Public Works Management &

Policy
Volume 13 Number 2
October 2008 114-125
© 2008 SAGE Publications
The State of the Practice of Value for Money 10.1177/1087724X08326176
http://pwmp.sagepub.com

Analysis in Comparing Public Private hosted at

http://online.sagepub.com

Partnerships to Traditional Procurements

Dorothy Morallos
Adjo Amekudzi
Georgia Institute of Technology

Literary sources regarding public–private partnerships (PPPs) often mention the importance of conducting a value for
money (VfM) analysis to determine the value of pursuing a project through a PPP versus a traditional procurement;
however, few sources detail how agencies actually use this analysis in practice. This article provides a state-of-the-practice
review of VfM analysis using examples from Australia, Canada, Europe, Africa, and Asia, focusing particularly on the VfM
model used by agencies such as Partnerships Victoria, The United Kingdom’s Her Majesty Treasury Department, and
Partnerships British Columbia. Despite its growing applications in PPP projects from all different sectors, VfM has faced
significant criticisms from academics and practitioners. This article evaluates reviews of VfM, noting the weaknesses and
strengths of the methodology. Using the information derived from the evaluation, this article provides a guided reference
for public agencies looking to adopt this VfM methodology in their current PPP decision-making framework.

Keywords: public–private partnerships; value for money; public sector comparator; risk allocation; discount rate

T he terms public–private partnerships, PPPs, or P3s

have been given different definitions by various
public and private sector agencies as well as academic
professionals. Depending on the degree of the transfer of
risks, responsibilities, and ownership from the public to
the private sector within a project, a PPP can also appear
in a variety of different structures. Some PPPs are struc-
tured so that a private sector performs or provides a ser-
vice or facility on behalf of the public sector. This
provision of service may be compensated through pay-
ments by the government or may be funded through user
charges and fees. In some cases, PPPs may include leas-
ing or a transfer of ownership of formerly government-
provided structures, facilities, or services to the private
sector. Along with the different structures, there are also
various names associated with different types of PPPs. In
the United Kingdom, some PPPs are known as private
finance initiatives (PFIs) and in other nations terms such
as design-build-finance-operate or design-build-finance-
operate-maintain are associated with this procurement
option. Despite its many forms and definitions, PPPs can
often be characterized as
an agreement where the public sector enters into
long-term contractual agreements with private sector
entities for the construction or management of
public sector infrastructure facilities by the private
sector entity, or the provision of services (using
infrastructure facilities) by the private sector entity
to the community on behalf of a public sector
entity. (Grimsey & Lewis, 2002, p. 108)
The use of PPPs has gained increasing global popularity
throughout the years. There are several driving factors that
have motivated public agencies to pursue this type of pro-
curement. First, PPPs enable public agencies to transfer a
substantial amount of costs to the private sector. The abil-
ity to shift the government’s financial burden of providing
and maintaining facilities and services is a major driving
force especially for nations and states facing funding
strains on their infrastructure budgets. Second, the involve-
ment of the private sector in these procurements aids in
accelerating the implementation of projects as well as
encourages the development of innovations in the delivery
of service and the technologies used. This is especially true

