Governments in Canada, at all levels, are making public infrastructure investments a priority. Many of these investments will involve undertaking big projects. But big infrastructure projects have big risks. They have cost risks, schedule risks, risks related to urban disruption and long term asset quality risks. So, it will be critical that governments employ the best modern project delivery techniques to ensure that these projects are successfully delivered. Luckily, over the last few years, project delivery expertise in many jurisdictions has improved and there has been significant advancement in the thinking around modern public infrastructure project delivery. Today, these jurisdictions – including Ontario – are moving towards delivery models that incorporate the best elements of both ‘traditional’ public procurement and the public-private partnership (P3) model to better manage the risks and costs of large infrastructure projects, to the benefit of taxpayers.
‘Classic’ Delivery Models for Large Public Infrastructure Projects
Historically, large, public infrastructure projects were delivered using “traditional” procurement methods. In simple terms, traditional infrastructure procurement involves the government hiring an architect or engineer to prepare detailed designs. These designs are then put out to tender and the contractor that bids to build the project for the lowest price wins. The government provides the necessary funding and financing for the project by making progress payments during the construction period. And at construction completion the government assumes responsibility for all future maintenance and capital expenditure costs associated with the new asset.
The traditional delivery model has some clear benefits. It is very prescriptive in terms of what the contractor builds – owners maintain control over the project and know exactly what they are getting. Traditional delivery also maintains flexibility for owners to make adjustments to the final scope of the project over the course of the design and construction period. And because all construction costs are paid by the government as construction is complete it avoids both short and longer term financing costs.
However, the traditional delivery model has some inherent weaknesses. Because the design and construction responsibilities are not typically contained in the same contract, when issues arise during construction that cannot clearly be identified as being the responsibility of the builder or the designer, the government can end up bearing the cost of addressing the issues. Also, because all construction costs are financed through progress payments made by the government, the builder does not have any financial ‘skin-in-the-game’ during the project. When issues arise during the construction period, the contractor does not have the same strong financial incentive to resolve the issue and complete the project. Their immediate exposure is limited and they could theoretically walk from the project if it started to encounter real difficulty, with the only consequences being the potential reputational impact and risk of legal recourse by the government. The traditional delivery model also provides the government with little protection (if it did not effectively monitor the project during design and construction) from long term asset performance and quality issues. If issues arise while in operation, it is hard to determine who is responsible and even harder to recover any costs/damages.
Over the past 20 years the Public-Private Partnership (P3) model has gained traction around the world as an alternative to the traditional delivery model for large public infrastructure projects. In some jurisdictions, this was in response to the inherent issues in traditional public infrastructure delivery described above. In others, the use of P3s was seen as a way of delivering public infrastructure projects ‘off balance sheet’, keeping debt off government books to make it appear as if public spending was lower than it actually was. However, Canadian public sector accounting standards now require governments to include infrastructure assets procured by way of P3s and any related obligations and commitments in their books. The Public Sector Accounting Board (PSAB) is currently developing specific accounting standards for P3’s in Canada.
P3’s can address a number of the issues associated with traditional delivery noted above. In simple terms, under a classic P3 arrangement, the government enters into a single contract with a group of private sector companies – a consortium – to undertake all of the key elements of a project. Often the group of companies is responsible for designing, building, financing, and in some cases maintaining the new asset. The consortium may only be fully paid out at the time of substantial completion – in these cases the private sector consortium is responsible for designing and building the asset but not for ongoing maintenance, and the use of private financing is purely to drive performance during the construction period. When the consortium is responsible for maintaining the asset, the government begins to make monthly payments designed to cover both the up-front capital cost of construction that were not paid at or prior to substantial completion, and the ongoing maintenance costs of the asset once the project moves from construction into operations. These continue to be made for an extended period of time and are subject to deductions in the event that the new asset does not perform or is not properly maintained.
This P3 structure can create a clearer alignment of incentives between the owner (government) and the companies tasked with delivering the project. It empowers/forces the consortium to make reasonable trade-offs between design, construction, and (where applicable) maintenance costs, and (by focusing on output requirements rather than prescriptive specifications) can provide more opportunity for innovation.
However, the ‘classic’ P3 model is certainly not without its critics, with the most common critique being that the P3 model comes with significant financing costs for taxpayers. The public sector generally has a lower cost of finance than any consortia, so requiring the consortia to finance some portion of the project costs during construction and over the life of the asset does adds costs. Some also question whether there is sufficient empirical data to support the claim that these costs are offset by the benefits of withholding payment (e.g., increased public sector negotiating leverage, alignment of interests and increased recovery rates/use of deductions in the event of claims against the private companies delivering the project).
