Joint Ownership: A New Approach in Public–Private Partnerships
The public-private partnership models that have been effective in building infrastructure have not translated well to projects involving public services, including healthcare, education, and e-services such as electronic payments. Now, a new model of partnership is emerging that may transform how public-services projects are structured.
George Atalla Karim Aly Tamer Hakim
Joint Ownership A New Approach in Public–Private Partnerships
This report was originally published before March 31, 2014, when Booz & Company became Strategy&, part of the PwC network of firms. For more information visit www.strategyand.pwc.com.
Contact Information Abu Dhabi Richard Shediac Partner +971-2-699-2400 firstname.lastname@example.org Cairo George Atalla Partner +20-2-2480-1444 email@example.com Karim Aly Senior Associate +20-2-2480-1444 firstname.lastname@example.org Tamer Hakim Associate +20-2-2480-1444 email@example.com
Bassem Fayek, Samia El Baroudy, and Omar El Orabi also contributed to this Perspective.
Booz & Company
Public–private partnerships (PPPs) have helped many emerging-market countries modernize their highways and telephone networks and build new power plants. However, the PPPs that have been effective in building infrastructure have not translated well to projects involving public services, including healthcare, education, and e-services such as electronic payments. Now, a new model of partnership is emerging that may transform how public-services projects are structured.
In the joint ownership model, the government and a private-sector partner team up to start a for-profit company. The government provides concession rights to its private partner and handles the political and legal roadblocks faced by the new company. The private partner designs and ultimately operates the service. The government’s position as a financial stakeholder does create some risks: There is the potential for the government to create a monopoly and experience conflicts of interest. Conversely, the new service may not generate the expected level of revenue. It is ultimately up to the government to mitigate these risks. Joint ownership must be seen as a temporary solution that can be used to launch new services quickly. In the long run, the government partner should look to spin off its stake. It is vital for the government to look for ways to address the legal, regulatory, and institutional problems that initially prevented the service from being launched by the private sector alone.
Booz & Company
KEY HIGHLIGHTS • Joint ownership between the government and the private sector is a viable model to create new entities that can provide critical services. • This PPP model allows both partners to leverage the other’s assets, share risk, and exit as necessary. The risks of these partnerships include conflicts of interest and the possibility that the resulting company will be a monopoly. • To mitigate these risks, the government should maintain its ownership stake for the shortest possible time—just long enough for the private sector to develop the capabilities needed to provide the services on its own. • For the partnership to succeed, the government must choose the right partner, have a clear implementation plan, and communicate effectively with key stakeholders.
A TEST OF THE JOINT OWNERSHIP MODEL
the unusual step of forming a new company, jointly owned with two private-sector companies. The partnership’s structure benefited both sides: The government could devote less capital to the project, while the private-sector companies gained instant credibility with lenders and investors and a chance to develop new technical skills. Public–private partnerships, of course, are nothing new; they have existed for decades and are in increasing use around the world, especially for big projects in the sectors of energy, telecom, transport, and water and sewerage (see Exhibit 1). These partnerships come in a variety of forms. Some are service contracts, in which a government pays a private operator to provide a service (say, solid waste management); some are management contracts, in which a private operator runs a facility owned by the government (such as the London subway system). Governments may also lease their assets or sell them outright, the assumption often being that the private sector can operate the asset more efficiently than the public sector.
In 2007, the Egyptian government was looking to set up an e-payment system that would automate government payments, including pension disbursements and the salaries of its workers. Lacking the expertise to create and run such a system on its own, the government decided to seek a partner from the private sector. Had it been a different kind of project—the building of a power plant or highway, or some other type of standard infrastructure—the government could have engaged a global construction or project management company. However, a government e-payment system requires a tighter collaboration between the client and the contractor. Egypt did not have any technology outsourcing companies that could handle a job of this scope, so it took
Booz & Company
Joint ownership, which has been used several times now in Egypt, is a new twist on the partnership idea (see “Case Study: Joint Ownership Facilitates E-payment in Egypt”). It bears a superficial resemblance to privatization, which the Egyptian government has used extensively in recent decades to reduce or eliminate
. 7 values
its ownership stake in ventures as varied as textile companies and soft-drink plants. The difference is that privatization aims to change the ownership structure of businesses that have been in existence for years. By contrast, these newer joint ownership arrangements are being established to create new companies and introduce
completely new services, those the government wants to provision in partnership with the private sector. The government and its private partners build the service from the ground up, sharing the benefits and risks in ways that work for both sides, without being burdened by the mistakes of the past.
