UK PPP is about to head off in a wholly new direction. Since May, the Coalition Government has signalled its intention through a range of initiatives, many of which feature radical new ways of thinking and, above all, a plan to “reconfigure” Government and public services to improve services and drive maximum savings.

In this Bulletin, we attempt to pull the strands together, put it all in context and give you an insight into what PPP might look like over the next fi ve years. The actual level of spending (or cuts) in each sector will only become certain following the outcome of the Comprehensive Spending Review due to be published in October. We can, however, say one thing for certain – PPP will change radically from now on.

Background – PFI

Recent articles in the press are a reminder that, in certain circles, PFI remains controversial. Arguments continue, despite the overwhelming evidence of success from more than 700 new capital public works projects, completed on time and on budget. The primary driver behind PFI was to find a way to replace (or refurbish) crumbling public buildings and infrastructure without increasing tax or the public borrowing requirement. By attracting new capital to fund public assets, the Government was able to start a wave of construction projects to replace many hospitals, schools, colleges, courts, prisons, fi re stations, roads and bridges, right across the UK.

Historically, the public sector had found difficulty in managing sinking funds required for the proper long-term care of fixed assets. PFI, therefore, transferred this risk to the private sector through long-term contracts, which (assuming contracts are not renegotiated) will ensure that the previous gradual decay and neglect of public buildings will be a thing of the past.

PFI projects by their nature tend to be complicated. Each project will involve the design, build, funding and long-term operation of high-profile public facilities which have to be fit for purpose. Before private sector funding can be secured, the lenders have to be highly confident that the project will be a success. Contractual negotiations involve dozens of parties from the public and private sector, each with their own legal and technical advisors, all of whom have to be satisfied that they understand their respective role, risk and reward in the project from start to finish.

PFI has been a huge success. Despite serious construction risks and billions of pounds spent, virtually no PFI projects have incurred material delay or cost overrun. Without PFI (or its equivalent) it is impossible to see how so much capital expenditure could have been made in public assets without industrial action, delay and cost overrun (all of which featured on the London Underground Jubilee line extension, procured on behalf of taxpayers without using a PFI structure).

The PFI mantra

PFI involved a lot of new ideas but was developed using wellestablished project fi nance concepts and documentation. The guiding light to success of these projects was a mantra which forms part of the DNA of PFI, namely that each risk in the project should be borne by the party best able to manage such risk. This mantra facilitated optimum pricing and management of risk which, in turn, meant very few projects going off the rails.

Whilst PFI undoubtedly met the need for private investment in public assets, it remains controversial primarily because of the host of questions it left unanswered. For example, was PFI value for money over the lifetime of the project? Does the private sector really provide services better than the public sector and, if so, why? Should public assets be owned by private investors? Should services be privatised? How should public services be reformed? Why were the legal and professional fees so high? Do the contracts have to be so infl exible and complicated?

These questions have been around for many years without any real consensus being formed. Citizens and civil servants have enjoyed the use of the new PFI assets whilst the unions have remained implacably opposed. The Labour Government carried on the PFI initiative with gusto and, through the panacea of more “investment” in public services, managed to avoid having to answer these tricky questions, leaving public services largely unreformed.

New PPP under the Coalition

The credit crunch and state of public fi nances has brought matters to a head and may force politicians to fi nally address the questions left unanswered by PFI. The Cabinet Offi ce, led by Francis Maude MP, has been talking about a “reconfiguration of public services”, which inevitably will herald a whole scale shake-up of the PPP market. What will PPP look like over the next fi ve to ten years, and what mantra will be developed to guide those deals? For reasons set out below, whereas in the past the focus was on allocation of risk, for future projects, we believe the focus will shift from the allocation of risk to the allocation of power.

