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7.4 Governments as Alliance Partners in PPP Infrastructure Businesses

So far we have examined alliances between private corporations. This section analyzes the issue of partnering with local governments as a means of expanding globally. Using the example of PPPs, which mainly deal in infrastructure-related projects, such as roadways, railways, and waterworks, we summarize the salient features of partnering with governments and the management involved in such partnerships.

In Chap. 5, we discussed the systems integration business in the context of infrastructure exports. For example, providing rail transportation services for people and freight requires the knowledge of signal systems, railcar management, and other operational factors, in addition to hardware infrastructure such as rolling stocks, railways, and stations. This, in turn, requires the creation of an overall consistent system that combines all of these elements, which are fine-tuned to function with all other parts. In addition, we discussed the necessity of systems integration, focusing on technical peculiarities to build such a large-scale system. In this chapter, we focus our discussion on the organizational aspects of managing actual operations, in particular, the partnering of public and private sectors to facilitate a successful venture.

Figure 7.2 presents a typical PPP business organizational structure. First, the government or public institution (in the case of railways, a business management agency such as a nationalized rail company) is the primary entity behind the public works service. The government (or public institution) enters into a PPP agreement with a special purpose company (SPC) established specifically for the purpose of maintaining the infrastructure—here both public and private entities manage the business. One form of PPP agreement often used is the build, operate, and transfer (BOT) method. In such a method, the government subcontracts the building and operation of infrastructure, after which the private company transfers ownership of the infrastructure back to the government once the business is complete, over an extended period of 30–40 years. The business is operated according to the agreement entered into with the government, thus providing rail or other public services to ordinary users. The company is subject to safety regulations, fee approvals, and other forms of oversight. Many SPCs involve joint ventures with multiple companies, in which an investment company provides the capital and the banks provides the project finance. In addition, the SPC orders construction services and equipment from construction companies, equipment manufacturers, and other suppliers to create the infrastructure. On the project's entry to the business operation phase, the SPC subcontracts business management to specialists. Infrastructure companies such as Alstom and Bombardier in the railway business, and Veolia and Suez in the waterworks business are suppliers to specialty firms such as equipment manufacturers and business operation specialists; these infrastructure companies are often SPC investors.

When providing infrastructure and public services, the government (or public institution) normally places orders directly with suppliers in the form of public works projects, after which public institutions such as national railway or highway companies operate the infrastructure. However, in PPPs, capital procurement and operational risk are shared by both parties, and performance is often improved. Particularly in emerging countries, infrastructure demand exceeds public funding, and government agencies lack the necessary experience to operate the businesses. Thus, PPPs with their private specialty technology and knowhow are analyzed with high expectations. PPPs are a form of alliance between public and private sectors. Note that this is different from the subcontracting and outsourcing shown in Fig. 7.1. In the case of public works projects, the government decides the infrastructure specifications, and private companies place bids for the business, making these projects similar to outsourcing or subcontracting. In comparison, PPP agreements promote innovation within private companies in the process of infrastructure creation through business operation. Such a framework is created with the intention to increase public services' return on investment (ROI). This does not imply that governments completely allocate the provision of public services to private companies. The government must ultimately provide a stable, high-quality service to citizens, and monitor the activities of private companies, while being involved in the operation of the business as required. Alternatively, where continuing a business led by private companies has become difficult because of unforeseen changes in the economic environment at the time when the PPP alliance was created, government institutions can support the business itself through policy benefits and funding. Between public institutions that aim at increasing public welfare and for-profit private corporations, there are, to a certain extent, contradictions in policy in the operation of the business, but ultimately, creating a relationship of trust between public and private sectors to establish a win–win situation is critical. This feature has a lot in common with alliance management between private companies.

There are general risks in the construction and operation of infrastructure projects, such as economic changes and disasters, as well as business-specific risks such as construction delays or a decline in the number of users. On directly operating the business by a country, these risks fall on the country itself; however, in case of a PPP, the risk is shared between public and private sectors. The value added of PPP businesses arises from risk-sharing optimization. Figure 7.3 summarizes the various risks associated with infrastructure projects that are to be assumed by government (or public institutions) or the main driver of the business—the SPC. The overall project is divided into the infrastructure creation stage (engineering, procurement, and construction, (EPC)) and service stage (operation and management, (O&M)). In the EPC stage, the government assumes the risk of land acquisition and delays in administrative procedures. First, system design occurs before the EPC stages. This design is formulated by specialists and is based on the government's business goals in terms of the public service, its scope, and service levels. The risk of design deficiencies is, of course, borne by the government. On the other hand, capital procurement for EPC is done by the SPC, and finance risk should be borne by the private sector. As for procurement and construction, necessary work should be given to equipment manufacturers and construction companies. For example, construction risk, such as delays in construction, should be borne by the private sector (the SPC and subcontracted construction company).

