Unique aspects of IT PPP projects

By Julian Gyngell.

Key Points:
IT public/private partnerships are growing, and have their own unique challenges.

Public/private partnerships play an increasingly important role in major IT projects, nationally and internationally, but IT PPPs projects differ from other PPP projects in a number of important respects. Some of these differences are more a matter of degree than of fundamental principle or structure, but they explain (at least partially) why IT PPP procurements have come to be out of step with other PPP sectors. In this article, we look at the main areas of difference.

Lack of replicable business models

Many areas of PPP activity, such as roads, hospitals and schools, have well established and replicable business models. By contrast:

• IT is a dynamic and yet (relative to other sectors) commercially immature industry, in which commonly accepted ways of doing business have yet to become established (and may be inappropriate); and
• IT is often crucial to an organisation’s core (and unique) business processes to the extent that descriptions of the services being delivered are not easily transportable or adaptable from one deal to another, particularly in the case of BPR (Business Process Re-engineering) projects, where the service provider’s responsibilities include developing new business models.

“Partnering” and “partnership”

IT service providers in all fields (not just PPP) frequently stress that they see the relationship with their customers as one of “partnership”, but for several reasons this concept can cause difficulties:

• The expression “partnership” itself means different things to different people. The term is rarely used in this context in its precise legal sense (of sharing the profits or losses of a business) and therefore parties should use the term “partnering” instead to avoid confusion.
• “Partnering” denotes a relationship in which the parties work together to achieve the business aims of the customer, the intention being that the services are as fluid and subject to change as the customer’s own business requirements. This can lead to contractual uncertainty if a thorough “what if” analysis is not undertaken and the necessary flexibility built-in to the contract.
• A partnering arrangement can work well to address certain issues that arise in IT deals but only if it exists within a sound contractual framework. The project is likely to lead to difficulties if partnering is invoked as a reason for avoiding the task of specifying from the outset the relationship between customer and service provider and what the deliverables are.
• The establishment of a partnering arrangement (including project and strategic alliances) without firm parameters may confuse what should be a clear allocation of risks between the customer and the service provider.

Failure to set these parameters will undoubtedly make the project more risky (usually for both parties) and may also deter third party investors (whose involvement might improve the value for money options available to the customer). This is because financiers, being distanced from day-to-day involvement in the progress of a project, have to be satisfied not only with the feasibility of particular solutions, but also that the project risks are specified with sufficient clarity and allocated correctly.

Customers, service providers and financiers should therefore equally recognise the importance of contractual certainty in partnering arrangements, as well as the need to provide for the flexibility that is essential for the purposes of the project. Partnering should not be used as an excuse for failing to decide or agree on important parts of the deal that should be included in the contract.

Corporate structures

Subject to a few exceptions, most IT PPP contracts have not (yet) involved either limited recourse financing or a stand-alone Special Purpose Vehicle (SPV) acting as the service provider, but have rather been handled directly by a major IT service provider financing the project through its own internal resources. The consequences of this trend have been:

• the procurement process (and in particular, due diligence as to the feasibility and management of the project) may not have been handled with the same degree of rigour that would generally be demanded in relation to the financing of a stand-alone SPV entity, with the result that (in many cases) insufficient attention has been paid to many of the key risks at a sufficiently early stage in the process;
• many competent IT suppliers who do not have access to the necessary levels of internal finance have been excluded from the sector, and consequently bidder competition has been limited; and
• the cumulative burden on service providers of bidding has, at times, become very onerous to their balance sheet as they have had to finance the costs of bidding and design and development of the services out of their own funds.

Of course, while the involvement of third party finance can help in reducing the risks identified above, externally funded structures should be assessed on an equal footing with the established service provider funded model. It is not the intention of this article to promote any one model. Indeed, there are advantages to the service provider funded model (ie. the security of a large organisation backing the deal) as there are to the externally funded model (ie. security that the deal terms have passed the scrutiny of a third party financier). However, we do expect that third party funding will increase in IT PPP projects as the market becomes more established.

The nature of the assets used to deliver IT services

Although the principal obligations of the service provider will be framed in terms of delivering services to meet the customer’s business requirements, performance will depend on the ability to develop, operate and maintain both tangible and intangible assets - put broadly, hardware and software. By contrast with many non-IT PPP projects, a substantial part of the benefit of an IT project may lie in intangible assets produced in the development phase, which impacts on the contract documentation in a number of ways. For example, special provision needs to be made in the contract as to ownership and use of intellectual property rights (“IPR”), access to source code and know-how, residual value risks and alternative use of the assets on termination or expiry.

The assets required for an IT PPP project have a number of other unusual characteristics. In particular:

• the development risks can be very high (especially in respect of leading edge technology or systems) and a part-developed IT system will almost certainly be less valuable than, for example, a part-completed prison or hospital;
• IT systems can (and usually are) heavily interconnected and inter-dependent, often making implementation and integration very complicated;
• information technology changes at a fast pace which means that the assets may have a relatively short economic life;
• the process of developing and maintaining computer systems is labour-intensive and the specialised nature of IT skills means that there is a particular need to ensure staff continuity and the access to know-how; and
• when considering the transferability of IT assets, regard must be had not just to the physical treatment of the system itself, but also to the IPR within that system, the matrix of supporting contracts (eg. support and maintenance, disaster recovery and other services agreements) that may underpin its use and, finally, the implications of disentangling shared use assets that the service provider uses for the benefit of both the customer and its other customers (or itself).

Frequency and extent of changes to the services

IT PPP projects invariably impact on core business; similarly core business will often dictate the type of IT services that are required. Consequently, aspects of the customer’s business requirements may need to change because of alterations in the customer’s business processes. These alterations may be caused by new laws, changes in Government policy, changes in administrative objectives or changes in the priorities of the customer. Alternatively, changes to the customer’s requirements may be the result of choices made by the customer (as opposed to impositions through circumstance). The fact is that core business is a moving object and, as it develops, the services that the service provider delivers will evolve. The parties will need to be careful to manage the issue of frequent and sometimes major changes in requirements.

Conclusion

There are five aspects of an IT PPP project that require special consideration:

• the change control mechanism, as it will be a much used element of the contract;
• there is a need for an agreed financial model in the contract (in most cases this will require a form of project open book accounting);
• there is a need for proactive partnering and contract management by the customer to realise the full value for money potential of the project - this necessarily involves the availability of human and financial resources that often are inconsistent with the business case for the project (which invariably refers to cost savings in terms of head-count and ongoing financial investment);
• there must be a clear understanding of the risks involved in the project and an appropriate risk management strategy must be adopted; and
• an appropriate exit strategy should be prepared to ensure that the parties have a clear understanding of the obligations and risks they will bear upon expiry or early termination of the contract.