Looking ahead, the PPP market will be shaped by various themes being developed by David Cameron and the new Coalition Government. The full picture will become clearer following publication of the Comprehensive Spending Review in October, but several clear themes are emerging, all of which include the transfer or sharing of power in some shape or form. These include:

  • Welfare reform
  • Shared services
  • Mutualism
  • Localism and the Big Society

PPPs will evolve to reflect yet more sophisticated relationships between the public and private sector. These will build on ideas and concepts developed by the pathfinder strategic joint venture PPP partnerships in the local government sector, such as IBM’s project with Essex County Council and Serco’s joint venture with Glasgow City Council. Such partnerships may become even more complex with the anticipated expansion of the third sector (social, charity and voluntary sector). Future projects could well be tri-partite – public, private and third sector partnerships, perhaps ushering in a new acronym: PP3P?

In any joint venture, the correct allocation of power is vital. Each party or stakeholder must have a voice, but the arrangement must include the right checks and balances to avoid any one party having too much power. Careful structuring of the deal from the outset will be critical in ensuring the vitality and longevity of the partnership. That said, once the correct balance is struck, it should be possible for the parties to get started without the burden of having to negotiate and record every last detail of a long-term service agreement. Instead, the parties can proceed with the partnership on a limited scale with each new system, service or works being added in sequence based on mutually agreed business cases. The Essex PPP is intended to work in this way.

Welfare reform

One of the first new waves of PPP projects to be procured by the Coalition is the highly publicised “Work Programme” under the Welfare to Work initiative. The Work Programme is billed as “a new approach” to delivering employment-related support services, intended to simplify the complex array of existing employment programmes and deliver one coherent scheme, providing personalised help for people who find themselves out of work. Unlike a PFI project where the assets delivering a return on investment are fi xed, the UK’s asset in this project is its workless population. The Coalition has recognised the urgent need to invest in the future of the UK’s workless demographic, but has also recognised the social and economic benefi ts of doing so.

Providers under the Work Programme will be paid on the basis of outcomes, which may mean the placing of an individual into longterm employment, but it is also open to providers to propose much broader solutions. There is a host of papers and studies which have identifi ed the benefi ts of increasing “social capital” (for example, moving an individual back into employment not only reduces their dependence on the state benefi t system, but also reduces their likely cost to the UK in terms of health or other community needs) so there is a wide range of potential outcomes on which payments could be based. The Programme also serves as a prime example of the way in which other future large-scale PPP projects are likely to be procured, with themes such as:

  • the encouragement of consortia, combining the appropriate mix of public, private, community and third sector companies, allowing a mix of expertise and investment, whilst empowering local entities
  • payment by results, to reduce the need for public investment and incentivise outcomes
  • contracts via a framework arrangements, to reduce procurement costs and allow flexibility.

Shared services

Drawing from the lessons on procurement of shared services under the Total Place pilots, it is likely that the Coalition will be seeking significant economies of scale through joint procurement of goods and services. The public sector’s track record on effective procurement is undoubtedly poor. The National Audit Office report published in May this year (A View of Collaborative Procurement Across the Public Sector) confi rms the worst. There is currently no overall governance of procurement in the public sector and, incredibly, 80% of the public bodies surveyed admitted they did not measure the cost of letting a contract, which makes it no wonder the public procurement process is so protracted.

Clearly, radical reform will be needed before pan-Government procurement can become established. With each Government department being set its own budget and savings target, it’s unlikely that simply telling departments that they should look for joint procurement with other Government departments will have any substantial effect on existing behaviour.

Even if public sector bodies can be incentivised to work together, in local government there is a fundamental legal issue likely to prevent local authorities combining forces without a change in the law. Over recent years, local authorities had started to embrace a more business-like approach having (in particular) been given limited rights to set up trading companies and charge customers for certain services (section 93 Local Government Act 2003). This, combined with the general “well-being” power (section 2(1) of the Local Government Act 2000, which gives local authorities the power to “do anything” that they consider is likely to improve the well-being of their area) meant that local authorities were gradually gaining confi dence that they could become more innovative, team with other authorities and look for new and better ways of doing things.

