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Abridged version of research report on efficiency of procurement of UK highway PPPs

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Despite being pioneers in PFI/PPPs, UK in the recent years has been exposed to much political criticism regarding the efficiency of PPPs. While the toll-based projects had problems of continuous toll ...

Despite being pioneers in PFI/PPPs, UK in the recent years has been exposed to much political criticism regarding the efficiency of PPPs. While the toll-based projects had problems of continuous toll price escalation, the annuity-based projects (performance-based as in congestion-based, lane availability and active management) lacked assessment of (i) operational efficiencies and (ii) extent of improved value for money. This research used economics and policy based approach to look into the efficiency of tendering process and payment mechanisms. Within consideration of the current issues, it has delivered three introductory models on (i) payment mechanism based on partial subsidy design (ii) restructuring safety elements in RFQ and (iii) cross-sectoral regulatory framework to encourage innovation.

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Abridged version of research report on efficiency of procurement of UK highway PPPs Abridged version of research report on efficiency of procurement of UK highway PPPs Document Transcript

  • RESEARCH REPORT UNIVERSITY COLLEGE LONDON 2010 The Efficiency of Procurement in Transport Infrastructure PPPs – The Case of UK Highways DEVAYAN DEY UNIVERSITY COLLEGE LONDON
  • The Efficiency of Procurement in Transport Infrastructure PPPs – The case of UK Highways by DEVAYAN DEY Bartlett School of Construction Economics and Project Management University College London September 2010
  • ABSTRACT The aim of this report is to appraise the efficiency of procurement in Highway PPPs in the UK, understand the causalities, and suggest possible improvements. This research uses an economics-based theoretical framework aided by current commercial issues to identify ‘implementation gaps’. This is followed by a statistical investigation on operational efficiency to determine the significance of the identified gaps and to what extent do they manifest into inefficiency. The focus of the research has been in investigating two very vital areas in PPP Procurement: tendering process and payment mechanisms. The research identified key areas of weaknesses and recommended possible solution to strengthen them. In the process, it has also put forward three introductory models: • Toll Price Regulation System – A new form of Payment mechanism using concept of partial subsidy. • Point Based System – Proposal for relocating safety elements from payment mechanism to RFQ. • Innovation Enhancement Proposal – A regulatory approach to promote efficiency and innovation. Key Words: Public Private Partnerships, Procurement Economics, Highways, Payment Mechanisms, Tendering, Project Development.
  • CONTENTS Abstract .................................................................................................................................................................. i Contents ................................................................................................................................................................ii List of figures ....................................................................................................................................................... iv List of tables......................................................................................................................................................... iv List of boxes......................................................................................................................................................... iv Disambiguation ..................................................................................................................................................... v List of abbreviations and acronyms ..................................................................................................................... vi 1. Introduction...................................................................................................................................................... 1 1.1. PPPs in Highways – Emergence of DBFOs in the UK ......................................................................... 2 1.2. Research Rationale ................................................................................................................................ 2 1.3. Research Methodology .......................................................................................................................... 3 1.4. Research Outline ................................................................................................................................... 3 1.5. Value of Research.................................................................................................................................. 3 2. Procurement Economics – A Literature Review of PPPs ................................................................................ 4 2.1. Economic Characterization of PPP........................................................................................................ 4 2.2. Theoretical Framework of PPPs ............................................................................................................ 4 2.2.1. Incomplete Contracts and Private Information ......................................................................... 4 2.2.2. Bundling and unbundling .......................................................................................................... 5 2.2.3. Transaction Cost Economics..................................................................................................... 6 2.2.4. Principal Agent Problem ........................................................................................................... 6 2.2.5. Optimum Risk Sharing ............................................................................................................. 7 2.2.6. Whole Life Cycle Costing......................................................................................................... 8 2.3. Description of Highway PPPs ............................................................................................................... 8 2.3.1. Revenues in PPPs:..................................................................................................................... 8 2.3.2. Costs in PPP .............................................................................................................................. 9 2.3.3. Public Benefits ........................................................................................................................11 2.3.4. Cost and Benefit Analysis & VFM Assessment .....................................................................11 2.4. Concluding Remarks ...........................................................................................................................12 3. Procurement through Public Private Partnerships in Highways .................................................................... 14 3.1. Tendering in Highway PPPs ................................................................................................................14 3.1.1. Competitive Dialogue – A Brief .............................................................................................14 3.1.2. UK Highway PPPs - Tendering Process .................................................................................14 3.1.3. Discussion ...............................................................................................................................16 3.2. Payment Mechanisms ..........................................................................................................................17 3.2.1. Congestion Mechanism (Performance Based) ........................................................................17 3.2.2. Lane Availability Mechanism (Performance Based) ..............................................................21 3.2.3. Shadow Toll (Traffic Based)...................................................................................................25 3.2.4. Commentary ............................................................................................................................27 3.2.5. Real tolls and Least Present Value of Revenue ......................................................................28 ii | Bartlett School of Graduate Studies, University College London
  • 3.3. Concluding Remarks ...........................................................................................................................32 4. Operational Assessment ................................................................................................................................. 34 4.1. Safety Performance .............................................................................................................................34 4.2. Innovation and Externality ..................................................................................................................42 4.3. Concluding Remarks ...........................................................................................................................43 5. Conclusions & Recommendations ................................................................................................................. 45 5.1. Research Overview..............................................................................................................................45 5.2. Research Findings ...............................................................................................................................46 5.3. Recommendations ...............................................................................................................................46 References ........................................................................................................................................................... 48 APPENDIX I: Forms of Public Private Partnerships (Source - Deloitte 2006) ................................................... A APPENDIX II – Safety Operational Performance Assessment Data Set ............................................................ B APPENDIX III – Structuring Safety Performance in PPPs: Points Based System ............................................. C APPENDIX IV: Innovation Enhancement Proposal for PPPs – Introductory Concept ...................................... G APPENDIX V: Equivalent Traffic Flow .............................................................................................................. J iii | Bartlett School of Graduate Studies, University College London
  • LIST OF FIGURES Figure 1 Transport Mode share - passenger transport (DfT 2010b) ___________________________________________ 1 Figure 2 Motor Vehicles licenced by Bodytype in the UK between 2000 and 2009 (DfT 2009) ______________________ 1 Figure 3: Monthly Payment (modified from Briggs & Drewett, Seminar at Warsaw, Poland, 2008) ________________ 21 Figure 4: Safety Adjustment (modified from Briggs & Drewett, Seminar at Warsaw, Poland, 2008) ________________ 21 Figure 5: Relation between the toll prices and K (the power of ‘a’) __________________________________________ 30 Figure 6: Box-plot for Cluster discriminating variable (Equivalent Traffic Fow) _______________________________ 35 Figure 7: Year-wise Weighted Accident Rate Comparison__________________________________________________ 36 Figure 8: Pre-transition Scatter based on year ___________________________________________________________ 36 Figure 9: Post-transition Scatter based on year __________________________________________________________ 36 Figure 10: Accident Vs Traffic Volume (Vehicle KM) _____________________________________________________ 36 Figure 11: Accident Vs Traffic Flow (Vehicle) ___________________________________________________________ 36 Figure 12: Cluster1- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) ___________ 38 Figure 13: Cluster1- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) ____________________ 38 Figure 14: Cluster 2- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) __________ 39 Figure 15: Cluster 2- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) ___________________ 40 Figure 16: Cluster 3- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) __________ 40 Figure 17: Cluster 3- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) ___________________ 41 LIST OF TABLES Table 1 List of the DBFOs executed in England. (GB, 2010) ________________________________________________ 2 Table 2: Sensitivity Analysis (Simplistic) _________________________________________________________________ 9 Table 3 Probable cost segments in a Highway PPPs ______________________________________________________ 10 LIST OF BOXES BOX 1: The Framework _____________________________________________________________________________ 13 BOX 2: Competitive Dialogue Procedure _______________________________________________________________ 14 BOX 3: Most Recent Tendering Process in UK Highway DBFO _____________________________________________ 15 BOX 4: Congestion Management Payment (Congestion based Payment Mechanism) ____________________________ 17 BOX 5: Performance Bonus / Performance Adjustment Mechanism (Congestion Based) _________________________ 17 BOX 6: Construction Payment (Congestion based) _______________________________________________________ 19 BOX 7: Safety Adjustment (Congestion based) ___________________________________________________________ 20 BOX 8: Payment Structure (Lane Availability based)______________________________________________________ 22 BOX 9: Condition Adjustment (Lane Availability based) ___________________________________________________ 24 iv | Bartlett School of Graduate Studies, University College London
  • DISAMBIGUATION It is necessary to understand the differences between certain terms used in this report in order to be accurate in interpretation. It is recommended that the reader understands them before proceeding with the report. Value for Money (VFM) and Efficiency: There is a relation, but also a distinct difference between efficiency and value for money. VFM improves only if greater private sector efficiency results in lower costs to the department or higher benefits to the taxpayers or both. That is, even if the contracts successfully incentivize greater efficiency in private sector, it may not lead to value for money unless there is a positive benefit to the public sector or to the public. Funding and Financing: This report uses the words in two separate meanings. Funding refers to the source of revenue to the private sector (either user toll based or annuity based). Financing refers to the way the private sector raises capital to execute the project. Externalities Externality relates to the spillover effect of an activity, action, investment, effort, innovation on the subsequent one, and the cost and benefits. Externality is positive, when the spillover effect leads to improvement in the cost or benefits, and negative when there is deterioration. Quality of service can be specified, Quality of service can be monitored, Quality of service is contractible: Quality of service can be specified only when the client knows what leads to a better service. For example, in an office building the client may know that a temperature of 23 degree centigrade will enhance the efficiency of executives. Here, the quality of service can be specified. On the contrary, monitoring the temperature throughout the whole office may not be possible. It may be higher in certain corners and lower in some. Here, monitoring of the specified quality of service is difficult. Quality of service is contractible only when the quality of service can be specified as well as monitored economically. Proxy Elements: Proxy elements are those parameters that can act as indication of quality of service. In the previous example, temperature is used as a proxy element with a measure of 23 degrees. Sharing of risk and allocation of risk: In this research, these phrases have been used carefully. While allocation refers to complete transfer of a risk out of many identified risks, sharing refers to distribution of a particular risk but with predetermined accountability. v| Bartlett School of Graduate Studies, University College London
  • LIST OF ABBREVIATIONS AND ACRONYMS CapEx : Capital Expenditure COBA : Cost and Benefit Analysis DBFO : Design Build Finance Operate DfT : Department for Transport, United Kingdom GMR : Guaranteed Minimum Revenue HA : Highways Agency, United Kingdom ISOP : Invitation to Submit Outline Proposals ITT : Invitation to Tender LPVR : Least Present Value of Revenue OBS : Observation OGC : Office of Government Commerce, United Kingdom OpEx : Operating Expenditure PBVI : Public Body Validating Innovation PPB : Provisional Preferred Bidder PPP : Public Private Partnerships PQQ : Pre-Qualification Questionnaire TUBA : Transport User Benefit Appraisal VFM : Value for Money WB : World Bank WLCC : Whole Life Cycle Costing vi | Bartlett School of Graduate Studies, University College London
  • 1. Introduction In transport infrastructure, the role of roads is dominant in most of the contemporary economies (WB, 2007; Boarnet and Haughwout, 2000; Banister and Berechman, 2000; Carapetis et. al., 1984). In the UK, DfT (2010a) reports that road transport has been responsible for 84 percent of freight movements within UK. In terms of passenger transport, 70 percent of the average number of trips and 83 percent of the average distance travelled in the UK were on roads (DfT, 2010b). Figure 1 Transport Mode share - passenger transport (DfT 2010b) In addition, there is a steady growth of 2 percent in the number of vehicles licensed each year (DfT 2009), indicating growing traffic. High mode share along with growing traffic indicates that road and highway infrastructure will remain a key investment area in UK’s transport infrastructure. Figure 2 Motor Vehicles licenced by Body type in the UK between 2000 and 2009 (DfT 2009) In the past, investment in roads and highways was undermined quite heavily, especially when the need was even more severe (Clark and Root, 1999). The poor condition of the infrastructure was blamed on the decade long under-investment under the Conservative Government (Rintala, 2004). Added to that was the perception that the public sector had efficiency problems in delivery of the public services. Operation and delivery were plagued with time and cost overruns yielding sub-optimal value for money (VFM) (GB, 1998). Limitations on public expenditures imposed by the Maastricht Treaty and economic recessions only worsened the investment situation (Allen, 2001; Hall, 2009). The search of an integrated solution to these problems led to what we know as Public Private Partnerships (PPPs), more often accepted as Private Finance Initiative (PFI) in the UK. However, in the recent years, many have questioned the effectiveness of PPPs, especially in its capacity of delivering superior VFM (Guardian, 2004; Building, 2008). This report acknowledges the importance of these
