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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

(introduction...)

Governments interested in seeking a partnership with the private sector will have to choose from the many options available. These options can be implemented on different scales, with different combinations of functional responsibilities, and with different forms of regulation. The quality of the process of designing and implementing a selected option can determine whether or not the option will succeed. The challenge is twofold: (a) to define and develop the best possible arrangement appropriate for local needs and conditions; and (b) to find a suitable private sector partner for this arrangement and obtain the best possible offer from that partner. To reduce the risk of failure and get the most appropriate deal, the process is suggested to proceed in stages: pre-contract analysis; narrowing the choice to one or a range of feasible options; making sure that the desired option is of interest to the private sector; and acquiring the private partner and contract start-up.

Pre-contract analysis

Once a government has determined that private sector participation appears financially and politically feasible, a careful assessment should be undertaken before moving on to the next stage of choosing an option. Five main questions need to be answered:

1. What is the state of the existing utility?

2. How compatible is the existing regulatory regime with private sector participation?

3. How committed - or opposed - to private sector participation are key stakeholders?

4. Is the deal financially feasible for the private sector?

5. What are the main risks that need to be allocated or mitigated to ensure that private sector participation can succeed?

Assessment of the utility

The purpose of this analysis is to assess the current performance of the utility and the quality of information available about its management and operation and to identify those conditions that might make it attractive for a potential private sector partner. The government will need to gather - or identify as unavailable information on matters such as: the utility's present and projected service area; the current characteristics of the service (water quality, pressure, supply security, sewer flooding, or metering); a basic inventory of the assets and their condition and serviceability; human resources (numbers, skills, wage rates, conditions of service, pension arrangements); financial performance and tariffs (level and structure, subsidy arrangements, collection performance, disconnection policy); consumer preferences, affordability, and willingness to pay. The data collected in this evaluation will provide valuable information on the nature of the investment and related costs required to improve services, on potential efficiency gains that could achieved, on future desired performance standards, and on asset rehabilitation needs. A clear understanding of the utility's present performance is an essential condition for deciding on what form of private sector partnership would be desirable and feasible. It will also help to identify areas where data are lacking or may be inaccurate and lead to the conclusion that improving the data base may be necessary.

Regulatory/institutional analysis

The possible nature and effectiveness of a private sector arrangement depend on the regulatory mechanisms that will govern the private sector participation. Because any decisions about the private sector option, industry structure, and regulatory framework are closely linked, consideration of regulatory matters must be faced early on. Entering a private sector arrangement without an appropriate and effective regulatory structure can lead to costly mistakes and an acrimonious process to rectify matters later on. The objective of the analysis of regulatory issues is to: (a) identify elements in the existing broad framework of laws, constitutional requirements, and regulatory activities that could impede private sector participation or affect the viability of a specific option; (b) consider the potential for restructuring the present regulatory regime to open up the spectrum of options; (c) develop the sector-specific regulations that would govern the relationship between the public sector and the private partner; (d) help specify the powers that will remain in the public sector, identify who will exercise these powers and at what level of government, and create new regulatory arrangements as needed; and (e) decide which elements of regulation should be incorporated into the private sector contracts, how much the contracts limit the discretion of any public sector regulators, and what safeguards the contracts should contain against regulatory and political risk.

In assessing how the broad regulatory framework will affect the choice and design of a private sector arrangement and the attractiveness of that arrangement to the private sector, governments need to consider a wide range of laws and regulations related to: the constitutional and legislative division of responsibility for public services among national, regional, and local governments; inter-jurisdictional arrangements, if service responsibilities are decentralized and the system covers several jurisdictions; laws that govern private sector intervention in the provision of public services; water resource management and environment; labour; taxes; procurement of goods and services; currency control; public health and safety; and social policy.