This trend, however, suffered a major setback when considered in the case of Brent London Borough Council v Risk Management Partners Ltd and others [2009] EWCA Civ 490. The judgment in this case is complicated but, in essence, the Court of Appeal dissected the general well-being power and concluded that it did not extend to cover arrangements that have as their sole object the improvement of the authority’s own fi nancial position. The court held that Brent’s participation in an insurance enterprise, involving the giving of guarantees to a company and assuming what could be substantial liabilities to other local authorities, did not come within the well-being power. It was held that the general power did not extend to a power to enter into the complex and somewhat speculative attempt to save money, which was the principal focus of the arrangement.

As part of the 38,000 word judgment, Lord Justice Moore-Bick states:

“In my view section 2 [the well-being power] gives a local authority power to take steps that have as their object, direct or indirect, some reasonably well-defi ned outcome which it considers will promote or improve the well-being of its area…In my view action to reduce the costs of goods or services purchased by the authority which does not have as its object the use of the money saved for an identifi ed purpose which the authority considers will promote or improve well-being does not, on a natural reading of the words, fall within the section. Moreover, only a year before the 2000 Act was passed, Parliament had imposed on local authorities a duty to secure continuous improvement in the way in which their functions were exercised, a duty which involved obtaining the best value for money and therefore a reduction in the cost of goods or services wherever possible. It is diffi cult to accept that section 2(1) was directed to the same end.”

HM Treasury’s detailed report on Total Place (A Whole Area Approach to Public Services) published in March 2010 (almost a year after the Court of Appeal decision) makes no reference to the major legal spanner created by the Brent case and blithely states that:

“local authorities have certain powers to foster partnership in delivery of services and there is a range of legislation, for example the Duty to Co-operate in the 2007 LGPIH Act, to require certain named public bodies and agencies to work together to deliver particular outcomes”.

The Brent case has led to other authorities reverting to a more cautious approach, as highlighted in the recent decision of Slough Borough Council to pull out of its proposed shared services partnership with Cambridgeshire and Northamptonshire County Councils following legal advice on the impact of the Brent case. The Local Government Association is now pressing for a change in the law and has published a draft bill to give local authorities a power of “general competence” which will hopefully (once passed) fi nally allow local authorities to escape their current tight constraints. The Coalition has recently confi rmed that, as part of the Big Society, initiative (see further below) they will give councils a general power of competence.

Mutualism

The election manifesto for the Conservatives included a fi rm commitment to more employee ownership. It said that public sector workers will be encouraged to form “employee-led co-operatives” and “bid to take over the services they run”. Co-operative members would set working practices and could remove managers who lost workers’ confi dence. Public sector workers “would be able to take ownership of previously state-owned buildings and other assets”.

This goal has been assumed by the Coalition and the fi rst wave of pathfi nder mutuals was announced recently by Minister for the Cabinet Offi ce, Francis Maude. Twelve fl edgling public service spinoffs have been chosen to be pathfi nders. The intention is to allow public sector staff within these Government departments (or Arm’s Length Bodies) to take ownership of the function or service and to radically change the way in which things are done. The pathfi nder projects are to be supported by a number of business mentors, including staff from the John Lewis Partnership.

In terms of a model for employee ownership, there is perhaps no better example than John Lewis. John Lewis plc (which is 100% owned by its 70,000 employee members) turns over in excess of £7bn a year. The partnership was created in the 1940s, when the philanthropic owner John Speden Lewis transferred the business into a trust for the benefi t of the employees. Under its constitution, the partnership puts the happiness of partners at the centre of everything it does. The partnership constitution is interesting as it provides the necessary checks and balances to ensure that the business is run commercially and in an entrepreneurial way whilst at the same time giving staff genuine ownership and a share of power. On a day-today basis the business is run by the Partnership Board (chairman and directors). The Partnership Board has a duty to report the members, who are represented by the Partnership Council (which is elected by the members). The Partnership Council has an important role in deciding how profi ts are spent, and in particular it determines pay, pensions and discount policies for staff. The Partnership Council has the ultimate power of dismissing the chairman if he fails to fulfi l his responsibilities.

