Private Finance Initiative - Treasury Contents

Written evidence submitted by Andrew Barrie, Vice President Operations and Jon Mitchell, Development Director, KBR International Government & Defence


1.1  As a large organisation which participates in major project delivery in several business sectors, KBR can give evidence of the value for money benefits of PFI where cost and risk considerations have driven key decisions in the design of the solution and adoption of new practices in the interest of reduced whole life cost. However, the authors consider that a major determinant of success or failure of any project is the quality and experience of the project leadership (both client and contractor) and that this is not currently receiving sufficient focus. We consider that PFI should have a firm place as a useful and effective procurement model in appropriate circumstances but that especially in the current period of severe fiscal constraint the government should place greater emphasis on project leadership and also actively promote the use of alternative procurement models such as financially incentivised collaborative alliance contracting.

1.2  We consider that the driver for selection of appropriate procurement routes should be to optimise risk transfer, recognising that different procurement models will impact on initial contract value as well as the risk adjusted outturn forecast—ie risk transfer may come with an initial price premium.


2.1  This memorandum is submitted by Andrew Barrie and Jon Mitchell of KBR International Government & Defence. The authors both have broad experience of project and operations management spanning defence, government, transport utilities, hydrocarbons and other commercial sectors, including in particular the negotiation and execution of a number of major PFI projects.

2.2  KBR is a leading engineering, procurement and construction company with more than 35,000 employees in 45 countries on five continents and offering a range of services through ten business units: Downstream, Gas Monetization, Infrastructure & Minerals, International Government & Defence, North American Government & Defense, Oil & Gas, Power & Industrial, Services, Technology & Ventures.

2.3  KBR is currently delivering Private Finance Initiative (PFI) and Design Build Fund & Operate (DBFO) projects in many sectors such as the Heavy Equipment Transporter and (in joint ventures) Project Allenby Connaught, the 1420 km Alice Springs-Darwin railway, several road projects in the UK and the N8 in Southern Ireland. KBR has also provided technical consultancy advice for DBFO schemes.

3.  What are the strengths and weaknesses of different public procurement methods?

3.1  Our perception is that Government contracting agencies can tend to follow a mantra that "outsourcing is more efficient and industry is better at managing risk" but then fail to give sufficient care and attention to structuring the procurement in order to optimise the transfer of risk. Contractors are of course unlikely to challenge those areas where the contracting authority has retained inappropriate risk.

3.2  In the hydrocarbons and utility sectors we observe a two way flow of senior personnel moving between client and contractor organisations and we see this as a healthy indicator of the intelligence of the sector in procuring and delivering major projects. On the other hand we see comparatively little interchange of senior project and commercial personnel between major contractors and public contracting authorities. This division into two resource pools together with the "arms length" separation between industry and public bodies that is being driven by public procurement processes is in our view having detrimental effects on project outcomes. Poachers often make the best gamekeepers and vice versa.

3.3  While the choice of the procurement method is important, it is our experience that the quality of project leaders and managers in the client organisation and the supply chain organisations a significant factor in determining whether a project succeeds or fails. We suggest that too little emphasis is currently being placed on the capability and experience of project leadership; (a) by the contracting authority when establishing its project team, (b) by project teams when selecting the supply chain and finally (c) in the integration of the project delivery team.

3.4  In commenting on different public procurement methods below we have obviously focussed on those which seek material transfer of risk. There is, of course, a very small class of projects where it is appropriate for contracting authorities to self perform the management and accept risk but these models have not been discussed.

3.5  PFI models

3.5.1  In the search to reduce cost and/or reduce risk in a competitively tendered PFI environment there is no doubt that designs and solutions differ from those produced through other procurement routes. We can cite many examples from KBR PFI & DBFO projects (eg bridge deck design, pavement design, buildings design, general scheme rationalisation, development of a supply chain strategy, selection of materials and the introduction of enhanced condition-based maintenance strategies) where new solutions have been used and/or current solutions have been improved or developed in the interest of lower whole life cost.

3.5.2  It is recognised that PFI has driven industry to develop much greater knowledge and understanding of operating and maintenance costs. BRE and other studies demonstrate that knowledge of lifecycle costs is greatest in sectors where PFI has been most extensively used (eg healthcare), confirming that PFI has and is adding value.