114

because of the performance-based structure typical of PPP
agreements, which ensure that a private agency will be
unable to receive its payments until the service or facility is
produced to the standards set by the public agency. Such
agreements provide the private firm with an incentive to
have shorter construction or delivery time frames. In addi-
tion, the presence of such incentives motivates improve-
ments in the private consortium’s overall quality of service
and the level of innovation it incorporates in these projects.
Third, public agencies are attracted to the concept of PPPs
for their ability to transfer a significant amount of project
risks to the private sector. PPPs optimize risk allocation by
transferring the risks to the party best able to manage them.
The competency of the private sector in determining and
handling these risks also lead to significant improvement in
risk management strategies over traditional procurement
methods. Last, traditional procurements often place the
entire burden of ensuring the project’s success on public
agencies who may have limited experience, capabilities,
and resources to expend on such projects.
The aforementioned motivating factors as well as others
considered by public agencies can contribute to the savings
the procuring agency can achieve through pursuing a pro-
ject as a PPP versus a traditional procurement. The calcu-
lation of the monetary value of such benefits (or savings) is
the concept behind the value for money (VfM) analysis, a
term that has frequently been mentioned within PPP litera-
ture. VfM analysis enables public agencies to compare the
costs of pursuing a project through a PPP versus the cost of
pursuing the same project through a conventional procure-
ment method. If the cost of the traditional procurement is
higher than the PPP, the difference between the two costs
is the potential savings or the VfM that can be achieved
through the PPP procurement option.
Although VfM may not necessarily be the conven-
tional term used to describe this type of analysis, most
public agencies do perform some sort of financial bene-
fit–cost analysis when determining which procurement
route to take. However, not all agencies pursuing PPPs
have established a specific set of guidelines or proce-
dures for performing a VfM or similar type of analysis.
Although several agencies have followed suit, the United
Kingdom was one of the first to establish a set procedure
for calculating the VfM that can be achieved in pursuing
projects as PPPs. Several agencies, including some in
Australia, Canada, and throughout Europe, have pub-
lished their own sets of guidelines that parallel the
United Kingdom’s VfM analysis.
The main purpose of this article is to provide a resource
for public agencies on VfM analysis in PPPs by exploring
the state of the practice. The first section of the article
provides a background on VfM. Afterward, the following
Morallos, Amekudzi / Value for Money Analysis 115
section provides an overview of the VfM methodology
using Partnerships Victoria as an example. It then provides
information regarding how other agencies have used a VfM
assessment as a means of comparison with the base
example. The sections explaining the methodology evalu-
ate the various quantitative and qualitative components of
these types of analyses as well as the factors considered in
calculating VfM. The third section of the article provides a
discussion of the debates and concerns regarding the use of
VfM analysis in PPPs, addressing the existing shortcom-
ings of the methodology. The conclusion provides guid-
ance for future applications of VfM based on the lessons
learned from the practices of these public agencies.
Defining VfM
Although various definitions of VfM analysis exist in
the current literature, the one that is referred to in this
article is derived from the U.K.’s Her Majesty’s (HM,
2006) Treasury Value for Money Assessment Guide:
Value for money is defined as the optimum combi-
nation of whole-of-life costs and quality (or fitness
for purpose) of the good or service to meet the
user’s requirement. The term whole-of-life is used
to refer to the lifecycle of the good or service. VfM
is not the choice of goods and services based on the
lowest cost bid. (p. 7)
VfM aids public agencies to determine whether to pursue
a project as a PPP versus a traditional procurement. The
HM Treasury’s definition emphasizes that in determin-
ing this value, public agencies must make sure to account
for the costs and savings throughout the lifetime of the
project. In addition, the VFM assessment should ensure
that these agencies focus on the quality of the work and
the competency of the private sector and not the lowest
bid to meet the objectives set forth in the project state-
ment. According to Shaoul (2005), it is also associated
with three Es: economy, efficiency, and effectiveness.
As previously mentioned, there are several ways that
a PPP can be structured. Table 1 provides details on
some VfM guides as well as the type of PPP structures to
which these VfM assessments would apply. There are
several phases in a PPP procurement process. Typically,
the process includes four phases: an initial feasibility
assessment (determining whether the project is econom-
ically viable and whether it should be pursued as a PPP),
the procurement phase (the bidding process), the con-
struction phase, and the operation phase. Typically, the
VfM assessment is conducted during the initial feasibil-
ity phase, when the economic viability of a project is
116 Public Works Management & Policy
reviewed before being open for bid. The VfM assessment
may also reappear in the procurement phase but typically
only to ensure that the costs submitted by bidders fall
below what it would cost in a traditional procurement
strategy. Additionally, VfM assessments may appear in
more than one phase of the process, as seen by examples
in Table 1.
VfM Drivers
In defining VfM, it is also important to determine the
factors that contribute to the VfM of a project. In many
cases, these factors may be called drivers of VfM. Arthur
Andersen and Enterprise LSE (2000) surveyed various
public agency officials and academic professionals on
what factors they perceive drive the VfM of PPP pro-
jects. According to the report Value for Money Drivers in
the Private Finance Initiative, those surveyed considered
the following to be the most significant factors in affect-
ing VfM:
• Risk transfer. The primary driver of VfM in PFI
projects is optimizing the transfer of risk in a PPP,
which is conducted by allocating the risks to the
party best able to manage them over the contract
period.
• Output-based specification. The services provided
under PFI contracts should be specified as out-
puts. The payments that the private sector receives
should be linked to the quality and timing of the
delivery of these outputs.
• Long-term nature of contracts (including whole
life costing). This is seen as a key condition for
delivering VfM because the contract’s time frame
should be long enough to recover the initial
investment. The long contract period also allows
for the development of alternative approaches to
service delivery and enables the service provider
to focus on whole life costing.
• Performance measurement and incentives. Such
incentives act as a means of ensuring that the stan-
dards and specifications set in place through the
original deal or contract will be implemented.
• Competition. This factor was ranked consistently
high by those surveyed. A high level of competi-
tion among bidders can result in improvements in
pricing and alternative means of providing VfM.
• Private sector management skills. The survey
indicated that those surveyed considered the pri-
vate sector’s ability to effectively manage the
delivery and operations of a project as critical to
the success of the PFI.
Additional reports on drivers of VfM include similar
considerations. Fitzgerald’s (2004, p. 17) report on PPPs
in Victoria, Australia, states that the government follows
the guideline that VFM can be delivered through risk
transfer, innovation, greater asset utilization, and inte-
grated whole-of-life management. According to an
Organization for Economic Co-Operation and Develop-
ment report (OECD, 2008, p. 37), VfM also depends on
several determinants, such as affordability and VfM,
affordability, limited budget allocations and legally
imposed budgetary limits, the role and nature of risk
transfer, the level of competition, and the nature of the
service. Nasir (2007) also adds that affordability, strate-
gies for risk transfer, and expertise in executing PPP pro-
jects were important drivers of VfM. The following two
sections show how some of these drivers may be incor-
porated in the quantitative and qualitative component of
the VfM analysis.
VfM Analysis Components
Although the specific workings of a VfM assessment
may differ between agencies, typically the analysis usu-
ally involves some financial comparison of the net pre-
sent cost of PPPs with that of conventional procurements.
In many cases, there are usually two components to a
VfM analysis: a quantitative and a qualitative assessment.
The quantitative component includes all the factors that
can be valued. It features a methodology that compares
the PPP project costs with a similar project scenario often
called the “public sector comparator” (PSC). The PSC is
a hypothetical scenario used in a VfM assessment to
determine what it would cost the procuring agency to pur-
sue this same PPP project as a traditional procurement.
The qualitative assessment of the VfM analysis takes into
consideration the aspects of the project that cannot be
quantified. The qualitative assessment also looks at fac-
tors such as the characteristic of the market and the com-
petitiveness present within the bidding environment. This
assessment portion also evaluates the resources and capa-
bilities of the private and the public sector as well as any
other additional benefits and costs that were not assigned
a value in the quantitative assessment.
This section of the article will use Partnership
Victoria’s VfM methodology to illustrate some of the typ-
ical features of the quantitative and qualitative assess-
ment. Because other countries and agencies may vary
slightly from Partnership Victoria’s method, a table has
been provided comparing Victoria’s method to other VfM
assessments as used around the world. Although not an
exhaustive list, Table 1 provides additional VfM informa-
tion from countries that have developed or established a
 Table 1
Examples of VfM Assessments
Quantitative Assessment Components

