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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PFI in Perspective

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