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways questions and focuses on improving the procurement framework of UK highway PPPs in delivering better VFM. 1.1. PPPs in Highways – Emergence of DBFOs in the UK While the history of PPPs dates back to 17th century, it has gained popularity in major projects only during the past two decades. Among the various forms of PPPs (see Appendix I), UK highway sector took a form that is more commonly known as Design, Build, Finance & Operate (DBFO). DBFO started as a precursor and transition to motorway tolling, designed to create an operation industry taking a long-term commercial view (HA, 2008). The DBFO concept was included for consultation in “Paying for better Motorways: Issues for Discussion” (May 1993). A preliminary note on the principles applying to DBFO was published in 1994. Table 1 List of the DBFOs executed in England. (GB, 2010) Till date, 12 major DBFO roads have reached financial close in the England (excluding those undertaken under the Scottish Office, Welsh Office and Local Authority Schemes). Highways Agency manages 11 of them, while Transport for London (TfL) manages the A13 Thames Gateway DBFO. 1.2. Research Rationale So far, there have been two separate forms of research in PPPs. While one generates numerous valuable models emerging from economic theories, the other emphasizes on pragmatic aspects like economic / operational efficiencies, governance, financing, etc. Although both are aimed at improving VFM, there is a missing link between these two forms of research that suppresses full potential of PPPs. The vital area of ‘contracts and procurement’ that connects the two realms of theory and practice were left unattended. Contracts are vital, as they are a major route of channelizing the theoretical concepts into practice. Unless properly channelized, PPPs may not deliver the expected. To assess the efficiency of contracts and procurement in PPPs, we need to answer three basic questions: (i) what is the economic framework for highway PPPs? (ii) to what extent do the existing PPPs conform to this framework? and (iii) under the current level of conformance, how efficient are PPPs in delivering results? The answers to these questions will be instrumental in strengthening the procurement framework of PPPs. 2| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways This led to the research aim, which is to appraise the efficiency of procurement of Highway PPPs in the UK, understand the causalities, and suggest possible improvements in the framework. 1.3. Research Methodology In UK Highway DBFOs, there has been a paradigm shift in the contractual framework. Over the years, the payment mechanisms have slowly shifted from demand to performance based i.e. from real and shadow tolling towards mechanisms like congestion and lane availability. Similar magnitude of shift can be noticed in the tendering process as well. Answering the three questions as identified in section 1.2 will help to identify the implementation gaps in the framework in tandem with the shift. The causalities of any identified gap will be used to structure the contract in a more effective way. The research, within its capacity, has put forward solutions to bridge the implementation gap. It is worth mentioning that the solutions in this research have been designed keeping in mind the commercial issues that have surfaced in the recent past. This makes them practical, implementable and result oriented. Thus, the primary methodology adopted in this research is to capture implementation gaps and bridge them by designing solutions that can improve the VFM aspect in highway PPPs. 1.4. Research Outline This thesis is structured into five major sections: (1) Introduction (2) Procurement Economics (3) Procurement through PPPs in Highways (4) Operational Assessment (5) Conclusion and Recommendations. Section 2 reviews the existing literature on the economic theories behind the concept of PPPs. The purpose of this section is to extract necessary theoretical guidelines to appraise the procurement framework. It also introduces the aspect of cost and benefits in PPPs, thereby exploring the commercial issues. Section 3 reviews the conformance of the tendering process in PPPs to the framework developed in Section 2. A similar methodology has been adopted for appraisal of the different payment mechanisms as well. Section 4 looks into the operational efficiency of the PPPs in areas of safety performances and innovation. Section 5 summarizes the entire study and consolidates the findings and recommendations. 1.5. Value of Research This research will strengthen the understanding the procurement and development of highway PPPs using a theoretical yet practical approach. It introduces a novel methodology for improving procurement in a way that can align both public and private sector motives. The framework developed in this research identifies the major considerations for structuring the tendering process and constructing payment mechanisms. Most importantly, it uses performance evidences to triangulate our observations. This research will be of interest to a wide range of individuals like central and local governments and their agencies, consultants, financiers as well as academics. 3| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 2. Procurement Economics – A Literature Review of PPPs There are various arguments as to why governments might undertake PPPs. There is a long history of publicly procured projects being delayed and turning out to be more expensive than budgeted (Flyvbjerg et. al., 2003). Transferring these risks to the private sector under a PPP structure and having it to bear the cost of design and construction overruns is one way in which a PPP can potentially improve VFM in a public project (Blanc-Brude et. al. 2006, NAO 2003; CIC, 2000; HA, 1997). De Palma (2009) points out that on a broader perspective, PPP has the potential to induce private sector skills and efficiency in delivering public projects. These arguments are derived from various theories and models that have been developed in the past 18 years of PPP economics. The purpose of this section is (i) to understand the models and the underlying principles of PPPs specific to tendering and payment mechanisms, (ii) to understand the commercial aspects and (iii) to use these understandings in generating a framework for our research. Throughout this section, the guiding observations used in framework have been put up in box figures and are denoted by the acronym ‘OBS’. 2.1. Economic Characterization of PPP The role of the private sector in public projects is justified only when it adds value, i.e. for PPPs to be economically superior to the traditional public provision. It should not give rise to costs that exceed the associated benefits. Most contemporary studies on economic gains in PPP are based on three basic hypotheses: • PPP can reduce costs without degrading benefits. • PPP can improve benefits without increasing costs. • PPP can do both, i.e. reduce cost and improve benefits. 2.2. Theoretical Framework of PPPs The foundation of this section is based on The Theory of Incomplete Contracts and Private Information. This will be key to introducing some of the very basic concepts and terminologies used in this report. 2.2.1. Incomplete Contracts and Private Information “In principle, a perfectly fashioned complete contract could solve the motivation problem. It would specify precisely what each party is to do in every possible circumstance and arrange the distribution of the realized costs and benefits in each contingency, so that each party find it optimal to abide by the contract’s terms” (Milgrom and Roberts, 1992). However, in practice, not all requisites of a complete contract are satisfied. Bounded Rationality of real people leads to limited foresight of all probable circumstances. In events of unanticipated circumstances, parties must find a way to adapt under profit maximizing tendencies, thereby, introducing the possibility of opportunistic behavior and imperfect commitment. For example, road construction is extremely dependent on the weather conditions. In event of unexpectedly high rainfall during construction, the construction company may have to invest heavily in avoiding time overruns. In absence of clauses in favor of the private sector, the public sector may behave opportunistically by imposing liquidated damages for time overrun, or by not sharing the cost overruns. On the other hand, in absence of liquidated damages clause for time overrun, the private sector may behave opportunistically by making no investment in reducing time overrun. In addition, the relevance of private information is extremely high in contractual agreements. Often, one of the parties is ignorant of certain crucial elements prior to the contract, termed as pre-contractual information asymmetry. This may lead to the problem of adverse selection. For example, there may be cases of strategic 4| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways misrepresentation (Flyvbjerg 2008) leading to renegotiations or claims, when the terms in contract are incomplete or ambiguous to one party due to information asymmetry. While contemporary literature considers adverse selection to be a consequence of pre-contractual opportunism (intended), this may not always be the case. For example, the cost calculations by which the contractor arrives at the bid quotes are often not disclosed to the public sector. In events of inaccurate estimation of key project parameters due to optimism bias (Flyvbjerg 2005), there may be a reduction in bid value that results in winner’s curse. Adverse selection manifests, when the contractor does not have the capacity to handle such inaccuracies and falters in executing the project. OBS 1: The procurement process must aim towards reducing pre-contractual information asymmetry in order to avoid adverse selection. This essentially relates to the pre-qualification and tendering process, where competitiveness of bids must be subject to proper validation of project parameters used in the bid quote. The private sector’s capacity in executing the project should be assessed. It is also important to keep the contractual norms clear and unambiguous to reduce opportunism. Post-contractual information asymmetry is another important aspect that needs to be considered while framing contracts. E.g., there may be inadequate information to tell whether the terms of agreement have been honored, or it may be costly to retrieve that information accurately. This opens the possibility of self- interested behavior, often known as moral hazard. In highway PPPs, this is particularly a problem, when monitoring the quality of service is difficult. In such cases, explicit incentive contracts may be ideal, making use of proxy parameters that are easy to measure. OBS 2: In order to eliminate the problem of moral hazard arising from post contractual information asymmetry, the quality of service in PPPs must be contractible. Use of explicit incentive contracts may be ideal when observing and monitoring service is difficult. However, in certain situations, the outcome may not be representative of the action or investment, and may be a function of many factors beyond private sector control. Disentangling such factors become necessary for the contract to be complete. 2.2.2. Bundling and unbundling Hart (2003) developed the HSV model further (Hart et. al. 1997) to include the case of unbundling (separate build & operate contracts) and bundling (integrated contract). Hart (2003) considers the investment of the builder (socially productive or unproductive) as the only parameter, and bases the analysis on the consideration that the investment is non-verifiable and hence non-contractible. The tradeoff is quite simple. In bundling, the builder internalizes the externalities, while he does not do so under unbundling. He further concludes that PPP (bundling) is good where the quality of the service can be well specified. Unbundling works where ex ante specification of service may not be that accurate. Valila (2005) expands further on ex ante specification of service in relation to monitoring. This leads to a different result, but not entirely inconsistent with Hart (2003). He states that although, bundling can lead to optimal level of quality enhancing improvements, it may also lead to high quality-shedding investments where the public sector cannot monitor the service quality precisely. Under such circumstances, unbundling may reduce quality-shedding investments as the builder aims at fulfilling just the construction contract. Bennett & Iossa (2006) enhances the Hart (2003) model further by assuming verifiable investments and adding another variable (investment considerations in operation stage). They conclude that PFI (bundling) is preferred when (a) more positive is the externality (b) stronger the effects that innovations have on the residual value of facilities. 5| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Grimsey and Lewis (2007) looked at the issue from whole life cycle costing (WLCC), which bases itself on similar concept of ‘internalization of externalities’. They concluded bundling to be offering better incentives for large upfront outlays in construction phase to achieve lower life cycle maintenance cost. Results of Iossa and Martimort (2008) remain consistent with above. However in practice, Rintala (2004) found no such WLCC in his case study of University College London Hospital. He concluded that this was a result of conflicting incentives that had weakened the case of internalizing externalities. OBS 3: Incentive-mapping techniques must be introduced in assessing the contracts. Conflicting incentives can often hold back the project from delivering desired results. 2.2.3. Transaction Cost Economics TCE considers transaction as a basic unit of analysis in the study of economic organisations, and any problem posed directly or indirectly as a contracting problem can be usefully investigated by TCE (Rahman and Kumaraswamy, 2002). TCE recognizes the existence of three categories of transaction - day-to-day purchasing, buying under long-term contract, and acquisition of "core assets.” Although, all three categories are highly relevant in PPP appraisal, PPP itself falls under the second category. TCE makes use of three major variables: frequency, uncertainty, and asset specificity (Williamson and Masten, 1999). While asset specificity and uncertainty justifies the concept of PPPs as a whole, frequency determines the strength of incentives for vertical integration. Therefore, in this section, our focus is primarily on frequency. Frequency: There will never be a situation in which a firm would want to integrate vertically to bring a rarely used provision of a good or service in-house. However, the long duration in PPP induces higher frequency through seasonal or cyclical investment over the entire contractual period. Thus encouraging the private sector to integrate vertically and maximize efficiency through economies of scale. (Note: integrating construction with maintenance derives benefits from economies of scope.) However, the quantification of long duration is a matter of concern. For the private sector, the duration must be optimum so that the savings due to vertical integration exceeds the cost of vertical integration itself. While the public sector may have its own views on the contract period, it may be appropriate if the contractor is allowed to put forward bid quotes based on both (i) its preferred period and (ii) public sector’s preferred period. This provides the public sector options to choose from and may improve value for money. OBS 4: It is appropriate not to predetermine the contract period and let the private sector quote based on different ranges of contract period and its preferred period. Consequently, the cost savings through vertical integration may be better reflected in the bid quote and the public sector have options to choose from. 2.2.4. Principal Agent Problem According to Jensen (2003), agency theory is a kind of relationship that is a contract in which one or more persons (the principals) engage another person (the agent) to take actions on behalf of the principals that involve the delegation of some decision-making authority to the agent. With its basic assumptions of information asymmetry and goal conflict (Caers et al, 2006), the agent may not always act in the best interests of the principal, and thus strategic behaviour might emerge (Rui et. al. 2009). 6| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Strategic behavior in PPP projects may manifest in several ways. Take for example a case, where the DBFO Co may use value engineering to reduce the immediate construction cost. In many of those cases, there is a possibility that the DBFO Co has undermined the whole life cycle costing approach, which may result in poor quality and therefore, increased defects on the road. Their solution to the maintenance problem may be simple: low cost patching of the defects with improved management (without use of more expensive repairing methods like resealing and strengthening). By this way, they may even be able to stay within the contract (strategic misconduct). The overall result can thus be reduced bid prices. VFM comparisons that use techniques in isolation from benefits may consider this to be an improvement. However, there is a flipside. Increased patching results into increased friction, roughness, ride severity, and thereby adversely affecting Vehicle Operating Costs (e.g. increased fuel consumption, accelerated tyre deterioration, accelerated shock absorber deterioration, etc). The extra road-user-costs accumulated over 30 years may lead to a scenario of lower benefits and higher costs. OBS 5: Private enterprises may show opportunistic behavior and this may harm public interests by delivering lower quality of service. The quality of service should be explicitly defined, if the associated benefits tend to bear even a little negative relation with opportunism. OBS 6: In some cases, the massive negative impact on the services due to strategic misconduct may not be observable due its distributed nature over a long period. In such cases, ex ante of implementation, it becomes necessary to validate whether the innovation/investment has any detrimental effect on the public benefits (negative externality). 2.2.5. Optimum Risk Sharing In the very essence of the word ‘partnership’, whenever either the public or the private sector carries all the risks related to production and supply, there would be no partnership (Valila 2005, Mumford 1998). Hence, a concession agreement where the public sector carries no risk at all may not be a PPP. Even when all the criteria above appear to be fulfilled, risk sharing may be withered down considerably by a government guarantee on the private borrowing to finance the construction of the asset. After all, the guarantee boils down to the fact that public sector is the ultimate risk carrier of the project (NAO 2009). Valila (2005) classify risks into external (political, economic, etc) and internal (Construction, operation, demand, etc). Allocation of these risks are project specific, but often complex. For example, consider the case of demand risk. On one hand, it is argued that the private sector partner should carry it, as this is the ultimate way to incentivize the private sector to act in the principal’s interest and promote efficiency, say by reducing toll prices (incentive compatibility constraint) (Iossa and Martimort, 2008). On the other hand, it is also argued that public sector should assume the demand risk given the fact that it is largely influenced by factors under public sector control (agents’ participation constraint) (Valila, 2005). In addition, there may be cases where even under low toll prices, the demand may not increase significantly. Based on the arguments, it may be said that optimum sharing of demand risk to both the parties is appropriate. OBS 7: Contracts must be designed to share the demand risk in highway PPPs, and not complete allocation to one party. Dewatripont and Legros (2005) attempts to disentangle the endogenous (internal) and exogenous (external) risk using economics of regulation under asymmetric information and theory of incomplete contracts. They conclude that the optimum degree of risk sharing should be such that the contractor’s marginal gain from bearing the risk should be equal or greater than marginal loss by not bearing the risk. OBS 8: The contract must be such that the contractor’s marginal gain from bearing the risk should be equal or greater than marginal loss by not bearing the risk. 7| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Construction risk now has substantial evidence of successfully being passed on to the private sector. Demand risk has been studied in transport infrastructure PPPs, especially the toll roads. It is now evident that demand risk should not be subject to complete allocation, but is to be shared by the two parties based on the nature of the project, although in an accountable fashion. 