Public-private partnerships: when they fit, testing value for money and governing the contract for decades

A public-private partnership, or PPP, is a long-term contract in which a private party designs, builds, finances and maintains an asset, and sometimes operates the services in it, while the public sector pays for availability or performance over many years, or the private party collects user charges. Hospitals, schools, prisons, roads, rail and water assets have all been delivered this way in Australia. For governments, PPPs promise whole-of-life efficiency, risk transfer and private-sector discipline. For businesses, they offer long-term work as consortium members, contractors, facilities managers, suppliers and advisers.

PPPs attract strong opinions. Some see them as inherently more efficient; others as a way of hiding public debt or rewarding private investors at public expense. Both views are too simple. A PPP is a conditional business model: it creates value only when a project’s characteristics allow its mechanisms of integration, risk allocation and performance incentives to work, and when both parties can govern a contract that will last for decades. Whether that is true has to be tested project by project.

This article explains how PPPs work, when a project is likely to suit one, how value for money is assessed using a public sector comparator and what its limits are, how risk and performance are allocated, and how a long-term contract should be governed after signing. It also covers what businesses joining PPP supply chains should look for. It is general information. PPP policy and guidelines in Australia are set nationally and by each jurisdiction and are revised over time, so check current requirements for any specific project.

How a PPP works

A typical availability-based PPP has a few key parts:

• The government party defines the services it needs, usually as output specifications, and pays the private party over the contract term.
• A special purpose vehicle is a company created by the private consortium solely for the project. It signs the contract with government and subcontracts the work.
• Equity investors own the special purpose vehicle and carry the first losses if the project performs poorly.
• Lenders provide most of the finance, repaid from the government’s payments.
• A design and construction contractor builds the asset.
• A facilities management or operations contractor maintains it, and sometimes runs services, for the contract term.

Payments usually start when the asset is available for use and are reduced, through abatements, if availability or performance standards are not met. At the end of the term, the asset is handed back to government in a specified condition. Financial close is the point at which contracts and finance are signed and committed.

In user-pays PPPs, such as some toll roads, the private party collects charges and carries some or all of the demand risk.

A PPP is not a financing technique

The most common misunderstanding is to treat a PPP as a way to get infrastructure without paying for it. Private finance is a cost, not a gift; governments can usually borrow more cheaply than private consortia. A PPP is a different way to buy and manage an asset over its life, and the long-term payment obligations are real commitments.

The right order is to decide first whether the investment is worth making, then how to deliver and finance it. The value first, financing second article sets out this discipline for any significant investment.

Where a PPP adds value, it is mainly through:

• Lifecycle integration: a party responsible for maintaining an asset for decades has reason to design and build it for low whole-of-life cost, not lowest construction cost.
• Risk allocation: placing risks with the party best able to manage them.
• Performance incentives: payments that depend on availability and service quality.
• Output specification: describing what is needed rather than how, leaving room for innovation.
• Due diligence by lenders and investors, whose money is at stake.

Each mechanism depends on conditions. Without competition, pricing discipline weakens. Without measurable outputs, performance payments become arguments. Without capable public management, long-term governance fails. Without sensible risk allocation, transfer becomes expensive. Without adaptability, long contracts lock in yesterday’s solution.

Testing whether a project suits a PPP

National policy and guidelines agreed by Australian governments state that value for money is paramount and that no delivery method is presumed to be superior. They describe characteristics that make PPP delivery more likely to suit a project. A practical suitability test covers seven dimensions:

Weak answers on several dimensions should lead to serious consideration of alternatives, such as design and construct contracts with separate maintenance contracts, alliances or managed contractor models. A useful discipline is market sounding before major procurement costs are incurred, to test appetite, capacity and likely competition.