Exhibit 1 PPP Projects Are on the Rise Worldwide
PPP PROJECT NUMBERS AND INDUSTRIES Number of PPP Projects per Region (Number, 1999–2007)
Global PPP Infrastructure Projects by Type (US$ in Billions, 2000–2007) 158
CAGR 4% 259 208
CAGR 5% 288 110 85 64 64 78 108 127
1999 2000 2001 2002 2003 2004 2005 2006 2007 East Asia and Pacif ic Europe and Central Asia Latin America and the Caribbean Middle East and North Af rica South Asia Sub-Saharan Af rica
2001 Energy Telecom Transport
Water and sewerage
Source: World Bank PPID; Booz & Company analysis
Booz & Company
CASE STUDY: JOINT OWNERSHIP FACILITATES E-PAYMENT IN EGYPT When the Egyptian government wanted to build an e-payment system, it formed a public–private partnership. This company, founded in 2007, provides a good example of how such partnerships can function successfully. Egypt took a 60 percent stake in the new company through three public banks; the two private partners had a combined 40 percent stake. The investors in the company all served on the board of directors and had voting rights that reflected the capital they had committed. The president of the company and two outside experts also became members of the board, providing input even though they did not have voting rights. Six permanent committees worked with the board, providing advice in the areas of governance and nomination, strategic planning, performance monitoring, auditing, public relations, and service delivery. Egypt gave concession rights to the newly formed company—specifically, the right to be the sole entity allowed to operate an electronic payments platform for the Ministry of Finance. The Egyptian government was also able to ensure the buy-in of the banks, pension fund managers, and others that needed to be part of the system. The private partners, meanwhile, provided know-how in the areas of software development, banking, automation, and e-services; and designed, installed, managed, and maintained the e-payment system. The private partners also contributed 40 percent of the required capital. Three risks endemic to this kind of partnership—that of the new company being a monopoly, of the government having conflicts of interest, and of demand falling short of expectations—all had to be addressed. Egypt addressed the monopoly risk by setting pricing in advance and by including service-level agreements that penalized the jointly owned company if it failed to deliver specified levels of customer satisfaction, processing time, operating hours, and network robustness. It addressed the risk of conflict of interest by separating its investment interests from its monitoring efforts. And it mitigated demand risk—the private sector’s concern that the 10-year revenue forecast might prove overly optimistic—by agreeing to minimum yearly payments and by allowing for flexibility in pricing in response to inflation and the level of financial return targeted by the private sector. Finally, the Egyptian government devised a robust implementation plan for the service’s development, and created a program management unit to handle communication between the project’s key stakeholders. Those stakeholders included the Ministry of Finance, government employees, pensioners, banks, and the e-payment company itself.
Booz & Company
HOW JOINT OWNERSHIP WORKS
In joint ownership, both the government and the private sector get a stake in the newly formed corporation. On the public side, the owners typically include the entities within government that will be consuming the service or that are mandated to provide the service to the general public. On the private side, the owners typically include the company or companies responsible for developing the service and providing startup capital. In cases in which the government wants to maintain control over offering the service, it may start out with a majority ownership position; alternatively, if the public sector lacks the budget and does not want to maintain control, the private sector may own most of the new corporation. As the company is getting started, each side has a unique contribution to make. The public sector contributes concession rights—meaning it awards a contract to the jointly owned company, giving it the right to be the
sole provider of the service. The public sector also contributes regulatory support, clearing a path for the corporation to operate without interference. The private sector contributes the technical and management knowhow needed to launch a high-quality service, and a portion of the financing for the project. As in any project with large ambitions and multiple stakeholders, jointly owned public–private partnerships require solid governance. Structurally, two kinds of oversight mechanisms are necessary to achieve such governance. One is a board of directors responsible for the areas of strategic guidance, corporate governance, auditing, and compensation. The second kind of oversight needed is standing committees to govern four distinct functional areas: Governance and nomination, strategic planning, day-to-day audit issues, and service delivery.
