Major Risks in PPP in Construction

Most infrastructure projects are composed of five elements for which responsibility must be assigned: design, construction, service operation, ongoing maintenance and finance. Theoretically, any of these elements and their related risks can be allocated to either the public sector or the private sector. The shape of that allocation determines the structure of the partnership


Answering this question correctly and allocating risks accordingly maximizes public value. There are several risk allocation conventions (for example, a private contractor is naturally positioned to efficiently manage construction risks, a government is better positioned to control and absorb regulatory risk), but every partnership is unique and carefully negotiated. Beyond the conventional wisdom of placing the various risks with the party best able to manage them lies the reality of competing public policy goals, the finite risk capacity of the marketplace and the difficulty of holding a risk allocation fixed throughout a negotiation. In short, risk allocation is the search for optimality.

As partnership models proliferate around the world risk allocation principles are becoming increasingly sophisticated and the parties are becoming more adept at crafting structural solutions to risk capacity constraints. For example, many PPPs have been structured to isolate discrete and identifiable “chunks” of risk (such as tunneling) to avoid contaminating the overall risk-sharing approach with inefficient pricing. The public sector has discovered efficient ways to “write down” those elements and still achieve value. The key is to optimize, rather than maximize, the level of risk transfer.

One of the core tools being used in international P3 that is now gaining ground in the United States is Public Sector Comparator/Value for Money analysis. The term Public Sector Comparator (PSC) refers to the risk-adjusted whole-of-life cost of procuring an asset or service through whatever is considered the conventional public procurement method. The term Value for Money (VFM) refers to the result of a comparison between the PSC and the risk-adjusted whole-of-life cost of procuring the same asset or service from a private party.

The PSC/VFM analysis is used to describe the difference in risk-adjusted cost to the public sector between conventional procurement and PPP procurement. In a direct comparison, whichever model produces a lower cost is said to provide Value for Money (see appendix B for a schematic of the analytical process). The practice in many countries is to perform this analysis as part of the approval process for undertaking a project as a PPP. In those cases, unless VFM can be proven, the project is either aborted or pursued by conventional procurement means.

A key first step in developing a PSC/VFM framework is to define “conventional” public procurement. For U.S. public sector entities, that is likely to be a marrying of the best-practice contracting method (design-bid-build or design-build) with some form of bond financing. In countries where this analysis has been widely practiced, the sovereign cost of capital is used as the benchmark. That concept is irrelevant for the United States, where infrastructure is conventionally financed in the tax-exempt long-term debt capital markets.

Common risk allocation mistakes

Several common mistakes can occur when governments set the risk terms of a partnership structure.

  1. Goldilocks syndrome. There can be a tendency in partnership structures to transfer either too much or too little risk. Because the public sector can be risk averse, with public sponsors often looking to PPPs to save up-front or total project costs, there are times when too much risk is transferred to the private sector. The result is a project that is difficult to finance, which in turn reduces the quality of partners willing to bid on it and ultimately increases costs of delivery. While the public sector must be vigilant in protecting its own interests, the point of risk transfer that will cause private partners to walk away from a deal can often be difficult to predict. Consequently, the public sector should be cognizant of the private sector’s risk capacity constraints when structuring the initial bid documents, and be open to further negotiations on some items when the preferred bidder is selected. Optimal risk transfer ensures that there are enough high-quality bidders to reap the benefits of robust competition and that the public sector does not “overpay” to transfer risk thait is better suited to retain.

  2. The Beetle vs. the Ferrari. The public sector often views partnering as a way to achieve higher service levels from the private sector. Private partners are more than willing to provide high-quality service levels, but they expect to be paid for doing so. The public sector cannot expect to get a Ferrari for the price of a Beetle. Understanding this at the outset will help to establish more realistic performance standards in the project agreement and mitigate sticker shock once the bids come in. PSC/VFM analysis seeks to create an apples-to-apples comparison that enables the public sector sponsor to make a best value choice. Once the project agreement is signed, the public sector is aware of the quality of service that will be provided for the term of the contract. This approach contrasts with conventional procurement models, where the quality of service has been shown to decrease over the length of the contract as maintenance requirements become more costly.

  3. Buy or Lease? Leasing a car might cost you less per month than making payments on a car you buy. But when the lease is up, if you want to purchase the car, there’s a balance to pay. Depending on the car’s features or service level, on top of anything else that may have changed since the lease was initially signed, the amount owed might be higher than the current value of the car. Consequently, before deciding whether to buy or lease, it is important to carefully evaluate what your needs are at the outset, and how advances in technology may affect those needs over time. The same is true of entering into partnership agreements. Making a realistic determination of actual needs up front, assessing how those needs may change over time and identifying the acceptable levels of risk associated with each of those needs are important steps in preventing surprises down the road.

  4. Optimism Bias. Several studies have found that during infrastructure procurements, public sector entities tend to be overly optimistic about a project’s costs and time lines and about its potential to generate revenue. Separately, bidders’ optimism is particularly pronounced when it comes to forecasting demand for a product or service, given the desire to provide the best bid possible. Governments use several approaches to mitigate demand optimism bias. These include setting a range of revenue returns in the contract terms; allowing for a renegotiation of the contract if the returns are below the set range and limiting the private partner’s profits if returns are above the desired range; providing financial payments to the private partner if demand is below a certain level; and setting the duration of the total project concession to a targeted revenue amount (that is, once the private partner has hit the specified revenue ceiling, the concession ends).

Integrated map for infrastructure modernization




Key questions to ask


Impact on private involvement

Determine public authority (What do I have permission to do?)


Laws and statutes



What laws and policies exist regarding private financing and delivery of infrastructure?

Are there political constraints that would make it difficult to use certain partnership structures?


A poor legislative and statutory environment will constrain efforts to increase private sector participation in infrastruc­ture development.

Many jurisdictions face limitations from the public on the type and level of responsibility that can be allocated to a private partner.

Define project needs and objectives (What do I want to do?)





Degree of certainty

How quickly does the asset need to be delivered?

How can the asset be delivered and maintained as efficiently as possible?

Is there an opportunity to incorpo­rate private sector innovation?


Will changes in technology, policy or demand affect how we would meet the need tomorrow?


Traditionally procured projects typically begin sooner and have shorter procurement cycles (provided financing for capital costs is available), while PPPs have a superior record in timely completion.

Properly structured partnerships focus the contractor’s at­tention on delivering the lowest overall life-cycle cost.

The greater the scope for flexibility in the nature of the technical solution/service or the scope of the project, the more opportunity for private sector innovation.

The greater the uncertainty about the project’s scope and scale, the more a hybrid PPP or traditional procurement is likely the best option.

Determine the best “owner” for each project component(Who can and should do what?)






Who is going to pay for the project?

What capabilities are there in-house to deliver the project and/or manage the project? What capabilities exist in the market?

How much risk should be trans­ferred? Who is best able to bear what risks?



Fiscal conditions can either widen or constrain the PPP options available.

If a PPP model is chosen, the public sector must create the institutional capacity to manage a complex set of contrac­tual arrangements.

Optimal risk allocation is critical to successful partnerships.

Marina Kostanian, Construction Consulting Partner, Deloitte

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