His Lordship's New Clothes

5 September 2011 The government's review of operational PFI has enabled ministers to launch a new round of social infrastructure spending. But has the report dealt with the underlying problems associated with the model, asks Paul Jarvis.
In July, Commercial Secretary to the Treasury Lord Sassoon confidently announced the Treasury could save the government £1.5bn on its existing PFI contracts.

The politicians were delighted. None more so than Jesse Norman, the Conservative backbencher who has made a name for himself fighting the evils of PFI. Indeed, his response to the Treasury announcement appeared to be much sought after by the national press.

Unsurprisingly, he pronounced himself satisfied with the result, and the impression given was that his campaign had been a success. “I am just delighted,” he told the BBC in the wake of the announcement. “I started the campaign because I was so angry at the waste of money through PFI under Labour.”

What most missed – apparently including Norman – was that the announcement was not endorsing his campaign for a rebate on PFI deals. Rather, it is looking at ways to improve existing contracts through efficiencies and, where necessary, renegotiation.

Nonetheless, the announcement seems to have done its job of lancing the political boil that has been ’costly’ PFI contracts. Over the past 12 months, PFI has become a dirty word. But planned savings of over £1bn seems to have polished up its reputation, in Whitehall at least.

Education Secretary Michael Gove launched a multi-billion pound school PFI programme just hours after the review was published. A few weeks later, Health Secretary Andrew Lansley promised to continue underwriting hospital PFI deals through the deed of safeguard, meaning
projects like the Royal Liverpool hospital and Papworth’s scheme can move forward.

But the partnerships industry has been less enamoured. Although most agree the report is right in its suggestions, they also say these are already being carried out in the majority of cases.

And there remain myriad questions over the future of PFIs, such as how they will be funded in the post-financial crisis world, and whether the model will remain attractive to departments.

“The report doesn’t solve any of the problems Norman had with the PFI structure,” says Nick Maltby, of lawyers Bircham Dyson Bell. “It’s not addressing the ways PFI could be improved, which the industry would be happy to look at.”

“The government is too hesitant in addressing the fundamental problems of PFI,” adds one source. “I would have made the report more specific.”

Perhaps one of the most glaring omissions is a lack of timetable for implementing any of its proposals, meaning there is no suggestion of how or when the savings will be made. “Most of the documents the government are producing have action plans,” says Maltby, referring to publications like the review into engineering costs published last year. “But this has nothing.”

Such detail is critical when attempting to discover whether the review has achieved significant results. If the £1.5bn figure is to be wrung out of deals over 30 years, for example, that represents a relatively small saving.

Tough task
There are also questions around whether the report offers anything new to existing practice.

The first of the report’s three key recommendations, which covers effective contract management, includes reviewing insurance provisions and reducing energy consumption. It says insurance provisions on the risk of damage or failure of the assets during the service delivery should be reviewed to ensure any savings are shared.

“That is a contractual obligation for us,” says David Taylor, of Greater Manchester Waste Disposal Authority. It is one example of where the experience of over a decade of PFI contracts has already overtaken this guidance, and most deals now have similar obligations to Greater Manchester’s.

The energy management provisions, too, are “part of the requirements of any more recent PFI contract”, according to Gerry Askew, at facilities management firm SGP. “When contracts are already streamlined, it’s hard to streamline further.”

Taylor is also sceptical about the potential to make savings through improved energy usage. “Our contract is about producing energy, so it is coming at it from a completely different angle,” he says.

Tim Care, at lawyers Dickinson Dees, is even more critical of this suggestion, especially given how long the report took to publish. “I was stunned that one of the major recommendations was to ’save energy’,” he says. “Every household in the country knows to do that when money is tight.”

The next major area outlined by the report suggests projects should “optimise the use of asset capacity”. There are plenty of examples – particularly in the hospital sector – where this may work. NHS trusts across the country have already looked at mothballing some wards in order to cut costs, whether under PFI contracts or not.

However, once again this recommendation cannot be applied to all deals. “The use of space suggestions don’t work as well for a contract like ours,” says Taylor. In a waste deal, the potential to change the use of a space or mothball a certain section is almost impossible if the
plant is to deliver good value. “I couldn’t see us subletting, for example,” he adds.

The concerns voiced at Greater Manchester over the potential for savings to be made should be worrying for the Treasury. If experts working on a scheme such as Greater Manchester waste – one of the most expensive PFI projects ever signed – are doubtful over where savings can be achieved, then the initiative may struggle.

Shaving a few million here and there on older contracts will be unlikely to deliver the £1.5bn target demanded by the government.

It also highlights a core weakness in the report and the subsequent guidance it aims to provide. “It looked at one health project and three defence deals,” says Maltby. “But local government is the largest sector for PFI, and the review didn’t look at these projects.”

It is understood the £1.5bn figure was reached by taking the savings made on those four pilots, and simply scaling them up. But that is not how PFI contracts work. Bitter experience from practitioners on both sides of the public-private divide proves that each deal is unique.

“It’s got to be done on a contract-bycontract basis with set rules of engagement on both sides,” says Robert Marr, of consultancy Appleyards.

One source who worked on the health scheme – Romford’s Queen’s Hospital in Essex –when it was being put together says the project was not the most appropriate for the savings pilot. The deal had several novel elements in it when it signed, meaning the costs were initially higher than might be the case today, as funders had yet to get comfortable with the ideas. Later schemes will have already driven out such efficiencies, the source suggests, so getting the same level of savings on later deals will be much harder.

