Pros and cons of PPPs models

Published Date: 23 Mar 2015 Last Modified: 18 May 2017

Introduction to Public Private Partnership

Public private partnership is a cooperative venture between the public and private sector in which the public and privates sector carry out a particular project on the basis of agreed task and risks, each party retaining its tasks and responsibility. The interest in PPPs is growing day by day because it is an efficient way of delivering the public services to the masses. The rudimentary principal behind public private partnership is that, Although Public sector entities may need to be responsible for the delivery of public services, but it is not necessary that it must be actually responsible for providing or undertaking the investment themselves. In this way all actors in public private partnership can concentrate on doing what they are likely to do in the best possible way by utilizing their resources and skills. In order to under take any public private partnership for a particular venture we have different modes or model for PPPs, Which are described briefly as under.

A brief overview of Prominent Models of PPPs

Operation and management contracts

In these agreements the responsibility for asset operation and management is passed on to the private sector entities. The duration for these contracts is generally short ranging from 3 to 5 years, but can normally be extended. The private party is remunerated on a fixed fee basis or on an Incentive basis with premiums linked to specific performance targets. Under this agreement the public party still bears the financial and investment risk associated with the projects. This type of contract is an efficient way to undertake a project because the private sector has enough skills and have strong interest in improving the service quality. This model of PPPs contract is suited for transaction phases which finally lead to privatization.

Potential strengths of management

The profound advantage of management contract is that many operational benefits that result from private sector can be availed without transferring the assets to the private party. Management contract are less thorny to develop as compared to others and are considered less controversial. Theses contracts are also less expensive as compared to others because fewer but efficient staff can be used to carryout the task. They can also be seen as interim arrangements, allowing for modest improvements while more comprehensive contracts and structures are developed. Similarly, a management contract can be structured to phase-in increasingly extensive involvement of the private sector over time and as progress is demonstrated.

Potential weaknesses

Despite of the aforesaid advantages of management contract it also embodies some drawbacks one of the key disadvantage of this contract is that in this contract the private sector entity who is managing a particular project does not enjoy the autonomy. This is important to achieve deep and lasting change also the division between the obligation for service and management, on one hand, and financing and expansion planning, on the other, is a tricky one.

Service contracts

It is a limited type of PPPs model in this agreement the Private party procure, operate an assets for a short span of time mostly for 2 to 5 years. In this contract the public sector is responsible for investment and management of the project which bears the financial and residual value risks. While the public sector entity provide the services. It is suited for simple and operational requirments.it is often used for toll collections.

Potential strengths of Service Contract

This contract is best suitable when the services are clearly defined in the agreement, the demand is reasonably certain and the performance of the project can easily be monitored. One of the the gigantic advantage of service contract is that it provides us relatively low-risk option for the expansion of private sector which in return brings efficiency in the system operation. It is a less expensive way to delivery the public services and due to low barrier to competition it encourage competition which in return enhance the public service delivery and it is also a good source of technology transfer and for the development of managerial capacity. The other prominent advantages include

• Decrease in operation cost
• Access to cheaper labor
• Cut up in labor training cost
• Access to advance technology at minimum cost
• Enhance service delivery

Potential weaknesses

Service contracts are used for simple and short term project in this the private sector only provide their services not the capital investment. But this contract is not suitable for such situation in which the objective is to pool up capital. An other important drawback of this contract is that of loss of managerial control because it is much difficult to manage the outside service provider as compared to own employees. Also other draw backs include the loss of flexibility in reacting to changing the business condition, lake of internal and external focus, loss of competitive edge, problem in contract renewal and contractual misunderstanding. In this it is difficult to calculate the hidden cost associated with the contract like legal cost and the time require to put the contract into action.

Leasing agreements

It is a financial arrangement in which the owner of a facility sells it to another entity, and subsequently leases it back from the new owner. In this contract both public and private sectors entities may enter into sale/leaseback arrangements for a variety of reasons. An innovative application of the sale/leaseback technique is the sale of a public facility to a public or private holding company for the purposes of limiting governmental liability under certain statues. Under this arrangement, the government that sold the facility leases it back and continues to operate it. Under this agreement the private party better off only if it manages to reduce operating costs while meeting the designated service level. On the other hand the public sector bears the risks associated with the network expansion, capital improvement and financing. Its life ranges from 12 to 16 years, this type of agreement is best suited for infrastructure. Other prominent leasing contract include

• Buy-build-operate (BBO)
• Lease-develop-operate (LDO)
• Wrap-around addition (WAA)

Potential strengths

One of the main advantage of this contract is that it brings efficiency in the public service delivery .Also in this contract the commercial risk is borne by the private sector which give a strong performance incentive and which coax the private sector to perform well. Under this contract the private sector competitively bid for providing the services which in return enhance the delivery of public services.

