The economic efficiency of accommodation service PFI projects

478 Pages·2005·8.32 MB·English

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VTT PUBLICATIONS 555

The economic efficiency of
accommodation service
PFI projects

Kai Rintala
VTT Building and Transport
ISBN 951–38–6434–0 (soft back ed.)
ISSN 1235–0621 (soft back ed.)
ISBN 951–38–6428–6 (URL: http://www.vtt.fi/inf/pdf/)
ISSN 1455–0849 (URL: http://www.vtt.fi/inf/pdf/)
Copyright © VTT Technical Research Centre of Finland 2004

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Rintala, Kai. The economic efficiency of accommodation service PFI projects. Espoo 2004. VTT
Publications 555. 286 p. + app. 186 p.
Keywords Private Finance Initiative (PFI), Design Build Finance and Operate (DBFO), Public
Private Partnership (PPP), accommodation service, economic efficiency

ABSTRACT

In 1992, the UK Government introduced the Private Finance Initiative (PFI) as a policy
to allow and regulate privately financed public projects. However, PFI is better
understood as an innovative procurement method. PFI involves a private sector entity
taking the responsibility to design, build, finance and operate (DBFO) an asset used in
the provision of a public service for a contract period of up to four decades. It is widely
propositioned that PFI procurement leads to improved value for money (VFM) and
profit for the public sector clients and private sector actors respectively as a result of
improvements in economic efficiency. The aim of this research is to generate a detailed
understanding of how the economic efficiency of an accommodation service PFI project
is determined in its development through contract whole life cost (CWLC )
P
minimisation.

This research consists of two case studies on large and complex accommodation service
PFI projects. It focuses, in particular, on the effects of PFI procurement on the heating
and ventilation design solutions of the project-facilities. The data obtained is self-report
interviews, public and private sector issued project documentation and expert opinions.
The data is subjected to solution, incentive, opportunity and perception analyses.

The research unexpectedly identifies only a small number of design solutions that are
incorporated in the project-facilities with the aim of achieving CWLC reductions. In
P
other words, the research finds that the economic efficiency improvement in the
procurement of public accommodation services due to the adoption of PFI is
considerably smaller than proposed by economic theory. This, however, does not
suggest that the economic efficiency of PFI accommodation services is found to be
worse than those procured traditionally. The research establishes that the limited
improvement is because of: the guidance documentation used to govern the design of
PFI project-facilities; the market testing mechanism used to adjust the payment for the
service provision in the operational phase; the organisation of the private sector actors
in the project development; and the lack of good quality data to estimate expected
CWLC reductions. The research develops possible strategies to rectify the identified
P
problems. The adoption of these strategies should enable the economic efficiency of
future accommodation service PFI projects to be improved through CWLC
P
minimisation.

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FOREWORD
This publication is an output of a research project titled: The Contract Whole Life Cost
in the Private Finance Initiative (PFI) Development Process carried out by VTT
Building and Transport. The project had a dual aim. First, it was to examine the
economic efficiency of accommodation service PFI projects in the United Kingdom
(UK). Second, the project was to determine the critical issues in the more successful
implementation of such projects in order to provide focus for future development work
on the application of PFI-type accommodation service procurement in Finland.
The research in pursuit of the first aim was carried out in the UK. This publication(i
reporting on that research is identical (apart from this foreword) to the thesis that Kai
Rintala produced for the degree of Doctor of Philosophy (PhD) in Building
Management at the Bartlett School of Graduate Studies (BSGS), UCL (University
College London), University of London.
In early 2003, a separate publication titled Thoughts on DBFO – A Study of UK
Accommodation Service Procurement for the Benefit of Finnish Practice(ii [in Finnish]
authored by yours truly and Kai Rintala came out in the VTT Research Notes series.
That report satisfied the second aim of the project.
This research project was funded and directed by:
• The City of Espoo
• The Confederation of Finnish Construction Industries
• JP Building Engineering Ltd
• The National Technology Agency of Finland, ProBuild Program
• Senate Properties
• SRV Viitoset Ltd
• VTT Building and Transport, and
• YIT Construction Ltd.