The final broad suggestion from the review may be more helpful. This suggests reviewing the specification of soft services in contracts. The idea is to cut out those that may have been nice to have in a time of boom, but are a burden on resources when money is tight.

Most admit that many PFI deals are gold-plated’ and could have their scope reduced. “Maintenance doesn’t need to be gold-plated,” says one. “There is a fair bit of work needed on this.”

The danger is if public authorities see this as carte blanche to cut out all the maintenance from their PFI contracts as a way of saving money. “As a nation, we are appalling at maintaining buildings,” warns Tim Byles, former head of Partnerships for Schools. “We need to make sure we have a proper whole-life system in place.”

Facilities management (FM) providers are most likely to suffer here, and could fight hard to retain what they have contracted for. “It needs to be a partnership,” says one. “The concern is that the public sector will come in and say ’we want this much off the contract’, not ’we want to create efficiencies within the partnership’.”

The big gains that the public sector might see are also likely to be unpalatable to FM providers. For example, the public sector might seek a change to existing health and safety standards, but that would leave the contractor open to far too much risk. And any moves to significantly strip out the FM services from a contract might cause problems with the banks. They are the ones funding the asset, and will want it in good condition at the end of the contract – something that underpins the PFI concept.

On the other hand, ’low hanging fruit’ such as not cutting the grass in winter is unlikely to cause too much concern on either side, but also won’t make a massive difference to the savings pile. Askew points out that such savings will generally already have been considered where contracts are working properly.

“We are already working with the Treasury on using its building more efficiently,” he says. “We all realise we have to share the pain.”

But he’s not convinced simply attacking the FM element is appropriate. “You’re looking for big savings out of the smallest slice of the cake. There is only so much you can do around FM.”


Support needed
The report has already been incorporated into the Treasury’s guidance on PFIs. But if it is to have the desired impact – and make the savings demanded – it will need to become more than simply a document on the Treasury’s website. The pilots had the whole weight of central government behind them. But will others have the same kind of support?

The Treasury promised, on announcing the outcome of the review, that the Cabinet Office’s Efficiency and Reform Group (ERG) will lead “a programme to secure the savings across the public sector”. What that will look like remains to be seen.

“It will depend on a case-by-case basis what needs to be done,” a spokesperson for the Treasury says. The two bodies are working out how the report’s proposals will be implemented.

James Stewart, of consultancy KPMG, says the ERG may be planning a similar operation to its work on cutting the costs of major government contracts. But he warns this will fail.

“It’s different to the previous exercise with service providers where government could have bilateral discussions,” he explains. “Ownership and the supply chain in PFI is much more fragmented.”

One source points out that, from a banking perspective, many PFI projects may not be looking like such good deals today, so asking them to renegotiate terms in favour of the public sector will be difficult. “Any deals between 2005 and 2009 are probably underwater from the banks’ point of view.”

The ERG could help develop the report’s recommendation for greater collaboration between authorities with similar contracts.

Craig MacDougall, of technical consultancy Davis Langdon, suggests the government’s chief construction advisor, Paul Morrell, might be well positioned to lead such an approach. “He would be able to take a look at how different deals were done across different authorities and work out where the efficiencies can come from – why some projects worked well and others less so.”

Another option referred to in the report is for a public authority to review its project benchmarking dates across its PFI portfolio. “Aligning benchmarking cycles is one of the more interesting suggestions,” says Maltby. The move might make it easier for councils to get some savings from their projects, by evaluating their value for money at the same time.

But Maltby warns this will not be easy. “I have had clients where I’ve suggested this year after year and they’ve not done it because it is very hard to do,” he says. “There has been no pressure on people to do the ’right thing’.”

The ERG might be able to apply that pressure. “If there is the will to do it and the drive from the top,” says Care, “people might be forced to come together.”

Capacity building
All the main proposals to make savings rely on one thing: a strong public sector client that is able to properly negotiate with the private contractor throughout the contract to drive down costs and keep the partnership working effectively. Unfortunately, the main complaint in the
industry has long been the lack of skills and capacity in this area.

A National Audit Office study last year revealed 12% of NHS contracts had no public sector contract manager. With budgets being squeezed on all sides, public bodies are unlikely to find the cash to suddenly plug this gap and employ someone to look after this area – particularly when any efficiencies are likely to be swallowed up by the employee’s wages.

At the moment, even the top jobs are proving hard to fill. In recent months, James Stewart, Andrew Rose and Tim Byles have all left top public sector jobs for roles with the private sector. “What’s happening now is proof that the Partnerships UK model worked well – one of the main aims was to be able to recruit and retain high-quality staff,” says Stewart. “That is a more difficult thing to do in a civil service environment.”

On the private sector side, the report proposes a voluntary code of conduct to improve operational savings on an ongoing basis. “We need that and the arm-twisting of contractors that goes with it to ensure contractors are sticking to that before we can get onto some of the other things in the report,” argues Care.

There is plenty of willingness to engage in this from the private side. “We have been talking to the government and we will continue to do so,” says Jay Doshi, of contractor Amey. “[But] the issue is the underlying point – how do you change the contract?”

Care says the contractors should take the initiative here. “Hopefully the private sector will be proactive, it would be better if they drive it,” he says.

Askew believes the key lies in good relationships, as partners on both sides work through the potential for savings. He warns that if the public sector begins using deductions as a way to generate income – which he says has happened in a minority of cases – the “spirit of partnership evaporates”, with both sides reverting to entrenched positions.

Only time will tell if this review drives out real efficiencies in PFI contracts. But even if it does, it’s not clear whether the government or anyone else will be keeping track to see just how much is being saved.

This page was last updated on:
4 January 2012.

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