*connectedthinking

Partnering in practiceNew approaches to PPP delivery*

Executive summary 3

Introduction 7

Planning and structuring a partnershipSection 1: What is partnering and when should it be used? 10

Section 2: Commercial arrangements 13

Selecting partnersSection 3: Competition structure for a partnering 21

Section 4: Identifying the “right” partner 22

Delivering the benefitsSection 5: Financial issues for a partnering 25

Section 6: Contract structures 29

Section 7: Risk allocation and payment mechanisms in a partnering 32

Section 8: Value for money in a partnering 38

Section 9: Partnership governance and management 41

Recommendations and Conclusions 47

Appendix A: Summary of the main features of private sector partnering and alliancing 50

Appendix B: Summary of guidance on PPPs 52

Contacts 53

Contents

The need for betterpartnering� With better public services at the heart of Government agendas, the need for private sector involvement in their delivery and management has intensified. The pioneering role of thePrivate Finance Initiative (PFI) brought theprivate sector into asset financing,procurement and management, while PPPshave brought the private sector into areas ofpublic sector business where more serviceprovision and greater flexibility is required.Arrangements such as the NHS LIFT schemesgroup smaller public sector clients together soas to derive, jointly with the contractor, thebenefits of repeat projects. Local authoritiesnow aim to involve strategic private sectorpartners in all aspects of improvement toservices.

� In general, PFI and PPP projects havetended to remain in non-core areas ofpublic sector business where arm’s-length contracts can be set up.However, greater efficiency and effectivenessare needed not only at the periphery but at theheart of public services. Here, the distinctionbetween activities that may or may not betransferred out of public sector delivery is morecomplex, and does not lend itself to rigidly-defined service agreements.

� It is becoming clear that arm’s-lengthcontracts alone cannot be relied uponto deliver better public services.Reviews of signed PFI and PPP deals haveshown repeatedly that their success dependscrucially on the ability of the partners to worktogether with shared objectives andinformation. In the wake of recent guidance,public-private parties are now devotingattention to wider aims than merely fulfilling acontractual obligation. Their focus is shiftingonto the partnering aspects of deals.

� There is no single agreed definition of ‘partnering’ – but partneringarrangements do tend to share anumber of specific characteristics.Joint working is a key feature of partnering, with the parties aiming to align themselvesbehind the delivery of an agreed set of project,rather than individual, targets. There is a sharedresponsibility not only to deliver a predefined,constant level of service, but also to incorporatescope for improvement, innovation and change.This is underpinned by provisions for opennessand sharing of information.

� Partnering is not a new concept.In contracts between private sector entities,partnering and collaborative working are widelyused and well developed. These approacheshave delivered real benefits in project cost,timing and performance.

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Executive Summary

� To date these techniques have notfiltered across to PPPs to a substantiveextent. Despite a growing body of guidance onthe importance of partnering, a number of PPPshave continued to use the standard PFI contractas a basis, sometimes in combination with a“good behaviour” partnering protocol. As aresult, the supply chain is kept at arm’s lengthand management involvement often limited toformal board meetings.

� Partnering in PPPs has tended to beused in cases where the parties areunable to scope the project fully at theoutset. Sometimes this lack of clarity arisesfrom a genuine need for flexibility, but it mayalso result from having insufficient time todevelop requirements fully. Partnering shouldnot be used because of lack of resources;indeed, it can take more resources to managean arrangement where client and contractorare working together. Instead, it should beused because joint working delivers benefits.

� Partnering in PPPs has focusedprimarily on the behaviours of theparties in addressing uncertainty, ratherthan the scope for joint working todeliver better value projects andservices. Whilst continuous improvement andinnovation may be covered by contract terms,there is little practical understanding of howthe parties can work together to deliver thistype of benefit.

� We believe that the limited applicationof partnering is restricting the benefitsrealised by PPPs and the ability of thetwo sectors to work together moreclosely on an even greater range ofactivities. There is a pressing need todevelop partnering practice further. However,this in turn raises many issues for PPPs: forexample, how to ensure value for money andaccountability, how to contract for a projectwhere the specification is to be developedthrough the project life, and how to deal withquestions about people and culturalcompatibility. This is why we have drawntogether experience from across the publicand private sectors to create a paper thatbrings together expertise developed in:

• PFI and PPP advice• merging and reorganising private sector

businesses• private sector partnering contracts and

the techniques that make them work• public-private alliancing transactions

overseas.

We have combined our experience andinsights in each of these areas to develop anew and more effective approach to public-private partnering. By enabling public sectorparties to use more effective techniques forestablishing cost transparency, joint riskmanagement and team working within PPPs,we believe our approach will enable them tomove with greater confidence towardsundertaking less specifiable and more flexibleprojects with private sector partners.

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Conclusion• Partnering is an established and growing

feature of the PPP landscape. It must nowevolve further in order to play a pivotal role intransforming the public sector’s efficiency andeffectiveness in the delivery of services totaxpayers. To date its achievements have beenheld back by a lack of practical understandingof how to partner more effectively.

• PPPs need better access to the techniquesdeveloped in private sector corporatetransactions, partnering, collaborative workingand alliancing. But better partnering will notbe delivered simply by adapting private sectorcontract forms, or even selected terms andconditions, as templates. Equally critical arethe contracting and management techniquesthat underpin successful delivery, and thematching of the contracting approach to theneeds and constraints of the project.Harnessing these will require relevant practicalexpertise both in project teams and their

advisors. A further requirement is a culturalchange, acknowledging that sharing savingsand gains is acceptable if these could nothave been realised without the joint efforts ofthe partners.

• Clearly, these collaborative and alliancingtechniques and approaches will not all berelevant in every case, and should not beimported wholesale across all PPPs.Traditional PFI contracting will continue tobe the best approach for many PPPtransactions, either exclusively or alongsidepartnered aspects of a contract. But webelieve that applying partnering selectivelyand judiciously will help projects to realise,and even exceed, their objectives – andultimately enable them to deliver the type ofgroundbreaking results already beingachieved by partnering deals in the privatesector.

� In addition to the behavioural changes which currently tend to be the mainfocus of partnering practice, PPP teams and advisers should consider theeconomic benefits they can achieve through the use of private sector partneringtechniques. Crucially, the partnering approach should be an active choice forproject delivery, rather than one driven purely by a desire for good behaviour inan uncertain environment.

� PPPs should draw on the full range of structures and contractual precedentsavailable for partnering. Standard PFI structures may not be appropriate.

� PPPs should change the way in which partners are selected. The choice of a“good” partner involves more face-to-face involvement with bidders in order toassess their cultural and personal fit.

� Asset-intensive PPPs should not assume that project financing is the onlyfunding method capable of delivering a value for money solution. Different formsof funding may be appropriate, and their impact on the structure and cost of thepartnering should be understood from the start.

� The public sector needs to change its view of partnering, particularly withregards to incentive payments. These should provide a fair reward for thecontractor’s efforts and should not be regarded as money that belongs by rightsto the public sector. To drive better performance there must be real andproportionate incentives for contractors.

� PPPs need more robust ways of ensuring continuing value for money. These are already being used in private sector partnered and allianced deals, and PPPs need to be able to emulate them.

� Management of the partnering should be addressed explicitly from the outsetand cannot be achieved through mutual board membership alone. PPPs need to draw more deeply on both the public and private sectors’ practical experienceof bringing together and managing teams of people.

Recommendations: a new approach

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Since the 1980s the role of the privatesector in the provision of public servicesand infrastructure has continued togrow and develop.

One of the ideas originally driving the privatesector’s advance into public provision wasthe assumption that the private sector doesthings better: it is more efficient, responsiveto change and outcome-focused. Based onthis concept, the overall thrust of PFI andPPP has been to create arm’s-lengthcontractual arrangements with private sectorproviders, leaving them to do what they dobest without interference from the publicsector client. This meant that private sectorprovision tended to be on the periphery ofthe public sector, in areas that could besegregated off into a separate contract.

The concept of “hiving off non-core activities”was behind much of the early contractorisationsand privatisations and has shaped the structureof most PFI projects and the resulting standardcontract form1 and funding terms. These arebased on a tightly defined scope and price ofwork and very clear and detailed risk allocation.These reflect the requirements of the funders ofPFI transactions, namely the project financebanks, which have provided the bulk of PFIfinance through project debt.

As they have developed, the scope of public-private transactions has changed in anumber of ways. In so doing, transactionshave often drawn on terms and conditionsfrom pre-existing contract forms to widen thescope of the two sectors’ involvement.

Thus early contracting-out experienceinformed the service provisions of PFI. It also contributed to the growth of processoutsourcing as the supply of equipment(particularly IT-related) evolved to include thebusiness processes served by that equipment.Privatised industry regulation has provided thebasis for gainshare and pricing provisions inPPPs. Some of the linkages between types ofcontract are shown in Figure 1 whichillustrates some of the cross-fertilisation ofpublic-private contracting techniques. Thesehave ultimately led to a spectrum of public-private arrangements, as shown in Figure 2.

All of these types of contracts involve anelement of partnering, in that contractualarrangements work better where thecounterparties align themselves with theproject objectives, and work jointly to deliverthese. In this way, partnering concepts havebeen used to try to make contracts operatemore smoothly and effectively. But for projectslacking the well-defined separation ofresponsibilities of PFI project structures, such as development partnerships, complexoutsourcing, Strategic Service Partnerships(SSPs) and flexible PFIs, partnering isfundamental to the deal.

An increasing range of projects, such as themany Local Authority SSPs, the structuresdeveloped by Partnerships UK for PrimaryCare facilities (the LIFT projects) and batchedschools and health schemes, fall within thesecategories and are pushing outward theboundaries of public-private relationships.

Introduction

1 HM Treasury Standardisation of PFI Contracts Version 3 (2004)

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This increasing need to harness the benefits ofpartnering has led, in turn, to the provision ofguidance aimed at assisting the public sector, inparticular, to try to change its approach toworking with contractors2. Although theguidance goes a long way to helping identify theissues and behaviours needed, it is not alwayseasy to translate these into practical change atthe project level. The guidance, whilst helpful incovering the range of issues, often poses theusers a series of questions to answer. Answeringthese is an essential step, but getting to thepoint where a satisfactory answer can be givenis a task for the project teams and their advisers.OGC, for example, lists some key questions inits Best Practice guidance “Forming partneringrelationships with the private sector in anuncertain world” and “Managing partneringrelationships”, including the following:

• Have we selected the right partner?

• How will we demonstrate VFM for newrequirements over the life of the contract?

• Have we established good communicationschannels? Are joint plans in place to help buildthe relationship?

• Are the potential partners financially viableand do they have clearly defined businessstrategies?

• Are the indicators targeting real improvement?

• Is the Department’s organisation delivering thecommitment and competencies to ensure thatthe partnering relationship is a success?

These are vital areas to address in a partneringcontract, but project teams find them difficult.For example, it is not easy to know how to get apartner to work co-operatively with the Authority.Teams do not always know how to create asuccessful relationship that is “open”, “trusting”,“collaborative” and “no-blame”. Nor is it alwayseasy to get comfortable with the robustness ofopen book accounting, benchmarking, or markettesting and the problem of how to ensure that apartnership delivers value for money.

The contract terms implicit in a partnering arealso more complex. A “partnering approach”does not lend itself to legal drafting. For thisreason the partnering provisions are oftencontained in a non-binding supplementaryagreement covering aspects of the relationshipand working practice. However this partneringcharter or protocol can sit awkwardly, or evenconflict, with the contract terms, creatinguncertainty in their legal interpretation.

The questions posed by partnering are not, we believe, always fully answered by projectteams and their advisers. But should they be?Does partnering really offer a new way ofcontracting or is it simply useful sentiment thatmay help a contract to function better?

2 See Appendix B for a selection ofpublications providing partneringguidance.

Figure 1: PPP development

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Outsource estaterationalisation,investment andrevenue generation

Public Private Partnerships

Developmentpartnership tomaximise assetvalues ondevelopment/sale

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What are the benefits ofpartnering?The advantages of closer involvementbetween the contracting parties and thegreater alignment of objectives that partneringcan facilitate include the following:

• In the type of long term contracts that havedeveloped under the PFI, partneringtechniques and relationships are an essentialingredient in project success. This wasrecognised in the NAO’s report of 2001,“Managing the relationship to secure asuccessful partnership in PFI projects”. Even though a PFI contract may stipulateprecisely the risk sharing and paymentmechanisms, change is almost certain toarise in a project of 20 or more years’duration and the parties need to be able torespond, regardless of how much flexibilitywas contracted for. And if one party cannotbear its allocated risks during such a period,then neither can the others escape some ofthe consequences. The client and itscontractors need to be able to work togetherto solve issues, whether the contractprovides for this or not.

• Partnering between the sectors opens upthe possibility of public-private co-operationwhere the precise scope and cost of theproject(s) in question is not known. By working together, the public and privatesector partners can develop such projectsjointly, pooling their skills, and sharingexperience and knowledge. This has beenthe approach used on “bundled” projectswhere an Authority or group of Authoritieswish to undertake a series of similar projectsover an uncertain future period, withoutstarting each from scratch.

• Partnering allows the public sector tocombine its skills and resources with thoseof the private sector. With a partneringrelationship it is not necessary to pass areasof public sector business wholly to acontractor. The private sector can bebrought instead into activities where it hasrelative strengths, without displacing keypublic sector expertise. This in turn reducesthe concern about private sectorinvolvement closer to the core of publicsector activity. In effect, partneringtechniques blur the core/non-coreboundaries, enabling greater co-operationbetween the sectors than ever before.

• The Gershon review highlights the need forgreater collaboration between GovernmentDepartments and for investment in costsaving systems and back-officerationalisation. This is unlikely to beachieved without private sector skill and

experience being brought to bear in theseareas of the public sector.

• Within the private sector, partnering andalliancing, as a distinct approach tocontracting, has delivered significantbenefits in terms of project cost, time andquality. By working collaboratively,contractors and clients have been able toachieve better scoping of requirements,better risk management, more efficientdelivery, better-than-expected performanceand significant cost savings.

Partnering, then, is not simply a way of doingexisting business more pleasantly. It offers newpotential for greater, and better, transactionsbetween the public and private sectors.

