1 Vision 2030 and Private Public Partnerships: Using Capabilities and Contracts Theory to Understand Ecosystem-Enabled Economic Development Professor David J. Teece, Institute for Business Innovation Chairman, Berkeley Research Group, November, 23, 2016
2 About BRG Global strategic advisory and expert consulting firm that provides independent advice, investigations, data analytics, authoritative studies, expert testimony, and regulatory and dispute consulting to Fortune 500 corporations, financial institutions, government agencies, major law firms, and regulatory bodies around the world. Named by Forbes as one of America’s Best Management Consulting Firms. Distinguished bench of in-house experts whose expertise spans economics and finance, data analytics and statistics, strategy and public policy in many of the major sectors of our economy, including banking, healthcare, technology, energy, construction, and real estate. Ability to assemble teams with the specific, nuanced talent needed to address a particular problem and provide highly specialized and strategic advice. Headquartered in Emeryville, California, with offices across the United States and in Asia, Australia, Canada, Latin America, the Middle East, and the United Kingdom. 2
3 “There is no manual on how to transform a traditional economy into an innovation economy.”Financial Times Special Report November 15, 2016 3
4 Table of Contents Introduction 5 Conceptual Framework 7Essence of Vision The Role of PPPs in Achieving Vision Sector Focus: The Role of PPPs in A. Education and Research and B. Healthcare Conclusions and Next Steps © Teece 2016 4
5 I. Introduction 5
6 Focus Today Examine the role of PPPs in building a vibrant diversified economy based on human resources (capital), not just natural resources We first explain how a vibrant, non-natural-resource-dependent economy requires human capital plus strong technical and organizational capabilities, undergirded by robust and innovative knowledge ecosystems We will then explain the important role PPPs can play in building firm-level capabilities and in strengthening ecosystems We will examine how PPPs can help in two key sectors: education and health The focus will be on (a) building business enterprises that grow, transform, and expand employment and profitability over the long run; and (b) renovating existing institutions and public agencies to make them more productive and innovative © Teece 2016 6
7 II. Conceptual Framework7
8 Insights from Capability and Contract TheoryWhile there is no manual for economic transformation, capability theory and (incomplete) contracting theory provide frameworks for: Understanding how innovation ecosystems work Designing and managing PPPs © Teece 2016 8
9 Capabilities, Ecosystems, and ContractsGovern whether and how organizations (business firms, government agencies) can define, select, and achieve specific goals. Two categories: Individual capabilities Organizational capabilities (ordinary and dynamic) Ecosystems Identify business firms and other private and public institutions and structures that make them succeed Contracts Govern how different organizations/partners cooperate and are rewarded (or penalized) © Teece 2016 9
10 Contracts National plus Expat PopulationsOrganizational Capabilities Are Undergirded by Individual Skills/Capabilities Organizational Capabilities Ordinary | Dynamic National plus Expat Populations INDIVIDUAL SKILLS INDIVIDUAL ABILITIES Learning w/out Doing and Using Learning by Doing and Using Strategy Contracts Competitive Advantage and High-Performing Organizations Human Capital (individual skills/capabilities) © Teece 2016 10
11 Ordinary CapabilitiesRoutines/standard operating procedures are key to ordinary capabilities Support operations, administrations, and governance “Best practices” are strong ordinary capabilities Ordinary capabilities reflect technical efficiency © Teece 2016 11
12 Dynamic Capabilities “The ability of an organization and its management to integrate, build, and reconfigure internal and external competences to address rapidly changing environments” (Teece et al., 1997: 516) Dynamic capabilities on higher-order capabilities can be thought of as falling into three categories: SENSING Identification of opportunities and threats at home and abroad SEIZING Mobilization of resources to deliver value and shape markets TRANSFORMING Continuous renewal and periodic major strategic shifts © Teece 2016 12
13 Ordinary vs. Dynamic CapabilitiesTechnical efficiency in basic business functions Operational, administrative, and governance Relatively easy; imitable Strategic “fit” over the long run (evolutionary fitness) Sensing, seizing, shaping, and transforming Difficult; inimitable Purpose Tripartite schema Imitability Doing things “right” Doing the “right” things © Teece 2016 13
