Winning strategy for public sector

Park Sung-hun is a partner and managing director of the Boston Consulting Group.

By Park Sung-hun

The need for infrastructure investment around the globe is increasing. In emerging markets, population growth and increasing urbanization are driving the demand for new roads, power stations, and schools. In the developed world, significant reinvestment in aging infrastructures is becoming urgent. Since this need for investment in infrastructure comes in the wake of a financial crisis that has severely constrained public budgets in many countries, there is a staggering gap of approximately $1 trillion to $1.5 trillion annually between demand and investment in infrastructure.

Thus, public-private partnerships (PPPs) will increasingly play a crucial role in bridging the gap. These partnerships—in which the private sector builds, controls, and operates infrastructure projects subject to strict government oversight and regulationprivate sources of financing and expertise to deliver large improvements to infrastructure. When managed effectively, PPPs not only provide much needed new sources of capital, but also bring significant discipline to project selection, construction, and operation.

Best practices throughout project’s life cycle

For governments accustomed to focusing only on public-driven services, it is necessary to change their mindset and begin viewing these partnerships as a great chance to deliver high quality services while minimizing overall economic costs. The Boston Consulting Group (BCG) has identified a series of best practices to help leaders successfully design and implement such partnerships.

Firstly, a comprehensive and prioritized infrastructure-investment plan should be created. The first order of business in infrastructure investment is to make sure that the right projects are given the green-light. Governments should devise a well-thought-out infrastructure master plan that will produce a transparent pipeline of projects. The plan should be based on a long-term agenda for economic development and must factor in the strategic infrastructure investments that should be funded to make the economic vision achievable. The most effective master plans will have clear targets for improving everything from roads to renewable-energy generation and will have been crafted with input from all crucial constituencies, including citizens and business leaders.

Then, governments should identify well-suited projects for a PPP. Once an infrastructure project has been selected, the key question is whether it should be a public-sector-only venture or if the private sector should play a role. That decision must be based on an objective analysis of the cost and benefits to the taxpayer of both approaches.

Governments need to invest in three areas to ensure that they can evaluate projects with the necessary rigor. First, they should train the right people and develop the appropriate systems for conducting these evaluations. One approach is to create new units within a government that have the experience and tools needed to conduct these analyses. Initially, it may make sense to tap outside experts to lead the effort while training in-house staff along the way.

Second, governments must develop benchmark databases that collect cost information on both public and PPP infrastructure projects. This information, which should include not only capital expenditure for developing a project but also the cost of operating the project over its life cycle, will drive the projected cost analysis of similar projects. An Asia-Pacific government developed a database of road construction projects for just this purpose.

And third, governments need to develop standardized methodologies for making these assessments and identify a source of common key assumptions, such as what the financing costs would look like under a public-sector approach versus a private-sector approach.

Sound business plans and technical specifications should be developed. Once the numbers show that a PPP makes sense for a particular infrastructure project, developers must address two key areas. The first is the business plan, which should include considerations such as how much traffic a new road is projected to carry or what ancillary revenue sources can be tapped. The second is the actual technical specifications of the project. These specifications are determined by the key requirements of the asset, such as the desired maximum passenger capacity of a new railway system or how fast the trains that travel on it must be able to go. Failure to plan effectively on either front can lead to major problems, including long—even indefinite—delays in construction or difficulties once the project is operational.

Sound regulatory schemes and PPP contracts are needed for designs. Details concerning a physical asset—a road or bridge, for instance constitute only half the equation. The other critical element of a PPP comprises the regulatory structure and the contract details that make up the ground rules for everything from pricing, to risk allocation between the private and public sector, to how investment requirements are set. Flawed regulatory models, which often fail to create an effective balance of risk between private and public partners, can deter investors, cause major problems once a project has become operational, and damage a government’s prospects for creating future PPPs.

To ensure that a regulatory scheme is sound, designers should seek input from key groups that have a stake in the project. Developers of the regulations for an Asian airport, for example, made sure to involve a group of diverse stakeholders in workshops and interviews. The stakeholders included users of the new asset, government ministries with oversight of the sector, and organizations—both public and private—engaged in similar projects. Since initial sessions focused on the key objectives and basic principles of the regulatory arrangement, planners avoided getting bogged down in minutiae, such as how pricing or service levels would be set. The agreed-upon principles of the broad regulatory structure then served as guidelines for later development of the regulatory details.

Selecting the right private-sector partners is essential. Finding the right partner is not a matter of simply putting a contract out for a bid and waiting for proposals. Governments must create a clear, competitive, and transparent process that encourages participation from many potential private-sector partners. That means being very clear about what the requirements are, including the timeline for the selection, the milestones that must be reached during the bidding process, and the criteria on which bids will be judged. Too often, bidders don’t know which factors are the most important when selecting a winner. Running the selection process in such a professional manner not only ensures a large pool of well-qualified bidders but also lays the groundwork for a productive relationship with the winner.

Lastly, the performance of all projects should be tracked. PPPs are long-term partnerships that will often last more than 20 years, so keeping a close watch on how well the operation of the project is going is critical. A government should dedicate resources to this effort and establish a team to monitor performances over time. This entails identifying a set of sector-specific KPIs that should be tracked, such as the System Average Interruption Duration Index (SAIDI), which is used to track the availability of electric power for consumers. Monitoring KPIs through a risk management system will allow the contract team or regulating authority to spot problems early on and take steps—which should already have been outlined in a contingency plan—to remedy the situation.

Even with a well-thought-out contingency plan, however, making changes to a PPP agreement may be necessary. After all, it is impossible to account for every potential development in advance. At a minimum, however, the contract should spell out what sorts of events trigger renegotiation, exactly how renegotiation will be conducted, and how disputes will be resolved.

Leaders in the public sector who follow the steps above will significantly increase the odds of making PPP projects a success. And as the demand for infrastructure investments rises while public funding remains constrained, well-designed PPPs will emerge as a critical tool for helping countries around the world advance their growth prospects and raise the standard of living for their citizens.