Sometimes life presents you with a tough choice. And then gives you a way out.
Take this common minor inconvenience in a store parking lot.
You’re done shopping. You’ve carted your stuff to your car. You’re ready to hit the road.
But you’re also parked a football field away from the cart corral.
You’re in a rush. You’ve got a choice.
You could hustle over to the corral and sprint back to your car. Or you could be THAT guy and leave the cart in the empty parking space next to you. The right thing is rarely the easy thing.
But sometimes it is. A third option presents itself.
A woman pulls in next to you, just about to walk into the same store you just walked out of. She needs a cart and you’re looking to offload one.
She happily takes your cart off your hands and you climb into your vehicle, ready to get on with your day. Win-win.
That’s a positive sum game.
Win-wins, positive sum games -- whatever you want to call them – are everywhere.
They’re what makes trade work. They’re how a customer and a merchant can both come away smiling from a sale – even when they don’t know or even like each other. Win-wins are what our economy is built on.
I gain something, you gain something.
When it comes to public-private partnerships, governments and firms should keep that shopping cart handoff in mind.
Good public-private partnerships are about positive sum games.
If one side is just trying to take advantage of the other to no mutual benefit, things can go badly for both. But if government and private sector partners are focused on the ways they both can gain, you could have a match made in heaven.
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Public private partnerships – PPPs if you will, or P3, to the truly initiated – can take many different forms.
I like to think of P3 as a project delivery method. Say I’m a government looking to build a highway. How am I going to deliver on this project?
If you want a job done well, do it yourself. Right?
Yeah, probably not when it’s a highway.
Instead, I’m likely to engage the services of contractors to do a lot of the work. That’s procurement. I’ll put together a Request for Proposals, an RFP, and procure the services of the firm that comes back with a winning bid.
And in traditional procurement, I’ll do that for each step. And I’ll keep some things in-house.
Send out individual RFPs when you design the highway. When you want to build the highway.
Maintaining it? Our Department of Public Works can handle that.
But the toll booth construction? Let’s send out another RFP.
You get the picture.
While the public and private sectors partner in this scenario, it’s not what most people have in mind when they use the term.
At the other end, you’ve got full-blown privatization. In recent decades, this has happened with everything from collecting taxes to managing prisons. Just hand the keys over to the private sector and let the market figure it out.
P3 can be thought of as a middle ground between traditional procurement and full-on privatization.
P3 involves the same relationship between government and private firms as traditional procurement but they take it a step further.
In P3, the role of the private firm is more prominent.
The relationship is longer term.
And much if not all of the funding for the project is done by the private sector.
Back to our highway. Different stages of the project were bid out through an RFP.
P3 often involves awarding a contract for more than one stage to a single bidder.
Instead of releasing an RFP just for the design of the highway, I might combine tasks. Send out a request for proposals on designing, building, operating and maintaining the whole thing. Or maybe I release an RFP for firms to just design, build and finance it.
The point is to get a single bidder, even if that’s a group of firms, to cover every stage of the project.
So what do these firms get out of the P3?
There’s two ways to structure a P3 where the private sector covers everything from design to operation.
One is called “revenue-risk.”
The private sector partner gets the revenue generated by the infrastructure and assumes the risk of a poor pay day if this revenue doesn’t cover costs.
The highway might be paid for by tolls. The private sector might operate the toll booths -- or electronic tolling system – and collect whatever pocket change each driver forks over.
If drivers frequently use the highway and tolls are set at the right level, the private sector partner will benefit.
If not, tough luck. They might not make a killing on tolls, but they’re still on the hook for the costs of the highway – for the life of the contract.
The other model for a P3 where the private sector designs, builds, finances, operates and maintains the infrastructure is called “availability payments.” Also known as AP.
This means that the contract dictates payments to the private sector partner.
For our highway, the contract might stipulate that once the road reaches a certain level of roughness, the private sector partner has to repave. So long as they adhere to that, they get paid.
So that’s one kind of P3. You send an RFP out. A group of firms responds with how they’ll deliver on the project from design through operation and maintenance. You select a bid and then either make regular payments based on agreements in the contract or allow them to charge user fees.