So, on the assumption that the public andprivate sectors can benefit from morepartnering arrangements executed moresuccessfully, this paper sets out our thoughtson how to make partnering work better. We believe it offers project teams a newapproach from us as advisers, which will inturn enable them to address the questions and issues more comprehensively.

A new approachWe believe that there is a real need to defineand communicate better the techniques ofpartnering and collaborative working for PPPs.Whilst there is now guidance on partnering,and sectors such as Local Authorities havedeveloped their own approaches, more can bedone by project teams and their advisers toaddress the issues raised by partnering andthe questions of how such arrangements canbe made to work in practice.

At PricewaterhouseCoopers we have for manyyears been assisting our clients in the privatesector to bring businesses together andnegotiate contracts that enable complementaryskills and resources to meet new demands.The private sector in fact reorganises itselfcontinually as business needs and marketschange. Mergers, acquisitions, disposals,rationalisation, cross shareholdings, jointventures and partnerships are a part ofcorporate life for all our private sector clients.We have also assisted our private sector clientsto develop the management and financialtechniques needed to provide a robust basisfor operating flexible contractual arrangements.And we have experience of advising publicsector clients on their alliancing arrangementswhere value for money has to be maintainednotwithstanding the establishment of targetcosts after contract signature.

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We believe that PPPs must now have accessto this deeper pool of experience and practicaltechniques if they are to develop partnering toits full potential. PPPs can only move forwardin a way that is accountable and delivers valuefor money if they can utilise this range ofcontracting and management practice.

That is why we have assembled the skills andexperience needed to deliver a practicalapproach to PPPs. We have drawn on a widerange of our people’s experience to develop anadvisory service for clients hoping to draw moredeeply on partnering in their PPP procurements.This has entailed a pooling of expertise from the

fields of privatisation, PFI, capital project advisory,corporate structuring, risk management, mergersand acquisitions and alliance audit. This approachaims to bridge the gap between best practicedeveloped in the private sector, on the one hand,and traditional PPP approaches, on the other.

This paper is intended to demonstrate thebenefits of this approach, by addressing someof the practical issues in making a partneringcontract work. It is not intended to provide fullguidance on good practice, but to show that weunderstand how and where a new approach isneeded and have the resources to help clientsachieve better partnering deals.

This paper is set out as follows

Planning and structuringSections 1 and 2 of the paper deal with the key strategic issues for public sectorplanning and structuring of a partnering arrangement with the private sector.

Selecting partnersThe partnering competition differs from traditional procurement because the aim is tofind the “right” partner with whom to share the client’s business in the future. “Soft”issues become more important, but steps must also be taken, wherever possible, to usethe competitive process to drive VFM. Sections 3 and 4 look at these issues.

Delivering the benefitsFor partnering to deliver real benefits the issues of financing, contracts, risk allocation,VFM and joint management have to be tackled effectively. Sections 5 to 9 of the paperdescribe the issues and our experience of delivering solutions to them.

Recommendations and ConclusionsFinally, we summarise our practical recommendations for moving partnering forward inthe arena of public-private partnerships.

Authors

We hope you find this paper useful and welcome comments.

Paul Brewer Libby Johnson

With Martin Callaghan, Graham Dredge, Daniel Earle, Caroline Johnstone, Roger McComiskie, Anthony Morgan.

PricewaterhouseCoopersOctober 2004

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What are the definingfeatures of a partnering?Partnering has no single agreeddefinition, but there is general consensusthat it exists in agreements where:

• There is a requirement for the deliverables toencompass not merely a predefined, constantlevel of service, but to incorporate scope forimprovement, innovation and change.

• To promote this way of working there isagreement as to the client’s objectives, and mechanisms to align these with thecontractor’s commercial objectives.

• There is trust and openness in therelationship between the parties and theywork together, pooling resources andcomplementary skills.

• There are also structures and processes toensure a degree of joint management of theproject, as though the contractor and clientwere in business together.

• There is a degree of risk-sharing betweenthe parties.

• The partnering relationship is managedproactively, with key individuals retained tofoster it.

The decision to partnerThis critical question needs to be addressedcarefully by the client at an early stage of theproject3 and as a key part of the business casepreparation. Advice will be needed from withinand outside the procuring body. A number ofpublic sector organisations provide guidanceon partnering. These include the Treasury, theOffice of Government Commerce and theStrategic Partnering Taskforce of the ODPM,which have prepared a body of guidance4.

The decision to include a partnering protocolwith the contract documentation is not in itselfdifficult: clearly the processes for organisingmanagement should be addressed in any deal,be it a traditional PFI, a set of “bundled”schemes or a strategic relationship.

What is less straightforward is to identify how,and where, the partnering agreement is criticalto success, ie,

• where the partnering will need to be effectiveenough to deliver project objectives

• how it should be made effective

• whether, in fact, it is feasible to expectpartnering to work in this way.

Planning and structuring

Section 1

What is partnering and when should it be used?

3 A partnering may, of course,encompass a long-term relationshipwhere both service delivery andmultiple individual projects areinvolved, but for simplicity, the term“project” is used throughout this paper.

4 For a selection of publishedpartnering guidance, see Appendix B.

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The considerations listed below may help toaddress these key questions.

What is the client’s requirement in terms of business outcomes?

Clients considering partnering need to startwith a clear view of the required businessoutcomes. For partnering this is particularlyimportant because the project objectivesprovide the framework within which the partieswork together.

Once business outcomes are understood, thelikely solution in terms of assets and servicesis a determinant of the contracting approach.The PFI solution for asset intensive projectsinvolves less scope for partnering because ofthe need for project debt to deliver finance atan acceptable cost. This, in turn, necessitatesa predictable cashflow to service theborrowing. However if the assets are deliveredover a number of years or across a number ofdifferent projects, then it is unlikely thatcashflows and funding will be determinable atthe outset. Partnering can be used to developthe project outputs and financial terms in thecourse of the project period. If it is not certainthat the assets will continue to be needed andthe client wants flexibility to dispose of them,then, again, a partnering that jointly assessesthe way of recycling assets and adapting tochanging needs may be more appropriate.

But if any aspect of uncertainty about the needfor, or costs of, the project arises simplybecause the client has not had time toestablish these, then this should be addressedby extending the programme so that objectivesand scope can be worked out to deliver aneffective procurement.

What is the service deliveryenvironment?

The client needs to establish the respectiveneed for public and private sector provision,addressing questions such as:

• how much of the service could be carriedout reliably by the private sector?

• what are the public sector’s specific skillsand competencies and where will the publicsector add value?

• what activities does policy require to bepublicly provided, as opposed to publiclyprocured and managed?

While there may be many clear boundariesbetween public and private sector provision, if there are any activities or processes thatwould benefit from being shared, thenpartnering may deliver a better solution thancontracting out or PFI. This may be the case inareas that appear to be too close to the “core”of public sector provision and where closeinvolvement of the public sector is neededalongside any private sector input.

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How can each party add value tothe service?

The private sector must have capability todeliver elements of the service better than thepublic sector could. Many public sector activitiesand assets are common to private sectorbusinesses, for example, the operation ofcustomer account and information systems orlogistics services. These can be simplycontracted to the private sector, but greaterbenefits may be delivered by involving theservice provider in delivery of strategic decisionsand/or operational improvements. This is betterachieved through a partnering structure.

It is always advisable to consult the potentialprivate sector partners before finalising thescope of the partnership, particularly where the service requirement is novel or unusual.But clients will normally get the most out ofconsultation with the market if they haveworked out their own views and potentialapproaches first and use the market soundingsto test these and discuss the issues arising.

Conversely, it is also worth considering whatassets, skills or intellectual property the clientwould bring to the partnership. There may bethings which only the public sector can provideand exposure to which may benefit the privatesector partner in terms of experience,information and understanding. If there are realbenefits to be gained from working with, ratherthan for, the public sector, then the privatesector partner should be more willing to partner.

What are the main risks and howmay these be allocated?

A clear and complete register of the projectrisks, which is continually utilised in riskmanagement, is an essential tool in developingand managing any project. The informationabout the nature and degree of risks will helpdetermine the structure of the public-privateinvolvement.

Risks that are capable of management withinthe private sector combined with some risksthat clearly lie with the public sector, lendthemselves to a PFI -type structure. But thepresence of risk that is best managed jointly, ofrisks that are likely to change, or of significantrisk that neither party can control, may point toa partnering structure where risk generally isshared, regardless of its origins. This appliesequally to performance risk where, as with aPFI, there need to be targets and objectivesthat can be measured.

Where the public and private sectors’responsibilities cannot be segregated, then theproject objectives measure the success of thepartnership as a whole and the parties sharethe risk and reward of their joint performance.

ConclusionWhile we have set out above a brief series ofquestions for consideration, the decision doesnot lend itself solely to a simple question andanswer process. Identifying the scope forpartnering should, of course, be part of arigorous option appraisal in line with currentguidance and practice.

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As part of the process of identifying thepotential for partnering, the outlines oflikely commercial structures will havebeen considered.

This next stage in the strategic process is todraw up the commercial structure, orstructures, in more detail. The precise legalterms of the transaction will need to bedeveloped in time for the full competition: thisis discussed further below at Section 6.

The decision to partner is likely to mean thatboth pure PFI, and arm’s-length contractingout, have been excluded. The project will entaildelivering a service that is not fully susceptibleto detailed, fixed specification at the outset,and the client and contractor will work moreclosely together to develop and deliver it.

Drawing up commercial terms is an exercisethat will be familiar to clients and contractors,even where partnering has not been theapproach used. For this reason, the process isnot described in detail here other than to saythat it is a significant exercise which involvesestablishing, inter alia, the following.

1 Objectives

A set of overriding objectives of the project orbusiness should be drawn up. It is worthwhileexamining the objectives which are not withinthe project scope as well. The objectives willunderlie the KPIs that are subsequentlydeveloped and dictate the nature of the keycontracting parties.

Example:A partnering project to provide an institution’sstaff accommodation has as its objectives:

• To upgrade all accommodation to newstatutory minimum standards in 5 years

• To provide the quantities of accommodationset out by the institution in itsaccommodation plan, through an optimumcombination of new and refurbished provision

• To release a given acreage of sites for theinstitution to develop or sell

• To generate savings in the long term cost ofaccommodation provision

• To promote the institution’s attractiveness topotential joiners through the provision ofaccommodation that continues to be attractive

These objectives will underlie the evaluation ofpartners’ proposals and the development ofindividual projects.

More strategic objectives are not part of theproject but are part of the partnering’s widerstrategic objectives. These will be the focus ofa strategic board involving both the institutionand the partner. These might include:

• To ensure value for money in delivering anyfuture changes to accomodation requirements

• To reduce the turnover rates of staff

• To maximise the potential development valueof the sites released

• To meet the institution’s continuingsustainability objectives

Section 2

Commercial arrangements

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2 What assets and resources arerequired to deliver the objectives, ie, what constitutes the business?

It helps to be able to define the boundaries ofthe business in question distinguishingbetween those activities that are part of itsremit and those which, while they may beinputs to it, take place outside the boundaries.

Example:The London Underground PPP draws theboundary between operations and engineering.The public sector manages day-to-dayoperations, and employs train crews, stationstaff, signalling controllers and theirmanagement. The private sector are responsiblefor maintaining, renewing and upgrading all theassets and infrastructure necessary to enableoperations, including track, bridges, earthworks,stations, trains and depots.

3 Contractual interface

Are there services within the project wherethere are clear client : contractor boundariesand the potential for a contractual specificationto be drawn up and priced at the outset?These aspects of the service can, and should,be contracted and priced for.

Example:In the LIFT projects, the work packages thatcan be specified and priced at the beginning ofthe partnership are competed, with contractorsrequired to bid their solutions and costs forthese in the traditional way. In order to preventcontractors “buying” their partnership byunderpricing the initial deals, they are requiredto commit to the rates underlying the initialpackages for future work.

4 Project flexibility

What are the areas of the project where therequirement and specification is as yetunknown? How and by whom should these bedeveloped?

Example:In the Watergrid PPP, British Waterways, PUKand a private sector consortium hold stakes inthe PPP company, whose remit is to managewater supplies through the network but also toidentify commercial projects and invest torealise these. No commercial projects arespecified in the agreement, however and that isleft for the PPP to identify.

5 Project assets

Who needs to retain the project assets at theend of the project term?

Example:The market for some asset types is sufficientlyfluid to allow for their sale by an Authority andacquisition on a lease basis. This can alsoallow greater flexibility in reproviding them.Leases are used for assets such as ITequipment and fleets of cars, but have alsobeen used by MOD on some shipprocurements and in simulator PPPtransactions where the MOD’s continued needfor the assets is uncertain, and the contractoris willing to take the risk of disposing of them.

6 Project investment

What are the future investment needs of theproject and how can they be financed? Will thepartners be able to raise finance for futureprojects? This can include investment ofdevelopment time and expense as well as thecost of assets.

Example: The Watergrid PPP (see above) provides for anelement of shareholder finance which must bemade available for (unspecified) capital worksto the network assets and for commercialinvestment projects meeting agreed criteria asto risk and return. In order to replenish thiscapital source and enable continued growththrough the 30 year term, there are provisionsto refinance projects with limited recoursedebt. The need to pursue new activities isacknowledged in the shareholders’ agreementand key staff roles are maintained in order toensure that the PPP addresses this task.

7 Risks

What are the project or business risks and howcan they best be shared between the parties?

8 Value

What is the value of the various aspects of theproject to a contractor? Is there potential foran acceptable cost : risk : reward profile for apartner?

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Identifying the potentialpartnersSo far we have talked about a simple, bilateralcontractual relationship between a “client” anda “contractor”. In reality the partnering maydeliver greater benefits if it incorporates moreof the contractor group than purely a leadcontractor or integrator.

The 1994 Latham Report5 and the 1998 Egan Report6 highlighted the importance ofpartnering between the public sector andcontractors. As a result, the public sector, in itstraditional procurement role, has worked with agrowing array of partnering-based contractualstructures. At the same time, the private sectorhas also moved forward in developing morepartnering-based contract structures. The benefits of private-private partnering, andits purest form, alliancing (see Section 6), arewidely publicised7.

