Using design flexibility and real options to reduce risk in Private Finance Initiatives : the case of Japan

Abstract

Private Finance Initiative (PFI) is a delivery system for public works projects to design construct, manage and maintain public facilities by using private capital, management skills, and technical abilities. It was introduced in Japan about 10 years ago to encourage the stagnant Japanese economy and provide public services with higher quality and less cost to the country and the local authority. It has been applied to many public works projects, but not to large-scale infrastructure projects, such as toll road and airport projects. One of the main reasons for this is that specific methodologies of handling risks and uncertainties involved in long-term projects have not been introduced and demonstrated to either the public or the private sector. This thesis aims to help those involved in large-scale infrastructure development projects apply PFI to those projects by proposing a flexible methodology that will allow them to handle risks. Specifically, this thesis 1) proposes a quantitative methodology so that project managers can handle uncertainty in large-scale engineering projects, and 2) demonstrates how project managers can apply the proposed methodology practically to real-world projects, including how to model and evaluate projects, and demonstrates how the proposed methodology is useful for reducing risks and enhancing the value of projects. As a quantitative methodology, this thesis proposes real options analysis as a tool for considering uncertainty and incorporating flexibility into design, based on the premise that it is crucial not how accurately project managers forecast uncertainty but how they can handle it. This thesis also explains barriers to the implementation of the proposed concepts and methodology, and recommends how to alleviate them. The thesis uses two real-world case studies: the "Tokyo International Airport New Runway Extension Project" and the "Tokyo Bay Aqua-Line Project".

(cont.) Both show the process of modeling and analyzing projects and they demonstrate the benefits of the proposed concepts and methodologies, which can guide and encourage project managers to apply proposed concepts and methodology. The first case study applies a user-friendly methodology, which can alleviate the barriers to the implementation of the proposed concepts. The second case study illustrates that, by using their management skills, ingenuity, and originality, in PFI, project companies can not only reduce risks and enhance the value of projects but also contribute to the consumers' benefits and socioeconomics from the perspective of public policy, which realizes the idea of PFI.