House of Commons - Public Accounts - Forty-Seventh Report

Select Committee on Public Accounts Forty-Seventh Report

THE PRIVATE FINANCE INITIATIVE: THE FIRST FOUR DESIGN, BUILD, FINANCE AND OPERATE ROADS CONTRACTS

THE MANAGEMENT OF THE PROCUREMENT PROCESS

7. The objectives of the Highways Agency in letting these contracts were as follows:

a) The new roads would be designed and constructed and the new and existing roads would be maintained and operated safely and satisfactorily so as to minimise any adverse impact on the environment.

b) The enthusiasm of the market for such road contracts would be tested across a range of different scheme types.

c) The contracts would assist in the establishment of a road operating industry within the private sector.

d) Innovation would be promoted.

e) Value for money would be maximised through the use of a competitive process and by allocating risks between the public sector and the private sector in the most appropriate manner.[4]

8. During April and May 1994, the Department and their advisors consulted widely with key players and potential participants on the concept of Design, Build, Finance and Operate roads. This exercise ensured that when the competitions for the four roads were formally announced in the Official Journal of the European Communities in August 1994 the market was well prepared, giving the Agency confidence that there was sufficient interest to stage worthwhile competitions.[5]

9. The Agency received pre-qualification submissions from 17 consortia comprising some 70 individual companies. Twelve consortia met the pre-qualification criteria and the Agency ranked them against the individual projects in accordance with the scores achieved.[6] The Agency decided to invite four consortia to bid for each project taking account of various factors in addition to the scores achieved at the pre-qualification stage. The ability to build and finance the project was a major consideration. No consortium was to be invited to bid for more than two of the projects and where possible the Agency took into account preferences expressed by the consortia at pre-qualification.[7] Table 1 shows the 11 consortia invited to bid for each project and their ranking position at pre-qualification.

Table 1: The consortia invited to tender for each scheme and their pre-qualification ranking

M1-A1	Ranked	A1(M)	Ranked	A419/A417	Ranked	A69	Ranked
UK Highways	2=	Road Management Group	1=	Road Management Group	1=	Autolink	3=
Yorkshire Link	2=	Connect	4	Connect	1=	Modern Highways	3=
Express Route	7=	Autolink	5=	UK Highways	3	RoadLink	7
Hochtief	7=	Modern Highways	5=	National Road Operators	7	Graham Network Operators	8=

Source: Comptroller and Auditor General's Report, Figures 4 and 5

Note: Route Management also pre-qualified but were not invited to bid

10. We asked the Agency why two of the top ranked consortia for each of the two largest projects—the M1-A1 and the A1(M)—were not invited to bid for those projects. We also asked why the Agency had selected for the A69 bidders whom they had ranked only third equal, a seventh and an eighth, and whether better deals might have been obtained had higher ranked consortia been invited to bid. The Agency told us that they sought to achieve a position whereby any consortium achieving pre-qualification was capable of producing a quality bid capable of winning the competitions. The pre-qualification stage itself was not aimed at selecting winning bidders but had to take account of the preferences expressed by bidders and of the likely capability of particular bidders to take on more than one project.[8]

The scope for innovation

11. Evidence from those involved in the bidding process indicated that although innovative solutions were encouraged in the tender documents, in practice, the Agency showed little enthusiasm for them. Twice as many indicated that the Agency were not enthusiastic about their innovations than those who indicated the Agency were enthusiastic.[9]

12. We therefore asked the Agency why they did not do more to encourage innovation. The Agency told us that they had been constrained by commitments and decisions made during the public inquiries which had taken place before the competitions were opened. Since the contracts were signed, however, they had varied core requirements where they had been convinced there had been a demonstrable case for doing so. Consortia had sought some 3,400 variations to standards of which some 3,000 had been pursued and 372 requests for innovative variations had been made of which some 94 per cent had been accepted. All of these variations had been consistent with the Secretary of State's statutory obligations. The Agency said that they had learned lessons from these four projects and would continue to learn in the future.[10]