One of the key differences between thepartnering structures used within the privatesector, and those developed in PPPs, is thatthe former are based on inclusion of more ofthe contracting parties. The underlying idea isthat the partnership should be between all thekey parties who can influence the contractsuccess. The potential partners are:

• the client – although if the client does notwish to become involved, this does notprevent the contractors forming apartnership among themselves as hasreportedly been done on some of the earlierPFI contracts

• a lead or prime contractor, which may (as inPFI) be a SPV, who has responsibility tointegrate all other contractors (both currentand future) to deliver the project

• the key contractors, which are likely toinclude the designer of the project the leadconstructors/providers of assets and thelead provider of services

• key subcontractors, which could be thosewith a key role but in a more limited area of the project

• specialist subcontractors, ie, those whoseexpertise is essential to the project but whoare not key to its delivery. An example would be technical advisers.

A client should determine the type ofpartnership it wants, rather than awaiting theformation of consortia by bidding groups.Situations in which a partnering involves morethan a bilateral client/lead contractorarrangement include the following:

• Where there are a number of distinctactivities contributing to project objectivesthat would otherwise operate in isolation andfail to contribute to their full potential. An example would be the use of a realestate developer to guarantee the value ofalienated sites in a building and estaterationalisation project. If the developer cancontribute at the project strategy and designstage, it has a greater opportunity tomaximise the estate realisation value which,in a partnering gainshare, would accrue to all the parties.

• There is a complex service, where clientpartnering throughout the supply chain willhelp the project to achieve its objectives. For example, in the design and provision ofserviced aircraft to meet a military capabilityrequirement, there will be a number of keycontractors for whom a closer relationshipwith the client will benefit the project.

• There are synergies, efficiencies andeconomies of scale that can be accessed ifthe client and key contractors work together.This is often the situation in private-privatesector partnered construction projects,where the key contractors work together toanticipate risks and drive out inefficiencies.

• The key contractors are potentialcontributors to the client’s strategicdevelopment. For example, in a schoolsproject, the construction contractor, thefacilities management contractor, the partymanaging revenue generation and, possibly,the IT systems supplier may all havecontributions to make in strategicdevelopment of the school project. A client working in partnership with only the construction contractor may fail to reapall of the potential benefits of the partnering.

There is a significant body of evidence of thebenefits that collaborative working has broughtwithin the private sector8. However deliveringthe benefits of a multi-party arrangement involves differentmanagement, performance measurement, risk,gainshare and payment arrangements from atraditional PPP. We describe these in therelevant Sections of this paper, where we drawon private sector collaborative contracting inthe methods we propose for the PPP “toolkit”.

Figure 3 sets out the broad options as topartnering groupings.

5 Constructing the Team: Final Report of the JointGovernment and Industry Reviewof Procurement and ContractualArrangements in the UKConstruction Industry (HMSO 1994)

6 Rethinking Construction(Construction Task Force 1998)

7 See, for example, The SevenPillars of Partnering (ReadingConstruction Forum 1998) orModernising Construction (National Audit Office 2001)

8 See footnote 7 above.

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A bilateral partnering applies between theclient and the lead integrator or SPV. This is ineffect the approach used in PPPs currently,although in a PPP the SPV’s shareholders areusually also the key contractors and may thusbe involved without the need for a multi-partyagreement.

A multi-party partnering incorporates theclient, the lead contractor and the keysubcontractors. Alliancing is, arguably, themost developed form of partnering. In analliance, project “participants” include all of thekey players and the client. In the case ofalliancing there are no separate bilateralcontracts between these parties and theyshare in all of the project gains and riskaccording to predetermined formulae.Alliancing is described further in Section 6. In multi-party arrangements that are not fullalliances, bilateral contracts will still exist butthere will be some sort of multi-partyagreement which may be more or less binding,and which deals with working arrangements,risk and cost sharing.

A supply chain partnering excludes theclient but will involve several of the contractingparties. Under this arrangement the suppliersindependently form a partnering arrangementamong themselves. In effect the leadcontractor acts as a client to the rest of thecontractors in the partnering.

This approach excludes the client from anysavings the partnership realises and may meanthat the partnership’s objectives conflict withthose of the client. But partnering through thesupply chain can still be a useful tool formanaging risk and meeting performancecriteria. Such alliancing has arisen on PFIcontracts, where the client has preferred toremain at arm’s-length from the contractors’working practices in order not to absorb anyrisk. If the client cannot provide themanagement required to partner with thecontractors, then this approach may be usedinstead.

ConclusionWhile a partnering approach implies that thereare aspects of a project that cannot bespecified at the outset, there are still manyfeatures which can and should be defined atan early stage. And once it is clearer where inthe project partnering has the most potential,the nature of the partners can be established.If the client determines that it is to be involvedin the partnering, then it can also select whichother players it requires to partner with it,rather than simply awaiting bidders’ proposalson the issue.

Figure 3: Potential partner groupings

Client

Integrator/SPVV

Key Contractor

SpecialistSubcontractor

Key Contractor

Key Contractor

Multi-partypartnering

Supply chainpartnering

Key Subcontractor

SpecialistSubcontractor

Bilateralpartnering

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Selecting Partners

21

Many PPPs seeking to adopt partneringdo so under a traditional EU negotiatedprocedure as used on PFI precedents.

While the proposals in the latest Green Paperfrom the EU potentially restrict the scope ofpublic sector clients to compete for partners,by requiring bidder selection based on specificprojects, these remain in consultation at thetime of writing and are opposed by a numberof UK commentators and public bodies.

In a traditional PFI the outputs and inputconstraints of the project are set out, togetherwith the draft contract, in an ITN. Bidders areasked, as far as reasonably possible, to makeinput proposals and price the project.

Competitive pricing of the project helps tosupport the case for VFM, as discussed inSection 8, and should be carried out whereverfeasible. But one of the reasons for entering apartnering is that the precise scope of the projectis not known at the competition stage. Given thatthe bidders are not going to be bidding for apredetermined project, it is necessary to focus onwhat will be the critical factors for projectsuccess, including future VFM. In a partnering,key determinants of success will include thefollowing:

• The contractor’s willingness to engage in apartnering relationship.

• The contractor’s previous experience ofpartnering and reputation with clients onpartnering deals.

• The contractor’s understanding of the client’sbusiness and project objectives.

• The ability of the contractor and the client towork together at a personal and team level.

• The effectiveness of the management andgovernance in supporting the partnershipand the building of the relationship.

• Ability to demonstrate VFM where thepartner effectively has “sole supplier” status.

These are all key issues, although only some ofthem can be tested at competition stage.Clients and their advisers need to think hardabout how to test bidders realistically and toensure that these less tangible criteria are notmerely illusory in the bidders under review. For example, a set of questions aboutcommitment to joint working can easily beanswered “correctly”. Actual delivery of a jointworking approach is harder to achieve and,equally, harder to test for.

The approach is likely to require a competitionwhich itself is less arm’s-length and moreconsultative in nature, with bidders’ teamsspending time discussing key issues with theclient and their approaches and attitudes beingassessed. Such a co-operative process can becarried out before formal ITN, as it is in someMOD projects where it is termed “convergence”,and in Local Authority partnerships where thereis often a pre-ITN scoping exercise with bidders.

As discussed further in Section 4, “Identifyingthe ‘right’ partner”, we have developedmethods for assessing the team and cultureaspects of working with different bidders.Briefly, management teams are assessedthrough a combination of meetings to discussthe approach to the project and questionnaires

Section 3

Competition structure for a partnering

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or tests to establish views of individuals andfeatures of the company’s culture and style.Again, the critical part of the assessment isinteraction with the bidders, and the processdoes not lend itself to a mere exchange ofdocuments.

In an alliancing project, the selection ofshortlisted partners (after they have passedfinancial and technical capability criteria) isoften based purely on their approach andcommitment to working with the client in analliance. All pricing is deliberately left until afterpreferred bidder selection. This approachshould be used with extreme caution in thepublic sector, recognising the competition lawenvironment and the need for accountabilityand value for money. Wherever it is used, thesubsequent costing must be based on arigorous, joint, and fully open book process, asdescribed further below in relation to alliancing.

In a PPP, even where the project cannot bepriced in its entirety, the client should considerwhether any and, if so, which, elements canbe priced in competition. This could includefinancing costs, rates of return, overhead andprofit percentages as well as the more tangiblecomponents of cost, such as hourly rates andmaterial prices. The focus should, of course,

be on key cost drivers and differentiators.Where there is a mix of price and non-pricecriteria in the competition, careful thoughtneeds to be given to the weighting of thosecriteria so that undue importance is notattached to a partial pricing of the proposal.

This approach has been used on some batchedschemes in the NHS, where the units that are firstto be built are priced fully and schedules of ratesgiven for the successive projects. But a definingfeature of a partnering is the need for flexibilityand therefore the future projects to which suchunit prices would apply are likely to change andoutturn costs cannot be reliably predicted fromthe rates. Pricing and payment mechanisms arediscussed more fully in Section 7.

ConclusionThe competition structure for a partneringneeds to focus closely on the determinants ofsuccess, one of which will be achievement ofvalue for money. But attention must also begiven at the competition stage to non-pricefactors to ensure that the right partner isselected. Section 4 discusses ways to assesspartners’ cultural and personal fit with theclient organisation.

There is an approach that states that the critical factor in making a partneringwork is that of integrating the peopleand teams involved and, before apartner is signed up, being able toidentify the team that will best be able to integrate with the client. Get thatright, the argument runs, and everythingelse will follow.

We agree that the integration and workingrelationships of the partnership are a criticalfactor. But they are not the sole factor, and agood working relationship will not compensatefor a lack of clarity about project objectives,responsibilities, risks and reward. All of these keyissues still need to be enshrined in a set ofcontractual arrangements. But it isacknowledged that bringing a set of contractual

terms to fruition depends upon effective workingpractices and relationships within thepartnership. Furthermore, these may be radicallydifferent relationships from those traditionallyexisting between the parties.

The importance of teams that can workeffectively together is recognised in most sectorsof business. Within PricewaterhouseCoopers wehave, for some time, advised companies inmergers and acquisitions about both thepractical and behavioural aspects of bringingcorporate cultures and organisations together sothat they can start to deliver value from their newstructure. The methodologies we use are nowbeing adapted to apply to PPP deals, bothbefore preferred bidder selection and aftercontract signing. They are summarised in theparagraphs which follow.

Section 4

Identifying the ‘right’ partner

Management teamassessment at thebid stageIn private sector mergers and partnerings, we assess management teams to gain a betterunderstanding of management’s suitability, as individuals and as a team, to implement thepartnering successfully and deliver the expectedbenefits. The assessment is conducted in orderto answer the following questions:

• What does the business strategy require ofmanagement?

• How will the partnership management teambe configured?

• How will this team’s mix of styles helpimplement the proposed strategy?

• Are individual roles clear and appropriate?

• How does each of the individual managersfit their roles?

• How do we address potential risks?

Such an assessment can be conducted byobserving team presentations or meetings,conducting targeted one-to-one interviews orutilising independent psychometric testing.

This process:

• Utilises a framework that clearly understandsthe partnership drivers and business needs

• Assesses the team as a whole as well as theindividual managers

• Helps to predict those situations in which theteam will thrive and those where they couldcontradict with the objectives of the partnering

• Assesses the suitability of individuals forparticular roles within the team

• Highlights predictive performance as well ascommenting on past performance.

With this assessment, partners can makeinformed decisions on management’scapability to deliver the business strategy andidentify the need for appointments or changesto roles and responsibilities. The analysis canalso help the partners set objectives forexecutives and determine their developmentalneeds.

The management evaluation exercise needs tobe undertaken at shortlist stage and to involvethe team on each side that will be responsiblefor delivering the project, rather than bid teams.

Corporate cultureassessment Assessment of cultural attributes can bedetermined at a number of stages in the bidprocess and involve varying degrees of rigour.For example:

• seeking individual assessments (often,anecdotal) of cultural fit from members of thebid assessment team

• using a defined “checklist” to profile eachbidder’s culture and how well it fits with thatof the public sector client. Such checklistsoften cover areas such as organisationalform (centralized vs. decentralized), businesshorizon (short term vs. long term), leadershipstyle (autocratic vs. collaborative) andapproach to staff performance reward.

• undertaking a full cultural diagnosticidentifying the dominant operating styles andentrenched behaviours within each bidder,along with fundamental similarities anddifferences that drive behaviours in key areassuch as strategic thinking, action orientation,people management, communication andinteraction.

Identifying and mapping the differences betweenthe operating styles, cultural drivers and humancapital policies of the bidders gives thepartnership a clear idea of the size of the gulfbetween the partners and helps to set prioritiesfor defusing the “cultural landmines” that canimpede, or prevent, the venture realising itsobjectives. In addition, it subsequently helps thenew management team to set its priorities,objectives and parameters for initiatives tomodify behaviours going forward and guides theteam on strategic communication requirementsand management incentives. These arediscussed further in Section 9.

ConclusionPartnering requires teams and individuals thatcan work together and the selection of theright partner should include a preliminaryassessment of whether this is achievable. We do not recommend the use of mechanisticevaluation processes or tools to deliver whatare, ultimately, subjective judgements. But the techniques described for facilitating ananalysis of cultures and teams should benefitPPPs running competitions for partneringtransactions.

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24

Delivering the benefits

25

Private sector finance

The financing needs for partnerships vary – from large up-front capitalcommitments, such as in an infrastructurePFI, to a rolling requirement for assetrenewal funded out of revenue, as canoften be found in an IT servicespartnership or simply front-end workingcapital requirements for a fully service-based partnership.

Private sector sources of funding are usually afeature of PPPs. This reflects the fact that, byproviding the finance, the private sector is ableto optimise the mix of initial and through-lifespending and will also engage in rigorous riskmanagement procedures. An important step isto develop the contractual and risk sharingframework that will allow the private sector tofinance the capital investment underpinning theservice delivery.

Critical questions that must be asked indesigning this framework include:

• What assets will the partnership be required tofinance in order to meet the servicerequirement?

• Will the public sector require the assets to bereturned at expiry of the partneringarrangements or upon termination of thepartnership?

• Do the assets have an alternative use or userfrom which value could be extracted?

