How Do P3s Work?
P3s are a long-term performance-based approach for procuring public infrastructure. The private sector assumes a major share of the responsibility in term of risk and financing for the delivery and the performance of the infrastructure, from design structural planning to long term maintenance.
|Integration of two or more phases of a project from design and build through to a concession period, which can include providing the facilities maintenance services or even the core services that rely on the use of the newly built facility. This feature means that P3 contracts are usually long-term contracts covering a large part of the economic useful life of the asset, which may exceed 30 years.
||Each phase procured separately through a succession of separate contracts. Facility design is completed before tendering of the construction phase, which is often accomplished through multiple contracts awarded to multiple contractors for separate pieces of work. This conventional approach is also known as “design-bid-build.” Once the new facility has been built, facilities maintenance services and other aspects of operations are delivered through contracts that are separate from the design and build contracts. Conventional construction contracts usually take the form of stipulated price contracts,3 or construction management contracts, where an engineering firm is hired to manage the successive contract phases, including the procurement for each phase.4
|Output-based contracts, in which the deliverables are specified in terms of the outputs required, leaving the private sector partner to put forward the best solution for meeting the output specifications. Output-based specifications are particularly important for the operational phase of the contracts (i.e., after the facility opens for public use), but they are also used for the design and construction phases, where the public sector owner specifies the functional requirements for the facilities to be procured.
||Input-based contracts, in which the public sector owner specifies the exact inputs required for the facility. In some cases, input-based contract provisions may be appropriate either because it is not possible to specify outputs that capture the contractor’s performance in a satisfactory manner, or because the potential benefits from specifying such outputs may not justify the effort required to develop, monitor, and enforce them.
|Payment upon delivery, whereby the private firm is paid only for defined assets or services once construction has been completed. 1 When this feature is combined with output-based specifications, the result is a performance-based contract.
||Monthly payments to contractors based on the percentage of the contract work completed. Up to 90 per cent of the stipulated contract price may be paid in monthly payments. Note: Payment on a percentage completion basis is not the same as payment initiated upon final delivery of the project.
|Private financing, in which a substantial share of the project is financed through project-specific equity and debt. The private financing is usually provided on a non-recourse basis2, with the equity provided by the consortium partners making up less than 20 per cent of the project financing. Third-party debt, bank loans, and contributions from governments provide the remaining finance requirements. In other words, private working capital is not enough to qualify a project as privately financed; it must have project-specific equity and debt. This kind of private financing is usually available only to projects that are at least $40 million in size, and often much larger.
||Private financing limited to relatively modest levels of working capital. Because conventional contracts involve regular payments to the contractors, private financing is limited to a modest amount of working capital.
|Private sector project stewardship, whereby overall control of project execution is transferred to the private sector partner. The completion of milestones is determined by an independent certifier and overseen by the private sector partner. The public sector owner must step back and allow the P3 consortium and its contractors the freedom to manage each phase of the project in a way that best meets the contractual obligations. However, the public sector owner ultimately retains ownership of the asset, including the right to make changes to the requirements or even to terminate the P3 agreement.
||Project stewardship by the public sector or a contract management firm. Overall control of project execution rests with the public sector owner (or a contract management firm acting on behalf of the public sector owner). The public sector owner (or its contract management firm) would typically have engineers on site to supervise and direct the project and to inspect and approve the work at key completion milestones.
Source: The Conference Board of Canada.
1 In some cases, partial payments have been arranged at key milestones during the construction phase.
2 Financing is provided on a non-recourse basis when recourse to the equity investor for any claims resulting from the project is limited to the investor’s equity contribution.
3 Stipulated price contracts, which are also known as Canadian Construction Documents Committee (CCDC) 2, require the contractor “to perform the required work for a single, pre-determined fixed price or lump sum, regardless of the contractor’s actual costs.” See www.ccdc.org/documents/index.html#CCDC2.
4 Construction management is sometimes referred to as an “engineering-procurement-construction-management” approach. In this case, the firm managing the contracts is the “managing contractor.” See Grimsey and Lewis, “Public Private Partnerships,” for a comparison of the advantages and disadvantages of traditional fixed-price contracts, managing contracts, and P3s. In addition, a matrix developed by the Canadian Design-Build Institute compares the performance criteria found in the design-bid-build approach with those in the construction management and the design-build approaches. See www.cdbi.org/documents/guides/matrix.pdf.