Written evidence submitted by Dr Chris
Lonsdale, University of Birmingham |
of the shortcomings of the PFI have reflected more general problems
within UK public sector procurement.
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.
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.
transfer under the PFI, and in public sector procurement generally,
has been further affected by limited public sector commercial
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
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
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 PFIa 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 outsourcedthat 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 riskbecause 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 increasednot 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 processit 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
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 workingthat 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 procurementand
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.
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
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
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