Testing value for money with a public sector comparator

To judge whether a PPP offers value for money, governments compare bids against a public sector comparator: an estimate of the risk-adjusted whole-of-life cost of delivering the same outputs through conventional public procurement. A comparator usually includes:

• Raw cost: the base capital, maintenance and operating costs.
• Competitive neutrality adjustments: removing advantages or disadvantages that government has simply because it is government, such as some tax treatments.
• Transferable risk: the value of risks that would be transferred to the private party under a PPP.
• Retained risk: risks government keeps under either approach.

Cash flows over the life of the project are discounted to a present value and compared with the present value of the PPP payments plus retained risk.

The comparator is a model, not a verdict

The comparator is useful because it forces a credible counterfactual and makes assumptions explicit. It is also an estimate of a hypothetical project decades into the future, and its known weaknesses deserve attention:

• Risk valuation is modelled, not observed in markets, and can swing results.
• Discount rates change the weight of distant cash flows dramatically. A $10 million payment due in 25 years is worth about $3.75 million today at a 4% discount rate but only about $1.84 million at 7%.
• Complexity can hide judgement inside spreadsheets.
• Qualitative factors such as service flexibility, design quality and public-interest effects are hard to capture.
• Uneven detail: comparing a detailed private bid with an underdeveloped public estimate biases the result.

Leaders should see how much of the result depends on judgement. Require sensitivity analysis on risk values, discount rates and key cost assumptions, and a qualitative assessment alongside the numbers.

What must be true

A strong test turns claimed benefits into propositions that can be checked. For each claimed benefit, ask:

• Mechanism: what creates the benefit?
• Evidence: why should it occur on this project?
• Dependency: what must remain true for it to hold?
• Failure mode: how could it disappear?
• Control: what can government do about it?
• Measure: how will it be tested over the contract’s life?

If several propositions are weak, the PPP case weakens with them.

Allocating risk and specifying performance

The principle is to allocate each risk to the party best able to manage it at the lowest cost. Transferring a risk the private party cannot control simply buys an expensive insurance premium. Construction, design, maintenance and availability risks are often well suited to transfer. Demand, policy change and some site and interface risks may remain largely influenced by government and are often better retained or shared.

Output specifications describe what the asset and services must achieve: available spaces, temperatures, cleanliness, response times and so on. Payment mechanisms reduce payments when standards are not met. Measures must reflect what users need; otherwise the public party may pay for contractual compliance that does not deliver the intended outcome, or create incentives to manage the measure rather than the service.

The contract is an operating system

Most of a PPP’s economic life occurs after financial close. A multi-decade contract cannot be managed as a static document. It needs governance that preserves performance, the original risk allocation and commercial integrity while allowing controlled adaptation to changes in technology, service standards, regulation, demographics and policy.

Common failures after signing include:

• Under-resourcing contract management because the contract is thought to be complete.
• Losing knowledge when the procurement team disbands.
• Treating each change in isolation, rather than tracking cumulative effects on value.
• Focusing on monthly abatements while missing asset condition and long-term outcomes.
• Hollowing out public capability, leaving government dependent on its partner’s information.

Good governance includes clear change mechanisms, periodic reviews, benchmarking or market testing of some services where the contract allows, a joint approach to performance data, and planning for handback years before the term ends, with condition surveys and agreed rectification. Governments need to remain intelligent owners, with enough technical, commercial and operational knowledge to challenge performance and negotiate change. Long contracts also need mechanisms for adjusting prices fairly over time; the price adjustment clauses in long contracts article covers the principles.

Value for money is a lifecycle hypothesis

A business case and a tender evaluation make a prediction: that the chosen model will deliver better service, risk and financial outcomes over the contract’s life. Financial close does not prove it. Value can be eroded by poor service, expensive change, weak contract management, technology obsolescence, demand shifts, disputes or poor handback condition.

Treat value for money as a hypothesis to be tested throughout the contract. Track availability, service quality, change costs, asset condition, disputes and user outcomes, and compare them with the assumptions that justified the procurement. Feed lessons into future decisions about which projects suit PPPs.