Studies show that employee-owned businesses generally outperform non-employee-owned businesses1. Where employees have a stake in the company they work for, they are generally more committed to delivering quality and tend to be more fl exible. Furthermore, employee-owned firms tend to be more resilient during downturns in the economy and have a lower risk of business failure.

The need for alternative business models and wider employee ownership no doubt comes, to some extent, from the banking crisis and concern that companies, driven to deliver shareholder profits year-after-year, fail to have due regard to the long-term sustainability of the business and the interests of the staff and wider community. Interestingly, the average lifespan of limited companies in Europe is just 12.5 years, and even Fortune 500 companies on average last just 40 to 50 years. The business writer and thinker, Arie de Geus (author of The Living Company2), who for many years has written and commented on the inherent weakness and short-termism of companies limited by shares, has stated that whilst there are many reasons companies fail:

“companies die because their managers focus on the economic activity of producing goods and services, and they forget that their organisation’s true nature is that of a community of humans. The legal establishment, business educators, and the financial community all join them in this mistake”.

Key features of successful employee participation include membership of the relevant organisation and some share of power or vote in the management and operation of the business. Interestingly, Arie de Geus states that it is this right to membership and ability to influence (rather than possible financial reward) that really matters:

“….in short, the changes necessary to increase productivity and efficiency from my point of view are not a matter of ownership and monetary remuneration, of targets and of privatisation, but rather a matter of membership instead of ownership, of power and the way it is exercised and limited, and of participation in the process of decision-taking, rather than sub-ordination to the decisions taken elsewhere”.

The Coalition’s encouragement of employee ownership could herald the beginning of a fundamental change in how businesses are organised and managed. It is certainly possible that employee ownership will become a common feature of PPP. Bidders may be expected to include such structures in their proposed solutions. Private companies have of course already been providing employees with employee share schemes but, going forward, it may be that these schemes will need to be replaced by much wider employee involvement in the operation and management of the business. If it is accepted that, as Arie de Geus suggests, mutualism improves productivity and efficiency, this could well become a winning differentiator on future bids.

Localism and the Big Society

The Coalition supports stronger local democracy and a substantial transfer of power from central to local government. They have stated that as part of the Big Society they will “promote the radical devolution of power and greater fi nancial autonomy to local government, including a full review of local government fi nance”.

If the Coalition is looking for precedents from history for such localism, they may want to look at the example provided by the Dutch water boards. These bodies, which were established by the Dutch in the 13th century to manage and operate the water barriers, waterways and water levels in separate regions, continue to exist today as shining examples of how local democracy can work.

Their longevity is testament to the careful balance of power engineered into their constitutions by medieval lawyers, including a general administrative body, an executive board and a chairperson. The general administrative body consists of local stakeholders such as landholders, local companies and, until recently, all local residents. Certain stakeholders (such as environmental organisations) are also given the power to appoint members. The general administrative body elects an executive board from among its members. The Dutch Government appoints the chairperson for a period of six years.

Decisions made by the water boards are literally a matter of life and death and affect the land and interests of many farmers, land owners and residents. Such decisions are best made locally by those most affected, providing a perfect of example of how local democracy can work in practice. The powers of the water boards include the right to raise local tax to meet the capital and operating expenses needed to operate, maintain and develop the water assets and infrastructure.  

We expect localism to become a recurring theme of future PPP, and bidders will need to be alert to the need and opportunities of involving local residents and other stakeholders in their bids. New businesses such as Rocket Sciences3 are springing up, providing a vital link between the public and private sector and ensuring that, where possible, local issues and concerns can be addressed as part of the PPP project.

Conclusion

This Bulletin gives a snapshot of the big shift in Government thinking and the radical change in priorities which is likely to drive the PPP market in completely new directions. We await the outcome of the Comprehensive Spending Review in October with interest and look forward to working in the new world of PPP as it takes shape over the coming year.