Time Frame VfM Public Sector Additional Qualitative How the VfM Is Used
Agency Analysis Conducted Comparator or Similar Components Risk Management Discount Rate Assessment in Justifying Project

Partnership Development of PSC Raw PSC +
Victoria conducted prior to
invitation to bid.
However formal VfM
test conducted after
submission of bids to
compare them
against the PSC
(benchmark).
UK's HM VfM approached in Has prepared a
Treasury three stages of
procurement process:
(1) during the annual
budgeting round, (2)
used to outline
business case prior to
invitations to bid, (3)
used after bids
submitted in selection
process. Continuous
assessment of VfM
until contract/financial
close.
Partnerships PSC development Similar to base, a PSC
British begins prior to
Columbia invitation to bid.
(2005) Formal VfM test
conducted after bids
submitted. VfM is
updated after
winning bid selected
but prior to financial
close to account for
the modifications in
the agreement.
Risk identification and Risk-free discount rate
Competitive then valuation. Risks
Neutrality + Risks are valued as cash
(transferable and flow items.
retained)
The quantitative In United Kingdom, Risk-free discount rate
spreadsheet for spreadsheet HM value of risks is
comparing the Treasury provides factored into project
Conventional also has a flexibility costs and then risk-
Procurement Option factor to free discount rate is
(PSC) to the PFI incorporate a applied to cash flows.
option. Considers probability factor In spreadsheet,
similar factors as for change of the accounts for
Partnership Victoria. scope or deal, etc. uncertainty through
factor called
"optimism bias,"
removes the need to
risk adjust the
conventional
procurement option.
N/A Similar to steps in risk Discount rate used is
is constructed. analysis of
Partnerships Victoria.
Risks and
consequences
identified using
simulation tools.
Identify material factors PSC is used as the benchmark
of 3% (in real terms) that have not been
plus a risk premium included in the PSC
that is dependent
classification of the
risks into very low,
low, or high risk
band
Considers three factors: PSC as benchmark is created
of 3.5%. viability, desirability,
and achievability of
the project during
three phases: program
level assessment,
project level
assessment, and
procurement level
assessment.
Not explicit like PSC costs and its baseline-
based on the private Partnership Victoria,
sector WACC, which but additional
reflects the minimum nonquantifiable
rate of return factors such as how
investors would the bid is able to
require in deciding to achieve the goals and
invest in a project. scope of the project.
WACC = public cost
of debt + project risk
premium.
to evaluate bids. However,
both qualitative and
quantitative factors are
considered in the final
decision to award the
contract.
and compared with PFIs.
However, affordability
calculations are conducted
prior to VfM and must be
met to proceed with
procurement process. The
decision to undertake PFI
investment, once
affordability has been
confirmed, is taken on VfM
(quantitative and qualitative)
grounds alone
required improvements are
used as the benchmark to
evaluate bids. Cost is not the
only factor.

(continued)

117
 Table 1 (continued)

118
Quantitative Assessment Components

Time Frame VfM Public Sector Additional Qualitative How the VfM Is Used
Agency Analysis Conducted Comparator or Similar Components Risk Management Discount Rate Assessment in Justifying Project

Netherlands PPC assessment is PSC is similar to base. N/A PSC risk analysis phase The discount rate IAfter comparison of PA PPC conducted prior to
Ministry of conducted in very It includes Crude consists determining applied to government PSC and PPP, the PSC invitation to bid. PPC
Finance: early stages in order PSC (same as Raw the risks & categorize projects is the same as team deliberates over qualitatively and
Public Private to determine which PSC) + risks + into transaction the nominal interest outcome. Specific quantitatively compares public
Partnership tender process supplementary (during bidding on government bonds considerations and PPP procurement option.
and Asset (conventional or PPP financial costs & process), realization for a similar period as unspecified; varies by PSC created after PPC and
Management is preferred for incomes (similar to (design & the duration of the team and project. used as a benchmark for
project). PSC drawn competitive construction), and project. For the PPP choosing between bids.
up after invitation to neutrality exploitation the market-related
bid and is used in (operation). spread risk is
selection. Afterwards risks are incorporated into the
valued. discount rate as a
surcharge to the risk-
free interest rate.
Central Public Four tests: (a) PSC called public Also include non-cash Same as base but Discount rate should Qualitative considers the Quantitative VfM assessment
Private qualitative VfM prior sector benchmark flow adjustments categorizes as be the same for PSB following of the PPP: includes comparing the PPP
Partnerships to bid invitation, (b) (PSB) and that can be transferable, retained, and PPP. Identified sufficiently large bid with PSB. However, VfM
Policy Unit in quantitative VfM and compared with quantified but are or shared risks. Risk by National scale, potential for risk and affordability of the project
the creation of PSB also NPV of PPP costs. not considered cash adjustment is based Development transfer to the private must be considered to
Department of prior to invitation, (c) Also accounts for flows: risk, residual on changes to risk Finance Agency. It sector, potential to be proceed.
Finance VfM comparison test third-party income value, and material transfer structure that should be based on output based, potential
used to compare bids (such as taxes and tax reliefs affect VfM the risk-free cost of for revenue
to (PSB), (d) final test other levies). adjustment. calculations. debt to the public generation.
conducted to sector (i.e., yield on
incorporate any appropriate long-term
modifications. government bond).
South Africa VfM considered prior Construct a base PSC Also construct a PPP Same as base. The risk- National treasury does Prepares needs analysis: A risk-adjusted PSC and risk-
National to invitation to bid. costing includes all reference model adjusted PSC is just not prescribe specific evaluate how the adjusted PPP are compared
Treasury PPP But formal VfM test capital and which is a Base PSC+risks. discount rate, but it is project aligns with and VfM determined. But
Unit (quantitative operating costs risk- hypothetical private They then check this assumed to be the goals and budget of benchmark value is
comparison) done adjusted PSC model party bid to deliver risk-adjusted PSC for same as the risk agency. affordability limit. Project
after invitation to includes a costing the specified affordability by adjusted cost of capital must meet affordability to be
choose between for all the risks outputs and has a comparing with to government. viable.
submitted bids associated with the specific procedure budget. Government bond
project for checking yield has been used by
affordability some institutions.
Efficiency Unit of Early as possible; Contains all same Handling of risk also Discount rate not No formal qualitative PSC is created and compared
the Government typically prior to elements as same as Victoria's. specified. assessment mentioned. with PPP projects that involve
of the Hong invitation to bid has Victoria's PSC. some public unitary payment.
Kong Special been released. Not necessary for PPPs that are
Administrative financially free-standing (i.e.
Region financed through user charges)

