With the Mafraq-Ghweifat Road linking the UAE with Saudi Arabia and Qatar having been put on hold, there has been a lot of discussion on the future of public-private partnership (PPP) in the region. One area of discussion has been the concept of value for money (VFM) and whether the PPP route offers the best VFM when compared to other procurement routes. In established PPP markets, projects are frequently criticised for lack of VFM, which is a key issue that has driven the need for undertaking lessons learnt exercises and refining the approach to public procurement and processes. The UK’s recent taking stock of the use of private finance initiative or PFI (particularly in light of the lack of available public funds) and consideration of procurement in the construction industry more generally, demonstrates, even in an established market, the importance of procurement delivering VFM.
VFM :
VFM can be defined as the optimum combination of whole-life costs and quality. It is not a lowest price assessment but rather an assessment of what you get for your money. For instance, the lowest construction tender may result in poorer quality materials being used and as a consequence the overall lifespan of a building may be less and the maintenance bill higher than it would have been with more expensive construction using better quality materials. Therefore, on a long-term view, the cheaper tender may not deliver the best VFM. The quality of outcomes and services is also important and a value needs to be credited to these.
VFM assessment :
VFM is not just something used to analyse success or failure after the event but is something that should be considered from the start. Once the decision to proceed with a project has been made, whether it is made on economic or social need grounds, the next question should be “is the proposed procurement route for the project in principle appropriate and capable of delivering VFM?” All methods of procurement should be considered in conducting this analysis. In the UK, the VFM assessment is part of the business case approval process and projects cannot go to market without this assessment being done. Doing a thorough VFM assessment at an early stage and before tender should minimise the chances of the project not being considered VFM at a later stage. After this initial assessment, the procurement is assessed on an ongoing basis to ensure that the original assessment of the procurement route offering VFM is still correct. It is not necessarily a bad thing that a project fails to go ahead with private financing. If a project is not thought to be VFM, it may be right that an alternative procurement route should be examined.
Procurement route :
Two key considerations in deciding the procurement route are the value of the project and the risk profile. The value of the project is crucial, as it needs to be sufficient to create market interest and justify the cost of raising private finance and the bid costs for the private sector. If bid costs are too high, they will encourage selective bidding by the private sector, in the sense that they will strategically bid for projects they think they have the best chance of winning, and also put off new entrants to markets. Market interest, of course, includes not only the appetite of bidders but also that of funders. If a project is too large, it will deter market interest as sponsors may not want to carry so much risk and may also not be able to raise sufficient funds. It, therefore, seems that there is range in value where private finance is attractive. In the UK, there is an assumption that for PFI to be VFM, the capital value of the project should be at least £20 million ($30 million). In addition to the optimum value of a project, there is the issue of risk profile and bankability. PFI passes the majority of risks, including cost overruns and delay, to the private sector. There has to be a substantial transfer of risk to the private sector to justify the additional cost of private finance. However, to achieve VFM, risks should be placed with the party that is best placed to manage them. If the private sector is not confident of being able to manage a risk, this will be priced into the cost at a premium, which will impact negatively on VFM. Whether the risk allocation represents VFM is something that should be kept under review as a PPP programme develops. What was once considered VFM may not be so in the future.
Ensuring VFM :
Both the value of the project and the risk profile will affect market interest, which is critical in delivering VFM through competition. It is the public sector’s responsibility to ensure that projects that come to the market are attractive to bidders. There is much the public sector can do to build private sector confidence in their projects and to reduce procurement costs, such as: • Ensuring that the project is adequately developed before coming to the market. At a basic level, this means having a clear understanding of the client’s requirements; • Undertaking a VFM assessment before going to the market. Once the procurement process has begun, VFM should be kept under review; • Having as clear and transparent internal approvals processes as possible. This will give the market confidence in the public sector and its capability to deliver projects; and • Ensuring good public sector project management. By having the required resources and experience and efficiently managing the procurement process, transaction costs will be kept to a minimum. All of the above items can be done without having a history of closed PPP deals. They are the first steps in making sure that PPP projects deliver VFM. Other things to improve VFM, such as standardisation of processes and documentation and reviewing operational projects, come later. The decision on whether to use private finance needs to be taken in view of the public sector’s ability to fund projects at a lower cost by more conventional means. Ideally, in making that decision, governments would be able to compare the VFM of using private finance against conventional government funding and be confident that, if necessary, they could fund the relevant projects by conventional means. Accessing funding by conventional means may not be realistic in the future, given the number of social and economic infrastructure projects in the pipeline in the region and the current global economic climate. It may be that to finance all the planned projects, private finance has to be used. If this is the case, it becomes a question of affordability and prioritisation.
Applying VFM assessments of procurement routes will be crucial if private finance is used because projects funded this way may become open to criticism on VFM grounds. The Mafraq-Ghweifat road project being put on hold may have shaken market confidence in PPP but market confidence is something that will recover. VFM assessment techniques will help with this and help us recognise when the right project comes along. * Katie Liszka is an associate at Norton Rose (Middle East) and is based in Dubai. Legal queries related to the construction sector can be addressed to Norton Rose (Middle East) LLP through Gulf Construction magazine at editor@gulfconstructionworldwide.com. Norton Rose Group has had a presence in the Middle East for 30 years and has advised developers, lenders, and contractors in relation to the legal aspects of a wide variety of construction and infrastructure projects in the region.
With a combined team located in the Abu Dhabi, Bahrain and Dubai offices, Norton Rose (Middle East) LLP is able to provide both contentious and non-contentious support to financiers, developers, contractors and specialist contractors in the region.
