Procurement issues including conventional and PFI/PPP procurement

5.1 Introduction to procurement issues

5.1.1 The central concern in taking procurement decisions is to achieve value for money (VFM). VFM in procurement is defined in Managing Public Money Northern Ireland (MPMNI) para 4.2.3 as "the optimum combination of whole life cost and quality (or fitness for purpose) to meet the customer's requirements". In March 2011, the NI Executive approved the following definition of best VFM in procurement: "the most advantageous combination of cost, quality and sustainability to meet customer requirements". In this context, cost means consideration of the whole life cost; quality means meeting a specification which is fit for purpose and sufficient to meet the customer’s requirements; and sustainability means economic, social and environmental benefits, considered in the business case, in support of the Programme for Government (PfG).

5.1.2 There is no policy preference in favour of any particular form of procurement. The majority of public sector investment has been, and will continue to be, procured through conventional means. PFI, PF2 or any other PPP should only be pursued where it delivers best whole life VFM, and then not at the expense of staff terms and conditions. Her Majesty's Treasury (HMT) has indicated that PPP solutions should only be considered for projects with a capital value of £50m or more because less capital intensive projects rarely justify the relatively high procurement and management costs. DoF agrees with this view and therefore does not expect NI departments to consider or submit PPP solutions for any project with a capital value of less than £50m.

5.1.3 A Green Book-style strategic option appraisal conducted in accordance with NIGEAE guidance is required prior to any assessment of alternative procurement routes, in order that the strategic policy choice and the procurement choice are both explicitly and separately justified at the earliest stages.

5.1.4 All proposals, including those where the private sector is involved, should be fully developed before tenders are invited. Where implementation will be by procurement, there are extensive requirements that need to be met under European Commission directives and also under regulations within the United Kingdom. These must be complied with at all stages.

5.1.5 Where there are alternative procurement options, they should be examined carefully before proceeding. DoF's Central Procurement Directorate (CPD) can provide detailed guidance on the procurement options that are available, and how to conduct the relevant procurement process.

5.1.6 The PfG includes a commitment to “include social clauses in all public procurement contracts for supplies, services and construction”. This should be considered at an early stage in the contract specification process. For more detailed relevant guidance, see social clauses in public procurement contracts (2.7.25-28).

5.1.7 The assistance of CPD, or if appropriate, another designated centre of procurement excellence (CoPE), must be sought before undertaking any procurement. The procurement pages contain a variety of useful resources on procurement issues including, for example, several procurement guidance notes and various other items of guidance for purchasers.

5.2 Public private partnership (PPP) policy framework and guidance

5.2.1 A PPP is a structured arrangement between the public sector and a private sector organisation to secure an outcome delivering good value for money (VFM). PPP includes private finance initiative (PFI) projects and other forms of partnership. The policy framework for PPPs, including PFI projects, in Northern Ireland is set out in Working Together in Financing Our Future (OFMDFM/DFP, 2003).

5.2.2 The framework applies to all NI departments and their agencies and non-departmental public bodies (NDPBs). It encourages the use of PPPs for the procurement of public services where it is appropriate to do so. Appropriateness must be judged in relation to:

• value for money (VFM); PPP must deliver value for money compared to conventional procurement, as assessed in relation to a properly constructed public sector comparator (PSC) where it is appropriate and necessary
• affordability; the PPP must be sustainable in the longer term (i.e. over the life of the contract) and compatible with the effective management of public expenditure
• best practice; PPPs should be taken forward in an open and transparent manner consistent with social partnership arrangements but respecting commercial confidentiality. The need for consistency with the Public Contract Regulations (2006) and best procurement practice applies in full to PPPs

5.2.3 The framework explains the role of the Strategic Investment Board (SIB), which includes working with departments to develop strategically important PPP projects, assisted by the Public Private Investment Unit. The framework also lists various sources of guidance that are relevant in Northern Ireland.

