Demystifying Infrastructure P3 Chapter Four: Is Value for Money a real thing?

Yes, Value for Money (VFM) is a real thing. To say otherwise could be blasphemy to the P3 Industry of which I am a part (more on them in later chapters). To outsiders, VFM analysis might look like a pagan ritual, followed by blind worshipers. Indeed, VFM requires a degree of belief, is open to multiple interpretations, and has doctrine to be followed. So let's pull back the curtain a little here.

Often, VFM is not what you think it is! Politicians and senior administrators alike, use phrases like "the project has value for money" or "the project has been tested and has value for money" or "pursuing the project as a P3 offers value for money to taxpayers". These phrases intend to conveyed that the project is a good project, a good P3, a good use of taxpayers money. It seems to suggest that this is the right project to undertake and that pursuing it this way will generate savings for taxpayers when compared to alternatives.

Yet VFM analysis is only one thing: a review of the anticipated, risk adjusted, all in cost (on a net present value basis), of pursuing the project in a P3 contract format, versus the anticipated, risk adjusted, all in cost (on a net present value basis) of pursuing the project in a non-P3 contract format. VFM analysis makes no judgement on whether the project is a good project, the right project, or the best project from a group of alternatives. Nor does VFM necessarily quantify a project's benefits versus costs (cost-benefit analysis). It doesn't tell you that the project makes sense or not for addressing a particular problem or need (which would be more typically completed through a needs assessment). And VFM is not necessarily about "savings" for taxpayers - it is about "value".

So when a project is said to have positive VFM as a P3, it is signaling that the VFM analysis has concluded that a) the anticipated, risk adjusted, all in cost (on a net present value basis) of pursing the project as a non-P3, is greater than b) the anticipated, risk adjusted, all in cost (on a net present value basis) of pursing the project as a P3. The VFM number is often displayed as a percentage being (a-b)/a.

There are a number of important aspects to the components underpinning VFM analysis that are worth exploring. The first and likely most important, is the "net present value basis" that is applied in the analysis. VFM analysis compares the net present values of the cash flows under the selected P3 and non-P3 models. Net present value calculations are founded on the concept of the time value of money. Time value of money is conceived of the investor portfolio theory world and as such, there is often debate about the applicability of "time value of money" principles in the public sector context. However, there tends to be a universal truth - that money's value is linked to time. Put another way, money today is more valuable than money tomorrow.

Here is a thought experiment to demonstrate the point - why doesn't government just tax its people more today - put the money in a savings account - and use the interest income to fund projects thereafter? The tension at play here is that governments know that people value money in their pocket today rather than less tax and more money in their pockets tomorrow. It is also why governments chose to borrow to pay for infrastructure projects rather than increase taxes on a one time basis to cover costs.

The time value principle works for money spent and money earned. Spending today is more expensive than spending tomorrow, the same way that revenue earned today is worth more than that earned tomorrow. Exactly how much more money today is worth compared to tomorrow is reflected in the "discount rate". The discount rate is then applied to the cash flows anticipated under the P3 and non-P3 models - to arrive at the VFM calculation.

The next thing to flag in the VFM analysis description is the word "anticipated". VFM analysis is often initially undertaken during the preliminary design phase of a project. So the project "need" has been established, and rough order of magnitude costing is understood. So before anyone has started to draft a tender document or P3 contract, initial VFM analysis is complete. Accordingly, given the precision of costing info, design info, risk info etc. at that time, these initial VFM analysis are only to show an indicative range of potential outcomes. VFM analysis ought to then be repeated as the project preparation, document development etc., progresses, as more information is gained.

The ultimate confirmation of anticipated potential VFM comes when the winning bidder is identified - but even then, the VFM is only "anticipated". This is the case because VFM analysis is being applied to the whole of life cash flows of the project and includes the costs covered by the contract as well as authority costs. Whether risks manifest or not, whether the project is designed and built on time, or whether the cost of maintenance and operations plays out as anticipated later - remain unknowns. At financial close, the VFM analysis represents the potential value that the taxpayer can attain compared to what would have been possible under the non-P3 format - but it is only possible to attain that VFM proposition if the P3 contractor performs in accordance with the P3 contract, and by extension - only if the authority undertakes its end of the partnership and enforces the P3 contract.

And herein is the challenge of the original question. Is value for money "real"? We can never really know. You would need to undertake two identical projects, one as a P3 and one as a non-P3 and measure the total all in cost of the project over a set time frame such as 25, 30 or 50 years. Then discount those cash flows to compare the net present values/costs of the projects - at a discount rate that is a true reflection of the authorities perception of time value for money at day zero. Any such experiment, even if it were truly possible, would then also suffer observation bias (the very act of observing could change the outcomes).

VFM analysis is not a panacea for good decision making when it comes to P3. Most authorities will also undertake a qualitative assessment prior to undertaking the quantitative VFM analysis. That said - it is a very valuable analysis to undertake and forces important dialogue among members of the authority to better understand the qualitative elements of the P3 and non-P3 models - as well as to undertake rigorous risk analysis and cash flow analysis. In long term P3 contracts, it also forces authorities to consider the long term costing impacts of projects, to understand operations and maintenance expenditure curves - and to test the tension between "gold plating" upfront spending, versus building infrastructure to an assumed maintenance standard.

When undertaken with honesty, VFM analysis will reinforce and provide strong foundational support for the pursuit of the project as a P3, or not as a P3, as the case may be. That said, too often, as the P3 Industry has developed and matured in various markets, and as P3 versus non-P3 has become ideological - honest, robust and critical analysis is too often replaced with dogma and ritual. This is true of VFM analysis that results both for and against P3. Dishonesty or blind obedience is often subtly and hard to truly uncover: risk analysis through risk workshops that under values various risks, or downplays differences between P3 versus non-P3 models; or the use of discount rates that do not reflect the authority's true risk tolerances or its true assessment of the time value of money. Failure to spend adequate resources to price the operations and maintenance costs under both models, or even the setting of capital budgets in a manner that skews the analysis more or less in favour of gold plating.

But perhaps the greatest perversion of the VFM analysis has occurred when various orders of government have sought to "push" P3 projects on other orders of government. In their effort to spread the good word - they have made projects affordable when they otherwise would not have been, through funding grants. The catch - funding in exchange for pursuing the project as a P3. And while indeed many projects that have received this funding boost in the past were very good P3 candidates - many were not ideal.

Is value for money real? Potentially yes. But even if a project has very good VFM and we could show it after 30 years that a project did indeed generate the targeted VFM - is that the most important thing to be asking ourselves? If the project is a road or a bridge or a transit system - surely there are other measures that would be more important in terms of performance measures - or measure of value created? Consider that, given the very nature of VFM analysis, covering the whole of life costs of the project - a project can have positive VFM as a P3 and still be over the capital budget!

Value for money may be real - but that doesn't mean that a project had value in the first place!