Chapter Summary This Chapter presents a variety of tools, old and new, that systematically distinguishes among project delivery and finance methods. “Systematic” is the key. In today’s environment, there are too many “alternative” schemes to deliver public infrastructure, too many “acronyms” for these schemes (DBB, DB, PP, FT, CM-At-Risk, DBO, DBOM, Turnkey, Super-Turnkey, DBFO, BOT, BOO), and too little logic to distinguish among them. Tight public resources and taxpayer recognition that alternatives should be considered have produced a destructive environment in which self-interested groups argue for “their” form of experimentation, and in which “one-of-a-kind” procurements have become routine. Hidden in the background are a substantial decrease in the level of competition and a substantial increase in the costs incurred for the transaction (not the project, the transaction). Also hidden is the fact that in most “alternative” procurements, neither the owner, contractor, nor user is assured that better service, lower costs, or lower prices will follow. The first tool presented in the chapter is a quadrant framework, which allows project delivery and finance methods to be systematically compared. Infrastructure projects have common phases that can be used to distinguish “segmented” from “combined” strategies for delivering projects along the horizontal axis in the quadrants. These phases are (a) design, (b) construction, (c) in-service operation and maintenance, and (d) replacement. The degree of integration of these phases is a reliable way to distinguish alternative delivery strategies. Design-Bid-Build, for example, is a fully “segmented” process, in which planning is provided prior to the procurement by the owner, design is separately obtained through a procurement for design services, construction is separately obtained through a second procurement, and operations and maintenance is typically self-performed by the owner. Design-Build-Operate is a fully “combined” process, in which the design, construction, and operation are integrated into a single procurement. The source of project cash is used to distinguish “direct” from “indirect” strategies along the vertical axis in the quadrants. When the owner of the project applies its own cash resources (from its own pocket) to finance an infrastructure project, the project finance method is “direct.” When an owner structures the project so that the developer/contractor provides its cash resources to pay for the project, the project finance method is “indirect.” Projects may be financed through combinations of direct and indirect means. The public portion of such financing is commonly called a subsidy or a shadow toll. Ironically, public cash resources are typically obtained through taxes or user fees. Private cash resources are typically obtained based on the expected future receipt of user fees or consumer receipts. In the final analysis, most infrastructure projects are financed by consumers, users, taxpayers, or combinations thereof. The taxpayer’s “interests” are typically best served through stable, high quality service at competitive rates not by purely ideological arguments that revolve around control. America has applied alternative delivery methods since 1789. Project delivery method has been a continuous variable throughout this period, and “segmented” strategies as well as “combined” strategies have been successfully employed, with numerous variations in between. Similarly, project finance method has been a continuous variable, and “direct” and “indirect” strategies have been used by Congress to allocate public resources and attract private financial resources to the development of infrastructure facilities. There is no standard project delivery method in American history and no standard finance method, although five key procurement strategies have emerged: Pure Operations and Maintenance, Design-Bid-Build, Design-Build, Design-Build-Operate, and Design-Build-Finance-Operate. The first three procurement strategies — Design Build Operate and Design Build Finance Operate — are “segmented” strategies, in which only one or two phases of the project’s life-cycle is procured. These are also “direct” strategies in which the owner provides the cash resources to complete this phase of the project. The latter two procurement strategies are “combined” strategies in which all phases in the project’s life cycle are procured at once. Design-Build-Operate is a “direct” strategy in which the owner either provides funding from its own cash resources, or commits user fees that it collects or controls to finance the project. Design-Build-Finance-Operate is an “indirect” strategy in which the producers of the project provide cash resources based on the expectation of future revenues collected from the project (typically user fees or development related revenues). Sources and uses of cash for infrastructure brings us to the second tool described in Chapter 2: discounted cash flow (and net present value). Every infrastructure project requires money to plan, design, construct, operate, and replace an infrastructure facility. The money typically comes to governments from taxpayers and users and to private owners through operating revenues and debt. How this money is invested, and whether it is effectively