Some elements of the existing framework cannot be changed or may take time to change. That may rule out a preferred option for private sector participation. If it does, it is best to recognize this early - and to adopt a stepwise approach to private sector participation that allows time to improve the general legal and regulatory framework. For example, if collection performance or requirements for providing subsidized services pose unacceptable revenue risks for the private partner, the best alternative might be to choose a private sector arrangement that reduces commercial risk by adopting a fee-based management contract type of arrangement. Or it might be possible to incorporate explicit safeguards into the contract - such as provisions allowing for additional payment for unexpected investments, protection from environmental liability, specified compensation or price adjustments for changes in service standards, and minimum revenue guarantees.

Stakeholder analysis

A range of stakeholders have a legitimate interest in the water business. Such key stakeholders and their potential support or opposition must be identified early. Stakeholders might oppose concessions or divestiture, for example, but accept management contracts, which give the private sector a more limited role. Or stakeholders might oppose any arrangement that has the private sector acting alone, but support joint ventures with the public sector. Generally these key stakeholders include: the national government (ministries with some jurisdiction over water-related matters, such as the ministries of health, environment, and urban and economic development); provincial and local governments that will act (or may act) as grantors of private sector contracts, regulators, partners, or financiers of the utility; regional or local planning departments, which coordinate land-use and infrastructure planning; other established regulatory entities (such as water commissions, environmental agencies, and competition and fair trade commissions); political parties and individual politicians; labour unions; utility management and staff; consumer organizations; and advocacy non-governmental organizations concerned with some aspect of utility conduct and operations.

Table 7.3 Potential stakeholder issues and policy responses

Stakeholder group

Possible issues

Policy decisions required

Ways to get inputs

Employees

Staff redundancies Changes in employment conditions

Redundancy packages and other arrangements encouraging staff to leave

Open and continuous consultations and negotiations with staff

Consumers

Consumers' preferences Willingness to pay

System for planning extensions Tariff methodology Design of a subsidy scheme

Social Assessment, participation, public relations/consultation campaigns

Environmental interests

Major environmental consequences

Environmental standards to be applied Liability for past pollution

Consultation with environmental groups

Existing government agencies

Major shifts in the allocation of responsibilities

Implementation of new regulatory system Redefinition of responsibilities among government agencies

Intensive consultation

Other citizens

Resettlement

Resettlement policy

Direct consultation with affected groups

Once the key stakeholders have been identified, government will have to engage in a dialogue with all of them to gain support or to defuse opposition to the proposed private participation. To bring these stakeholders on board, government may have to consider a variety of conciliatory actions or safeguards (table 7.3), which may include protection for: (a) labour and management through redundancy packages, worker share allocations, minimum wages and working conditions, health and safety measures; (b) contractors or suppliers through regulatory rules to ensure competition in subcontracting and procurement; (c) customers through tariff adjustment rules, subsidy policies, complaint mechanisms; (d) public health and environmental protection through regulation of service standards, penalties for default. Although such safeguards can secure sufficient support to allow private sector participation to proceed and to ensure that it benefits users, they all involve costs that need to be carefully considered.

Among the most important stakeholders are utility staff and unions. Often, improving the efficiency of management and operations and introducing better technologies and know-how can be achieved only by restructuring personnel policies and reducing a costly and bloated workforce. Unless the staff's fear of layoffs can be managed, government's initiative is probably not possible.

The example of Buenos Aires in Argentina shows how government could deal with labour issues. The public water company in Buenos Aires, like many around the world, was heavily overstaffed. It had 7,600 employees, or about 8 employees for every 1,000 connections -around twice as many as needed to operate efficiently. Under a preferred plan, 1,600 employees accepted voluntary early retirement on severance packages financed by the government at a cost of around US$40 million. Soon after taking over the operation, the concessionaire offered another voluntary early retirement programme. This offer was accepted by 2,000 employees, at a cost to the concessionaire of around US$50 million. Within six months of the start of the concession, the number of employees had been reduced by almost half. The cost of achieving this reduction was considerable, but it was viewed as an investment necessary to achieve the efficiency targets sought by the concessionaire. Today, many of the former employees are among the 8,000 or so small contractors now providing services to the Buenos Aires company.