13. The core requirements specified by the Agency were derived from the project plans and orders following public inquiries. In response to the Agency's invitation some bidders proposed variant bids which sought to provide value for money but departed to some extent from the core requirements. To ensure fairness the Agency did not pursue such proposals without allowing other bidders the opportunity to bid on the same basis. This led on one occasion to the bidder withdrawing the suggested variation, as the bidder did not wish to share the idea with other bidders. In the event the bidder concerned won the competition and re-introduced the variation which was accepted by the Agency and saved an estimated £600,000. The bidder had, however, originally estimated the saving at £1 million.[11]

14. We asked how such a case would be handled in the future to ensure that the benefits of innovations put forward could be exploited and whether a way could be found to enable bidders with innovative ideas which gave them a competitive advantage to bid on that basis. The Agency told us that on implementing innovative ideas they would remain constrained by undertakings given during public inquiries. They said that European procurement rules required them to be careful to ensure that all bidders felt that the process was fair to them all. The Agency admitted, however, that they needed to look closely at the lessons learned from this first set of contracts to see how best they might encourage and exploit innovative ideas.[12]

The length of the procurement process and the cost of advisors

15. There were delays in the procurement process compared with the original timetable. Ministers had originally said that the first contracts would be let within 18 months of the announcement that competitions were to be established in December 1993. In practice they were awarded between January and March 1996, some six to nine months after the latest target date.[13]

16. We asked the Agency why the competitions took so long and what steps had been taken to improve matters. The Agency told us that they accepted that it had been a long process but the reason for the delay was the experimental nature of the projects. The contracts were complex, required extensive consultation with the industry and the City and clear financial models. The development of the model contract had also extended the time required. They said that they had learned lessons, and that documents such as model contracts had and would be used on subsequent contracts. They had also been passed to other organisations such as local authorities who might wish to adopt the Design, Build, Finance and Operate approach. The Agency told us that they were hopeful that these lessons would reduce the cost and time required for future contracts.[14]

17. We asked the Agency whether they believed bundling individual road projects together had risked delay to the projects concerned and jeopardised the PFI as a whole. The Agency told us that decisions on which projects should go ahead were for Ministers but that they believed the decision to use the PFI approach had brought these projects forward earlier than had they been subject to conventional procurement. They did not believe that bundling projects together would lead to delays in the future because they had now been through the learning curve.[15]

18. The Department of Transport and the Highways Agency made extensive use of external advisors to provide financial, legal and technical advice during the procurement competitions. In total they spent some £8.3 million on external advice to let the first eight Design, Build, Finance and Operate contracts. Information was not available to disaggregate this figure between individual contracts.[16]

19. We asked the Agency why their advisory costs had been so high and why they had no disaggregated information about the costs of individual projects. The Agency told us that there were three reasons for the high costs: Ministers had sought policy advice on whether the schemes were viable or not; specific project advice was sought on the first four projects themselves; and, project advice was also provided on the second tranche of four schemes. All of this work had been covered by single contracts with the legal and financial advisors.[17] Although they had not disaggregated the different elements in the fees paid to individual advisors, they told us that fees were mainly in respect of financial and legal advice. This had been required because of the financial complexity of the deals and because of the development of the model contract aimed at securing the position of the Secretary of State in the future.[18]

20. We asked the Agency for information on the original fee caps set for the advisors and why these had been renegotiated. The Agency told us that in 1994-95 they had set fees for individual advisors and had subsequently renegotiated them as shown in Table 2. In 1995-96 the Agency had set a total budget of around £6 million to cover all three sets of advisors but had not set individual budgets.[19]

Table 2: Original and renegotiated 1994-95 fee caps set for advisors

Advisors	Original cap (£)	Renegotiated cap⁴ (£)
Hambros / Price Waterhouse¹	660,000	1,008,000

Denton Hall²	264,000	426,000
Sir William Halcrow and Partners³	70,000	150,000
Totals	994,000	1,584,000

Source: The Highways Agency

Notes:

1. To assist in the development of the Design, Build, Finance and Operate concept up to tender invitation stage.

2. Appointed to provide legal advice on the development of a model contract.

3. Appointed to supplement Agency resources in preparing tender information.

4. Caps were renegotiated during 1994-95 in recognition of the complexities involved, and the addition of four new projects to be taken forward.

