How should the private partner be selected in a PPP?

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[Response by Rui Cunha Marques, February 2010]

The procurement procedure to choose the private partner is a key issue for the success of a PPP project. One of the major advantages of PPP is that in most situations the government uses market prices (bids) to choose the private partner. These savings provide the “value for money” for the project and are frequently the justification for the PPP option. However, experience shows that failures of PPP contracts are often related to the procurement procedure. In addition to transparency and fairness, which are essential in any bidding process, thinking about appropriate procedures can reduce the likelihood of problems arising in the future. Problems that typically arise are:

  1. Partners sign incomplete contracts that lack clear responsibilities for particular activities;
  2. The winning bidder is not necessarily the best partner. Due to ‘lowballing’ (ie submitting particularly attractive bids in the expectation that there will be ex-post renegotiation after contract award) and a strategic renegotiation the preferred bidders do not correspond to the best offers;
  3. The contract results in inappropriate or inadequate risk allocation;
  4. The bid documents inadequately account for contract management, i.e., ex-post supervision and regulatory arrangements.

These problems are a consequence of tender documents being prepared with inadequate view on long term objectives rather than contract closure alone. Maximum preparation and the creation of a comprehensive data room before the tender call notice benefit all parties. Supporting consultancy studies, adequate time for preparation of bidding templates and involvement of other agencies with appropriate expertise facilitate the spreading of information and places all bidders on a level playing field. Weak preparation leads projects to be launched with incomplete (often inadequate) information, including necessary financial and operational studies. The resulting lack of public information on the current operator’s performance increases the risk of the project (thus raising the cost of capital) and often translates into the assumption of significant commercial and operating risks by the public sector.

In a PPP, when selecting a private partner, a public tender is normally compulsory and the rule is to choose the most economically advantageous bid. When only one criterion exists, usually the price (e.g. average tariff), the royalty paid, the level of subsidy, the NPV, or the contract term, the winning bidder corresponds straightforwardly to the bid which presents the lowest price, minimum subsidy, highest value of royalty or net present value (NPV). However, when there are several criteria, the situation is more complicated and it is necessary to adopt a multi-criteria decision analysis to choose the winner. In this case, the awarding authority should define the criteria (and eventually subcriteria) and the bid evaluation methodology before the tender call notice.

There are several types of public procurement:

  • open procedure;
  • selective or restrictive procedure;
  • limited procedure;
  • negotiated procedure;
  • competitive dialogue.

In the open procedure, everyone is allowed to bid. In the selective or restrictive procedure there is a pre-qualification step, with the bids submitted afterwards. The limited procedure consists of an invitation to a closed set of bidders to present their offers. The negotiated procedure allows the bidders to propose different solutions and an intense discussion among all bidders can arise. Then, two or three bidders are usually chosen; more negotiations are carried out and a ‘best and final offer’ (BAFO) is submitted. After the winner is selected, the negotiations for the contract signature are still sometimes open. Finally, under the competitive dialogue procedure and following a pre-qualification stage, the Public Authority discusses the PPP contract and the corresponding technical specifications with the pre-qualified bidders.

Three principles have been identified as helpful guidance for the bid evaluation methodology:

  1. Ensuring comparability among bidders, including meeting some minimum organizational standards for the submissions—usually involving a template to facilitate comparisons;
  2. Adhering to the rules that were initially established and provided to the competitors before presenting their bids; and
  3. Evaluating only the essential factors, including the delineation of appropriate risk sharing (avoiding giving weight to superficial elements).

Also, when there is a two-stage bidding system, in the second stage the evaluation criteria should be the same as in the first one: only the players in the short-list can improve their initial bids. This would be the case even though, depending on the type of public procurement, some alterations to the first stage may be allowed.

Past experience and financial and technical capacity of the bidders should be included in pre-qualification or qualification criteria when they exist and not be part of the bid evaluation process. Criteria which are difficult to measure and allow for discretion, like quality of service or safety, should be avoided. Rather, metrics and data collection requirements should be specified in advance. Criteria or targets should be, whenever possible, pre-specified. If quality targets differ across bids, such elements are difficult to evaluate and translate into cost differences. Rather, minimum quality requirements can be pre-specified has having to be met by all bidders subject to ex-post verification.

Typically, PPP procurement procedures involve dozens of subcriteria with substantial detail. Such elements should, however, avoid increasing the complexity of the evaluations and the cost of bid preparation. For the purpose of the bidding stage, all the variables should be standardized to increase the comparability of the bids. If a NPV of a bid is derived using a different discount rate from another bid, the values are not comparable. The same screening should be done for population projections, annual consumption patterns, peak demand forecasts and other key variables.

In order to address the inherent risk of renegotiation, the elements that create valuation discrepancies should be taken into account from the beginning. First, the evaluation process should conduct sensitivity analyses of the business case proposed to adverse situations (e.g. change in demand or macroeconomic recession). Second, different assumptions adopted by each bidder in the business case can also be very important. For example, two bidders may have a proposal for a similar price in a waste water treatment plant but the shareholders of one of them demands an equity internal rate of return of 15% and the other requires only 10%. The financial and economic equilibrium of the business case will be determined by that rate, with lower prices (or the investment recovery period shorter) for the latter case. So, the implications of renegotiation will be very dissimilar depending on the winning bid. Such contingencies must be incorporated into a PPP awarding process.