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3. Procurement

3.1. Procurement timescales

The mean time taken to procure PPP projects was 28 months, which is generally perceived to be slower than non- PPP procurement.

The mean time taken to procure the PPP projects included in the survey (i.e. the time from issue of the OJEU notice to financial close) was 28 months. Most authorities thought that PPP procurement was slower than alternative methods. Most contractors also perceived PPP procurement to be slower, although 20 percent of contractors believed that there was no difference from conventional procurement. The differing responses from authorities and contractors may reflect the fact that authorities commit a considerable amount of time to developing PPP projects in the period after issuing the OJEU notice, but before detailed bids are invited from contractors.

Figure 3: Are PPP projects procured more quickly or more slowly than non- PPP projects?

The length of time taken to develop a project from the initial strategic planning stage through to the agreement of a contract with the private sector affects the speed with which new public services are delivered, and the short-term costs accruing to both the public and private sectors.

One of the main benefits of PPP has been the discipline imposed on the public sector to specify its requirements clearly and up-front. Detailed design work carried out during the procurement phase of PPP projects often would have been included in the construction phase of conventionally procured projects. Although a short procurement process is desirable, bringing design work forward at the expense of increasing the procurement period is not necessarily a bad thing.

The involvement of lenders in PPP contracts generally results in more due diligence being carried out during the procurement phase than is the case for conventional procurement, and this increases the time taken. Similarly, longer contract lengths for PPP projects (typically 20 to 30 years) mean that both public and private sectors invest more time up-front to ensure that the contract meets their requirements and allocates risks appropriately.

3.2. Procurement costs

The procurement process is expensive, and represents a greater burden for smaller projects.

The median cost incurred by authorities for external advisers was £750,000. Contractors reported much higher median costs of £2,800,000 (although only six contractors provided information).

The average cost of authorities' advisers as a percentage of capital cost was 3 percent, and the range was 1 percent to 9 percent. Higher percentages generally related to the smaller projects, reflecting the fact that costs do not vary much with project size. In interviews contractors commented that it was difficult to justify bid costs for projects with capital value below £40 to 50 million. In the schools sector, bundling projects has successfully reduced authority costs as a percentage of capital investment; average authority costs in this sector were 2 percent of capital costs.

Where bundling projects is possible, this can reduce the relative size of the authorities' costs. It would be worth considering whether more bundling of projects is possible, in particular in the health sector, if further small capital value projects are proposed.

Contractor costs are ultimately passed on to the public sector. Competitive pressure should drive these costs down, within the constraints of the bid requirements. Costs might be reduced further through the use of exemplar designs or standard contracts, by postponing due diligence requirements until later in the bidding process and, as discussed above, by bundling projects. These options must be weighed against their impact on value for money.

3.3. Competition

PPP contracts typically last for thirty years, with relatively limited opportunities after contract signature to test or re-tender the total price paid by the authority over the life of the contract ( see Section 6.3 on benchmarking). It is therefore vital for the authority to satisfy itself that it has achieved the best possible value for money at the point it lets the contract. We looked first at the number of bidders for each project, which provides a good indication of the authority's success in creating effective competition (Section 3.3.1). We also looked at price movements in the period after the authority had chosen its preferred bidder (Section 3.3.2). During the preferred bidder stage, although the authority generally has the right to re-introduce the second placed bidder, it rarely exercises that right. Competitive tension is greatly reduced, and it is important to ensure that price movements are closely monitored.

3.3.1. Number of bidders

Authorities ran effective competitions for the projects surveyed. Although the level of competition has reduced over time, it is still sufficient to deliver value for money.

On average nine pre-qualification submissions were received per project, indicating strong competition. The minimum number of bids received was two, and this only occurred in one case. Pre-qualification for the projects in this survey, all of which are now operational, took place between 1995 and 2000 ⁹. There is no evidence of a downward trend in the number of bids per project received during that period.

Fewer pre-qualification submissions were received in the health sector than in other sectors, possibly reflecting the relatively low capital values of many of the projects.

When considering the current situation, authorities and contractors alike said that they believed that the number of pre-qualification bids had fallen in recent years (see Figure 4 below). Authorities had some concerns that this meant that there was now limited competition and three respondents thought that competition was insufficient to obtain value for money. Contractors noted that the reduced number of bidders was partly due to the scale of recent projects, with smaller contractors unable to compete and the field reduced to the serious contenders.

Figure 4: Do you believe that there is currently a healthy level of competition for PPP contracts in your sector?