Analysis of financial and tariff conditions

Perhaps the most critical issue in selecting a private participation option relates to financial concerns. Unless the private sector feels that the deal is financially feasible, it will not enter. Typically, the following questions must be answered: If the private sector partner is expected to invest in rehabilitating the system or expanding coverage, how will that affect the tariff? Will the current tariff cover costs after allowing for expected efficiency gains? If the projected tariff exceeds what some households are willing to pay, will the government provide subsidies? If not, could investment programmes be reduced to match the financial capacity of the consumers? Unless these issues are analysed seriously and realistically early on, much time and resources may be spent on options that turn out not to be financially feasible or not affordable. To find answers to these issues requires detailed financial work, including: assessing the financial status of the water and sanitation utility, and testing the financial and tariff implications of hoped-for service expansions and efficiency. Such financial analysis will narrow the options to arrangements that are feasible and sustainable.

Key parameters to be considered in this analysis include: (1) the utility's current operating and maintenance cost for water supply, treatment, and distribution, and for sewage collection and treatment; (2) current tariff levels and structure and collection efficiency; (3) current and projected water consumption; (4) the cost of capital improvements to the water supply, distribution, and sewerage systems, and annual expenditures necessary to achieve intended service levels; (5) the availability of funding for service improvements through grants, equity, and loans; (6) the additional annual operating costs due to system expansions, considering the efficiency gains that private operation might achieve.

Risk analysis

It is important for governments to recognize risks and to consider how they might best be allocated between the public and private sectors. Early thinking about the risks associated with private sector participation can save time later on and help ensure that the resulting private sector arrangement comes close to what was originally intended. Different risks are associated with different options, but they fall into two general categories. For fee-based service/management-type contracts, the most significant risk is that the performance of the private contractor may fall short of expectations. Arrangements need to be in place to monitor the contractor's performance, and to ensure that water quality and other standards required from the operator can be enforced. If adequate staff are not available to monitor performance, the government might consider contracting with a third party - an audit firm, for example. For lease/concession/BOT-type arrangements that require the private operator/investor to depend on tariff revenues for financing operating costs and investments, incentives need to be in place for the contractor to improve the efficiency of operations and investments. Under a natural monopoly situation, there is always the concern and risk that the contractor will reap windfall profits by charging excessive tariffs or reducing service quality. These risks need to be managed carefully through the design of appropriate and effective monitoring and regulatory systems and arrangements.

The special problem of smaller cities

Private sector participation is easiest and most attractive in larger metropolitan areas, say cities with populations of at least half a million. Yet smaller municipalities have just as much need for better water and sanitation services and can also benefit from private participation. But their financial, economic, institutional, and technical conditions present difficult problems. A private contractor will often find it harder to make sufficient returns on its investments in small networks unless the operator can benefit from economies of scale by operating several smaller systems located close to each other. Also the generally lower average household income in smaller towns makes it more difficult for families to pay tariffs that cover costs and yield a reasonable return. Limited administrative skills and institutional capacity in many smaller municipalities limit their ability to undertake the effort needed to design, implement, and supervise private sector arrangements. Local officials and their staff will need assistance from higher-level government agencies in preparing for private sector entry. There are several ways to tackle these problems. The most effective is for several smaller towns to form an association and a single administrative entity, which provide the economies necessary to undertake private participation efficiently and competently. The national government can help smaller cities by supplying advisory services, financial models, and contractual documents.

Choosing among the options

Once a government has worked through the preliminary analysis it may begin to choose among options available. To narrow down the options, the following key questions must be answered:

· What problems are to be resolved? If the purpose of bringing in the private sector is primarily to improve operational efficiency and management and administration, a management/lease-type contract would be most appropriate. If, in addition, investments are sought to increase service coverage and improve service quality, a concession may be the preferred solution. If there is need for a new plant, a BOT may be the best way of tapping private sector know-how and financial resources.

· What are the implications for tariffs? Do current tariffs cover costs? Can the private sector reasonably be expected to boost efficiency enough to meet the proposed service objectives without increasing tariffs? If not, will consumers be willing to pay higher tariffs? If not, will grant finance or subsidies to needy households be available?