The portfolio view

Each PPP also commits future budgets. Across a portfolio, leaders should watch aggregate long-term payment obligations, concentration of contracts among a few operators or financiers, the public sector capability retained, common risk exposures and the timing of contract expiries and handbacks. A project that offers value on its own can still contribute to a portfolio that constrains future choices.

For businesses in PPP supply chains

Businesses that join PPP consortia or their supply chains take on long-term obligations:

• Understand the payment mechanism and how abatements flow down to subcontracts. A maintenance subcontractor may carry deductions for availability failures it did not cause unless the contract is clear.
• Price the whole life, including lifecycle replacement, inflation, labour and materials over decades.
• Check back-to-back risk: risks passed from the special purpose vehicle to subcontractors should be ones they can manage and insure.
• Plan for change: how variations will be priced and approved over a long term.
• Allow for bid costs, which are high, and for the probability of losing.

The matching the contract to the work article explains how contract structure should scale with duration and complexity, which applies directly to long-term subcontracts.

A worked example

This is an illustrative example. A state agency is considering a PPP for a group of new regional schools, including 25 years of building maintenance. Its business case compares a PPP with conventional delivery, in which a design and construct contract is followed by separate maintenance contracts.

Comparator. The agency’s public sector comparator estimates a raw cost of $340 million in present value, plus $5 million for competitive neutrality, $45 million of transferable risk and $20 million of retained risk, a total of $410 million. The indicative PPP cost, including retained risk, is about $405 million, a difference of about 1%.

Testing. Sensitivity analysis shows that a plausible range in the valuation of transferable risk, about $15 million either way, and a modest change in the discount rate are each enough to reverse the result. Market sounding finds only two consortia likely to bid. Outputs such as availability and building condition are measurable, but the agency expects significant changes to school layouts and technology over 25 years, which would require frequent contract variations.

Decision. The agency concludes that the claimed value depends on assumptions it cannot confirm, that competition is thin and that the need for flexibility is high. It proceeds with a design and construct contract with whole-of-life design requirements and a separate ten-year performance-based maintenance contract, retaining the option to market test maintenance later. The agency records the decision and its reasons for future reference.

Applying this in an Australian context

• Decide the investment first, then the delivery and financing model.
• Test suitability across scale, integration, outputs, risk, market, innovation and flexibility.
• Treat the comparator as a model, with transparent assumptions and sensitivity testing.
• Allocate risks to parties who can control them.
• Specify outputs that reflect user outcomes.
• Resource contract management for the whole term and retain knowledge.
• Track value for money through operations to handback.
• For suppliers, understand payment mechanisms, abatement flow-down and whole-of-life pricing.

Where PPPs go wrong

• Choosing PPP for access to finance rather than for value.
• Transferring risks the private party cannot control.
• Treating the comparator result as certain.
• Vague output measures that reward compliance over outcomes.
• Thin competition at bid stage.
• Under-resourced contract management after financial close.
• No plan for change or handback.

Questions for the leadership team

• Is the project justified regardless of how it is financed?
• What lifecycle value does integration create here, and how do we know?
• Which risks can the private party genuinely manage better?
• How sensitive is the value-for-money result to risk values and discount rates?
• How will the contract adapt to change over its life?
• What capability will we keep to govern it for decades?

Bringing it together

A PPP is a long-term business model for delivering infrastructure and services, not a financing technique. It can create value through lifecycle integration, sensible risk allocation and performance incentives, but only where the project suits the model, the market is competitive, outputs are measurable and both parties can govern a contract for decades. Test suitability honestly, treat the public sector comparator as a transparent model rather than a verdict, allocate risks to those who can control them, and govern the contract as an operating system from financial close to handback. Value for money is proven over the life of the contract, not on the day it is signed.

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Source: KEVOS editorial notes, drawing on earlier KEVOS corporate articles on PPP business models, suitability testing, the public sector comparator, value for money over the lifecycle and long-term contract governance, together with general knowledge of Australian PPP policy. The worked example is illustrative. This article is general information; check current national and state PPP guidelines for specific projects.