Infrastructure, P3s, and the need for a "paradigm shift"

Sometime over the next few weeks, the Trump Administration is expected to release a plan for how America's critical infrastructure can, and will be, rebuilt. The expectation is that a foundational element of this plan will be the encouragement of private investment and public-private partnerships ("P3") as methods of realizing these critical projects (For the purposes of this article, I'm defining a "P3 arrangement" as any government acquisition that veers from the standard "I'll pay you X to perform service Y").

Regardless of whether P3s will be front-and-center in the Administration's Plan, state and local governments, across the country, will continue to consider these arrangements as levers to do everything from lowering the costs of certain operations; to improving the "citizen experience"; to leveraging them as a way to fund large, prohibitively expensive, infrastructure projects.  With this being the case, it's as good a time, as any, to discuss these arrangements - and what cities and states can do to make them a reality while improving success rates.

What is a P3 arrangement? 

Governments procure an incredible array of products and services. Traditionally, a provider, or "vendor", is paid a fee to deliver that product or service - a model that has been in place, and, largely worked well, for eons. Today, however, situations have emerged that require new ways to fund these acquisitions and projects. Critical infrastructure requires upgrading at an increasing pace. In many cases, traditional process transformation efforts (which includes out-tasking) aren't sufficiently reducing operational costs and/or improving service and outcomes. Governments are, thus, looking for alternative arrangements to upgrade and transform, bypassing the traditional budget constraints.

P3 arrangements can come in a number of "flavors" - from full-on privatization at one end of the spectrum, to outsourcing ("franchising") the management of certain critical operations at the other end (my local municipal golf course was franchised to a management company, and the conditions and service have never been better). While each flavor can take on starkly different characteristics, I've found that P3 arrangements, generally, can be characterized by three truisms:

1) They have tended to work better when associated with a revenue stream - a toll road, a municipal golf course, a municipal utility, among others.

2) P3 arrangements are complex and challenging - even in cases involving the assumption of straightforward operations and hard revenue streams.

3) While there have been innumerable successful P3 arrangements, there have been more than a few failures.

With these truisms in mind, the question should be asked "Is there a better way to approach P3 arrangements?". I would answer that not only must we capture and apply the lessons learned from two decades of these arrangements, but that effectively addressing America’s infrastructure needs will require entirely new modes of thinking, procuring, and acting. Essentially, a new paradigm for P3 arrangements is needed. 

Why a Paradigm Shift is needed...

Let's return to our three truisms to surface why a paradigm shift is required:

1) They have tended to work better when associated with a revenue stream - a toll road, a municipal golf course, a municipal utility, among others.

Today's challenge is that these arrangements are most needed for infrastructure and critical service areas that do not involve revenue streams (think school buildings or social services delivery). With no revenue stream to attract investment and P3 providers, this starts looking like a traditional services procurement. But governments don't have the funds and are reluctant to issue new bonds.  Something needs to change.

2) P3 arrangements are complex and challenging - even in cases involving the assumption of straightforward operations.

In any P3 arrangement, numerous elements (financial, risk, legislative, workforce) must be factored in, and modeled, as the implications differ from those of a traditional solution or commodity procurement. Also, as most of these arrangements are long-term, decision-makers must contend with how an arrangement will be viewed ten, fifteen, or even thirty years later. In my experience, many governments don't have the resources to adequately design and evaluate these arrangements - especially if the number and pace of these arrangements pick up, as is anticipated.

3) While there have been innumerable successful P3 arrangements, there have been more than a few failures.

Even "traditional" P3 arrangements, with hard associated revenue streams and well-established providers, have had their share of failures. The recent spectacular collapse of one of the largest infrastructure and managed services firms in the world, has cast a bright light on the flaws found in traditional P3 arrangements - particularly around how they are designed and executed. The failed firm's problems were less associated with their ability to design and manage large infrastructure projects, and more associated with their embrace of a model where the winning "partner" was the one willing to assume a large amount of risk at a low price. While this may work (although it usually doesn't) when acquiring a new information system, it is a recipe for disaster when handing over a critical infrastructure project, or process, to a third party.

Driving the paradigm shift

At face-value, it may make sense to assess the blame, of a P3 failure, on a vendor who prices their offer unrealistically low; or who assumes an unrealistic amount of risk. I can, also, confidently state that it is borderline "malpractice" for a potential partner/provider to build a resource cost model without including contingencies such as inflation, or the possible raising of the minimum wage. But does the blame rest entirely on the vendor/partner?  In my view, governments have a shared responsibility to protect their interests, and the interests of their citizens and taxpayers. While I firmly believe that most governments realize this, I don't think they are fully prepared to execute on it. 

Cities and states looking to accelerate their use of P3s should revisit everything from how the "best" partner is selected, to how they view risk-sharing.  A particular challenge is adjusting these models to address those assets and operations that don't generate any (or enough) revenue. New, creative, methods of “valuation” must be developed and applied to these “idle” assets and infrastructure. Experts will need to be engaged who can identify where value can be unlocked in everything from a school building to a reservoir. City managers will have to start thinking more broadly - possibly lumping revenue and non-revenue assets together into a single tranche.

At the risk of over-simplifying things, here are three recommendations that I believe will help governments as they look to further leverage P3 arrangements to meet their critical infrastructure and operations needs:

1.     Governments looking to leverage P3 arrangements, especially for operational needs, should embrace the notion that the more financial risk pushed to the vendor, the greater the likelihood of unintended consequences - consequences of degraded service, or worse. I have seen numerous procurement organizations strive for a "zero risk" position. While many vendors avoid these types of procurements, other firms will gladly take on this risk - often ending up in a position of being unable to perform. Over my 30+ year Advisory career, I have walked away from numerous bids, often correctly predicting that failure awaits any firm that accepts the risky terms.

2.     Procurement organizations need to be better trained to identify the true cost of operating a process, or building a piece of infrastructure. Cost baselines should be established against which bidders are evaluated (it might be time to dust off those Activity-based Costing textbooks). Organizations experienced with complex infrastructure projects tend to do this well; but this approach should also be applied to other P3 arrangements from outsourcing school lunch programs to managing municipal recreation areas. Any bidder falling significantly below this baseline should be quizzed as to how they plan on delivering the service at said price. Driving a vendor to a razor-thin margin is a recipe for future trouble; and can often end up costing taxpayers more than if a vendor with a healthier margin was selected.

3.     These new, more realistic, risk-sharing and cost models must be factored into the business case for pre-justification of P3 arrangements. Too many times I have seen overly rosy estimates of "benefit"; or seen the desire to significantly improve service but at a reduced cost. Sometimes, the goals of attaining better citizen service, and operating at a lower cost, are mutually exclusive. Governments must decide what the ultimate goal is for a given arrangement, and whether they are willing and able to sacrifice operational cost reduction for improved citizen servicing - or vice versa.

Public-Private Partnerships can be a wonderful vehicle for governments to improve infrastructure, and services, in a way that traditional self-funded methods won't allow. P3 arrangements, however, are not a panacea. They need to be carefully designed, modeled, and executed. With the right planning, along with the setting of realistic objectives, the failures of the past can be avoided; and P3 arrangements can be successfully applied to an even broader range of critical infrastructure and operations needs.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.