Booz & Company
BENEFITS OF JOINT OWNERSHIP
and support regulatory changes that may be vital for the new company’s success. In the political realm, the public partner can also create support for the nature, pricing, and timing of the services to be offered. The second benefit of these partnerships has to do with risk sharing. Any new company faces multiple risks: that it won’t succeed in developing the new product or service; that the demand for the product will be lower than expected; that the company will run out of startup capital; that a shift in politics or environmental laws will undermine its proposed offering. In a typical startup situation, these risks are borne entirely by entrepreneurs and investors. In a company with both public and private ownership, however, the risks are shared in a way that can increase the initiative’s prospects of success. For instance, political, legal, and environmental risks are borne
by the public partner; after all, the public partner can directly influence outcomes in those areas. Risks relating to the design of the service or financing, by contrast, fall to the private partner, which presumably has more expertise in those areas. Risks that neither side can control directly are shared (see Exhibit 2). Finally, new companies jointly owned by the government and private sector offer straightforward exit strategies not available in most other types of public–private partnerships. In particular, if the company is prospering, the public partner can push for an initial public offering, giving it a way to cash out of its position. Or the public partner can sell all or part of its stake to a strategic investor. This liquidity is useful because, in the long run, most governments won’t want to be in the business of owning stakes in for-profit enterprises.
Jointly owned public–private partnerships offer three fundamental benefits. Foremost is the ability to leverage assets or resources that neither side would have on its own, in order to efficiently create a highquality service offering. The public partner gets the technical, financial, and management resources of its private-sector partners. In many cases, the private sector can pay more for talent; for this reason, the private sector often has better-trained workers and deeper expertise than exists in government. In turn, the public partner can offer concession rights
. 7 values
Exhibit 2 Putting Risk Where It Belongs
TYPE OF RISK
RISK ALLOCATION Private Public
Demand and Revenue Risk Design and Construction Risk Operation and Maintenance Risk Financial Risk Legal Risk Political Risk Environmental Risk Force Majeure
- Demand/revenue risk is an external factor that cannot be controlled and should be shared by both parties - Private sector has the technical knowledge, technology, and people skills required to handle this risk - Private sector can better manage operation and maintenance risks - Private sector can take on debt and invest financial resources - The government has the authority to propose and amend laws to regulate the market - The government can better manage political risks - The government has control over setting rules and regulations regarding environmental protection - Force majeure risk is an external factor that cannot be controlled and should be shared by both parties
Source: Booz & Company
Booz & Company
RISKS OF JOINT OWNERSHIP
The same structure that bestows benefits also creates some risks. The first risk is of monopoly. After all, if the government has granted concession rights, the new company may be the only player in the market. Without competition, the new company could theoretically dictate prices, generating huge profits at the expense of the government’s social responsibility to consumers. The lack of competition may also prevent a
company that has a monopoly from feeling any urgency about improving service quality. To address this issue, the government and the company should use service-level agreements to determine the services to be provided and performance targets to be met. The risk of monopoly pricing can be mitigated through a contractual agreement that takes into account what is reasonable for consumers to pay and what investment returns the
The government and the company should use service-level agreements to determine the services to be provided and performance targets to be met.
Booz & Company
company should earn, and that makes provisions for the government to subsidize service. The second risk is that the joint ownership model creates a conflict of interest for the public partner. In its role as public servant, the government would normally push to maintain low prices for a service it is helping to create. But as a stakeholder in the new company, it should be
maximizing profits. This is a clear conflict of interest. Another is the fact that the government is both an operator and a regulator of the service. There is a chance that the government will be less vigilant about regulating one of its own companies than others in which it does not hold a stake. This risk can be lessened by creating a separate entity within the government—separate, that is, from the investing entity—to monitor the
performance of the company and make sure it meets the terms of the service-level agreement. The conflict of interest can also be addressed through a contractual pricing mechanism that adjusts for inflation and that seeks to keep the company’s financial returns in an agreed-upon range. The third risk relates to demand and revenue. Every company starts by making assumptions about volume
The government should be at least somewhat responsive to the private partner’s attempts to ensure the company’s profitability, lest the private partner focus on its own financial exposure and decide against doing the deal.
