Winning and profiting from PPP contracts
Date: 25 March 2015
Faced with a growing government appetite for public private partnerships (PPPs), local construction companies need to evolve their traditional business thinking, embrace the process and, most pertinently, understand how to identify and manage the various new risk factors.
Where once construction firms could bank on a relatively low-risk, publicly funded environment – entailing progress payments, Crown-borne debt and the potential to negotiate over-cost and time overruns – PPPs now require them to absorb those risks.
This transfer of risk in major infrastructure projects – Transmission Gully being a prime contemporary example – is increasingly finding favour with the New Zealand government, observes PricewaterhouseCoopers director Chris Money.
“On every project, the government is always asking the question, ‘What is the best value contract?’,” he tells NZCN. “Transmission Gully was picked because there is a lot of potential for transfer of risk to the consortia. Basically, they have handed over the entire corridor – there are power lines to move, gas pipelines, interesting geotechnical issues – and the Crown is essentially stating, ‘What goes wrong on that site is your problem’. Furthermore, the consortia won't even start receiving payments until the road is up and running.”
However, with New Zealand having entered the world of PPPs some years later than other construction markets, Mr Money says there is prime opportunity for local construction firms to “learn from others’ mistakes”.
KNOW YOUR PARTNERS
Emphasising the need for thorough due diligence prior to bidding for any contract, Mr Money encourages construction firms to form their core team early, foster an appropriate culture, embed themselves in the market-sounding process and, just as importantly, “know who you are partnering with”.
“A number of us across the sector have been generally surprised about the degree to which some firms in the New Zealand market have not done their due diligence on who they are partnering with,” he comments. “PPPs have brought a whole lot of new players on the financial side of things into New Zealand who local constructors are not familiar with. Go through the financial details with a fine-tooth comb and follow the money trails.”
Albeit formulating a sound and successful PPP bid is a multi-million-dollar exercise, Mr Money says the consequence of failing to invest in sufficient modelling and third-party advice can be catastrophic.
As a case in point, he cites the Sydney Cross City Tunnel. Despite constructing a “wonderful facility”, the toll revenue-reliant consortia over-calculated full-day traffic volumes off a base of morning peak flows alone, ultimately causing it to go under.
“Utilise professional services – financial modelling, risk modelling, commercial modelling and third-party advice. Understand what the full risk proposition is,” he says.
MANAGE THE RISK
Mr Money emphasises that PPP contracts “do not magically remove” the possibility of problematic issues arising during a project.
“Cost and time overruns do not disappear – but there are lots of things you can insure against to manage financial risk.”
He cites the five most common failures in the design and construction phase of a PPP as being:
• Unclear project definition and objectives
• Lack of a transparent control environment
• Lack of internal accountability
• Poorly defined project delivery and engagement strategies
• Absence of a robust approach to communication and reporting.
In terms of developing a successful governance model for PPP contracts, Mr Money recommends that managers:
• Prepare for failure
• Give their professionals the space to succeed
• Establish a common language
• Think about risk and disputes in the contracting phase
• Take a longitudinal approach to risk.
Furthermore, he says that in PPPs, it needs to be accepted by construction firms that their debt and equity providers will “effectively become part of the consortia”.
“Under PPPs it is a much more personal relationship between the constructor and financier. Construction firms will be dealing with hard-nosed financiers who are ready to action step-in rights and subcontract to another party if they are messing up.”
RISK VS REWARDS
Despite the numerous risks inherent with PPPs, Mr Money says there is potential for hefty reward for those construction firms that successfully navigate the pitfalls. One example is through pocketing the costed-risk portion of a contract by having minimised potentially problematic issues via process efficiencies and innovation.
“It’s the innovation component where the contractors will make the money. It’s about the outcomes. For example, with UK prison PPPs they have the ‘42 commandments’, but they then say ‘we simply can’t have any escapes – over to you to design a method by which that won’t occur’.”
He says there is also a large potential return to be gained through the long-term operation of the facilities. “Traditionally, in transport projects there has been the ‘give us the asset for the cheapest possible price’ type of thinking, which drives one type of construction behaviour. Whereas, with say Transmission Gully, if the emphasis is to have a great asset at the lowest possible cost over the next 30 years, the consortia start to look at higher-quality pavements so only two reseals rather than three will be required over that term,” he adds.
“The private sector is often better than the public sector in monetising those whole-of-life costs. It’s the trade-off between the short-term capital costs and long-term operating costs.”
Praising the New Zealand infrastructure industry for its prowess at designing and constructing to a given specification, Mr Money sees the pending major change in mindset as being it fully embracing the transfer of lifecycle cost risk: “For one example, the interface with the long-term asset management company, that really knows their business, and identifies that a workstation placement might save a worker ten minutes per shift and is willing to talk about the price associated with that move.
“That dynamic, and the construction people really understanding that the world is changing and it is about those whole-of-life costs and the value chain, is where we expect to see real success here. That is a newer area that the traditional New Zealand construction sector has not had to really think about before.”
– By Iain MacIntyre