Source: Central PPP Unit (2007), Efficiency Unit of the Government of the Special Administrative Region of Hong Kong, Her Majesty’s Treasury (2000), Partnerships Victoria (2001), Partnerships British
Columbia (2005), Industry Canada (2002), National Treasury PPP Unit (2004), PPP Knowledge Center (2002).
NOTE: VfM = value for money; PSC = public sector comparator; PPP = public–private partnership; PSB = public sector benchmark; PPC = public private comparator; WACC = weighted average cost of capital;
HM = Her Majesty; PFI = private finance initiative.

comprehensive VfM assessment. These countries include
South Africa, China, Canada, Ireland, the Netherlands,
and the United Kingdom.
Quantitative Assessment of VFM
The PSC
A major component of the quantitative assessment of a
VfM analysis is the PSC. As previously mentioned, the
PSC is a hypothetical scenario that estimates the net pre-
sent value (NPV) of the expected life cycle costs to the
public agency if it were to pursue the PPP project through
a traditional procurement. In Victoria, the PSC typically
consists of four components: the raw PSC, competitive
neutrality, transferable risks, and retained risks
(Partnerships Victoria, 2001). The following sections pro-
vide further details on each of these components.
A discounted cash flow (DCF) analysis is used in both
the PSC and PPP cost calculations to provide a projec-
tion of the expected cash flows in NPV terms. Each of
the four aforementioned PSC components includes its
own DCF calculation. Critical to DCF analysis is the dis-
count rate used. As will be discussed in later sections of
the article, the choice of the discount rate can be some-
what controversial, especially as it can significantly
affect the VfM of a project. There are, however, several
approaches to assigning a discount rate, including the
following (Grimsey & Lewis, 2004; Yescombe, 2007):
• One way would be to use a single discount rate
(could be project or sector specific) for both the
PSC and the PPP without adjusting for the risks a
public sector would acquire in the PSC (tradi-
tional procurement) option.
• A second way would be to calculate the values of
the project risks (valuation of risks explained in
“Transferable and Retained Risk” section) and
then incorporate the costs of such risks in the pro-
jected cash flows of each procurement option (i.e.,
PPP or PSC). Then, a risk-free discount rate is
applied to these risk-adjusted cash flows.
• Last, a risk markup or a risk-adjusted discount
rate can be added to a risk-free discount rate to
account for “risky” cash flows, while the risk-free
rate can be used for the “nonrisky” cash flows.
The approach that is used by Partnerships Victoria in
Australia reflects the third approach in the discount rate
alternatives listed above. According to Partnerships
Victoria (2001), the discount rate that a public agency
Morallos, Amekudzi / Value for Money Analysis 119
decides to use should reflect the government’s time value
of money plus a systematic risk premium for the inher-
ent risks involved in the project. Partnerships Victoria’s
total real discount rate is the aggregate of the risk-free
interest rate, which is currently at 3% (in real terms) plus
a risk premium (Partnerships Victoria, 2003).
Partnerships Victoria (2003) classifies projects into risk
bands of very low, low, and medium. The amount of risk
premium added will depend on the project and where it
is classified in the risk band. For example, a project that
falls into the very low risk band will have a risk premium
of 1.8% real (Partnerships Victoria, 2003). Added to the
risk-free rate of 3%, the total discount rate (in real terms)
that would apply to this project would therefore be 4.8%
or rounded up to 5% real.
Components of the PSC
Raw PSC. The raw PSC accounts for the base costs,
which are the capital and operating costs of producing
the reference project. The reference project is virtually
the same as the PPP minus the private sector involve-
ment. For these two projects to be compared, the calcu-
lations should assume that the reference project will be
subjected to the same level of standards and specifica-
tions that would be required in the PPP scenario. The
raw PSC calculates the costs associated with building,
owning, maintaining, and delivering the service (or
underlying asset) during the same period specified in the
PPP proposal (Partnerships Victoria, 2001). It will
include the cash flows of costs from the aforementioned
services but will not incorporate the cost of risks
involved in the project as there are two separate compo-
nents of the PSC that determine the costs of transferable
and retained risks.
Steps in calculating the raw PSC. The first step in cal-
culating the raw PSC is to identify the costs and assign
them into two categories: direct or indirect costs. Direct
costs are those costs that can be traced or assigned to the
provision of the particular service or facility (Partnerships
Victoria, 2001). It includes capital, maintenance, and
operating costs. Direct capital costs are those needed to
construct or upgrade a facility, typically associated with
the acquisition of land, design and construction, purchase
of materials and equipment, demolition, any upgrades,
and cost for additional external consulting. Any estimates
for the sale or disposal of the assets, as well as the resid-