14 Central to Competitive Advantage and Transformation Are Organizational/ Institutional and Supporting Ecosystems Dynamic capabilities lie at the core of corporate success; learning is at the core of capability building Strong ordinary capabilities (operations, administration, governance) are necessary but not sufficient for long-run (financial) success. They can be acquired (“bought”) from consultants or through investments in training. Strong dynamic capabilities and good strategy are necessary and sufficient for long-run (financial) success. They cannot be bought and must be built. © Teece 2016 14
15 Components of a Vibrant Business Ecosystem Support Capability Development© Teece 2016 15
16 III. Essence of Vision 2030 16
17 Health systems information Virtual reality Autonomous vehicles Foundational to Vision 2030 is training and motivating large numbers of technically sophisticated (and motivated) individuals, building organizational capabilities, and strengthening knowledge ecosystems. Capability development (individual and organizational) is needed in areas including: Hard Skills Applied data sciences Digital media Health systems information Virtual reality Autonomous vehicles Greater energy efficiency Minimizing carbon footprint from oil and gas Soft Skills Entrepreneurship Management Institutional design Coherent design Good governance © Teece 2016 17
18 KSA’s Trajectory Toward a Dynamically Capable EconomyKSA has to build a dynamically capable economic system that can animate and govern a complex economy in an uncertain world There are three relevant horizons: National- and firm-level Dynamic Capabilities in national and regional systems of innovation Development of human capital and “ordinary” capabilities and entrepreneurial culture Economic potential Resources, factor endowments Horizon 1 Horizon 2 (Vision 2020) Horizon 3 (Vision 2030) 18 © Teece 2016
19 Vision 2030 Implicitly Shouts Out for the Development of Dynamic Capabilities to Sense, Seize, and Transform Sensing requires: Assessing current capabilities and diagnosing current and future challenges and opportunities to develop and apply new technologies. Consultants can help with this diagnostic step. Seizing requires: Making the decision and committing the capital to reshape the physical and social infrastructure. Focus is on special incentives for new enterprise formation. © Teece 2016 19
20 Transforming requires:Bringing about the reformation of the public sector and of other incumbent organizations so that they at minimum get out of the way of Vision Hopefully they can assist. Eliminating patronage and various forms of protection so that the new enterprise can flourish. Institute merit-based systems in government and business (Saudi Aramco modus operandi is one model). Cutting off the explicit (and embedded) energy subsidies to give alternative technologies a chance. Making the necessary institutional changes and performing the data analytics to enable the capture of the massive cost savings and performance improvement available from using best practices © Teece 2016 20
21 Enabling Entrepreneurship and Innovation Lies Naturally at the Core of Vision 2030Vision 2030 mentions need for Transformation in education (K-12, vocational), health, and government, and implicitly stresses entrepreneurship and innovation. How else can one generate economic dynamism and diversification? 21
22 Vision 2030’s First Priority Should Be to Develop a Robust National Knowledge- Generation Ecosystem Incentive realignment and targeted expenditures are required to develop the human capital and entrepreneurial culture required to power the entrepreneurship and innovation needed to escape the oil-based economy (the “curse of oil”). Universities and allied research entities must: Benchmark and then upgrade to world class Reorient toward a greater focus on STEM Develop and enhance ecosystems around campuses © Teece 2016 22
23 IV. The Role of PPPs in Achieving Vision 203023
24 PPPs: Definition and NatureAn agreement between a public entity and one or more private-sector partners (including operators, financiers) to allow and enable the private party to charge (or be paid) for delivering a valued service or product. NATURE In essence, a cooperative arrangement between the private sector and the government that involves building and/or managing physical and/or social infrastructure and sharing risks and rewards A tool for coordination for capability development PPPs can range from informal cooperative public and private arrangements to highly specified design, build, finance, and operate deals. © Teece 2016 24
25 TRENDS 1 Around the world, public agencies have looked to improve efficiency and effectiveness by using PPPs. Infrastructure development projects involve significant risks given large costs and the time needed to negotiate contracts and construct, operate, and maintain assets. The private partner traditionally plans and builds; once built, the public sector usually manages. Increasingly, the private partner is invited to manage the built infrastructure. 2 3 4 25
26 PPPs for Social (and Institutional) Infrastructure vsPPPs for Social (and Institutional) Infrastructure vs. Physical Infrastructure Most studies/experiences focus on PPPs for building physical infrastructure, but opportunities for strengthening social infrastructure and associated capabilities are more exciting. 26
