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close this bookWater for Urban Areas (UNU, 2000, 243 p.)
close this folder7. The role of the private sector in the provision of water and wastewater services in urban areas
close this folderPreparing for a private sector venture
View the document(introduction...)
View the documentPre-contract analysis
View the documentChoosing among the options
View the documentMaking sure that the desired option is of interest to the private sector
View the documentFinding and contracting a suitable partner

Finding and contracting a suitable partner

Once a decision has been made on a feasible and appropriate option, the next task is to find and contract with a suitable private sector partner. Generally, the most effective way to do this is to require prospective partners to compete with one another to win the contract. The extent to which competition for a contract can be achieved - and the extent to which this competition translates into the best possible outcomes for consumers - depend on how well bidding is organized and managed. Several discrete steps are involved: the preparation of the bid documents, which communicate to prospective bidders the nature of the contract and the information on which to base their bids; organization of the bidding process and the way bids are evaluated and the contract signed; and selecting the private sector firms to submit bids.

Bidding documents and information for bidders

Based on the information prepared and decisions made during the pre-contract analysis, documents need to be prepared that clearly convey the information on which prospective operators and investors are asked to submit a proposal. The nature of the information to be provided depends of course on the option chosen. For a fee-based service or management contract the information requirements are relatively simple. Such a contract places little risk on the contractor. It could be bid much like a technical assistance contract, with the contractor's experience, proposed work programme, staffing, and cost as the basis for bid evaluation.

Long-term contracts, leases, concessions, and BOTs are usually awarded to the bidder proposing the lowest future tariff levels. For these kinds of contract, the operator/investor is running considerable risk when agreeing to a tariff arrangement that is to last for years. This risk can be reduced by having good information available that allows contractors to prepare their offers with good knowledge of what is to be expected. The more risk is involved, the higher is the need for good and reliable information. The better the information, the higher is the chance of concluding a contract that is realistic and responsive to both the government's and the public sector's requirements. The higher the risk is perceived by the contractor, the higher will be the price. If the risk is too high, the private sector may not be willing to get involved at all. For longer-term contracts, the bidding package should include the following information: (a) technical in- formation: a detailed description and assessment of the existing facilities and asset analysis, improvements to be obtained under the contract in terms of service improvements and performance standards, and an estimate of capital expenditures; (b) legal and regulatory information: a clear definition of the legal and regulatory system under which the contract will be done and the provisions that will be covered under the contracts; (c) economic and financial information: demand projections and willingness-to-pay analysis, policy on tariffs and tariff structure, the proposed capital structure of the deal - in short, all the information that prospective contractors/investors would need to perform their own financial analysis and forecasts; (d) human resources information and the policy to be implemented by the contractor; (e) the rules and scoring mechanisms that will be used to evaluate bids and deal with complaints and appeals; and (f) a timetable for bidding, evaluation, and award.

Operators/investors bidding for long-term contracts that require a financial commitment will carry out their own analysis. The less confidence the private sector has in the veracity of the information provided by the public contracting entity, the more exhaustive and time consuming this analysis will be. For large contracts involving decisions on hundreds of millions of dollars, private partners may spend several million dollars in making their own assessment of all aspects of the future project to make sure that their offer is based on a realistic understanding of the task at hand and the risks involved. These costs can be reduced by having good and reliable information available to bidders and limiting the number of bidders invited.

Organizing the bidding

Experience suggests that the best way of finding a suitable partner at a reasonable cost is to require competition among prospective partners. There is a variety of possible contract bidding and award procedures, which can be grouped into three categories: competitive bidding; competitive negotiations; and direct negotiations. Each has its advantages and disadvantages.

A competitive bidding process involves a formal, public process for presenting proposals, evaluating them, and selecting a winner. Its main advantage is that it ensures transparency, provides a market mechanism for selecting the best proposal, and stimulates interest among a broad range of potential partners. It works best where outputs are standardized and all technical parameters can be clearly defined. To avoid misunderstandings and avoid underbidding, the quality of information must be high, an undertaking that is often difficult given uncertainties and the long time-frame - 20-30 years for a concession - involved. Also, direct competition limits the scope for the presentation of innovative proposals that deviate from the base requests made in the bidding documents. These issues do not mean that competitive bidding should be avoided, however, but particular attention should be paid to providing good-quality information to potential bidders and to the detailed design of the bidding process.