In my capacity as the project manager responsible for this research, I wish to thank those
who made it financially possible and contributed to the project in the steering group
meetings. I also want to express gratitude to the staff at BSGS, and others involved, who
collaborated with us and enabled our research to capture the leading edge thinking on PFI.

Tampere, Finland
December 2004
Pertti Lahdenperä
––––––––––––––––––––––––––––––––––––––
i) Available at http://www.vtt.fi/inf/pdf/publications/2004/P555.pdf
ii) Available at http://www.vtt.fi/inf/pdf/tiedotteet/2003/T2192.pdf

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ACKNOWLEDGEMENTS

I am forever in debt to my supervisor Graham Ive of the Bartlett School of Graduate
Studies at UCL (University College London) for being the intellectual giant that he is
and for always having the time to review my drafts and to debate the feasibility of the
ideas in them. It is impossible to overstate how much I have learned from him.

I would like to thank to my back-up supervisor, Dr Andrew Edkins. He fought my
corner and made himself available whenever I needed his guidance.

I must acknowledge staff and students at the Bartlett School of Graduate Studies
working in the areas of construction economics and management for fostering a most
stimulating research environment.

I am grateful to Veijo Nykänen and Dr Pertti Lahdenperä of VTT Building and
Transport for their faith in me. Thanks go to Veijo for coming to my aid when the initial
funding for this research fell through, and to Pertti for managing the interface between
the industrial partners of our research project and the day-to-day research. I consider the
Construction Management research group at VTT Building and Technology to be my
professional home.

I would like to thank the following parties for the financial support that made this
research possible and for the guidance provided in the steering group meetings:
• The City of Espoo (Espoon kaupunki)
• The Confederation of Finnish Construction Industries (Rakennusteollisuus RT ry)
• The Finnish Foundation of Technology (Tekniikan edistämissäätiö)
• Foundation L.V.Y. (Säätiö L.V.Y.)
• JP Building Engineering Ltd (JP-Talotekniikka Oy)
• The National Technology Agency of Finland (Teknologian kehittämiskeskus, Tekes)
• Senate Properties (Senaatti-kiinteistöt)
• SRV Viitoset Ltd (SRV Viitoset Oy)
• VTT Building and Transport (VTT Rakennus- ja yhdyskuntatekniikka), and
• YIT Construction Ltd (YIT Rakennus Oy).

I want to express my gratitude to Kings College London (KCL) and University College
London Hospitals NHS Trust (UCLH) for allowing me to study their projects. I would
like to thank Health Management (UCLH) plc for being especially supportive and
genuinely interested in what I was doing. I truly appreciate the time and the insights
provided by the people I interviewed in the course of this research.

Thanks must go to Dr Simon Williams of UCL Language Centre for the things that he
has taught me about academic writing.

5
I also wish to acknowledge all the people that I have got to know in London and who
have become my friends. They have all contributed to my development as a human
being. You know who you are.

I would also like to express my unreserved gratitude to my parents for doing what
parents do.

Lastly, and most importantly, I wish to thank Piia for her support and unconditional
love. She is my girlfriend, my best friend and my partner in life.