DoF guidance

5.2.4 Northern Ireland departments should generally follow the guidance on the approval of business cases for procurement projects set out below in NIGEAE section 5.3; and the guidance on the expected content of business cases for procurement projects provided in NIGEAE section 5.4 below. The latter explains the general approach to value for money assessment of alternative procurement options and elaborates on the roles of the shadow bid model and the conventional procurement option in PPP/PFI cases.

5.2.5 As indicated above, a Green Book-style strategic option appraisal conducted in accordance with NIGEAE guidance is required prior to any PPP/PFI VFM assessment, in order that the strategic policy choice and the procurement choice are both explicitly and separately justified at the earliest stages.

5.2.6 Procurement by private finance is only considered suitable for capital projects of £50m and above, because less capital intensive projects seldom justify the relatively high procurement and management costs involved. DoF does not expect to see any private finance proposals being considered for projects involving capital spending of less than £50m. Note that this £50m figure refers to the capital cost of a single project, not the sum total capital cost of a bundle of smaller projects. Projects must offer VFM individually. There should be no bundling together of good VFM and bad VFM projects.

5.2.7 Resources should not be wasted investigating private finance solutions where they are clearly not appropriate. For instance, PFI solutions are not usually considered appropriate for information communication technology (ICT) projects.

5.2.8 Where there is doubt over the relevance of PPP solutions, advice should be sought from departmental PPP advisers, TEO's Public Private Investment Unit or DoF Supply.

5.3 DoF approval of procurement projects

5.3.1 All procurement projects categorised as major projects as defined in section 8.5 of NIGEAE require DoF approval at SOC stage. Most PFI/PPP projects fall into this category.

Beyond SOC stage, all PFI/PPP projects, and all conventional projects above delegated limits, require DoF approval prior to commencement of procurement, based on submission of an outline business case (OBC).

In addition, all PFI projects (but not generally other PPP projects - see box below) require DoF approval at the following stages:

1. prior to appointment of a preferred bidder, based on an appointment business case (ABC) providing an update on key developments since the OBC, including a detailed BAFO or final tender evaluation and an updated affordability assessment
2. prior to financial closure, based on submission of a full business case (FBC)

DoF reserves the right to require approval at ABC and FBC stages for individual non-PFI PPP cases. This may occur, for example, where the PPP is considered novel, contentious, repercussive or in some other sense significant.

5.3.2 DoF approval at OBC stage constitutes approval to proceed to procurement, whether it is a PPP or conventional procurement, but does not include approval of expenditure required to implement the proposed project.

5.3.3 DoF approval at FBC stage allows the project to proceed to the award of a contract and sanctions the expenditure required to implement the recommended option.

5.3.4 Where DoF approves a PPP procurement at OBC stage, the FBC must be submitted subsequently to DoF for approval, even if the decision at FBC stage is not to pursue a PPP solution.

5.3.5 DoF approvals will generally be subject to all the usual terms and conditions applying to the approval of capital projects including, for example, those laid down in Section 9 of NIGEAE.

5.3.6 Departments should note the statement at 4.2.5 of MPMNI: "In particular, departments should consult DoF (and ALBs their sponsor departments) at an early stage about proposals to undertake unusual transactions or financing techniques." For example, DoF would regard index-linked borrowing as a potentially risky financing technique and would expect departments to seek specific approval from DoF, preferably before permitting the private sector to bid on the basis of index-linked financing.

5.3.7 Departments should also note the HMT guidance application note - interest rate and inflation risks in PFI contracts, which explains how to deal with interest rate and inflation risk and warns of the risks of over-indexation of unitary charges, among other things.

5.4 OBC and FBC requirements

5.4.1 A summary table indicating what is required in both the OBC and the FBC is included in the table summary of DoF OBC and FBC requirements. It may be used as a checklist to aid assessment of whether an OBC or FBC covers all the necessary issues. DoF will expect departments to address all of the issues in this checklist in their OBCs and FBCs, with appropriate and proportionate effort. The remainder of this section elaborates on a number of key considerations concerning OBCs and FBCs.