Such questions will begin to determine how farthe partnership must rely upon contractualarrangements with the public sector in order toraise finance, and how closely the partnershipmight mirror a more conventional private sectorbusiness. If, as will more often be the case, thepartnership will to some degree be relying uponpublic sector contractual support, then the typesand level of risk that are transferred to thepartnership must be clearly defined and wellunderstood. In addition, the scope for thepartnership to manage risk needs to beunderstood. Where the contractualarrangements can be made to help riskmanagement, this should be factored into theproject structure. For example, if different projectactivities have differential risk profiles, then thesecan be placed in separate subcontracts anddelivery vehicles to promote their efficientmanagement and competitive financing.

A variety of funding methods has been usedacross the public-private spectrum. Forprivatisations, where entire undertakings aretransferred to the private sector, funding hasgenerally come from the balance sheet of thenew shareholders. Part of their consideration forthe shares may be investment into the privatisedentity. Where the business plans are credible, theentity may raise debt in its own right, secured onits own, or its shareholders’ assets.

In contrast, the most common form of funding todate for PFI, and similar infrastructure projects,has been via bank debt loaned to the privatesector project company (as opposed to itsshareholders), and combined with a smallelement of risk capital from the sponsors orother shareholders. The key to raising significant

Section 5

Financial issues for partnering

26

proportions (up to 90% being common) of thefinance as debt has been the existence ofcomprehensive and clear allocations of riskbetween each of the parties and, in particular,away from the debt and asset-holding vehicle.These limit the risk to the project cashflows andmake borrowing on the back of them feasible,with associated financing cost savings.

As public-private deals move into areas wheregreater flexibility is needed and the public andprivate sector are jointly involved in projects,there is less clear definition up-front of eachparty’s risk and responsibility. In order for a truepartnership to fulfil its aspirations andobjectives, it is likely to require a significantdegree of operational and financing flexibility.Without this flexibility, it will be difficult for thepartnership to adapt to changingcircumstances, fund projects if they differ fromthose originally conceived and integrateservices as seamlessly as may be desired.

At a simple level, a degree of financingflexibility can be achieved by keeping bankinglines of credit committed and available forfuture use. Keeping committed lines of credit isonly going to be achievable and representvalue for money if there is a high degree ofcertainty with regards to the size, timing anduse of the future funding need.

Other departures from standard PFI financingarrangements must therefore be considered ifthe partnership is to achieve the flexibility torespond to new funding requirements andoperational demands. This may take the form ofcapital structures that involve higher levels ofshareholder-provided finance. Another solution isto require the partner vehicle to retain earnings inreserve to fund certain types of expenditure.Finally, the project can simply provide forsubsequent fundraising on the terms provided inthe financial markets at the time. On the LondonUnderground PPP this approach is used, withthe partnership required to raise finance onmarket terms unless it is deemed by anindependent arbitrator that the funding hasbecome unavailable at acceptable terms.

Where provision of assets of a similar natureunder a consistent risk allocation framework is afeature of an overall capital programme,framework funding structures may be used.These allow individual projects to access a poolof funding which is available for the programmeas a whole. Such framework finding structures,which have been used in the past in housingand oil and gas, increase certainty and reducecomplexity for fundraising in PPP programmes.They are acknowledged as such by the Treasury9

and are under consideration for some of theGovernment’s major PPP programmes.

It is likely, therefore, that the partnership will befunded not simply by debt but by a mixture ofdebt and other funding sources. This will, in turn,have an impact on cost, as such funding istypically more expensive than debt. It alsoreduces the availability of funding. Whilst theproject finance debt market is relatively deep inthe UK, the availability of other sources of fundsis more limited. As an alternative, the publicsector may choose to finance part of thepartnering. This is discussed further below.

Public sector equityOne common model for partnership involves thepublic sector client co-investing directly with theprivate sector contractor in a newly formedlimited company. In order to protect thisinvestment, there will frequently be public sectorrepresentation on the company’s board ofdirectors. This representative will nonethelesshave a fiduciary duty to protect the interests ofall shareholders.

Where there is an exact alignment of public andprivate sector objectives, for example in a jointventure to exploit a piece of development landfor maximum value, the interests of allshareholders will be consistent. However, wherethe public sector is the client of a company inwhich it also takes a role as shareholder, theissues will be more complex. As shareholder,and commonly with the associated right toappoint Directors, the public sector will havegreater access to information about the PPP’sperformance and will be more closely integratedinto its governance. However the issue offiduciary duties become more important.

An example of such a situation would be in thefuture pricing of a new investment or service thatthe public sector wishes to deliver via thepartnership. In its capacity as client, the publicsector will be seeking to transfer as much risk atthe cheapest price possible to the partnership.In its capacity as shareholder, its expectedinvestment return will be maximised by acompletely opposing set of conditions –minimum risk transfer for maximum price.

This dual client/shareholder role has the potentialto result in conflicts of interest that, from theperspective of the private sector, could manifestitself in public sector behavioural uncertainty.Such uncertainty may be considered a risk byprivate sector equity investors and debt fundersand they may incorporate pricing premiums intheir returns as compensation. It is therefore inall parties’ interests to take a keen interest inunderstanding and structuring the partneringrelationship in such a way that will allow asmuch clarity as possible as to how thepartnering vehicle is to be governed.

9 In PFI: meeting the investmentchallenge (HM Treasury 2003)

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Expanding the partnershipAs previously discussed, it may be the case thatlending to a partnership will not be a propositionthat is as well defined as that of lending to a PFIproject company. If this is the case, lenders willwish to consider and assess the current state ofthe relevant business, and make projections asto how the business may grow. In the case ofmany partnerships, however, growth will dependupon the development of future activity with therelevant public sector entity and that may not besusceptible to forecasting. Although futureactivity may have been well defined andtransparently communicated within anoverarching strategic plan, lenders are unlikely totake any significant risk on the timely delivery ofsuch a plan. This risk is ultimately out of theircontrol, and to some extent, that of thepartnership itself.

The consequence of this is that lenders will notbe able to rely upon future growth, and will onlybe able to fund the partnership on the basis ofthe scope and level of continuing activity. This may result in initial funding arrangementsthat – on the face of it – appear suboptimal.It may therefore be in the long-term interests ofthe partnership for either the public sector orshareholders to take an element of risk duringthe “ramp-up” phase of the partnership and thenfor this to be refinanced with the lendersassuming the (now reduced) risks.

Multiple tranches offinancingFrom the perspective of the public sector it willbe important that any funding arranged duringthe lifetime of the partnership is invested or lenton terms and conditions which can bedemonstrated to be in line with the then currentmarket - this is most transparently achieved bycompeting investors, banks and other fundinginstitutions for each new tranche of finance thatis required. Under such a process it is thereforepossible that there maybe more than one debtfacility provided by more than one lenderfinancing the activities of the partnership.

This, however, increases the complexity of thecorporate and contractual structure of thepartnership due to the intercreditorarrangements that need to be establishedamongst the different banks that have, atdifferent times, provided debt finance. Althoughthis is commonplace in all complex financingarrangements, it is desirable to minimise theserelationships, not only to keep down the timeand cost associated with establishing them, but also to allow the partnership as muchoperational flexibility as possible.

In most circumstances, this is most efficientlydone by structuring and financing assets orservices within ring-fenced companies for eachproject element that have the ability to operateon a standalone basis. The more operationaldependency there is between assets or servicesfinanced by different lenders, the more complexand restricting the intercreditor arrangementswill be.

Alternatively, for large-scale partnerships with aflow of similar funding requirements, it may be possible to put in place a frameworkarrangement with one or more lenders with asingle financing vehicle acting as the conduit for lending into the projects.

Due diligencePartnering in traditional asset procurement dealsdoes not usually involve much in the way of duediligence. The contractor financial strengthshould be tested by reference to its balancesheet on the back of which parent companyguarantees may be provided. The workingrelationship is shorter-term and the contractorsinvolved seldom bear ongoing project risks.

However in longer-term PPPs, where whole lifeand operating risks are borne by the privatesector, and usually in a thinly-capitalised SPV,due diligence on partnership robustness iscritical. In bank-financed PPPs, there are in-depth reviews of the technical, financial, legal and risk management arrangements. As a result there is comfort that it should be able to bear its allocated risks, and that thesewill not rebound onto the client other than underspecific known provisions in the contract.

Where bank debt is involved in funding apartnering, consideration should be given toensuring that due diligence processes, whileeffective, are streamlined and do not involveunnecessary re-examination of the same issuesas the partnership’s business plan develops.Clear implementation structures and informationflows to the lenders will help to support this.

As mentioned above, it is less likely that apartnership will be financed by bank debt to the same extent as a typical PFI transaction.Where such debt is absent, there may be a lessrigorous process in place for ensuring risks areallocated, mitigated and managed. This canspeed up the process of letting a contract butcan also give rise to issues for both public andprivate sector partners. For, while the banks’sole aim in risk management is to protect theirinvestment, there will be a benefit to the projectfrom effective due diligence, risk managementand lay-off.

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In a partnering arrangement, where the extent ofrisk-sharing is greater than under the strictallocation regime of the PFI, there will still be animpact on the contractor and subcontractorsfrom their respective shares of risk. They willneed to be sufficiently robust, and to havesufficient risk mitigation measures in place, tobear these.

In a corporately-financed deal, the partners willtherefore need to consider undertaking somedue diligence themselves on, for example:

• technical aspects of the project

• the contractual arrangements between theconsortium members

• the robustness of subcontractors and theirability to manage risks passed down to them

• the baseline financial model

• insurance arrangements.

The client should ensure that the contractors arenot easily able to declare the partnering vehicleinsolvent. Measures may be put into place toensure that, for example:

• terms of inter-company financing arereasonable and not changed without theclient’s knowledge

• default is disincentivised by, for example, across-default clause if there is more than onecontract with the partner (as in multiple projectpartnerships) and/or by termination provisionsthat do not make full compensation of futurelost earnings

• cash and reserves for risk are maintainedwithin the partnership vehicle through controlsover dividends and other distributions toshareholders

• if reserves are to be built up for futureinvestment, then these are built up andreserved for the specific purposes for whichthey were intended

• partnership assets are not caught in the parentcompany’s security arrangements

• and, ultimately, there is protection for the clientthrough robust parent company guarantees,bonds or other instruments, with creditmaintenance provisions underlying them.

The extent and nature of such work andprovisions will be highly specific to thepartnership in question. Ultimately the provisionsare unlikely to be as exhaustive as the duediligence carried out by bank lenders, but therewill be a need on both sides to ensure that thepartnership is robust.

We have developed techniques for reviewing thefinancial health of corporates who are membersof partnerships that are wholly or partially fundedon balance sheet. These entail reviewing acombination of measures of the company’sbalance sheet strength and the impact of thecontract on their balance sheet. The measuresdeveloped are based on those used by thecredit ratings agencies and enable a morerigorous financial strength test than thosetraditionally use to prequalify bidders.

Corporate structures Having established the commercial and likelyfunding structures, the partnership’s legalstructure can be addressed.

As described in many of the guidance notes onpartnering, the choices of vehicle for thepartnership broadly consist of:

• a contractual arrangement alone, includingunincorporated joint ventures

• a partnership

• a company.

The majority of PPP deals currently use anagreement-based structure, although thecontractors themselves are generally formed in to one, or several SPVs, as a result of therequirements of their parent companies andfunders.

But there may, for certain clients, be advantagesin entering a legal partnership or even acompany. This is particularly the case in LocalAuthority transactions where the decision maybe driven by issues of funding, vires and,possibly, taxation. This is a complex area whichshould not be addressed without legal,accounting and taxation advice.

ConclusionPartnering transactions require finance but this islikely to come from a broader range of sourcesthan traditional PFI limited recourse debt. The source of funding remains a criticalconsideration in structuring a partnered deal. But with partnering it is less a question ofscoping a project that fits the single projectfinance lending source, as understanding thecombination of funders that may be present and the resources and needs of this group. The impact of the funding on the terms andprocesses of the transaction, both at the outsetand throughout its life, require expert analysis,and specialised documentation.

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Contractual structures

Many partnering arrangements beginthe task of contract structuring byassessing the different legal structuresthat could be set up in order to deliverthe project.

While it is important to be clear on the distinctstructuring options available and to identify theone that best suits the parties and the project,we believe that the commercial and workingarrangements should be established first andthe legal structures formed subsequently todeliver them. That said, an understanding ofthe contract terms already tried and tested inthe market can save much reinventing ofarrangements, and legal advice should besought once commercial principles areestablished.

Most PPP contracts have as their basis thestandard contract set out in HM Treasury’s“Standardisation of PFI Contracts Version 310”(“SOPC 3”). This core document was updatedin April 2004 and has been developed since itsfirst, 1998, edition in consultation withDepartments, contractors and advisersinvolved in PFI and PPPs. The standard PFIcontract had been developed for PFI deals andis based on the following assumptions11:

• the party contracting with the public sectoris a special purpose vehicle with sub-contractors providing the actualperformance on its behalf;

• the project involves some development orconstruction phase, followed by anoperational phase during which the fullservice is provided; and

• the project is wholly or partly financed bylimited recourse debt.

On the face of it, this does not align with thestructure of most partnerings where there may,for example, be:

• a jointly-owned public-private vehicle (orvirtual vehicle)

• a series of joint development phases andconstruction phases for as-yet-unspecifiedassets

• less limited recourse debt and morecorporate financing from the contractor’sown balance sheet (see Section 5).

However, SOPC 3 is still used in manypartnerings because it deals comprehensivelywith most of the risks in a public-privatecontract and because, despite theassumptions listed above, it does actuallyprovide some guidance on both contractualchange and corporate funding.

Because SOPC 3 does not deal with theprovisions for a partnering relationship, this isusually provided for by adaptations onindividual projects to provide for more flexibilityor to try to address the need for closer workingrelationships. The relationship provisions are,as mentioned above, often addressed in anadditional “partnering charter” or “protocol”with more or less legal force.

But these adaptations have generally involvedminimal, ad-hoc deviations from the standardwhich have not always been applied in acoherent way. In fact applying partneringtechniques piecemeal to PFI structures isunlikely to be as successful as some of theearlier grafting between terms of differenttypes of contract (as illustrated in Figure 1).This is because the terms of a partnering needto be applied throughout the contract in orderto work properly. In short, there are somesignificant differences in management, riskallocation, responsibilities, incentives andpayment between a PFI and a partnering. To work coherently, these terms need to beapplied as a “package”. They also need to beunderpinned with different ways of workingand with strengthened provisions around termssuch as open book accounting, due diligenceand risk allocation. These are discussed inlater sections of this report.

