As most PFI contracts span a period of 20 to 30 years, they tend to have built-in provisions for periodic price realignment, based on market rates for similar services. Although the responsibility for managing this process rests with the contractor, the client must ensure that the contractor manages the process properly and that the post-realignment price offers value for money and opportunities for improved service.
Covering the principles and pitfalls of PFI benchmarking and market testing, this article provides you with 10 key lessons on how to make PFI benchmarking and market testing work to your advantage by adjusting service provision to your current needs and while keeping costs in check. For ease, we’ll use the term “value testing” as shorthand for both benchmarking and market testing.
PFI Benchmarking and Market Testing – Why is it Important?
Most PFI contracts include value testing clauses which set out the procedure for aligning the cost of different services with market prices. These are often seen as an opening for the contractor to rack up prices. However, if used effectively value testing can:
- Be the ideal opportunity to implement service changes that are needed and achieve related cost reductions
- Give better visibility of the contractor’s costs, which will help with evaluating the benefits of reshaping or cutting services in the future
- Re-align costs to real market value and satisfy end users that costs are reasonable, especially if they see that the contractor’s costs are robustly challenged
- Help keep the cost of implementing service changes in check.
The Difference Between Benchmarking and Market Testing
As a first step towards taking control of benchmarking and market testing, you need to understand what they are and the difference between them.
Benchmarking means the contractor comparing its costs with the market priceof equivalent services. If the market price is shown to be above or below the current contractual costs, the price will be adjusted up or down, unless the client chooses to proceed to market testing. It is a comparison of like with like and is difficult to apply if the specification is changed. If,therefore, the client wants to change the service specification as part of value testing, it will need to instruct the contractor to proceed to market testing, regardless of the outcome of benchmarking.
In some of the later PFI contracts benchmarking has been scrapped, with market testing left as the only value testing mechanism.
Market Testing means re-tendering by the contractor of the relevant service. Any subsequent increase or decrease in the cost of the service should be reflected by an adjustment to the unitary charge.
The scope of services subject to value testing differs widely between different contracts, but in the majority of cases it includes only soft FM services (i.e. cleaning, caretaking, grounds maintenance, etc.). If the client has concerns about VFM of services which are not subject to value testing, or wishes to remove them from the contract, there are other contractual provisions for service and cost review and amendment, which will be the subject of future blogs – to subscribe, please click here.
Take note…
It is worth noting that in some PFI contracts, particularly the earlier ones, contractors have under-priced value tested services in order to win the contract. In such scenarios, the contractor expects to recover its costs in due course through an increase in the unitary charge following the first value testing process. It is important, therefore, that the client ensures that the contractor’s existing costs are independently verified, as well as those prevailing in the market.
How to Get the Services You Need at Reduced Cost
As previously mentioned, we have 10 tips to help you get the services you need at reduced cost through the process of Benchmarking or Market Testing, as follows:
Benchmarking
1. Be prepared:
- Ensure the timing of value testing is set out in the Monitoring Calendar
- Ask FM managers of similar non-PFI assets and PFI managers in other client organisations, particularly organisations with the same PFI contractor, to provide figures for what they pay for the same services. Alternatively commission an independent benchmark report to get a sense of how the service costs compare against the market and what is acceptable in terms of cost increases or decreases, following value testing
- If the value testing provisions specify that either party needs to inform the other that it wishes to go ahead with value testing, ensure that a formal notice is issued by the contractual deadline.
2. Require the contractor to commission an independent benchmarking report from a reputable, specialist company and interrogate the report carefully to ensure it compares like for like services and costs and that there are no assumptions (e.g. regarding volume or scope) that are out of sync with the actual service provision.
3. Before agreeing an increase or decrease in costs following benchmarking, it is important to check that:
- Any contractual ‘buffers’ (i.e. that only those increases and decreases beyond a given percentage result in a change in the unitary charge) are taken into account
- Any formulas for calculation of cost adjustments are applied correctly
- All the costs are presented at base prices and indexed correctly for invoicing purposes.
Market Testing
4. Consider in advance what services you may wish to change and consult with stakeholders on client and contractor side on the proposed changes. End users should be consulted on the proposed changes in the first instance, as this will help secure their buy-in to the outcome of market testing and to re-shape the services to meet their needs.
Linking service changes with market testing means the contractor will be more engaged in the review of proposed changes. This will help to ensure these are viable and not too expensive to implement. It is worth bearing in mind that the contractor will have little incentive to suggest or support changes that reduce its profit margins, but on the other hand will be likely to favour a reduction in or exclusion of services that are unprofitable or risky for it to deliver. It is, therefore, advisable to engage consultants with experience of negotiating service changes with PFI contractors to get an independent opinion on the viability of the proposed changes, as well as ideas for additional cost-saving options.
5. Ask the PFI company to commission an independent third party to manage the tender process and ensure it is advertised properly, with market warming and early notices to prospective bidders. Where a third party is not engaged to carry out this role, insist that the process is managed by the PFI company and not by the FM contractor, which will have a conflict of interest as a potential bidder. If the FM contractor or a member of its group of companies has directors on the board of the PFI company, ask for them to be excluded from market testing-related activities (apart from their role as a bidder) and from taking part in any related decisions.
6. Ensure that a client representative has a view of the full tender pack and has a say in the specification and the evaluation criteria and weightings
7. Ensure that the client is represented on the evaluation panel. If client personnel have no experience of market testing, engage an adviser with PFI-related tendering experience to represent the client’s interests. This will help ensure that the selected bidder provides the best price while adhering to the service specification.
8. The complexity of PFI contracts and their robust availability and performance provisions deter many potential bidders, so it is not uncommon for there to be only one tender submission, from the incumbent provider. If that is the case:
- Review the market testing provisions in detail to see if the client has the right to require a re-tender
- Review the service specification, to see if it can be made more attractive to the market
- Interrogate the incumbent contractor submission, to ensure that the costings accurately reflect actual provision and any changes made by the client to the service specification.
9. If the scope of the tendered service has been changed, ensure that any implementation costs, including legal fees, are agreed prior to accepting the market testing outcome. With the contractor keen to get market testing signed off, such fees are likely to be much more reasonable if agreed at this stage.
10. Insist that the PFI company re-runs the financial model to reflect any adjustment in service costs following market testing and that any changes from the original unitary charge profile are reflected in the client’s affordability model and payment profiles held by the finance team.
For support and advice on managing value testing, including:
- Independent benchmark of current service costs
- Service specification review, including stakeholder consultation, to align services to client needs and reduce scope and costs
- Review and challenge of contractor benchmarking reports
- Review of market testing tender pack
- Client representation on the tender evaluation panel, to secure the most economically advantageous deal for the client
- Negotiation of implementation fees for any service changes
- Interrogation of the amended financial model and payment profile to ensure agreed cost changes are accurately reflected
Contact us on T. 0845 345 0130 or email Vicky vladizhinskaya@bestpracticegroup.com to arrange an informal, no obligation discussion.
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