ual value of assets at the end of the useful life of the pro-
ject, should either be deducted from the direct capital
costs or included in third-party revenues (Industry
Canada, 2002). Direct operating costs are associated with
the operations and maintenance of a facility according to
certain performance standards or service levels (Industry
120 Public Works Management & Policy
Canada, 2002). Operating costs can include repairs and
maintenance, staffing, equipment for the maintenance or
operations of a facility, utilities, and so on.
Costs that are not directly related to the provision of
services can be classified as indirect costs (Industry
Canada, 2002). An example of indirect costs are over-
head costs, which are typically associated with corporate
or administrative costs such as support services (i.e.,
human resources management, IT support, project man-
agement, accounting, etc.). In addition to direct and indi-
rect costs, the raw PSC also takes into account any
third-party revenues. Third-party revenues reduce the
raw PSC or the net costs to the government in pursuing
the project through a traditional procurement. Third-
party revenues can include user charges, increased
demand for a facility or service, or any payments
received for situations where the government allows a
third party use of the facility (aside from the uses the
facility was originally meant for). These revenues should
be deducted from the total operating costs in the raw
PSC. Partnerships Victoria (2001) provides a simple raw
PSC calculation shown in Equation 1:
Equation 1: Raw PSC = (operating costs – third party revenue)
+ capital costs
As previously mentioned, the expected cash flows for the
raw PSC are forecasted over the life of the reference pro-
ject. It is presented in NPV terms assumed throughout
the term of the project, assuming the nominal discount
rate determined by the procuring agency.
Competitive Neutrality
The competitive neutrality value included in the PSC
removes the inherent competitive advantages or disad-
vantages that would be available to a government agency
pursuing the PSC but inaccessible to the private sector
completing the PPP. The competitive neutrality calcula-
tion allows for the PSC and the PPP to be compared at an
equal level. If competitive neutrality is unaccounted for,
the PSC may be artificially lower than the private bids.
Typically, the competitive neutrality inclusions fall into
two categories: difference in state tax obligations or dif-
ference in state regulation costs (Partnerships Victoria,
2001). Examples of public sector advantages include
exemptions from land taxes, local government rates, and
other taxes and fees. Typically, the valuation of the com-
petitive neutrality will depend on current and historical
dates regarding the costs of such advantages and disad-
vantages. For example, in a situation where a public
agency would be exempted from a property tax on
acquiring land for the project that the private sector
would be subjected to, the procuring agency would quan-
tify the amount of land tax that a bidder would incur and
include it in the competitive neutrality calculation.
Competitive neutrality can also account for the disad-
vantages that arise from public ownership in many public
works and service-type projects. Disadvantages of the
public sector can include accountability costs, public
scrutiny, and reporting requirements that a private sector
agency would not face in pursuing the same project.
After all the inclusions have been quantified, the com-
petitive neutrality value is forecasted throughout the life
of the project and presented in NPV terms using the dis-
count rate determined by the public agency.
Risk Adjustment and Valuing Risks
Valuation. The valuation of risks plays a major role in
PSC calculations. Such risks can include those trans-
ferred from the public agency onto the private sector and
those risks that can be better managed under the control
of the procuring authority. The steps typically involved
in the valuation of risks include:
1. Identification—The first step in risk valuation is
to identify all the potential risks that can occur
within the context of the project.
2. Consequence assessment—After identifying all
the pertinent risks, the consequences or impacts
of each risk need to be assessed. The conse-
quence of the risk measures the difference
between the base cost (or revenue) in the raw
PSC and the change in that base if the risk does
occur (Partnership Victoria, 2001).
3. Risk probability calculation—After calculating
the consequence of each risk, the procuring
agency will have to estimate the probability of
each occurring. Oftentimes, these calculations
will depend on historical data from similar pro-
jects, best practices, and so on. Probability calcu-
lations can vary between agencies. Calculation
methods can range from simple techniques such
as point estimation (determining how likely final
costs are to be above or below the amount speci-
fied in the raw PSC) to more advanced techniques
such as continuous probability distribution using
techniques such as Monte Carlo Simulation.
4. Contingency factor—Last, a contingency factor
should be included in the risk valuation to
account for any unobservable costs that could
lead to the undervaluation of identifiable and
unobservable risks (Partnerships Victoria, 2001).

