaller facilities and reduced levels of public services

It is sometimes suggested, particularly in the context of health projects, that PFI schemes are not affordable unless they are made smaller in size and scope than the facilities they replace, for example by reducing bed numbers in new PFI hospitals. However, the affordability ceiling and the level and mix of services to be delivered under any new capital investment project is determined long before the private sector is involved in negotiations.

To use the NHs as an example, the services to be provided at any new hospital - which in turn determine the number of beds needed to deliver them - are set out in an initial Outline Business Case (OBC). This is drawn up by NHs managers, clinicians and health experts and must be approved by the Department of Health before a decision is taken on whether to use public capital or the PFI route to fund the project. An affordability ceiling must also be determined for the OBC and, together with the number of beds required, be included in the first tender documents which go out to prospective private sector bidders under the PFI route.

The reductions in bed numbers at new hospitals have been driven by developments in medical techniques and practices such as the increased use of day surgery and shorter hospital stays. It is not a result of the introduction of PFI.

Publicly-Owned Businesses - A Tailored Approach

The Government believes that, in order to meet all three of its objectives - better services, better value and benefit for all stakeholders - it needs to devise solutions which are tailored to the particular circumstance of the public enterprise or public service concerned. As the privatisation programme of the 1980s and early 1990s demonstrates, trying to apply a single model to each case leads to a sub-optimal result. The starting point is therefore to define the specific outputs the Government wants to see delivered, and then to determine which elements are better provided by the private rather than the public sector.

The Government's policies for state-owned businesses provide an illustration of this approach, with differences in structure reflecting the different objectives and circumstances. Where new investment is central to the operation of the business (as with London Underground and NATs, for example), the investing part of the organisation is being transferred to the private sector to make best use of the private sector's ability to manage often large and complex capital projects. Where there are matters of public interest at stake, the Government is safeguarding these, for example by providing for economic regulation of the business alongside the comprehensive regulation of safety (as is the case for BNFL and NATs). The details are set out below:

NATs

The Government's objectives are to build on this country's enviable reputation for aviation safety and manage increasing volumes of air traffic (rising by an average of 5-6% per annum), with a solution which separates safety regulation from service provision, and provides the funding and management required to modernise the UK's air traffic control systems (an estimated 1 billion programme of investment in high technology infrastructure) and enable NATs in due course to exploit business opportunities around the world. The PPP meets these objectives by:

Separating NATs from the CAA, with CAA remaining in the public sector as the body responsible for ensuring that NATs maintains, and where necessary enhances, high safety standards; introducing incentive-based economic regulation (which will also be the responsibility of the CAA). This will replace the existing "cost-plus" regulation which fails to encourage either timely and productive investment or value for money for airlines and their customers; transferring a controlling interest to a private sector strategic partner with the commitment, capability and skills that are required to manage large and complex investment projects to time and budget, and to take advantage of new business opportunities, in a framework which balances private sector shareholder scrutiny with commercial freedom from government. The private sector will bear the risk of and provide the funding for NATs' capital programme and new business opportunities; the strategic partner will also help more generally to introduce commercial dynamism and innovation into what is a natural monopoly business; safeguarding national security and the public interest through powers of direction in primary legislation. The Government will also retain a special share in NATs; and allowing the taxpayer and employees to share in the long term success of the business by retaining in public ownership a 49% stake, and making 5% of the shares available to NATs staff.

CDC

The Government's objectives are to leverage CDC's position as an important investor in poor countries by drawing in additional private investment, while ensuring that CDC's unique investment and business principles are maintained. All CDC's investments are for the benefit of developing countries, with at least 70% for the poorest of these countries. CDC also aims to ensure that at least 50% of its investments are for the benefit of countries in sub-saharan Africa and south Asia. The PPP would meet these objectives by:

    transferring the company into the private sector so as to benefit from private sector funding, drawing on the disciplines of the private sector to ensure the extra investment is used to maximum effect, and using CDC's exposure to the private sector capital markets to help leverage in funds from third parties into CDC's target markets in the developing world;

  • protecting CDC's business principles and investment policy through the partnership arrangement; and
  • allowing taxpayers and staff to share in the long term success of the business by retaining in public ownership a substantial minority stake and by plans to develop an employee partnership scheme.

BNFL

The Government's objectives are to provide a commercial framework which will enable BNFL to grow its global business in a competitive market, while ensuring high safety and environmental standards. A PPP would meet these objectives by:selling a minority equity stake, which would introduce private sector capital market disciplines into the business, ensuring that proposals for new business ventures are thoroughly scrutinised for their commercial viability; retaining rigorous independent safety and environmental regulatory regimes; and the continuing Government shareholding in BNFL, and the employee partnership scheme which the Government intends to introduce in the run up to the PPP, will ensure that taxpayers and BNFL staff share in the long term success of the business. The Government has set BNFL performance targets relating to the safety of its operations, the skill levels of its staff and the company's financial performance. A decision to proceed with the PPP will be taken in the light of the company's overall progress towards achieving these targets and in the light of further work by the Government and its advisers.

DERA

The Government's objectives, which would be delivered by a PPP, are to enable DERA to grow its commercial business for non-defence customers more quickly, and to encourage the 'spin-out' of its advanced technologies into civil applications, while ensuring that DERA continues to provide high quality, impartial advice to the MoD on the acquisition of new military systems of all types.

Privatisation

The UK's programme of privatisation began in 1979. since then around 100 major businesses have been transferred to the private sector. Overall, privatisation had beneficial effects, with productivity improved and the economy better able to respond to change, but the record varied significantly industry by industry. At its best privatisation, when combined with competitive markets, led to the creation of world class companies, reduced costs and prices and improved services to the consumer.