21. The Agency told us that as the complexity of the deals became better understood, it was clear that the original budgets would not be sufficient. During the process Ministers decided to go ahead with a further four schemes under tranche 1A which also came within the remit of the advisors' contracts.[20]

22. We asked the Agency whether the fees were charged on an hourly rate, whether they were fixed for a particular task or whether a simple cap was applied above which reference back to the Agency was required. They told us that fees were based on hourly rates and that they were satisfied that such an approach offered value for money as the appointment process had been very competitive.[21]

23. We asked the Agency why they had not paid their advisors on a task by task basis. The Agency told us that it was a matter of judgement but that it might have been more risky to adopt a fixed price basis for developmental work of the kind involved. This was because should the Agency decide to cut the work under the contract they would still have been liable for full payment. We asked whether the use of hourly rates had weakened the Agency's negotiating position with their advisors. The Agency told us that there had been some extremely straightforward conversations during and since the contract negotiations.[22]

24. We asked the Agency why advisors for the second tranche of contracts had not been tendered for separately rather than simply re-appointing existing advisors and whether any change in hourly rates had been negotiated. The Agency told us that the same advisors had been appointed for the second tranche because Ministers considered there to be an overlap with the first four contracts. There had been no re-negotiation of rates although since then the Agency had re-tendered the contracts for advisors .[23]

Conclusions

25. The Agency ranked the consortia who had achieved pre-qualification, but did not invite two of the top-ranked consortia to bid for the two largest road schemes. We do not see the point of ranking consortia at the pre-qualification stage, if those rankings are to be ignored, and we remain puzzled at the rationale for the choice of bidders for each scheme.

26. Following the award of contracts, the Agency accepted proposals put forward by the operators for more than 3,000 variations and innovative ways of varying standards. This suggests that the core requirements in the original tender documents were too tightly drawn to encourage novel ideas. However, the exploitation of private sector innovation is critical to the success of the PFI in delivering improved value for money. We expect the Agency to do their utmost in future to minimise core technical requirements.

27. These post-contract changes reflect innovations which might be applicable to other road schemes, whether or not privately financed. The Agency should learn from these ideas and consider how far they might be applied more widely.

28. We expect the time required to let such contracts in the future to reduce substantially now that the Agency have invested the time, money and effort in developing model contracts.

29. PFI contracts are inherently complex and there is therefore often a need for expert external advice. Notwithstanding the explanations offered by the Agency, we are concerned at the escalation in the cost of advisors from the original limit of just under £1 million to a final cost of more than £8 million. The Agency have now paid for their expensive policy advice and the development of a model contract. We therefore expect them to drive a much tougher bargain with their advisors in the future. Whenever possible advisors should be appointed on the basis of fixed prices for specific pieces of work. In the case of development type work, capped fees should be set in the light of experience and held to. Costs should be closely monitored and controlled against the agreed fees as they are incurred on a project by project basis.

4 C&AG's Report paras 1.2 and 1.4 Back

5 C&AG's Report para 1.10 Back

6 C&AG's Report para 1.12 and Figure 4 Back

7 C&AG's Report para 1.13 Back

8 Q2, Qs 33-36, 115-118 Back

9 C&AG's Report para 1.27(f) and Figures 22 and 23 Back

10 Qs 3-5, 100, 122 Back

11 C&AG's Report para 1.23 and Box 1 Back

12 Qs 101-103 Back

13 C&AG's Report para 1.1 Back

14 Qs 6, 82-87 Back

15 Qs 86-87 Back