Private Finance Initiative - Treasury Contents

Written evidence submitted by Dr Chris Lonsdale, University of Birmingham


—  Many of the shortcomings of the PFI have reflected more general problems within UK public sector procurement.

—  In terms of commercial skills and capabilities, the UK public sector has spent the 20-year life of the PFI attempting to create the necessary capacity. For many years, there seemed to be too little appreciation in the higher civil service ranks of the extent of the difficulties of complex procurements.

—  Genuine risk transfer is hard, although not at all impossible, for the public sector to achieve on major projects as a commercial team's negotiation stance is often affected by both the need to perform, without interruption, statutory duties and political imperatives.

—  Risk transfer under the PFI, and in public sector procurement generally, has been further affected by limited public sector commercial skills.

—  Collaborative working under the PFI has been criticised in the past. However, "strategic supplier management" is a relatively weak area of procurement practice in general.


1.  The Committee raises a number of pertinent questions in this inquiry. As the National Audit Office has said on a number of occasions, however, the evidence available makes it difficult to produce definitive answers. Nevertheless, some observations are possible and those here will mainly focus upon risk transfer.

2.  A key task in any attempt to answer the type of questions posed by the Committee is to differentiate between those factors driving commercial outcomes that are inherent to the PFI and those that are common to UK public sector (and, for that matter, private sector) procurement practice more generally.

3.  Issues related to the raising of finance, re-financing, excessive transaction costs and the designing of projects so that they are feasible for the PFI would appear to be, or have been, PFI-specific. Also specific to the PFI are concerns over the public sector comparator process and the "off-balance sheet" controversy.

4.  However, other issues, including one of the Committee's specific issues of concern, the transfer of risk, are more generic, either to UK public sector procurement or procurement practice in general. In this submission, I intend to focus on this latter category of issue, as my work extends beyond the confines of the PFI and therefore comparative observations can be made. Such a focus may also mean that this submission provides a different perspective from others.


5.  In the political arena, the PFI is often casually referred to as a form of privatisation. This is, of course, not the case, not least when it comes to the benefits that might accrue to the UK from its adoption. With privatisation, a set of economic activities is taken out of the public sector. With the PFI, economic activities remain a direct concern of the public sector and any benefits that the public sector obtains from private sector involvement have to be earned through effective procurement and contract management.

6.  Many reports have claimed that the increased use of the private sector in delivering public services and infrastructure over the past 30 years or so has generated benefits for the UK taxpayer. For example, the Julius Reporti cited cost savings of between 10% and 30%. These figures may or may not be accurate. However, value for money improvements (whether they be the aforementioned cost improvements or improvements from the other side of the value for money equation) cannot be assumed to automatically follow from private sector involvement, or from a deepening of such involvement (such as that which the PFI represents). Indeed, they will not follow if, as has been the case with the PFI, there has been a persistent, if by no means complete, lack of negotiation and contract management capability brought to bear on individual projects.

7.  Recent talk of a "revolution" in local government, with the Nicholas Ridley vision of an enabling authority at last potentially coming into being, suggests that there is still an under-estimation within large parts of the UK public sector and political ranks of the difficulty of effective procurement and contract management, and the shortage of genuine talent, especially when it comes to complex procurements. The proposed local government "revolution" (and ambitious outsourcing plans generally within the UK public sector) is reminiscent of the PFI—a policy that is to be rolled out ahead of capacity.

8.  Complex procurements, which PFIs usually are, contain relationship-specific investments and high switching costs (which render the threat of a return to the market less credible), uncertainty (which make negotiations over contract variations inevitable) and information asymmetries (which raise the possibility of moral hazard during contract delivery). These are highly challenging circumstances that test the best commercial minds. The extent of the team-building, preparation and internal political engagement that led to the successful procurement by National Savings and Investments in the late 1990s is instructive of the level of care and resources needed for success.ii

9.  Part of this under-estimation of complex procurements would also appear to be related to a lack of appreciation on the part of some of the sophistication, determination and robustness with which some private sector organisations pursue their self-interest as suppliers. This is a controversial area in the procurement and related economic literature, both empirically and philosophically (ie there is a debate over the frequency and extent of private sector robustness and a debate over the ethics of such robustness), but often public sector procurement and contract management practice has seemed weak or naïve, or both. As a head of a PFI unit within an NHS Trust commented in 2007: "Without doubt, the private sector will try to come back for extra money for every risk they haven't thought of before and do so by trying to pass off that risk as something new. They will use everything to increase costs, in particular any ambiguities in the trust's requirements. It is like a game of chess and you need an experienced team who knows how to play the game in order to obtain value for money."iii

10.  To a significant extent, therefore, many of the weaknesses in practice that can be identified across a large range of PFI projects, and which have limited the benefits of the policy, are simply a reflection of weaknesses in UK public procurement in general - an observation that cuts a different way across the question of the strengths and weaknesses of different public procurement methods.

11.  The problem of frequent asymmetries of skills and capabilities, vis-à-vis private sector counterparts, has also, as the National Audit Office continues to report, been supplemented by inadequate historical information held by government departments. Problems have existed at a number of levels.


12.  A key question being asked in this inquiry relates to risk transfer. A further question, regarding state guarantees, would appear to be related. The issue of risk transfer is affected by the aforementioned problems with commercial acumen, but is affected by other factors as well. Many of the problems with risk transfer under the PFI are not PFI-specific.

