PFI in Perspective
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articletechnical PFI in Perspective
INTRODUCTION
The Private Finance Initiative (PFI) has developed to provide an
alternative route for public sector clients to procure buildings,
infrastructure and associated support services. Evelyn McDowell
sets out the principals of PFI, examines the key stages in the
procurement process and provides insight to the role of parties
involved.
The Private Finance Initiative (PFI) first became established in the
health sector for the procurement of new hospitals, and intransport to finance road improvement programmes. Its application
in other market sectors has been slower. The Treasury Task Force
(TTF) has begun to co-ordinate the development of the
procurement route in the UK, in an attempt to reduce the cost to
Clients and Bidders of the procurement process and to reduce the
time taken to reach financial close on contracts. Although PFI has
specific relevance to public sector bodies and the facilities
management supply industry, the principals are also of interest to
private sector facilities managers.
TYPES OF PFI PROJECTThe principals of PFI have been applied to many types of project,
such as hospitals, courts and central government buildings. In
financial terms, PFIs vary from being financially free-standing to
joint ventures between public and private sectors.
While PFI schemes were originally developed to fund new
buildings, they have also been applied to projects with greater
emphasis on refurbishment, and to portfolio PFIs including several
(often smaller) buildings of a similar type or for one client body.
Examples include the UK-wide portfolio of the Department of Social
Security (DSS) (750 properties) and a number of schools projects
including Stoke Schools (120 schools) and Glasgow Schools (29
schools).
Multiple locations are also no barrier to the application of PFI
principles the DSS project (known as Prime) includes benefit
offices in the majority of UK towns and cities.
One other application of interest to facilities managers is in smaller
projects for a single service requiring capital investment, such as
combined heat and power projects where an energy provider will
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take on the risks of consumption and pricing in return for long-
term payment streams from the client.
Security issues no longer prevent private sector involvement in the
procurement of sensitive government projects. For example, thenew GCHQ headquarters building is adopting PFI as the
procurement route.
Characteristics of PFI
There are a number of characteristics distinguishing PFI from
Traditional Procurement routes:
Service Focus the main difference is in the change fromregarding buildings and infrastructure as assets to considering
them as services offered by the private sector.
Ownership the buildings are typically owned by the privatesector (or leased for the period of the contract) and leased
back to the public sector client as part of a monthly charge foruse of the building and related services (cleaning,
maintenance, security, for example).
Performance the service provider delivers services on thebasis of an output specification and is paid according to the
extent to which the service is delivered (referred to as
availability) and how well the clients performance standards
are met.
Innovation the service provider has the flexibility to meet therequirements of the output specification by adopting its own
approach. There is greater emphasis on the management
ability of the service provider. Innovative methodologies to
meet service requirements are sought to optimise the value for
money derived from the project. The client also seeks to
exploit the private sectors more highly developed commercial
skills in delivering public service needs.
Risk transfer the PFI route is complex because of therequirement for the public sector client to transfer risk to the
private sector through the terms of the contract. The
determining factor with risk transfer is that the organisation
best placed to manage the risk should be responsible for it.
Typical risks to be transferred to the private sector are
summarised in Table 1.
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Table 1: Typical risks transferred to the private sector
Risk Examples
Design andConstruction
Risk of changes in interest rates,inflation.
Operation Service provider must accommodatereplacement and upgrade of assets tomeet modern standards (imposed bytechnological advances or statutoryrequirements).
Demand Service provider takes the risk for thepatronage of services to generate
income.
Technology /
Obsolescence
Facilities not being available to users
during the contract period. Standardof accommodation not meeting thespecification. Quality of servicessupplied below specified standards.
Financial Cost increases from variations to thedesign of the building. Buildability affecting cost and time scale forbuilding delivery. Use of new productsand systems. Longevity of buildingelements and components.
It should be noted that some risks are shared or capped so the
deal remains affordable to the client and fundable by banks andother financial institutions. A balance should be sought between
incentivising the service provider to perform and the cost of
including the risk in the contract price.