2.2.6. Whole Life Cycle Costing Whole Life Cycle Costing (WLCC) is a mathematical method used to form or support a decision and is employed when deliberating on a selection of options. Selection of options on a rational basis requires the comparison of different levels of investment at the present time compared with their respective consequential future costs. For example, the adoption of higher design standards normally lead to higher initial costs, but may lead to lower future costs of maintenance and renewal. WLCC takes on another dimension in roads, when it also becomes appropriate to consider ongoing costs of the road user e.g. vehicle operating costs, time and delay costs, and the costs of road accidents. The road user costs are central to WLCC in Highways as over the life of a road, road user costs generally far exceed the costs of construction and maintenance of the road. In fact, for typical roads, road user costs can represent up to about 80% of the total transport costs over the project life (Bull 1993). However, the fact that road user costs are extremely difficult to observe and verify restricts them from being entirely contractible elements in a contract. The private sector may not have any incentive to internalize the road user costs into their WLCC, in absence of contractibility. OBS 9: It is extremely necessary to build in appropriate provisions (proxy elements) in the contract that are representative of road user costs and can incentivize internalization of user costs into the private sector WLCC model. Bull (1993) lists road user costs into five major categories: vehicle operating cost, fuel consumption, spare parts consumption, time-savings, and reduction of accidents. He also examines the key elements that affect the road user costs. Vertical gradient, curvature, roughness, ride severity, vehicle speed and road width are found to be the major parameters that affect road user costs. As these physical characteristics are relatively easy to observe than road user costs like vehicle operating cost and spare parts cost, the contract may focus on regulating these physical characteristics (proxy elements) as an indirect way to regulate road user costs. 2.3. Description of Highway PPPs While this section aims at introducing the basic commercial aspects of a PPP, we have also used this section to point out the issues that exist in practice. 2.3.1. Revenues in PPPs: Toll Based: The earliest form of tolls (real tolls) used the duration of private ownership as the criteria for tender competitions. During the contract period, the concessionaire is allowed to collect tolls from the users, after which the asset is transferred to the public authority. In certain parts of the world, owing to political considerations, shadow tolls emerged. Here, the user does not see the cost, but the public body pays the private sector according to the usage. However, in both the cases, the demand risk is retained by the private sector. While low traffic on road was a risk to the private sector, high traffic led to excessive and unfair profits. Consequently, capped form of tolls called the Least Present Value of Revenue (LPVR) evolved (Engel, 2010a & 2010b). Under LPVR, the tender competition is based on the lowest quote of the real revenue that is to be retrieved through tolls. In this case, the concession period ends as soon as the projects target real 8| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways revenue is reached or the time limit is up. In the UK, this form of mechanism can be seen in both the Severn Bridges. However, the problem is the ever-increasing toll prices irrespective of the prevailing economic conditions (HoC 2010). The problem as identified in the Severn bridges is twofold: • The Severn bridges enjoy natural monopoly, as the alternative route is excessively long and time consuming. • The payment mechanism in the Severn bridges is LPVR mechanism, but is not equipped with toll price regulating provisions. OBS 10: Public regulations on toll prices are essential in Real Toll based PPPs. Unitary Payment: Performance based payment mechanisms like congestion, lane availability, and active management involve unitary payments subject to bonus/deductions based on the performance. In these cases, the private sector is shielded from the demand risk and the focus has been shifted to higher efficiency and accountability of private sector in its performance. However, these mechanisms may not be ideal for all economies. With the increase in such projects, the flexibility of government expenditures face crisis due to relatively fixed payments to be made in successive years. Under economic crisis, the severity of this problem may have exponential impacts on the entire economy. 2.3.2. Costs in PPP Financing Cost: Private sector financing makes use of a combination of equity investment and debt finance (bank loans and/or bond finance). The equity contribution in UK is generally in the tune of 5% to 20% depending on the risk profile of the project. Higher the risk, the financiers need more equity to be tied up to the project. This ensures that the private sector consortium retains an interest in the success of the project, while also incentivizing the consortium to maximize economic efficiency (Rintala, 2004). Table 2: Sensitivity Analysis (Simplistic) SENSITIVITY ANALYSIS: DBFO Cost to Increase in Interest Rate HYPOTHETICAL PROJECT DATA DBFO Project Cost 100 Million Construction Period 3 Years Debt Finance (85%) 85 Million Equity Finance (15%) 15 Million VARIATION Interest Rate @ 8% @ 9% Accumulated Interest during Construction 20.40 Million 22.95 Million Interest as a percentage of project cost 20.40% 22.95% Increment per percent increase in interest rate 2.55% It must be noted that the contractual framework has a very important role in the financing aspect. Stronger performance based mechanisms incentivize the private sector to improve its performance and deliver high quality public services. However, this also translates to higher probability of fluctuations in the revenue, and the risk premium increases accordingly (Standard & Poor, 2003). On an average, 1 percent increase in the interest rate can lead to 2.55 percent increase in the interest payable during construction period, expressed as a percentage of total project cost (see Table 2). This cost is ultimately 9| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways borne by the public sector. Hence, it is essential to structure the contracts to optimize VFM while also reducing fluctuations in revenue, thereby, reducing risk premiums. OBS 11: It may be appropriate for the public sector to structure procurement of PPPs in a way that does not affect the revenue stream of the private sector, but can incentivize the private sector to deliver improved services. Refinancing is one of the recent innovations in PPPs. It takes place at a time where there is substantial decrease in project risks. The inflection point in the risk profile is normally during the period of transition from construction to operation. This enables a lower interest rate as the design and construction risk of the project is reduced. In UK, the private sector is now allowed to refinance the project with a mandatory sharing of benefits (GB, 2004 and 2007). Capital Expenditure: According to RICS (1986), the capital cost is the total costs to the owner of acquiring an item and bringing it to the condition where it is capable of performing its intended function. In terms of road transport, the capital cost would include the cost of acquiring land, design and construction of roads, professional fees, technological hardware setups like signaling systems, CCTVs, etc (depending on the scope of the project). Normally in a road PPP, the cost of land acquisition rests with the public sector, while the rest is financed by the private sector. Table 3 Probable cost segments in a Highway PPPs Capital Expenditure Operating Expenditure Other costs4 Bid Phase Operational Phase Public sector Design and SPS1 development cost Periodic Maintenance2 Consultant Fees Cost of obtaining Finance Non-Periodic Maintenance3 Bid Management Legal, advisory and Professional fees Structure Repair/Maintenance Monitoring Cost6 Construction Phase5 Lighting Repair/Maintenance Renegotiation Structures Hardware7 Maintenance Land Acquisition Main Carriageway Data Collection Activity Preliminaries Monitoring Activity Earthworks Security Side Roads and Interchanges Insurance premiums Sign, Marking, Lights and Telecom Taxes (e.g. Service Tax, etc) Fencing/Barriers HR benefits and increments Data Coll. and Monitoring Hardware Statutory Undertakers Horticulture, Archaeology, etc Acomm. and Maintenance Compounds Site Clearance 1 – Service Provision Solution; 2 – As per routine and winter service code, network management manual, other output specification; 3 – Depending on the unanticipated conditions on road (like requirement of strengthening overlay); 4 – Costs that are not projected in the contract and are incurred by the public sector; 5 – The items as listed are based on the major design components. They include the cost of labor, plant, machinery or executive involvement from the private sector consortium; 6 - Monitoring cost as incurred by the public sector in auditing performance against output specification and thereby, release of payments; 7 – Hardware refers to elements like electronic loops, CCTVs, vehicle count sensors, etc. The cost of bidding in a PPP project forms a significant part of the entire capital cost. While all the bidders may invest significantly in developing proposal, the project is awarded to a single bidder. This often renders other bidders with substantial amount of sunk cost in form of professional fees, advisory fees, legal fees, cost of obtaining finance, etc. 10 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways This sunk cost may lead to two different perverse possibilities. On one hand, a risk averse bidder would be often discouraged from participating in the bid, thereby reducing competition. On the other hand, a risk taker may be prone to optimism bias and hence, winner’s curse. This may be extremely detrimental for the project causing delays in time, overrun of costs and even cost of rewriting contracts and rebid. OBS 12: It is essential that the procurement process in PPPs aim at reducing the sunk cost of the bidders Operating Expenditure: Operational cost in relation to road infrastructure may be categorized as running costs and maintenance costs. The running cost involves operation of the tollbooths and transport hardware like signals, Variable Message Signs (VMS), cost of monitoring and collecting data to be supplied to the public data, etc. The maintenance cost includes the cost required to ensure smooth operation e.g. road maintenances, equipment maintenance, hardware maintenance, etc. 2.3.3. Public Benefits Roads provide an essential service by allowing mobility, diffusion of goods and people and enhance nationwide connectivity. When looking at projects in the road infrastructure development, DfT (2004 and 2006) considers four basic parameters to judge the level of benefits achieved from road. The idea is not only to provide these benefits, but also to constantly improve them in favor of the public (Bull, 1993). Contractual framework plays a vital role in incentivizing such improvements. The user benefits associated with roads are (as per COBA and TUBA): • Reduction in user time delay: This aims at reducing the congestion on the roads and thereby, saving valuable time of the users. • Reduction in Vehicle operating costs: This aims at reducing the cost of commuting on roads arising from fuel consumption, vehicle maintenance costs, etc. • Reduction in Accidents: This values the cost of accidents to the users. • Reduction in User Charges: User charges may be in form of tolls, parking charges, fares, etc. OBS 13: Contractual incentives must aim towards constant improvement in the desired benefits. 2.3.4. Cost and Benefit Analysis & VFM Assessment Discounted Cash Flow and Discount Rate: Virtually all forms of economic evaluation weigh future against the present. The social time preference discount rate is related to the way people value future benefits against present sacrifices, whereas the opportunity cost of capital is about alternative investments. The time preference rate is expected to be lower than the opportunity cost rate. If lower rates were used as public discount rates, then the opportunity cost of public investment is generally understated and vice versa. However, many treasury officials prefer a discount rate based on opportunity cost of capital rather than on social rate of time preference (Taplin et. al. 2005). These rates are in real terms so that projects are evaluated as if prices will remain constant in future. The difficulties in selecting a rate have led some governments to establish a uniform or central discount rate, often set at a relatively high level around 10 percent, to provide a severe test of merit of alternatives. 11 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways For example, the Chinese Government’s specification of a real rate of 12 percent for road projects was in force for over a decade. In the UK, the basic discount rate is set out to be inflation plus 3.5 percent (GB 2009), which is rather low. It is argued, unless a lower rate is used, future generations’ benefits will be unduly discounted and their interests virtually ignored. The basic idea is that 3.5% is made up principally of two elements – the social time preference for having benefits sooner rather than later, which is put at 1.5%, added to the rate of per capita growth in the economy. This growth rate is put at 2%, based on a past real growth of 2.1% per annum in the period 1950 to 1998 (Hanton, 2010). Cost & Benefit Analysis: In cost and benefit analysis, costs and benefits are discounted to a suitable base year. The NPV comprises the discounted benefits less the discounted costs. The rate of return is the rate that gives zero NPV, and the benefit-cost ratio is obtained by expressing the discounted benefits and associated costs as a ratio to the constrained capital outlay. A project or investment programme will be accepted, if the rate of return is greater than the predetermined discount rate. VFM Assessment: VFM assessment of a PFI route against traditional route is conducted by establishing an alternative business case called Public Sector Comparator. When a Public Sector Comparator is constructed, the comparator takes into consideration just the costs (Bain 2009, TTF 1999) and not the level of benefits delivered. Although, it is true that ex ante of operation the benefits are non verifiable, it must be realised that change in level of benefits can definitely influence the achieved value for money in a PFI procurement route. Lower level of benefits over a period of 30 years can easily offset the positive value for money as reported in the PSC. OBS 14: It is essential to setup a VFM assessment framework that also considers the level of benefits delivered in the PPPs. Project-specific benchmarks can be established, against which the actual VFM may be compared each year. 2.4. Concluding Remarks This section has put up a detailed discussion on various aspects of PPPs based on various literatures. The emphasis has not been on justifying PPPs, but on the aspects, that procurement of PPPs must abide by. In the process, it has developed a framework that must be the basis of structuring procurement in PPPs. However, based on the scope of this research, the literature review was specifically chosen based on relevance to two aspects of the procurement: Tendering and Payment mechanisms. The framework that has been generated is summarized in the box below. 12 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways BOX 1: THE FRAMEWORK OBS 1: The procurement process must aim towards reducing pre-contractual information asymmetry in order to avoid adverse selection. This essentially relates to the pre-qualification and tendering process, where competitiveness of the bids must be subject to proper validation of project parameters used in the bid quote. The private sector’s capacity in executing the project should be assessed. OBS 2: In order to eliminate the problem of moral hazard arising from post contractual information asymmetry, the quality of service in PPPs must be contractible. Use of explicit incentive contracts may be ideal when observing and monitoring service is difficult. OBS 3: Incentive-mapping techniques must be introduced in assessing the contracts. Conflicting incentives can often hold back the project from delivering desired results. OBS 4: It is appropriate not to predetermine the contract period and let the private sector quote based on different ranges of contract period and its preferred period. Consequently, the cost savings through vertical integration may be better reflected in the bid quote and the public sector have options to choose from. OBS 5: Private enterprises may show opportunistic behavior while focusing on profit maximization, and this may harm public interests. The quality of service should be explicitly defined, if the associated benefits tend to bear even a little negative relation with opportunism. OBS 6: In some cases, the massive negative impact on the services due to strategic conduct may not be observable due its distributed nature over a long period. In such cases, ex ante of implementation, it becomes necessary to validate whether the innovation/investment has any detrimental effect on the public benefits (negative externality). OBS 7: Contracts must be designed to share the demand risk in highway PPPs. OBS 8: The contract must be such that contractor’s the marginal gain from bearing the risk should be equal or greater than marginal loss by not bearing the risk. OBS 9: It is extremely necessary to build in appropriate provisions (proxy elements) in the contract that are representative of road user costs and can incentivize internalization of user costs into the private sector WLCC model. OBS 10: Public regulations on toll prices are essential in Real Toll based PPPs. OBS 11: It may be appropriate for the public sector to structure procurement of PPPs in a way that does not affect the revenue stream of the private sector, but can incentivize the private sector to deliver improved services. OBS 12: It is essential that the procurement process aim at reducing the sunk cost of the bidders OBS 13: Contractual incentives must aim towards constant improvement in the benefits. OBS 14: It is essential to setup a VFM assessment framework that also considers the level of benefits delivered in the PPPs. Project-specific benchmarks can be established, against which the actual VFM may be compared each year. 13 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 3. Procurement through Public Private Partnerships in Highways The purpose of this section is to deliver the first level of contractual assessment based on the guidelines developed in the previous section. Here we shall discuss two key areas: (a) Tendering Procedures and (b) Payment Mechanism. 3.1. Tendering in Highway PPPs This section will describe the tendering process used by Highways Agency. Then the guidelines developed in literature review section will test the completeness of the process. To begin with, we will provide a brief description of Competitive Dialogue, which forms the basis of tendering in Highway PPPs. 3.1.1. Competitive Dialogue – A Brief In March 2004, European Council’s Directive changed the procurement law by introducing the Competitive Dialogue procedure under Recital 31, Article 1 and Article 29 (Directive 2004/18/EC). The procedure is only to be used in projects, where it is difficult for the public sector to define the needs at the outset or to have a complete knowledge of what the private sector can offer. Recital 31 considers integrated transport infrastructure projects as appropriate for use of Competitive Dialogue. OGC guidance on Competitive Dialogue procedure was released in January 2006. It is now being used by most of the agencies under Department of Transport, including the Highways Agency. The main features of the competitive dialogue procedure (OGC 2006) are: BOX 2: Competitive Dialogue Procedure • The public authorities are required to publish a contract notice as descriptive document and NOT specification, setting out their broader needs to which different solutions may be proposed. The notice for expressions of interest (EoI) has to be set out in the Official Journal of European Commission as per law. • Following the EoI and prequalification procedure, the number of selected candidates for invitation to dialogue (ItD) may be reduced to three, provided the perceived impact on competition is low. • Dialogue is allowed with the private sector to identify solutions that best meets the needs and requirement of the Authority. Dialogue may be conducted in successive stages, with the aim of reducing the number of solutions/bidders. • The award is made only on the most economically advantageous tender criteria. The criteria have to be given relative weighting at the outset. Where it is not possible to do so in advance, importance of criteria in descending order should be listed and bidders must be informed. • Post Tender discussions should be fair in the sense that it should not provide the tenderer with information that distorts competition. • As per Article 29(3), contracting authorities may reveal solutions or aspects of solutions of other candidates on condition that they agree to such disclosure. Such disclosure without permission of the candidate may be in violation of Intellectual Property Rights. 