PPP Development Stage – Selecting Options
11.2 What are the key processes involved in selecting options?
Generally, the processes involved in selecting PPP options can
be presented by the following procedures:
- 1. Defining organisational options
- 2. Developing a partnership framework
- 3. Identifying the main PPP options
- 4. Feasibility management
1. Defining organisational options
The organisational framework of the partnership is an important
step in the decision-making process. In order to establish
an organisational framework, the municipality needs to consider
what type of framework will help it meet its objectives and
respond to the specific opportunities and constraints of its
Municipalities are encouraged to compare different organisational
arrangements to see how best to reach their objectives. The
operational models include those listed below.
A. Direct contractual model.
The private sector is contracted directly to the municipality.
B. Utility model.
The municipality creates an independent utility to separate
responsibility for the service. The municipality has
an agreement with the utility and the utility has a management
contract with a private operator. This organisational framework
creates a series of contractual relationships at the
higher level, supplemented by subsidiary contracts for
C. Joint venture model.
The public and private actors assume co-ownership of
the system assets and co-responsibility for the delivery
of services. The public and private sector partners can
either form a new company or share ownership of an existing
company. Joint venture creates a new entity to implement
various types of project structures.
D. Community-contracting model.
The municipality delegates its role to the community. In
some situations, the municipality does not have a contractual
relationship with the community; however, through a structured
programme of change, the community establishes contractual
relationships with the private sector. Significant community
capacity development may be required to ensure this organisational
framework is sustainable.
…refers to the aggregation of components or functions
to create a larger scope of work. For instance, a municipality
may approach its neighbours to determine whether there are significant benefits
in them presenting their problems as a part of a consolidated
package. This might include arrangements where municipalities group together:
to attract the private sector; to introduce economies
of scale not possible in smaller municipalities; or to share high transaction
…refers to the desegregation of components within a service
sector. An “unbundled” sector may enable
a range of service delivery options to be adopted and
may be politically helpful in introducing a private sector
approach. Breaking a service sector down into a number
of parts may enable municipalities to keep control of
controversial functions or it may allow them to involve
a range of actors and build on existing local assets.
2. Developing a partnership framework
Once the municipality has agreed an organisational arrangement,
it needs to decide upon a general strategy and select a contractual
option, developing a partnership framework in the process.
The key elements of the partnership should be defined, discussed
and agreed. This will include taking into consideration aspects
already analysed, namely:
- clarifying realistic objectives;
- defining the basic principles of the partnership;
- establishing the programme of change;
- defining the scope and functions of the
- identifying the key partners, their roles and
- defining the levels of service, and how the poor
will be targeted;
- identifying the potential financing
- establishing the legal and regulatory
- identifying the major risks
3. Identifying main PPP options
After the municipality has defined the organisational option
and a strategy for developing a partnership, the next step
can be taken to identify the contractual option; this in
turn can formalise organisational option.
The major options for PPP can be defined clearly in terms
of how they allocate responsibility for functions such
as: asset ownership; the level of responsibility and autonomy
delegated to the private sector; the required capital investment;
regulation; the duration of the contract; and the contractual
relationship with the consumer.
At one end of the spectrum is the option of a fully public
sector, where the government is responsible for all stages
of service delivery. At the other end of the spectrum there
is the option when the government delegates full responsibility
for the service to the private sector, retaining only its
roles as enabler and regulator. Between these, there is
a plethora of other available options. The selection of a
particular one depends on the results of a thorough analysis,
described later it this Tool.
Different countries have adopted different contractual
options for Public-Private Partnerships. In practice, these
arrangements are often hybrids or a combination of the
basic options: service and management contracts; lease;
concession; Build-Operate-Transfer (BOO) arrangements;
or a complete transfer of ownership through divestiture [Tool
A. Service contracts
Service contracts are simple contracts awarded to private
companies for particular tasks, such as installing or reading
meters, monitoring losses, repairing pipes or collecting accounts.
normally last long – say, six months to two years. The
responsibility for coordinating these tasks remains with the
public utility managers. Service contracts will not remedy a
situation where the utility is poorly managed and costs are not
B. Management contracts
A management contract is a more comprehensive form of service
contract, under which the public authority appoints a private
contractor to manage all or part of its operations.
The simplest management contract is the payment of a fixed
fee in exchange for performing managerial tasks. More complex
contracts will set payment based on meeting performance
targets. Government has to decide whether the extra regulatory
costs of setting and monitoring these targets will promote
appropriate levels of efficiency.
