Establishing Public-Private Partnership (P3) Agreements for Outsourcing

* NOTE: GFOA has an Advisory on Public-Private Partnerships alerting governments to the risks involved with these agreements.

Traditionally, the term “public-private partnership” refers to private or public-private projects that involve the use of public resources or financing to promote economic development. The term also refers to transactions that are essentially privatization efforts, in which a government entity enters into a long-term lease of a public asset, or a transaction aimed at privatizing or outsourcing services that a government utilizes or provides. These transactions present a fundamentally different set of opportunities, risks and concerns than what is otherwise evident within customary P3 agreements.
The use of P3 agreements for outsourcing involves multi-faceted decisions at several stages as to how to best promote the public interest, including determining feasibility, fully negotiating agreements, assessing performance, and resolving concerns. Significantly, P3 agreements involve a substantial shift in duties away from government and therefore require considerable coordination. Each transaction is inherently complex, and requires estimating the cost of service delivery; measuring service levels; selecting the most competent provider; ensuring equity, fairness, and transparency; addressing technical concerns; and ensuring accountability.

For governmental entities, successful partnering requires an understanding of a transaction’s risks and benefits for both parties and sufficient knowledge of potential service providers to assess their capabilities. For the public entity, outcomes need to be realized while financial risk is minimized – the public benefit should at least justify the public cost. For the private entity, the project must provide an appropriate return related to the level of resource investment and/or risk that is involved. Often times, expected savings fail to materialize, particularly when outsourcing initiatives are not planned or administered effectively. Though many arrangements achieve their objectives, others are neither profitable nor efficient, and most are more difficult to implement than originally anticipated.

Most outsourcing initiatives are driven by a government’s financial needs or constraints. Accordingly, the finance officer is well-positioned to function in a lead role upon the team exploring privatization. Recognizing that such arrangements involve not only public-private entity agreements, but also intra-governmental decisions that include complex analyses, the finance officer acts as a communicator and interpreter of financial results to elected officials and the general public.

The following list acts as a guide to help conduct a comprehensive examination of issues that must be addressed before, during and after an opportunity is determined to be viable and prudent. The list emphasizes that a great deal of due diligence must be completed prior to the execution of an agreement, since these decisions may have significant and long-lasting ramifications. Actions that should be taken, and issues for which procedures should be established, include:

  1. Analyze Motivations for Outsourcing. Typically, there are several reasons to consider outsourcing: cost savings, improved performance, increased responsiveness, and reduced financial obligations. But feasibility, costs and benefits cannot be fully evaluated without clarity of purpose. Informed determinations depend largely on a thorough understanding of the rationale that supports consideration of a particular outsourcing initiative.
  2. Assess Initial Plan & Scope of Project. Most often, the private sector can deliver efficiencies when the task being sought is well-defined, easy to measure and subject to competition. An adequate cost assessment necessitates a thorough understanding of the project’s scope. When decision-makers are clear about objectives and expected outcomes, they are better positioned to plan major processes, tasks, and milestones, as well as identify associated costs.
  3. Evaluate for Consistency with Priorities, Plans & Policies. P3 agreements should be consistent with the strategic plans, master plans, and financial policies of the organization. In addition, the organization should evaluate project objectives and determine if participation is consistent with the governmental entity’s overall vision and mission.
  4. Identify Unmet Staff Competencies. Early in the process of analyzing a proposed “partnership”, the finance officer should assess the nature and degree to which any outside consulting or financial services may be necessary, in order for the governmental entity to analyze or negotiate a transaction. With many outsourcing initiatives, in-house staff will be able to complete the necessary analysis. More complex outsourcing opportunities may require the use or subcontracting of more specialized resources, including legal counsel, industry experts or independent financial advisors.
  5. Conduct a Feasibility Analysis. Public entities should complete feasibility studies to determine if potential opportunities are viable from both a short- and long-term perspective. The finance officer involved in such analyses should work to promote full disclosure, and ensure that recommendations regarding participation do not result in excessive risk to the public. Statutes, regulations, taxation issues, labor contracts, and intergovernmental partnerships may all have implications for assessing feasibility. Additionally, the interests of stakeholders and key constituencies should be understood and acknowledged. Preparing a comprehensive list of issues will help guarantee that outsourcing opportunities are beneficial to the public, as well as prospective private entities.
  6. Determine Fiscal Impact. A cost analysis of a service that may be privatized must be performed to determine what such a service should actually cost the government. This appraisal, based on estimates that include all related expenses, is critical towards assessing if proposals are realistic and reasonable. It is also imperative to understand the services offered by potential providers, and the underlying concepts and technologies associated with such proposals. Comparisons between internal and external options should involve a consideration of likely transaction costs, including data gathering, contract negotiation, performance monitoring, and contract review or amendment.
  7. Determine Service Level Impact. Potential partnerships must also be evaluated to determine if existing or expected service levels will be impacted by the decision to privatize. Any direct or indirect impacts on existing services should be carefully considered and entirely disclosed in connection with a government entity’s consideration of any outsourcing opportunity. Within the evaluation process, the privatization agreement should also include appropriate enforcement features to promote service quality and compliance with all applicable standards and requirements. 
  8. Analyze Other Alternative Arrangements. A full array of service delivery options should be considered, so as to ensure efficient pricing and informed decision-making. Alternatives might include delivery in-house or by another unit of government, contracting with non-profits or for-profit institutions, or service provision through a hybrid arrangement. In order to compare such alternative options, decision-makers will require complete cost, benefit, and performance data for all functions and services that may be subject to potential outsourcing.
  9. Analyze and Promote a Competitive Market. In order to realize efficiency gains through outsourcing, government entities must ensure that the solicitation process is both competitive and transparent. Accordingly, finance officers should gather pertinent information about the capabilities, expertise and past performance of potential partners, and tailor contract specifications so as to attract a significant number of quality proposers. A method for evaluating responses, assessing financial strength and selecting the winner should also be established, and include clear criteria that can be appropriately weighted or ranked.
  10. Institute Clear and Effective Contract Requirements. Outsourcing agreements should reflect an organization’s goals and mission and establish specific expectations, roles, and responsibilities. Contract management and enforcement require a significant degree of discipline and expertise, and can lead to costly uses of staff time or other resources that are often difficult to quantify. Contract provisions should balance the need for specificity and flexibility with opportunities for adjustment. An agreement’s term should provide appropriate consideration to any necessary investments, while also accounting for risk tolerance, past performance, and the cost of rebidding.
  11. Assess Potential Performance Metrics. P3 outsourcing agreements must include standardized metrics (e.g. milestones, service level expectations, output measures) so as to establish a basis by which performance can be both measured and assessed. The finance officer, in particular, can assist in this process by incorporating suitable accounting, auditing and financial reporting standards into a privatization agreement. Provisions should also be established to insulate any contract evaluations or disagreements from undue political influence, and to address any concerns regarding future ownership of data or intellectual property.
  12. Ensure that Outsourcing Considerations are Open, Public & Transparent. When a government entity considers whether to outsource or privatize a particular function or service, it is imperative that the deliberation process allow for adequate input from key stakeholders affected by such an initiative. A thoughtful and well-designed process that encourages a range of input from vendors, employees, elected officials, citizens and other parties helps ensure that potential issues or problems are identified before solicitation or contract finalization occurs. An open process also helps educate stakeholders and decision-makers on the details of a particular outsourcing initiative, and allows the initial project scope or proposed agreement to be continuously improved and refined.