If competitive negotiations are used, the government invites proposals from selected bidders to meet specific service objectives. After review of the proposals based on their technical merit, the government negotiates contract terms and conditions with a small number (usually two or three) of selected bidders. This involves simultaneous negotiations with these bidders. Competitive negotiations are well suited to projects in which many technical variations are possible and the contracting entity wishes to explore different and creative proposals without being bound by the standard solutions that a competitive bidding process would require. They offer a richer means of considering other factors than price. Competitive negotiation has some risks, however. It is less transparent than competitive bidding and may raise concerns about corruption and favouritism. The government can reduce the risk of any impropriety by specifying publicly, and as clearly as possible, what the evaluation criteria will be, by standardizing the negotiation processes across bidders, and by keeping a detailed record of the process.

Direct negotiations occur most often where a project idea originates with a private sector sponsor rather than with the government. A developer or operator seeks to negotiate directly with a government or a public utility the terms and conditions for a management contract, BOT, or concession. Direct negotiations can be a good way of attracting innovative projects and securing private sector involvement in smaller cities and towns where the costs of entering competitive bidding contests may be high relative to the expected returns. But direct negotiations make it difficult to ensure transparency in the selection process and an efficient outcome. Without competition, it is much harder to assess the reasonableness and cost-effectiveness of a proposal. And direct negotiations, even more than competitive negotiations, can be associated with corrupt and improper behaviour of the public agencies carrying out the negotiations. Allegations of improprieties, whether they are well founded or not, can lead to resistance from key stakeholders and in the extreme to the eventual cancellation of the contract. If direct negotiations are contemplated, governments must take extra steps to ensure transparency and efficiency. For example, a government might establish an independent advisory panel to advise on whether direct negotiations are appropriate for a particular project. It may require all contracts to be reviewed by a national or regional regulatory entity that may use benchmark comparisons of construction costs or service tariffs to assess the efficiency and appropriateness of the negotiated deal.

In general, the more competitively and transparently the selection of the private partner is conducted, the greater is the likelihood that the best possible deal will be achieved and that the deal will be politically sustainable. For these reasons, most governments - and also multilateral agencies such as the World Bank - favour or require competitive bidding for private sector contracts. Many countries have laws that explicitly forbid direct negotiations. However, it should be recognized that there may be circumstances that make it difficult to achieve perfectly competitive bidding. If information is incomplete, for example, or there is a range of possible solutions to the service problems the government is trying to solve, the government may wish to enter into a dialogue with potential bidders to work out how best to specify the contract. This approach does not preclude competition, but it does reduce transparency and the chance that bidders will be able to bid on equal terms. Direct negotiation is clearly less preferable than competitive bidding, but in some situations it may be a feasible approach. For example, the costs of competitive bidding can be so high relative to the expected revenue stream from small contracts as to deter bidders. In these cases, governments ready to undertake direct negotiations would be well advised to employ special safeguards, processes, and auditing procedures to ensure that the best possible partner is found on the best possible terms, and that the resulting contract will stand up to political and technical scrutiny.

Pre-qualification of bidders

Pre-qualification is strongly recommended for all types of contract options as a way to ensure that potential bidders have the technical and financial capacity that the task demands and a track record in performing similar tasks. It is important to weed out firms that clearly do not have the capacity to take on the job before they prepare costly proposals; once they have entered the evaluation process, they may bring political connections to bear to win the job. Reducing the number of bidders also reduces the cost of preparing proposals, which, as outlined above, may be several million dollars for large projects involving the provision of substantial amounts of private capital. Limiting the number of bidders will increase a private firm's incentive to participate in the bidding, because it increases each bidder's chance of winning. Faced with a dozen competitors, some of them with questionable credentials, most qualified firms may choose not to participate in the bidding.

Pre-qualification criteria generally include some combination of: financial capacity; relevant experience; and past record on similar ventures. The criteria for evaluating firms participating may be either qualitative or quantitative. Qualitative criteria allow greater flexibility and discretion, but they are also less transparent and more likely to produce complaints by bidders that fail to pre-qualify. Again a balance needs to be struck to ensure a fair and transparent process. In defining pre-qualification criteria for water and sanitation contracts, governments need to keep in mind that the number of private companies with substantial experience in providing water and sanitation services is relatively small. Few firms today meet stringent and ambitious pre-qualification criteria. To broaden the range of potential bidders, governments may consider firms other than water and wastewater operators. For example, a telecommunications company or a company with experience on the commercial side of electricity distribution might be able to handle the commercial side of a water business when paired with a company with engineering expertise in the sector.