New standard contract forms have been drawnup, including the Association of CharteredArchitects’ Project Partnering Contract (“PPC 2000”), the NEC Partnering Option12

and the BE Collaborative Contract13. The structures of these contracts aresummarised in the paragraphs which follow.

Section 6

Contract structures

10 Version 3 (HM Treasury 2004)11 SOPC 3 1.3112 NEC Partnering Option Option X12

(Institution of Civil Engineers 2001)13 Be Collaborative Contract

(Be - Collaborating for the BuiltEnvironment 2003)

Getting to grips with the entire package ofpartnering provisions should enable PPPs totake partnering further. There is in fact a muchbroader range of contract structures, developedin both traditional procurement and in the privatesector, to deliver partnering and collaborativeworking. These approaches have not only madecontractor/client relationships better: whenbacked up by robust processes and workingpractices they have also helped to drive downcosts, timescales and risks for projects.

The broad types of legal structure aresummarised below.

Here the project agreement takes the form of abilateral contract between the client and theproject SPV, or integrator, who in turn, placessubcontracts. The partnering protocol oragreement is a separate document, which mayhave more or less binding effect and may takeprecedence over certain provisions of theproject agreement. The protocol describes theparties’ intentions to work together and mayset out arrangements for so doing. If it is morebinding, it may provide for suspension ofdisputes resolution and contractual remediesfor a given period in order to make the partnersaddress differences among themselves.

However, flow-down of the main contractobligations to the key contractors is not visibleto the client and therefore not a feature of thepartnering arrangement.

The alternative to bilateral partnering agreementsis the multi-party partnering structure, asdescribed in Section 5. In this, the parties involved are the client, who drives thearrangement, and the key contractors. It is thisform of partnering that has been the focus of themost significant developments within the private

sector. As a result, there is now a variety ofstandard contract forms available for multi-partypartnering.

Clearly this involves a much greater degree ofintegration of the client and the supply chainthan any PPP partnering relationship has so farachieved. That said, it is now the case thatsome departments, such as the MOD, areconsidering moving away from simple bilateralarrangements with prime contractors. Instead,they are looking for a greater degree ofinvolvement by the department as a client withthe various key members of the supply chain.We believe that more departments should nowconsider the use of these multi-partyapproaches as procurement options whenassessing the potential for partnering.

Some of the main multi-party contractualstructures are illustrated in Figures 5 to 7 anddescribed in the paragraphs which follow. A further summary of the key features ofprivate-private partnering and alliances isprovided in Appendix A.

This structure draws on the bilateral partneringapproach where the partnering provisions areenshrined in a series of non-binding, bilateralprotocols that sit alongside each bilateralcontract and subcontract. There may also be partnering protocols between parties who do not have a direct, bilateral contract. The partnering protocols contain provisionsthat are developed jointly and require theparties to exchange information openly, toshare risks and work together to achieveproject objectives. The standard form providedby the NEC Partnering Option broadly reflectsthis approach.

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Figure 4: Bilateral partnering

Figure 5: Multi-party partneringprotocols

Client

Integrator/SPV

Key Contractor

Partneringprotocol (non-binding)

contract

contract

Client

Integrator/SPV

Key Contractor

Partneringprotocol

Partneringprotocol

(possible)Partneringprotocol

contract

contract

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The option set out in Figure 6 takes theconcept of multi-party partnering further andrequires the partners to sign up to a single,multilateral partnering agreement, with agreater degree of enforceability.

This arrangement goes further than the others in that the partnering agreement is legallybinding and sets out the rights, obligations andworking arrangements between all the parties.The partnering agreement is the lead documentgoverning the relationships between the parties.This will still be supplemented with individualbilateral agreements covering issues which havebeen excluded from joint responsibility, such asdefects liability and indemnities, but the keycontractual document is the partneringagreement. The standard form contract, PPC 2000, broadly follows this structure.

Clearly this involves a far greater degree ofjoint working, information exchange, risksharing and partnership management than a traditional contract structure supplementedby bilateral partnering protocols. The approachis nonetheless increasingly widely used in theprivate sector with notable successes, such as BAA’s Terminal 5 contract.

The multilateral approach is taken further in the approach known as alliancing, as shown in Figure 7.

This structure arguably represents partnering in its most fully developed state. In an alliance,the bilateral commitments are subsumed intothe project agreement, and the parties bear aconsiderable degree of risk and reward as asingle body. Whilst alliancing has not beenused on any UK PPPs, it is widely practised inthe private sector and has been used onpublic-private contracts in Australia, wherePricewaterhouseCoopers has been one of theleading advisers to alliances.

Alliancing is important to a betterunderstanding of partnering because of themethods and terms it uses to deal with issueswhich are also critical to partnering. A significant body of literature exists onpartnering and alliancing in private-privatecontracts14 and we do not reproduce it to anydegree in this paper. However Appendix Asummarises some of the key features ofalliancing alongside those of multi-partypartnering and reference to alliancing willappear where it is relevant to the issues underdiscussion later in the paper.

ConclusionThere is a spectrum of contractual optionsavailable for a PPP partnering which give moreor less precedence to the partneringarrangements, involve more or fewer of theparties within the partnering, and carve moreor less out into bilateral commitments. At theend of the spectrum is alliancing. While a purealliance structure may not always be feasible inPPP procurement, a PPP may well use someof the tools developed in alliancing.

We believe that developing the commercialand contractual structure on a project-specificbasis is a necessary and, in fact, vital exercise.We think it is unlikely that a partnering cansucceed if it starts from a pre-determinedstructure based on a previous transaction, and tries to fit its objectives into that structure.The rights, obligations and processes betweenthe parties are critical to the success of thedeal and the partnering should draw fromacross the spectrum of contract precedents todeliver the specific objectives in thecircumstances of the project constraints.

Client

Key Contractor

Partneringagreement

bilateralcontract

bilateralcontract

bilateralcontract

Integrator/SPV

Figure 6: Multi-party partneringagreement

Figure 7: Alliancing agreement

Client

Key Contractor

Allianceagreement

Integrator/SPV

14 See, for example, Sally Roe andJane Jenkins' Partnering andAlliancing in Construction Projects(Sweet & Maxwell 2003)

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Traditionally PFI has involved transfer ofmost project risk to the private sector.

This has included not only the risk of design andconstruction, but also of life cycle costs, anelement of residual value, some demand and alloperating risk. To achieve this there needs to bevery clear definitions of what each party is tobear, especially where the public sector takesback risk as a last resort in certain situations.

PFI projects can achieve this clear riskallocation because their scope, and thereforemost of the risks, are identifiable at the outset.This makes the majority of them manageable.Indeed, projects with significant unknown orunquantifiable risks are not held to be suitablefor PFI. However where risks (and rewards) are shared in PFI contracts, there are well-developed mechanisms for allocatingsuch risks. The process for dealing withchange, the process for risks that becomeuninsurable and for change of law are veryclearly set out in SOPC 3.

This contrasts with the greater degree ofunforeseeable risk experienced in contractsusing partnering. Here risks are more likely to beshared because they cannot be identified at thestart of a project whose parameters areunknown. Ideally there should be a jointapproach to risk identification, management, andownership. The following paragraphs look at risksharing arrangements in private sectorpartnerings and in alliances.

Risk sharing in privatesector partneringsAs for PPPs, risk sharing in private sectorpartnering is effective when the risks toachieving a successful project outcome can beidentified, quantified and managed over time.When risks cannot be identified and quantifiedsufficiently for allocation between two partiesthen a process must be drawn up showing whatprocedures are to be used in the event of aforeseeable risk of unknown magnitudeoccurring. The collection of actual cost andresource data is then key to equitable allocationbetween the parties.

The typical pitfalls to agreeing the costs ofchanged scope or changed risk profile come inmany guises but normally involve:

• the link between cause and effect

• the direct costs of the consequences of the change

• the indirect cost and overhead costassociated with the changed scope or risk profile.

A large number of partnering contracts within theprivate sector are executed each year where therelationship between client and contractor canbe described as long term and where partneringapproaches are used to identify, allocate andmanage some of the risks. In this model theselection of a contractor is based oncompetition of part of the price of thetransaction while the more complex risks arenegotiated after preferred bidder selection aspart of early contractor involvement. Such risksare likely to be those that drive costs, andinclude areas such as the wording of warrantiesor guarantees, how designs may be novated tothe contractor or how liability to third partiesmay be capped. A partnering approach isrequired to ensure that the risk allocation isagreed in an open manner between the partiesand is accepted as fair.

In the private sector an example of such“hybrid” partnering may be a power station,where the client wants a contractor to meetcertain performance requirements with theequipment provided under the contract. After the performance standards and deliverycontract have been finalised, the client then tiesthe contractor into a separate operation andmaintenance contract. The timing of this O&Mcontract, after the competitive process iscomplete, requires an element of partnering.The objective of a separate contract is toreduce the impact of the as yet unquantifiedrisks (of defects, breakdowns and life cyclecost/design issues) on the financial metrics ofthe original design and build project. Thesemore complex, through-life risks are thus dealtwith after some of the design and buildparameters are known and this necessitates adegree of openness between contractor andclient. The end result, though, is that the risk ispriced more accurately than where it isincluded in an up-front lump sum pricing.

Section 7

Risk allocation and paymentmechanisms in a partnering

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But in such contracts where only a limitedrange of risks has been negotiated, there isoften no “partnering charter” or “open book”approach to costing. The difficulty with this sortof partial partnering is that the partnering intentbehind the negotiated aspects of the deal is notalways apparent in the legal documentationand this can lead to uncertainty. It is our beliefthat, where partnering underlies the approachused on any aspect of risk sharing, then thisshould be explicitly stated in the documentsand fully backed up by complete open bookprocesses. A partnering approach can sitalongside a firm priced element of a project, aslong as it is very clear where partnering does,and does not, apply.

Under a partnering arrangement there should bejoint ownership of the risks and a jointly agreedrisk management plan incorporated in theproject documentation. The programme canthen become a contract document whichaccurately reflects the current status andremaining forecast for the work. The risk registerand associated financial contingency is updatedin line with the programme and forecast tocomplete.

The issue of liability for defective work orproducts can be blurred in a partneringarrangement. When both parties contribute tothe design and/or development of the design forthe purposes of construction, it is not clearwhether risks should be shared when it comesto liability for defects and remedials for poorquality workmanship. Contractors normally havean obligation to provide work that is fit forpurpose and to give adequate notice when thismay be compromised. So the partnering needsto be clear as to whether the contractors arerelieved of this obligation, otherwise they wouldnormally hold the responsibility for defects intheir design or workmanship.

Upside sharing is also a feature of partneringarrangements. Project completion targets for a specified scope or work content can have absolute cash bonuses or percentagegainshares for early completion or forcompletion under a specified target. Care must be taken in specifying what costs are included/excluded from the target and howspecified risk events impact this target. If theseare not addressed correctly, gainshare caneffectively negate risk sharing if the targets arenot moved in line with variation procedures orthird party risks (for example insured events).Where the parties are sharing this type of risk,then the mechanism for adjustments to thetarget needs to be carefully worked out. There isconsiderable evidence of contracts that haveone-sided gainshare mechanisms or where thegainshare and painshare elements are notevenly balanced.

Normally at the end of a project a postcompletion audit is carried out to verify theactual costs against the target and to calculatehow the bonus or share is to be divided.Thought needs to be given as to how to treatfuture liabilities such as defects rectification,third party inspections, certification or first yearmaintenance works, and to how these willimpinge on the measured gain for sharingpurposes.

Risk sharing in alliances Project alliances are focused on creatingmutually beneficial relationships between allparticipants, so as to produce project outcomesthat achieve performance beyond expectation.As opposed to traditional contracting methodswhere risk is allocated to different parties,alliance participants assume collectiveownership for all of the risks involved indelivering the project works with an equitablesharing of the pain or gain depending on howactual performance measures up to project KPIsand the target cost.

The contractual allocation of pain or gain, whichwill directly affect all parties’ financial outcomes,is used to encourage co-operation and isembodied in the commercial framework for analliance. This typically sets out the followingmechanism for payment of contractors.

• All project costs and project specificoverheads incurred by a contractor arereimbursed at cost based on audited actualcosts.

• A fee is paid to cover corporate overheadsand “normal” profit

• A performance based incentive payment ispaid to or by the contractor participants toshare equitably the pain or gain depending onactual project performance compared toagreed KPIs.

However the maximum risk for the contractorparticipants (ie the maximum painshare they cansuffer) is the loss of their fee component(covering corporate overhead and profit). This leaves them reimbursed only for the directcosts incurred in the project works. These directcosts are not at risk. The party ultimately bearingthe further risk, not shared by the contractors, isthe client. It is important to recognise that clientrisk is uncapped in an alliance and that clientmanagement and contractor returns shouldreflect this.

An alliancing will include a highly developed plotof risk and reward for each participatingcontractor and each measure of projectperformance. This is accompanied by the

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allocation of financial values to different levels ofactual outcome for the range of indicators. This can be as simple or as complex as theproject demands. The most simple would be arisk reward curve with KPIs concerning, forinstance, just time, cost and rework. For morecomplicated projects, issues such asenvironment, industrial, safety, community,availability and any number of other factors(dependent on the project and the client’sobjectives) can be weighted and included with periodic assessment.

Payment mechanisms forpartnerings and alliancesThe payment mechanism for a partneringenshrines much of the risk transfer thatunderpins the project and it is beyond the scopeof this paper to address all of the issues andtechniques involved. Instead we examine belowsome of the basic payment mechanismstructures and indicate how they might be used.

A partnering payment mechanism needs to:

a) reimburse the contractor for its initial capitaloutlay, and be sufficiently secure to meet thefunders’ criteria

b) cover ongoing periodic operating costs of theproject

c) reimburse the contractor for any investment oftime in developing the project and/orsubsequent projects as part of the partnering

d) adapt to cover changes in the current projecte) be extendable to new projects undertaken by

the partneringf) deal with risk sharing arrangements, both

upside and downside riskg) provide incentives for better performance and

continuous improvementh) include a process for dealing with uncertainty.