Potential weaknesses

As we know that in lease agreement the contractor revenue is based on the revenue stream of the customers' payments so in such situation the question of tariff levels is of sensitive nature which can lead to possible conflict between the public and private parties. Also under this agreement the responsibility of capital investment is of public sector and the financial risk is borne by the public sector so in this contract no capital is mobilized from the private sector entity and also labour issues are of more sensitive nature as compared to other PPPs contracts.

Concession Contract

It is a type of leasing contract in which the ownership remain with the government while the private party not only provide capital investment but also responsible for the maintenance of the assets. After the completion of the project the government pays the agreed sum of money to the private party and gets the assets. It is suited for the construction and its life is from 15 to 30 years.

Potential strengths of concession contract

One of key advantage of Concessions is that it helps to mobilize capital from private sector for the construction or rehabilitation of existing projects. As we know that under this agreement the private sector also contribute capital for the project so it coax the private sector (concessionaire) to bring efficiency and effectiveness in order to increase his return in the project. It also encourages the private party to bring innovation in the delivery of public services.

Potential weaknesses

One of the major drawback of this contract is that the complexity of defining the activities of private sector entity. One of the major disadvantage of this contract rises in case of long-term projects i.e. more than 25 years because this complicate the bidding process and the contract design which hinder in anticipating the events of the project. Also due to its long term tenure it is deemed politically controversial and difficult to organize. Another drawback of this contract is that it limit the competition because of limited number of qualified contractors are available.

Green field Contracts

This type of agreement is mostly used for the development of new projects. Such projects are often demanded by engineers. Examples of Greenfield projects are new factories, power plants or airports which are built from scratch. Those facilities which are modified/ upgraded are called Brownfield projects.

Build-Operate-Transfer (BOT)

In this the private party is responsible for designing, construction and operation of the assets. In this public party bears the financial risks but it has control on important phases of the life cycle of the project. This type of contract bring efficiency in the projects and removes the important maintenance issues from public budget This integrated scheme obliges the private operator to take into account the cost of operating the asset during the design and operation phase and therefore stimulates a better planning and management of the service itself It include the following types

• Build-own-operate-transfer (BOOT)
• Build-rent-own-transfer (BROT)
• Build-transfer-operate (BTO)
• Build-lease-operate-transfer (BLOT)

Potential strengths

As we know that BOTs have been mostly used to attract private funding to the construction or renovation of infrastructure. Hence one of the key advantage of BOT agreements is that it reduces commercial risk for the private partner because there is often only one customer, i.e. public sector (government) .The following are some of the major advantages of BOT contract

• Due to the efficiency of private sector the public services can be delivered with minimum cost
• As the private sector directly involved in this so it reduces the public debit, balancing the beget deficit and reduce the role of public sector.
• It also facility the transfer of advance technology by intruding international contractors in the host country.

Potential weaknesses

The following are some of the major disadvantages of BOT contract

• The transaction cost in this case is higher as compared to other contracts
• Not suitable for small projects.
• The success of this project depends upon the successful raising of funds.
• BOT projects are successful only when substantial revenues are generated during the operation phase.

A CASE STUDY

This case study is one of the best example of public private partnership (service contract) which is contributing to the overall economic development of Pakistan.

Faisalabad Industrial Estate Development and Management Company (FIEDMC)

This is one of the classical of PPP (service contract) .In this contract the government of Punjab provided funds and the private sector were assigned the task to develop two industrial estates at Faisalabad by contributing there services on voluntary basis. This company constitutes of 21 members in its board 5 from public and 16 from private sector. Under this agreement the private sector will contribute their expertise to develop a world standard industrial estate in order to use the public money in a fruitful way. The following two prominent projects were undertaken under this agreement.

Value Addition City.

This industrial city was basically established in order to address the need for SMEs and to provide land on small scale to the industrialist. This estate consists of 200 acres land .where all utilities and facilities to the industrialist and a great emphasis is given to the security, further more The VAC offers facilities like a state of the art road network, electricification, natural gas, optic fiber telecommunication network, hospital, commercial area and extensive landscaping for environmental friendly atmosphere.