spent, present more complex qualitative and quantitative questions. The limitations of using net present value as a decision rule in making capital investment decisions are reviewed, but the importance of correctly modeling cash flows on public and private projects is confirmed. Consumers, taxpayers and users have a common interest in seeing Client resources spent productively — on planning, design, construction, operation, or repair — rather than on transaction costs associated with experimental, noncompetitive procurements. Cash flow is an important tool that is widely ignored in the allocation of resources to infrastructure spending. Proper cash flow analyses of facilities (and collections of facilities) allow public and private sector owners governments to show taxpayers, consumers, users, and potential private sector producers how, why, and where receipts and user fees are spent on infrastructure services. Regrettably, for most public owners, the actual cost, by activity, of a public infrastructure facility is not known — to governments, legislatures, taxpayers, users, or to potential producers (such as designers, constructors, and equipment suppliers). Elaborate financial records show expenses — such as salary, equipment, supplies, and overhead — associated with entire collections of facilities. For most public owners, the actual cost of running and maintaining an individual facility — a school, a pumping station, a police station, a bridge, or a terminal — is purely guesswork. The harsh reality is that without a good understanding of current actual costs, by activity, it is not possible to correctly assess the incremental effect — positive, negative, or neutral — of any new project on the overall cost of a facility. It is this type of analysis that is needed to efficiently manage collections of facilities. Examples of proper cash flow modeling of incremental revenues and incremental costs of projects are presented that allow infrastructure owners to make capital investment decisions with a clear picture of the effects on overall quality and cost. The concept of “opportunity cost of capital” is introduced along with the importance of constantly evolving technology, and our inability to accurately predict future events (“uncertainty”). Most owners only “model” cash flow during initial delivery, i.e. design and construction. This is an easy task because actual cash flows are typically fixed by contract. These cash flow models ignore the cost of operations and routine maintenance (typically 90+% of total life cycle costs). Moreover, as each facility ages, annual operations and maintenance costs change due to increased requirements for repair and replacement of components, systems, and assemblies. Condition assessment (i.e., what repairs will be required when to keep the asset functioning properly) and activity based costs (i.e., what are the cost of operations and maintenance — historically, currently, and in the future) will continue to emerge as the key concepts in managing a portfolio of infrastructure assets. Cash flows differ for each project delivery method; i.e. the amount and timing of cash required to produce the project are different for DesignBid-Build, Design-Build, Design-Build-Operate, and Design-Build-FinanceOperate. These differences create a significant opportunity for owners and producers of infrastructure that has largely been overlooked — the third tool described in the chapter. This opportunity — the simultaneous use of multiple project delivery and finance methods to improve portfolios of infrastructure assets — is described in more detail in Chapters 4, 5, 6, and 7. These three tools — the Quadrant Framework, discounted cash flow analyses, and different cash flows for each delivery method — are the building blocks of a more comprehensive, competitive approach to infrastructure planning, delivery, and replacement. The emerging problem for owners of collections of infrastructure facilities is how to operate the portfolio. The key elements of this problem are to understand current activity costs, current condition, and the project delivery methods available to solve the problem. The chapter also offers a “two-key” test for the proper application of project delivery and finance methods to a collection of infrastructure projects. Both “keys” are required in the analysis. The first “key” is the owner’s to apply, and is based upon a good understanding of the Owner’s expected cash flows (revenues and expenses) for each project, and for each project delivery method considered for use on the project. Only those project delivery methods that produce a positive net present value to potential producers can be selected by the Owner. The second key is applied by private sector producers, and is based upon an independent confirmation by private sector bidders of the existence of positive net cash flows for the project delivery method chosen by the Owner. The “two key” test reduces to this: an owner has an obligation before soliciting bids or proposals, to confirm that its choice of project delivery and project finance structure will produce a viable business opportunity to private sector producers. Private sector competition to confirm the government’s assessment is then a very useful check on the viability of each project.