Outline business case (OBC)

5.4.2 The OBC provides the basis for a decision on whether to proceed to procurement. The main components of an OBC include:

1. an economic appraisal, which reviews business need and assesses strategic options in accordance with NIGEAE
2. an assessment of procurement options, which appraises all the available contracting options, including conventional methods and others where relevant
3. a full affordability analysis covering the year-by-year capital and revenue DEL impact, cash flow analysis and funding statement; and
4. consideration of other relevant issues ranging from output specification to arrangements for post project evaluation and scheduling arrangements for gateway reviews. (See summary of DoF OBC and FBC requirements, components 4 to 17)

Appraising procurement options at OBC stage

5.4.3 For every project, there should be an initial economic appraisal according to NIGEAE guidance to determine a preferred option in terms of the public services to be delivered. This should be followed by a separate assessment of all the relevant alternative procurement options available to deliver the preferred option, including conventional methods and others where relevant.

5.4.4 Until December 2012, DoF recommended use of the HMT quantitative VFM assessment model, which provided for a broad comparison of a single PFI option with a single conventional procurement option. This model was withdrawn by HMT and DoF in December 2012. In its place, departments should use standard net present cost (NPC) models in keeping with the relevant guidance in NIGEAE. The following paragraphs expand on what this means in practice.

5.4.5 Considering the alternatives

It is always appropriate to consider the procurement options available, for example in terms of alternative forms of contract. Evidence of such considerations, including consultations with DoF’s Construction & Procurement Delivery (CPD) or other relevant Centre of Procurement Excellence (CoPE), should be recorded in the outline business case (OBC). All procurement options should be designed to deliver the same required output specification and their ability to do so should be confirmed. The alternatives considered and the justification for selecting the intended form of contract should be stated clearly.

However, it is rarely necessary to conduct detailed formal option appraisal, nor are detailed quantitative VFM assessment calculations generally required. In the great majority of cases, qualitative consideration of alternatives is sufficient and the most appropriate form of contract to suit the project may be decided based on advice from CPD or other relevant CoPE, without such detailed assessment.

The main circumstance in which detailed quantitative VFM assessment of procurement options remains necessary is when private finance is being seriously considered. Given that the cost of raising capital through private finance remains generally higher than the cost of obtaining it through government borrowing, DoF currently does not generally require detailed consideration of private finance solutions for all capital projects. However, departments may consider private finance solutions in particular cases where they appear to offer a realistic prospect of delivering best VFM.

5.4.6 Quantitative VFM assessment: identifying the least cost option

Where detailed quantitative VFM assessment is considered necessary, the assessment should seek to determine the procurement option that offers to deliver the required project at least financial cost to the public sector procuring authority.

Costing should be conducted in accordance with standard NIGEAE appraisal principles. The assessment should focus on comparing the net present costs (NPCs) of the financial costs and benefits to the public sector procuring authority for each of the various procurement options. Only those impacts that give rise to a financial cost from a NI perspective should be included in the relevant NPCs.

The NPCs should reflect financial costs and benefits over the whole life of the project. The relevant costs and benefits should include all the expected financial impacts on the procuring authority, including, for example, financial expenditures, financial opportunity costs and financial residual values.

In order to calculate NPCs, costs and benefits should be discounted to present values using the standard discount rate, which remains at 3.5 per cent per annum in real terms. Note that, since this rate is defined in real terms, it must therefore be applied to values which are also expressed in real terms, as opposed to nominal or cash values. This means that the anticipated effects of inflation should generally be removed from all the figures before discounting.

5.4.7 Financial costs of conventional funding options

The financial costs of conventional procurement options should be based on mature estimates arising from thorough assessment of the relevant costs and risks borne by the procuring authority. To the extent that risk assessment helps identify financial costs, this may be reflected in the financial figures.

Financial values for land and other assets employed should be counted as costs at the start of the appraisal period, whether or not the assets are already owned by government or have to be purchased, to reflect their financial opportunity cost.

Likewise, financial residual values of assets owned by government at the end of the appraisal period should generally be included as benefits, whether or not the assets are to be disposed of or put to another use.

The estimated financial costs may include some allowance for contingencies and/or optimism bias, provided they are supported by sound evidence and analysis. Such allowances may be expected to be relatively modest given the anticipated maturity of the cost estimates.

