City falls out of love with the private finance initiative

One of the few things the City and the trade unions agreed on, for a time, was that the Private Finance Initiative was a one-way ticket to riches for the companies involved.

One of the few things the City and the trade unions agreed on, for a time, was that the Private Finance Initiative was a one-way ticket to riches for the companies involved.

The unions see PFI as a way for the private sector to fleece the taxpayer in the delivery of public services, undermining the jobs of their members in the process.

The City loved the initiative, introduced under the Conservatives in 1992, not only because it promised bumper profits but it provided a reliable and lengthy revenue stream. So during the Nineties the City embraced the public sector, which started to provide some companies with more than 50 per cent of their revenues. Companies like Serco, Amey and Capita become the darlings of the City. Old-fashioned building contractors were turned into sexy outsourcing specialists overnight.

Over £20bn worth of PFI contracts have now been awarded.

While yesterday's Labour Party conference showed that union attitudes are unchanged, the City and contractors have undergone a dramatic change of heart, questioning the attractiveness of PFI work.

Given the massive sums in PFI and the key public policy objectives involved, this is a highly significant development. Deal-flow has dried up, caught up in political anxiety and bureaucratic tardiness, which has led to a huge escalation in bidding costs for contractors. Also new contracts have reduced the profits that companies can make on PFIs. The unions won't buy it, but PFI contractors are squealing with pain.

Bill Tallis, director of the Major Contractors Group, an industry organisation, said: "PFI used to be high risk, high reward. Now it's high cost and the rewards are being squeezed."

Amey's spectacular fall from grace is the most high-profile example of the serious obstacles on PFI's path to riches. Amey shares were once rated by the stock market at 30 times its annual earnings. That rating is now about three times earnings. Laing almost went bust in building the National Physical Laboratory under a disastrous PFI contract. Capita shares now change hands at a third of the level of two years ago, after its Public Private Partnership work, such as the £400m contract to run the Criminal Records Bureau, generated enormous controversy and criticism.

Amec, another major player, recently warned that, it was so frustrated by the PFI, it was considering either doing less work under the scheme or none at all.

Stephen Rawlinson, an analyst at Peel Hunt, said: "The companies have shot themselves through the foot and the Government is not delivering as many PFIs as expected. There has been a falling out of love with the PFI in the City."

Under the PFI, public-sector infrastructure projects, such as new hospitals, roads and schools, are financed, built and maintained by the private companies or consortia. These are then "rented" back to the state, over, say, 25 or 30 years. At the end of this period, the asset belongs to the state.

Public Private Partnership is a broader term to cover collaboration between the private and public sectors, where assets may not be transferred to the private entity, such as the massive project to modernise London Underground.

The main private-sector concern with PFI and PPP is the length and complexity of the bidding process, which makes it a very expensive exercise to bid for each contract, with no certainty of winning the deal.

The bureaucracy is getting worse, not better, increasing bidding costs to the extent that several players have publicly declared they must compete for less work. This will lessen competition for PFI contracts, seriously undermining the "value for money" case for the scheme. It should be noted, however, that banks and those providing just the equity for PFI schemes remain as enthusiastic as ever.

Bidding took about three years in the case of London Underground, leaving the successful bidders with bills in the tens of millions (which will be reimbursed by the state), after it was caught in a political fight between the central Government and the Mayor of London.

Even after a company has been selected as "preferred bidder" for a contract, the process can be torturous before a deal is sealed. Robert McAlpine has been preferred for Colchester Barracks for three years, while Gleeson was preferred bidder on a hospital PFI for five years.

Two main reasons exist why the bidding process has slowed down over the last few years. The big issue is devolution of the PFI, as it has evolved from its original role as a method of central Government procurement. PFI has now expanded its reach enormously, to encompass much smaller projects where it is a local public body that awards contracts. There is a basic lack of experience and procurement skills at local the government level and this is holding up projects, for years at a time.

John Gains, the chief executive of John Mowlem, said: "The [central] Government is not the sole client of PFI, it is also local authorities and hospital trusts. These people are new to this process and are not being guided by central Government. This has made it extremely time-consuming and very bureaucratic."

It is no accident that the two PFI sectors usually cited as trouble-free are roads and prisons, where there is a single central customer and standardised procurement procedure. However, the Ministry of Defence's central PFI procurement exercises are the glaring exception, being universally condemned by bidders.

At the local level, public-sector teams are having to learn to complete a PFI procurement from scratch, struggling to cope with the biggest contract any of them will ever have handled. This means that bidders have to tie-up dozens of their staff, for months or years at a time, for each project being contested.

Brian Staples, the chief executive of Amey, said: "When it works, it works very well.... But there are some problem areas and we have made our criticisms known to the Government. I think most people would agree that the Ministry of Defence is the worst of the lot when it comes to PFI schemes awarded by central Government."

Amey, which has re-stated its PFI profits after accounting up-front for the bidding costs, is selling its equity stakes in nine high-profile PFI projects.

Despite the grandiose pledges of a massive increase in public investment made by the Chancellor, Gordon Brown, over last year, PFI contracts have slowed to a trickle. One consultant said this is due to "political nervousness" after a union campaign against the scheme.

It is the process of PFI, rather than the concept, that has led to huge frustration in the private sector. But given the massive sums up for grabs, the private sector is not going to walk away from PFI work. Nor will this Government return to traditional procurement, mindful of running up public debt. The PFI is here to stay, but while the system retains these serious flaws, the relationship between Government and contractors is not going to be smooth.