Getting More P3s Built by Guaranteeing Performance

As our infrastructure continues to decay, the best option for repair is public-private partnerships

By Manuel H. Lazerov

Many infrastructure projects still haven’t been built, despite urgent needs. Public officials resist considering public-private partnerships because they want concrete assurances about performance, not just estimates, prepared by experts. Taxpayers have become increasingly skeptical because of massive cost overruns in construction and deferred maintenance everywhere.

Historically, state and local governments have received the majority of their funding for construction from the federal government. Operations and maintenance costs (O&M) have always have been the sole responsibility of state and local government, which amount to 10 times those of construction. Federal policy focuses on reducing the dependence of state and local government on its resources. This has been reinforced by Congress’s unwillingness to adequately fund future state and local infrastructure, reflected in legislation, the new tax bill, and in its most recent budget.

The Construction Phase

To build projects, public officials at every level need to rely on practices and procedures from the private sector for building projects, especially where private investment is involved. Using Design-Build agreements, they can shift design and construction risks to the contractor, making the contractor responsible for the design and any flaws in it. The purpose of design-build helps to ensure projects are delivered on time and on budget. This is important since it’s not uncommon for major U.S. projects to have serious cost overruns. Guaranteed Maximum Price contracts (GMP) or a Construction Manager at Risk agreement shifts the overrun cost to the contractor.

One difficulty in using this type of arrangement is a public officials’ perceived loss of control, who feel their government protection depends upon their control over design, and materials and equipment specifications. Actually, these forms of contracts need not sacrifice any control. They can still maintain control, while shifting the risks of late delivery and costs overruns.

Performance guarantees can be written into any agreement, both for construction, and operations and maintenance. There is no outsourcing of responsibilities, but rather employment of alternative procurement procedures to insulate government from development and operating risks.

When using a GMP contract, the most critical planning takes place during the preliminary design stage. Cost estimates generated throughout the construction phase are a constant check on possible cost increases. About 90 percent of the project decisions are made during the first five percent of construction. After that, any flexibility to change the program without significant costs is lost.

Many larger contractors have both the experience and software to enable them to provide the final construction price to a client during the preliminary design stage. They have the capacity to predict costs within two to three percent of total construction costs. Having the contractor onboard earlier in the process also helps to clarify and maintain the original objectives of a building program. Should some cost increases arise, there is no proceeding to the next stage until every issue surrounding a possible cost increase is first resolved. Usually, any cost increases are the result of the government’s change in the scope of the work after a contract is signed.

Operations and Maintenance Phase

Operation and maintenance costs are normally 10 times those of initial construction costs. This is one reason why user rates have been suppressed for so long. Elected public officials and legislators are under intense pressure not to raise user fees or increase taxes to fund O&M costs, which explains why our infrastructure is in such poor condition.

While there is still federal money to fund those kinds of state and local projects, most funding is for new construction. State Revolving Funds, which are appropriated by Congress for the EPA to provide to the states, are split 80/20 for new construction repairs. This incentivizes deferring maintenance until a new plant is needed, relieving local government from having to make some politically difficult decisions, like raising user fees or taxes.

Operating and maintenance costs need to be the result of informed cost effective decisions at the project level, which is a tradeoff between low initial costs and long term savings. It’s necessary to identify the most cost effective system and determine how long it will take for a specific system to pay back any increased costs. The focus is on the systems that are most likely to have that largest impact on costs over time.

Manuel H. Lazerov is President of Infrastructure Financial, Inc. He may be reached at www.infrastructurefinancial.org

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