A typical PFI payment mechanism needs toaddress the costs of asset availability, subjectto deductions for non-availability, and ofservices delivered, subject to deductions forfailure to meet agreed service levels. Theremay additionally be volume-related paymentsfor example, linked to the number of vehiclesusing a road, passengers on a transportproject, or students attending a course.Typically these PFI payment mechanismsachieve objectives (a), (b), (c) and, to someextent, via deductions, (g), above. Furthermorethe projects involved usually have risks clearlyallocated between the parties at the outset sothat there is little need to meet objective (f)above. But such typical payment mechanismsare poor at dealing with change, uncertainoutcomes and new projects (objectives (d), (h)and (e) above), ie, they do not provide theflexibility that is a feature of partnering.

Example: How the LondonUnderground PPP addresses the criteria

a) reimburse the contractor for its initialcapital outlay, and be sufficiently secureto meet the funders’ criteria

b) cover ongoing periodic operating costs ofthe project

c) reimburse the contractor for anyinvestment of time in developing theproject and/or subsequent projects aspart of the partnering

d) adapt to cover changes in the currentprojects

e) be extendable to new projectsundertaken by the partnering

f) deal with risk sharing arrangements, bothupside and downside risk

g) provide incentives for better performanceand continuous improvement

h) include a process for dealing withuncertainty.

Availability payments with step-ups whenadditional capacity is delivered

Availability payments

Gainsharing provisions to incentivise innovation by private sector. Range of procedures to enableLUL to commission additional works.

Rules to cover impact of changes to e.g. safetystandards which increase private sector costs.

Existing payment mechanism applies to additionalassets created by additional works.

Some sharing e.g. upside: private sectorinnovation which reduces public sector costs;downside: revenue impact of business interruption.

No cap on availability or capacity payments whichprivate sector can earn.

Exchange of plans at various levels of detailbacked up by joint planning meetings.

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There is a body of guidance on types ofpayment mechanism and this is not repeatedhere15. We focus below on the key issues offlexibility required within a partneringarrangement and risk sharing and incentivisationthrough the payment mechanism.

Payment mechanismflexibilityPFI contracts pass all start-up, development,build and commissioning risk by paying only fora service once it is received and paying nothingtowards the cost of creating the infrastructureneeded to deliver the service. This overridingprinciple is applied also to many PPPs wherethere is no payment until services are delivered.However it assumes that all pre-service costsare incurred up front. In a partneringarrangement there may be successive projectsand service changes, requiring unpredictedinvestment during the contract term. Clients

need to find ways of dealing with the cost of,and payment for, these through a more flexiblepayment mechanism. Such a mechanism oftenoperates by offering a “price list” for variousinputs or outputs.

As mentioned in Section 8 in relation to VFM,there is a case for maximising the extent towhich the pricing of likely future changes isagreed in advance. This can apply to unit pricesfor inputs (eg, man-days) or to unit costs peroutput (eg, a classroom). The choice betweeninput and output pricing and payment is adifficult one where risk transfer, VFM andflexibility requirements conflict. The features ofeach are summarised below.

15 See, for example, Technical Note:Payment Mechanisms (StrategicPartnering Taskforce, ODPM2004)

Inputs are priced and paid for

Suitable where the assets are non-standardwith no pre- agreed specification.

Transfers risk of pricing for individual inputs(or set of inputs) but not delivery of outputs.

Allows a more comprehensive menu ofprices to be agreed, and thus greaterflexibility within the pre-priced contract.

Cost of future projects less easy to predict.VFM likely to need establishing at the time.

Outputs are priced and paid for

The more standardised the assets, the easierit is to produce a menu of asset prices.

Transfers risk of all input prices, anddelivery of output.

Applies only to those assets that can bepre-priced, therefore the menu of optionswill be more limited and less flexible.

Cost of future projects more predictable.VFM can be more easily pre-determined.

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If the project has as a key variable the usagelevels of a given set of assets, then it does notrequire the right to purchase more or fewer ofsuch pre-priced assets, but needs a flexibleapproach to the periodic amounts it pays. Thiscan be achieved in the specific case of assetsthat are consumed, or depreciate, in accordancewith the extent to which they are used (asopposed to depreciating steadily over time).Here the payment mechanism can set a rate forusage and the amount of usage can be varied.This can be used for example for aircraft enginespaid for via “power by the hour” arrangements,or for vehicle fleets. A fixed fee can meanwhilebe paid to cover start up, integration,management and any other standing costs.Although this type of asset is less common inPPP deals, it can be worthwhile identifyingwhich assets in a project can be contracted foron this basis.

To the extent that subsequent additions to theproject cannot be priced in advance in a waythat delivers VFM, then there will be a need toagree costings at the time of the change. Themost common way of doing this is through openbook accounting, which is discussed in greaterdetail below. Open book provisions allow for thegreatest degree of flexibility in a contract,enabling any unforeseen event to be covered inthe payment mechanism, and they exist in someform in every PFI in order to cater forunanticipated changes. Where their use isanticipated to be more regular, then it isadvisable to devote more time to agreeing inadvance the principles and methodologies fordetermining prices on an open book basis. Inprivate sector partnerings, where client andcontractor share more risks, accountingprinciples are set out in the contract and aproject auditor role may be established from theoutset. Open book provisions often extend downthrough the supply chain and are discussedfurther in Section 8.

Risk sharing andincentivisation through thepayment mechanismBecause a partnering often starts with lessclear identification of risk and cost, thepayment mechanism may have to allow forrisk to be shared to a greater extent thanunder a traditional PFI. At the same timepartners aim to reduce the impact of risk andthe payment mechanism may be used toprovide incentives to do this, through, forexample, working together to mitigate riskand reduce cost impacts.

Risk sharing is described more fully above but itis important to note that even the most basicdecisions about the payment mechanism canembody a risk-sharing element. For example,the simple choice of an index for escalation ofthe payment leaves the contractor with differentlevels and types of risk.

Incentivisation in a partnering can be linked toupside benefits achieved by the partners’ jointefforts and therefore shared between them.Where the benefits are influenced more by oneparty than others, the sharing arrangementneeds to incentivise most the party in the bestposition to influence outcomes.

Incentives exist in contractual gainsharearrangements, where payments are made toshare out the benefits of better than expectedoutcomes. The precise mechanisms foroperating gain/painshare structures aredescribed in the many guidance documentsavailable on partnering and alliancing, and we donot reproduce them in this paper. The mostsuccessful arrangements reimburse thecontractor for involvement in innovation and/orcost saving. This can be in pre-agreedproportions, which might vary according to whomakes the relevant proposal, or can reflect theoverall share of each partner in the total value ofthe contract.

Incentivisation is also used in a longer-term,service delivery contract to maintain or improveperformance (although this is often only bymaking deductions for poor performance). Inaddition to any incentivisation contained in thegainshare arrangements, ongoing performancecan be assessed against service KPIs for theproject, as is common in PFI and PPP deals.

A partnering payment mechanism is likely to becomplex with a range of payment, risk transferand incentivisation arrangements broughttogether to reflect the objectives and constraintsof the parties concerned. Each paymentmechanism is likely to be bespoke to thepartnering concerned, but should nonethelessdraw on precedents available across thepartnering spectrum.

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Alliancing and target costincentive fee structuresAlliancing techniques enable both flexibilityand incentivisation through the use of fullinput costing. The key features of alliancetarget costing are that a target cost isdeveloped in detail by the alliance participants once the Alliance Agreement has been established and executed.

Target costing is most commonly used anddescribed where the project involves creationand delivery of an asset. Whole life andoperating costs can be subject to similararrangements where the contractor has the taskof delivering a target rate of savings below thecurrent operating cost benchmarks over a givenperiod.

The negotiation of savings post bidder selectionenables the issues around cost reduction to beaddressed in partnership and can deliver asolution that more closely reflects clientrequirements. The argument for bidding the newcost line is that it encourages the contractor todeliver the maximum savings as quickly aspossible and enables the client to take the fullbenefit of that. In reality, though, a significantdegree of risk is likely to be priced for in the bid,which can offset this effect.

Example: Partnering and pricing in a continuousimprovement environment

The Utility sector (in particular water companies)have adopted partnering approaches to achievecontinuous improvement of the cost efficienciessought by regulators in their capital investmentprogrammes. Framework agreements based onschedules of rates, are agreed to cover low-technology, bulk work such as pipe and sewerrenewals. The cost efficiencies are then meteither through more efficient work practicesforged in partnership, or through economies ofscale where large volumes of work are spreadacross wide geographical regions. Performancemeasures are then used to drive comparisonsbetween companies and geographical regionswith prizes for best in class competitors. Herepartnering is a driver of cost efficiency buteconomic risk sharing plays a part in keepingcosts down.

ConclusionPPPs have typically involved clear risk allocationfrom the start with a defined process for sharingthose few risks that cannot be dealt with in thisway. Partnering in PPPs takes place whereprecise project scope and risk allocation cannotbe determined in advance. There is no reasonwhy these approaches cannot be combined in aproject, but the documentation does need to bevery clear as to the approaches being taken.

This does not simply mean that the contractorcomes to the client with a full “open book” claimfor each risk that crystallises. Private sectorpartnering practice shows the need for jointidentification and ownership of risk but, moreimportantly, for joint management and mitigationof those risks. Such behaviour is incentivised notsimply by the fact that both parties share thedownside, but by the possibility of bothbenefiting from upside bonuses when risk issuccessfully managed out.

The payment mechanism in PPPs hastraditionally enabled a relatively predictablecashflow for an agreed level of service. This hasbeen attractive to the public sector because itgives an unambiguous price competition andenables affordability to be assessed up front.Partnering requires more flexible paymentmechanisms with incentive structures built in.While this may reduce clarity at the start,protection for value for money can still beprovided by elements of pre-pricing and by openbook provisions. But the objective of partnering,as illustrated most clearly in alliancing practice,is not merely to enable flexible purchasing.Instead it seeks, through incentivisation, to makethe client and contractor work together toidentify the most cost effective ways ofdelivering the business outputs that are theoverriding aims of the partnering.

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Partnerships have sometimes beencriticised as cosy, long-termexclusivity arrangements betweencontractor and client.

The question of whether procurement of theunderlying assets and services complies withcompetition law is an important legal issuewhich must be addressed at the outset, andspecialised legal advice should be sought.Even where the arrangement complies with thelaw, it is easy to make the criticism of cosinessfor deals where the competition is not an opentender of fixed pricing of a fully scoped project.

Any organisation contemplating a partneringarrangement will want to ensure that Value ForMoney is protected at the start of, andthroughout, the partnering. Clearly, animportant part of protecting future VFM lies inthe management of the quality of the servicesdelivered and improvements thereto. These arediscussed in Section 9. In this section, the“money” element of VFM is discussed, ie, howto ensure that pricing of the service remainscompetitive. In so doing, clients have to offsetthe advantages of seeking competed prices forthe project, and therefore having to specify itfully, against the time and cost of so doing aswell as the fact that they really require flexibilityfor future change and to avoid thedisadvantages of a multiple supplier base.

It may be possible in some cases to pre-priceon a per unit basis and use this price list, or“menu” of prices, to determine the cost offuture orders under the contract. This approachworks where a partnering delivers repeat ordersof similar assets, such as in IT partnerings, forexample. Such repeat projects also lendthemselves to continuous improvementmeasures, aimed at reducing costs over time.

But some prices cannot be predicted over aPPP contract period. Finance terms, forexample, are unlikely to be committed to forperiods over 5 years. Assets incorporatingmajor technological change are difficult toprice in advance, and many soft services arepriced on the basis that there is scope forreview every 5 years should pricing movesignificantly out of line with forecasts. Theprices that cannot be committed to in theinitial competition must be subject to a test of

their VFM at the time when they are quoted.This will be after the partnership has becomesole supplier.

One way of testing VFM post formation of thepartnership is to compete the subsequent workat the time. This is a feasible approach wherethe contractor is not a key sponsor andshareholder of the partnership. But one of theobjectives of partnering is to involve all the keyparties in the partnering and drive out savingsthrough closer working between the parties.This cannot be done if the major contractor iskept out of the partnering to promotecompetition. And the savings may in any casebe outweighed by additional procurement costs.

Partnering therefore looks to rely on open andtransparent information about pricing, and agood understanding by the client of the factorsdriving the partners’ costs. Similarly thecontractor’s understanding of the contractshould enable more accurate costing on itspart. But there remains a need to avoid thissort of arrangement turning into a long-term“cost-plus” contract. This can be done in partby very clear specification and understandingof the costs that make up a price. But to bringgreater rigour to the process, this should becombined with access to benchmarking data.

Benchmarking can use industry data but thismay not always be available. For partneringswhere there are numerous repeat projects, orthere is a market price for the assets orservices concerned, then this data can providebenchmarks. In the case of the LIFT projects,for example, the existence of repeat projectsthroughout the country is enabling the creationof a specific benchmarking database.

If there is more than one partnership deliveringsimilar projects for the client, then a databaseof information from the multiple partners canbe built up for benchmarking future costs. Thepresence of more than one partner can beused to exploit the advantages of partneringwhilst maintaining the pressure of competition.This approach is used by major retailers whouse a number of contractor partnerships todeliver their programme of new storeconstruction. Some degree of competition,albeit from a restricted shortlist, can beintroduced to each new project. An alternative

Section 8

Value for money in partnering

39

approach is to introduce another partner only asa last resort as in the LIFT primary healthcareschemes, where a local contractor’s continuedexclusivity depends on each proposal passingVFM tests against benchmarked schemes withpartners across the country.

Ultimately, measures which enable thepartnership to be terminated provide the lastresort if VFM cannot be delivered. In otherwords, the partners need to ensure that anyexclusivity is not forever. Methods oftermination and any compensation arisingneed careful consideration. The PPPtermination provisions of SOPC 3 may notnecessarily be appropriate for every scenarioin this type of arrangement. Where thisapproach is used, consideration must be givento how to deal with the implications for theservice of early termination, otherwise thesanction may be impractical to apply.

Open book accountingOpen book accounting is acknowledged as acornerstone of successful partnering.Openness is needed not only to ensure VFMbut also to build a good working relationshipbetween the parties. But open bookaccounting needs careful definition to ensurethat it really works for both sides and that keyinformation is not still firmly “closed”.