3.1.2. UK Highway PPPs - Tendering Process The tendering process in the Highway PPPs has undergone significant change and innovation in the past three years, especially with the tendering of the high profile M25 DBFO project. The process described in this section is in line with the tendering stages in M25 DBFO and Competitive Dialogue. In addition, changes from previous practices have been highlighted and rationales that support such changes have been put forward. The information has been retrieved from online archives of Highways Agency, UK. 14 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways BOX 3: Most Recent Tendering Process in UK Highway DBFO STAGE I - Prequalification The Agency evaluates Prequalification Questionnaires (PQQ) and selects bidders based on predetermined parameters with appropriate weightage and defined marking schemes. The prequalification parameters that are generally taken into consideration are (HA, M25 DBFO, 2008): Relevant Experience Management Systems Resources • Operation and maintenance • Certification • Average Workforce • Construction • Health and Safety • Turnover • Skills • Enforcement Notices • Litigation • Specific Experience • Fatal Accidents • Financial and Economic • PPP standing. • Raising Finance • Damages, etc All respondents who meet the Agency's requirements and score above the total and individual cut-off scores go through to the next stage. STAGE II - Invitation to Submit Outline Proposals (ISOP) The Agency issues an Invitation to Submit Outline Proposals (ISOP) to all the successful bidders in Prequalification. The ISOP questionnaire is usually accompanied by a document containing relevant background information about the Project. The responses to ISOP questionnaire is treated as firm commitments to be taken forward into the Invitation to Tender (ITT) stage. The Agency evaluates the responses to the ISOP questionnaire against the following criteria: delivery of the required service to the required standard, processes, supportive values and behaviors, appropriate resources (human, financial and technical), pricing methodology. The Agency selects three bidders based on the evaluation of ISOP. STAGE III - Invitation to Tender (ITT) Following ISOP, the agency issues full Tender Documents to the three bidders, including complete contract documentation, illustrative designs for all works, and complete or draft environmental statements. Bidders submit comments on the contract during the tender period, followed by a dialogue where the agency negotiates comments with bidders and issues a revised contract. The bidders now have the liberty to deliver their bids based on their preferred choice of contract period. Thereafter, bidders submit fully developed tenders, including technical proposals and provisional pricing for the entire project. During this period, there is a continuous interaction between the agency and the bidders, whereby the agency can assess the externality of the bidders’ proposal on long-term public benefits, and comment on the acceptance of the proposal. Under the newly adopted procurement strategy of the Highways Agency, the bidders are expected to submit their bids in two parts. One part shall contain the detailed proposal pointing out the deviation from the illustrative designs (may be termed as innovations), while the second part is expected to contain details regarding the innovations with evidences of successful implementation from past projects. This further helps in effective assessment of the externalities related to any innovation. Finally, the agency evaluates tenders based on the most economically advantageous tender using the same criteria as the ISOP stage, and selects the Provisional Preferred Bidder (PPB). 15 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways STAGE IV - Financial Close The Agency and the PPB finalize the DBFO Contract. The Agency awards the DBFO Contract, with provisional price. The PB runs a financing competition. The provisional pricing is adjusted to reflect only the outcome of the funding competition. The DBFO Contract is signed, if it has not been signed before the financing competition. 3.1.3. Discussion Change in Process Previously, on all of the Agency's DBFO projects, the process included a Best and Final Offer stage (BAFO). Under BAFO, after the Agency received and evaluated tenders, it shortlisted two bidders for further negotiation. Following those negotiations, the shortlisted bidders were asked to confirm their bids in a best and final offer and selected the provisional preferred bidder on the basis of these BAFOs. However, this stage has been eliminated in the current process. Under the process discussed above, the agency shortlists only three bidders based on the prequalification and the ISOP stage. While this procedure is a significant improvement in line with OBS 12, its reliability on OBS 1 increases exponentially. Although, the Prequalification Questionnaire seems to be robust, it does not take into account the bidder’s performance in the past projects in terms of quality of services. It might be appropriate for the Highways Agency to contact some of the former clients (both private and public) of the bidders for an objective assessment of the quality of the services delivered in the past by the bidder. Past projects executed by the bidder for the Agency is of great importance in this respect. This will help the Agency to assess any gaps that have existed in the bidders’ commitments and actual performance in the past. In such cases, the PQQ may ask the bidder to furnish an exhaustive list of their clients during a specific period, say, the past five years. Submission of client certificates directly by the bidder (prevailing practice) may not be effective, as the bidder then has the incentive to produce only those certificates that enhances their credentials. There are two problems associated with the ISOP stage. Firstly, the nature of the parameters appears to be subjective, and therefore, there is a risk of not selecting the best three bidders. This is because the selection is not based on complete assessment of the solutions offered by all. It restricts the complete potential of PPP to deliver VFM. Secondly, the subjective nature is also unfavorable to the bidders, as the assessment on processes, behaviors, and pricing methodology are relative and there does not exist any standard. The subjective assessment provides undesirably high power to the Agency personnel, and at times may incentivize malpractices within the Agency. The need is to set up an objective evaluation process in ISOP, or else at least to supplement the bidders with a standard to which the improvements can be substantiated by the bidders and can be measured. In the tendering stage, although the Agency provides the bidder with illustrative designs, it may be appropriate for the Agency to provide the bidders with an illustrative list of cost segments (not costs itself) within the scope of work. This may be based on Agency’s prior experience in PPPs where the bidders unintentionally missed out costs. This will help in strengthening OBS1 further and avoid winner’s curse. It will also demonstrate a collaborative approach from the Highways Agency. The flexibility in choosing the preferred contract periods for bidding is a change in line with OBS4. Financing competition post selection of PPB In past DBFO procurements, bidders have been required to provide with their tenders, documentary evidence of commitments from financial institutions. However, given the magnitude of the financing required in highway projects, holding funding competitions post selection of PPB avoids the potential strain on the financial market of providing commitments for such large amounts for multiple bidders. 16 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways This also helps in obtaining the best terms for senior debts as the leverage of PPB increases over financiers. This is a considerable improvement in line with OBS 12. Also, ex ante of selection of PPB, bidders are required to submit a funding plan, deliver evidence of the achievability and realism of the funding plan, and commit to those equity elements of the funding plan that will come from the Bidder. This delivers OBS 1 quite substantially. 3.2. Payment Mechanisms In this section, we shall focus on the various payment mechanisms that have been used in the UK highway PPPs. 3.2.1. Congestion Mechanism (Performance Based) The payment mechanism in this case can be broken into three broad kinds of payment: Congestion Management Payment, Safety Adjustments, and Construction Payments. In the following sections, we will deal with them individually. Congestion Management Payment This primary function for the Congestion Management Payment is as following: BOX 4: Congestion Management Payment (Congestion based Payment Mechanism) MCP = (GCP, PB, PA) Where, MCP = Monthly Congestion Payment GCP = the Gross Congestion Management Payment for Contract Year n derived from ‘Base Annual Gross Congestion Management Payment’ and corrected according to the RPI index of year n. PB = the Period Congestion Management Payment Bonus in respect of Carriageway Section s for Payment Period p. The constituent of this has been explicated in greater details below. PA = the Period Congestion Management Payment Adjustment in respect of Carriageway Section s for Payment Period p. The constituent of this has been explicated in greater details below. ns = the number of Carriageway Sections on the Project Road As seen from the above function, the Congestion Management Payment is structured into a primary component of payment, subject to either adjustment or bonus as per the performance of the project road. The primary payment is a pre-determined stream of service payments agreed by the DBFO Co and the public sector before the financial close. The monthly payment starts only after the O & M commencement date. BOX 5: Performance Bonus / Performance Adjustment Mechanism (Congestion Based) PB or PA = f (TPTr, DF or BF, TS, LTS, AS, AF, DC) 17 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Where, DF or BF = Factor (0 or 1) based on the fulfillment of the condition criteria, which is primarily based on the condition of the road and auxiliary requirements like timely submission of reports. This area will be discussed further in the following sections. TPTr = the aggregate of the number of PCU Kilometres on each of the Links of the Carriageway Section s in the equivalent Payment Period on the equivalent day of the week in each of the four Weeks preceding the Week in which Payment Period p falls. TS = Target Speed for Carriageway Section s as specified LTS = Lower Target Speed for Carriageway Section s as specified AS = Section Average Speed in respect of Carriageway Section s for Payment Period p AF = Number of PCUs recorded on the Relevant Link of Carriageway Section s for Payment Period p DC = Deemed Capacity for the Relevant Link of Carriageway Section s. The payment adjustments or bonus are based on two basic parameters: fulfillment of (i) minimum performance criteria and (ii) congestion management. A target band is set in the traffic speed between the Target Speed and Lower Target Speed. Full payment is made on exceeding the Target Speed. The payment deduction gradually increases as the Average Carriageway Speed reduces towards Lower Target speed. Payment becomes zero when Average Carriageway Speed is below than the Lower Target Speed. There are also provisions, which incentivize the DBFO Co for bearing risks. For example, where the actual traffic exceeds the Deemed Capacity of the road, the DBFO Co is eligible for payment even if the Average Carriageway Speed is below the Lower Target Speed. Under such circumstances, if the DBFO Co manages to achieve speed greater than Lower Target Speed, it may be eligible for appropriate bonus amounts. In addition, if the congestion is caused by an incoming traffic from a non-project road, an ‘excusing factor’ is incorporated accordingly to reduce the target speeds. However, the DBFO Co is responsible for putting up such issues to the Highway Agency. It must also provide substantial proof to establish the claim, and demonstrate sufficient effort to aid mitigation of the condition. This is in line with OBS 2, OBS 8, and OBS 9. However, the use of predetermined target speeds (absolute values) reduces the incentives in line with OBS 13. In a period of 30 years, there are possibilities of technological advancement in automobile industry that makes possible achievement of higher average speeds. In those cases, the DBFO Co may not be inclined in maintaining pace with the advancement, as there is no change in the targets. Infact, it may lead to degradation of VFM, as the DBFO Co may be eligible for bonuses without any investment at all. This may be considered as a risk of obsolescence to the public sector, arising from inappropriate structuring of proxy element in the contract. Construction Payments The structure of Construction Payments is very similar to the Congestion Management Payment, and is structured into a primary component of payment subject to either adjustment or bonus as per the 18 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways performance of the project road. The Construction Payment is also made on a monthly basis. This complete payment is expressed as the following function: BOX 6: Construction Payment (Congestion based) CP = (GCP, CPA, CPB) Where, CP = Monthly Construction Payment GCP = the Gross Congestion Management Payment for Contract Year n derived from ‘Base Annual Gross Congestion Management Payment’ and corrected according to the RPI index of year n. TPTr = the aggregate of the number of PCU Kilometres on each of the Links of the Carriageway Section s in the equivalent Payment Period on the equivalent day of the week in each of the four Weeks preceding the Week in which Payment Period p falls CPA = Construction Payment Adjustment in respect of Carriageway Section s for Payment Period p. CPB = Construction Payment Bonus in respect of Carriageway Section s for Payment Period p. Ns = the number of Carriageway Sections on the Project Road CPA or CPB = f (GCP, TPTr, CPDF or CPBF, TS, LTS, AS, AF, DC) Where, CPDF / BF = Factor based on the fulfillment of the condition criteria, which is primarily based on the condition of the road and auxiliary conditions like submission of reports. TS = Target Speed for Carriageway Section s as specified LTS = Lower Target Speed for Carriageway Section s as specified AS = Section Average Speed in respect of Carriageway Section s for Payment Period p AF = Number of PCUs recorded on the Relevant Link of Carriageway Section s for Payment Period p DC = Deemed Capacity for the Relevant Link of Carriageway Section s. As seen above, the construction payment is linked to the performance in Congestion Management. The payment is linked to the quality of constructed road through CPDF/CPBF in a limited manner based on fulfillment of minimum criteria. The emphasis throughout the payment mechanism is on congestion management and much less on the quality of the road. This weakens the incentives for higher investment in constructing better quality of roads, reducing the focus of the DBFO Co in internalizing vehicle operating costs and residual value (OBS 9). Unless the Agency perceives time value of the user more important than long-term vehicle operating costs, the imbalance in the incentives may need to be rectified through incentive mapping (OBS 3). 19 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Safety Adjustments The adjustment may be expressed in form of a function: BOX 7: Safety Adjustment (Congestion based) SA = f (PRpia, PRP0, CRpia, CRLn, CRL0, CRP0, LLn) Where, SA = Safety Adjustment PRpia = Number of PIAs occurring on the Comparator Roads for Contract Year n. PRP0 = The average annual Project Road performance for a given period before commencement of contract (The case will be different for a completely new route with no previous record) CRpia = Number of PIAs occurring on the Comparator Roads for Contract Year n. CRLn = Total length of the Comparator Roads at the SP Date for Contract Year n. CRL0 = Total length of the dual all purpose Comparator Roads as at the date of Commencement of contract. CRP0 = The average annual Comparator Road performance for a given period before commencement of contract LLn = The total length of the Project Road on the Service Payment Date for Contract Year n. As seen above, Comparison of the DBFO road to that of a Comparator Road forms the basis of safety adjustments. The parameter for comparison is the absolute value of the Personal Injury Accident (PIA) occurring on the two set of roads. Differences between DBFO Road and Comparator Road PIAs over a certain range yield a bonus or a deduction accordingly. The bonus and deductions are capped for any differences over a specified range. However, in this case, the use of comparator road incentivizes the DBFO Co to perform just better than the public sector, even if it is capable of performing far better. This leads to partial fulfillment of OBS 13. 20 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Payment Structure Diagram Figure 3: Monthly Payment (modified from Briggs & Drewett, Seminar at Warsaw, Poland, 2008) Figure 4: Safety Adjustment (modified from Briggs & Drewett, Seminar at Warsaw, Poland, 2008) 3.2.2. Lane Availability Mechanism (Performance Based) Lane Availability (LA) is the most recent form of payment mechanism implemented. As opposed to the Congestion mechanism, LA uses a compact Gross Monthly Payment with various forms of performance-based adjustments structured around it. 21 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways The Core Payment One of the main features of this payment is the fact that it allows phase-wise commissioning of the project that is trafficable and release of payments accordingly. This has been quite helpful for the consortium to maintain the cash flow. LA appears to be especially useful for projects that involve less new route construction and more segregated sectional improvements like widening. The Gross Monthly Payment on any month ‘m’ of year ‘n’ (GMPm, n) will depend upon the status different parts of the project and usability. The payments are increased (step up) on attaining the Completion Certificate and then on issue of Permission to Use. It is determined by the following formulae: BOX 8: Payment Structure (Lane Availability based) s =7  Days s ,c Dayss , p y = NPCs  Days pc , y  GMPm , 0 = Basem + ∑ SUC s ×  + SUPs × + ∑  TMPCAs , y ×    s =1  Daysm Daysm y =1  Daysm  GMPm, n = GMPm ,0 × INDEX n,1 Where: GMPm ,0 = Gross Monthly Payment as agreed in the contract before indexation Basem = the base payment for Monthm SUCs = the Relevant Monthly CC Step Up Amount payable to the DBFO Co for the Upgraded Section “s” upon the issue of a Completion Certificate in respect of that Upgraded Section “s”. SUPs = the Relevant Monthly PTU Step Up Amount payable to the DBFO Co for the Upgraded Section “s” upon the issue of a Permit to Use in respect of that Upgraded Section “s”. Dayss,c = the number of days in Monthm after (but including) the date of issue of the Completion Certificate applicable to Upgraded Section“s” Dayss,p = the number of days in Monthm after (but including) the date of issue of the Permit to Use applicable to Upgraded Section“s” Dayspc,y = the number of days in Monthm after (but including) the date of the occurrence of a Qualifying Traffic Management Phase Change Event “y” applicable to Upgraded Section “s”. TMPCAs,y = the Qualifying Traffic Management Phase Change Amount payable to the DBFO Co upon the occurrence of a Qualifying Traffic Management Phase Change “y” in respect of Upgraded Section “s”. The Net Monthly Payment on any month ‘m’ of year ‘n’ (NMPm,i) is determined by the following formulae. NMPm,n = GMPm,n – MAm-1 Where, MAm-1 = Monthly Adjustments in the previous month ‘m-1’ of a particular year. The Monthly Adjustments for any month M is in accordance with the following formulae: MAm = [ToDCAm + CAm − ARPMAm − SPAFACTORn * + ECAm − ACIAm ]× INDEX n , 2 22 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways *Note that SPAFACTORm is incorporated into the payment once at the end of every yearly cycle, based on the performance of the entire year. where: ToDCAm = the Total Monthly Delay Cost Adjustment for Monthm. CAm = the Condition Adjustment for Monthm. ARPMAm = the Applicable Route Performance Measure Adjustment for Monthm ECAm = the Exceptional Circumstances Adjustment for Monthm ACIAm = the Applicable Monthly Critical Incidence Adjustment for Monthm- SPAFACTORn = the Applicable Yearly Safety Performance Adjustment for Yearn. INDEXn,2 = the indexation figure for Contract Yearn. ARPMAm, SPAFACTORm and ACIAm can be either positive (superior performance) or negative (inferior performance) and will act to increase the amount of MAm when negative and decrease the amount of MAm when positive, through the operation of the above formula. Adjustments In this section, we have made a qualitative effort in explaining the basis of each of these adjustments. The emphasis has been on condensed explanations as detailing each of the elements is beyond the scope of this paper. However, we have tried to include every necessary intricacy. Delay Cost, Exceptional Circumstances and Critical Incidence Adjustments: The rationale of delay cost adjustment is to minimize lane closure in any section of the road. In events of lane closure, the mechanism deducts costs of the ‘delay to the users’ from the Gross Monthly Payment of the DBFO Co. Exceptional circumstances use a similar methodology to assess any delay caused by non-fulfillment of obligations by the DBFO Co. Note that Delay cost adjustments are based on the performance, while exceptional circumstances adjustments are based on contractual obligations of the DBFO Co in reducing inconvenience to the users. Critical Incident adjustment is a provision that follows a similar mechanism as well. However, the purpose is to offset any delay cost adjustment triggered by a critical incident beyond the control of DBFO Co, while furthering deductions for any negligence of the DBFO Co that led to the critical incident. The lanes on the project road are usually divided into sections, which are monitored daily over 96 periods of 15 minutes each. To quantify the monetary value of the delay in events of lane closure, the mechanism uses a mathematical relation between total vehicle delays, economic cost per vehicle hour, multiplied by an economic cost factor subject to conditions. The calculation of total vehicle delay is based on a comparison between the expected travel time under normal and lane closure conditions aided by expected hourly volume of traffic for each period p. Any delay originating from traffic over the normal capacity is also taken into account for the purpose of a fair calculation. 