Once the infrastructure is in place, projects enter the O&M stage, with risks of administrative procedure delays, which push back the launch of services, and political risks that originate from regulatory and policy changes during the term of the PPP agreement. Therefore, these risks should be borne by the government. On the other hand, the SPC that operates the business should undertake the responsibility

Fig. 7.3 Risk sharing between public and private entities

of stably providing a certain level of service during the term of the PPP agreement. To do so, the management of the infrastructure service may be contracted to a specialty company, in which case the risks in that agreement should be borne by private companies. Asset and technology obsolescence and financial risk should be assumed by private companies in principle. In the O&M stage, depending on the businesses, both public and private sectors must consider the optimal sharing of risk. For example, the risks of inflation or disasters cannot be controlled by either public or private entities. It is normal for both parties to clearly delineate how these risks are to be shared in the PPP agreement. Furthermore, using disaster insurance externalizes disaster-related risks, and the fees can be added to the operating costs of the business. Off-take risk (from users) is important during the O&M stage. However, the risk size depends on the nature of the infrastructure. For example, governments or public institutions enter into long-term service acquisition agreements for wastewater treatment businesses because, generally, the amount of wastewater to be treated does not overly fluctuate, thus creating a marginal off-take risk. On the other hand, in a railway business, the number of passengers, as well as long-term changes in them, cannot be accurately forecasted. In addition, fares must typically be approved by the relevant government agency; therefore, it is likely that such fares will be offered at subsidized rates—typical for a public service. Accordingly, these kinds of services have a high off-take risk. The off-take risk in railway services can become too large, and it is typical for governments to undertake a certain amount of risk as part of the PPP agreement, with provisions for government subsidies on fares when the number of expected passengers drastically falls (so-called ridership clause).

Emerging countries do not often have a legal code governing PPPs, and government agencies lack such knowledge. This sometimes causes negotiations for agreements and business operation to go awry. There are also great political risks due to agreements being trashed by political instability or regime changes. These political risks must be accepted as part of conducting business for private companies overseas, and are likely to be the greatest risk factor in the infrastructure business within emerging countries. However, PPP businesses must not exclusively be perceived as businesses between governments and private companies; there is an analytical framework that accounts for the intent of service recipients, such as civic action in the partner nation (Kivleniece and Quelin 2012). This framework treats civic actions referred here as a force that confronts political risk with a bias toward the government's objective of maximizing public interests in politicians' election cycles. In democracies such as India, where one can relatively depend on the power of civic action, it is possible to minimize political risk by providing quality public services to local residents. Corporate social responsibility (CSR) activities are another effective means to this end.

That said, in emerging countries with little government experience in PPP businesses, one cannot depend on risk sharing, as shown in Fig. 7.3. Generally, in these cases, it is appropriate to have an agreement that offers a high degree of independence to private operators, which, to the extent possible, does not allow interference by the partner government through monitoring of the business. However, in such a case, the private company must bear a larger share of risk. Accordingly, the needs may be high for PPP businesses in emerging countries, but in reality, the risks are too high for private companies to independently undertake, and therefore not many companies enter the infrastructure businesses in these countries. Japanese companies, in particular, have a strong track record as equipment suppliers, such as water treatment membranes for water projects and train cars for railway systems, but have not participated as operators of these businesses. Infrastructure exports have been prioritized in the government policy and measures have been taken to strengthen the trade insurance system and utilize official development assistance (ODA). However, conducting risk analysis for projects or countries and painstakingly negotiating the required risk sharing with the partner government agencies is what is required the most. In doing so, companies must select businesses that are in high demand in specific countries to develop compelling proposals that have merit for these countries too. It will also be effective to partner with local companies or companies in countries, such as Singapore, that are working actively on expanding infrastructure businesses in India and China.

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