13.  here are a number of ways in which the term "risk transfer" can be understood, but my understanding here is highlighted by two contrasting situations. In the aforementioned National Savings and Investments PPP, Siemens Business Services was expected to take the risk of being able to reduce the cost of the business operation being outsourced—that is, if target costs were not met, no further monies would be made available to cover the consequent losses. In the PPP between the Ministry of Defence and Devonport Management Limited, by contrast, there was a cost overrun of £283 million on the Devonport facilities upgrade.iv In this case, rightly or wrongly, the main responsibility for footing the bill ended up with the Ministry of Defence, despite the fact that the original agreement stipulated that the risk for such an eventuality had been passed to the supplier.

14.  There often appears to be an underlying asymmetry in PFI and other significant public sector procurements in respect of risk transfer. There often seems to be an emphasis on the public sector body, given its statutory duties and wider political sensitivities, to both "do the deal" and ensure service continuity/project delivery. While an extreme example, the Libra project run by the Lord Chancellor's Department, as was, highlighted this point.v The supplier simply had a greater ability to walk away from the project, which was a major factor in the negotiations. In short, it facilitated "hold-up".

15.  If true, this means that the public body needs to work hard to create a contractual arrangement that will allow risk to be genuinely transferred. This is possible, as the National Savings and Investments procurement showed, but again highlights the need for highly developed commercial functions. It also highlights how the EU procurement regulations can often make life no easier in this respect.

16.  If we look at private sector practice, we see that one of the criteria for the selection of "strategic partners" (that is, suppliers used for complex, long-term contracts) is the amount of influence the private sector buying organisation has/will have over a supplier. This influence, in turn, is something that flows, in part, from the attractiveness to individual suppliers of the buying organisation's offer of business. Different suppliers in a supply market will often view a buyer's offer of business differently. A recent report by the highly-regarded consultancies Future Purchasing and Vantage Partners, referred to this as an analysis of "strategic interdependence".vi

17.  Private sector organisations can (and many do) include this criterion in their supplier selection methodology and explicitly seek to avoid selecting for complex, long-term projects those suppliers that are unlikely to be willing to accept a reasonable level of risk—because of how they view the buying organisation. Because of the EU procurement regulations, the inclusion of such a criterion in public sector procurements is much harder (although some things can be done and sometimes a project can, in its own right, be very attractive to even the most dominant players in the market). This fact, allied to the aforementioned lack of commercial acumen in many areas of the UK public sector and perceived need to "do the deal", may explain why, in research I have undertaken with two colleagues, we found that in the private sector contractual strife decreased with the need for relationship-specific investments, while in the public sector it increased—not dramatically so, but to a statistically significant extent. Private sector buying organisations seem, on average, to be able to manage the dependencies that arise from the need for relationship-specific investments better than those in the public sector.

18.  To refer back to the National Savings and Investments PPP again, the reason why National Savings and Investments was successful in transferring risk, whereas some other public sector bodies have been less successful, was that it succeeded in creating "private enforcement capital" during the procurement process—it made future business under the contract contingent on initial performance, posted a "hostage" and carefully crafted the contractual re-numeration arrangements. This success, in turn, was the result of a careful designing of the project, so as to generate market interest in an "attractive" project, a careful management of the competitive process, so that competitive pressure was maintained, a resistance of internal political pressure, especially over time, and extensive knowledge of the operation being outsourced under the PPP. Underlying all of this was also an appreciation of the need to manage the dependences that would inevitably arise out of the need for relationship-specific investments.

19.  Therefore, the answer to the question regarding whether risk transfer can occur under the PFI (and in other complex public sector procurements) is yes, but that there are many factors that make it difficult.

20.  As a supplement to above discussion, the frequent inability of public sector bodies to develop an interdependent relationship with a supplier may also be behind the findings of the National Audit Office that there is little evidence in many areas of the PFI of collaborative working—that is, in the cause of increasing the value created by the relationship.vii However, it should be noted that limited collaborative working is a broader issue within UK public sector procurement—and within procurement generally. A report by the International Procurement Leadership Forum in 2008 reported that "strategic supplier management was still in its infancy" both within the public and private sector.viii


21.  In this submission, it has been argued that some of the problems with the PFI, for example, those related to risk transfer, are part of broader shortcomings across UK public sector procurement - and, to some extent, procurement practice in general. Some of these issues and shortcomings appear to have been addressed, at least in part, over the years since the inception of the PFI in 1992, although problems remain.ix Having said this, while many problems of the PFI are generic, there is no question that the imperatives of the PFI have meant that, on many occasions, projects have been even more complex than they would have been using other procurement methods. This has put an even greater strain on a shaky commercial skill base.

May 2011


i  Julius, D (2008) Public Services Industry Review, London: Department for Business, Enterprise and Regulatory Reform.

ii  National Audit Office (2003) PPP in Practice: National Savings and Investments' Deal with Siemens Business Services, Four Years On, London: The Stationery Office.

iii  Quoted in Lonsdale, C. and Watson, G. (2007) "Managing contracts under the UK's Private Finance Initiative: evidence from the National Health Service", Policy and Politics, 35 (4), 683-700.

iv  National Audit Office (2002) Ministry of Defence: The Construction of Nuclear Submarine Facilities at Devonport, London: The Stationery Office.

v  National Audit Office (2003) New IT Systems for Magistrates's Courts: The Libra Project, London: National Audit Office.

vi  Hughes, J, Wadd, J and Webb, M (2010) Value Delivered by Strategic Supplier Relationship Management in Major Organisations, Guildford/Boston MA: Future Purchasing and Vantage Partners.

vii  National Audit Office (2011) Lessons from PFI and Other Projects, London: National Audit Office.

viii  International Procurement Leadership Forum (2008) Business Relationship Management: The Four Faces of Building Value with Strategic Suppliers, IPLF.

ix  National Audit Office (2011) Lessons from PFI and Other Projects, London: National Audit Office.

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© Parliamentary copyright 2011
Prepared 10 August 2011