23 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways The DBFO Co is relieved from any delay cost adjustment in events where the delay is beyond the control of the DBFO Co. Although this adjustment mechanism is in line with OBS 9, it is unknown whether the monetary value of unitary delay adjustment conforms to OBS 8. In projects where the OBS 8 becomes dysfunctional, the incentive imparted by OBS 9 becomes ineffective. Condition Adjustment: As observed in earlier mechanisms, the road condition criteria used in LA is also based on the Network Management Manual and the Routine and Winter Maintenance Manual. However, the emphasis of certain areas of condition criteria is more pronounced in this mechanism in comparison to its predecessors. In LA, the condition criteria is governed by the idea conforming to a basic standard, fast repairing of high priority defects and fast repairing of technology defects. The basic criteria take into consideration four physical characteristics of road (a) Ride Quality (b) Rutting (c) Texture Condition (d) high friction surfacing, micro surfacing, and surface dressing. The Condition Adjustment is based on the following formula. BOX 9: Condition Adjustment (Lane Availability based) CAm = CCCAm + HPDCA + TeDCA m m Where: CCCAm = The Monthly Carriageway Condition Criteria Adjustment. HPDCAm = The Monthly High Priority Defect Condition Adjustment. TeDCAm = The Monthly Technology Defect Condition Adjustment. The essence of the Carriageway Condition Criteria Adjustment (CCCAm) lies in the Carriageway Condition Factor (CCF). This factor represents the permissible limit of defects. For example, CCF value of 0.2 represents that the cumulative value of section-lane-km-days for those with unacceptable condition must not exceed 20 percent of the maximum possible value of section-lane-km-days. Here, this permissible limit decreases with time, incentivizing the DBFO Co to perform better with time and not to lose focus. This is in line with OBS 13. HPDCAm and TeDCAm evaluate the impact of failure to rectify any high priority defect or technology defect within the allotted rectification time. Route Performance Measure Adjustment This mechanism is based on the assessment of the travel time of the users on the project route. The reference travel time is based on the average of data for the past twelve months on the same route. The DBFO Co is allotted reliability and delay points based on superior and inferior travel time respectively. While excess of delay points as compared to reliability points will trigger a deduction, the opposite will lead to a bonus. However, the bonus and deduction is both subject to a maximum cap. This mechanism tries to incentivize the overall performance and management of the DBFO Co in reducing the travel time gradually. LA focuses on reducing travel time rather than specifying high-speed 24 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways movement as in case of Congestion mechanism. The answer to ‘how to reduce travel time?’ is left to the innovation and efficiency of the DBFO Co. This is in line with OBS 13, OBS 9 and significantly reduces the risk of obsolescence as discussed under Congestion Mechanism. However, even in this case, it is unknown whether the monetary value of adjustment conforms to OBS 8. In projects where the OBS 8 becomes dysfunctional, the incentive imparted by OBS 9 becomes ineffective. Safety Performance Adjustments The safety performance adjustment is similar to that used in the Congestion mechanism and shall not be discussed here. A13 DBFO Payment Mechanism (A Brief) A13 DBFO payment mechanism can be considered as the earliest form of lane availability. This payment mechanism moves away from the shadow-toll payment mechanism used on previous DBFO contracts, replacing them with a combination of: i. Availability - Accounting for approximately 70 per cent of the DBFO Co's income, payments are linked to road availability which, in turn, incentivises them to maximise the time that the road is available to road users, particularly during peak hours. Financial incentives include keeping bus lanes open and available for use. ii. Separate footway and cycle way availability payments - The needs of the non-motorised user are also recognised by linking payments to the DBFO Co's performance in keeping footways and cycle ways available to pedestrians and cyclists. iii. HGV/bus shadow tolls - Long-vehicle volume-based payments encourage the DBFO Co to efficiently manage public transport and commercial goods vehicle traffic, while providing no incentive to increase car usage. iv. Safety payments - Safety payments are designed to encourage the DBFO Co to reduce the number of accidents. 3.2.3. Shadow Toll (Traffic Based) Under Shadow Toll mechanism, the Highways Agency pays each DBFO Co an amount, which is based on the number and type of vehicles using the road, with adjustments made for lane closure and safety performance. These are known as shadow tolls as opposed to real tolls, as payment for usage is made by the Highways Agency rather than by the road user. The payment mechanism incorporates three basic elements: Traffic payment, Lane Closure Charges and Safety Performance. Traffic Payments: Shadow toll payments are made per vehicle using a kilometre of the project road (vehicle-kilometre), in accordance with the tolling structure and increase over time in accordance with Baxter index. (Baxter index takes into consideration the escalation of construction costs based on labour, plant and material used in road construction). Payments are not based simply on the product of traffic volumes and a single shadow toll. Instead traffic is divided into two to four "bands" representing different levels of annual traffic volumes with different vehicle category payments. The lower bands have higher per-vehicle payments, while higher bands have lower per-vehicle payments. In all cases, the top band must be zero so that the government's liability is capped in the event of higher-than-expected traffic. The bands themselves may be increased over time to match anticipated growth in traffic. 25 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Separate bands are constructed for two vehicle classes — vehicles less than 5.2 meters in length, and vehicles greater than 5.2 meters. The DBFO performs continuous traffic counts to calculate annual vehicle-miles, which are verified by the Government every 90 days. Payments are indexed to retail price indexes. Note that the increasing slope over time does not represent inflation but the change in bands to match traffic growth. Where the project road consists of an existing stretch of road with one or more construction schemes along its length, then shadow toll payments will be made at a reduced level representing the cost and operation for the existing road. Figure 3.2.4a Band diagram in a Shadow Toll Mechanism Safety performance payments The DBFO Co is encouraged to suggest safety improvement schemes with incentives for improving safety on the Project Road. If approved, the DBFO Co constructs and pays for the scheme and is recompensed by receiving 25% of the economic cost of each personal injury accident avoided in the following five year period. (Highway Agency, 1997) Lane closure charges A deduction is made from the toll payment when lanes are closed. The size of the deduction is dependant upon the number of lanes closed, the duration of the closure, and the expected hourly flow rate at the time of the closure. Lane closures charges are only made for closures within the control of the DBFO Co. 26 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 3.2.4. Commentary The following chart shows the mode of contracting the quality of service in different payment mechanisms: Table 3: Service Quality contracting modes under different mechanisms Quality of Service Shadow Toll Congestion Lane Availability Condition criteria • Vehicle Operating Cost None Condition criteria Timely Repairing of • • high priority defects Speed Related Incentive • Lane Closure Delay Time of users Lane Closure • within deemed capacity • Travel Time reduction • beyond deemed capacity • Critical Incidences Safety on Road Accident reduction Comparator Road used Comparator Road used (i) Incentives It can be observed from the previous sections that the payment mechanisms have become much more rigorous from being demand based to entirely performance-based. While under shadow toll the private sector hardly had any incentive to internalize vehicle-operating costs of users, incentives for the same have been created under Congestion mechanism and Lane Availability. Similar levels of improvements can be seen in incentivizing reduction in delay time of users and improving the safety conditions. Both forms of performance-based mechanism uses incentive contracts to define the quality of service (in line with OBS 2 and OBS 9). However, the effectiveness of the incentives shall heavily depend on the monetary value of the adjustments/bonuses (OBS 8). Assigning inappropriate value would weaken the incentives under OBS 2 and OBS 9. In addition, it is important to establish proper incentive mapping mechanisms to assess the contractual framework before implementation, and eliminate any case of conflicting incentives and perverse incentives (OBS 3). Use of proxy elements instead of direct use of user benefits can be seen in the performance-based mechanisms. This is because the effort required to deliver the public benefits is not perfectly contractible. Moreover, the effectiveness of the effort (as in innovation) is non-verifiable ex ante of operation. To worsen the situation, the benefits themselves are not easily measurable. Thereby, proxy elements have been used, whose outcomes can be measured relatively with ease. For example, 1. Improvement in vehicle operating cost is measured by assessing quality of roads using condition criteria. 2. Valuation of user time is based on traffic speeds and reference time of travel. The risk of obsolescence to the public sector needs to be kept in mind while assigning the proxy elements. For example, use of reference time travel as seen in Lane Availability mechanism must be preferred to target speeds as in Congestion mechanism. The former bears a relation to the technological advancement and incentivizes the DBFO Co to invest keeping pace with time and technological advancement. However, this incentive is not there in the later. Infact, VFM is degraded, if the technological advancement in automobile industry or satellite systems automatically lead to higher speed of vehicles. In congestion, the DBFO Co may become eligible for bonuses without any actual investment. Another aspect of the mechanism is the fact that fulfilling minimum level of road condition makes the DBFO Co eligible for its payments. This provides incentives for the DBFO Co to maintain the road as per standard, but not better. Under WLCC and bundling, it is expected that the DBFO Co shall invest in 27 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways construction of better quality roads to minimize the investment cost. However, current PPP contracts have weak incentives for doing so. (ii) Monitoring Under Congestion and Lane Availability mechanism, the whole project road is divided into several sections depending on the anticipated nature of traffic variables in those sections. It strengthens the contractual basis of the DBFOs. However, this makes the whole payment structure quite complex in terms of data collection, documentation, and monitoring. This intricate contract design comes at an extra monitoring cost topped by a risk premium. This cost may be justified only under evidence that prove substantial improvement in services. Also, assessment of operational performances has to be carried out to ascertain whether the right proxy elements have been used in contracting the quality of service. The responsibility of monitoring and reporting of the road quality rests with the DBFO Co. For example, DBFO Co is required to procure the TRACS contractor for monitoring and reporting ride severity and rutting. Although the accuracy of the data is checked by the Highway Agency officials, the checks are often cumbersome and may not be entirely efficient. Under such circumstances, there is a possibility of opportunistic behavior of the DBFO Co to manipulate data in its favor. As constructing, maintaining, and operating this infrastructure is a responsibility of the DBFO Co, the ease of manipulating the data provides an incentive it the DBFO Co to be opportunistic, knowing that checking the data is difficult. (iii) Demand Risk Sharing While Shadow Toll mechanism has provisions for sharing of demand risk, Congestion and Lane Availability mechanisms have eliminated this risk from private sector domain. This may not be entirely desirable as demand risk is beyond control of both private and public sectors. In addition, removal of demand risk might provide a perverse incentive to the DBFO Co to discourage traffic on road. This is because lower traffic would require less maintenance cost, and may even reduce delay time of users. The Monthly Gross Payments under the Congestion and Lane Availability mechanism may be structured with certain amount of demand risk sharing. Use of shadow tolls in conjunction with performance based and LPVR mechanisms may be ideal in such circumstances. Toll price regulation mechanism as discussed in next section may be a solution as well. 3.2.5. Real tolls and Least Present Value of Revenue In this section, we would try to address the problem of absence of toll price regulation as discussed in 2.3.1. The proposed mechanism is in line with the guidelines developed under literature review. 3.2.5.1. Toll Price Regulation Mechanism The mechanism has been presented in two parts: The Core Payment and Real Income Linked Toll Pricing System. The Core Payment has been adopted from the LPVR system that was first implemented in highway projects in Peru and subsequently improvised in Litoral Centro Highway project in Portugal. The first sophistication appears in introducing an element of subsidy in form of Guaranteed Minimum Revenue (GMR). The mechanism has performance-based deductions to incentivize internalization of social costs, similar to Lane Availability based mechanism. The Real Income Linked Toll Pricing creates a relation between the GMR, Toll Prices, Consumer Price Index (CPI) and nominal Average Earning Index (nAEI), thereby taking into consideration the willingness to pay aspect. 28 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways The Core Payment The revenue generated per year shall be dependent on the quantity of road users and type of vehicles using the road (in case of differential toll prices for different category of vehicles). As demand risk can be controlled neither by the private sector nor by the public sector completely, there must be a proper sharing of this risk. For this purpose, a guaranteed minimum revenue (G) may be agreed upon for each year. The concessionaire obtains whichever is greater of (i) Real Tolls (Ri) and (ii) GMR (G). The government contributes ‘GMR minus real tolls’ (M). In that case, the revenue for private sector in i-th year will be f(Ri) = Ri (if Ri ≥ Gi) = Ri + Mi (if Ri ≤ Gi, Mi = Gi-Ri) Where, Gi = Guaranteed Minimum Revenue for year i. Mi = Contribution of government to fill up the gap between Gi and Ri. Now, let ‘I’ be the target present value of revenue to be achieved during the concession period. In this LPVR mechanism, the concession period has two threshold periods (t0 and t1) and an upper limit period (T). If ‘I’ is reached before ‘t0’, the concessionaire is allowed to collect tolls up to ‘t0’ giving the concessionaire an upside. Similar will be the treatment of second threshold period ‘t1’. However, between ‘t1’ and ‘T’, the concession period ends as soon as the revenue reaches ‘I’. If the target revenue is not achieved even at ‘T’, the concession period ends mandatorily at ‘T’. The mechanism in supplemented by performance-based deductions. The equation may take the following form: (a) (p) (q) (s) 1 < t0 < t1 < t2 ≤ T and t є {t0, t1, t2} k=0, j = 0 if, p≥ I k=1, j = 0 if, p ≤ I ≤ q k=1, j = 1 if, p+q ≤ I Where, I = Target Present Value of Revenue as agreed in the contract. Ai = Deduction at the end of year ‘i’ for the performance in period ‘i’. α = Weighted Average Cost of Capital for the project. t = Actual duration of the concession as achieved in the project. T = Maximum possible period of concession. t0 = First threshold period. t1 = Second threshold period. t2 = Period between t1 and T, where revenue I is achieved. If not, the concession ends at T. f(Ri) = Retail Price indexed value of total revenue generated by user toll in the year i. However, in projects where the right to set the toll prices rests with the private sector, there may be a perverse incentive. This arises from the fact that the adjustments are based on aspects like condition of road, journey time reliability (delay cost adjustment), safety performance, etc. The cost arising from these aspects has a positive relation to the traffic flow. Under such circumstances, the private sector has an incentive to bargain substantially high on Guaranteed Minimum Revenue, while also setting up a higher 29 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways toll price to reduce road usage and thereby reduce any performance-based deduction. Here, neither the efficiency gains are achieved as expected from a PPP, nor does the creation of the road maximize benefits like reduced congestion. This calls for a proper regulation on toll prices as well as GMR. For this purpose, we propose a flexible system for determining the toll prices and GMR linked to each other. The first step would be to agree upon a Base GMR (Gb) and a Base toll price (Pb) at the outset. As usual, the effective base on the i-th year may be corrected according to the retail price index of the previous period and may be represented as Gb,i and Pb,i respectively. The Guaranteed Minimum Revenue in the i-th year (Gi) can be determined by the following equation: Where, Pi = Toll price set for a particular period ‘i’ (may be differentially set for different vehicles) a = Constant (>1). It may be predetermined according to the financial capacity of the public authority. This creates an inverse dynamics between the toll prices and the GMR. Increase in the toll prices results in a reduction of the GMR and vice versa. This allows the concessionaire to decide on an optimum. It also allows the concessionaire to be open to toll price reductions during unfavorable economic condition, as the risk is appropriately covered both by flexible term of contract and increased GMR for reduced toll prices. Under unfavorable economic condition, the private sector also enjoys the certainty of its revenue from higher GMR and helps in stabilizing cash-flow. Figure 5: Relation between the toll prices and subsidy 30 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Real Income Linked Toll Pricing System (RILToPS) In areas, where the necessity of further regulation of the toll prices is felt, the above mechanism can be supplemented with Real Income Linked Toll Pricing System (RILToPS). The aim of this system is to further integrate and relate the toll prices with the economic conditions. In this system, the right of the private sector to vary the toll prices is expropriated, while rest of the Core Payment mechanism based on GMR remains the same. Here, the public sector and the private body agree upon a Base GMR (Gb), a Base toll price (Pb) and an indexation ratio (Ir) at the outset. The essence of this mechanism lies in the indexation ratio. The two elements that are considered in the indexation methodology are the CPI and the nAEI. The year of commencement of contract may be considered base year for both these indexes. Note that the real value of AEI is not considered here, but the nominal value. The reason for such consideration is justified by the fact that CPI may increase or decrease at a faster rate than nAEI, thus affecting the willingness to pay by the users. Consideration of either nAEI or CPI singularly may put both the users and concessionaires into financial hardships depending on situations. The indexation methodology helps to create equilibrium and may be defined as follows: Where, nAEIi = nominal Average Earning Index in year ‘i’. CPIi = Consumer Price Index in year ‘i’. Higher Ir shall mean higher proximity of Equivalent Index to nAEI, while lower Ir shall mean higher proximity to CPI. The value of Ir needs to be agreed between the public and private sector before financial close. The effect of the EI will be reflected on the toll prices in the following way. Where, EI0 = Equivalent Index at the time of commencement of contract. The revision of the toll prices can be done monthly, quarterly, six-monthly or yearly as per the convenience and feasibility. The reason for attractiveness of this mechanism lies in the previous mechanism. Even if the toll prices are reduced due to lower AEI, private sector will enjoy certainty in revenue from increased GMR. This makes the whole mechanism much more flexible and adaptive to the economic conditions without much impact on the private sector accounts. This can be considered as a virtual load-shift mechanism, where the share of the financial burden between the user and the public sector can be adjusted based on the economic scenario. Benefits • While the component of LPVR provides cost certainty to the public sector, the thresholds help in creating an upside for the private sector to make profits. 