There was a flurry of news reporting on PFI back in September, when the House of Commons spending watchdog the Public Accounts Committee (PAC) issued the report HM Treasury: Making Changes in Operational PFI Projects criticising operational projects. Headlines grabbed our attention: ‘MPs attacks PFI’, ‘PFI projects are not well managed’ and ‘MPs slam under resourced PFI Projects’. Are things really this bad? Because if so perhaps we should be worried with 790 PFI projects in place (worth over £54bn) and 500 projects fully operational. Well, the answer is probably more no than yes. Criticisms that have dogged the procurement phase of PFI projects over the last few years continue to be raised and addressed. In addition, there is still the instinctive belief held by some that a bit like the gunslingers competing to find a fortune in buried Confederate gold, the private sector competes to get a licence to print money at the expense of the British Treasury. The plain fact is, however, that without private sector investment many, if not most, PFI projects would never happen.
The difference now is that a large number of projects are operational, shifting the discussion to scrutiny of this phase. Consequently, Treasury has set up the Operational Task Force to support and monitor operational projects. The common themes that unit the critiques of the different phases are difficulties caused by change to specifications (either before contract signature or thereafter), avoidable delays by the procuring authority, and a lack of competition. In 2007, the PAC announced that a third of projects in the last year had only attracted two viable bids. It reports now that less than a third of major changes on PFI’s are put to competitive tender.
Government has been trying to incentivise the market by reinforcing its long-term commitment to PFI, promoting LIFT and BSF programmes, introducing incentives for market participation through diversified funding options and the batching of projects in part to decrease procurement/bidding costs. Accordingly, the debate is now about where improvements and future developments in the operational phase may lie. The PAC identified three main areas:
- the management of changes
- the failure to put major changes (costing over £100,000) out to competitive tender;
- the high management fees charged by some project management companies.
The management of changes
This issue probably represents the primary tension in the operational phase. This is due to the fact that the contract is a long-term arrangement spanning 25 years or more. It has to include detailed specifications governing the requirements of the procuring authority, which have to provide for the assets and services to change over time.
Looking into the future and working out what public services may be required can be very difficult. Take, for example, a highly specialised project such as the construction and operation of new health care facilities. Now imagine you were designing and planning it 30 years ago, you might have heard of MRI scanners, but you hadn’t seen one, HIV had not been discovered and there was no such thing as the ‘Patient Choice’ Charter. It’s no surprise therefore that most contracts are changed once services become operational or that some changes are fundamental. The PAC’s criticism is that there are large variations in the level of resources devoted to the management of change. It recognises that there needs to be some flexibility; small projects might not need a full time contract manager, but evidence quoted from a survey by the NAO indicates that as much as 15 per cent of PFI contracts are not being managed on a full time basis and a third of PFI hospitals do not have contract managers. The result is change is poorly managed. The watchdog concludes that to ensure the operational stage of a PFI project is a success the public sector has to ensure adequate staffing capability, with the right level of skill and flexibility, to meet changes in workloads, for example, at the time of a large contract change.
Failure to put major changes out to competitive tender
In 2007, the PAC announced that a third of projects in 2006 had only attracted two viable bids. Accordingly, government has been trying to incentivise competition by reinforcing its long-term commitment to PFI, promoting LIFT and BSF programmes, introducing incentives for market participation through diversified funding options and the batching of projects to decrease procurement/bidding costs.
The PAC now report that major changes costing £100,000 or more account for 90 per cent of the overall cost of changes to operational projects, but only 29 per cent are competitively tendered for. The PAC’s view is that at least another third might be suitable for competitive tendering. The work is in fact going to the incumbent contractors often on poorly negotiated terms, creating a paradox since competition and VFM is at the heart of PFI.
The watchdog suggests that alternative bidders should compete to undertake change related work wherever possible. Recognising that some work will always be undertaken by the company already in place, the report states that all PFI contracts should include provision for additional work to be undertaken on a VFM basis, by reference to benchmarking provisions or agreed rates for changes. Presumably, this will require some parties to amend their existing contracts to comply with this recommendation some parties will be keener to do this than others. Rates can also only be agreed in relation to anticipated changes, doubtlessly not all will be forecast and the parties will still be required to negotiate terms. The expertise and skill of the public sector staff conducting any negotiations will be key to achieving VFM.
High management fees
The report states that there is a growing phenomenon amongst project management companies to charge a management fee for the processing of change requests, often on quite spurious grounds. The fee can range from 2 per cent to as much as a massive 25 per cent of the value of the changes. The PAC states there should be no need for management fees for individual changes unless they are particularly complex.
Treasury guidance Standardisation of PFI Contracts, published in March 2007 (SOP4) recommended that the scope of duties agreed for the day-to-day management of the project paid for out of the unitary payment should include the proper remuneration of project management companies for providing an effective change management service. SOP4 recommends that management fees should therefore be removed from existing contracts, but the legal basis for doing this is not clear.
The report concludes that resolution of each of these issues is key to the government achieving VFM on operational projects. It’s clear that there is already a great deal of knowledge and guidance in place to enable this. The apparent tension between allowing each procuring authority to decide how to deal with operational issues and promoting VFM by non-mandatory guidance will, however, have to be kept under review. For the moment, it’s too early to assess how much impact SOP4 has had. There is little data for example on whether it has assisted in reducing or eliminating management fees. It may be exactly that sort of information which in the future determines whether operational projects require further regulation.
It is also clear that achieving VFM is going to be dependent on government continuing to incentivise competition. Growing international PFI markets are attracting participants from the UK and the credit crunch is likely to fuel that. The private sector has to remain confident in the future of the market if it is to remain committed to it and to providing a good service to the projects they already manage. Effectively managed relationships are going to be crucial to this, along with further innovation from government.