3.5.3  A common criticism of PFI is inflexibility however we can point to examples such as Heavy Equipment Transporter and Project Allenby Connaught where the contracting Authority properly foresaw the need for flexibility. Appropriate mechanisms were built in to the concession agreements in order to accommodate significant variability in utilisation levels, collaborative development of detailed elements of the solution and provide much additional transparency in pricing data which has and will continue to facilitate the effective pricing of change and deliver enhanced value for money.

3.5.4  PFI is denigrated (by the press and less well informed) for the high cost of change and any additional services. We wholly endorse the view expressed by Dr Tim Stone of KPMG in his memorandum on PFI procurement to the Economic Affairs Committee where he noted that costs of late changes are often and quite appropriately material but that under other procurement methods such costs are rather easier to bury.

3.5.5  A weakness of PFI can be the time & high cost of the procurement phase itself and this may be significantly exacerbated by poorly managed Competitive Dialogue and any lack of data or general uncertainty around the requirement. This is a factor which must be considered and managed but should not in our view rule out the method.

3.6  Turnkey or EPC models, potentially with two stage appointment

3.6.1  Turnkey or EPC models provide for effective transfer of cost, delay and some aspects of performance risk and but pay little heed to issues associated with through life cost and will not lead to optimised solutions. We view this as a material drawback.

3.6.2  Two stage contractor appointments are becoming the dominant route in the private sector. Initial selection is focused on the competencies and skills of the contractor's team and the price for the capital works is then developed in collaboration with the client, which in turn leads to much closer integration of the overall project team and tangible benefits in quality, cost and time.

3.6.3  Such routes are in no way ruled out by the EU Procurement Directive or SI 2006 No 5 however we observe that few public contracting authorities focus on selection of the design and delivery team and instead revert to capital cost estimates as the principle method of selection. We believe this hesitancy should be challenged very robustly.

3.7  Alliance models with gainshare/painshare mechanisms

3.7.1  The private and utility sectors have had considerable success in the use of incentivised alliance procurement models (eg Scottish Water, Southern Water) in which client and contractor sign up to a target cost at an early stage and thereafter adopt this as the basis for common financial incentive structure, sharing the gain or pain of the final outcome by formula. Whilst there have been a number of defence projects which have been procured through hybrids of this model ( eg CVF Carrier project, Surface Ships Alliance, MBDA Complex Weapons, D154 Devonport) our view is that the outcomes have not always been optimal.

3.7.2  Having reviewed KBR's long track record in incentivised alliances (which dates back to the North Sea offshore developments of the 1990s) we have drawn two key conclusions which may in part explain why the alliance route has not yet had the success one might expect in public works and services:

—  As noted above, success is often related to the capability and effectiveness of leadership and focus on successful integration of the project team.

—  The incentivised alliance model has been most powerful where the 'business as normal' cost base is well understood and the driver is major cost reductions. The dramatic fall in oil prices spawned the use of alliances in the North Sea and it is widely recognised that that savings in the capital cost of delivery of between 15% and 20% were normal and repeatable. The alliance models adopted by most clients provided a vehicle for delivering transformational change, although it may not be so well suited to "first of type" projects where there is material uncertainty in the calculation of a target cost.

3.7.3  The ability of incentivised alliance models to deliver transformational change and major cost savings resonates very loudly in current times of post CSR/SDSR austerity measures. We encourage the Committee to ensure these options are properly considered as an alternative to PFI on appropriate projects.

3.8  LABVs

3.8.1  While KBR has no Local Asset Backed Vehicle (LABV) projects currently in its portfolio, we have undertaken detailed investigations of various LABV models and consider them to be an attractive option for outsourcing of non core activities of government departments. It is our view that LABVs have the potential to integrate many of the best of elements of the Alliance and PFI contracting models:

—  Encourage a business management perspective where contracting authority and contractor work together to a common goal rather than creating an adversarial contracting environment.

—  Provide a robust and balanced governance framework based around articles of association of a joint venture and the well developed rigour of a board of directors.

—  Enable capital investment from private sources - but subject to proper scrutiny.

—  Avoid the lengthy procurement periods and start up costs of PFI models.

—  Create a business relationship that can cope with a changing and dynamic environment.

4.  If PFI debt had been on-balance sheet rather than off-balance sheet would PFI projects have been used as much? How should PFI deals be accounted for?