31 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways • The demand risk is substantially mitigated. While public sector’s risk of over-paying the concessionaire in case of high traffic is nullified by the target present value of revenue, the demand risk is substantially reduced from the private sector by a Guaranteed Minimum Revenue and flexibility in contract. • The emphasis on performance and efficiency of private sector is highly strengthened by the introduction of performance-based adjustments. This can substantially improve the performance of roads as well as the residual value of the assets post contract period. It helps in providing better value for taxpayers’ money. • The issue of perverse incentive for the private sector in case of Guaranteed Minimum Revenue has been addressed by inducing flexibility through a reciprocal relation with toll prices. • The toll pricing mechanism gets aligned with the economic conditions of a region or country by linking to both CPI and nAEI. This can considered as a form of virtual financial stimulus during economic crisis. Under this system, the efficiency of the private sector in long-term capital budgeting can be leveraged upon by the public sector. • There can be considered as the closest we can get to true sharing of demand risk. • This mechanism enjoys the properties of real tolls, shadow tolls, and performance-based mechanisms all within one mechanism. • Most importantly, this mechanism introduces an innovative way to contractually regulate toll prices without compromising value for money. 3.3. Concluding Remarks This section provided a complete assessment of the tendering process and the payment mechanisms under the theoretical framework developed in section 2. In this process, this section delivered one new model (Real Toll Regulation Mechanism) that can substantially improve the overall VFM in User Toll based roads. Some key findings of this section are: Tendering Section 3.1 found significant improvements in the tendering process in UK Highways. However, the following changes can further strengthen the process. • Prequalification may be supplemented by an objective process to evaluate the performance of the bidders from the perspective of their past clients. • To be fair as well as accurate in judgment ISOP needs to be structured objectively, or else to supplement the bidders with a standard to which the improvements can be substantiated by the bidders and hence can be measured by the Agency. • Among the illustrative documents, an illustrative list of cost segments to be considered for the project may be included. 32 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Payment Mechanism Although the payment mechanisms have evolved in a positive direction, the effectiveness of the mechanisms is still doubtful. The key observations are: • The monetary value of the adjustments and bonuses must be studied further. Assigning inappropriate values may render the incentives ineffective. • Incentive mapping processes must be established to assess the framework before implementation, and eliminate any conflicting incentives or perverse incentives. • The risk of obsolescence to the public sector needs to be kept in mind while structuring the proxy elements. Referencing should be a preferred form of benchmarking than assigning target values. In addition, it is necessary to understand the implications in order to decide what kind of referencing is appropriate e.g. use of comparator roads or previous performance on the same road. • Monitoring is the most vulnerable area and must be improved. At present, it is costly and vulnerable to opportunism. • Demand risk needs to be shared in an effective way. Current mechanisms shield the private sector completely from this risk, which is undesirable. • Toll prices must be regulated to the benefit of the public. Toll Price Regulation System as developed in this section may be helpful in alleviating the current issues of toll-based PPPs. 33 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 4. Operational Assessment 4.1. Safety Performance In 2000 the Government set a target to reduce road accident casualties on all roads by the year 2010. Although, the report (HA, 2009a) points to a significant improvement in the safety of the roads and Highway Agency’s success in meeting the targets, it is worth assessing the contribution of the DBFOs in such reduction. In economic theories of PPPs, the argument of private sector’s superiority in terms of efficiency is rather clichéd. In the following section, we will evaluate the performances of the DBFO roads as compared to the traditionally procured roads. Choice of Data In this evaluation, we have used the National Accident Data (secondary data) from the Safety Operational Folder of Highway Agency with due permission from the Agency. The data provides us with the Killed or Seriously Injured (KSI) statistics of 14 areas and 9 DBFOs from the year 1994 to 2005. We triangulated statistics with a similar set of Data from Operational State of Network 2009 (HA, 2009b). Some incongruence was observed in the data, possibly because of different sources of data and different methods of classification. On cleaning the data from such disputes, the population was reduced to 12 areas and 8 DBFOs. Also, DBFO 23 (A1 Darrington to Dishforth) was further eliminated from the population, as the DBFO became operational in the year 2005. This further reduced the population to 12 areas and 7 DBFOs. Refer Appendix II for the data. Statistical Constraints Before we proceed any further, it is important to acknowledge some of the constraints inherent in this analysis. • Relatively few DBFO roads have been executed so far, which inhibits the scope of grouping variables with significant amount of cluster membership from the DBFO projects. • There exists another problem posing a substantial threat to statistical analyses. A single DBFO/non- DBFO road may consist of variables that vary not only between groups/projects/areas, but considerable entropy in data exists in a project itself. For example, different carriageway sections under the same DBFO road may tend to have different characteristics like different traffic volume, traffic flow, width, number of lanes, junctions, and even different social variables. Discrete analysis of such data from each project is complex and may tend to distort the overall effect of the procurement route, which is the prime question to be answered. Methodology of Data Analysis The methodology follows a two-stage analysis. The first stage will employ a sophistication of crude analytical techniques. The second stage will employ clustering techniques. Both the stages have their own benefits, which will be discussed next. Stage I It was observed that the entire population of DBFOs in our data pool becomes operational between early 1997 and 1999. Hence, we have considered the year 1999 as the benchmark. Year 1998 was not considered for benchmarking as majority of the DBFOs became operational in the year 1998, and the pure effect of the transition is most likely to appear in statistics from the year 1999. Here, we will use a two-dimensional approach. The analysis involves: • Comparison of performances of DBFO and AREA under a specific period, say PRE 1999 • Comparison of performances pre 1999 and post 1999 under a specific set, say DBFO. 34 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways The benefit of this analysis is derived from the timeline comparison (before and after transition). While, the post-1999 comparison will provide us with some indicators, the transition comparison pre and post- 1999 helps us to understand if any inherent characteristic of the area is distorting the indications. This can be considered a powerful method of addressing any masking problem created by factors beyond human control. E.g. Hilliness, weather, social characteristic, demography, etc. Stage II For stage 2, we have considered Equivalent Traffic Flow (refer Appendix V) as our discriminating parameter and employed K-means cluster analysis to group the project cases into three relatively homogenous clusters. K-means clustering is a method of cluster analysis aiming to partition n observations into k clusters, in which each observation belongs to the cluster with the nearest mean. Then the performances of the DBFO and non-DBFO projects are compared within each cluster to capture any plausible indication of performances. The grouping into clusters based of TF helps us to compare the data within homogenous groups of similar characteristics. This is because, Traffic flow bears a relationship with physical character like road width, number of lanes, etc, and also to the demographic factors like industrialization. It is worth mentioning that the projects in a cluster may not be identical in all respects, but is expected to be similar to certain degree. Cluster Membership Cluster 1 Cluster 2 Cluster 3 Area 1 Area 2 Area 3 Area 6 Area 4 Area 8 Area 7 Area 12 Area 10 Area 9 DBFO 16 DBFO 20 Area 13 DBFO 18 Area 14 DBFO 19 DBFO 15 DBFO 21 DBFO 22 Figure 6: Box-plot for Cluster discriminating variable (Equivalent Traffic Flow) Data Analytics and Interpretation Stage I Post transition (1999 onwards) the weighted average accident rate in the DBFOs has always be better than other non-DBFO Areas, if not substantially better (Figure 7). However, before the transition, the case has not been very different either (except in 1996). Hence, there appears to be no significant improvement through the difference in procurement routes. Similar is the observation in pre-transition and post-transition scatter (Figure 8 & Figure9). In addition, while DBFO roads constitute 9% of the total road length in our data pool, it accounts for more than 8% of the accidents. This is proportional and indicates similar level of performance in the DBFO and the non-DBFO roads. 35 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Figure 7: Year-wise Weighted Accident Rate Comparison Figure 8: Pre-transition Scatter based on year Figure 9: Post-transition Scatter based on year Figure 10: Accident Vs Traffic Volume (Vehicle KM) Figure 11: Accident Vs Traffic Flow (Vehicle) 36 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways We can consider that the reduction of accident rate post 1999 should speak about the learning curves and the safety management capacity of the public sector and the private sector. While the rate has reduced by 29% in the non-DBFO roads from 1999 to 2005, the reduction is merely 21% in the DBFO roads. In this case, the public sector seems to be learning faster and delivering better performance than the private sector in reduction of accidents. We do acknowledge the possibility that inspite of superior effort from the DBFO Co, the reduction has been not substantial due to other factors like demography, driver tendency, etc. These factors are beyond control of the DBFO Co. Figure 10 looks at the behaviors of the DBFOs and the non-DBFOs, both before the transition and after the transition. Before 1999, the rate of increase in accidents with increase in traffic volume was relatively similar in both DBFO routes and the non-DBFO routes. Post 1999, although, the non-DBFO routes have remained consistent, the scenario for DBFO routes have deteriorated drastically. This may be indicative of the inferior ability of the private sector to reduce the accidents on roads under gradually increasing traffic volume. However, we must remember that the scope of DBFO have been restricted to maximum of 4 Billion Vehicle kilometers per year, while the public sector has dealt with a broad range of 2.5 Billion to 15 Billion vehicle kilometers. On extrapolating the regression line of the DBFO to a range of 15 Billion vehicle kilometers, the prediction may point at better performance of DBFOs. However, this roots from a variance in our assumption of similar safety levels caused by the physical, social, and environmental factors. The extrapolation points at better performance primarily due to the inherent character of the roads and may not reflect superior performance by the DBFO Co. The is partly because of the fact that the intercepts in the period before transition is similar to that after transition. Had there been significant improvement because of the DBFO Co, the intercepts should have been different. This raises the question that on further increase in the road length or traffic flow of DBFOs, how successful the private sector may be in controlling the accidents. As of now, the behavior predicts a disappointing trend. Let us further decompose our analysis to assess the behavior of the DBFOs under increasing traffic flow. On a visual inspection of Figure 11, we can again rule out the effect of the intercepts in our interpretation because of the same reasons mentioned previously. Although, on comparison of the behavior of DBFO and non-DBFO post transition represents better performance of the DBFOs, this appears not the case on comparing the pre-transition and post-transition behavior. Hence, we will look at the percentage variations in the rate of change individually under DBFO and non-DBFO. This will be able to remove the masking effect of inherent characteristics of the DBFO and the non-DBFO routes. It is observed that although there is deterioration in behavior of both DBFO and non-DBFO routes, the deterioration in case of DBFO (108%) has been substantially more than non-DBFO (35%). This may point at two possibilities. It may be that the DBFOs are not very capable in handling safety under increasing traffic volumes. It may also be that the safety adjustment is not significant enough to offset the savings generated from underinvestment in safety. In either case, the safety payment mechanism is not working in the expected direction. Stage II We shall begin this stage with the analysis of cluster 1, which consists of a population of six non-DBFO areas and three DBFO areas. 37 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Figure 12: Cluster1- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) Figure 13: Cluster1- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) Figure 12 presents the dot-scatter plot between the accidents and the traffic volume post 1999. In accidents vs. Traffic volume, there is substantial similarity with the nature of graph presented in stage I 38 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways for the total population. These points to the fact that DBFOs are certainly not very superior in safety performances than non-DBFOs. However, there is a substantial difference with the nature of the graphs presented in stage I, when the dot scatter is plot between accidents and the Equivalent Traffic Flow (Figure 13). Infact, the trends can be seen to have reversed. While in Stage I, accidents had a positive relationship with the Equivalent Traffic Flow, in this case the relationship is negative. However, even under diagrammatically opposite trend, it must be noted that the rate of decrease in KSI under non-DBFOs is much superior to DBFOs. Does it point to better performance by DBFOs in managing safety under increased traffic flow? For that, we would need to look at the pre and post scenario to understand better. Note: A positive relationship seems to be more logical than a negative relationship. This is because Traffic flow is a count of number of vehicles passing across a point in a given duration. Higher traffic flow would mean (in extremes) either a combination of higher speed of vehicles or a higher headway (higher spacing between the vehicles in transit), or lower speed of vehicles at lower headway. In both these cases, higher speed and lower headway can result into increased accidents. The positive relationship between speed and accidents is statistically evident by TRL report (Taylor, Baruya & Kennedy, 2002). Now, let us have a look at the scenario before 1999 for accidents vs. traffic flow plots (Figure 13). On comparing the post transition scenario with that of pre transition, there does not appear to be any significant difference in the behavior of the DBFO and non-DBFO areas. The difference between stage I and stage II behaviors in KSI vs. TF plots root from possible variations in our assumptions that the physical, social, and environmental conditions have similar effect on all roads. Therefore, our prime indicator should be derived from the pre and the post comparison in stage II and not stage I. The comparison of the pre-1999 and post 1999 (Figure 13) reflects no substantial improvement, and the capacity to manage safety under growing traffic flow is quite similar for both private and public sector, and resonates with the indications of Stage I analyses. Figure 14: Cluster 2- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) 39 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Figure 15: Cluster 2- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) Figure 16: Cluster 3- Pre and Post 1999 Accident Vs Traffic Volume (100 Million Vehicles KM per year) 40 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Figure 17: Cluster 3- Pre and Post 1999 Accident Vs Traffic Flow (Million Vehicles per year) The final indications for Cluster 2 and Cluster 3 are coherent to Cluster 1. On a broader view, the indications in Stage I and Stage II remains consistent: DBFO performances have not been significantly better than the non-DBFO performances. Commentary In this, we tried to answer the question “Are the DBFOs substantially superior to the non-DBFOs in safety performances?” The assessment reveals that the private sector performance in managing safety has not been very superior to the public sector performance, in spite of incentives in the payment mechanisms of Highway DBFOs. This may be a result of: • The monetary value of safety payment adjustments/bonus is not significant enough for better investment in safety. • The safety aspect is influenced by factors that are beyond the control of the DBFO Co. Whichever be the reason, the question here is if there is any necessity of including the safety element in the Payment mechanisms. Although we do not argue the presence of safety element in the overall contract, weaving safety to the payments has not proved to be entirely effective. Therefore, it is necessary to reassess the contract and restructure the responsibility with a view to optimize costs without compromising the benefits. There are several reasons, which justify the removal of safety element from the payment mechanism. For example, 41 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways • Structuring and monitoring the comparator roads may be a complex task and is costly. This extra cost would have been justified, if the performance of the DBFOs were exceptionally better than the non-DBFOs. However, this is not the case. • The safety adjustments affect the stream of revenues for the private sector, and may be contributing to the risk perception of private sector and their lenders. This perception of risk contributes to an extra risk premium. The extra premium is being borne for a purpose, which is not being served! Removing the safety element from the payment mechanism and structuring it differently may contribute to a reduction in risk premiums. • Certain elements affecting accidents (e.g. social factors) can be controlled by the public sector better than the private sector. • Even if, it can be argued that private sector is more efficient than public sector, the assessment results show that they do not have any inclination of raising their standards above public sector performance. Atleast, the current contract structure has been unable to incentivize superior performance. In the capacity of this research, we have developed an alternative mechanism to restructure the safety element into the procurement process. It is called Point Based System (refer Appendix III) and is expected to deliver a stronger incentive to the private sector in improving safety without any commercial side effects. 