Management contracts are not a good option if government
wants to raise finance for new investment. The company
takes on little or no commercial risk, so there is hardly
any incentive to reduce costs or improve services.
However, management contracts are useful options in preparing
for PPP where:
- the regulatory framework needs to be
- tariffs are too low and government needs
time to develop a system of subsidies;
- stakeholders have not yet agreed to long-term involvement
of the private sector; or
- the country has no record or experience of
C. Lease contracts
Under a lease contract, a service utility leases the
full operation and maintenance of its facilities within
an agreed geographic area to a private operator for a
period of time.Because the lessor effectively buys the
rights to the income stream from the utility's operations
(minus the lease payment), it assumes much of the commercial
risk of the operations. Under a well-structured contract
the lessor's profitability will depend on how much it
can reduce costs (while still meeting the quality standards
in the lease contract), so it has incentives to improve
Government retains the responsibility for financing and planning
investment. So if major new investments are needed, the government
must raise the finance and coordinate its investment program with
the operator's operational and commercial program.A company may
not be willing to take on a lease, unless government makes adequate
investment. A lease arrangement puts a regulatory burden on government,
almost equivalent to that for concessions. Leases are most appropriate
where there is scope for big gains in operating efficiency but
only limited need or scope for new investments.
D. BOT contracts
Under Build-Operate-Transfer (BOT) or build-own-operate-transfer
(BOOT) schemes the private sector typically designs, constructs
and operates facilities, and provides services to municipal
or government-owned service utilities. In contrast with lease
contracts, BOT-type contracts allocate much more of the commercial
risk for specific projects to private parties rather than governments.
BOT contracts are similar to concessions, except that the company
invests in building the utility and operates it over an agreed
period, often decades. The government, or distribution utility,
pays the contractor for the service provided (water or electricity,
for instance) at a rate, which covers the building and operating
costs, plus a reasonable rate of return. The utility must
pay for all the water or electricity produced, even if not all
that water or electricity is used. This places demand risk on the
distribution utility or government.
E. Concession contracts
Concession contracts combine elements of operation leases for
existing assets and BOT contracts for greenfields. Under
concession contracts, a private operator is given a contractual
right to use existing infrastructure assets to supply customers
and to finance and manage all capital extensions and upgrades
to the existing services supplied. This tends to result in
concession contracts being of longer duration than lease contracts
to enable the operator to recover its capital and financing costs.
Typically, under a concession agreement, the constructor and
operators also are given the right to supply retail services
direct to customers.
A concession gives the private partner responsibility for investment,
as well as operation and maintenance of the utility. Assets
remain with the government. The full assets, including any
built by the private partner, go back to the government when
the concession ends, usually after 25–30 years. The private
bidder who intends to operate the utility and meet investment targets
by charging the lowest tariff, usually wins the concession.
A concession is an attractive option if large investments
are needed to extend and improve services. However, government
will have a complex role in administering the arrangement.
Quality of regulation is essential in such arrangements
in order to balance profits earned by the concessionaire with lower
prices and better services for the customer.
A full divestiture, like a concession, gives the private sector
full responsibility for operations, maintenance and investment.
However, unlike a concession, a divestiture transfers ownership
of the assets to the private sector. This leaves the government
responsible solely for regulation. The company now has
the full responsibility for managing its assets. The regulator
will require the private water company to report how its assets
are being serviced.
Divestiture can take place through a sale of assets, sale
of shares or management buy-out. Divestiture is likely
to work best in an environment where financial services are extremely
well established and stable. To date, divestiture has only
taken place in England and Wales, although private water
companies have been working in the United States for many years.
4. Feasibility management
The choice of the most viable PPP option for a particular country/
municipality at a particular point in time will depend on
a number of factors. These include, but are not limited to:
- government and the community support, or the lack of
such support, for private sector involvement;
- the nature of the problem at hand – lack of investment
funds, lack of expertise, low cost recovery mechanisms,
low quality of the service provision, weak poverty reduction policy and so on;
- existing municipal and private sector capacity in terms
of human resources, organisational development and regulatory
Feasibility management should provide clear information concerning
all existing and expected factors, which may support
or oppose the implementation of the PPP options.
Feasibility management of all PPP options requires:
- analysis of a government commitment and community support
for a certain option;
- a well-researched and negotiated legal contract;
- a strong regulatory and institutional environment; and
- analysis of the state of the utility, existing regulation,
financial viability and risks.
However, it should be borne in mind that the quality
of the written contract will play an important part in the
ultimate success or failure of all possible PPP options.
A good quality contract will, among other things, encompass
an appropriate allocation of risks.