Why a Public-Private Partnership? (Grantor Series, Part 1)

This is the first in a series of posts we’ll be writing for governments thinking of utilizing the P3 model to deliver a public project. (In P3 speak, the government is referred to as the “grantor.”) In future posts, we’ll delve into planning for and structuring a P3, engaging appropriate professionals, managing the procurement process, negotiating project agreements, etc., but we concluded that the most sensible place to start is the threshold question: why use the P3 model, to begin with?

A P3 is, of course, not the only way to deliver a public project. Although P3s are far older than many people realize (through the 1920s, most infrastructure in the United States was delivered through what we would now call P3s), publicly financed approaches have dominated for the past several decades. Nor is a P3 necessarily the best way to deliver any particular public project—P3’s are not cure-alls, and while they make a lot of sense in certain situations, there will continue to be projects that are best delivered with a traditional method, such as a bond-financed design-bid-build approach.

Although we cannot identify the best delivery approach for different generic project types, as that analysis is always case-specific, we do wish to generally identify what we see as the two key advantages (for the grantor) of the P3 model. Although this list is certainly not exhaustive, we do hope to explain both why P3s are becoming more and more popular in the United States and why they deserve to be at least considered for every new public infrastructure project.

Risk Transfer

If we were to pick the single most important advantage of a P3, this is it. P3s are not always the cheapest option (and they certainly are not free, a common misconception), but they do always serve to transfer risk from the grantor to the project developer, and this risk transfer can be extremely valuable. Consider, for example, a new road constructed near the coastline—how high should the road be elevated in order to ensure its continued utility in the face of sea-level rise for decades into the future? Predictions related to climate change are all over the place and ever changing, seemingly by the day. But making the wrong bet can have disastrous consequences. If the government assumes that one foot of elevation is sufficient, but the sea level rises 18 inches, the asset becomes worthless and needs to be entirely reconstructed. Sea-level rise is a significant risk--one of countless risks that the government would need to bear itself under a traditional delivery model. A P3 certainly does not make these risks disappear, but it does transfer them to the private sector, which is in the business of managing volatility. If, in the example above, the sea rises faster than the developer’s assumptions, the developer, and not the public, is on the hook for reconstructing the road. And the same goes for any of the innumerable risks that are transferred from the public to the private sector in a P3—fluctuations in materials, labor, revenues, etc., can all be borne by the private developer in a P3. A challenge to the P3 model is that the value of these risk transfers can be difficult to quantify in a traditional value-for-money analysis. That, of course, is the nature of risk itself, and at some level, the more difficult it is to quantify a risk, the more valuable its transfer to another party becomes.

Long-Term View of Lifecycle Costs

The second key advantage relates to price, but is more about the way price is considered than whether the price of a particular project is higher or lower if delivered as a P3. A P3 forces the project developer to take a long-term approach to assessing lifecycle costs. In a properly structured P3, the developer is on the hook not only for the initial design and construction costs, but also the long-term operation and maintenance costs, as well as the costs associated with handing the asset back to the government at the end of the term in a manner that meets agreed standards. As a result, the developer will be willing to pay more up front for a longer-lasting, easier-to-maintain asset. That approach can save the public significant money in the long run, both during the contract term and after the hand-back at the end of the term, when the grantor gets the benefit of the overbuilt asset.

Traditional delivery methods, on that other hand, favor lower up-front costs, without the same regard for long-term operating costs, and deferred maintenance (when maintenance costs are not borne by the developer, as in a P3) is a well-known phenomenon in public infrastructure. When budgets are tight, maintenance is often the first area to suffer cuts. Unfortunately, deferred maintenance is extremely costly in the long run--saving a few dollars today can cost the public billions in the long run. In fact, a recent report has calculated the cost of deferred maintenance of public infrastructure in the United States to be 1 trillion dollars, or 5% of the nation’s GDP. Deferred maintenance is a serious problem, and one that a P3 is able to avoid.