London, United Kingdom
September 2004

Kai Rintala

6
TABLE OF CONTENTS
Abstract............................................................................................................................3
Foreword..........................................................................................................................4
Acknowledgements..........................................................................................................5
Table of Contents.............................................................................................................7
List of Figures and Tables.............................................................................................13
List of Abbreviations, Acronyms and Initialisations....................................................15
Part A - Introduction.....................................................................................................19
Chapter 1 - Introduction..........................................................................................19
1.1. Background.......................................................................................................19
1.2. Principles of PFI Procurement..........................................................................20
1.3. Research Rationale............................................................................................23
1.4. Outline of the Thesis.........................................................................................24
1.5. Research Outcomes...........................................................................................26
Part B - Literature Review.............................................................................................27
Chapter 2 - Client Governance in PFI Procurement.............................................27
2.1. Introduction.......................................................................................................27
2.2. Approach to Analysis........................................................................................27
2.3. The Client’s Privileged Role.............................................................................29
2.4. PFI Procurement Process..................................................................................31
2.4.1. Procurement Preparation Stage....................................................................................31
2.4.2. Bidding Stage.................................................................................................................33
2.4.2.1. Prequalification....................................................................................33
2.4.2.2. Competitive Negotiation......................................................................34
2.4.3. Preferred Bidder Stage..................................................................................................36
2.4.4. Implementation Stage....................................................................................................36
2.5. Risk Transfer.....................................................................................................37
2.5.1. Design and Construction Risks....................................................................................39
2.5.2. Availability and Maintenance Risks............................................................................41
2.5.3. Operational Risk............................................................................................................41
2.5.4. Demand, Occupancy and Usage Risks.......................................................................41
2.5.5. Residual Value Risk......................................................................................................42
2.5.6. Technology Risks..........................................................................................................42
2.5.7. Planning Risk.................................................................................................................42
2.5.8. Legislative and Policy Risk..........................................................................................43
2.5.9. Financing Risk...............................................................................................................43
2.5.10. Inflation risk.................................................................................................................43
2.5.11. Force Majeure..............................................................................................................43

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2.6. Task Integration................................................................................................44
2.6.1. PFI Procurement............................................................................................................44
2.6.2. Traditional Procurement...............................................................................................44
2.6.3. Concluding Remarks.....................................................................................................44
2.6.4. Concluding Remarks.....................................................................................................45
2.7. Long Term Contract..........................................................................................46
2.7.1. PFI Procurement............................................................................................................46
2.7.2. Traditional Procurement...............................................................................................46
2.7.3. Concluding Remarks.....................................................................................................47
2.8. Output-based Specification...............................................................................47
2.8.1. PFI Procurement............................................................................................................47
2.8.2. Traditional Procurement...............................................................................................49
2.8.3. Concluding Remarks.....................................................................................................49
2.9. Procurement Competition.................................................................................50
2.9.1. PFI Procurement............................................................................................................50
2.9.1.1. Discounted Cash Flow.........................................................................50
2.9.1.2. Competition..........................................................................................52
2.9.1.3. Value for Money Assessment..............................................................53
2.9.2. Traditional Procurement...............................................................................................55
2.9.3. Concluding Remarks.....................................................................................................57
2.10. Incentive Contract...........................................................................................57
2.10.1. Traditional Procurement.............................................................................................61
2.10.2. Concluding Remarks...................................................................................................62
2.11. Concluding Remarks.......................................................................................62
Chapter 3 - ProjectCo Strategies in PFI Development..........................................63
3.1. Introduction.......................................................................................................63
3.2. Approach to Analysis........................................................................................63
3.3. The ProjectCo...................................................................................................63
3.4. The ProjectCo’s Aim........................................................................................64
3.5. Revenue and Cost in a PFI Project...................................................................65
3.5.1. Unitary Payment............................................................................................................65
3.5.2. Miscellaneous Revenues...............................................................................................66
3.5.3. Financing costs...............................................................................................................66
3.5.4. Capital Costs..................................................................................................................67
3.5.5. Operational Cost............................................................................................................68
3.5.6. Occupancy Cost.............................................................................................................69
3.5.7. Residual Value...............................................................................................................70
3.6. Whole Life Costing – History and Use.............................................................70
3.7. Whole Life Costing Techniques.......................................................................71
3.8. Contract Whole Life Cost Decision-making.....................................................73
3.8.1. Contract Whole Life Cost Quantification...................................................................73
3.8.2. Visions of Rationality....................................................................................................74

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