Quality Infrastructure Investment: Life Cycle Costing and PPPs (and CP3P correlations)
Life Cycle Costs (LCC) is one of the key drivers for Quality Infrastructure Investment (QII), and initiative issued by the government of Japan during their presidency of G20 (2018).
As stated in the CII Principle 2 (“Raising Economic Efficiency in View of Life-Cycle Cost”) more attention has to be paid to LCC as the fundamental driver for long term efficiencies.
You can see the complete set of QII principles by G20 here annex6_1.pdf (mof.go.jp)
Life Cycle Costing is about optimizing the overall cost of an infrastructure considering construction costs, renewals, operating and ordinary maintenance costs.
For those that are familiar with PPPs and for anyone familiar with infrastructure costs, the Life Cycle Cost concept is not new at all. However it is really needed to emphasize the concept in the context of a true reflection and concern about long term sustainability including financial sustainability.
QII initiative has been followed by the Italian presidency and we expect to see what role will have in this year′s G20 round. But what we know is that MDBs, especially WB, together with the Government of Japan, are spending significant efforts in disseminating and capacitating in this area.
In this article, we try to illustrate how PPPs are an excellent and “natural” tool to get efficient lifecycle cost outcomes, whereas traditional delivery fails in this regard, and will explain how LCC is present all over the PPP cycle (using the PPP cycle description of the PPP Certification Guide).
At the same time, we may see how LCC is nothing new within PPPs. But it is worthy that everybody remember how the natural incentives for LCC optimization that are built in the PPP approach will be lost if any other core principle of true PPPs is missed, basically those conditions to succeed related to “properly structured” (with respect specially to appropriate significant risk transfer) and “properly tendered” (need for competition). (Read about the conditions to succeed in 5.5. Conditions for Accessing the Benefits: Introducing the Elements and Phases of a Proper PPP Process, the Need for Project Governance and the Role of the PPP Framework | The APMG Public-Private Partnerships Certification Program (ppp-certification.com).
Life cycle management is at the heart of the value drivers of a PPP
In a PPP, the “contractor” (private partner) is in charge of managing the full cycle (unlike a conventional procurement for construction), and will be capable (unlike a conventional contractor) to look to the asset costing from a LCC integrated perspective.
Among others, “the private partner has a natural incentive to design and construct the infrastructure in a manner that reduces maintenance and renewal risks, looking for long-term savings in the overall life-cycle cost” (CP3P Guide).
And there will be a natural incentive in PPPs for optimizing Life Cycle Costs, to the extent that the CapEx has to be financed by the private partner (i.e. to the extent that a material part of CapEx is not financed by the government) and the investment will need to rely in the operational cash flows (revenues – O&M costs) to be recouped and retributed with the expected return.
(i.e., the combined amount of the different cost components of the picture below will be lower, so that the revenue required -payment by government in government pays- may be lower).
This value driver is linked to the value of risk transfer
For the former statement being true, the revenue has to be unitary -at least to a significant extent -, either through charges to users or a unitary service payment from the Authority, without distinction between uses of the funds. All (or most) of the revenue or payment is linked to the effective availability of the asset (under the defined set of performance criteria). That means that if the private party does not maintain properly (and in due time, i.e. preventive maintenance), we may loss funds to recover investment / repay equity and debt (it may loss the payments described in the picture below).
And risks on cost overruns (construction and O&M) have to be transferred (which is the standard practice in properly managed PPPs), even if there may be specific exceptions for specific risks when this protect VFM.
?As any potential PPP efficiency, this will be lost without competition
What is the first objective of private sector? Selling.
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Without selling (gaining a new contract), there is no revenue, regardless how efficient a company can be and how capable to maximize benefits.
So, project has to be subject to effective competition: that’s the incentive for the private sector to share the potential efficiencies of a proper LCC approach (and other possible efficiencies) through a lower price offer (otherwise the payments in the picture above will be higher).
This is obvious but it is good to remember for those countries that still consider direct negotiations without submitting a public contract to a public tender, or even those that grant “excessive” rights of incentives for unsolicited proposals. (note: this doesn’t mean that selection criteria should be necessarily based only or mostly in price, but that’s another topic to be discussed in another article).
?In D&B and D-B-B contracts this efficiency doesn’t happen
Using the words of our partner Richard Foster, “traditional procurement is not focused on LCC, and can actively disincentivize LCC: for example, traditional capital budgeting is separated from budgeting for recurrent costs, and traditional tender processes don’t account for the impact on later costs”.
And the contractor is not responsible for the impact on later costs and even doesn’t have any incentive to build in a resilient manner to save renewal or O&M costs, rather than an incentive to save costs in construction and maximize construction margin.
?As described in the CP3P Guide 2.1. Infrastructure Procurement Options that are Not Regarded as PPPs | The APMG Public-Private Partnerships Certification Program (ppp-certification.com):
"B or DB contracts therefore have a lack of natural incentives for the contractor to care about quality and resilience of the asset. However, the contractor does have a clear motivation to increase profits by either reducing costs (and hence compromising quality) or claiming extra payments (for example, for government variations to the scope of the contract)".
Where is LCC present along the PPP cycle
To conclude, lets see how LCC concept could (or should) be present in the different phases of the PPP cycle, using the CP3P description of it (the 6 phases described in Chapter 1, section 10 and developed in Chapters 3-8).
Phase 1: Identification & Screening
?PPPs are better than traditional delivery at catching lifecycle cost efficiencies and that should be considered as part of PPP screening.
?Phase 2: Appraisal and Preparation
?Phase 3: Structuring and drafting
Phase 4: Tendering
?Phase 5 and 6: Contract management (during construction, during operations)
?There is no direct impact in managing the contract, as the general cost risk has been transferred and the payments (in government-pays) will be based on outputs.
?However, procuring authority should pay attention to the commitments offered by the successful bidder in terms of life cycle management, including materials and approach to construction as committed in the offer, and especially the renewal plans and the plan to fund those reinvestments.?
PS: please don′t hesitate in commenting or discussing.
Director at Foster Infrastructure Pty Ltd
3 年Good analysis! For the right projects, PPPs can drive significant life-cycle costing efficiencies. In Australia we see bidders examining every aspect of a project from the life-cycle cost perspective: Should I use carpet tiles (low cost, but shorter life and hence needing replacement more often) or broadloom carpet (higher up front cost, but longer lasting)? Should I install a wastewater treatment plant in the building so that water can be re-used, which means a higher up front cost but a saving on utility bills in costs in the long run? And so on.