Thankfully, project delivery thinking and practice in many jurisdictions continues to evolve beyond the simple choice between using either the traditional delivery model or the most basic version of a P3. There has been a recognition that both models have their benefits and drawbacks, and that today, the most successful projects are in many ways a hybrid of the two models. In the remainder of this paper, we explore the common characteristics of these projects, and attempt to outline the keys to modern public infrastructure project delivery.
Myths Surrounding Project Delivery Methods
Before we discuss the elements of successful project delivery, it is important to dispel certain myths that frequently make their way into discussions about public infrastructure delivery models.
The first myth is that there is a pool of private capital waiting to fund public infrastructure needs and that the government should simply allow the private sector to step in and assume responsibility for financing and delivering all public infrastructure. While there is no question that there is interest on the part of many private investors in financing infrastructure, and while private finance can have benefits to project delivery in some cases, there is a fundamental difference between financing and funding infrastructure. In fact, barring major policy changes, much of the infrastructure being planned in Ontario is going to be funded by general government revenues and will be owned by the taxpayers of Ontario. Hospitals, post-secondary institutions, courts, jails and public transit projects are still publically funded, even when P3s are used. Private finance does not offer a solution to challenges on the funding side. What it does offer (described in more detail below) is one way to manage some of the problems that can occur in large public infrastructure projects. But overstating the benefits of private capital is ultimately harmful to the case that can be made for some amount of private finance some of the time.
The second common myth that infiltrates the discussion around public infrastructure projects is that the use of public-private-partnerships is synonymous with privatization, and that these new ways of delivering projects are resulting in the diversion of public funds to private profits. While it is true that new arrangements can result in new cost categories for public projects – like private sector financing – it ignores the fact that the private sector has always designed, built and has frequently maintained public infrastructure. And it misses the important realization that combining the responsibilities of the private sector in a single contract or enhancing enforcement mechanisms by withholding payment can help drive innovation and hold the private sector more accountable. And it is also possible that new categories of cost, like private financing, can be more than offset by potential reductions in other cost categories, for example the cost of overruns, delays, and asset impairment, that may have been the consequence of not having specialized design/ construction/operations management skills in the public sector to avoid these problems and/or the lack of leverage that may be inherent in traditional delivery methods. What is key is that governments should be careful to ensure that when they involve the private sector in new ways and incur costs not previously incurred under traditional delivery that there is in fact a net benefit to taxpayers.
Success Factors in Modern Project Delivery
The following are a number of strategies that taken together could be described as the building blocks of modern public infrastructure project delivery that contribute to successful projects. No single ingredient is sufficient to guarantee success. Large project delivery is complex and public authorities delivering projects should constantly be reviewing their track record and adjusting to incorporate new data and experience.
There is no substitute for proper upfront planning. No contract can protect the owner if they have not properly planned a project. It is critical that the full requirements of any project for the benefit/use of taxpayers are identified at the outset. Introducing changes during construction is extremely expensive under both traditional and P3 delivery. And it is almost always cheaper to manage project risks if they are identified upfront. While these statements may sound obvious, too often, upfront planning is inadequate. Sometimes this is due to an optimism bias surrounding the project. Many large-scale projects generate political excitement and public interest which can sometimes lead to budgets being understated at the approvals stage to increase the likelihood of moving forward. Projects are also sometimes launched before important decisions are made because there is a desire to show progress. Whatever the reason, large projects should follow the old axiom that applies to small tasks: measure twice and cut once.
Empirical Data and Improved Budgeting
Good decisions should be informed by all available data. There is lots of anecdotal data when it comes to large public infrastructure projects. You have only to open the newspaper on any given day to read about projects (both traditional and P3 delivered) that have not gone well. But when it comes to planning and delivering large projects, as much as possible, decisions should be informed by hard data such as actual construction cost overruns on previous similar projects or their on-time performance. Public reports do not always compare data in a systematic way. In fact, this kind of high quality data is just starting to be collected in a systematic way in many jurisdictions.
All public organizations should track their projects and report on what made them successful or unsuccessful so that they and others can benefit from that knowledge. Future decisions should be shaped by such data. Ultimately one of the biggest benefits of tracking past project budgets and costs is better budgets in the future. Better budgets mean better informed and possibly different decisions. They also mean projects that do not need to be reshaped or changed (e.g., scope, designs, timelines) late in the process when actual costs exceed budgets – a process that can be expensive and inefficient.
Proper People Resourcing
Planning and delivering large public infrastructure projects requires specialized expertise. Many public sector organizations have recognized this and built up dedicated project delivery groups or organizations. This is wise given that delivering large public projects is different in important ways from managing smaller projects or for that matter from the core policy, budgeting, regulatory and legislative functions of many public organizations. Public projects involve a commercial interface with specialist firms and there are frequently complex stakeholder and community impacts that need to be considered as well as unique procurement issues. Public sector organizations that have not built up project management expertise and have ambitious public infrastructure investment plans should consider doing so or alternatively they should identify ways to leverage the expertise of other public sector organizations with experience in matters such as procurement, financing and project management. Successful public infrastructure project management involves more than good project delivery models and contracts. People – and their knowledge, experience, and behaviours – matter just as much if not more.
