Public Private Partnerships

Session 2
 Discussion Themes
• Why organizations come together ( Resource dependence theory)
• What collaborative forms they choose (Resource dependence theory
Transaction cost economics, Social Capital Theory)
• How they decide about terms of exchange ( Incentive theory and
Incomplete contract Theory) session 4
• How they manage the relationship (Transaction cost economics,
Relational Contract Theory, Social Capital Theory) (session 8)
 1. Why Organizations come together
• Organizations require resources from their environment, which, when
successfully obtained, produce power, influence, and long-term
stability.
• Organizations come together to secure the resources critical to their
survival and growth
• Organizations possessing necessary resources are in a power position,
whereas the organizations depending on others for resources are
vulnerable to control. Thus, according to the theory, power and
resource dependence are inversely related: organization A’s power
over organization B is equal to organization B’s dependence on
organization A’s resources.
1. Why Organizations come together
• What resources does my organization need? How critical are these
resources? Are they essential to the organizational mission? To what extent
can my organization produce what it needs to fulfill its mission without
compromising effectiveness?
• How scarce are the resources overall? (Some services are, by their nature,
complex even if many organizations are potential suppliers.)
• How many individuals or organizations are in a position to provide the
resources that my organization needs?
• To what extent is reliance on other organizations necessary to achieve our
goals?
• How might the linkages among other organizations affect my organization’s
access to critical resources?
1. Why Organizations come together
• According to the RD perspective, different strategies for obtaining
resources (joining an association, forming alliances, contracting, co-opting,
merging, etc.) imply different levels of coordination and varying degrees of
dependence.
• Managerial strategies can be conceived on a continuum, based on the level
of coordination required and the degree of autonomy to be achieved or
preserved.
• Joining an association in order to connect with valuable external organizations does
not require much coordination, nor is it likely to result in reduced organizational
autonomy
• Merging with another organization is likely to demand high levels of coordination
and imply losses of control and/or autonomy.
• As dependence creates uncertainty and vulnerability, managers must
decide what level of dependence is tolerable.
 2. What collaborative forms ?
(1) Co-Opting (Low autonomy loss) ------- (2) Alliances and Partnership (Moderate
autonomy loss) ------------ (3) Merger & acquisitions (complete loss of autonomy)
 2. Collaborative Forms- (1) Merger and
acquisitions
• Mergers and acquisitions
• Mergers and acquisitions are considered among the most constraining
methods of managing interdependence.
• Compared to other strategies, mergers and acquisitions involve greater levels
of coordination and often entail losses of autonomy.
 2. Collaborative Forms- (1) Merger and
acquisitions
• Mergers and acquisitions • Three general types of mergers and
• Organizations will engage in mergers acquisitions:
and acquisitions for one of three • Vertical integration, (between buyers
reasons: and sellers)
• To manage interdependence and • Horizontal expansion (between
reduce uncertainty related to sources competitors)
of inputs or outputs; • Diversification (taking on different
• To reduce competition by absorbing activities /services)
competitors; or
• To diversify operations, thus lessening
dependence on organizations with
which it exchanges.
• Various re-organization and
consolidation in organizations can be
explained on the basis of resource
dependence theory.
2. Collaborative Forms- (1) Merger and
acquisitions
• Mergers and acquisitions in Public sector
• Merging may be an attractive strategy for
• stabilizing;
• achieving economies of scale or scope;
• increasing effectiveness by consolidating or streamlining decision-making authority;
• reducing competition for funding;
• expanding into a new market (when an organization’s dominant service is expected to
change);
• finding use for existing capabilities; and
• combining different organizational strengths to improve services and programs, among
