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Disadvantages of PPPs

Disadvantages include…

…the very large tendering and contracting costs,

Tendering and negotiation: PPP contracts are typically much more complicated than conventional procurement contracts. This is principally because of the need to anticipate all possible contingencies that could arise in such long-term contractual relationships. Each party bidding for a project spends considerable resources in designing and evaluating the project prior to submitting a tender. In addition, there are typically very significant legal costs in contract negotiation. Having several bidders do this involves a cost which can add up in total to tens of millions. It has been estimated that total tendering costs equal around 3% of total project costs as opposed to around 1% for conventional procurement.[13] The cost of both successful and unsuccessful bids is, in effect, built into total project costs. The Australian Council for Infrastructure Development has expressed the view that “unless tendering processes are well run it is possible that the benefits of using a PPP for delivering the project may be outweighed by the tendering costs”.[14] Under conventional procurement, the sunk costs of private contractors are much smaller and contracts (e.g. for operations) often do not exceed 5 years. The risks to be covered off in the contract are therefore significantly less.

… the costs of contract re-negotiation, which are often high,

Contract renegotiation: Given the length of the relationships created by PPPs and the difficulty in anticipating all contingencies, it is not unusual for aspects of the contracts to be renegotiated at some stage. Wherever possible, provisions are included in the contract that spell out how variations are to be priced. But, given the length of time spanned by the contract, it is almost inevitable that circumstances will arise which cannot be foreseen.

Where the need for renegotiation comes from the public agency (which, it appears, is often the case, perhaps as a result of a change in government policy) and no pricing rule is contained in the contract, the Crown can end up paying a heavy price, since the price is not determined in a competitive bidding context. The cost of such changes is difficult to factor into the original project evaluation, since by definition it is unanticipated.

… the difficulties of ensuring good performance, especially with respect to “soft” performance  dimensions,

Performance enforcement: One of the difficulties with performance specification in the area of service delivery is that performance sometimes has dimensions which are hard to formulate in a way that is suitable for an arms-length contract. Examples include maintaining good customer relations, and not creating public relations blunders which rebound on the government. In the case of building a motorway through a dense urban setting, a public roading authority will sometimes find it difficult to specify all performance elements in service level terms.

The reputation effect and the prospect of repeat business can sometimes provide incentives to achieve “soft” performance targets. For example, unsatisfactory performance by a prison management company will affect its reputation and therefore its ability to obtain contracts elsewhere.

However, in other cases neither reputation effects nor contractual remedies will be sufficient. A “command” relationship or “master-servant” relationship, such as exists within an organisation, may be more efficient. In essence, if for whatever reason one isn’t able to clearly specify the required services, then a master-servant relationship enables one to change the service requirement as one goes along, at relatively little cost.[15] At the construction stage, a project alliance approach may be most appropriate, while at the infrastructure operation stage a series of short-term contracts may be acceptable as they provide the opportunity for the public agency to take corrective action if it finds that some performance dimensions were inadequately specified or no longer appropriate given changing public expectations.

… and the difficulty for the government not to intervene if the provider threatens to go bankrupt.

Political acceptability: Given the difficulty in estimating financial outcomes over such long periods, there is a risk that the private sector party will either go bankrupt, or make very large profits. Both outcomes can create political problems for the government, causing it to intervene. Examples of the former include the National Air Traffic Services (NATS), which encountered financial difficulties after 11 September 2001. The British government bailed it out rather than let NATS’ bankers take it over. Another example is Melbourne’s tram and train services, contracted out in 1999. Patronage didn’t increase to the levels expected, causing the operator to threaten to fail. The government agreed to increase the operating subsidy.

The “public sector comparator” used in some other countries is a useful tool, but is not evidence that a PPP is superior to conventional private sector procurement.

Both kinds of risk are often reduced by including in the contract loss sharing or profit sharing provisions. But such provisions reduce the extent of risk transfer, and therefore the advantages of PPPs.[16]

Notes

  • [13]See BEC and Sir Michael Latham, Constructing the team, reproduced in Dr Eamonn Butler & Allan Stewart MP, Seize the Initiative, Adam Smith Institute, 1996, quoted in Grahame Allen (2001), p.34.
  • [14]Australian Council for Infrastructure Development, Australia at a Crossroads Public/Private partnerships or Perish?, quoted in Webb and Pulle (2002).
  • [15]There is an extensive literature on the choice between entering into explicit contracts and coordinating activities via a command relationship. This is loosely known as the “theory of the firm”. See, for example, O. Williamson (1980).
  • [16]Ehrhardt D and Erwin T (2004)
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