In our view, provided that the number of pre-qualification submissions from consortia that demonstrate the technical, financial and commercial capacity to complete the project does not fall below two to three genuinely competing bidders, there remains sufficient competition to demonstrate value for money. Where there is evidence of very little competition, at worst a sole bidder, or two bidders but a suspicion that one has agreed to drop out late in the game, then a lot more attention must be given to pre-bid value for money. The greater self-selection of bidders can benefit authorities as it reduces evaluation costs incurred reviewing non-credible submissions.

Lack of co-ordination between projects inhibits competition.

In interviews, contractors commented on the lack of co-ordination between projects. Given the resources needed to bid, they said that they chose carefully which projects to go for, and then expected to bid aggressively for those projects. This approach by contractors should ensure that authorities receive good value for money, although it is important to ensure that there is no collusion between contractors over which projects each will bid for (there is no evidence or suggestion that this has happened to date).

The Scottish Executive already provides information on its website about the PPP project pipeline. But Scottish PPP projects compete with PPP projects around Europe, as well as with other construction work, in particular regeneration work taking place in Scotland. In addition to capacity constraints in the construction industry, there may be constraints on the number of PPP projects that the SPV management teams within construction and maintenance companies can take on. In interviews, authorities noted that, as the SPV shareholders' portfolio of projects grew, they were committing less time to the earliest projects. It was not clear from our discussions the extent to which constraints on bidding and construction capacity were physical constraints, or the result of relatively low capitalisation and therefore inability of companies to take on more risk.

Recommendation: The Scottish Executive / Departments / Local Authorities should continue to monitor the number of pre-qualification submissions received from credible consortia for new procurements to satisfy itself that competitive tension is being achieved.

There is perceived to be less competition for PPP projects than for non- PPP projects.

73 per cent of authorities thought that there was less or much less competition for PPP projects than for non- PPP projects (see Figure 5 below). This is probably partly explained by the fact that non- PPP projects tend to be smaller and therefore there are more contractors who have the capacity to take them on. But the general perception was shared by a health board with recent experience of procuring new large-scale assets under Design and Build contracts rather than PPP contracts; they believed that construction companies were more eager to bid for their work than for comparable PPP contracts coming to market at the same time.

Figure 5: How do you think competition for PPP contracts currently compares with competition for non- PPP contracts?

3.3.2. Price movements between selection of preferred bidder and financial close

On more than half of projects, the price changed at the preferred bidder stage because of a change to the design or service specification.

Based on responses from authorities and contractors, the price moved on 69 percent of projects (24 projects out of 35 that responded), with a total of 66 individual price changes reported. Figure 6 and Figure 7 below show the reasons for the changes and who initiated them. In the majority of cases the design changed and there was also a change to the services specification. Other reasons for price changes included correction of errors in the financial model, cost increases following funder due diligence, cost increases to compensate for delays in reaching financial close and the impact of negotiation by the authority.

Figure 6: Changes to the contract price

Changes were only initiated by the contractor in 4 cases. Most of the time the authority led the change or it was jointly agreed.

Figure 7: Who led the change?

Note that several respondents stated that there was a price change but did not state who led the change

The PPP procurement process aims to limit movements in the contract price during the period between selection of a preferred bidder and financial close. This is to ensure that value for money achieved during the competitive phase of the project is not eroded. Typically the interest rate risk during this period is retained by the public sector since it would not be cost effective to ask the private sector to take this non-controllable risk, and the price is adjusted to reflect any changes according to a pre-agreed mechanism ¹⁰. Significant price changes at this stage which are triggered by a change to the design or to the services specification need to be minimised, and evaluated carefully to ensure that value for money is achieved in these non-competed additions to the original specification.

The scale of price changes appears significant and should be monitored.

Figure 8 below shows the price movements recorded at preferred bidder stage as a percentage of contract NPV. The price increased by more than 5 percent in 11 of the 24 projects where the size of the change was reported.

Figure 8: Percentage change to the NPV of the contract

The scale of the price movements at preferred bidder stage could raise concerns about value for money, since the only competitive pressure at this stage of procurement is the relatively weak threat that the second placed bidder could be re-introduced into the competition (or, perhaps, the threat of cancellation of the procurement process). Note, though, that we are not able to identify separately the percentage change that related to interest rate risk taken by the authority and it is quite possible that an increase in interest rates, of say 1 percent, could increase the NPV by more than 5 percent ¹¹.

It is certainly better to agree changes at this stage rather than post financial close. But authorities should aim to introduce any design or service changes before inviting best and final offers, and the Scottish Executive should monitor the scale of changes at preferred bidder stage. As the use of standard contracts increases, and authorities' experience in developing designs and service specifications grows, we would expect to see the size of price changes made after selection of a preferred bidder decreasing, other than those relating to changes in the interest rate.

Recommendation: The Scottish Executive should continue to monitor the size of and reasons for price changes that happen during the procurement period.

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