Booz & Company
levels and pricing. As the main consumer of a service, the public partner could conceivably delay the launch date or, during a time of internal budgetary pressures, reject price increases that might be required for the company to remain profitable. Demand and revenue risk can be minimized if the government agrees to a minimum fixed payment regardless of actual volume levels. This has been one of the key points of negotiation as the joint companies in Egypt discussed above have gotten started. Generally, the partners agree on a target internal rate of return (IRR) for the company. The annual contract fee is one way
to achieve this IRR, and the private partner will push for this fee to be as high as possible. The private partner also negotiates for high transaction fees, hoping for a best-of-bothworlds deal in which the company gets downside protection through the guaranteed annual fee and enjoys an upside if volumes meet or exceed expectations. Together, these two revenue sources can minimize the amount of paid-in capital the partners need to provide. The government should be at least somewhat responsive to the private partner’s attempts to ensure the company’s profitability, lest the
private partner focus on its own financial exposure and decide against doing the deal. On the other hand, the government does not want to offer such a high guaranteed contract fee—a steady yearly cash flow regardless of transaction volume— that it removes the incentive for the company to improve its service and increase efficiency. In short, there is a trade-off between the value of the contract and the transaction price, so that the company is not taking on excessive risk, yet has the necessary incentives to enhance its operations. That is the balance that needs to be struck, and that the government needs to help find.
Booz & Company
JOINT OWNERSHIP IN THE MENA REGION
In recent years, Middle East and North Africa (MENA) countries have invested heavily in their transportation, telecommunications, and energy infrastructures. These infrastructure projects, though enormous in scale, have tended to be fairly standard—a new highway in Oman is not that different from a new highway in China; a new telecommunications network in Morocco is not that different from a new telecommunications network in Belarus. MENA governments have thus been able to turn to global companies outside the region to help with their infrastructure projects. This has resulted in big growth in infrastructure-related partnerships with
the private sector, especially between 2004 and 2007 (see Exhibit 3). However, the region’s governments have not been anywhere near as successful at using public–private partnerships to execute publicservices projects. There are a few reasons for this. To start with, these projects—which might involve services related to healthcare, education, customer service, or services such as e-payments—aren’t as tangible in terms of their deliverables or completion schedules. It is relatively easy to know when one-quarter of a 200-mile highway has been completed; it is when the first 50 miles of asphalt have been laid down
. 7 values
Exhibit 3 The MENA Region’s Growing Use of Public–Private Partnerships
PPP INFRASTRUCTURE INVESTMENTS BY SECTOR, MENA REGION
US$ in Billions (1997–2007) 12.8 CAGR +10% 11.6
Percentage in Value (1997–2007)
7.9 7.0 5.1 3.4 4.1 2.9 1.6 1.9 4.4 64%
Energy and Utilities
Booz & Company
and tested. By contrast, it is relatively hard to know when a national healthcare database is one-quarter finished; the fact that you can run a few queries over the database at that preliminary stage doesn’t mean it will do everything necessary when it is complete. In countries that have highly sophisticated private companies with deep technical skills, the partnership options are straightforward. The U.S. government, for instance, has no trouble finding a private-sector partner within its borders if it needs to outsource a big software development job. Indeed, a government in a developed country will often have multiple options in terms of private partners. In most countries in the MENA region, the environment for such partnerships is much less sophisticated. Thus, few successful non-infrastructure outsourcing initiatives have taken place. This has not made for an atmosphere of
trust between the public and private sectors. In addition, private-sector companies in the MENA region generally don’t have the required experience that would set them up to handle public-services projects. And plenty of problems exist on the government side too; many MENA countries have a level of political instability that could easily put a public project at risk, and some of them don’t have judicial or legal frameworks that would protect a private company’s rights in the event of a conflict with the government. Finally, few MENA governments have hired program managers or developed the human capital necessary to run outsourcing programs that rely on skills in procurement and project management. The joint ownership model addresses many of these endemic weaknesses, so it would not be surprising to see it used in MENA countries beyond Egypt, where early efforts are making good headway. As it has in Egypt, the joint ownership model could
attract private-sector participants elsewhere in the MENA region that want to cast their fortunes together with the government. After all, these aren’t conventional government procurement deals—the private sector and the government are co-owners of a newly created company. This is unique, and should make the private sector more confident both of the government’s commitment and of the degree of alignment likely to exist between the two sides. With respect to the political and legal risks that can derail any new initiative, the private stakeholders could reasonably expect their government partner to be their advocate. In addition, with a big government project—likely to last for years and to be sweeping in scope— the private sector knows it will have the time and opportunity to develop world-class skills in the field related to the project. Of course, this is a benefit to the public sector too: At the same time that it is addressing its own needs, it is helping its private sector advance along the capability curve.