M-3 Industrial city (M-31C)

This is a larger project as compared to value added city with a vast area of 4500 acres. This industrial city is catering for the needs of all business sectors both industrial and services It entails the fulfillment the needs and wants of the prospective investors. This industrial city provides the important facilities according to world standards including, state of the art telecommunication system, transport facilities and labor colonies to the labor. This industrial city constitute of all kinds of textile industries, high quality chemical units, engineering including automobile and agricultural machinery firms and construction material firms. It will also cater the needs of pharmaceutical companies and food processing units. Other industries include IT equipment manufacture and software industry, electrical devices, electronics and other value added products.

This is one of the classical example of PPP models in which the private party provides their services in the shape of their expertise to boost industries in Pakistan and it will boost the Pakistani economy.

A Failure of PP Project (Metronet UK)

The London underground rail system is the world first underground system which was established in 1863 and up to early twenty century it was operated by six private operators. But due to their substandard services its activities was directly or indirectly classified by the UK authorities by 1933.

In February 2002 it was decided to bring improvement in the public service delivery by entering into a PFI contract with the private sector .Under this arrangement it was decided that maintenance and renewal of London underground infrastructure would be incorporated through three PPP contracts

Under this agreement the Responsibility for stations, train operations, signaling and safety remained in the Public sector, being run by London Underground Limited, a new operating company set up for the purpose. It also had responsibility for determining service patterns and setting fares. Under this PPP project there were three private sectors companies which were called infracos namely

• Infraco BCV Bakerloo, Central, Victoria, Waterloo & City.
• Infraco JNP Jubilee, Northern, Piccadilly.
• Infraco SSL Circle, District, East London, Hammersmith & City, Metropolitan.

To improve the Services and to ensure long-term assets management a 30 year contract was signed which is divided into 7.5 year segment. In this arrangement an Arbiter was also appointed whose role was to resolve the disputes between the London Under Ground Limited and an infaco regarding the payment and other issues.

On December 31 2002 Tube Line acquired Infraco JNP and on April 2003 Metronet acquired the other two infracos.The PPP contract give legal ownership of London Underground infrastructure during the term of the contracting In July 2007 the work of modernization of London Underground Infrastructure was entrusted to Metronet BCV and Metronet SSL.and the fund was provided by the Government under PPP.

But Metronet was unable to complete their task in the agreed time and estimated cost of bid. By March 2005 Metronet had not completed any of the eight stations due. Only 11 out of 35 stations were accepted as delivered by March and finally the London Underground Limited purchased 95% of Metrone's outstaniding debt obligations from its private sector lenders in February 2008 rather than repaying this debt over the 30 years of the contract. The Department for Transport (DfT) made £1.7 billion of grant available to help London Underground do so.

Causes of Failure of this Debacle of PPP

The following are some of the main reason for the debacle of this PPP contract.

• Poor Corporate Governance and Leadership structure of Metronet and tied Supply chain management
• Supplier was failed to give timely information to Metronet management about the costs against delivery.
• Ambiguities in the scope of the project and poor program management.
• Also it was found that it was unable to execute the the operation in the best possible way and lake of efficiencies in business administration activities.

Conclusions

From the aforesaid discussion on various prominent types of PPPs models we conclude that It is not always fruitful to enter to a PPP agreement .So the government should not enter into such contract without accurate and comprehensive assessment of the risk transferred to the private sector and a firm idea that what would constitute an appropriate price for taking such level of risk. If it does not transfer an appropriate level of risk to the private sector then it should not be availed. PPPs can be very helpful for the public service delivery if the underlying drawbacks are minimized and to minimize the risk associated with these models we must apply each model according to the type of problem we are solving. For instance if we need for Capital then BOT/BOO/Divestiture can be used. In case if we need for Expertise and Performance then Management Contract can be the best option. But if we need for Expertise only then Service Contract is the best option. Or if we are facing a complex problem which can not be solved with one model then a combination of these models can be used.

References

• www.ncppp.org/howpart/ppptypes.shtml
• Article by By Brig.Ahmad Riaz Siddiqi (Retd), X-Chief operating officer FIEDMC (Dawn Saturday, December 20, 2008)
• PUBLIC - PRIVATE PARTNERSHIPS Models and Trends in the European Union Authors: Andrea RENDA (Senior Research Fellow, CEPS) and Lorna SCHREFLER (Research Assistant, CEPS)
• India time.com http://www.cyfuture.com/disadvantages-of-outsourcing.htm
• http://www.investorwords.com
• The failure of Metronet REPORT BY THE COMPTROLLER AND AUDITOR GENERAL | HC 512 Session 2008-2009 5 June 2009 Department Of Management Sciences Ciit Islamabad