Grin and bear it - PFIpanel's message to contractors

In June Contract Journal and James R Knowles published a challenging report on the Private Finance Initiative. It concluded that not enough companies were prepared to fund the hugely expensive PFI bids. As a result, the Government would not be able to find enough bidders to tender for its œ14 billion of schemes.

Since Making PFI Work was published, there have been a number of high profile withdrawals from PFI, and a growing disillusionment with the status of PFI health schemes in particular.

Making PFI Work proposes that the Government has a basic choice: either it takes new action to attract fresh participants to PFI; or it standardises PFI to cut bidding costs for its current pioneers, the hard pressed construction industry.

In July the findings of the Making PFI Work were presented to the Private Finance Panel. At the end of August, Rees Griffiths, deputy chief executive of the panel, gave his response.

In terms of the action it promises, it will not set many pulses racing. But the content is provocative and will inform the thinking of contractors who are developing PFI strategies.

Griffiths says that the Private Finance Panel is against large scale standardisation (which could bid cut costs and help the construction industry) because it would limit the scope for innovation. He says that he wants construction groups either to mature into major operating companies or to retreat to their core business.

Making it easy for the construction industry is not, in his view, a sensible option.

"The likes of Tarmac Service-master should not blanch at the recognition there is a cost to achieving this business. It would be giving up far too soon in the process to tilt the pitch to the construction industry by making PFI little more than a design and build hire purchase deal with a bit of FM tacked on the back.

"There is a requirement to transfer risk. If we pursue the line of standardisation, I don't think we would achieve that."

One of the key recommendatins of the CJ/JRK report was that there should be a concord of acceptable risks to reduce negotiating times. The suggestion gained widespread suppoprt from clients and construction industry bodies. The Private Finance Panel, although sympathetic, is cautious: "We would like to have a base line of standard terms, but standardisation will only go so far.

"We will put out guidance in the Autumn on risk transfer and residual values. Possibly this will include some models for the form these should take."

The reluctance to skew PFI in favour of construction arises from the view, widespread among clients and in Government, that it is not the appropriate sector to lead PFI. This belief is based on the relative weakness of its balance sheet, coupled with what they fear is its short term interest in what may be a 25 year-long committment.

For his part, Griffiths says he has not been dismayed by construction groups withdrawing from certain areas of PFI. He has actually been pleased to witness it:

"I'm encouraged when I hear major contracting groups saying we're withdrawing from this or that sector. One of the things leading contractors have suffered from is that they have gone for everything, and that really has stretched them."

Many contractors might find that attitude puzzling, given that without the construction industry PFI might never have got off the ground.

Griffiths goes on: "To see them start to recognise that there are areas of business they are not so good at, is encouraging for the longer term.

"I'm hoping we will get to a day when you can look at a list of applicants for a project and say that those three or four companies will be on the shortlist: they've done it before, they're experts, they are major corporations - these are the people we want."

Griffiths hopes the top 20 construction groups will gravitate towards niche areas of PFI in which they feel they can add value. The redistribution would cover all key areas of engineering, resulting in three or four specialists in each.

He hopes there will be a polarisation of the construction industry:

"You have to realise UK contractors are pretty small in international terms. It would be very nice to see one or two the major UK groups mature into a full design, engineer and operate business that may put subcontract packages out to specialist firms. In turn, one would like other firms to develop to handle those specialist packages."

If construction companies are not to lead PFI, then who is?

Making PFI Work found that operating companies are likely to lead bids for only 18% of the œ14 billion programme. The report also discovered only tepid interest from major industrial and utility companies who might conceivably act as operators.

Obviously a gap exists. But how is it to be bridged?

Making PFI Work proposes specific Government action to stimulate interest from new players - something clients are keen to see. It is not an idea Griffiths readily accepts. Indeed, he offers no quick fix solution.

"It will take time to move from where we are today with contractors in the lead and FM companies in the rearguard, to having operating companies at the front and construction companies picking up the subcontracts."

The report suggests that FM companies should play a key role as operators. However, it found them lacking the necessary financial muscle and investment confidence. Griffiths concedes both points.

"The key element is a lack of capital. FM companies here are built out of QS firms, or they have come out of short term council contracting, neither of which has required capital."

If FM companies are to grow into major infrastructure operators, it will not happen quickly.

This begs the question: if they are not ready to lead PFI projects, and contractors are already dropping out, how will the Government's three year programme be completed? In other words, is the report's warning of a 40% shortfall in the œ14 billion of schemes realistic?

"Looking at the project list we are monitoring - which is not comprehensive - letting œ14 billion of projects does not seem to be unreasonable.

"Only on two or three projects have we had a problem with getting sufficient interest to create a real competitive situation. They were all this year, but were in a technical sector."

The present reality, though, is that the construction industry is cooling towards PFI and operators are not ready to take their place. So far less than œ6 billion worth of projects have been let - a figure boosted by the massive œ3 billion Channel Tunnel Rail Link scheme.

There is sceptism within the industry that Government will hit its target. But Griffiths is unwilling to concede the possibility of defeat. He offers interest from foreign firms as a missing piece in the jigsaw:

"I know from my own company, Generale des Eaux, that the French have been sceptical about PFI. But now senior Frenchmen based in this country are going back to Paris to beat the doors down and say this thing is for real. I'm sure that is happening with Japanese and US companies too."

Overall, the construction industry is unlikely to find Griffiths' response very palatable. He gives few signals that the Government is ready to grasp the reins of leadership in a more positive way. Instead he promises that change will come gradually as a result of market forces and trial and error.

Griffiths' message may offer less than most people would like. However, he is still concilliatory toward the industry. His tenor is not so much like it or lump it. More grin and bear it.

Given the growing pains of PFI, that is something many contractors will find rather hard to do.n Rees Griffiths, deputy chief executive of the Private Finance Panel, gives his response to Contract Journal's report Making PFIWork.

He offers cold comfort to contractors pioneering the PFI, writes David Nunn