It would not be surprising to see the joint ownership model used in MENA countries beyond Egypt, where early efforts are making good headway.
Booz & Company
PPP INFRASTRUCTURE INVESTMENTS
US$ in Billions (1997–2007)
IMPERATIVES FOR SUCCESS IN JOINT OWNERSHIP
Three factors determine success in a jointly owned public–private partnership. First, the government must select the right partner. This is not altogether different from the vendor selection process that occurs with any other big government transaction. It starts with the government sounding out the market,
and ends, months later, with the government awarding the contract. Along the way, the government should issue four key documents that 5.1 help the process along (see Exhibit 4). 3.4 • Document No. 1 (sent at the very beginning of the process), the Tender Process Manual, is essen1997
. 7 values
Exhibit 4 Road Map for Selecting a Partner
OVERVIEW OF THE DOCUMENTS SENT TO POTENTIAL BIDDERS
Notification & Short-listing
Negotiation & Contract Awarding
1 Tender Process Manual
2 Expression of Interest
3 Request for Information
4 Request for Proposal
Source: Booz & Company
Booz & Company
tially a guide document for those who may want to participate in the bidding. It details the procedures that will be used in evaluating the bidders and in making the award. • Document No. 2 is an Expression of Interest. It is a high-level description of the project with key figures and estimates, designed to encourage investors to bid. It lays out timelines and deadlines that investors must meet. • Document No. 3 is a Request for Information. It includes a questionnaire that prospective bidders must fill out; the government uses it to create a short list from among those who have expressed interest.
• Document No. 4 is the Request for Proposal, and includes more details on the project and the evaluation criteria. It also contains a draft of the contract. As with any other big contract, price is an important factor. However, governments should base their decision on the value they would receive rather than solely on price. This approach takes into account non-financial attributes (a prospective partner’s relevant experience, track record, and technical and management skills, among other things), assigning them a dollar value that becomes part of a simple mathematical equation. This can shift the math in favor of a partner that hasn’t made the lowest
bid, but that does offer the best combination of quality and price. The second success enabler is to have a well-thought-out implementation plan. The evolution from an idea to a fully functioning public service will generate dozens of initiatives, which can be broken down into four main categories: organization, governance, operations, and market/financial. There is a natural sequencing to these initiatives. Some are dependent on others, and many of them will overlap. All of them have an owner; all require a description; all need a list of key deliverables. Clearly, the master project plan that lays out the development of a jointly
Governments should base their decision on the value they would receive rather than solely on price.
Booz & Company
owned public–private partnership from inception to service launch has to capture an enormous amount of complexity. For instance, one project plan supporting a new customs outsourcing company in Egypt listed 24 initiatives, starting with hiring the CEO (an organizational initiative that was completed in the first few weeks); this was followed by the creation of a program management office, or PMO (a governance initiative); finally, the concession agreement (a market and financial initiative) was forged. It was more than a year before any operations initiatives (such as the launch of the service) actually appeared on the plan, but by then, the company had been incorporated,
millions of dollars in capital had been invested, and dozens of workers had been recruited and trained. The third success enabler is effective communication with key stakeholders. The government entity can set up a program management unit (PMU) to assume the burden of this imperative. The PMU sits within the government and facilitates interactions between the government and the jointly owned company. To a great extent, it mirrors what the PMO is doing at the company, and works with the PMO to ensure that the master plan’s milestones are being met. The PMU’s areas of functional responsibility include strategic planning, service
deployment, and service enactment. Handled well, these three imperatives will vastly increase the likelihood that a jointly owned public–private partnership can succeed. The success of the partnership, however, also depends on the environment that the public entity has created. In particular, these partnerships have the best chance of thriving in countries that have a legal framework that enables partnerships rather than discouraging them, a structure in place to provide good governance for their partnership efforts, and some internal project management expertise.
