Student becomes teacher

From a US perspective, where some states still employ the ‘design-bid-build’ method to procure infrastructure projects, the unbundling and tendering of separate contracts has been seen by many as a bad idea.

Yet this appears to be what Industry Super Australia (ISA), an organisation representing superannuation funds, proposes through the ‘Inverted Bid (IB)’ model, which it has developed in collaboration with fund manager IFM Investors.

The rationale behind the proposed model is that long-term equity investors need to be brought in at the initial stage of procurement of greenfield infrastructure projects, replacing short-term equity investors whose interests are allegedly not aligned with the long life-cycles of infrastructure assets.

Under the IB model, the government agency procuring a project tenders initially for the long-term owner-operator. The long-term equity investor selected as owner-operator then launches three separate bids for construction, operations and management, and debt finance, in effect becoming manager of the project.

According to the ISA, changing the existing model will speed up the procurement process, reduce costs and level the playing field, allowing smaller contractors to participate which cannot afford to do so under the current model.

Many industry insiders, however – not only in Australia, but in the US and Canada as well –are skeptical.

“How can long-term equity be priced before the construction and debt funding costs are known?” one source asked in conversation with Infrastructure Investor.

Furthermore, long-term equity investors have long been unwilling to take on construction risk. The new model would not change that. As for those investors which have no fear of cost overruns and time delays related to construction, there is nothing preventing them from bidding as long-term owner-operators under the existing model.

While the IB model would indeed open up the playing field to smaller construction companies, one P3 expert pointed out that “perhaps companies that can’t afford to participate in the current process shouldn’t be bidding for these types of projects in the first place”.

Speaking of competition, how many superannuation funds or other types of long-term investors have the capacity to step into the shoes of an owner-operator? Not many. Very few superannuation funds have invested directly in infrastructure and arguably most do not have the expertise or the resources to manage such complex projects.

It’s true that some short-term equity investors have made a killing by exiting projects early, but there are ways of addressing that.

In the US, for example, the public sector is looking for ways to capture the upside. One way is to not let the short-term equity investor exit before a specified amount of time or allowing them to exit only under certain conditions that will be negotiated upfront.

In Canada, the procuring agency consults with the long-term equity investors, which provide significant input before the bid stage.

“By disaggregating all the pieces of the value chain and tendering them separately, you create inefficiencies,” one source said.

$1bn saving

A case in point is New York. Until three years ago, New York state used the ‘design-bid-build’ model. In 2011, however, it adopted the ‘design-build’ method for a three-year trial period. According to the New York Department of Transportation, costs for projects procured under ‘design-build’ dropped 27 percent.

The Tappan Zee Bridge, which at $4 billion is one of the largest projects in New York’s history, was procured under the ‘design-build’ model, but will still cost $1 billion less than the state anticipated thanks to the competition created by the bidding consortia. Under Australia’s proposed method, that competition would cease to exist.

While there may be room for improvement in how Australia procures its infrastructure projects, its proposed new model may not be the best way to do it. And that’s speaking from (US) experience.