Pre-bid contacts with bidders

In deciding what form a private sector arrangement should take, governments may want to know early on the opinion of the private sector. For example, a government might want the private sector to make large investments in new capacity and take all the commercial risks associated with them - only to find that the private sector judges the risk to be too high. Or a government might assume that local circumstances are so unattractive that the best it can hope for is a fixed-fee management contract - and unknowingly preclude initiatives by private companies that would be prepared to take more commercial risk. To avoid these misunderstandings it is generally a good idea to have informal discussions with bidders before finalizing the bidding documents. Bidder feedback on early drafts of the bidding documents or regulatory design can help identify changes that would make the transaction more attractive to private firms with no loss to the government or other stakeholders - and result in better, more affordable bids. The government must assure, however, that all prospective bidders receive the same information, to avoid complaints that some bidders were favoured over others.

Bid contents and evaluation

Central to the bidding process are decisions about what (pre-qualified) bidders should be asked to include in their bids and how these bids should be evaluated. Traditionally a two-stage bidding system is used, requiring bidders to submit a technical envelope and a financial envelope.

The technical envelope may have various purposes varying in complexity and transparency. In the simplest case, the technical envelope contains legal certification of the bidding consortium and a bid bond. Once these items have been confirmed, the financial envelope is opened and the contract is awarded to the best offer. In a second approach, the technical envelope serves some of the purposes of pre-qualification - if pre-qualification has not taken place earlier - and provides technical and financial information on the bidder. Some bidders may be disqualified once this information is assessed. The financial envelopes of the surviving bidders are then opened, and the contract is awarded to the best offer. These two approaches are relatively simple and transparent. They tend to work well when technical requirements can be specified. A third approach requires bidders to include a technical proposal that sets out the proposed business plan (including investment and financing plans) for meeting the service objectives. The plans are reviewed for consistency with the project specifications and requirements, and proposals either pass or fail. Again, the contract is awarded to the surviving bidder with the best financial bid. This approach was used for the Buenos Aires water concession. Under a fourth approach technical proposals are required as in the previous case but, rather than passing or failing, the proposals are scored. The financial proposals are also scored, and the contract is awarded on the basis of the weighted technical and financial scores. This approach was used to allocate freight rail concessions in Argentina. These latter two approaches are more complex and less transparent. They may be preferred when the technical criteria cannot be clearly specified in advance and when the government is looking to bidders to present their own ideas on how to achieve service objectives. The third approach might be chosen if the government has firm and clear ideas on the minimum technical requirements; the fourth if there is less clarity about requirements, and if different technical proposals may have different financial implications at different stages of the project's life. For these more complex approaches, the government should specify as clearly as possible and in advance the processes and rules that it will use for evaluating bids.

The financial envelopes provide information on the financial conditions under which the operator/investor offers its services and bids are awarded. They also vary in form and complexity, depending in part on the form of private sector participation. For management/service-type contracts, bids are awarded to the bidder that quotes the lowest service fee. For concessions or BOTs, the financial envelope contains the bidder's proposed future service tariffs for which it would be prepared to enter into a concession or the take-or-pay fee for bulk supply. This approach was used, for example, for the Buenos Aires water concession. Bids may also propose an up-front payment in combination with future concession fee payments. This approach is appropriate for concessions and leases and was used, for example, in the Argentine freight rail concessions. The bid is evaluated on the basis of a weighting of the up-front payment and future fees. In the case of privatization involving the sale of shares or the divestiture of assets, bids present a price of the shares or assets being sold.

Complaints and appeals

The more complex a bidding process, the greater the chance that competition will be perceived to be unfair or that losers will question the choice of winner. The first-best solution to such problems, of course, would be to make perfect information available to all the bidders, have truly unambiguous bidding rules (the lowest price or tariff wins), and preclude substantive negotiations after the bidding contest. For obvious reasons this is rarely possible. The next-best solution is to structure the process as clearly as possible, ensuring that everyone has access to the same information, that bidding and evaluation rules are as simple as possible and are clearly explained at the outset, and that there are clearly defined limits on post-bid negotiations. But no bidding process, no matter how carefully structured, can eliminate the potential for complaints and appeals. Consequently, the government should create a mechanism for handling complaints, specifying: who will be responsible for hearing and arbitrating complaints and appeals; on what basis complaints and appeals will be heard; how complaints and appeals should be formulated; whether a fee will have to be deposited for each complaint to discourage frivolous complaints; and what the deadlines are for the receipt of complaints and appeals and their resolution.