1. SESSION 4 Tuesday 16.15 – 17.45 Value for Money and Affordability

2. WHAT IS VALUE FOR MONEY? Value is not the same as lowest cost - it takes in performance, reliability, lifetime costs and maintenance and flexibility Historically the public sector has procured on lowest upfront cost - for reasons of annual cash budgets, transparency, limit on resources Too often this has led to overruns in cost and time, poor build, inadequate maintenance, expensive re-fits and poor service The construction industry has responded by bidding low and recouping margins on claims due to inadequate design briefs

3. PPP and VALUE FOR MONEY PPP aims to be VALUE BASED The Public Authority Client specifies outputs and performance levels The bidder takes responsibility for all technical and design inputs to meet the outputs The bidder finances the investment, so has capital at risk The bidder is paid periodically over the contract life during operations Shortfalls in performance lead to payment deductions

4. AFFORDABILITY AND VALUE FOR MONEY Affordability must be distinguished from VFM Affordability flows from limits to resources, thus the need to prioritise and allocate resources is a political judgment Affordability requires matching of resource and expenditure over time Affordability does not imply good VFM or vice versa Affordability applies to total project costs, not just those transferred to the bidder No project should go ahead if, at business case stage, a vfm offer is unaffordable

5. ESTIMATING VALUE FOR MONEY(VFM) in PPP Adjusting project cost elements for: Risks - whether commercial, technical, regulatory etc., have to identified and evaluated Timing - payment outflows are even over the life of the contract. Conventional projects have large early construction outflows followed by periodic “spikes”. Comparison requires re-statement using Discounted Cash Flow techniques PPP attracts a monitoring cost

6. RESPONSIBILITY FOR ACHIEVING VFM The business case should justify the project in terms of likely VFM The Project Board/Committee should develop the formal VFM benchmark (or Public Sector Comparator - PSC) The PSC must be affordable The Project Board/Committee should ensure that bids pass the VFM threshold and that the best bid is chosen Post-contract the Client is responsible for ensuring that what is contracted for is delivered (good monitoring, good management of change)

7. SETTING AFFORDABILITY AND VFM THRESHOLDS 1 At Business Case - THE REFERENCE PROJECT Compile a spreadsheet of project cost estimates (capital and recurring) over the project life cycle Assume conventional procurement and include all project development costs (land acquisition, planning etc..) Estimate costs to reflect scale and scope of project and up-to-date information on construction and service costs Divide costs between those for the client and those for the bidder Apply contingencies to capital and recurring costs(15-35% to 12-25%) Adjust for one-off receipts/non-recurring income and ongoing savings

8. SETTING AFFORDABILITY AND VFM THRESHOLDS 2 The Reference Project on a PPP basis Risk contingencies should be discounted for those costs allocated to the bidder (those which the bidder is best able to mitigate and manage) Re-state the costs as equal monthly charges incorporating an Internal Rate of Return (IRR 9-16%). This represents the bidder’s return on investment/profit Adjust for tax-sales and profit taxes Add the cost of monitoring CHECK THAT AFFORDABILITY IS CONFIRMED

9. CONSTRUCTING the PSC Bidder costs should be captured on a spreadsheet Bidder costs should be adjusted for risk following the risk evaluation exercise Costs should be estimated at contract date NPV of costs calculated at contract date

10. CONSTRUCTING the PSC NPV adjusted for tax NPV adjusted for monitoring costs PSC compared with earlier estimate to validate major change PSC is the value to the Public Authority Client of the costs/risks to be transferred under the contract to the bidder

11. USING THE PSC as BENCHMARK The PSC should be affordable, so it is a test for affordability (but check the client-side costs) The PSC should be frozen on entering procurement (never amended to reflect bidder solutions) The PSC is only amended if scale or risk allocation changes substantially during selection phases The PSC is a negotiating tool to probe the bidder financial models and indicate where fine-tuning required at final offer stage. Bidders should be left in no doubt that the PSC is a test they must pass Decide whether to reveal the PSC – or only disclose tactically underlying costs and risk-pricing

12. Using the PSC as a Compass If it has been produced using methodical analysis and no false accuracy Its compilation and underlying assumptions should be recorded at the time It must be affordable It is a negotiating lever A compass and even a warning light to abandon a procurement A matter of formal record to justify the PPP transaction in the event of subsequent audit