4.2. Innovation and Externality Innovation in construction is difficult to define as compared to telecommunication, software or the manufacturing industry. The reason lies in the very fact that construction is a customer led industry and not product-led. Here, the product is defined by the customer more often than the producer. Hence, each product requires an individual treatment with multitude of possible innovations. In addition, factors like geographical location, demography and even weather conditions define the specificity of the product and constrain implementation of all innovations. Secondly, innovation is relative, especially in construction industry. What may seem to be innovation to a person of less exposure and experience may not be an innovation to a person of greater exposure and experience. This further constrains the identification of innovations. Thirdly, definition of innovation bears a substantial relation to time. While at times, short term benefits like cost or time effectiveness may be the basis of identifying innovation, it may not remain the same in the longer term when the externalities surface. Any such innovation that has a high amount of negative externality ceases to be an innovation in true sense. This not only constrains identification of innovation, but also weakens the reliability of innovations without substantial evidence in practice. In the capacity of this research, only one form of specific innovation could be identified in UK DBFOs, which is use of Rhinophalt in road surface treatment. Rhinophalt is a single application preservative, which slows the natural ageing and deterioration of the road surface. The process can be reapplied every few years to help protect the surface from the effects of heavy traffic and weathering, and works on asphalt and macadam. The product is considered to have negligible externality in terms of skid resistance and texture depth. The product was under approval by the Highways Authorities Product Approval Scheme (HAPAS) in April, 2010. 42 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Although no other specific innovation was identified, consensus was on the fact that the emphasis is majorly on reducing the construction time in DBFOs. Thereby, innovations via programme management are dominant that lead to reduced construction time. The emphasis on cost saving innovations seems to be lot less than what is expected under the economic models in PPPs. The lack of innovation is partly attributed to the financing system and the payment mechanisms, which incentivizes time saving effort rather than cost saving effort. Secondly, approval of innovations by the public sector authority is time taking. In such cases, the time dimension further discourages even investments to explore any possible cost saving innovations. Thirdly, due to bounded rationality and non-availability of proper knowledge management systems, the possibility of implementation of the available technologies is sometimes weakened. Leakage in Value for Money – Innovation drainage There is a vital leakage in VFM arising in the tendering process (both this and previous forms). Firstly, owing to bounded rationality, it may be argued that an individual bid may not be able to take into consideration all the possible innovations. This restricts the solutions from being optimum and the bid proposals fail to achieve full potential in improving VFM. Secondly, it is possible that certain desirable innovations are particular to individual proposals. The legality involved due to intellectual property rights (IPR) restrict such innovations to be incorporated into the PPB’s proposal without prior permission from the other bidders. This is further worsened by the fact that the unsuccessful bidders do not have any incentive to permit such transfer of innovation to the successful bidder, unless properly compensated for. This leads to a leakage in VFM, as often the contracting authority may have to leave out valuable innovations. The basic requirement to address this problem is to establish a robust knowledge management system. In this regard, a model for rectifying the leakage has been put forward. This model attempts to address this leakage through a proposal of an externalized structure called the Innovation Enhancement Structure (see Appendix IV). However, this model is an introductory concept and can be developed further. 4.3. Concluding Remarks Two forms of assessment were carried out in this section. While, safety performance assessment was purely quantitative, innovation assessment was based on qualitative analyses. The key findings were: Safety Performance: The performance of the private sector has been comparable, but not superior to private sector. The possible reasons may be: • The monetary value of safety payment adjustments/bonus is not significant enough and weakens the incentive for better investment in safety. • The safety aspect is influenced by factors that are beyond the control of the DBFO Co. It may be desirable that: • Safety performance adjustments may be removed from the payment mechanism. Instead, safety element may be restructured in a way that strengthens the incentives, but does not affect the payment stream. • In absence of safety performance incentives, the Agency may release manuals that outline the complete standards to be maintained for safety (analogous to road quality manuals). 43 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Innovation: • No substantial evidence was found in terms of innovation except for one. The argument of PPP theories on enhancing innovation fails in this case. • A leakage in VFM was identified in form of innovation drainage. These issues can be addressed by: • Establishing a strong knowledge management system led by a public body. • Indirect and non-financial incentives are desirable to enhance and share innovations. 44 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 5. Conclusions & Recommendations This fundamental aim of this research was to appraise the efficiency of the contractual framework in Highway PPPs in the UK, to understand the causalities and suggest possible improvements in the framework. Thie methodology focused on capturing implementation gaps and bridge them by designing solutions that can improve the VFM aspect in highway PPPs, be it through increasing efficiency or reducing costs. The research used a two-tier approach to assess the contractual framework of Highway PPPs in the UK. In the first tier of assessment (Section 2 & 3), the contractual framework was vetted against the economic theories leading to improved knowledge about what aspects of the theories have been ignored by the contractual framework (implementation gap). In the second tier (section 3 & 4), the operational performances were vetted against the contractual framework leading to improved knowledge about the effectiveness of the current contractual framework under light of the implementation gap. Overall, it helped in identifying problems that restricted alignment of the two realms and contributed towards rectification of these problems. This research has also made an effort in developing solutions in form of institutional and payment models. 5.1. Research Overview The research required in depth understanding and conscious knowledge of three basic questions. These were: ‘What is the theoretical framework for highway PPPs? ‘ After study of various literatures on PPP economics, those that were found relevant to our area of research are theory of incomplete contracts and private information, transaction cost economics, concept of bundling and unbundling, principal agent problem and optimum risk sharing, supplemented by the concepts of whole life cycle costing. However, it was also felt necessary to take into consideration the commercial issues that the contemporary PPPs are faced with like revenues (Toll and Annuity), Costs (financing, CapEx and OpEx) and benefits. This helped in structuring a very practical and result oriented framework for our analysis. The framework was structured into 14 points addressing key issues pertinent to the tendering process and payment mechanisms. It included issues of moral hazard, adverse selection, incentivizing, toll regulation, financing, use of proxy elements and contractual ambiguity. To what extent do the existing PPPs conform to this framework? The study of the tendering process and the payment mechanisms were carried in tandem with the framework. While the tendering process was found to be quite sound, the payment mechanisms were found to be plagued with various non-conformities. The problematic area in payment mechanism was particular to improper incentive mapping and use of proxy elements. In events, where proxy elements appeared to be sound, the need to study the monetary value of the incentives was felt. In terms of regulation problem in toll-based projects, a payment mechanism called the Toll Price Regulation System was developed. This mechanism may be considered as one of the major contributions of this research. Under the current level of conformance, how successful have PPPs been in delivering results? This section tested two areas of the operational performances. One related to the safety performances, while the other related to the extent of cost saving innovation in PPPs. Both these assessments did not fetch any encouraging results. 45 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Safety performance was found comparable to public sector project, but not better. Incase, the public sector’s motive has been to incentivize better safety performance, it seemed to have failed due to low strength of incentives. However, there also appeared a possibility, where safety may not be controllable by the private sector due to other factors. This research attempted to rectify this problem by developing a model called point-based system (see Appendix III). Innovation in highway PPPs were not encouraging in particular. Just a single innovation was identified. The reason here are numerous. Firstly, incentives in the payment mechanism was found to be somewhat overruled by the commercial aspects. Secondly, the time taking approval process was found to be another discouraging factor. Thirdly, lack of knowledge management system was found to be another major obstacle. It not only restricts innovation, but also causes a leakage in Value for Money in PPPs. In this regard, an introductory concept in form of Innovation Enhancement Proposal has been put forward (Appendix IV). 5.2. Research Findings Some key findings of this research are: • The tendering process is well aligned with the theoretical concepts of procurement economics. However, there is still need for further improvement in the Prequalification and ISOP stages. • Payment Mechanism appears to be the vulnerable area of the contractual framework because: Effectiveness of the valuation of incentives in form of unit values of performance bonus/adjustment seems uncertain. There are considerable areas of conflicting incentives and perverse incentives that need to be reassessed. The effectiveness of certain proxy elements is uncertain. Current monitoring methodology is costly and vulnerable to moral hazard that may degrade value for money. Demand risk, in most cases, is completely borne by the public sector, which is undesirable. In real tolls, toll prices lack regulating mechanisms, which is absolutely essential. • Safety performance mechanisms were found to be ineffective as per the operational assessment. • The case for innovation is considerably weak. Proper incentivizing mechanisms for innovation must be put into place. 5.3. Recommendations • To include a criterion in the prequalification procedure based on the comparison of a bidder’s commitments to actual delivery in past projects. E.g. Time and cost overrun, quality of delivery based. • To be fair in judgment ISOP needs to be structured objectively, or else to supplement the bidders with a standard to which the improvements can be substantiated by the bidders and hence can be measured by the Agency • Among the illustrative documents, an illustrative list of project specific cost segments may be included. • The monetary value of the adjustments and bonuses must be studied further. 46 | Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways • Incentive mapping processes must be established to assess the framework before implementation, and eliminate any conflicting incentives or perverse incentives. • The risk of obsolescence to the public sector needs to be kept in mind while structuring the proxy elements. Referencing should be a preferred form of benchmarking than assigning target values. In addition, it is necessary to understand the implications in order to decide what kind of referencing is appropriate e.g. use of comparator roads or previous performance on the same road. • Toll prices must be regulated to the benefit of the public. Toll Price Regulation System as developed in this research may be helpful in alleviating the current issues of toll-based PPPs. • Safety performance adjustments may be removed from the payment mechanism. Instead, safety element may be restructured in a way that strengthens the incentives, but does not affect the payment stream (as in Point Based System). In absence of safety performance incentives, the Agency may release manuals that outline the complete standards to be maintained for safety (analogous to road quality manuals). • A strong knowledge-management system led by a research oriented public body needs to be established to boost cost effective innovations. Indirect and non-financial incentives are desirable to enhance and share innovations. Innovation Enhancement structure as developed in this paper may be further researched in this direction. 47 | Bartlett School of Graduate Studies, University College London
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  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways 86. Taylor M.C, Baruya A, Kennedy J.V (2002) The relationship between speed and accidents on rural single carriageway roads, Report TRL511, Transport Research Laboratory (UK) 87. Valila T (2005) ‘How expensive are cost savings? On the economics of public-private partnerships’, EIB Papers, 10, 1, 94-119 88. WB (2007), Transport Investment, Economic Growth and Poverty reduction, World Bank , Bangkok (http://siteresources.worldbank.org/INTURBANTRANSPORT/Resources/340136- 1152550025185/TransportGrowth&Poverty-ZL.pdf) 89. Williams, T.M. (1999), The need for new paradigms for complex projects, International Journal of Project Management, (1999), Volume 17(5), 269-273 90. Williamson, E.O and Masten S.E. (1999) The economics of Transaction Costs,E. Elgar, Cheltanham. 91. Winch, G.M (2002), Managing Construction Projects: An information processing approach, Oxford: Blackwell. 92. Woodruff, C. (2002). Non-contractible investments and vertical integration in the Mexican footwear industry, International Journal of Industrial Organization, vol. 20(8) (October), pp. 1197-1224. 93. World Bank (2003): World Bank Group Private Sector Development Strategy Implementation Progress Report, Washington DC 53 | Bartlett School of Graduate Studies, University College London
  • APPENDIX I: Forms of Public Private Partnerships (Source - Deloitte 2006) Design-Build (DB): Under this model, the government contracts with a private partner to design and build a facility in accordance with the requirements set by the government. After completing the facility, the government assumes responsibility for operating and maintaining the facility. This method of procurement is also referred to as Build-Transfer (BT). Design-Build-Maintain (DBM): This model is similar to Design-Build except that the private sector also maintains the facility. The public sector retains responsibility for operations. Design-Build-Operate (DBO): Under this model, the private sector designs and builds a facility. Once the facility is completed, the title for the new facility is transferred to the public sector, while the private sector operates the facility for a specified period. This procurement model is also referred to as Build- Transfer- Operate (BTO). Design-Build-Operate-Maintain (DBOM): This model combines the responsibilities of design-build procurements with the operations and maintenance of a facility for a specified period by a private sector partner. At the end of that period, the operation of the facility is transferred back to the public sector. This method of procurement is also referred to as Build-Operate-Transfer (BOT). Build-Own-Operate-Transfer (BOOT): The government grants a franchise to a private partner to finance, design, build and operate a facility for a specific period of time. Ownership of the facility is transferred back to the public sector at the end of that period. Build-Own-Operate (BOO): The government grants the right to finance, design, build, operate and maintain a project to a private entity, which retains ownership of the project. The private entity is not required to transfer the facility back to the government. Design-Build-Finance-Operate/Maintain (DBFO, DBFM or DBFO/M): Under this model, the private sector designs, builds, finances, operates and/or maintains a new facility under a long-term lease. At the end of the lease term, the facility is transferred to the public sector. In some countries, DBFO/M covers both BOO and BOOT. PPPs can also be used for existing services and facilities in addition to new ones. Some of these models are described below. Service Contract: The government contracts with a private entity to provide services the government previously performed. Management Contract: A management contract differs from a service contract in that the private entity is responsible for all aspects of operations and maintenance of the facility under contract. Lease: The government grants a private entity a leasehold interest in an asset. The private partner operates and maintains the asset in accordance with the terms of the lease. Concession: The government grants a private entity the exclusive rights to provide operate and maintain an asset over a long period of time in accordance with performance requirements set forth by the government. The public sector retains ownership of the original asset, while the private operator retains ownership over any improvements made during the concession period. Divestiture: The government transfers an asset, either in part or in full, to the private sector. Generally the government will include certain conditions with the sale of the asset to ensure that improvements are made and citizens continue to be served.
