The City Accelerator cohort on Urban Infrastructure Finance focused on innovative tools, models and revenue sources that can help cities across the country address their infrastructure challenges while promoting equity for diverse communities and incorporating the realities of climate change. This is the first installment of a three-part series exploring some of the ways in which cities can allocate infrastructure project risks to the private sector through innovative use of public-private partnerships (P3s). Part 1 focused on the evaluation process cities can employ when deciding whether to pursue a P3 project. Here in Part 2, we explain some common (and less-common) P3 models.
The central branch of the Brooklyn Public Library stands majestically at the intersection of some of the busiest avenues in New York City. The Art Deco building, which opened to the public in 1941, is notable for its sweeping entry portico, bronze sculptures of American literary figures, and gilded depictions of the evolution of knowledge. The grand entrance is also framed by an inscription lauding “the joining of municipal enterprise and private generosity.”
“Private generosity” may have been enough to build great cultural institutions in years past, but cities today must find new ways of supporting massive infrastructure projects that engage the private sector as partners, not merely donors. Public-private partnerships (P3s) are an opportunity for cities to leverage their “municipal enterprise” in innovative ways that can have lasting impact for low-income people and communities.
There are many types of P3s, with varying degrees of complexity and risk allocation. The broadest distinction among P3 project types is whether they’re being used for major capital improvements (building something new, or upgrading an existing asset) or for operations or maintenance services.
Let’s take a look at some of the various sorts of P3 models, and which projects they may make the most sense for.
P3s for Capital Improvements
In the most straightforward example of a public-private partnership, a local government might simply pay a private contractor to design and build (DB) a new asset. The private sector can assume some of the risk involved with the project by agreeing to maintain and/or operate the asset for a period of time in exchange for performance-based payments.
In a design-build-operate-maintain (DBOM) structure, the private contractor staffs the facility, performs routine maintenance and delivers needed technology upgrades during the life of the contract. Government can also partner with the private sector for operation (DBO) or maintenance (DBM) functions on their own. In these examples, commonly called publicly financed P3 concessions, government is responsible for securing long-term financing for the project.
On the other hand, the private sector can assume more risk (and generally higher potential returns) by financing the project directly, in addition to taking on any, or all, of the previously discussed functions. These privately financed P3 concessions are known as design-build-finance-maintain (DBFM) arrangements or Design-Build-Finance-operate (DBFOM).
Private partners who assume financial risk for a P3 project can be compensated in several ways. Sometimes, a private entity will collect a portion of revenues generated by users of the new facility – for example, the tolls collected on a bridge, or the fares paid by passengers on a new light rail system. In this revenue-risk (RR P3) model, government grants the private partner the authority to collect these charges from users directly, but the private partner is wholly responsible for achieving the demand (and revenue) levels needed to make the project financially sustainable. In other words, the private sector takes the risk that user fees will be sufficient to pay for the project. This risk might be mitigated if government offers a guaranteed minimum level of revenue or an extension on the concession if certain demand targets are not met. On the flip side, governments can negotiate for a share of the profits if revenues are higher than expected.
Another model places the long-term financial liability on the public sector. In the availability payment (AP P3) model, the government agrees to make fixed payments to the private partner in exchange for making the facility “available” at a specified standard of performance. These standards might include quality of construction, cleanliness or response times to maintenance requests. Since the payments can be reduced or eliminated if standards are not met, governments can hold the private partner to a high level of performance. In this model, the public sector needs to identify a revenue source for these ongoing payments, since they are not tied to usage or demand.
In some cases, government can choose to combine elements of the AP and RR models for a hybrid approach.
In all of these models so far, government continues to own the underlying asset. But there’s another approach, in which the private sector may actually take ownership – either for a fixed period or indefinitely – under various types of “franchise-based” P3 agreements. The private sector might build the asset and operate it for a period of time, transferring it to the public sector later (build-operate-transfer, or BOT). Private contractors can also build the asset, sell it to the government and then lease it back to operate it for a period of time (BLT or BLOT). In still other examples, the private partner may buy and own the project indefinitely (build-own-operate, BOO, or buy-build-operate, BBO). This is essentially asset privatization, and tends to work best when there are no major political concerns about private sector ownership.
P3s for Operations and Maintenance
Governments can also partner with the private sector to provide operation and maintenance (O&M) services only. Municipal services, like trash collection or snow removal, might be outsourced to a private vendor through a long-term contract. In these cases, the private sector might make investments in O&M efficiencies, taking on a greater share of the financial risk but increasing the potential for cost savings and a higher return on investment. O&M agreements can help maximize the efficiency of existing assets, without needing to build new ones. These types of P3s are especially useful where government lacks the ability or resources to effectively operate or maintain the core services associated with an asset.
Other types of P3s might generate revenue or savings for government, while offering incentives for private sector investment and risk-sharing. A private company might design, build and finance a portion of a new mass transit hub as part of a new corporate office campus. A marketing agreement might create a new revenue stream through naming rights or advertising on a new or existing public asset. A private technology company might develop a mobile app or payment system that makes it easier for government to collect revenue, with the tech firm keeping a cut.
Which (If Any) P3 Works for You?
Ultimately, any local government infrastructure project involves considerable risks.
In a traditional procurement set-up, government bears almost all of those risks, from engineering failures and major cost overruns to traffic delays and irate taxpayers. Choosing a P3 model for a project boils down to a strategic decision to shift some of those risks to the private sector. Far from simple “private generosity,” this risk transfer typically doesn’t come cheap.
Terms like “concession,” “franchise” and “lease” are sometimes used interchangeably to refer to very different P3 structures, and state laws may govern the type of agreements possible. Cities may find that multiple P3 structures could be appropriate for a project given its type, scale and objectives.
Taking the P3 plunge requires cities’ thoughtful decision-making about which risks to keep, which ones to allocate to the private sector, and which ones to share.
In our final installment, we’ll explore how Washington, D.C.’s Office of Public-Private Partnerships is developing a citywide strategy for evaluating, prioritizing and selecting P3 vehicles for its most pressing infrastructure needs.