· Does the envisioned regulatory framework provide sufficient support for the private sector to take on commercial risk and at the same time protect consumers from abuse of monopoly power? If not, can the necessary changes be made easily? If not, can parts of the regulatory function be simplified or contracted out in the short term? Can the risk of political interference be minimized?

· Do key stakeholders support or at least not oppose a specific private sector option? Can processes and policies be put in place to meet stakeholder concerns?

· Is information about the utility's assets good enough to serve as a base for a long-term contract? If not, can better information be produced rapidly or would it be better to take a staged approach: start with a management contract to assemble better information in preparation for a concession later on?

The answers to these questions will point governments to different choices or a range of choices for private sector participation. Table 7.4 depicts the relationship between private sector options and objectives. For example, a government seeking improvements in operating efficiency and responsiveness to consumers will prefer a management contract with performance incentives or a lease to either a service contract or a concession. A government seeking greater efficiency and new investment will prefer a concession or divestiture - or, for investment in bulk services, a BOT.

Making sure that the desired option is of interest to the private sector

A government's preferred option may not be attractive to the private sector. Where regulatory capacity is weak, political commitment low, the regulatory environments uncertain, and information poor, a concession or a BOT would be difficult to implement. Table 7.5 summarizes the enabling conditions that a private sector operator/investor would need to see fulfilled to agree to a given arrangement at a reasonable cost.

Table 7.4 Private sector options and objectives


Objective

Option

Specific technical expertise

Improving managerial capacity

Improving operating efficiency

Improving investment efficiency

Strengthening management autonomy

Service contract

Yes

No

Some

No

No

Management contract

Yes

Some

Yes

No

Some

Lease

Yes

Yes

Yes

No

Yes

BOT

Yes

Yes

Yes

Yes

Yes

Concession

Yes

Yes

Yes

Yes

Yes

Divestiture

Yes

Yes

Yes

Yes

Yes

For a private sector option to be feasible, sustainable, and best suited to mobilize private sector skills and resources, it has to make sense technically, financially and politically. A technically sound arrangement is well targeted to the problem to be solved and is compatible with the existing legal framework - or includes supporting changes in that framework. A financially sound proposal is one that can be financed at a tariff that consumers are willing to pay - or with the aid of a fiscally responsible and politically viable government subsidy scheme. A politically sound proposal enjoys political support, both within government and among interested stakeholders. Experience around the world demonstrates that political commitment is absolutely crucial. To succeed, a political champion needs to provide support throughout the process of bringing in a private sector operator and/or financier in order to address sufficiently the concerns of key stakeholders. Political commitment is also essential to attract private sector interest. Potential private sector partners - and their financiers - will be looking for signs that the present government is willing not only to sign a contract but also to put in place regulatory arrangements that will protect their legitimate future interests. Unless there is a sense of political commitment, the private sector will provide less attractive bids or decide not to get involved.

Table 7.5 Private sector options and enabling conditions

Option

Requirement


Stakeholder support and political commitment

Cost-covering tariffs

Good system information

Developed regula-tory framework

Good financial rating

Service contract

Low

Preferred, but not necessary

Possible to proceed with limited information

Monitoring capacity for contract needed

Not necessary

Management contract with fixed fee

Low to moderate

Preferred, but not necessary

Possible to proceed with limited information

Monitoring capacity for contract needed

Not necessary

Management contract with performance incentives

Low to moderate

Preferred, but not necessary

Sufficient information required to define incentives

Moderate monitor-ing capacity needed

Not necessary

Lease

Moderate to high

Necessary

Good system information essential

Strong capacity for regulation and coordination essential

Not necessary

BOT

Moderate to high

Preferred, but not necessary

Good system information essential

Strong capacity for regulation and coordination essential

Better rating will reduce costs

Concession

High

Necessary

Good system information required

Strong regulatory capacity essential

Better rating will reduce costs

Divestiture

High

Necessary

Very good system information essential

Strong regulatory capacity abso- lutely vital

Better rating will reduce costs

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.