PPP and concession structures

0:00 When the public sector buys a service, not an asset

Imagine a government that needs a new hospital. It could borrow, hire a contractor, build it and then run it for thirty years. Or it could sign a long-term contract with a private company that designs, builds, finances, operates and maintains the hospital, and gets paid only if the building is available and performing to standard. That second route is a public-private partnership. In this lecture you'll learn the main PPP structures, the difference between availability-payment and user-pays models and who carries demand risk in each, how governments test value for money, the fiscal risks involved, and the contract features lenders scrutinise most. By the end, you'll be able to sketch the right structure for a public asset in your region and explain the trade-offs to a sceptical minister or investor.

0:57 Why it matters

Why does this matter? Because PPPs commit public money for decades and use private finance, which usually costs more than government borrowing. The case for doing it rests on two things: private-sector discipline over the whole life of the asset, and genuine transfer of risks such as construction overruns and poor maintenance. But risk transfer only works if performance is clearly specified and measured, and if deductions actually bite. Badly designed PPPs can create large hidden liabilities, through guarantees and termination payments, and politically painful disputes. For finance professionals, PPPs are also where public policy, contract design and project finance meet most directly.

1:42 The concept: structures and payment

Here are the main structures. Design, build, finance, operate and maintain, or DBFOM, where the private party does everything over the contract term, common for hospitals, schools and roads. Build, operate, transfer, or BOT, where the asset goes back to the public side at the end, common for power plants and toll roads. Build, own, operate, or BOO, used in some independent power and water projects. And concessions, where the private party operates an existing or new asset and collects user fees. Then the crucial distinction: how the private party gets paid. With availability payments, the authority pays a unitary charge for making the asset available to specified standards, minus deductions for failures, so demand risk stays public. With user-pays, revenue comes from tolls or fees, so demand risk sits with the private party, financing is more expensive and gearing lower. Hybrids exist: minimum revenue guarantees, revenue sharing and shadow tolls.

2:48 Value for money and fiscal risk

Governments typically test whether a PPP offers value for money compared with conventional public procurement. A common tool is a public sector comparator: a risk-adjusted estimate of what the project would cost if the public sector delivered it. The PPP offers value for money if its risk-adjusted whole-life cost is lower, or its service quality meaningfully better. That analysis is sensitive to discount rates and to how risks are valued, so it should be transparent. PPP payments are long-term commitments affecting future budgets, and guarantees and termination payments are contingent liabilities that must be recognised and managed. Legal frameworks matter too. Pakistan has federal and provincial PPP authorities, Saudi Arabia has its National Center for Privatization and PPP, the UAE has frameworks such as Dubai's PPP law, the UK moved away from PFI and PF2 for new projects in twenty eighteen, and in the US, use varies with state legislation.

3:53 Worked example one: a deduction calculation

Let's walk through an availability deduction from the lesson, illustratively. A hospital PPP in the UK pays an annual unitary charge of twenty million pounds, indexed. The payment mechanism deducts for unavailable areas, weighted by importance: an operating theatre is weighted far more heavily than a storeroom. It also deducts for service failures. In one quarter, a theatre is unavailable for four days after an air-handling failure. The deduction is calculated exactly as the contract formula specifies: typically a daily share of the unitary charge, times the area's weighting, times the days unavailable, sometimes with escalating factors for repeated failures. Here's the key bankability feature. The SPV passes that deduction down to its facilities management contractor under a back-to-back subcontract. The SPV's CFADS, and therefore its lenders, are protected. The party that caused the failure pays for it.

4:53 Worked example two: a motorway concession in Pakistan

Now a user-pays example from the lesson, also illustrative. A motorway concession in Pakistan collects tolls for twenty-five years. Traffic risk sits with the concessionaire, which makes financing harder, because new-road traffic forecasts are notoriously uncertain. Lenders size debt on a conservative traffic case, not the sponsor's base case, and require a cash sweep if traffic outperforms, so their exposure falls quickly when things go well. To support bankability, the government provides a limited minimum revenue guarantee for the early years. That guarantee isn't free: it appears as a contingent liability in public finances, and a good fiscal risk unit will estimate its expected cost. So the same road shows every theme at once: demand risk, conservative sizing, structural protection and public risk-sharing.

5:46 Watch me do it: a unitary charge and deduction model

Let me show you how I model a payment mechanism for an availability PPP. First, the unitary charge: the base annual amount, times an index factor from the contract's base date, divided into payment periods. Then an area table: each functional area with its weighting, as defined in the contract schedule. Then an unavailability log: which area, how many days. The deduction for each event is the daily charge times the area's weighting times the days, with any escalation for repeat failures. Then a check against any cap on deductions in a period. Finally, the pass-down row: the share recoverable from the facilities management or O and M subcontractor under their contract. In the base case, deductions are small. In a downside case, I stress the number of failure days and check how much the SPV bears after pass-down. That residual is what lenders really care about.

6:50 Contract features and common mistakes

The contract features lenders and authorities scrutinise. The output specification: what service standards must be delivered, not how. The payment mechanism: unitary charge, deductions and indexation. Handback requirements: the condition the asset must be in at the end of the term, which drives lifecycle costs in the final years. Change mechanisms: how the authority can change requirements and how costs are compensated. Termination and compensation: what's paid on authority default, contractor default or force majeure, which determines lenders' recovery in a worst case. And refinancing gain sharing. The common mistakes: vague or unmeasurable output specifications, deductions not passed down to subcontractors, handback obligations ignored in lifecycle costs, underestimating how long public approvals take, and assuming a PPP is automatically off the government's balance sheet, when that depends on the accounting and statistical rules applied.

7:48 Recap and try this now

Let's recap. A PPP is a long-term contract where a private party delivers, and usually operates, a public asset, bears significant risk and is paid for performance. Structures range from DBFOM and BOT to BOO and concessions. Availability payments keep demand risk public; user-pays concessions transfer it to the private party, at a higher financing cost. Governments test value for money against a public sector comparator and must disclose long-term payments and contingent liabilities. And bankability depends on measurable outputs, deductions that are passed down back to back, and clear termination compensation. Your try-this-now: choose a public service in your region, perhaps a hospital, road or water plant. Sketch whether an availability or user-pays structure fits better, and why, including who should carry demand risk.