5. Value calculation—The value of the risk can then
be calculated by multiplying the consequence and
the probability of occurrence together with the
contingency factor, as shown in Equation 2
(Partnerships Victoria, 2001).
Equation 2: Value of risk = consequence * probability of
occurrence + contingency factor
The valuation technique used by a public agency will
depend on the size of the project and the capabilities and
resources that the procuring authority could devote to the
risk calculations. Industry Canada also suggests another
way of assessing risks in a project by using a scale for each
risk and a tiered system for the probability of occurrence.
Optimal risk allocation—Transferable and retained
risks. After all the risks have been valued, the public
agency would have to find the optimal risk allocation to
determine which party would be best able to manage
each risk. The risks are categorized as transferable or
retained risks. Transferable risks are those risks that are
likely to be transferred from the procuring agency to the
chosen private consortium. The value of transferable risk
in a PSC measures the cost that the government could
expect to pay for that risk over the term of the project in
a public procurement scenario. Retained risks are those
risks or responsibilities retained by the procuring agency.
The retained risks will typically be the same for the PPP
and the PSC.
Optimal risk allocation is determined “by assessing
the ability of each party to reduce the probability of a
risk occurring, and to minimize the consequences if that
risk eventuates” (Partnerships Victoria, 2001, p. 52). The
allocation of risks will therefore depend on a variety of
factors, such as the size and scope of the project and the
particular capabilities of each party in managing risks.
As previously mentioned, optimal risk allocation is a sig-
nificant VfM driver. Transferring too little risk to the pri-
vate sector would make the project inefficient but also
transferring too much of the risks will result in high-risk
premiums and larger payments that would make the pro-
ject too costly to pursue as a PPP, thereby driving down
the VfM.
Once all the risks have been allocated as transferable
or retained risks, the size and timing of the expected cash
flows associated with each of these risks need to be
aggregated to determine their NPV. Each of the risks
should be included as a separate cash flow item and then
added to form the transferable and the retained risk com-
ponents to allow for a detailed analysis of the key risks
and the sensitivity of the overall PSC to these risks. A
Morallos, Amekudzi / Value for Money Analysis 121
Figure 1
VfM Comparison of PSC and PPP
Note: VfM = value for money; PSC = public sector comparator; PPP =
public–private partnership.
sensitivity analysis is often performed to determine the
adaptability of the estimated cash flow to changes in
assumptions, risks, and so on.
Comparing the PSC and PPP Option
Once the NPV of the four components has been cal-
culated, the NPV of their costs are summed up to total
the final risk-adjusted PSC cost. For the PPP cost calcu-
lation of the VfM analysis, the procuring agency then
determines the projected cash flows based on the
retained risks and the service payments it would pay the
private sector for the provision of the service or facility.
The projected PPP costs are then brought to NPV terms.
The total PSC cost is then compared with the NPV of the
PPP, the difference being the VfM. Figure 1 below shows
the comparison between the PSC and the PPP as evalu-
ated in a VfM assessment.
After this initial calculation has been done, the agency
can then choose to go over a qualitative assessment along
with the quantitative in deciding whether to pursue the
project and continue onto the next phase of procurement.
The agency practitioners may also conduct the qualita-
tive assessment after bids have been submitted. If it has
been determined that a public agency wants to pursue the
project as a PPP, the agency can reassess the VfM after
the bids have been submitted to determine which bid
would bring in better VfM. Other agencies have also
chosen to reassess the VfM during different stages of the
procurement phase prior to awarding the contract to a
private bidder.
122 Public Works Management & Policy
Qualitative Assessment of VfM
Although the quantitative assessment constitutes a
significant portion of the VfM analysis, it is not the sole
factor driving the VfM of a project. Partnerships
Victoria, as well as other agencies, as shown in Table 1,
mentions that qualitative factors should also be consid-
ered in determining whether pursuing a project through
a PPP will achieve VfM. Unlike the quantitative assess-
ment, the qualitative assessment is often less prescrip-
tive; it will often vary by what the procuring agency
deems important to consider depending on the project
and other conditions.
Partnerships Victoria (2001) suggests pursuing the
qualitative assessment after the completion of the quanti-
tative assessment and after the bids have been submitted.
In considering the impact of the qualitative factors,
Partnerships Victoria suggests identifying all material fac-
tors that have not been incorporated in the PSC and then
considering the impact of these qualitative factors on the
private bids. Some examples of qualitative risks according
to Partnerships Victoria include material costs that cannot
be quantified, the reputation and competency of the pri-
vate bidder, wider benefits or costs that a PPP could bring,
and the accuracy and comprehensiveness of the informa-
tion used and assumptions made in the PSC. According to
Partnerships Victoria, the consideration of qualitative fac-
tors can make or break the attractiveness of the PPP pro-
curement route especially when the lowest private bid is
very close to the PSC.
How Are Other Agencies Using VfM?
Table 1 below presents public agencies outside of
Partnerships Victoria and how they have used a VfM
methodology to compare PPPs and traditional procurement
options. Although not an exhaustive list, this table provides
further examples to show how these agencies’ methodolo-
gies compare to those of Partnerships Victoria. As Table 1
shows, there are slight differences between agencies
regarding the timing of their assessments and the compo-
nents of both their qualitative and quantitative assessments.
However, it also shows that despite these slight differences,
many of these nations follow a similar methodology to that
of Victoria’s and even for the most part contain similar
components in their PSC calculations.
Assessment of VfM Analysis
Although the VfM methodology is being used exten-
sively by many agencies across the world, there is often
great debate regarding its use. Many of the concerns
regarding the methodology often pertain to how agencies
create the public sector comparator especially in regard
to risk management and handling of discount rates. This
article breaks down some of the major concerns regard-
ing the credibility of the VfM methodology into four
areas: discount rate, weakness in calculations and bias
towards PPPs, limitations in risk management proce-
dures, and flexibility and continual assessment of VfM.
Discount Rate
One of the major concerns often voiced in regard to
VfM assessments has to do with what discount rate a
procuring agency should use in discounting the cash
flows. Because the VfM is highly dependent on the dis-
counting cash flow analysis to determine the final NPV
costs of both the PSC and the PPP, the procuring agency
should be careful in choosing the rate and be aware of the
PSC’s sensitivity to the discount rate used (OECD, 2008).
As previously mentioned, there are several options in
terms of what discount rate to use. Each option has its set
of caveats. One option is using the public sector’s bor-
rowing rate as the discount rate for the VfM discounting
cash flow analysis. Grout argues that using the same dis-
count rate for both public procurements and PPPs is
biased against the public sector. He notes that when the
public sector provision is valued, a discount rate is
applied to a cost cash flow that is representative of pro-
viding the facility or service, but with the private sector,
the rate is applied to a revenue stream (Grout, 2003, as
cited in Grimsey & Lewis, 2004, p. 142). In a PPP, this
revenue stream is not the equivalent to the cost of build-
ing the facility, and therefore, there is no reason to sup-
pose that the risk characteristics are the same for these
two cash flows (Grimsey & Lewis, 2004). Grout there-
fore suggests using a higher discount rate for the PPP
revenues that are more risky than costs. He argues that
failing to do so will suggest that private provision is less
efficient than public because the present value of private
provision will be overestimated relative to public pro-
curement (Grimsey & Lewis, 2004, p. 143).
The second option, which employs a risk-free dis-
count rate and the risks are valued in the cash flows, also
has its limitations. According to Grimsey and Lewis
(2005), this method can be quite difficult because it still
entails relying on practitioners’ estimates of the risk val-
ues to adjust the cash flows. Additionally, the third
methodology, the risk-adjusted discount rate, as used in
Australia, also presents some difficulty because identify-
ing the market or systematic risks that are transferred in
a PPP model as opposed to a public procurement can