Open book for partnering

It is important with open book accounting todefine the scope and means of delivery ofwork and/or services within the open bookregime. Open book costing may existalongside fixed or firm pricing, but the contractmust be clear as to which is which.

Once the scope of the work is known, ancillaryor indirect costs can be defined together withthe nature of related costs. Prior definition ofthis type of cost is important because theirrelevance to the project is the most likely to bequeried at a later date. It is common then toagree a fixed percentage for recovery of headoffice (and local office) overheads and profit.

The question of how far down the supply chainthe open book provisions should be carried, mustbe addressed. All the key subcontractors shouldbe required to agree to open book provisions.

Early consideration needs to be given to thecategories of cost that will be incurred on aproject and how these might be audited, giventhat statutory accounts do not give the level ofdetail required for project accounting.The recommended approach is therefore to

establish two types of review:

(i) a procedures review to determine how thecompany is going to establish its approachand policies for project accounting

(ii) an actual costs audit, where a sample ofcosts can be tested against the proceduresestablished in part (i) above.

Time and cost contingencies for risk should be clearly identified in the budgets togetherwith the assumptions underlying them. Where necessary, expiry dates should be given so that the unexpired amounts can bemonitored over time and duly distributed to theagreed beneficiaries or recycled. Care shouldbe taken to focus on the major risks andcontributors of contingency.

The most common issues relate to costs whichmay be argued to be project related but wouldnormally be categorised as part of the corporateoverhead. This typically relates to support fromtypical head office functions such as humanresources, communications and public relations,research and development, finance, IT, and so on.

Another question that frequently arises is thatof staff seconded from one group company (orsubsidiary) to another and whether this attractsthe level of overhead of the donor or recipientcompany. And when staff are self-employedshould the company add the same level ofoverhead as for full time employees where thebenefits and support they receive are different?

When a company has to repair or re-do work that has resulted from a risk event, the parties need to have a process fordetermining whether all these costs arereimbursable or whether there is some allocationof liability between the parties to reflect eitherrisk-sharing or the individual’s culpability. And finally, the parties need to establish what is the procedure when the costs that actuallyincurred (and audited) are higher than thoseforecast and/or claimed by the parties.

Open book provisions in analliancing

Alliancing provides the ultimate open booksituation in that the “books” are those of thealliance as a whole.

In Australian public-private alliances, a keyfeature of the Alliance Agreement bindingalliance participants and supporting thealliance process is the approach totransparency and open-book, both during thedevelopment of the commercial framework andthroughout the duration of the project.

At the outset of an alliance project all partieswork together with a mutual aim to develop adetailed estimate of the costs to complete thescope of works – the target cost estimate. This process is undertaken in a collaborativeenvironment where communication and sharedunderstanding of joint risks and contingencyanalysis is embraced by all.

In developing the target cost estimate,inclusion of appropriate contingencies isintegral in developing a robust and defensibleestimate that appropriately accounts for risksthat cannot be mitigated in other ways.

In order to ensure the integrity of the targetcost estimate and its ability to stand up topublic scrutiny, there are a number ofmeasures that are often implemented byproject sponsors, such as the following.

• Appointing an Independent Estimator whosebrief is to validate the estimate that has beendeveloped by testing and agreeing keyinputs, assumptions, productivity rates andunit costs. In addition, the Estimator willreview the assessment of contingencies andrisk, considered and embedded in the costestimate.

• Validating benchmark project results fromprevious projects, which have beensubmitted by the alliance participants at thecommencement of the target cost estimateprocess, in order to substantiate actual unitcosts and productivity rates, as well asconfirm the actual way the project isintended to be delivered.

• Develop the target cost estimate as anintegrated team in the alliance project office.

Australian public-private alliances have alsoinvolved an independent alliance auditor role.During the establishment of an alliance projectincluding the commercial framework, analliance auditor is engaged by the sponsorswith the role of validating the cost andoverhead structures, profit margins andprevious project data of contractorparticipants. The information collected, andbenchmarked, during this initial open-bookaudit is used as the basis for the costing ofinputs in the target price.

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ConclusionAchievement of value for money is a coreobjective of every partnering. The scope for agenuine price competition at the early stage ofa partnering may be limited or hampered bylack of information. Without price competition,partnering will often rely on open andtransparent information flows on pricingsupported by full understanding of the factorsdriving the partners’ costs. This requires arange of techniques which, in a large scalepartnering, need to be carefully consideredand applied in a tailored way to the individualcircumstances.

Alliance case studyA consortium of gas companies wantedto construct a gas pipeline between theUK and the continent. They engaged afirm of consulting engineers to design theworks and produce tender documents.They split the works into four packagesfor the purposes of a competitive tender.Having selected the companies theywanted to contract with, the client thenformed an alliance which included theirown project management groupresponsible for delivering the project, andthe project’s designers. The client thenincentivised the participants by agreeingto share any savings made against atarget cost between them in a pre-defined manner.

Given the significant risks in carrying outthe project, the newly formed alliancedecided to re-design the project and re-allocate the work scope between theparties from that originally tendered.Changes were made to the pipe materialspecification, jointing specification andland-based equipment. This was done tomaximise the use of marine plant andequipment that the contractors hadavailable and to reduce risk onimplementation.

The alliance completed the project earlyand saved nearly £80m from a £380mtarget cost. The cost, saving and bonuscalculation were independently auditedbefore any payment was made.

The designers spent a lot of timeredesigning the project and in checkingthe integrity of the revised specificationbut earned a bonus nearly four times thatof their original fee.

Perhaps the most crucial differencebetween partnering transactions andtraditional contracting is in the way thatthe partnering is managed.

Even where partnering is only an adjunct to atraditional contracting arrangement, it is themanagement aspects that are usually the focusof the drafting.

There are two features of management ofpartnerships, namely:

• the attitudes of the parties towards workingtogether

• the processes and roles set up to deliver theproject.

Approaches towards the first set of issues areoften included in partnering charters or non-binding protocols, but are much harder todefine. It is often the vagueness of theseprovisions to, for example, “adopt a no-blameculture” or “work honestly and openly” thatinduces scepticism about the benefits ofpartnering generally. However, partnershipsthat have achieved their objectives are clearthat some sort of culture change was critical totheir success.

Team and culturalintegration: managing the“soft” issuesThe vital task of building relationships within thepartnering starts once the operationalmanagement teams take over from the bidteams. Once the contract is signed, then all thecontractual provisions for relationshipmanagement will come into force. Strategicboard level and management teams will beformed, communication and monitoring groupsset up and co-location plans put into action. Thebetter these processes and practices are, thestronger the ground for a good workingrelationship.

However good or bad the contract is in termsof fostering working relationships, there will stillbe a need to get the individuals and teamsinvolved to work together, with a shared set ofobjectives and a sense of cultural identity. InPPPs this may involve significant culturechanges on both sides.

Successfully bringing together two partners andmaking a joint venture function as one, requiresmore than merely “horse trading” key executivesto promote parity between partners. It involvescorrectly understanding and addressing culturaldifferences between potential partners.

Corporate culture is often defined as: “the set ofbehaviours that characterise how a business getsthings done”. In our experience, it is easier totransform culture in the period immediatelyfollowing contract signature than at any othertime. Partners, customers, user groups,suppliers and employees all expect changes tooccur as the new venture is defined andestablished.

Fundamental to success in aligning cultures isquickly identifying key “influencers” orstakeholders from each partner, learning whatmotivates and concerns them and winning theirsupport. This group, more than any other, is key,since it is their attitudes toward the venture thatcan affect the behaviour and performance of theentire partnership.

Many executives believe it is possible to mergecultures gradually by preaching vision andvalues; however, we believe that you cannotmerge two cultures by waving a bannerproclaiming common vision and values. Culturalintegration needs to focus on organisations’actual behaviours and business processes andnot on the rhetoric surrounding their conceptualvalues. Leaders need to “walk the talk” in orderfor proposed values to be adopted by staff.

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Section 9

Partnership, governance andmanagement

In our experience, successful partnerships focuson four factors when identifying, aligning andchanging corporate cultures.

• Defining desired behaviours. Business strategylargely dictates what behaviours are to beencouraged; however, we have found thatemployees respond best to concreteexamples of how people are expected tooperate in the joint venture environment.

• Use of role models. When changingentrenched behaviours, what matters most iswhat people will do, not what they can do. Put simply, if you want employees to make thedesired behavioural changes, leaders need toexemplify these behaviours. Those who doshould be placed in visible positions ofauthority throughout the partnership.

• Providing meaningful incentives. Shower rolemodels with recognition. This positions themas people whose behaviour should beemulated. To reinforce this message and senda signal throughout the venture, considerquickly and visibly recognising, rewarding andpromoting employees who adopt the desiredbehaviours.

• Ensuring consistency. Avoid the significantconflicts that often exist between writtenpolicies and rewarded behaviour (for example,claiming “we are going to share risk” whilstvisibly “punishing” those who do not claimagainst the other party for every item theycontractually can). This can confuse and angerkey employees. The communicationmessages need to match the managementbehaviour that employees observe, thesemessages should be reinforced over and overand their understanding confirmed throughtwo-way communication.

Establishing a dedicated “integration” team forthe venture can be critical to transformingculture. Members of such an integration teamshould not be chosen based on availability;rather, “star performers” should be sought forthe role and leaders, in particular, should be“right-for-job”. Teamwork and mutual respect areessential since integration teams can beexpected to stay together for some considerabletime (commonly 12 to 18 months, sometimesmore). It is also helpful if senior executives fromboth parties demonstrate commitment to theintegration and communicating with theiremployees.

An issue for longer-term alliances andpartnerings is that of the way in which staff arecycled through the project by their employersor seconding companies. It is normal for thebest available candidates to be put forward forpositions in the project vehicle at the start ofthe project, when their impact can be thegreatest. There will come a point in time,however, when these individuals, who will behighly regarded by their employingorganisations, will add more value andcontribute more to profit in another part of thebusiness. They will therefore be replaced, or“cycled” through the course of the project withless highly rated staff members replacingthem. The cultural impact on the project canbe considerable and care has to be taken toplan and manage succession issues jointly.

In our experience, partners should closelymonitor how well the cultures and workforces of both organisations are coming together. Ongoing feedback is critical during the transitionprocess. Undertaking brief surveys, conductedon a regular basis, can provide input on howwell different stakeholder groups understandwhat is expected of them and whatmanagement expects the corporate culture tobe. Such feedback helps the integration teamfine tune its strategic communications.

This need for culture change has been evenmore emphasised in the case of alliancing,where the technique for delivering it has been toemploy culture change management expertsand undergo a team “breakthrough” process.This is regarded as central to the parties’identification as a team whose objective is todeliver the project, sharing goals, costs and risksopenly. Many alliances use specialistconsultancies experienced in facilitating thesetypes of change process.

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Management structure and processesBefore the bodies and processes are defined,there are some essential decisions to make at anearly stage about governance. If the partneringis essentially a client-contractor relationship,then the client is likely to want an overriding rightof veto on any decisions made jointly within thepartnership. In other words, the parties can meetto discuss issues, but, ultimately, it is the clientalone who determines what actually happens.This is often the structure that is used in manypublic-private partnerships, for reasons ofaccountability. An alternative, which has beenapplied in Australian alliances, is for the clientand contractor to act as business partners,agreeing a joint approach, but with anindependent audit role in validating the decision-making.

Strategic Board levelVirtually all partnerings set up a board includingrepresentatives of the partnership members. This takes place regardless of the corporatestructure of the partnering.

If one of the partners is a special purposevehicle set up for the project, then there is aquestion of whether the company board is theforum for bringing in other partners, such as theclient, or whether a separate project boardshould be set up. The co-existence of acorporate board for some, or all, of the keycontractors, with a separate strategic board towhich the client is invited, can undermine thepartnering. There should be a single partneringboard which has sight of all the issues underdiscussion between the parties.

The remit of the board has to be decided andvoting rights to be determined. Conflicts ofinterest will also need to be addressed. Corporate Board representation by the relevantparties, sometimes combined with a minorityshareholding, is a way of promoting apartnering relationship. But we do not believethat this is effective if it is the sole means ofpromoting partnering. Board levelrepresentation does not involve teams on theground working together and does not buildrelationships that deal with the complexity ofday-to-day project management.

Relationship managementIn addition to groups managing operations andservice delivery, partnering arrangements shouldinclude a forum for discussing the partnering,the service performance and the parties’relationship. As mentioned above, such a forummay also have a specific “integration” brief in theearly stages of the contract.

The issues addressed in this forum shouldinclude:

• any issues over performance, risk and therelationship generally

• ideas for, and achievement on, improvement

• whether the partnering is delivering theexpected benefits over traditional contracting,as set out in the business case

• review of performance indicators relating tothe service

• assessment of any performance indicatorsrelating to the partnering relationship, forexample instances of disputes, or cases ofagreement to share unforeseen risks

• resolution of disputes from the managementgroups (see below).

The group should be attended by seniormanagement in the client and contractor(s) whoare removed from the day-to-day interface.

If the partnership is charged with continuousimprovement and/or the identification ofbusiness opportunities, it is necessary toensure that processes and channels for thisexist. All parties must commit to drive thepartnership forward as well as to deliver the“steady state” outputs.

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Figure 8: Alliance governance structure

Management levelA joint management, or steering, group is usuallyassembled, with responsibility for day-to-daymanagement. Beneath this there are usuallyteams for individual tasks. In private-privatesector partnering the teams are based oncustomer outputs, rather than on processesrequired in delivering them. In this way a seriesof mini integrated project teams are set up, withorganisational barriers removed. The objectiveon these is not to have “one-to-one marking”with representatives of all the parties, but to staffthese groups with the individuals best for thejob. Communications between the groups isactively managed and teams are encouraged toidentify problems and solutions at team levelrather than to escalate everything.

Co-location of the parties is a recommendedway to achieve integration on a day-to-daybasis. If the partnership is to achieve an identity of its own, then it may be best if it issited at a venue separate from the parties’ own home locations.

Alliance managementPublic-private alliances, as pioneered inAustralia, have arguably the most structuredmanagement processes of any partnering, in order to ensure that the benefits are delivered and accountability maintained in an environment where the client and contractors are virtually merged into a single organisation.An example of an alliancing managementstructure is set out at Figure 8.