5 Elsewhere its record was more mixed, with certain stakeholders (in particular the new shareholders and the senior management) benefiting at the expense of others (most clearly, customers and taxpayers). Businesses were sold for less than their full value, prices have been higher than they should have been, services have not met consumers' expectations and yet shareholders and senior managers have done well.

Many of these deficiencies can be traced back to the way privatisation was implemented. In particular too many assets were sold too quickly and too cheaply. The valuation at the time of sale did not take full account of the improvement in performance which could be achieved through commercial pressures and incentives in the private sector. A more phased approach to sale, involving the initial retention of public sector stakes, would have given a better return to the taxpayer; regulatory regimes were initially too lax because the potential for efficiency gains well in excess of those which had traditionally been achieved in the public sector was underestimated. shareholders gained at the expense of consumers as mistakes were only slowly corrected through price reviews; not enough was done to create competition. Industries perform best in a challenging competitive environment.

The rush to privatise too often left unnecessary elements of monopoly in place and regulation proved an imperfect substitute for the market; in some cases, the new structural arrangements and regulatory regimes did not provide enough incentives on the private sector to invest to provide better services; senior management were often enriched beyond any reasonable requirements for incentives to achieve commercial success and with insufficient direct link to performance. Where rewards were linked to performance, they were based solely on performance post-privatisation. There was therefore no consistency of interest with the public sector vendor in the run up to the sale; in contrast, employees often failed to benefit, and were not truly partners in the new enterprise. The limited opportunity for many of them to invest in shares meant that they received little of the gains to which they had contributed; and the proceeds, some 90 billion in current prices, were not used effectively. The asset base of government was run down to finance current deficits.

The Windfall Tax

The Windfall Tax, introduced in July 1997, tackled the concern that the utilities were sold too cheaply, and that the initial regulatory regimes, which had been based in large part on information supplied by the companies themselves, were too lax. This one-off tax on the excess profits of the privatised utilities was levied in two equal instalments to raise some 5.2 billion to fund the Welfare to Work programme. The tax applied to the main privatised utilities, namely those companies privatised by flotation and regulated by statute.

Improving Regulation Of The Utilities

Some of the weaknesses of privatisation were most evident in the utilities, where public sector monopolies were transferred to the private sector with significant monopoly characteristics in place. Experience has demonstrated that more competition should generally have been introduced at the outset. In some cases, the development of technology since privatisation has pushed back the frontiers of potential competition, for example in telecoms, gas supply and, most recently, electricity. In the meantime, greater weight has needed to be placed on economic regulation to restrain monopoly and protect consumers. The UK's basic structure of economic regulation has stood the test of time. The RPI - x price control formula, which provides regulated companies with a genuine incentive to achieve efficiency gains, and the independence of regulators, have produced a climate favourable to investment and significant gains for consumers. But there is room for improvement. The Government's utility review concluded in July 1998 that changes could be made to: make protecting consumers, wherever appropriate through promoting effective competition, the principal objective of the regulators; establish strong and independent consumer councils to investigate complaints and champion consumer concerns; give the energy regulator powers to implement new electricity trading arrangements, so enabling the generation market to be more competitive; provide for greater transparency of decision-making; and replace individual regulators in the energy and telecoms sectors with regulatory authorities to improve consistency and predictability in decision-making; and require regulators to have regard to statutory guidance issued by Ministers on social and environmental objectives relevant to their sectors, while leaving economic regulation to the regulators acting at arm's length from Government.

The Government is legislating (through the Utilities Bill) to implement these conclusions for the electricity and gas industries. Arrangements for taking these conclusions forward for the telecoms industry will be set out in a Communications White Paper (due to be published later this year) and for the water industry in a Water Bill (due to be published in draft also later this year).

Early Performance Of The Private Finance Initiative

Progress in the PFI in the early years was relatively slow. It became clear that many of the advantages that PFI was expected to have over traditional public sector procurement were not materialising. There were five main reasons for this: a requirement for universal testing of the suitability of PFI for all new capital investment, which overstretched resources in both public and private sectors, and meant that not enough attention was paid to the organisational issues that needed to be resolved if a timely flow of sound projects was to be achieved; inadequate project management skills for such a complex procurement process in the public sector; public sector clients had insufficient commercial knowledge and experience, in many instances even to select suitably qualified advisers; often inflexible input specifications reduced the scope for delivering better value for money through (for example) innovation and greater synergy between the design and operation of assets; and investment projects were poorly prioritised, which was illustrated most dramatically with the culling of hospital schemes in 1997.

Bibliography

Quiggin, J. (1996), 'Private sector involvement in infrastructure projects', Australian Economic Review, 1st quarter, 51-64.

Spackman, M. (2002), 'Public-private partnerships: lessons from the British approach', Economic systems, 26(3), 283-301.

Strauch, L. (2009), 'Public Private Partnership in European Road Infrastructure: PPP as Investment Asset Following the M6 Road Project in Hungary',VDM.

Monbiot, G. (2000), 'Captive state, The Corporate Takeover of Britain', Macmillan.

Marian Moszoro, Optimal Capital structure of Public-Private Partnerships, National-Louis University; IEsE Business school, 12-2007



Please be aware that the free essay that you were just reading was not written by us. This essay, and all of the others available to view on the website, were provided to us by students in exchange for services that we offer. This relationship helps our students to get an even better deal while also contributing to the biggest free essay resource in the UK!