Payment Mechanisms for PPP Development off PPP and Implementation Possibilities in Latvia Conference, September 2008

Payment Mechanisms for PPPDevelopment off PPP and Implementation Possibilities in Latvia Conference, September 2008

Payment Mechanisms for PPP

Public Private Partnerships

“PPP is a long term relationship where the

provision of a public service is handed to

the private sector for a defined period, in

return for access to an agreed revenue

stream”


Typical Sectors

Transport Roads Railways Airports Ports

Health Hospitals Clinics

Education Schools

Justice Courts Prisons

Defence Barracks Equipment maintenance Other support services

Municipal Services Refuse collection Road maintenance Social housing


Typical PPP Arrangements

- Design Build Finance OperateDesign and build infrastructureOperate and maintain it for a set periodFinance the whole project

- Operate and MaintainProvide service for defined periodProvide working capitalSome re-investment may be needed


Design of the Payment Mechanism

Incentivise contractor to provide a good service at the best possible price

Private contractor will aim to provide the quality of service that maximises his profit

Payment mechanism needs to ensure profit is maximised when the public partner’s desired quality of service is achieved

Need to be realistic about the trade-off between cost and quality


Potential Payment Mechanisms

User charges

Usage payments

Availability payments

Performance payments

Ancillary revenue


Typical Payment Structures

Source of Payment Sell services to consumers

Sell services to public partner only

User Charges √

Usage Payments (√)

Availability Payments (√) √

Performance payments (√) √

Ancillary Revenue √ √


Stage Payments

Stage payments sometimes made to contractor during construction phase of high capital cost projects (eg if EU grant available)

Can reduce overall costs because of lower cost of capital to the public sector

However need to ensure that incentives to long term good performance are not undermined


User Charges

Applicable where consumers expect to pay, for example: Toll roads Railways Public utilities (eg water, gas, electricity)

Potential to operate without subsidy

Need to satisfy customers provides incentive to quality

Revenue guarantees may be needed

Risk of inflexibility due to contractual guarantees

Risk of monopoly abuse


Controlling Monopoly Abuse

Regulate profits No incentive for good service Potential to hide profits eg through cross-charges

Regulate prices Potential to increase profit through efficiency gains Design price controls to meet social objectives Avoid excessive complexity and very rigid controls


Usage Payments

Useful where private partner’s performance affects usage but where the public partner does not wish to charge

Common in the highways sector

Risk of unexpected changes in payments

Risk of inflexibility due to contractual guarantees


Availability Payments

Based on the facility being available for use when needed, with penalties if all or part not available

Typical unavailability criteria for a building: Not accessible Not weather-proof Not compliant with safety regulations Inadequate lighting Too hot or cold Lack of required furniture Toilets not functioning


Performance Payment

Availability payments alone will not guarantee high quality delivery

Significant element of payment often related to quality of performance delivery

Performance factors vary between projects, but typical factors include: Equipment reliability Speed of response to failures Cleanliness Responsiveness to user comments


Incentive Regime

Unacceptable Poor Fair Good Excellent

Terminate

Pe

nalty

Bo

nus

Benchmark Performance

Payment


Performance Measurement

Self reporting

System monitoring

Inspection and testing

“Mystery shopper” surveys

User surveys

Staff feedback

User complaints


Ancillary Revenue

Often opportunities for contractor to provide ancillary services at a profit, for example: Shops and retail kiosks Cafes Sell advertising Charge for ancillary services (eg car parking)

Generally a small contributor to financing

Useful if does not work against main aim of contract


Case Study: Northern Line Train Service Provision Contract


Case Study: Northern Line Train Service Provision Contract

Public party: London Underground Ltd.

Private party: ALSTOM

Contract: 20 year contract to take over maintenance of existing train fleet, replace it with new trains and maintain new fleet

Payment: based on number of trains available for service

Reliability of old fleet quickly exceeded benchmark

New trains unreliable when introduced

Contractor and his staff incentivised to improve performance

Now operating reliably


Case Study: Liverpool Women’s Hospital, Hospital Information Support System

Public party: Liverpool Obstetrics and Gynaecology Services Health Trust

Private party: Data General

Contract: Install and operate new hospital data system

Payment mechanism: Availability 70% (with penalty for late delivery) Performance 20% Usage 10%


Calibration of Payment Mechanism

Important to model likely impact of proposed payment mechanism using proposed penalties and realistic data on likely faults

Ensure that the mechanism:Provides right balance between cost and rewardProvides the appropriate incentivesDoes not contain loopholes that the contractor can exploitDoes not impose excessive risk of performance penalties or

termination

- Potential role for Monte Carlo simulation


Indexation

Need to consider how inflation will be covered in the payment mechanism

Some elements of contractor’s costs not subject to inflation (eg fixed price construction contract)

Other elements may inflate at higher or lower rates than general inflation

Desirable to use a range of indices to try to match payment increases to contractor to his actual cost increases

Payment Mechanisms for PPPDevelopment off PPP and Implementation Possibilities in Latvia Conference, September 2008

Documents

Payment Mechanisms for PPP Development off PPP and Implementation Possibilities in Latvia Conference, September 2008