other reason
2. Collaborative Forms- (1) Merger and
acquisitions
• Challenges in Mergers
• Mergers require high levels of coordination
• Mergers may leads to
• loss of organizational identity,
• shifts away from the core mission,
• decreases in employee morale, drains on personnel and case resources, and
• program disruptions
Organizational leaders should consider less constraining strategies such as
formal or informal partner- ships or written agreements with other
organizations that hold key to critical resources before considering mergers
2. Collaborative forms- (2) Alliances and
Partnerships
• Alliances “involve agreements between two or more organizations to
pursue joint objectives through a coordination of activities or sharing
of knowledge or resources”.
• Alliances are less constraining and require lower levels of
coordination than mergers or acquisitions
• Hybrid governance may include partnerships, service delivery
networks, and the most common form, long-term contracting
relationships with other agencies
 2. Collaborative forms- (2) Alliances and
Partnerships
• Alliances are more typical than mergers because they offer flexibility; an
organization’s need for particular resources may only be temporary, and
contractual agreements can be designed to bind the organizations together
“just enough” to satisfy short-term needs.
• They can be established and terminated as needed and with more ease
than a merger.
• Contracts entail partial absorption of one organization by another, and
anything less than gaining full control also has a downside.
• With organizational autonomy comes a level of discretion to act in ways
that are not necessarily mutually beneficial to the organizations involved.
Therefore, the organization choosing this strategy must carefully design the
agreement to mitigate principal–agent problems.
 2. Collaborative forms- (2) Alliances and
Partnerships
• Benefits- access to critical resources, save on costs, increase organizational learning,
provide a sense of community, and diffuse risk.
• Risks- mission drift, loss of public accountability, and increased difficulty measuring
performance.
• Terms of the relationship is important whether the deal is labeled as a formal or
informal agreement, contract, joint venture, franchise agreement, collaboration, or
other type.
• Specific contract terms (length, flexibility, termination, etc.) can shift authority and
reduce autonomy.
• Type of contract depends upon the importance of the resource
• Critical resource- a formal contract.
• Not critical for operation- less formal collaborations
• Sole sourcing ( contracting with single organization) –increases dependence More
than one contractor
 2. Collaborative forms- (3) Co-opting
• Co-optation
• as “a situation in which a person or a set of persons, is appointed to board of
directors, advisory committee, policy making or influencing group, or some other
organizational body that has atleast the appearance of making or influencing
decisions”.
• By incorporating external actors, co-optation functions as a bridging mechanism that
managers employ to reduce dependence, acquire critical resources, and coordinate
actions with independent entities from the environment.
• Used as a bridging strategy for subsequent strategy such as partnering and
aligning, which requires more complex coordination
• Example: Agencies often involve potential market suppliers in the initial stages of
the procurement process. As a result, agency obtains valuable information about
service and pricing. This knowledge can have an important payoff in reducing
resource uncertainty.
2. Collaborative forms- (3) Co-opting
• Other uses
• Can be an effective strategy for increasing support for an organization or adding
skills to an organization, whether technical, financial, or decision making,
without incurring steep labor costs.
• Can be an attractive strategy for actively building coalitions
• Costs.
• co-optation also leads to decreases in the agencies organizational autonomy, as
many of the co-opted entities posses narrow and somewhat insular goals that
did not always align with the agencies original mission.
• Representatives from other sectors may change the organizational culture, for
example, by pulling the organization toward market-based approaches.
• New members bring their own perspective, which may or may not be aligned
with the mission of the organization.