Integrating Project Elements
One of the bigger sources of cost overruns in the past has been the tendency to break large integrated public infrastructure projects up into smaller separate contracts. Perhaps one of the most famous examples of this is the “Big Dig” in Boston, where the government procured the project using hundreds of separate contracts. The government was left with the responsibility for integrating all those project elements. When projects are broken up, the government retains the risk of integrating separate works and there is no incentive on the part of the various builders to minimize integration issues – in fact, in some instances there can be a perverse incentive to maximize these issues as a means of increasing profitability through claims. Getting the degree of project integration right is complex. Governments need to strike the right balance between integrating as many elements as possible to avoid “Big Dig” type problems, while at the same time avoiding combining more potentially unrelated elements than is necessary, which can result in a very small pool of potential bidders and potentially construction or operational challenges if the selected consortium does not have the expertise to deliver all elements of the project.
Avoiding Design Risk and Encouraging Innovation
The design phase is a critical stage in the life of a public infrastructure project. At this stage, the potential for innovation – which in this context means finding creative ways to meet or exceed the public’s needs, at lower cost to taxpayers – is greatest. Changes in asset layout, the materials used, how assets are maintained – all of these ‘innovations’ can bring significant value. At the same time, the design phase is a particularly risky time for a public infrastructure project. Mistakes or omissions in design can have significant consequences in cost and schedule during construction.
One of the ways governments have reduced risk and increased innovation is by having bidders design, build, and in many cases maintain assets. By doing this, three or more teams develop design solutions for the outcome the government has identified. This increases the potential for an innovative design that reduces construction, lifecycle and maintenance costs. Bidding teams also have a clear economic incentive to work together to drive to the best solution for taxpayers at the lowest cost. Requiring integrated teams also reduces one of the bigger sources of change orders and cost overruns in the past, design errors. By making bidders responsible for both design and construction, when design issues are discovered during construction, the design-build team is prevented from claiming against the government for additional costs.
Having integrated consortiums design, construct and maintain public infrastructure also creates opportunities for lifecycle-based innovations on key components and materials – for instance, spending more up front but creating savings over the maintenance period of the asset. However, it does not completely eliminate the risk that lower-quality materials are used in order to lower bids/improve margins. As a result, the public sector must continue to do a good job in setting clear output specifications before procuring public infrastructure projects, and must maintain a level of oversight throughout the life of the project to safeguard against this risk.
Selecting Good Partners
Another key ingredient to successful project delivery is selecting good private sector partners. It is critical that the public sector select highly competent private sector partners who can be counted on to approach projects in the spirit of partnership that is required to work through the inevitable issues that arise on large complex projects. This means that the pre-qualification process to identify the eligible bid teams must be rigorous. And it means that the complex rules that govern public procurement need to be applied thoughtfully. Public procurement rules are designed to ensure fairness and transparency of process – this is obviously a good thing and something around which there can be no compromise. But, if the rules are not applied intelligently they can result in the selection of partners that appear highly qualified “on paper” but who lack relevant local knowledge or who in fact have a poor performance track record. Care must be taken to ensure that fairness and protection of the public interest through the selection of highly capable partners are both achieved through the bidder pre-qualification process.
Alignment of Interests, Negotiating Leverage and Counterparty “skin in the game”
One of the biggest issues with the way large public infrastructure projects were carried out in the past is that the public sector owners had little negotiating leverage when disputes arose during the construction period. This is because governments used to make regular progress payments to cover all construction costs. This may be fine for smaller, less complex projects where the risks and chances of a complex dispute are smaller. But for big projects, with a high degree of risk, it meant that the government was the only party with a significant investment in a project when issues arose and may have had to seek legal recourse. Under this scenario, the private builder has significant leverage. They theoretically could “walk away” if their terms were not met. Not paying upfront can provide the public sector with proactive protection rather than having to sue to recover damages.
Under modern public infrastructure delivery approaches, significant payments are withheld until construction completion or significant construction milestones are achieved. By tying payments to completion of the project or significant milestones, the contractor’s financial interests are more closely aligned with governments’ and they are focused on advancing the project. Another way to align interests and focus the contractor on advancing the project is to impose payment deductions for delay. In either case, the success of these mechanisms is contingent on public sector owners consistently enforcing their rights under the contract.
Increasingly, governments are also withholding some portion of the payments even after construction is complete and paying amounts out over the life of the asset. This provides the public sector with more protection from risks such as latent defects, early lifecycle failure and higher than anticipated maintenance costs. In the past, when those sorts of risks arose, governments would have been left trying to establish responsibility amongst various parties and then pursuing the parties, often many years following completion of the project. This was extremely difficult and left the public sector exposed to significant long term risk.
