The government believes broadly that all of its suppliers have been earning easy profits for far too long and public servants have been unable to stop them doing so. So fresh from ‘negotiating’ savings from their big suppliers in relation to traditional contracts, like IT outsourcing deals, they are now turning their sights on the Private Finance Initiative. Will they win out again
PFI has been with us a long time. But Gordon Brown was probably its most enthusiastic supporter as chancellor and he used private finance as a means to drive huge investment in public services. Let’s be clear: this resulted in large-scale investment in a short period of time and delivered huge chunks of new infrastructure on budget. It also delivered real risk transfer to the private sector and injected new ways of doing business into the public sector. It was transformational.
However, PFI has a downside. It needs an expensive and long-winded procurement process, scrutinised intensely for adherence to Gatt (General Agreement on Tariffs and Trade) procurement rules. Individual decisions are often politically charged, contracts can be enormously complex and service levels are frequently fixed and rigid.
Again, there has been a spate of media reports of PFI outrage, possibly as part of government ‘conditioning’ ahead of its blitz on suppliers – the the hospital that was charged more than £300 to change a light bulb, the school that had to pay £300 to install a single plug socket and so on.
Stories abound of how PFI facilities are lying redundant and unused. (In reality, this is not the fault of the PFI services company but the public sector managers who commissioned the facilities in the first place. If planning was so poor that they were not needed, the facilities would be surplus to requirements under any procurement model.)
And the government has now mobilised: the Treasury confirmed this week that it is sending a team of accountants and lawyers to the Queen’s Hospital in Romford, Essex, where a rebuilding programme that originally cost £261m will end up costing the taxpayer more than three times that, with interest payments alone totalling £20m a year.
Can such deals actually be unpicked thus saving huge sums for the taxpayer? We would all like the answer to be a resounding ‘yes’. But the short answer is that it partly depends on the size and scale of projects and partly on the imagination and deal making capability of the government team.
Appeals that ‘we are all in it together’ are unlikely to be enough. For example, once a building has been constructed, it is very difficult to remove capacity unless there is an ability to sell part of that structure. Theoretically, one option is to rent space to other government organisations – but the government has huge excess capacity already and the Government Property Unit seems to be finding it difficult to make progress in resolving the issue.
Treasury accountants would need to look at the type of finance used in each PFI deal; but bonds are very expensive to break so there is little room for manoeuvre there. And although bank debt, by contrast, is more flexible, there are no guarantees that significant savings could be realised by re-financing.
Above everything else, the penalty clauses for breaking these deals are generally prohibitive. That is precisely why private sector companies invested huge amounts upfront and were willing to take that risk on their balance sheets. They were alive to the danger of a new government having a big idea to screw them to the floor later.
The only weapons the government really has in its locker is the offer to extend contracts to new services or new bodies in return for adjustments to unit charges and service levels that can be claimed as savings. And the similar threat approach of ‘if you don’t play ball and give us your profit back, we will make sure you can’t bid for more work and there is a lot of outsourcing coming’.
Both ideas, unless deployed with enormous care, can sail very close to the wind as far as Gatt rules are concerned, of course. This stick and carrot approach seems to have worked in relation to more traditional outsourced IT contracts, so it might just work here too.
But, and it’s a big but, PFI contracts are financed in an entirely different way to traditional deals. Suppliers will have taken huge risk and pain in the early years of these deals. They have strong contractual positions and not a lot in reality to lose. Someone this time round might say ‘the emperor has no clothes’. It will be interesting to see what happens then.
Martin Cook is lead partner for government and public sector at Ernst & Young