Economic Theories of the
contract
 Contract
• Any transaction that is of the nature ‘quid pro quo’ can be considered as a contract. This
contractual element is downplayed in case of spot markets as transaction takes place
almost simultaneously but in situation where there is long term relation or a long duration
between purchase and delivery, contract becomes an essential element of the transaction.
• A contract is the legally binding rights and obligations that govern an exchange between a
two parties, whether formally written in the contract or informally understood but still
backed by public law.
• The purpose of a contract is to structure the exchange so that the both parties realize its
win-win payoff potential.
• In procurement contract, the buyer’s payoff is the difference between the purchase price
and the value she receives once she owns the product. The seller’s payoff is the difference
between the price and the costs of producing the product and executing the sale.
• In PPP, governments payoff is getting the product \service delivered and private company
payoff is returns on investment
 Why focus on Contract
• Williamson (1985) has argued that in addition to lens of choice which is hallmark
of neoclassical economics, contract could be another lens through which
economic activity could be analysed.
• “the science of the choice is not the only lens for studying complex economic
phenomena nor it is always the most instructive lens. The other but less fully
developed approach is science of contract”.
• He referred to the lens of contract as “private ordering” which entails self-help
efforts by the intermediate parties to a transaction to align incentive and craft
governance structure that are better attuned to their exchange.
• Brousseau and Glachant ( 2002), write that “analysis of contract allows us to re-
examine the exact nature of difficulties associated with economic
coordination.....various provisions for coordination.... how agents frame rules
and decision making structure to guide their behaviour......and understating
evolution of contractual mechanism helps us understand changes in the structure
that frame economic activity.
 Why focus on Contract
• All collaborative arrangements could be analysed through a lens of
contracts Exchange between two organizations and governance
arrangements (Partnerships , collaboration , contracts, procurement
etc.) adopted to manage them.
• Using contract as lens, different models of public private arrangement
can be easily analysed from one single framework
• How terms of contract (formal or informal) are designed; how they
are enforced - influences behaviour of parties- determines
performance of these arrangements.
 Economic Theories of the Contract
• Recognition of transaction as the basic unit of analysis diverted
attention of economist from the price theory to contract. Contract
can be used as another lens other than price to analyse economic
activity.
• Three schools
• Incentive Theory
• Incomplete contract Theory
• Transaction cost Economics
 Transaction cost Economics-Key Idea
• It assumes
• TCE assumes transaction as the basic unit of analysis.
• Individuals are rational but boundedly so-- that is, people have limited information and
a limited ability to process it.
• All human beings as opportunistic^1.
• Because of this bounded rationality all contracts that occur in a transaction
are said to be incomplete except some very simple ones.
• Because of the incompleteness of the contract, when a conflict arises
between what people want and what they have agreed to do for others, they
will act in their own interest, insofar as it is costly for others to know their
behaviour.
• The parties in a transaction anticipate this risk of opportunistic behaviours by
others, and take action ex ante, but again due to bounded rationality, these
ex- ante interventions may also fail.
Transaction cost Economics- Key Idea
• Because of this risk of failure of ex-ante interventions, parties in a
transaction adopt organisational structures to mitigate the hazards
and restore efficiency.
• These organisational structures take the form of spot markets at one
extreme (when transactions are simple and transaction cost is
minimal) to Hierarchy (when transactions are complex and
transaction cost is high) with various kinds of hybrid organisational
structures in between, depending upon the transaction cost.
Low High
Transaction Transaction
cost cost

