For decades, government agencies have worked to make government work more like business—reduce costs (particularly initial capital costs), streamline procurement, and reduce the risk of capital project cost overruns—all to deliver projects faster and cheaper with reduced risk. This quest to deliver projects faster, better, and cheaper have led some public agencies into a long term relationship with a private sector provider called a “Public Private Partnership.”
What is a Public Private Partnership?
A public-private partnership (P3) is a contractual relationship between a public entity—usually a government organization—and a private company. A simple but typical example might be a term contract with a food service provider to operate a cafeteria on a college campus. In the context of this article, it will mean a long-term contract between an educational institution and a private corporation to finance, design, construct, and perhaps operate and maintain all or a portion of campus infrastructure.
For example, a community college needs to increase campus parking—since capital funds are limited and are committed to other educational needs—the college might opt to solicit proposals from a private corporation to provide a parking structure on campus, with the proceeds from parking revenue going directly to the corporation to offset the costs of design, construction, operation, and maintenance of the structure as well as providing the corporation a reasonable return on investment. The college provides the land and the users—the corporation builds, owns, and operates the parking garage.
This is a simple but feasible example of a P3 arrangement.
Challenges
As simple as it sounds, challenges can and often do arise. Consider the differences in mission between the college and the corporation. The college is non-profit, probably tax-supported, and exists to educate young students. In contrast, a corporation exists for the sole purpose of maximizing return on investment to the shareholders. Colleges are under constant pressure to provide their students the best educational opportunities at an affordable cost to their students. Parking is a cost to students that has no direct influence on their education. While the corporate interests might be to charge the absolute maximum for parking, the institution might want to keep the costs down to make the educational experience more affordable. The net result is friction between the two interests.
Other complexities can arise:
- Who owns the parking garage after the term of the contract expires?
- Do parking garage employees need a background check because they are working on a college campus?
- What about special events on campus? Or off-campus events where the parking garage can be used? Who gets the revenue and determines the rates?
- Who will be responsible for security in the garage?
- Who maintains the garage?
- Who owns the garage—the school or the investor?
Those are, no doubt, just a few.
While a parking garage, or perhaps food service or student housing, all generate revenue that can be used to provide the essential return on investment, P3s can get more challenging when there is no accompanying revenue stream. A classroom building, laboratory, or library typically does not generate revenue, but the investor will still need to be paid. This means that the investor must be paid out of other school funds guaranteed by the school. From where will these funds come?
One touted advantage of P3s is risk sharing, where risks are shared between the school and the investor. Experience has shown us that some P3s are not successful because unknown construction risks have driven costs up and additional investment was required that were ultimately born by the investor. Another example is if the projected revenue stream was optimistic. In recent years, investors have insisted on guarantees from proposers to minimize the investment risk.
A Case Study
Though not education facility-related, the following is a discussion of an actual investigation into a proposed 3P infrastructure project:
Anchorage, Alaska, is situated on an irregularly shaped triangle of land with Knik Arm and Turnagain Arm, both tidal inlets from Cook Inlet forming two sides of the triangle, and the Chugach Mountain range forming the third side. Thus, Anchorage is landlocked and largely built out. For decades, it has been proposed to construct a bridge across Knik Arm to access developable property on Mat-Su, the borough to the north across the Knik inlet. A bridge across Knik Arm is exceptionally technically challenging with poor foundation conditions, limits on bridge height because of the approaches to Elmendorf Air Force Base, ice flows, strong tides, ship traffic, tight roadway access on the Anchorage side, and very limited funding. After efforts to obtain federal funding failed with cries of “bridges to nowhere” and “boondoggle,” the Knik Arm Bridge and Toll Authority (KABATA) explored P3s as a method to deliver the project. KABATA assembled a world-class group of constructors, financial firms, potential operators, and key stakeholders from Alaska and the United States in a charette to explore ways to fund, construct, and operate the bridge. My wife—an experienced construction manager—and myself—an experienced bridge and highway design engineer and project manager—were selected to moderate the teams and report on the outcome of the charette. Almost immediately, challenges arose between the participants. The engineering/construction challenges, though technically complex, were straightforward, and this group worked collaboratively to reach a consensus on potential solutions. The financial team and the stakeholder team were at odds. The financial team wanted guarantees: if revenue fell short of projections, who would make up the difference? Who determines the tolls? The investors wanted development rights on the currently vacant (but privately owned) land in Mat-Su. After two days of intense discussions, several conclusions were reached:
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- The bridge would cost more than anticipated.
- There were many unknowns, and thus, a significant construction contingency would be required.
- KABATA insisted on keeping “reasonable” tolls; the investors wanted a guaranteed revenue stream and to maximize the ROI.
- No government agency was able to underwrite the project or to provide revenue guarantees,
- Mat-Su property owners were unwilling to give up development rights.
As a result, nothing came of the effort, and KABATA and the project are now dormant.
As a moderator, what struck me was the outsized influence of the financial/investor interests in the project. Senior members of the New York investor community that participated spoke only in “investor-speak,” a language that was somewhat foreign to the other participants. They insisted that, without financial guarantees to assure investors of a sound ROI backed by the government, a P3 approach could not work.
Overcoming the Challenges, Making Things Work
From this experience, one might conclude that P3s add more complexity to already complex projects and should be avoided. However, they can be successful provided that all parties recognize the partnership between owner, designer, constructor, and financer is maintained.
A 2019 article in the Harvard Business Review by Elyse Maltin states,
“…when we examined what led to productive working relationship over the life of these projects, we found they had three things in common: a commitment to a strong partnership beyond the terms of the contract; built-in mechanisms to share perspectives about the project (especially problems and concerns); and effective ways to rebound from failures to deliver.
The same article goes on to say, “each party must be as committed to achieving the others’ goals as they are to their own goals.”
In the construction world there is a very effective process that is often used to establish a sound working relationship between owner, designer, and contractor, as well as a procedure for resolving the inevitable conflicts that occur during construction. It is called “Partnering” and it is a formal structured collaborative relationship between all parties to a construction contract. In a partnering session, an outside neutral facilitator establishes relationships between the parties, develops a charter that includes a process to resolve issues, establishes communications, and develops an understanding and acceptance of each partner’s motivation for engaging in the contract.
Such a process seems ideal in a P3 environment.
Conclusion
P3s can be problematic because they introduce a partner into the project delivery process whose primary motivation is to generate profit for the investors, while the other partners, owners, designers, constructors, and stakeholders are interested in the successful delivery of the project. At the same time, bringing in a third party—especially one with strong financial and management skills—can allow projects to proceed that may lack public financing. A third party can also bring private sector management, expertise, and even access to experience, technology, creativity, and unique insights that may not be otherwise available.
Michael S. Ellegood, is a practicing civil engineer, a former senior executive of major international engineering firms, and a former large county public works director. He serves on the Arizona State School Facilities Oversight Board, the state agency charged with overseeing all public-school construction in Arizona. An experienced project manager, he has published articles and conducted training on project management. He can be reached at [email protected].