also be complicated, and in turn, practitioners may have
to turn to estimating discount rates based on assumptions
rather than market information. Because each option has
its limitations, a public agency pursuing PPPs may face
some contention despite what discount rate it uses.
Weakness in Calculation and Bias
Because the PSC is a hypothetical scenario that heav-
ily relies on estimates made by the procuring agency and
on the experience of the person(s) conducting the analy-
sis, it is prone to error because of the complexities of the
financial methods used, along with the potentially lim-
ited experiences of personnel within the agency (Corner,
2006). These technical weaknesses of the VfM method-
ology and potential errors present in the calculations may
also contribute to the assessment’s vulnerability to bias.
Corner studied the use of the public sector comparator of
PFIs in the United Kingdom using the House of
Commons Committee of Public Account’s findings and
discovered some of the major weaknesses in the applica-
tions of the VfM analysis. One such weakness he identi-
fied was agencies’ inability to quantify or account for the
VfM’s sensitivity to contract term changes, which lead to
an output that may be false. In additional, he also found
that agencies were approving the PPP despite there being
only a small difference between the PSC and expected
project cost (Corner, 2006, p. 45). Despite realizing these
weaknesses, Corner also noted these agencies decided to
move forward with the PPP option, disregarding the
errors present in the assessment.
Because the PSC is a hypothetical scenario that is not
truly representative of a project that a public sector
would or could undertake, it may not make for an ade-
quate benchmark with which to compare the PPP project
costs by (Shaoul, 2005). In fact, as the OECD (2008)
states, “a good number of public-private partnerships are
conceived due to the lack of public financial resources,
in which case benchmarking efficiency against an infea-
sible policy option is problematic” (p. 77). If for
instance, the NPV of the PPP option turned out to be
more costly than the PSC, it would not necessarily mean
that the procuring agency would complete the project
through a traditional procurement, for it may lack
resources to complete the job. Because an outcome where
the PSC proved to be more affordable than the PPP
would technically lead to the cancellation of the project,
agencies may make slight adjustments to the VfM calcu-
lations despite a potentially large margin of error to make
the PPP seem cheaper (Corner, 2006). The main purpose
of the PSC and PPP comparison is to aid agencies in
determining whether to pursue the project as a PPP or
Morallos, Amekudzi / Value for Money Analysis 123
not pursue the project at all. However, there are several
instances where the calculations are biased, and this
main purpose is lost in the process.
Limitation in Risk Management Procedures
There are also several concerns regarding the limita-
tions of the risk management procedures of the VfM
assessment. It is quite difficult to ensure or even define
an optimal risk allocation scenario, as it is highly
improbable to account for all of the risks and possible
outcomes of a project. Shaoul (2005) notes that risk
transfer is conceptually flawed, as the number of possi-
ble outcomes of each risk occurring is infinite and that
therefore the issue is uncertainty, not risk. However,
some critics voice that many public agencies conducting
some form of VfM or other financial analysis for their
PPPs fail to distinguish between risks and uncertainty.
Frank Knight (1921), in his book Risk, Uncertainty, and
Profit, notes that for both risks and uncertainty, the
actual future outcomes of events are unknown, but the
main difference between the two is that the probability of
the outcome occurring is known in risks and unknown in
uncertainty (as cited in Grimsey & Lewis, 2004). For
instance, a risk would include those unknowns associ-
ated with the service provision (i.e., cost overruns,
changes in material costs, etc.) and even natural disasters
common to the region where the project is located. The
probability of those risks occurring can be calculated
based on historical information. However, certain
unprecedented events including terrorist attacks, civil
unrest, or natural disasters uncommon to the region can
qualify as uncertainty because there are no historical data
or way of quantifying the probability of these scenarios
actually occurring. Therefore, several authors have noted
that VfM analyses should also create some sort of adjust-
ment for uncertainty to fully capture the inherent risks
and uncertainties present in reality (Grimsey & Lewis,
2004). So far, the United Kingdom’s VfM quantitative
assessment tries to capture uncertainty through a factor
called optimism bias (HM Treasury, 2006).
In addition, Shaoul (2005) mentions that the risk
methodology does not always align risks, outcomes, and
penalties correctly. Should the project be cancelled or
experience delays, not all affected parties are compen-
sated after such an occurrence. For instance, the general
public who suffer as a result of the delays in provision of
that particular service or facility may not be compen-
sated by the procuring agency or the private sector for
any inconveniences. Furthermore, despite an agency’s
efforts to optimally allocate risks, risk transfer does not
absolve public agencies from certain responsibilities or
124 Public Works Management & Policy
the delivery of the service (Edwards & Shaoul, 2002).
Therefore, there will always be some risks that are still
held by the public sector and potentially the general
public that are not always factored into the VfM assess-
ment (OECD, 2008).
Flexibility and Continual Assessment of VfM
Last, the VfM methodology should be more adaptable
to potential changes in the project scenario, probability of
risk outcomes, or stages of the project. Because the
PSC–PPP comparisons and their estimates may differ
from the actual final costs of construction, there should be
adjustments made to the original VfM analysis, especially
if these actual costs fall below the estimates. In addition,