Booz & Company
A SHORT-TERM SOLUTION
Promising as these partnerships are, they should be seen strictly as shortterm commitments, not open-ended ones. Governments, after all, should not be owners of individual companies; their economic role should be to set policies and enforce regulations that enable competitive markets. Most MENA governments came to this realization 20 years ago, when a wave of privatization swept through the region. If these governments hold on to their ownership stakes for too long, it increases the likelihood of conflicts of interest, and casts doubt on their commitment to free market dynamics. That could undermine the primary goals of these partnerships. Still, three conditions must be met before the public partner can spin off its stake. First, the government needs to ensure that the private-sector partner has developed the required scale and capabilities to handle the risks previously carried by the public
partner. Second, there needs to be a stable policy environment with clear laws and regulations to smooth the way for the private-sector partner to operate independently. Third, the public partner needs to be able to realize a gain on its investment, whether through an IPO or through sale to a strategic partner. The would-be government seller may also have to overcome a few psychological barriers, including its desire to maintain control of a service upon which it has come to depend; its desire not to remove itself from an initiative that is generating positive cash flow; and its reluctance to deal with the human resources issues created by an exit, including the career paths of the public servants who were involved. Still, whether the government intends to exit should never be the question; the only question should be when that happens.
If governments hold on to their ownership stakes for too long, it increases the likelihood of conflicts of interest, and casts doubt on their commitment to free market dynamics.
Booz & Company
In emerging markets where there is a dearth of suitable private partners to take on public-services projects, joint ownership can be expedient. A set of services that might otherwise require years to introduce can be brought out relatively quickly. However, joint ownership should always be regarded as a temporary solution, never as a permanent one. Almost from the beginning, the government should be thinking about how it will exit its ownership position and leave the company in private hands.
Indeed, in the long term, what any government partner should be doing is figuring out what fixes are required in its legal, regulatory, and institutional frameworks so that its private sector can launch public-services projects without such a high level of government involvement. This is the true sign of success—when the government doesn’t need to offer itself up as an owner in order to spur privatesector participation. Until that happens, joint ownership will remain as a possible strategy for the short term.
Booz & Company
About the Authors George Atalla is a partner with Booz & Company in Cairo. He has advised Middle East government clients on economic policy setting, investment prioritization, and subsidies realignment. He has led large public-sector modernization initiatives that focused on public–private partnerships, outsourcing strategy, and organizational restructuring. Karim Aly is a senior associate with Booz & Company in Cairo. He specializes in strategy development and organizational transformation. Tamer Hakim is an associate with Booz & Company in Cairo. He specializes in strategic and organizational restructuring for the public sector.
Booz & Company
The most recent list of our offices and affiliates, with addresses and telephone numbers, can be found on our website, www.booz.com.
Worldwide Offices Asia Beijing Delhi Hong Kong Mumbai Seoul Shanghai Taipei Tokyo Australia, New Zealand & Southeast Asia Adelaide Auckland Bangkok Brisbane Canberra Jakarta Kuala Lumpur Melbourne Sydney Europe Amsterdam Berlin Copenhagen Dublin Düsseldorf Frankfurt Helsinki Istanbul London Madrid Milan Moscow Munich Oslo Paris Rome Stockholm Stuttgart Vienna Warsaw Zurich Middle East Abu Dhabi Beirut Cairo Dubai Riyadh North America Atlanta Chicago Cleveland Dallas DC Detroit Florham Park Houston Los Angeles Mexico City New York City Parsippany San Francisco South America Buenos Aires Rio de Janeiro Santiago São Paulo
Booz & Company is a leading global management consulting firm, helping the world’s top businesses, governments, and organizations. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in 1914. Today, with more than 3,300 people in 60 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage. For our management magazine strategy+business, visit www.strategy-business.com. Visit www.booz.com to learn more about Booz & Company.
©2010 Booz & Company Inc.