A PFI marriage of convenience

April 19, 1996

Are strategic partnerships between the public and private sectors of benefit to higher education or not worth the risk, asks Fari Akhlaghi

There appears to be a growing consensus among commentators and those involved in the administration of public sector services that finding the massive capital investment required for these areas means securing capital from sources other than Her Majesty's Treasury.

It is a sign of the times that the Labour party is reportedly keen to promote the notion that the Government's Private Finance Initiative (PFI) was, in fact, a Labour party initiative stolen by the Conservatives in 1992. Indeed, embracing private sector capital is now regarded as a sign of maturity and sanity, not to mention political expediency, since the alternative is likely to be the greatest political taboo of our time: raising income tax.

If the above is a fair picture of the overall "demand side" of the PFI equation, then it is perhaps equally true to say that on the "supply side", the prospects for business gains from PFI are potentially so great (especially for construction companies suffering from a massive downturn in traditional workload) that there is, undoubtedly, growing enthusiasm to bid for PFI opportunities, despite vocal protests that bids are often expensive and their processing invariably slow and unfair.

Notwithstanding this compelling background, the key question for any PFI scheme must be whether or not this inevitable meeting of demand and supply, with private finance acting as the matchmaker, turns out to be nothing more than a forced marriage of convenience or the basis for a long lasting, mutually beneficial relationship.

The answer may lie in the way that we conceive a PFI scheme. Borrowing capital through PFI or otherwise to fund expansion in a competitive higher education market may be justified according to calculations relating to market opportunities and timing. To view PFI as merely a means to access other sources of capital than the Treasury, however, would be to ignore the most powerful dimension of this initiative: its potential for fostering long-term service and income generation relationships between a PFI client and the consortium that is providing the capital.

This is particularly important for the health service and higher education, where alternative use of assets, short-term leasing and so on are less likely to feature as serious possibilities with regards to PFI projects involving the design, building, financing and operation of specialised facilities.

In a typical scenario, it usually takes a facilities management company, a specialist service provider (if applicable), financiers (eg, City bankers) and construction contractors to team up to bid for a particular opportunity.

If successful, these partners formalise their consortium by forming a special purpose company. They then invest in a small proportion (5 per cent to 15 per cent) of the total cost of the project through purchasing of equity (ordinary shares) in, or providing a loan to, the company. Naturally, any release of private finance will be conditional to the existence of security in the form of assets and/or sufficiently large revenue streams.

The deal would, therefore, have to ensure that future cash flows will generate enough revenue to pay interest on the debt, to repay it according to an agreed schedule and to make a profit for all those involved while ensuring value for money service for the sponsoring public sector organisation.

It would not require a mathematical genius to work out that over the functional life of most intensively used facilities, particularly if they house costly machinery and/or employ highly salaried people, the initial expenditure of designing and building the facility is most probably far outweighed by the operational costs.

The usability and management of facilities and their effects on the operational productivity of the users and occupiers are, therefore, the most important factors to bear in mind, especially when a PFI deal can tie a service user organisation to a provider consortium for as long as 25 years. Nothing could be more naive and void of imagination than equating PFI to a mere sourcing of alternative finance for capital projects.

PFI has the potential to create strategically significant partnerships between the client organisation and the providers which could influence facilities management and income generation. Inevitably, the user's requirements and internal and external factors affecting most operations will change over time. An important feature of any long-term service contract must, therefore, be its flexibility to accommodate change while ensuring mutual benefit and a reasonable balance of risks between parties.

The financial issues of investment and the legal aspects of forming a contract for designing, building, financing and operating new facilities are relatively straightforward. Less so is the question of how best to add the operational dimension into the equation and it is this that can often determine the eventual success of a PFI contract.

One way is to see the deal as a long-term facilities management partnership and an opportunity for carrying out a fundamental review of the effectiveness of services management and delivery.

Once an institution breaks the established moulds and explores new avenues, it embarks on a journey of hope through commitment - rather like a well- intentioned marriage. The possibilities are virtually limitless and largely governed by the collective imagination of the senior management team of the public sector institution.

The stated objectives of PFI are to relate policy to the ongoing desire to achieve the best value for public money. Added to this is the intention of transferring to the private sector risks that would normally be taken by the public sector and for which the private sector is believed to be better equipped (and for which the public sector will have to pay).

Research by facilities management researchers at Sheffield Hallam University on potential links between market testing, outsourcing and PFI indicates that to achieve breakthroughs in service provision, PFI must achieve reasonable scores against the three axes of quality improvement, cost reduction and strategic improvement (in the form of increased flexibility and/or lowering of risks).

In exploring these more exciting avenues, higher education could learn from the experiences in the NHS. Since 1994, work at Sheffield Hallam has pioneered an approach to support service management and contracting that could, potentially, revolutionise the customers' ability to ensure "value for money" from internal and outsourced providers of services.

Through its independent research and work with members of its Health Service Facilities Management Forum, the university has started to link these ideas to the development of new approaches to PFI.

At a recent meeting of 18 university directors of estates and facilities at Sheffield Hallam University a 12-month agenda for joint research and active learning workshops was discussed. PFI and its relationship to long-term facilities management contracts will be one of the subjects to be explored through workshops and applied research involving up to 35 universities which have, so far, registered their interest in becoming active members of a forum set up by the university's unit for facilities management research.

Fari Akhlaghi is head of the unit for facilities management research at Sheffield Hallam University.

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