Appraising a PPP project means checking that it makes sense to develop and implement the project as a PPP. This typically involves assessing the project and proposed PPP against four key criteria:
- Project definition and feasibility;
- Economic viability;
- Commercial viability; and
- Value for money.
Before a project is appraised, it must be defined using the following elements: its physical outline, the technology it will use, the outputs it will provide, and the people it will serve. Capital, operating, and maintenance costs should be estimated, as well as any revenue expected to be generated. This definition should be sufficiently broad to apply to a project delivered as either a PPP or a conventional publicly financed project.
It makes sense to do a project as a PPP only if the project itself is sound. Most governments therefore subject proposed PPP projects to the same technical and economic appraisal as any other major public investment project. There are two broad elements to this assessment:
- developing, and assessing the feasibility of, the project concept; and
- appraising whether the project is a good public investment decision—based on some form of economic viability analysis.
This assessment may take place prior to ever considering a project as a PPP. In other cases it may be undertaken as part of the PPP appraisal process. Either way, the project feasibility and economic viability analysis for a PPP should be no different from that of any other major public investment project.
Project definition and feasibility lay the foundation for the rest of the PPP appraisal. The project definition provides the basis for establishing economic viability, developing the PPP financial model and commercial viability analysis, and any quantitative value for money analysis.
Many governments undertake some form of economic viability analysis to decide whether a proposed project is a good use of public resources. A project is economically viable if the economic benefits of the project exceed its economic costs.
Generally speaking, the economic costs of the project are the same as its financial costs—though in some cases, other non-market costs, such as environmental damage, may be taken into account. The economic benefits are a measure of the value the project will deliver to people. The revenue a project will generate is usually a lower bound estimate of its economic benefits—but benefits can be much higher than revenues. For example, the benefits from improved transportation can exceed the tolls paid on a highway. The value of education at a high school is measured by the enhancement in the lives and prospects of the children who attend, even if no school fees are charged. Economic viability analysis can also include cost-effectiveness analysis, to determine whether the project is the lowest-cost way to achieve the identified benefits.
Having established that the project is viable, the next step is to consider whether, if structured as a PPP, it would be commercially attractive to the market. Generally, private parties will find a project commercially attractive if it offers good financial returns, and requires the private party to bear only reasonable levels of risk.
Assessing returns involves building a project financial model and checking project cash flows, returns, and financial robustness. Where revenue from user charges exceeds costs plus the commercially required return on capital, the project will generally be commercially attractive (provided risks are seen as reasonable). Where user charges are not at this level, government can use the financial analysis to assess the government contributions that will be needed—which in turn needs to be assessed as part of the fiscal analysis of a PPP project.
Governments should also assess the appetite of potential partners for a proposed PPP before taking it to market. This could include simply considering whether similar projects have previously been implemented with private partners in the country or region. It can also include testing market interest by market sounding—that is, presenting to potential investors the main parameters of the project for questions and comments.
Value for money
A key objective of most governments in implementing PPPs is to achieve value for money in providing needed infrastructure. Value for money means achieving the optimal combination of benefits and costs, in delivering services users want. Many successful PPP programs require an assessment of whether a PPP is likely to offer better value for the public than conventional public procurement—often called value for money analysis. A value for money comparison can be done for a specific proposed PPP project. It can also be done at a program level for projects with common characteristics.
Value for money (VfM) analysis typically involves a combination of qualitative and quantitative approaches. Qualitative VfM analysis involves sense-checking the rationale for using PPP—that is, asking whether a proposed project is of a type likely to be suitable for private financing, and whether the conditions are in place for the PPP to achieve value for money (for example, that the PPP has been structured well, and that the project is attractive to private parties). This often takes place at a relatively early stage of PPP development.
Some PPP programs also require quantitative assessment of value for money. This typically involves comparing the chosen PPP option against what the project would look like if delivered through conventional procurement (what is known as the public sector comparator). This comparison can be made in different ways. The most common is to compare the fiscal cost under the two options. An alternative is to compare the two options on an economic cost-benefit basis—that is, to quantitatively weigh the expected benefits of a PPP over conventional procurement against its additional costs. This can be difficult to do meaningfully in countries with poor availability of benchmark data. In these situations, governments and their advisors should carefully consider the value of the qualitative approach.