We’ve seen considerable scrutiny of the way that public services are contracted out to private sector businesses since the failure of the UK’s second largest construction company. The chaos it brought has demonstrated the potential risks of relying on a few large contractors to service local authorities’ outsourcing needs.
Several councils have already begun to bring services back in house, and some commentators have suggested that Carillion’s liquidation could signal the beginning of the end for public-private partnerships.
However, this seems too hasty – particularly as many of the issues raised can be mitigated through legal structures and terms of agreement that allocate risk and reward appropriately, not to mention thorough due diligence at the outset of discussions.
Rather than throwing the baby out with the bath water, the public sector needs to put more time and energy into the conclusion of partnerships with suitable candidates on the right terms, rather than eschewing collaboration with private companies entirely.
Many of Carillion’s contracts with the public sector were in the form of Private Finance Initiative (PFI) schemes. Worth billions of pounds, these agreements provided essential construction and facilities management services. Designed originally as a way for the government to build and provide services without bearing the financial strain upfront, private sector investors cover the initial costs of delivering a project. The public sector then makes gradual repayments over time.
PFIs are now widely considered to be an outdated model that doesn’t provide good value. Although their original selling point was the transfer of risk from the public to the private sector, Carillion has demonstrated that such risk transfer may not be all it seems. In failed schemes, the taxpayer picks up the tab along with the many thousands of affected sub-contractors, notwithstanding the profits made by the private sector during the good times.
As we consider the future of public-private partnerships, it’s important to point out that PFIs are not the only way to construct this kind of relationship. In fact, part of their inadequacy stems from the reality that in one view they are not “partnerships” in any fair and equitable sense. The risk and rewards available to each differ vastly, putting the parties’ interests at odds from the outset.
Successful public-private joint venture structures – which are becoming increasingly common – require a great deal of honesty up front. Each party should openly declare what it needs to achieve and determine the extent to which their prospective partner can realistically help to deliver that ambition.
In the case of local authorities and private housing developers, for example, a shared objective involving the delivery of housing will be driven by very different motivations. For private developers the bottom line is key, while local authorities need to build homes that best serve their local community and provide much needed housing. Melding partisan and apparently opposing objectives together into a single, unifying purpose can create an extremely powerful delivery force that achieves far more than either partner could on their own.
Within equitable JVs, there is also an expectation that both parties will invest alongside each other, in return for receiving a proportional benefit. If, for example, a local authority is contributing public land while a private developer brings cash and skills to the table, there is the expectation that these contributions will not only be equitable, but also invested along a comparable timeline.
If a local authority is putting forward all its land on day one, then a private developer would also be expected to invest its capital upfront. If this isn’t possible, a local authority may be able to have security on the land to guard against issues down the line. This truly collaborative approach offers some protection against the overreliance on one party that was the downfall of Carillion’s schemes.
Many JVs deliver complex, challenging projects over decades – for example, estate regenerations lasting between 15 and 20 years. Risk can often be better managed by dividing a project into more manageable elements where risk and reward is shared equally. Done intelligently, this drives the partners to develop realistic strategies that best manage project risks. For example, incorporating mechanisms that enable the partners to assess the viability of a large project on a phase by phase basis, recognizing that costs, sales and the economy may all be subject to fluctuations over say, a 20-year development period.
JVs structured in this way provide far greater opportunity to manage project uncertainties before catastrophic failure occurs. If one of the parties fails to deliver – for example by missing payments because of solvency issues – then the other will usually be entitled to buy them out at a discounted price. The surviving partner can then continue with the project without viability being undermined by the misfortunes of the other. They could even choose to bring in another investor to take the departing partner’s place.
Of course, how easy it is to bring another partner on board at this stage depends on numerous factors: the current state of the project, financial expectations on both sides and how attractive the opportunity is for those capable of delivering it. A potential new investor will need to consider the opportunity not only on its own merit, but also weigh up the risks associated with stepping into someone else’s shoes on a project that may have changed fundamentally since it first came to market.
Carillion’s collapse has rightly led to considerable soul-searching, but rather than abandoning all public-private partnerships and the many benefits they can bring, we need to focus instead on how processes can be improved to identify partners suitable for the task at hand, with use of structures that allocate risk and reward in a sustainable and fair manner.
If both the public and private sectors heed the other’s needs and pay closer attention to finding common ground at the outset, there is a bright future ahead for this kind of collaboration.
Richard Tinham is head of commercial and corporate at Winckworth Sherwood