The risks to be transferred not only affect the initial provision of
assets and services, but also continue to affect payment streams
throughout the contract period. The Treasury Task Force is
currently working on outline terms and conditions to concentrate
efforts in any PFI on the particular issues pertinent to that
contract, not generic contractual issues.
OVERVIEW OF THE PFI PROCESSThe Process is dynamic in nature, particularly on large PFI projects
where the issues are complex and there are many alternative
approaches to meet the specification requirements. The output
specification is subject to discussion and negotiation with bidders
to optimise the scope and cost of the project.
Early PFI projects relied on an initial competition between a
number of tenderers before choosing a preferred bidder. The most
recent projects have introduced a further period of completion
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the Best and Final Offers stage (BAFO) to maintain an element of
competition in the final negotiation stages before the preferred
bidder is announced.
ROLES IN THE PROCUREMENT PROCESS
Establishing the client team
During the early stages of the process, the client may rely on
internal advisers are often used in PFI projects to supplement the
skills and knowledge of in-house personnel. This may be because
the client has not tackled a project on such a scale before or
because existing staff are fully deployed on other projects. The
time scales involved may require additional resources to meet
deadlines.
The skills required represent three categories financial, legal and
technical. The technical team includes traditional construction-related specialisms and facilities management disciplines. The
process of appointing external consultants will be dependent on the
public sector procurement procedures appropriate to the market
sector. Clients traditionally appoint advisers independently, but a
turnkey appointment may also be used as consultants gain
experience of working effectively with each other and clients gain
confidence in using external advisers to support the process.
The bidders team
A bidding team typically consists of representatives from several
organisations to meet the scope of the project. The structure of a
consortium varies depending on the type of project and depending
on the project funders. A common characteristic of PFI projects is
that members of the bidding consortia also play key roles as they
will be responsible for underwriting the performance of the service
over the contract period.
Service provider team
Once a contract has been signed a special purpose company is
established to run the contract. It will have its own administration
functions and will be governed by a management board (with
representation from consortium members and funders). The
management structure of the service provider will change over the
duration of a project.
While the structure for the construction phase of a contract may berepresentative of traditional procurement, the operational phase
will reflect typical facilities management contract structures.
In portfolio PFI projects, a regional model may be adopted where
regional contracts are established for each function, such as
maintenance, cleaning and security. National contracts are only
adopted where demonstrable value for money can be justified.
Regional contracts have the advantage of providing opportunities
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for managers to benchmark costs and quality between regions and
manage the risk of poorly performing suppliers.
Determining the feasibility of PFI
The choice of PFI as the most appropriate route for procurement isgoverned by Treasury rules for developing an outline business
case. The client has to support an application for funding with
appropriate feasibility studies and, in addition, has to demonstrate
that significant benefit would be derived from this type of contract
over any alternatives. This includes cost savings, but is principally
governed by the benefits of transferring inherent risks to the
private sector. In considering the PFI as a procurement route over
and above the technical merits of investing in new buildings or
replacing existing assets, clients should examine the following
questions:
Does the scope of the project attract sufficient private sectorinterest to deliver the service over a long time scale?
Does the package of services represent value-for-moneyagainst existing service delivery arrangements?
Does the scope between the parties involved in design,construction and management issues?
Does the project generate the potential for income streamsthat could not be established by the private sector without
significant investment?
Does the project effectively transfer risk to the private sector?The service focus of PFI and the emphasis on outputs differentiates
the process from traditional procurement.
Development of PFI
PFI is still at an early stage in its evolution as an established
procurement route, but the potential advantages for public sector
clients, in terms of greater guarantees for consistency and quality
of public services, will continue to perpetuate its development.
Both parties will have to continue examining the procurement
process, the nature of the negotiations and the relationships
formed to enable clients and service providers to ensure
sustainable performance over long contracts. Both for individual
projects and for the procurement route in general, therefore,
continued commitment from the client is essential in driving the
process forward to a successful conclusion.
References: PFI in perspective, Evelyn McDoswall,Facilities Management, February 1999, P/8-9.
Copyright: Evelyn McDowall
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