16 Mar 2010

Is public sector alliancing dead?

by Owen Hayford, Robyn Metledge

Four State Treasuries recently released a report that highlights the high costs associated with using an alliance. There are various options available for enhancing value for money in alliances.

The key question to be answered by government when choosing a project delivery method is: will this delivery method offer the best value for money? That is, will the prospective delivery method achieve the optimal outcome once all relevant costs and benefits over the life of the project are taken into account?

The use of the alliance delivery method is a relatively new phenomenon and has grown dramatically over the past decade, now accounting for one third of the total value of public sector infrastructure projects in Australia. But are they really delivering value for money? Until recently, limited independent inquiry into the outcomes of alliances had made answering this question difficult.

In our last edition of Project Insights we reported briefly on the release of a report by the Treasuries of Victoria, New South Wales, Queensland and Western Australia in October 2009, "In Pursuit of Additional Value: A benchmarking study into alliancing in the Australian Public Sector". This report, based on a five-year study of 14 projects covering a range of major infrastructure sectors, was compiled with the aim of making alliance outcomes more transparent and improving government decision-making with respect to project delivery options.

A key finding of this report is that the actual outturn cost of the 14 alliance projects studied exceeded the business case cost estimate by an average of 50 percent. In comparison, the report noted that PPPs have historically involved an increase of just 5-10 percent, and traditional delivery an increase of 20 percent. With alliances offering such poor cost certainty at a business case stage and the Government's imperative to establish value for money, justifying the use of an alliance delivery model will now be a lot harder.

Enhancing value for money from an alliance

The report proposes a number of key policy recommendations for enhancing value for money. On a broad level, it suggests that State Treasuries collaborate to develop guidelines which will assist government agencies both in deciding when to use an alliance and when selecting the non-owner alliance participants (NOPs), and urges governments to more proactively oversee individual alliance projects to ensure they are achieving value for money goals.

The report recommended additional measures for implementation at the individual project level to contribute to improved value for money, particularly:

Policy Recommendation 1: the alliance delivery method be retained and developed further as one of the mature procurement strategies for the delivery of government's infrastructure projects that are complex with significant risks that cannot be dimensioned in the business case or soon thereafter.

Going forward, government agencies will need to justify the selection of the alliance delivery method based on project characteristics. Complex projects with unquantifiable risks, or projects whose scope is not sufficiently defined to enable sensible pricing are well suited to the alliance approach, given the significant premium for risk/uncertainty which would likely be included in any tendered lump sum price for such projects. Alliances are also well suited to projects where early commencement of works is critical as alliances enable more front-end activities to be undertaken in parallel, rather than sequentially. Agencies need to recognise, however, that there is often a significant price premium associated with early commencement, and that early commencement does not guarantee early completion.

Policy Recommendation No 5: An adequate business case, which includes the case for the procurement decision, to be prepared and approved as required by relevant state government guidelines before the alliance selection process continues.

Time and effort must be invested in devising a robust business case that accurately reflects expected capital costs. The case for pursuing an alliance, as opposed to other delivery methods, will need to be well made and properly supported. When an alliance is being proposed in order to fast track a project, the business case should alert decision-makers as to the significant price premium that may be associated with fast-tracking.

Policy Recommendation No. 6: A competitive process should be used as the default approach to selecting NOPs having price (including outturn costs/TOCs) as a key selection criterion.

The NOPs in most alliances to date have been selected on the basis of non-price criteria (such as expertise of proposed team, ability to work within an alliance framework, ability to work with other alliance participants, ability to achieve project objectives, preliminary ideas on innovation and strategies to deliver exceptional results). Indeed, the current government guidelines recommend against the use of price criteria (such as each tenderer's proposed target outturn cost, margin and painshare cap), predominantly because of fears that price competition will erode the trust based relationship which alliances can create.

The report found, however, that in terms of relationships that developed between the parties, "[n]o discernable difference was found between alliances that used price competition and non-price competition". Moreover, when price competition was used the target outturn cost was found to be 5-10 percent less, relative to non-price competition. Thus, while price competition will not always be appropriate, it will be harder for future alliances to justify the selection of NOPs on criteria that do not include price competition as a key factor.

Is public sector alliancing dead?

Government agencies will now find it harder to get a business case for an alliance project through Treasury. However, the alliance model is certainly not dead. There is no doubt that an alliance delivery model can potentially offer the best value for money outcome on projects with characteristics that are ideally suited to the model

That said, the report has concluded that value for money outcomes for alliances can be enhanced. Although government is yet to respond to the reports recommendations, government agencies seeking approval to implement a the project on an alliance basis can expect their project business case to be put under the microscope by Treasury. Business cases which recommend an alliance based on the need to fast-track a project will need to properly address the price premium that may be associated with fast tracking. Business cases will also need to address how the agency will ensure it has access to the commercial capability and capacity which matches that of the private sector NOPs. Agencies will also probably need to adjust their current selection processes for alliances to include price-based criteria other than in exceptional circumstances.

Thanks to Jennifer Ingram for her help in preparing this article.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.