Alliance projects are characterised by theselection of an integrated project team,determined on a “best for project” basis,whereby each project role is filled with theperson best qualified to fill that role. On thisbasis, sponsor / owner personnel and allianceparticipant (e.g. designer, constructor or otherparties) personnel are combined to form theproject team without any duplication of roles orcounter parting.

The success of this approach relies on theleadership and management structure embodiedin alliance projects which comprise two keyelements, the Alliance Leadership Team (orProject Alliance Board) and the AllianceManagement Team.

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Designer1

Sponsor organisation board Designer2

Designer3

Constructor1

Constructor2

Sponsor

Sub contractors /Sub alliances

Allianceleadership

team

Project Sub

commitee

Independentestimator

Engineer QA

Probityauditor

Internal audit

Allianceproject

manager

Alliance management

team

Alliance Commercial Participants

Wider project team

The Alliance Leadership Team is established sothat each participant in the alliance isrepresented equally by senior executives fromeach organisation forming the alliance. The roleof the Alliance Leadership Team is defined bythe members during the establishment of thealliance and embedded in the AllianceAgreement. Typically it is to:

• create Alliance vision, principles andobjectives

• set policy and delegations

• appoint members of the Alliance ManagementTeam on best person for the job basis

• empower the Alliance Management Team toperform the obligations under the AllianceAgreement

• promote commitments, principles andobjectives throughout the alliance team

• agree and approve the target outturn cost andkey result area performance benchmarks

• resolve all issues within the alliance.

An Alliance Project Manager is responsible forthe day-to-day management of the project andto lead the Alliance Management Team. The roleof the Alliance Management Team usuallycomprises:

• deliver project objectives

• undertake day-to-day management

• provide leadership to the wider project team(ie, including all sub-contractors)

• appoint members of the wider project team onbest person for the job basis

• try to resolve all issues.

The Alliance Auditor also has a continuing role inoverseeing aspects of the project. The auditor isrequired to develop an audit plan that sets outprocedures designed to monitor and ensurecompliance with the terms and conditions of theAlliance Agreement. These monitoringprocedures are undertaken periodically by theauditor and findings reported to the AllianceProject Manager.

A distinguishing feature of alliancemanagement is the absence of a disputeresolution process. This reflects the alliance’sidentity as a single organisation, andnecessitates the resolution of inter-partydispute within that organisation or in Court.

In common with any other publicly procuredproject, the alliance must be seen to beaccountable and to deliver value for money.Allianced projects usually establish a separateclient ownership board, whose members are notpart of the alliance and do not sit on itsleadership or management teams. Thisownership board receives the reports of theauditors and other experts and appoints thealliance internal auditor to operate the pain andgainshare mechanism. This board must takeownership and management of the risks that theproject owner bears (as distinct from thealliance’s shared risks) and of the project’s valuefor money. Where there have been issues withallianced projects they can often be attributed toa lack of separate oversight by a totally distinctbody representing the client itself.

ConclusionManagement of a partnering arrangement is keyto its ultimate success. Management must bereviewed at all levels. Top level commitment tothe partnering is essential, but will not deliverbenefits on its own. Intermediate managementand the working interfaces are equally importantto delivering the partnering objectives.Structures and processes need to be put inplace but private sector experience shows thatcultural and behavioural change is equally criticalif new teams are to deliver partnering effectively.

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To date, partnering in PPPs hastended to focus on the “partneringprotocol”, which sets out behavioursthat make the management of a PPPoperate more effectively.

This is a vital component of anytransaction, and the approaches used todate could be strengthened further bydrawing on management experience incontracts and newly-merged businessesin the private sector. But partnering offersPPPs much more than simply a way ofdoing existing business more easily.

Partnering gives PPPs the scope toachieve greater private sectorinvolvement, and to bring it closer to thecore of public sector services, than everbefore. Because it enables the sectorsto work closely together, there is lessneed for the private sector to undertakea clearly-defined and discrete activity.Working together enables the strengthsof both sectors to be combined – andthereby redoubled.

Partnering entails the use of contractingtechniques, highly developed in theprivate sector, for ensuring costtransparency and joint riskmanagement. Using these moreeffectively within PPPs will enable themto move with greater confidencetowards undertaking less specifiable, ormore flexible, projects with privatesector partners, even where these havenot been selected solely on the basis ofa tender price competition for a fixedoutput.

But partnering in the private sector is notdriven primarily by a need to deal withuncertainty and flexibility. When, forinstance, major retailers partner withcontractors to create new outlets, there isno uncertainty about what is required andwhen. The reason that these clients usepartnering is because it delivers greaterefficiency and better performance, often at a lower cost. All this is achievedthrough more effective joint workingwith the contractors.

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Recommendationsand Conclusions

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Recommendations: a new approach

� In addition to the behavioural changes that currently tend tobe the focus of partnering practice, PPP teams and advisersshould consider the economic benefits available through usingprivate sector partnering techniques.

The partnering approach should be an active choice for project delivery, rather than one driven purely by a desire for good behaviour in an uncertainenvironment. Partnering should be seen not merely as a way of dealing withunforeseen costs and risk with a degree of openness, but as a means of workingtogether to deliver unforeseen improvements in cost and delivery of outputs.

� PPPs should draw on the full range of structures andcontractual precedents available for partnering.

Standard PFI contract structures may not be appropriate. Alternatives may involvejust two partners or the entire supply chain, be bilateral or multilateral agreements,and may give more or less legal force to the partnering agreement. It may also bepreferable for the client to identify which contractors should be represented in thepartnership, rather than allowing the contractors to form what might turn out to bean unbalanced consortium. While developing the legal structure is a necessarystep, it will not in itself engender partnering – the real bedrock of a partnered PPPlies in the ability of the parties to work together, and the robustness of thetechniques used to fund, manage and audit this joint working.

� PPPs should change the way in which partners are selected.

Too many project teams and advisers are still relying on well-trodden PFIapproaches where financial incentives alone are assumed to be sufficient toachieve the outcomes desired. Whilst it must comply with law, the competitionprocess is often a barrier to early face-to-face involvement with bidders, andmeans that the need for cultural and personal integration of the organisationsand teams are not taken into account.

� PPPs should not assume that highly geared projectfinancing is the only funding method capable of delivering avalue for money solution.

While this will most likely be the case in projects with a significant up-frontcapital requirement, other sources will have to be considered where financing isrequired for more risky projects or for future investment. These considerationswill affect the nature, and cost, of the deal that can be done.

� The public sector needs to change its view of partnering,and particularly of incentive payments.

These should provide a fair reward for the contractor’s efforts, and should not beregarded as money that belongs by rights to the public sector. Cost, risk and gain-sharing arrangements are necessary in partnering because these parameterscannot be identified and assessed at the start of the project. Techniques fromprivate sector partnered deals need to be used in partnered PPPs for assessing,documenting and, more importantly, managing cost and risk. However, full and effective implementation of gain and pain-sharing requires real andproportionate incentives for contractors to improve performance and reduce cost.

Recommendations: a new approach

� PPPs need more robust ways of ensuring continuing value for money.

Open book provisions are a cornerstone of effective partnering. A full range ofbenchmarking, competitive pricing and auditing techniques must be available toPPPs adopting a partnering approach. These are already widely used in privatesector partnered and allianced deals, and PPPs need to be able to emulate them.

� Management of the partnering should be addressedexplicitly from the outset, and cannot be achieved throughmutual board membership alone.

Partnering and alliancing projects in the private sector use a combination of pre-established management structures and task-specific teams with “right-for-task” membership. But the attitudes of the parties and individuals tojoint working are as critical to success as management structures. PPPs nowneed to draw more deeply on both the public and private sectors’ practicalexperience of building joint teams in newly-merged organisations.

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ConclusionWe would like to see the public and private sectors doing more business together,and doing it more effectively. We believe that partnering offers a way to do this. In this paper we have discussed why we think this to be the case, and have shownthat the practical obstacles – namely the use of different contracting techniques, the choice of partnering approach, the issue of value for money, and the need toassess partners’ cultural and personal “fit” – can be overcome. We have also shownhow we have brought together a wide range of experience to help clients andcontractors on PPPs deliver a new approach. We summarise above our practicalrecommendations and we look forward now to the public and private sectorsputting partnering into practice to create a new generation of high-performing PPPs.

Private:private partnering

The overriding principle is that the employerand all the principal contractors act as thoughthey were in business together with the sharedaim of delivering the project objectives.

The client is involved in the partnership or, ifnot directly, appoints an integrator to managethe partnering on its behalf.

This is achieved through alignment of theparties’ commercial objectives with those ofthe project.

There is a multi-party legal agreement, whichmay be binding, whereby all the partiesundertake to act collaboratively and to co-operate in addressing problems, rather thanmerely apportioning liability. This will notnormally replace underlying bilateral contractsfor works and services, but the intention will beto use the former to regulate day-to-dayworking. In a more formal relationship, thepartnering agreement may be enforceable, andits relationship with any underlying bilateralagreements needs careful legal review.

Fully transparent information flows aremandated throughout the supply chain and upto the client. There is usually provision for auditof these open books.

Risks are managed collectively by the partiesand when they crystallise, there is, dependingon the risk, a sharing of the consequences.This replaces strict apportionment to individualparties.

Incentivisation exists to perform beyond target.Bonuses are paid for doing better on cost,time and performance than the original plan.Failure to meet the plan results in a sharing ofthe pain.

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Appendix ASummary of the main features of private:private sectorpartnering and alliancing

Alliancing

As for partnering.

The client has to drive the alliance if it is toachieve its aims.

As for partnering.

The multi-party agreement governs therelationship between the parties and isenforceable.

Bilateral agreements have a very limited, or no, role.

The information is the joint property of thealliance. An alliance auditor is appointed,responsible to the alliance itself, to ensure thatall information is valid and properly prepared.

As for partnering, except that the sharing ofrisks is likely to be done on an aggregatebasis, up to pre-agreed limits, and thereafterborne by the client, providing a floor to thecontractor’s downside risk.

As for partnering, except that the over-performance is measured in aggregate and thebonuses allocated according to overallpartnership shares, rather than to individualcontractors’ specific incentivisation schemes.

The typical terms and arrangements in a private:private sector partneringagreement and a full alliance agreement are shown in the following table.

Private:private partnering

Continuous improvement is frequentlymandated: contractors must work togetherand produce ideas for delivering a project thatexceeds the original objectives.

Integrated Project Teams are often used todeliver individual tasks, comprising the mostrelevant experts for the job, rather thanrepresentatives of each organisation.

There is usually an overall project steeringgroup comprising representatives of all thepartners, and there is normally also a similarmanagement group dealing with more day-to-day issues.

Where a client procures a number of similar,repeat projects, continuous improvement canbe applied between projects, deliveringsignificant savings and improvements.Examples include the use of partnerships bymajor retail chains to deliver newsupermarkets, restaurants and fuel stations.

Tendering time and cost is reduced becausecontractors are not being asked to quote firmprices to incorporate large amounts of risk. Butthis saving can be offset by the cost ofdeveloping a robust cost for the project afterthe partnership has been entered into, intesting this against benchmarking data and inaudit of the project’s open book accounts.

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Alliancing

Continuous improvement is central to therationale of the alliance and work is structuredso as to drive it.

Project teams are picked only on the basis of“best-for-task”.

As for partnering, except that these jointworking groups are the only forms ofmanagement.

Repeat projects with the alliance usuallydeliver greater levels of savings with eachsuccessive experience.

Tendering time can be very short because allthe pricing work is done post-contract by thealliance and involving alliance audit.

Office of Government Commerce

Effective Partnering (2003)Best Practice Guidance: Managing partnering relationships Best Practice Guidance: Forming partnering relationships with the private sector in anuncertain world (2002)Best Practice Guidance: Value for Money Evaluation in Complex Procurements (2002)Central Unit of Procurement Guide number 57: Strategic Partnering in Government (1997)Construction Procurement Guide number 4: Teamworking, partnering and incentives (1999)

National Audit Office (“NAO”)

Managing the relationship to secure a successful partnership in PFI projects (2001)Planning for Joint Ventures (page 7 of the NAO report The Public Private Partnership forNational Air Traffic Services Ltd)

HM Treasury

Standardisation of PFI Contracts Version 3 (2004)

Office of the Deputy Prime Minister – Strategic Partnering Taskforce

Rethinking Service Delivery series:Volume 1 – An introduction to Strategic Service Partnering and the Decision-maker’s GuideVolume 2 – From Vision to Outline Business CaseVolume 3 – Public - Public PartnershipsVolume 4 – Outline Business Case to Contract SigningVolume 5 – Making a Partnership a Success

Technical Notes:Structures for PartnershipsEmployees and PartnershipsRisk ManagementPayment Mechanisms

Final Report (2004)

Partnerships UK

A Guidance Note for Public Sector Bodies forming Joint Venture Companies with thePrivate Sector

Strategic Forum for Construction

Accelerating Change (2002)Integration Toolkit

Construction Industry Council

A Guide to Project Team Partnering (second edition 2002)

Appendix BSelected published guidance on Partnering and PPPs

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Contacts

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PPP Advice

Charles Lloyd+44 20 7804 5130charles.lloyd@uk.pwc.com

Martin Callaghan+44 20 7213 4855martin.j.callaghan@uk.pwc.com

Paul Brewer+44 131 260 4263 paul.k.brewer@uk.pwc.com

Libby Johnson+44 207 213 5298libby.g.johnson@uk.pwc.com

David Padwick+44 20 7804 3289david.padwick@uk.pwc.com

Sarah-Jane Eglen+44 20 7212 3124sarah-jane.eglen@uk.pwc.com

Michael Kitts+44 1509 604025 michael.kitts@uk.pwc.com

Local Authority Strategic Service Partnerships

Anthony Morgan+44 207 213 4178anthony.j.morgan@uk.pwc.com

Contracting & Issue Resolution

Caroline Johnstone+44 113 289 4263caroline.a.johnstone@uk.pwc.com

Marcus Black+44 113 289 4264marcus.w.black@uk.pwc.com

Management Integration

PricewaterhouseCoopers Partnering Advisory Services

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PricewaterhouseCoopers(www.pwc.com) provides industry-focused assurance, tax and advisory services forpublic and private clients. More than 120,000 people in 139 countries connect theirthinking, experience andsolutions to build public trustand enhance value for clientsand their stakeholders.

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