Spot Markets Hybrid Hierarchy

 Attributes of transaction
• Three attributes of the transaction - asset specificity, uncertainty and frequency that distinguish
one transaction from other.
• These attributes of the transaction along with the self interestedness of human beings gives rise
to transaction cost in a transaction.
• Transaction cost is costs of making a transaction-search and information costs, bargaining costs
(designing contract) and enforcing contracts (including monitoring and addressing disputes).
• Asset specificity (or relationship specific investments) is durable investments that are undertaken
in support of particular transactions , the opportunity cost of which transactions is much lower in
best alternative uses or by alternative users, should the original transaction be prematurely
terminated” . Six types of asset specificity
• (1) site specificity
• (2) physical asset,
• (3) Human asset
• (4) dedicated asset
• (5) brand name capital and
• (6) temporal.
Transaction Attribute -1 -Asset specificity
 Transaction Attribute-2: Uncertainty
Uncertainty refers to “unanticipated changes in circumstances surrounding an exchange”.
Environmental Uncertainty
Behavioural uncertainty
 Transaction Attribute-3: Frequency
• Frequency is volume of transactions

• Example:
Transaction Characteristics

(Asset Specificity)
Example of Transaction cost in two extreme
cases
 Transaction Cost- Other Reasons
• The fourth cause for transaction cost is because of difficulty of
developing a common language between contracting parties (Hart
1995) and
• Fifth cause is difficulty of enforcing contracts in the event of a dispute
(Sappington 1991)
 In High Cost Transactions
• The governance structure designed by the parties in the contract will fail
because of
• Inability to come up with all possible future situations and difficult to determine
trustworthy individuals’ ex-ante.
• if circumstances change unexpectedly,
• Partners have a tendency to behave opportunistically (Cheat)
• Partners will find opportunities to cheat by not fulfilling the commitments
they have made in the contract
• If we think through logic of transaction economics, a number of methods
can be used to make partners commitments credible (believable).
• Transaction Specific Investments
• Monitoring
• Detailed Contract
• Rights of decision and coercion
Implications of TCE for contract design and
contract management
• One of the tools to make commitment credible is to have legally
binding, explicitly detailed contract with responsibility of parties in
different scenarios, including sanctions outlined. The parties in the
transaction use contract as an instrument to exercise authority and
control and thus written contract plays a core of the governing the
exchange relationship.
• Monitoring and Sanctions in case of contractual breach.
• Transaction specific investments in case where the transactions
involve high asset specificity.
 Which Structure to Choose ?
• TCE proposes two stable governance structures- spot markets and hierarchy
at the two extremes of the transaction.

Spot Markets (Buy)-------------------------------------------------------------------- Hierarchy (Make)

• For complex mode of transaction, complex mode of governance is required

to prevent contractual hazards where as for simple transaction simple
mode of governance structure suffice.
 When to engage in collaborative
arrangements (Hybrids)
• Transaction cost Theory
• Transaction cost are moderate  Hybrid arrangements
• If there are no relationship specific investments (no transaction cost) - then spot
market is preferred. Governments should buy from private sector based on a
contracts like buyer and supplier relationship (like in case of food stamps).
• If relationship specific investment + uncertain exchange environment vertical
integrations
• If relationship specific investment but no complex and\or uncertain exchange
environment PPP is a better strategy (like building bridge) as it provides possibility
of writing effective contracts.
• Resource dependence theory
• The organisations should enter in partnership when there are critical strategic
interdependence with other organizations
 When to engage in collaborative
arrangements (Hybrids)
• Parker (2003) proposed a framework combining transaction cost
perspective with the resource based perspective. The framework
doesn’t consider a transaction cost as the sole reason why firms need
to collaborate but as strategic choice taking into account both cost
and firms internal capabilities and strategic goals.

Internal Capability
High Low
Transaction High In house production Partnership
Cost
Low Partnership Outsourcing based on market
contracts
 When to engage in collaborative
Arrangements (Summary)*
• Moderate Transaction cost. Too high or too low should be avoided
• Capability- Transaction cost high but capability low or Capability high
and transaction cost low
• Strategic interdependence and economies of scope OR Sufficient
competition or contestability
• Ability to write effective contracts OR Prior ties and trust
• Measurability – Easily observable quality standards that can be easily
measured and monitored

*general irrespective of public or private

 Typical Reasons Why governments collaborate
with private sector*
• Failure of public sector ( Public Choice Theory)
• Too much debt on the public sector
• Political interference
• Dependence on private sector because private sector
• has resources/ technical know how
• Is widely available
• More efficient
• More innovative

*Normative arguments
 Political Reasons for governments engaging
with private sector
• Partnerships gives them opportunity to quickly announce new projects
and announcing new projects give kudos to the government.
• When these projects are financed through private finance, the cost for the
present government is almost zero and thus freeing government from
borrowing, or additional taxation or diverting resources from other uses,
and thus improves governments’ image and credit ratings as a prudent
manager of funds.
• Using partnerships governments also get approval of the business
community.
• As partnerships make services and infrastructure available quickly
governments also gain electoral support by pursuing such PPPs.
Political Reasons for governments engaging
with private sector
• Public servants, private consultants and international agencies have
embraced neoliberal economic ideology (too much belief in markets
and failure of government).
• In case of problems, inefficiency and waste, governments can also
save the skin by pointing fingers towards private sector.
• Private sector also gains from these arrangements as these contracts
can be quite lucrative and some companies can also generate
additional benefits and favours like tax credit through their political
connections.
• Push by IFIs- Country becomes eligible for loans
So when should your organization
collaborate with other agency ?
Basic conditions for engaging in collaborative
arrangements
• Other agency is efficient
• Strategic interdependence.
• Contestability- sufficient ex-ante competition
• Can write effective contracts
• Capacity to design contract and monitor performance