In theory, the profit motive and the efficiencies that can be realized by having the same group of firms involved at every point in process – design, construction, financing, operation and maintenance – will result in a piece of high-quality public infrastructure.
If the government tried to do it itself, the thing probably never would have been built. And it might have not provided the best service even if it was.
This picture isn’t entirely rosy though.
For private sector partners, there are risks.
For one, profits aren’t guaranteed. The highway might not attract as many drivers as hoped, so toll revenues will fall short.
P3 also means committing to a long-term relationship with a public sector partner. And that can be tough when it sours. Think of a bad marriage that goes on for 30 or 40 or 50 years.
But these risks to the private sector can be offset by the chance to work on a major infrastructure project. This is the kind of opportunity firms often don’t get a shot at otherwise.
Lessons learned from this initial foray into highway building for example, can be applied by the firms to future work. P3 aren’t just a money-making opportunity for private firms. They’re a chance to build skills and qualifications.
For government, there are risks as well. And ways to offset them.
They say “no pain, no gain” but when the pain is measured in the millions and billions of dollars, you still might be better off avoiding it.
Here’s three risks that governments face when shopping around for a P3, and three ways they can overcome them.
One challenge governments face with P3 is having only a small number of firms who can undertake the project you need completed.
Say you want to build a high-speed rail line.
These are exceedingly rare in the US. For a megaproject like that, there might only be a handful of firms with the necessary size and expertise to tackle the project.
That lack of competition drives up price.
One way costs can be kept down is through bundling.
An advantage of P3 is that individual parts of a project aren’t siloed. The people designing the highway are on the same team as the people building the highway. And they’re also on the same team as the people operating and maintaining it.
Private sector partners that demonstrate an ability to effectively hand off the baton between these different parts of the project are showing you a way to tamp down costs.
Beyond a limited talent pool, there is always a political and financial risk associated with P3 for governments.
Say your highway is built and your toll revenue is rolling in. Or maybe more like trickling in. Or maybe it’s arriving in fits and spurts.
You don’t have enough to cover the costs. And taxpayers on the hook for the bill.
But there’s more than one way to structure a P3.
Make the contract risk-reward: if toll revenue comes in below estimate, the private sector partner has to figure it out while still operating and maintaining your highway. That’s the risk they assumed.
This is called risk transfer. And it’s one of the advantages to governments when pursuing P3. You can transfer much of the risk of a major infrastructure investment to the private sector.
This brings us to our third problem: if firms are assuming a bigger risk, they’ll expect to be paid in a way that offsets that risk to some extent. This can drive up costs.
Bigger risks mean bigger costs.
But there’s another way to transfer risk in a P3.
Access to different the kinds of capital that only the private sector holds the keys to make P3 more flexible in terms of financing.
When shopping around for a P3, get firms to be up front about how they will manage risk and take advantage of the expanded capital opportunities the model offers.
Different kinds of equity and debt financing are available. Or specific loans like a Transportation Infrastructure Finance and Innovation Act (TIFIA) loan.
Additionally, there are other ways to sweeten the pot for the private sector that can keep costs down.
Your highway might need rest stops with restaurants and other amenities that revenue can flow from.
Your rail corridor might have opportunities for transit-oriented development (TOD), with a mix of residential and commercial growth in close proximity to train stations.
These kinds of add-ons can nudge private sector partners into a willingness to take on more risk without breaking your budget.
P3 should be win-win. Think back to our parking lot: governments should be able to offload the cart. And the private sector should enjoy the benefit of receiving it.
Public-private partnerships are here to stay.
In the wake of the Great Recession, cash-strapped governments at every level took interest in the ability of P3 to deliver on big projects at a lower cost.
Championed by both Presidents Obama and Trump, P3 gets love from both sides of the aisle. Beyond bipartisan support, circumstances have once again conspired that favor the use of P3.
As governments recover from the revenue hit endured during the COVID-19 pandemic, infrastructure spending has been a focus of ways to stimulate the economy.