Public-private partnerships (P3s) for infrastructure development can greatly boost efficiency and effectiveness—but if they’re not structured appropriately, they can just be a waste of time, or worse, wreak havoc on budgets and even fail miserably.
So says Frank Beckers, a former senior advisor to McKinsey & Co. on infrastructure, energy finance and public-private partnerships, and owner of Symbulos Management Consultancy based in Dubai.
BENEFITS OF P3S
The main benefit of P3s for public entities is efficiency gains through transferring risk to the private sector, as the latter can manage certain risks better than the public sector because companies face much harsher consequences when specific risks emerge, like cost overruns or delays, Beckers says. In the worst-case scenario, they can go bankrupt.
Governments on the other hand seldom face liquidity problems, and the failure of a single project usually does not affect its credit rating, he says. The additional funds are taken from government budgets—i.e. from taxpayers.
“As such, successful private sector players have had to develop superior skills to manage those risks,” Beckers says. “When you unlock these benefits, then you really create value as the private sector will assess, price and bear those risks that it can manage better. It will do so throughout the entire life cycle, reducing the cost of those risks, creating efficiencies and speeding up execution.”
UNDERSTANDING THE RISKS
However, if governments cannot achieve a meaningful risk transfer in a P3, they should not go that route, he says. It won't create benefits but will only cost time and higher transaction costs.
Indeed, optimal risk allocation so often is not achieved for two main reasons.
First, the public and private sectors have a very different understanding of risk due to the differing levels of consequences each face, with the public sector experiencing hardly any real impact. As such, their approach to risk on projects is not as sophisticated. Moreover, some public entities take certain risks because they don't want to pay the risk premium that private sector companies charge if they were to assume the risks.
“It may initially look cheaper because the risk premium goes away, but the risks do not—and we also fail to leverage the private sector's superior capabilities in managing these risks,” Beckers says. “Even if the project may initially be less expensive, this supposed initial saving can come at a high cost if the risks materialize later. It’s usually easier and less expensive to prevent problems than to solve them later.”
To be sure, public entities are becoming more sophisticated in pricing risks from large infrastructure projects, but even then, there is often a tendency to underestimate those costs, he says. That’s because the price isn’t based on their historical track record but rather under ideal circumstances—or what they currently have the budget for.
For example, if a government had an average cost overrun of 20 percent on publicly procured projects over a 10-year period, then it should also apply a risk premium of 20 percent to the projects it’s currently undertaking.
“But that's often not done because they think they can manage projects better than they did before, and they price risks at a lower level than what history tells them,” Beckers says. “But to be fair, the private sector can also get it wrong.”
Sometimes, private sector companies simply overpromise their risk-taking capabilities—particularly regarding market risk—to win the deal, he says. However, if they can't properly manage the risk, their projects will also fail.
Even if the project may initially be less expensive, this supposed initial saving can come at a high cost if the risks materialize later. It’s usually easier and less expensive to prevent problems than to solve them later.
Frank Beckers
Owner, Symbulos Management Consultancy
CHOOSING THE RIGHT MODEL
P3s also often fail because public entities don’t choose the best model of private sector participation for a specific project.
“Rather than assessing a specific project's particular needs and risks and finding the optimal level of private sector participation for this project, public entities tend to shortcut and copy-paste existing solutions from other countries or sectors,” Beckers says. “This lack of flexibility in assessing the available models leads to an overly rigid focus on existing P3 models and often to suboptimal results.”
The advisors and public authorities who design these models must move beyond established templates, critically assess all available models and always question the status quo, he says. They must adapt P3 models as markets change due to technological advancements and regulatory changes.
“But due to time pressure, that often isn't done,” Beckers says. “Public entities sometimes forgo these analyses to get to results very quickly, and they opt for a familiar standardized solution rather than the bespoke solution required for the project.”
Public entities must adequately invest in early-stage preparation of the business case and assessment of risk allocation options, he says. If they try to save money and effort during a project's early structuring phase, this often leads to undermanagement of risk. Later, when risks materialize and problems emerge, advisors are called to the table for solutions—but this can be costly.
Becker recommends that public entities analyze all procurement model options to overcome these obstacles. They can consider what's available in the market, but they should also correctly assess all the available options.
This starts with defining clear objectives for the procurement, including resolving any conflicting objectives, he says. For example, the more risk the public sector wants to transfer to the private sector, the higher the risk premium and the longer the execution time. Public entities need to clearly prioritize specific objectives over others to resolve such conflicts effectively.
“When you then start assessing the potential P3 models against these objectives, I recommend segmenting procurement models for large projects comprising multiple asset classes like rail or port projects,” Beckers says. “Different private sector participation models may be best suited for different asset classes.”
Public entities can also consider phasing the private sector involvement, he says. Projects with varying risk profiles over their lifecycle may benefit from different P3 solutions at various stages.
“If the options analysis results in an optimal structure that is new and relatively unprecedented, I recommend public authorities get some feedback from selected market participants before they start any procurement law-regulated tender process,” Beckers says.
Headshot courtesy of Frank Beckers.
Header image credit: SUSHIMAN/BIGSTOCKPHOTO.COM
