As a result of the current financial situation, public expenditure must be optimized as much as possible. Government institutions are in need of reaching an equilibrium between quality and cost in the services they provide.
Moreover, government institutions have to make an effort and try their best to keep an investment level that makes it possible to increase competitiveness and the technical and economic development of the driving forces of society, which are at the core of employment creation and economic future.
All the aforementioned leads us to consider that the private sector should start playing an increasingly important role in investment participation and therefore in the management of infrastructure where investments may be made profitable. This would free public administrations from making such financial efforts, thus enabling them to improve their economic situation and to earmark their resources for projects that benefit people directly.
This is the reason why the Energy Services Enterprise (ESE) model is being increasingly used. In this model, private companies play an active role in the design, management and investment involving infrastructure that could be “optimized”. These would be the infrastructure that could bring an economic benefit on their own just by considering “avoided cost”.
This business model is becoming increasingly popular, which creates great opportunities for companies; companies provide stability, while competitiveness, technological development and an increase on technical capacity are encouraged.
Benefits of the ESE contracts
For Government institutions:
- Given that the contractor has now become a partner and an ally, he will be highly committed to the project.
- Cost reduction. On the one hand, facility maintenance usually becomes the contractor’s duty, which minimizes potential lack of productivity and contributes to the adjustment in maintenance expenses. On the other hand, benefits are obtained based on achieved or consolidated goals as the administration may claim a bonus on consumption reduction.
- Increased safety. In case goals are not reached, penalties may be established to guarantee the agreed-upon reductions, thus ensuring bonus management.
- Energy-consuming facilities shall be renewed at no extra cost, given that the required investments should be made by the contractor company.
- Increase in facility performance: the awardee company is highly committed to having all the energy-consuming facilities work at their full capacity.
- Both technical and technological capacity will be increased, as the know-how of a highly experienced company in maintenance and energy efficiency will be available.
- Reduction in supply costs. Sometimes this will be a result of better conditions in supply contracts; on other occasions, this will be a consequence of taking advantage of scale economy.
- Optimization of job places. There will be no need to manage auxiliary services (infrastructure maintenance and energy management); the government institutions may focus all efforts on supervision and control and avoid the assignment of resources to direct management tasks. This enables the government institutions to devote all its resources to its raison d’être: the provision of public services.
- A better financial situation for the government institutions, as financial efforts shall be undertaken by the private sector. The economic resources that subsequently become available may be earmarked for their use in other projects, such as increasing the provision of social, health and education services.
For private companies:
- An increase in the market share; this is an already-existing business niche, which should remain stable and last long in the future. Apart from that, it should be taken into account that the last economic period was a buoyant one, in which infrastructure were not analyzed regarding their energy and maintenance costs; a great deal of investments and efficieny improvements may be required.
- Stability and long-term contracts. ESE contracts are investment-related, and therefore they must stipulate the years of private management appropriate for return on investment. Should these contracts be tendered by a Public Private Partnership (PPP), they may last up to 20 years.
- Income return. A proper technical and economic study of the project, as well as an appropriate contract in which the measurement and verification systems are accurately and duly established, may render the income return of ESE contracts stable all along its duration period.
- An increase in technical capacity. Such contracts encourage an increase in the managing companies expertise, as the obtention of benefits depends on their capacity and training in the required specialisation fields.
- Constant technological development. Technology advances fast, remarkably in relevant sectors such as communications and energy, which implies companies should be willing to evolve as fast.
Shifting from contractor to partner
The introduction of the ESE model is currently encouraging a fundamental role change between clients (mostly government institutions) and contractors, favouring the creation of relationships based on partnerships and alliances. This is due to a system that makes it possible to establish common goals which are of interest to both parties, and working in partnership is essential if the aforementioned goals are to be achieved. Working in partnership also involves making the most of the expertise and qualities of each partner in order to achieve optimization, management efficiency and cost reduction.
A cultural change is therefore required: we should forget about the usual client-supplier relationship and move a step forward towards a relationship based on sharing goals and joining efforts. Far from the usual government-contractor relationships, we should now evolve by creating connections between partners; the more both parties works, the better the outcome will be, and benefits will be increased for all of them.
A well-designed contract should render mistrust unnecessary. Everything should be defined in the contract: investments, installments, guaranteed cost reduction, bonuses, penalties, systems for measuring and verifying cost reductions, quality standards… This is why we believe that the key to success in this management model lays on the agreement and establishment of a carefully-thought, well-defined contract known in detail and accepted by both parts. Public Private Partnership (PPP) contracts become extremely useful here, as the definition of all the aforementioned is made by putting the vision, experience and knowledge of each of the parties together. Both the client and the contractor contribute to the contract, and all the contributions play a part in the obtention of the most reliable, objective and optimum way to perform the service.
Control, measure and verification systems
Right now, several methods are available to efficiently measure the savings achieved in consumption. One of the most widely used is the International Performance Measurement and Verification Protocol (IPMVP) from the Efficiency Valuation Organization (EVO).
The most usual way to establish control on cost reduction is the inclusion in the ESE contracts of a professional such as the Certified Measurement and Verification Professional (CMVP) -or a similar one. Those professionals -in case they belong to an external and independent company- play an impartial role in the quantification of avoided cost, which is used as a base to calculate bonuses on cost reduction, or else to calculate penalties.
Most investments are to be made at the beginning, so that they may be amortized for a longer period of time. This implies a huge financial effort at the beginning of the contract, a hindrance for the private company sector nowadays.
The main problem that energy services enterprises are now facing is how to finance their investments. Required investment amounts may be extremely high depending on the type and magnitude of the contract, which plays to the advantage of bigger companies; most of them are sufficiently capitalized to face the required investments, or else have greater access to external financing.
Small and Medium Enterprises (SMEs) find themselves in a harder situation, given that their capitalization level is usually low, and so is their access to external financing. It should also be taken into account that, depending on the public organism involved, banking institutions do not consider all financial operations to tackle this projects equal.
A tool to leave the crisis behind
ESE contracts are a good measure to help leave the crisis behind; they make it possible to increase competitiveness, efficiency and employment creation by creating value and wealth by means of cost optimization. This is why many public administrations have recently decided to choose this model, such as the Diputación de Castellón (a local council) or the City Councils of Betxi and Burriana, among other public administrations that are currently taking advantage of this management system.
CEO at Telecso Business Administration and Management MBA and PDD (Management Development Program) IESE www.telecso.es