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways APPENDIX II – Safety Operational Performance Assessment Data Set Table 1: Killed or Seriously Injured Statistics in Numbers % decrease from 1994- Sample 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2005 Area 1 85 74 100 86 94 86 102 110 92 71 72 68 20.00% Area 2 146 167 96 133 116 125 118 136 130 128 130 90 38.35% Area 3 237 249 176 214 256 298 273 292 262 269 238 201 15.18% Area 4 318 287 273 295 295 322 216 239 259 265 214 234 26.41% Area 6 273 264 292 253 221 239 229 253 256 170 215 224 17.94% Area 7 241 232 251 248 188 216 227 226 207 175 192 155 35.68% Area 8 281 343 352 310 321 331 313 298 261 281 232 280 0.00% Area 9 290 254 300 289 261 220 213 220 201 141 139 162 44.13% Area 10 220 174 171 196 228 189 225 205 179 224 179 196 10.90% Area 12 219 241 230 269 192 191 180 218 220 206 187 158 27.85% Area 13 204 160 204 199 157 190 185 126 129 167 124 132 35.29% Area 14 128 97 138 110 118 137 92 83 101 101 101 86 32,81% DBFO 15 34 31 39 29 24 26 21 25 22 24 23 21 38.23% DBFO 16 64 46 70 69 31 48 44 59 43 59 46 45 29.68% DBFO 18 13 5 1 9 19 9 11 7 8 14 8 10 23.07% DBFO 19 16 22 12 18 10 2 4 5 3 5 14 4 75.00% DBFO 20 46 63 67 46 49 72 76 61 64 73 52 57 (-)23.91% DBFO 21 12 20 26 23 14 9 23 15 16 12 13 9 25.00% DBFO 22 48 41 41 28 68 34 41 24 49 22 31 30 37.50% Table 2: Traffic Volume in 100 Million Vehicle Kilometers Sample 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 % inc Area 1 27.4 28.20 28.80 29.50 30.50 30.60 31.30 32.70 33.70 34.40 35.20 36.00 31.38 Area 2 56.6 58.70 61.20 62.20 64.20 65.40 65.50 69.80 70.80 72.90 73.40 76.10 34.45 Area 3 104.5 107.8 112.1 115.6 119.4 123.3 125.0 129.1 132.2 131.6 133.5 134.5 28.70 Area 4 57.1 58.90 61.50 63.50 67.10 67.00 67.10 69.50 70.60 72.10 73.90 75.20 31.69 Area 6 48.5 49.80 50.90 53.30 54.50 56.00 56.20 58.40 58.60 60.40 61.80 61.70 27.21 Area 7 50.8 52.50 55.20 56.90 57.80 59.40 57.90 59.50 60.00 62.30 64.50 64.70 27.36 Area 8 77.4 79.90 83.30 84.70 89.80 91.40 89.30 92.90 93.20 96.20 99.80 99.60 28.68 Area 9 73.4 75.70 79.00 81.30 84.60 85.20 85.70 85.50 89.20 89.40 90.70 91.90 25.20 Area 10 107 111.2 116.0 119.5 123.2 125.2 126.8 134.3 135.2 139.9 144.6 143.1 33.73 Area 12 70.3 72.60 76.10 77.40 79.90 80.70 82.00 84.80 87.30 87.80 91.10 91.30 29.87 Area 13 37.1 38.30 39.70 41.00 42.60 43.50 42.30 42.40 44.40 43.80 46.40 46.30 24.79 Area 14 30.6 31.50 32.70 33.80 34.50 35.10 34.10 35.90 37.00 36.80 37.70 37.70 23.20 DBFO 15 4.10 4.20 4.30 4.40 4.50 4.80 4.70 5.10 5.20 5.10 5.10 5.10 24.39 DBFO 16 13.6 14.00 14.60 15.00 15.50 16.40 17.20 17.60 17.90 18.40 18.60 18.80 38.23 DBFO 18 5.90 6.10 6.30 6.50 6.70 6.80 7.10 7.80 8.40 8.60 7.90 8.10 37.28 DBFO 19 3.60 3.70 3.70 3.90 4.00 4.00 3.80 4.10 4.00 4.30 4.10 4.40 22.22 DBFO 20 31.7 32.80 34.40 35.20 36.60 38.50 38.90 39.10 40.20 39.00 39.60 38.90 22.71 DBFO 21 4.30 4.40 4.50 4.60 5.00 5.20 5.40 5.80 5.70 6.10 6.10 6.30 46.51 DBFO 22 5.20 5.40 5.50 5.60 5.60 5.70 6.10 6.40 6.40 6.70 6.70 7.00 34.61 B| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways APPENDIX III – Structuring Safety Performance in PPPs: Points Based System The following system is aimed at strengthening the incentives for private sector to improve its services without involving any direct financial impact on the payment streams. It reduces cost in numerous ways, reinforces the conditions for competitive bids, and integrates the Highway Agency procurement system to an extent for DBFO, MAC, eMAC routes. The system is not only capable of affecting the performances for the future contracts, but can significantly affect the performances of already signed and established contracts. It has been designed keeping in mind the existing information technology system of Highway Agency, so that the system can be implemented with minor modifications in the system without incurring substantial IT up-gradation costs. What is Point Based System (PBS)? As the name suggests, PBS uses points to measure the performances of the private sector, without making any complex use of comparator roads. The idea is to make these points an essential element in awarding contracts of any form (in PQQ), wherever the responsibility of safety rests with the private sector. This means introducing a new criterion in the selection process with appropriate weights on the points gained by private sector. How to award Points? The system uses accident rate (PIAs per 1000 Million Vehicle Kilometers) as the primary assessment parameter. This ratio helps in bringing the performances to a similar scale, taking into account both the traffic flow (scope) and the length (scale) of the project. It tends to make the judgment fairer. In case of absolute measurement of PIAs, a company managing higher stretch of road or higher traffic flow would have been in a disadvantageous position as compared to a company managing smaller stretch of road or smaller traffic flow. Then, it is required to set up a benchmark from a particular year (say 2006) for measurement of the performances. All companies may be allocated a common score of points (say 100 points) at the beginning of this stage. The accident rate for the benchmark year is used as the first reference point for basing the comparison. The accident rate for the next year can be compared to that of previous year for addition of further points or deduction of points (benchmark year in this particular case). The number of points to be added or deducted is determined by setting up a band based on percentage improvement or percentage deterioration. Consider the following example. Percentage Improvement (PI) = [(ARn-1 – ARn) * 100]/ARn-1 Where, ARn = Accident rate of the year in consideration. ARn-1 = Accident rate of the previous year. In case of the 1st year (say 2007), the previous year would be the benchmark year (2006 in this case). (Note that the comparison is made between the performances of the same road on two consecutive years and does not use a comparator road for measurement.) The band for awarding points may be designed as follows: Deterioration / Deduction of points Improvement / Addition of Points PI 80+ …… 20-39.99 0-19.99 0-19.99 20-39.99 …. 80+ Point Award -5 points -2 points -1 point 1 point 2 points 5 points C| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways The above band allocation is solely for purpose of explaining the system, and is to be designed appropriately subject to feasibility of this proposed system. Under such band, the points scored (PS) by a company for a particular project in a particular year is: PS = [PI] Where, [ ] = Box function indicating the points allocated for percentage improvement or deterioration, falling in a particular range as defined. What projects to be considered? Any project/road/area, which uses a form of contract that makes the private sector responsible for the safety performance should be considered in this system. For example, DBFO, MACs, etc. The domain must be defined depending upon the contract agreements. Whom to allocate the points? The concerned organization responsible for managing safety may be allocated the points. It must be noted that in case of DBFOs, the points must not be allocated to the SPV. In this case, the points must be allocated to the constituent parties in the SPV. That is, if the performance comparison in a project results in deduction of 5 points, 5 points should be deducted from the existing scores of all the parties involved in the contract. This helps in making the constituent parties accountable for the performance irrespective of the SPVs they are involved in past, current or future projects. A similar methodology can be used for other forms of contract, where similar situations may arise. Special Cases It is possible that a particular company in a particular year is involved in different SPVs in different projects or is involved in two or more MACs as well. In those cases, the average of the points gained or lost may be assigned to its previous year score. For example, say a company is involved in 2 DBFOs and 1 MAC with (-)5, (+2), (+1) points respectively after current year’s performance comparison. The effective points to be awarded is (-5+2+1)/3, i.e (-)0.66 points. If the company’s previous year’s score is 105, then the revised score will be 104.34. A score of 100 is assigned to any new entrant in this market, who does not have a history of previous projects. However, this area can be further researched to decide upon what score to be assigned to a new entrant. . Effective score (ESAn) = Sn-1 + ( )/k Where, ESAn = Effective Score of an private sector organization A in a particular year ‘n’. Sn-1 = Effective Score in year ‘n-1’ for a organization A k = Number of projects undertaken by organization A in year ‘n’ under the defined domain of considered contracts. PSi = Points Scored by Organization A in the year ‘n’ in the i-th project. How to use this point score in the selection procedure of future contracts? It is possible that there is ‘p’ number of constituent members in an SPV or other entity bidding for a contract. In those cases, average of the Effective Scores of all the constituent members may be assigned to the combined entity. The average score may be used as a criteria for awarding the contract, be it a DBFO Contract, a MAC Contract or any other contract. D| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Average Effective Score = ( ESin )/p Where, ESin = Effective score of the i-th constituent member of the combined entity consisting of ‘p’ members in the year ‘n’, when the contract is awarded. Benefits • This system completely removes use of ‘comparator roads’ and encourages the private sector to compete with its own performances as well as performances of its competitors. This increases the incentive for the private sector to improve its services and improves the case for consistent improvement. • The system is structured into the initial stages of project and directly affects the prospects of future business based on performance. This can be far more effective than use of financial incentives or penalties, which have not proved significant in aligning the behavior of private sector to the public interest. • The removal of safety adjustments eliminates impact on the long-term stream of payments, which helps in alleviating the risk perception of private sector for a particular project. • This system is not only capable of affecting performances under contracts to be signed in future, but can substantially affect the performances of already signed contracts. • The system is a very significant regulatory step from the public sector, which reduces the public perception of PFI as a ‘backdoor entry of privatization’. • It can be instrumental in continuing the interest of the private sector in delivering high quality performances throughout the period of the DBFO contract. This arises of the fact that the performances in DBFOs will also affect the selection of contractors under short-term contracts like MAC. The performance will affect their future business prospects and hence, provides them with an incentive to perform equally in all projects. • This system can contribute heavily towards reducing bid prices for contracts. This arises from the fact that if a company has lower score (reflecting inferior performances in the past), it will have to close the gap with lower bid prices in orders to be competitive. • The system reduces contract structuring and monitoring costs substantially by eliminating the use of ‘comparator roads’. The scores can be generated from the existing IT system of Highways Agency, and can be automated with minimal expenses. • This system integrates the Highway Agency network largely irrespective of the contract. • The system is extremely flexible as the final weights of the Average Effective Score in awarding a contract rests with the public sector. In cases, where the preference of the project is somewhere else, the weights can be considerably reduced. Auxiliary Regulations E| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways Scope can be kept for the private sector to claim better scores. In those cases, Highways Agency can authorize specific consultant organizations for validating the claims. The cost of consultants in those cases is borne by private sector, who wishes to put up a claim. In addition, private sector can be allowed to put up possible recommendations to the public sector in terms of laws, rules, or regulations, that the private sector may consider valuable in reducing accidents. This system incentivizes the private sector to research its area of operation in the social or environmental domain, which tends to increase accidents. The private sector may be encouraged to commission studies to universities and research organizations in such domains. This transfers a substantial cost of research to the private sector, and encourages proactive participation of private sector to make roads safer. F| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways APPENDIX IV: Innovation Enhancement Proposal for PPPs – Introductory Concept The design of this structure is driven by three objectives: a) Encouraging increased innovations by alleviating the problem of bounded rationality. b) Capturing the benefits of these innovations in the bid proposals, ex ante of financial close. c) Overcoming barriers of IPR by incentivizing private sector to share the innovations. Innovation Enhancement Structure Under the current form of PPP procurement, the bid proposals, especially the technical aspects of innovation is evaluated by a body inside the Agency or is commissioned to another body by the Agency. However, given the limited work force of the public sector, evaluations (both ex ante and ex post of financial close) take considerable amount of time. This structure proposes establishment of a Public Body for Validating Innovation (PBVI), or leveraging over existing bodies like Transport and Road Research Laboratory (TRRL), Highway Authorities Product Approval System (HAPAS), etc. Under this structure, every organization involved in road transport is encouraged to register its innovation with the PBVI under the condition that the innovations shall be available to any interested party through the PBVI database. The bottom line of this structure is to establish a robust knowledge management system that can cater to the above three objectives. The incentive for the organization is to accumulate score assigned by the PVBI, which depends upon the impact of the innovation on the public benefits and associated cost reduction. These scores can be introduced as a criterion in the PQQs (irrespective of the procurement route) and ISOP (in PPPs). The incentives for the bidder to participate in this structure emerge from the facts that: • Being a part of tendering criteria, the score will play a crucial role in any project under public domain. • The availability of scores in public domain increases the possibility of being used by the private clients as well. This incentivizes the bidder to participate, enhance the scores, and increase its chances of winning even private clients. • This score can go a long way in establishing the reputation of the bidder in delivering innovative solutions. • The opportunity cost of sharing an innovation can be offset by the availability of innovations from other bidders. • The return on investment in an innovation can be threatened by not sharing it. This is because; the bidder then looses points and can end up not qualifying, which restricts him from leveraging from the innovation. Defining Innovation Here, innovation refers to any concept or technique that leads to maximization of ‘measure of innovation’, which is ‘associated benefits less associated costs’. Please note that we are not using the word ‘new’, which often forms the basis of any proposed definition of ‘Innovation’. The reason is the very fact that new concept is a relative to experience and expertise. Any concept or technique that is new to a particular bidder may not be new to the others. The idea of this structure is to create a database, which can not only leverage from private sector’s capability to innovate, but can also benefit from its efficiency in implementation. Hence, any concept that has a positive measure of innovation may be included, and it must be left to the bidder to decide whether to implement it or not. Measure of Innovation = ΣBenefits - ΣCosts G| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways However, it is to be made clear to the bidders that neither PBVI nor the Agency will be endorsing or taking up the responsibility of any innovation. It is not always possible to understand the externality of innovation ex ante of implementation, and it must be left with the bidders to take the decision. This will avoid any possibility of future claims that would arise otherwise. Regulating use of database in Highway PPPs The innovations must be archived with reference to time-line. Pre-financial Close • Any innovation that the bidder might want to implement needs to be evaluated and registered with the PBVI. • The use of the database in bids can be restricted up to those that have been archived before the submission of the priced bids. • Innovations that emerge between the submission of the priced bids and financial close should be reflected into the bid price, if the bidder feels necessary. Post-financial Close • Use of innovations that were registered before financial close can be restricted post financial close, or may be agreed on the basis of price reduction or any other benefit to the public sector. • Any valuable innovation that emerges post financial close may be implemented based on a negotiation between the agency and the contractor. The basis of such negotiations should be long- term relationships and the agreement may or may not be in favor of price reduction. Who can contribute to the database? • The database can receive inputs from Agency personnel; PBVI personnel; private sector organizations like consultants, contractors, etc; research institutions like universities and independent institutes, etc. However, points can be gained only by private sector organizations based on only those innovations that they share. This aspect can be developed through further study. • It may be possible that certain innovations may involve use of certain materials or technology that belongs to a third party vendor e.g. chemicals to increase life of road surface, technology involving intelligent traffic systems, etc. These innovations may be shared and registered by a bidder only with prior permission from the third party and when there is evidence of their successful use in previous projects. Benefits • These encourage the bidder to carry out due diligence on the available range of innovations and internalize those before financial close. Consequently, there is an increased possibility of improved bid proposals and therefore, improved VFM for the Agency. • It reduces the strain on the Agency and lets it focus on the other aspects of the bid. There is a shortening of time, as the PBVI’s evaluation process is simultaneous to Agency’s evaluation of other aspects of the bid. • It creates uniformity in the knowledge of the bidders and helps in furthering the competitiveness of bids. • It can lead to enhanced collaboration between industry and the academics and encourage research led innovation. H| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways • The structure may generate revenue and can be self-sustainable, if periodic subscription charges are levied. The PBVI may also collaborate with public sector in other nations for sharing the benefits, and may be able to generate revenue from grants. • PBVI may be able to keep a continuous track of the innovations that are registered and are implemented. In the long term, it can develop into a substantial source of knowledge regarding the externalities of the innovations registered in the database. I| Bartlett School of Graduate Studies, University College London
  • The Efficiency of Procurement in Transport Infrastructure PPPs The Case of UK Highways APPENDIX V: Equivalent Traffic Flow Traffic flows vary according to the carriageway sections due to continuous entry and exit of vehicles using slip roads, etc. This translates to the fact that different vehicles may travel different distances on the same road. Hence, the Traffic Volume takes the value of T= (Ki . Xi) Where, Xi = Distance between to points on road allowing entry or exit to the road Ki = Traffic Flow in the particular stretch Xi measured per year in this case. and, X1 < X2 < X3……………………….Xn ≤ ( ℎ ℎ ) For simplicity in our analysis, we will consider Equivalent Traffic Flow (TF) for the entire road or area, which can be representative of the general trend in the entire area. (K X) = …….eq10 Hence, = ……..eq 11 Where, X is the total length of the road. J| Bartlett School of Graduate Studies, University College London