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Commercial incompetence?

January 30, 2018

The UK’s National Audit Office (NAO) recently issued a report on government’s use of PFI (private finance initiatives) to support public sector projects. Its findings were not in general positive – and came at a time of increasing scrutiny of private sector contract performance, exacerbated by the collapse of Carillion, a major outsource provider.

Writing in the Financial Times, commentator Martin Wolf observed that the NAO report “investigates the rationale for PFI and finds it wanting. If done in the right way and for the right reasons, PFI is not a bad idea. Unfortunately, this has not happened”. Once again, a key question that surrounds this debate is whether it indicates commercial incompetence by government and opportunism by industry. This issue of opportunism arises because of the perception that suppliers gain excessive benefits in the later years of agreements – sometimes for assets that are no longer in use.

The report examines three of the arguments that have been advanced for using PFI contracts. One is certainty of budget; another is reduction in running costs; and the third is superiority of maintenance. On the issue of budget, it acknowledges that the contracting process offers greater certainty, but argues this does not imply control over price. Suppliers may charge a premium to cover their risk. On running costs, the report found no evidence of greater efficiency, though acknowledged that standards might be higher. And on maintenance, it found there are benefits, largely because government cost-cutting often targets areas such as maintenance costs so private provision protects against this.

This is a complicated area and any assessment is inevitably somewhat subjective. For example, on costs, it seems likely that suppliers will price for uncertainty and risk, but situations such as the Carillion collapse indicate that this is not universally the case. Indeed, the criticism of supplier and government in this example is that pricing was too aggressive and this is not the only instance where over-optimism or hunger to win has resulted in poor decisions on price. If government had retained control and funded these projects, would it really have achieved lower costs? History suggests often not – indeed, the EU found that major public projects have an average cost overrun of 80%.

It seems to me that the real challenge on public sector projects is the need for greater openness and collaboration. Commercial decisions are distorted by policies, perceptions and precedents, which tend to constrain conversations and introduce an unhelpful level of skepticism. Governments do not operate in the same way as private firms and good commercial assessments take acount of that in the way that risks are identified and contracts are structured. As Martin Wolf concludes: “If the government can specify and monitor the contract, can be confident that the private sector will deliver, cannot find a superior organisational form and wants to bind itself to delivering the service over the term of the contract, then it can make good sense”.

So once again we come back to that key skill, for so long ignored, of effective commercial analysis supported by strong contract management, both in design and implementation. And when it comes to shortage of supply of those skills, governnment does not have a monopoly.

 

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