Withholding Payments in Proportion to Risk
When governments withhold payments it is important that they always keep in mind the rationale for doing so. It is not a financing technique. It is a risk mitigation technique – and one that has a cost. Withholding payment necessitates private borrowing by the contractor to bridge costs. The incremental cost of that financing must be offset by the benefits of better alignment of interests, negotiating leverage, and improved access to compensation for damages. The public sector should always be mindful of the costs of this approach, and seek to minimize third-party financing costs by withholding no more of the payments than is required. Just like insurance, the object is to pay no more than is required given the risks.
In recent years, a number of jurisdictions including Ontario have reviewed the payment structure and amounts typically withheld on its projects. This has led to a series of changes, including the more consistent use of construction period payments on all larger projects to reduce short-term financing costs, and an increase in the amount paid at the time a project is substantially complete. In Ontario today, payments are fully made at the time of substantial completion where the private sector consortium is only responsible for designing and building the asset but not for ongoing maintenance. Where the consortium is responsible the ongoing maintenance of building/social projects, 60% of the capital cost of the project is paid out at the end of construction, with only the remaining 40% paid out over the life of the asset. And on transit and transportation projects, the amount of long-term financing is even smaller, in the range of 15-25% of construction costs. Both of these changes are meant to better reflect the risks inherent in these projects as they pass key milestones and enter into operation.
Taking Externalities into Account
Many large projects have the potential to cause significant community disruption while they are being built. This is especially true in the case of large public transit and transportation projects in developed urban environments. Given the amount of civil work being planned in cities across the country, care should be taken to ensure that bid processes evaluate each bidder’s approach to minimizing that disruption. Enforceable measures should always be included in construction contracts to ensure contractors have a strong incentive not to exceed their commitments regarding disruption. And protocols should be included in construction contracts to ensure regular and timely communication by the builder with affected communities regarding planned and unplanned disruptions.
Taking a Whole-Life Approach to Projects
It is very important that plans for the construction of a new public infrastructure asset also include plans for the proper maintenance of that asset. This is true from a number of perspectives. First, it means that upfront budgets should estimate the true costs of a new asset, including both its construction costs as well as its future maintenance costs. This is important for obvious reasons from a long term budgeting and government estimates perspective. Second, it means that there is a greater likelihood that proper maintenance of the asset will occur. Proper maintenance leads to both better asset performance over its useful life and lower long-term cost because emergency repairs and early replacement can be avoided. Finally by taking maintenance into account when planning a project, whole life costs can potentially be optimized. This perspective is lost when projects are not planned on a whole life basis. If maintenance planning is not combined with design and construction responsibilities at the outset, government owners need to have comprehensive asset maintenance plans and maintenance contracts with clear performance metrics and enforcement mechanisms – and then they need to enforce those contracts.
Conclusions: Striking the Balance in Modern Public Infrastructure Project Delivery
Fifteen years ago, the first P3 projects were initiated in Ontario, leveraging the private sector to deliver publicly owned infrastructure. These initial projects demonstrated both the strengths and the drawbacks of ‘classic’ P3s described above. While they, in most instances, minimized cost overruns from established budgets for government, they came with a significant private sector financing cost.
Since that time, the approach used in Ontario through Infrastructure Ontario to deliver large public infrastructure projects has continued to evolve, incorporating the fundamental principles of modern public infrastructure project delivery outlined above. A central team, with significant large infrastructure project management expertise, is leveraged across the portfolio of public infrastructure projects, working closely with government Ministries and Agencies to ensure projects meet program needs at the lowest lifecycle cost. The AFP approach uses both design-build-finance-maintain (DBFM) projects where the private sector is responsible for long-term maintenance as well as design and construction, as well as design-build-finance (DBF) where private financing is only used during the construction period and is fully repaid when the project is complete. Substantial completion payments, and the more recent introduction of construction period payments, are now being used to significantly reduce the private financing cost, improving the balance between “sufficient skin in the game” and cost. At the end of the day, taxpayers pay for and own public infrastructure assets, from hospitals and courts to highways and transit systems, to deliver services for Ontarians.
Big projects will always have big risks. But there are a number of proven strategies, combining the best of both traditional procurement and classic P3 delivery, to reduce project risks and financing costs, and ultimately increase the likelihood of successful public infrastructure delivery. With the amount of infrastructure investment being planned in Canada, it is important that public organizations make their decisions based on empirical data, employing the best practices associated with modern public infrastructure project delivery.
The preceeding article has been provided by Ehren Cory, Infrastructure Ontario Divisional President, Project Delivery.
The article was produced in consultation with the Office of the Auditor General of Ontario.