PFI contracts often include incentives and penalties to ensure good performance on services. But if they are not well targeted, they'll miss the point
The recent debate about THE PFI at the TUC and Labour Party conferences was all about whether it was philosophically and financially right for public buildings to be constructed by the private sector. In fact, the PFI is only partly about construction. Look at a typical PFI new-build hospital project and you will see that for every £1m of capital spent, the cost to run and maintain it over its 25-year life will be something like another £1m. This is because it is not just the building that is being provided; it's all of the services to run and maintain it during the concession period.

Because the PFI is partly a contract for the provision of services, the special purpose vehicle (SPV) – the company set up to run the project – gets paid a fee for providing a functioning building. This basic fee is reduced if performance is bad. It is interesting to see what effect the adoption of this type of mechanism has. One thing it does is take the focus away from the capital cost of the building and move it on to the proper functioning of the building.

It is easy to see why. Take the example of a ward in a hospital. If the temperature in the area drops below the level required in the performance specification, the ward becomes unavailable and a penalty will be imposed, which can mean the SPV losing x amount of money a day. This penalty will probably increase quite steeply if the situation continues. Problems like this can be caused by something as simple as a failed valve in the heating system. The building therefore has to be designed with the right combination of back-up systems to minimise the risk of something going wrong. The result is a balanced decision-making process and a real focus on the whole-life performance of a building. The contract performance mechanism is direct, and it works.

Some of the more recent and complex public–private partnership contracts edge well away from the straightforward provision of buildings to the whole-life management of facilities in partnership with the client. This involves integrated delivery of a combined service by the SPV and the client. The aim of these contracts is to allow the SPV the freedom to make decisions on how best to meet its obligations for such things as carrying out catch-up backlog maintenance and future renewal works. The client is relieved of the responsibility for these issues and can focus on delivering its core service. However, the structure of the partnership basis of the PPP means that delivery, or otherwise, of the SPV's obligations closely affects the delivery of the client's service.

In these cases the contract typically includes both penalties and incentives. Normally the SPV is paid an underlying charge for the running and maintenance of the facility – usually on a monthly basis. On top of this basic payment sits the contract mechanisms that are designed both to encourage good performance and to penalise bad. These mechanisms are designed to create adjustments, either up or down, for results that on the face of it may be more to do with the client's service than the SPV's performance.

Performance factors measured can include:

  • The quality of the customer environment. This can cover issues such as customer satisfaction (tested by means of independent surveys) and quality of the facilities.

  • Problems with maintaining the facilities that result in reduced customer access.

    The partnership basis of PPP means that delivery of the SPV’s obligations closely affects delivery of the client’s service

  • The quality of the client's service to customers. This might be based on the speed and quality of delivery of the service, whatever that might be, and it can extend down to some quite detailed measures of service delivery.

    It is by no means clear that the incentivisation element will work in these circumstances, for several reasons:

  • Incentives need to be targeted at the critical issues to the success of a project.

  • They also need to be focused on issues that are within the control of the provider.

  • The measurement process needs to be simple and the number of things measured needs to be kept to a minimum.