All figures for costs, risks, contingencies and optimism bias should be robust and clearly justified, avoiding exaggeration and double counting, and focused on determining the actual financial costs that the procuring authority will bear.

5.4.8 Financial costs of private finance options

Shadow bid models should continue to be used to estimate the financial costs from any PFI or other similar private finance procurement options, taking account of all the factors that will impact on annual financial charges (often called unitary charges). These charges should generally to be taken to reflect all the costs and risks borne by the private sector, and in consequence they will often represent most or all of the financial impact on the procuring authority.

In the event that any of the financial costs identified for conventional procurement would still be borne by the public sector under a private finance solution, they should be added to the cost of the relevant private finance option(s) to ensure like for like NPC comparisons.

Note that only the financial impacts on the procuring authority should be counted. For instance, the residual value of a property should not generally be included as a benefit if the private sector provider rather than the procuring authority will own it at the end of the contract.

5.4.9 Tax adjustments

There should be no tax adjustment to any of the procurement options. Previously, when using the old 2006 HMT model, there was a tax adjustment to conventional procurement options. That guidance is now out-dated and from a NI perspective it serves only to inflate unduly the financial cost of conventional procurement.

5.4.10 Impact on resource budgets

Private finance can help to bring forward capital projects when capital budgets are limited, although procurement decisions should primarily be based on VFM and not affordability. It must also be noted that resource budgets are limited too and are expected to be severely constrained in the coming years. The aim should be to obtain maximum overall VFM from both capital and resource budgets.

Private finance options invariably place greater pressure on resource budgets than conventionally funded alternatives, resulting in reduced budgetary flexibility and displacement of other projects. Whether considering projects individually or in bundles or programmes, the potential negative impact upon future resource budgets through displacement of other projects and the consequent loss of benefits to Northern Ireland should be assessed and given due consideration.

Private finance is only a viable option when it is clearly the best VFM procurement route and its potential negative impact on future resource spending plans has been assessed and is considered worth bearing.

5.4.11 VFM decision

The NPCs of the financial costs should provide the primary indicator of VFM and should be the key determining factor in the choice of procurement option. However, other relevant factors such as qualitative considerations and affordability including impact on capital and resource budgets should also be assessed and weighed into the decision.

The OBC should recommend which form of conventional procurement and (where applicable) which form of PPP should be carried forward to ABC and FBC stages. In cases where a PPP arrangement is considered to offer the prospect of VFM, the requirement to develop a shadow bid model and continue assessing a viable conventional procurement option at ABC and FBC stages remains in force.

Full business case (FBC)

5.4.12 The final test of VFM, affordability and achievability occurs at FBC stage. The FBC's purpose is to inform the final decision on the project and provide a basis for approval to proceed to the award of a contract. The FBC should cover the requirements indicated in summary of DoF PFI OBC and FBC requirements.

5.4.13 In brief, the FBC should include:

• an update on key changes and developments since the OBC
• full details of the procurement process, including detailed description of private sector bids received
• thorough appraisal of the private sector bids and (where applicable) the conventional procurement option
• final review of strategic fit, options, value for money, affordability and achievability
• a plan and timetable for final negotiations and award of contract
• final plans for monitoring, evaluation, gateway reviews and benefits realisation

Shadow bid model

5.4.14 A detailed shadow bid model (SBM) should be developed in all PPP/PFI cases for use throughout the procurement. It should be updated at all key stages, including, where applicable, OBC, ABC and FBC stages.

5.4.15 The SBM should reflect the estimated cost of meeting the same output specification as that supplied to bidders in the course of the procurement. It should be developed by suitably qualified personnel, such as financial advisers appointed to the project, based on their knowledge and experience of what the private sector is likely to deliver.

5.4.16 Creating a SBM is helpful for benchmarking affordability and VFM throughout the procurement. It also helps to provide additional reassurance where there is limited experience of PPP in the area of activity under consideration; or when there are relatively few bidders and hence competition cannot be relied upon to ensure VFM.

