Flexible Design in Public Private Partnerships: A PFI case study in the National Health Service

The focus of this paper is improving individual Private Finance Initiative (PFI) projects to deliver better value for the benefit of the partners in PFI. Signing long term contracts of 20 to 30 years with the private sector typically enlarges demand risks in PFI. Subsequently, this report seeks a way to deliver more valuable PFI projects by the effective management of demand risks. Incorporation of flexibilities in design is found to be a promising solution to deal with greater demand risks. Flexibility can add a significant value to the project as it allows actively reacting to the unforeseen circumstances in the future. Consequently, it will enable to cut losses in downside scenarios and amplify gains in upside scenarios. In order to benefit from the use of flexibilities in PFI project, it is essential for the public sector to structure flexibilities into the contract at the start of the project. This paper proposes managerial ways of considering the flexibilities systematically and structurally by an illustrative process using matrices called “OUF Matrices”: Operational Matrix, Uncertain Event Matrix and Flexibility Matrix. The process is designed in a way to help the partners to consider a sufficient number of scenarios and to look at the possibility of using flexibility. This paper also makes a contribution to the financial valuation of flexibilities in design to deal with demand risks using a case study of a PFI development in National Health Service in the UK. The financial model built for the case study suggests that the incorporation of flexibilities can substantially increase the value of the project only for the public sector who is responsible for taking demand risks. However, the fact that the private sector owns the asset limits the public sector’s interests in adopting flexibilities. It is thus desirable to develop a way of sharing the added value of flexibility in order to motivate the private sector to create and exercise flexibilities in the project. An approach by introducing the “option fee” in the contract is suggested in this paper, which the public sector pays to the private sector in terms of an additional unitary payment over the concession period. In this way, both partners in PFI can take advantages from incorporating flexibilities in the project.