Dealing with risk is a vital part of a successful PPP, but in discussions it is not always given the prominence that is necessary.
PPPs are entered into by public sector organisations to provide access to private sector competencies and capacity to deliver greater economy, efficiency and effectiveness than they can achieve; to reduce risk; and to provide an acceptable profile of investment/cost to reduce their annual financial pressure.
PPPs are attractive to the private sector if acceptable returns, within a defined risk framework and timescale, can be achieved.
Key elements in the success or failure of PPPs and their cost is the identification, transfer and management of risk and risk appetite.
The private sector has high levels of competence in identifying potential risks. The public sector needs to be able to match this level of competence to ensure that they can identify and agree the risks and take a view of the costs associated with them.
It also has to be recognised that the private sector’s input for the delivery of assets and services is often delivered through a network of sub-principal relationships. This creates an additional interface risk within the private sector. If private to private sector relationships are not working, the PPP will not work. This risk is not always sufficiently identified.
The reality is that whilst public sector responsibility for some risks can be transferred to the private sector, the accountability for them cannot. It is also the case that some intrinsic risks, as opposed to operational/performance risks, cannot be transferred.
Risk transfer to the private sector comes at a cost. Unrealistic risk allocation leads to unrealistic costs. Incurring private sector cost for non-transferable risk is a waste of money and can lead to the public sector paying twice for them should they occur or lead to the failure of PPPs. Is the transferability of risks sufficiently understood? Are the costs of transferable risks fully understood, negotiated and agreed? Do public sector organisations budget for non-transferrable risks when pursuing PPPs?
A core competence of the private sector is risk management. The public sector should expect the private sector to be able to manage ‘normal’ risks and not to have to pay a premium for them. The mitigating action to be taken and costs, should abnormal risks occur, should be identified.
The public sector needs to be able to match the private sector’s understanding of risk management and agree ‘normal’ risks. It should also be able to evaluate the impact of abnormal risk on the delivery of what has been agreed and the costs of it throughout the life of the PPP.
Different organisations within sectors have different risk appetites. For example, in the private sector financial institutions often have a different risk appetite to that of the asset providers to whom they lend or invest in.
There is also often a difference in risk appetite between sectors, with public sector organisations often having a lower risk appetite than the private sector as the consequences of risk can be very different for organisations in different sectors.
These differences can have a significant impact on costs and on how assets and services are delivered. If there is not a shared risk appetite, conflict undermining the PPP can occur.
Risk and PPP sustainability
In sustainable partnership working there will be transparency of risk identification, transfer and management, the costs associated with them and a shared understanding of risk appetite that translates into consistent behaviours and actions. There will be agreement on what should be expected as a norm for risk management and what are abnormal risks.
The private sector will not capture and retain as profit the costs from risks not occurring or from their impact being less than the costing for them. There will be agreement on the incentivisation for, and the sharing of, the benefits arising from risk management.
Crises in PPPs are often due to an asymmetry of risk management competence and capacity between the public and private sectors, the failure to lay the foundations for a risk based partnership relationship above and the cost implications of the failure of risk management.
It is often only when things go wrong that the sustainability of the relationship in PPPs is tested and revealed.
Time to create new norms
Whilst progress has been made in addressing risk in seeking to create sustainable PPPs, much remains to be done to create a new norm for risk management, performance and cost.
This requires early engagement with, and the input of, the private sector in the procurement process. It also requires the public sector to improve its risk management competencies and its ability to understand a commercial view of risk.
Much more work is required to align public and private sector organisations’ approaches to risk management, the transfer of risk and the cost of it. Those that successfully do so will reap the rewards of sustainable PPPs in terms of performance, cost/profit and reducing risk.
Professor Morley is author of The Public Private Partnership Handbook: How to maximise value from joint working and can be reached at: email@example.com