Conventional procurement option

5.4.17 Departments should have the flexibility to pursue an alternative procurement route without undue delay if at any stage it emerges that a PPP solution has become unaffordable or does not offer the best VFM. Accordingly, there remains a general requirement to develop a fully detailed conventional procurement option (CPO).

5.4.18 The CPO should provide the same output as the private sector bids. It should be updated regularly throughout the procurement process, taking account of any changes in scope to the project, to provide a genuine comparator to any private sector bids and thus help ensure that the procurement route offering the best VFM is chosen. Key points for updating a CPO and comparing it with the PPP alternatives should include:

• prior to commencement of procurement, within the outline business case (OBC)
• prior to appointment of a preferred bidder, within an appointment business case (ABC)
• prior to financial closure, within the full business case (FBC)

Appraising options at FBC stage

5.4.19 VFM should be tested regularly throughout the procurement. The bids received from private firms responding to the invitation to tender will usually present a number of options for appraisal. Each short-listed bid represents an option to be appraised. Two categories of options are typical:

• standard bids: every short-listed proposal should include a standard bid for appraisal alongside the other standard bids
• variant bids: in addition to a standard bid, firms may submit variant bids reflecting the scope which PPP allows for innovative solutions and the incorporation of commercial elements. Variant bids should normally meet the requirements of the output specification but offer special features which are additional to, or which vary from, those included in the standard bid. Variant bids should be treated as separate options to be appraised alongside the standard bids and (where applicable) conventional procurement to see whether their special features offer benefits worth pursuing in terms of improved VFM

5.4.20 A thorough appraisal of the bids should be conducted in order to determine a preferred bid. The bids should be assessed against pre-defined bid evaluation criteria, covering the relevant monetary and non-monetary factors. The advice of CPD or, if appropriate, another designated centre of procurement excellence (CoPE), must be sought regarding the appropriate bid evaluation criteria to use and how to apply them.

5.4.21 Calculation of the net present cost (NPC) of the costs of the PPP bids and the CPO is a vital element of VFM assessment. The calculation includes:

• for the PPP bids, the expected NPC of the service payments to the private sector over the life of the project
• for the CPO, the expected NPC of the public sector costs required to procure the same service, typically a capital investment and subsequent annual operating costs

5.4.22 Once calculated, the NPCs should be compared to identify which option offers the best VFM in monetary terms. Note however that NPCs are point estimates. It is sensible to consider ranges around these estimates, to avoid spurious precision. Sensitivity analysis, involving the recalculation of NPCs for various possible outcomes of key assumptions, can help to achieve this.

5.4.23 Comparison of NPCs is vital, but it is also important to give due weight to non-financial considerations such as how the bids perform against service quality criteria. These should be reflected in the pre-defined bid evaluation criteria.

5.4.24 The decision on whether to proceed with the project, and, if so, by which procurement route, should be informed by a final review of strategic fit, options, value for money, affordability and achievability.

5.5 Advice and guidance

5.5.1 Advice should be sought from DoF's Central Procurement Directorate (CPD), or if appropriate, another designated centre of procurement excellence (CoPE), on all procurement issues.

5.5.2 Most Northern Ireland departments have PPP advisers who will provide general advice on PPP/PFI issues.

5.5.3 Economic appraisal techniques are required to prepare PPP/PFI business cases including, for example, NPV calculations and assessment of non-monetary factors. Departmental economists can provide expert advice on these aspects.

5.5.4 Departments have often employed external advisers to assist in taking forward PPP/PFI procurements, for example to develop shadow bid models and conventional procurement options. Within reasonable cost limits, this use of external advisers is acceptable when it will clearly offer value for money. This may be the case where relevant skills and experience (for example in financial modelling and risk assessment) are scarce in some areas of the public sector.

5.5.5 The general guidance on the use of external consultants in section 12.2 applies to the use of consultants for PPP/PFI proposals. For example, where the cost of a consultancy assignment is expected to exceed £10,000, an external consultancy business case is required before employing consultants; and a separate external consultancy business case is required for each separate consultancy assignment.