it is possible that the VfM methodology should not rely
on single-point comparison but instead should consider a
value range. This range should be reflective of the fact
that scenarios and the probability of risks and outcomes
within the PSC and PPP change. Therefore, a range,
rather than a single point value, would be more flexible to
these potential changes. Because there is the potential for
scenarios to change, especially during different stages of
the project, others also suggest that there should be a way
to monitor the VfM in the long term beyond the predeci-
sion stage. Broadbent, Gill, and Laughlin (2003) recom-
mend that there adjustments should be repriced and the
allocation of risks be readjusted if necessary to maintain
VfM. Failure to monitor VfM in the long term can have
significant consequences for the public sector and may
give the private consortium an unfair advantage over the
procuring agency, including a sizeable profit, especially if
the risk premiums are not adjusted when the levels of
risks in a project change (Broadbent et al., 2003).
Partnerships Victoria and the United Kingdom have rec-
ognized that the levels of risks may change in different
phases of the project. Therefore, they have incorporated
in their policies a way for the public agency to share in
the benefits of equity returns from the private sector’s
refinancing during the term of the project (HM Treasury,
2006; Partnerships Victoria, 2001). However, in several
cases, the use of the VfM methodology occurs primarily
before the conclusion of the contract but is not revisited
afterward. The OECD (2008, p. 79) argues that this is not
enough to ensure the actual performance of the private
sector will yield the expected VfM.
Conclusion
This article’s main goal is to provide public agencies
with guidance on the use of the VfM analysis tool in their
decision-making procedures regarding PPPs. The first
section provides an overview of the state of the practice
of the VfM analysis and how it has been used by various
public agencies focusing on the methodology established
by Partnerships Victoria. The second segment of the arti-
cle examines the different concerns voiced by various
academic researchers or practitioners regarding the use
of the VfM methodology to justify the use of PPPs.
Some of the criticisms tout the faultiness of discount
rates used, the weaknesses of the risk allocation, and bias
in the public sector comparator and PPP comparisons.
What can be gained from the criticisms are important
next steps in improving the current VfM methodology.
Recommendations for future improvement are needed in
the risk valuation and allocation strategies. In addition,
the VfM needs to take greater consideration of the role of
the qualitative factors in making the final decision to pur-
sue a PPP or not. In addition, the current VfM quantita-
tive assessment needs to incorporate wider social costs
and benefits associated with either procurement option.
From the governments’ end, the VfM can also be
strengthened through greater efforts in knowledge shar-
ing or coordination between agencies regarding informa-
tion and data that could improve the calculation of risk
probabilities and cost estimates.
As evident from the concerns voiced, VfM analysis is
far from perfect. However, the benefits of this methodol-
ogy should not go understated as well. At the moment,
VfM is one of the leading tools available for public agen-
cies looking to assess the value of pursuing a project
through a PPP versus a traditional procurement.
Although VfM assessments are frequently critiqued
because of their susceptibility to bias or faulty estimates,
they provide the public sector with a simple methodol-
ogy to present quantifiable figures regarding the poten-
tial gains of a PPP. They also provide the public sector
with an easy tool to account for the costs, benefits, and
risks involved in the project without having to contract
out the financial analysis to a private contractor. Last, its
simplicity makes it possible for VfM to be applicable to
different government structures, agencies, and industry
sectors pursuing a PPP.
It is important to note that the very exercise of con-
ducting a VfM analysis helps an agency to develop better
knowledge of the project and have a better grasp of the
potential scenarios that can unfold, all of which can be
very good information in crafting a successful PPP
option (or opting for a traditional procurement). The
VfM exercise and the experience of costing the project
early on act as a key management tool for these agencies.
It helps to make them aware of the potential costs, risks,

and other issues that they should be aware of before
going any further into the project planning and the pro-
curement phase.
As the use of the PPP procurement option continues to
grow globally, the importance of an assessment tool such
as VfM analysis is made more evident. Although PPPs
have gained popularity and have even been seen as a
potential solution to governments’ infrastructure funding
crises, they are not necessarily the best fit option for all
projects or public agencies. Although the VfM assess-
ment can be used to determine whether to pursue a PPP,
public agencies must be aware of the complexities of the
overall PPP process and the limitations of the VfM
methodology. It is important for agencies to realize that
VfM cannot be the only factor in the decision to pursue
a project as a PPP; they must evaluate their own capacity
to manage such large, complex, and long-term projects
aside from what the final value might say.
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Dorothy Morallos is a graduate student at Georgia Institute of
Technology, working on her M.S. degrees in civil engineering and
city and regional planning. Her research examines the state of the
practice of transportation public private partnerships and related ben-
efit/cost analysis tools.
Adjo Amekudzi, PhD, is an associate professor in the School of Civil
and Environmental Engineering at Georgia Institute of Technology.
Her research and teaching interests and professional activities support
asset management of civil infrastructure systems to promote sustain-
able development.