Highways Agency - Safe roads, Reliable journeys, Informed travellers

NAO and PAC reports into the first four DBFO projects

A summary of the National Audit Office and Public Accounts Committee reports into the first four DBFO projects

General

1. The first four DBFO projects were selected as pathfinder projects to test the market and to discover the types of project that offer the best value for money. Following the award of contracts in 1996, the National Audit Office (NAO) examined the procurement process and the final contractual arrangements to ascertain whether the process and deals were likely to deliver good value for money.
2. Generally, the NAO's report, published on 28 January 1998, was positive about the way in which the former Department of Transport and the Highways Agency managed the procurement process. It highlighted that two of the four projects were expected to deliver savings of around 20 per cent compared with conventionally procured alternatives, but that the other two could cost some 7 per cent more. The main criticism was that the agency's analysis of the winning bids overstated the expected savings by £69 million because of the Treasury's advice to use an 8 per cent discount rate. The NAO's view was that a 6 per cent discount rate was more appropriate.
3. A Public Accounts Committee (PAC) hearing took place on 23 February 1998 which discussed the findings contained in the NAO's report. On the central issue of value for money, PAC report concluded that the four projects could be expected to deliver savings of £99 million. However, it also focused on the discount rate issue and the sensitivity of the analysis to changes in the rate, and drew attention to the fact that two of the projects are likely to have cost the taxpayer £15 million more than had they been procured conventionally.
4. The key issues, which attracted some media attention when both the NAO and PAC reports were published, are as follows.

The discount rate

5. The PAC criticised the use of an 8 per cent discount rate rather than a 6 per cent discount rate to appraise the projects. Although it acknowledged that the Highways Agency was acting on Treasury advice, it concluded that, by 'using a discount rate of 8 per cent the agency overstated the value of the savings' and that these savings were 'overstated by £69 million'. The PAC also criticised the agency for not being 'aware of the fact that a small change in the discount rate would have a large impact on the evaluations of these schemes' and expressed dismay 'that officials did not do these calculations in accordance with Treasury's published guidance and draw the results to the attention of Ministers'.
6. Throughout the period 1994 to 1996, when these projects (and the next four projects) were being procured, 8 per cent was the Treasury's recommended discount rate for appraising both railway and roads investment. The PAC report records that, in using a discount rate of 8 per cent, the agency was acting on the advice of Treasury. The PAC also concluded that, even using a 6 per cent discount rate for comparing the costs of public and private finance options, the value-for-money savings across the four projects were about £100 million. This still represents a significant saving to the taxpayer.
7. The criticism of the agency's failure to undertake sensitivity tests is unfounded: such tests were carried out by the agency, although the decision to proceed was taken on the basis of the Treasury's recommended rate.

Risk transfer

8. The PAC concluded that, 'with one major exception, the agency placed the risks inherent in these contracts with the parties best able to manage them and thus promoted good value for money. The exception was the decision to use traffic volumes as a basis for payments to operators'. The PAC's view was that, because traffic risks are notoriously difficult to forecast, 'the Agency has created a risk which is borne by the operators and which can be expected to have increased their costs'. Its conclusion was that 'bidders can be expected to have included a premium in their pricing for taking this risk, which is likely to have reduced the value for money offered by these contracts'.
9. Traffic volume risk is not new, but the risk has traditionally been borne by the public sector. The relative simplicity of payments related primarily to the use of the road was the best method available at the time the first contracts were developed. It also accorded with the then policy objective of encouraging the development of a road-operating industry. While there may be a cost to be paid for transferring traffic volume risk to the DBFO companies, the value-for-money savings achieved were between £99 million and £168 million (depending on the discount rate applied).
10. The PAC's suggestions reflect the subsequent development of the payment mechanism to focus more on the availability of the road, as introduced on the A13 Thames Gateway DBFO project.

Selection of bidders

11. The PAC expressed puzzlement at the choice of tenderers and the related decisions not to overload any bidding group by broadening the number of tenderers for the first pathfinder projects. The PAC did 'not see the point of ranking consortia at the pre-qualification stage, if those rankings are to be ignored', and described the agency as being 'on dangerous ground' as a consequence of not selecting the best-qualified bidders to tender for two of the four projects.
12. Pre-qualification submissions were received from 17 consortia, of which 12 were assessed as meeting the criteria to proceed to tender stage. These were ranked in accordance with the published criteria. Tenders were being invited for four projects simultaneously, so it was desirable not to overload any bidding group and no consortium was invited to bid for more than two of the four projects. Where possible, tender lists also reflected the preferences expressed by pre-qualifying consortia. This enabled more bidders to be involved in the process, which at the time was also desirable to further the policy objective of encouraging a private-sector road-operating industry.
13. It is unlikely that the particular circumstances at the time the first pathfinder projects were tendered will be repeated. In future, where individual DBFO projects are tendered, the rankings at pre-qualification stage are likely to be the key criteria for determining the companies selected to bid. For example, bidders for the A13 Thames Gateway project were selected on the basis of their pre-qualification rankings.

The costs of advisers

14. The PAC was 'concerned at the escalation in the cost of advisers, from the original limit of just under £1 million to a final cost of more than £8 million. The agency has now paid for its expensive policy advice and the development of a model contract. We therefore expect them to drive a much tougher bargain with its advisers in future.'
15. The £8.3 million spent on legal, financial and technical advisers covers the development and delivery of the first eight projects and not just the four considered in detail in the PAC report. This is just over £1 million per project, or 1.5 per cent of the total capital value of these projects. The significant savings achieved by DBFOs are unlikely to have been deliverable without the contribution played by the external advisers.
16. The PAC report implies an overspend in excess of £7 million on advisers' fees. The agency provided detailed evidence to the PAC on advisers' budgets and costs, which is reproduced in Appendix 1 of the PAC's report. The total annual budgets and outturn figures are also recorded in Figure 9 of the NAO's report. These show there was an overspend of £103,000 (about 4 per cent) on a budget of £2.60 million in 1994/95 and an underspend of £540,000 (about 9 per cent) on a budget of £6.12 million in 1995/96. The problem appears to be that the PAC interpreted the fee cap to be the budget whereas the fee cap was an internal cost control mechanism which ensured that rigorous progress and financial control of the policy development costs were exercised.

Innovation

17. The PAC recognised that the bidders were given freedom to produce innovative detailed designs, but expressed some concern that the agency did not do enough to encourage greater innovation in other areas.
18. All the projects had completed the statutory procedures (including consideration by an independent inspector at a public inquiry) and the agency had to ensure that the core requirements of the contract reflected the commitments given at those public inquiries. It was not possible, therefore, to give the private sector the greater degree of freedom to produce more innovative solutions. The agency recognises the PAC's concerns about the need to minimise other constraints to innovation for bidders and has reduced its core requirements for subsequent tenders. The agency is also learning from the innovative ideas introduced on DBFO projects and, where appropriate, applying those in conventionally procured projects.