4.1  We can only comment upon those projects which KBR has either bid or ultimately won and in this context we are confident that all of our PFI projects would have proceeded, regardless of the accounting methodology. We are, however, aware of projects which we consider were suitable for consideration as PFI projects but where the client subsequently reverted to a more traditional procurement route and sense in some cases a subjective reaction to the complexity of PFI procurement and concern about the on/off balance sheet issue.

4.2  It is our view that accounting rules should not unduly influence the selection of procurement routes. PFI saves money by driving more carefully considered and cost effective solutions however transferring risk to the private sector inevitably carries a price. Dependant upon the project and the contracting authority, we hold the view that the price premium for risk transfer can and does still represent good value for money.

4.3  We are not well placed to express views on the matter of controlling public sector borrowing and how debt funded PFI projects should be treated in this context, save to note the vital importance of maintaining adequate investment in infrastructure during the next decade of fiscal constraint.

5.  How far can risk really be transferred from the public to the private sector?

5.1  We would propose a different perspective on this question and ask the Committee to reflect upon how much and how far could the private sector contribute to the management of public sector's risks, which we believe is substantially more than is achieved at present.

5.2  PFI has proven to be an effective vehicle for the transfer of delivery and operation risk to the private sector. Project audits have demonstrated much greater certainty of timely delivery, increased customer focus and success in transferring risk associated with the cost of construction and operation. The contracting authority nevertheless retains some key risks such as lack of future flexibility, changes in legislation, future sale of consortium members and increased service demand.

5.3  As discussed above, PFI is but one of a number of models which can achieve effective transfer of risk, but no public procurement method will relieve the contracting authority completely. Each method has its own distinctive 'fingerprint' of risk transfer. It is therefore up to the contracting authority to determine which procurement method and which "fingerprint" best suits the particular project and the contracting authority's strategic needs.

6.  Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals, or particular projects which are suited for PFI?

6.1  As noted above, PFI has proven extremely effective in transferring delivery risk and cost risks in circumstances where there is a robustly defined and enduring requirement, where the nature of the project is not novel, and there is a good understanding of current and future utilisation levels. PFI projects are in the largest part delivered to time and to budget.

6.2  In our view a contracting authority should not use the method for the whole of its asset portfolio unless it is extremely confident that it can manage the potential need to reduce or indeed enlarge the portfolio in the longer term.

7.  What state guarantees are explicit or implicit in PFI deals?

7.1  Early in the negotiation of Project Allenby Connaught, the client & contractor teams reached a conclusion that given the size and scale of the project, failure was not a realistic option and which should be avoided as far as possible. The response was to design a concession agreement which, as far as possible, focussed on rectification and not remedy—anticipating those circumstances which might require either state guarantees or contractor parent company guarantees and ensuring that the agreement set out fair and effective mechanics to ensure timely mitigating action before crisis was reached.

7.2  The contracting authority deserves due credit for its maturity of approach in this regard and we would hold that the final solution offers better value as a result.

7.3  In PFI projects, the state should reasonably provide guarantees for those aspects which it is best able to (or it alone) can manage, principally its own utilisation of the asset, and also such matters as war and certain risks associated with change in legislation.

7.4  We consider that the Committee should give some thought to customary approaches to insurance of assets in PFI deals and whether this provides best value for money.

8.  In what circumstances are PFI deals suitable for delivery of services?

7.5  Two of the projects in which KBR is participating are predominantly service contracts (Heavy Equipment Transporter and Project Allenby Connaught). We would hold that PFI can be extremely effective for the delivery of services and suggest that this view is fully supported not only by the end users but also by the NAO audits that have been carried out on these projects.

7.6  As touched on above, we would commend that the Committee gives careful thought to the use of long term business partnerships (ie GoCo &/or LABV models) as routes to delivering cost savings for non core activities, such as provision and operation of training facilities and logistics infrastructure as is used by the armed forces, police and other emergency services.


9.1  It is the view of the authors that the PFI model has earned itself a firm place in the public procurement toolkit based on the evidence of successful delivery. It should not be ruled out because of known issues, which we see as largely associated with lack of flexibility.

9.2  Notwithstanding, the use of PFI needs to be considered on a case by case - or project by project basis. Indeed it would be sound strategy to maintain several solutions in the toolkit, including turnkey, incentivised alliance and LABV models and then ensure that each deal is carefully shaped and structured and the final decision on procurement methodology made by an experienced commercially competent core team.

April 2011

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Prepared 10 August 2011