27 The Exciting Promise of PPPs in KSAReal value of PPPs is not so much the CAPX savings but in building the organizational capabilities PPPs. Private enterprise can transfer/create the new institutional arrangement, cut costs, and build capabilities throughout the Kingdom. PPPs are one of the few ways to effectuate these outcomes. PPPs can do so in a bundled fashion, which ensures effectiveness and simplifies management. © Teece 2016 27
28 The Exciting Promise (cont.)A vehicle for the achievement of several policy objectives in concert, including: Economic diversification Economic growth Productivity improvement Transfer and diffusion of technology PPPs can enable governments to evolve from the direct provider/ actor/funder of business initiatives to a more supervisorial role aiming at “monitoring” the market economy, as “commissioner’/‘governor.” PPPs have a huge potential for developing indigenous capabilities to power innovation and diversification 28 © Teece 2016
29 Ten Requirements for Successful PPPsHigh-level political commitment and understanding is needed for PPPs to succeed—especially for “social infrastructure” PPPs. A consistent policy framework (i.e., policies cannot be at war with each other at the same time or over time). At all stages, there must be a clear and transparent framework that both the private and public parties can trust. Where possible, contracts need to be standardized to improve clarity and lower transaction costs. If PPPs are to be long term, clear rules for continuation and renegotiation need to be developed. © Teece 2016 29
30 Ten Requirements for Successful PPPs (cont.)Because PPPs are contractual agreements, compliance and enforcement issues are relevant and transparence and the rule of law is paramount. Consideration should be given to eliminating regulation, except that which is contained in the contract. A “One-Stop Shop” for PPPs where all permits, licenses, and permissions necessary for a project (or program) can be obtained from one agency or tendering authority is likely required because of the sophisticated contractual/incentive design issues likely to arise. Investment by all parties in cultural immersion and understanding of context and alignment of expectatures. Improved existing procurement and investment legislation. © Teece 2016 30
31 Adequacy of Legal FrameworkNothing special is needed for PPPs when there is a solid body of commercial law as in the UK, US, Canada, Australia, Germany. If a solid body of commercial law doesn’t exist, special legislation is likely required (e.g., Kuwait has a well-established PPP framework: Law no 7/2008). © Teece 2016 31
32 Regional Challenges A Middle East business intelligence service (MEED) reports that 23% of the 80 projects brought to market in the MENA region since 1996 failed to close.* The main reason was a poor deal structure. Investors felt they had been asked to accept high risk for an uncertain upside.* * Khaleej Times (25 September 2016) © Teece 2016 32
33 Challenges to Successful PPPs in KSAKSA ranked poorly in World Bank doing business report. This must be overcome to enable PPPs, or KSA will need to bear most of the financial risk. Overregulation, suffocating bureaucracy, patronage, and privileged access to resources and decision makers cripples competition and makes PPP success more difficult. © Teece 2016 33
34 Design Principles: Economic and Legal Scholarship Informs Us That Control Rights MatterIf given complete control, the private partner might exercise market power. If given insufficient control, the private partner will not invest, or will charge a high premium to participate. The ideal is for the government to retain certain clear but necessary control rights, such as those over KPIs.* * See O.E. Williamson, “Franchise Budding for National Monopolies” (1976) © Teece 2016 34
35 Control rights trade-off Control rights allocationPPP Contract Design Principles: The Teachings of Nobel Laureates Oliver Williamson, Oliver Hart, and Jean Tirole Control rights trade-off Control rights allocation If given complete control, the private partner might exercise market power* If given insufficient control, the private partner will not invest, or will charge a high premium to participate The ideal is for the government to retain certain clear but necessary control rights, such as those over pricing Private provision is preferred when cost reductions don’t have a strong negative effect on quality, or when quality reductions are observable (Hart et al., 1997)** If best practices can be tightly specified by contract, the problem fades It is often the case that best practices cannot be fully specified or enforced * O.E. Williamson, “Franchise Bidding for Natural Monopolies” (1976). ** E.g., prisons. Private provision can lead to quality reduction, and US data shows that violence is higher in private prisons. © Teece 2016 35
36 PPP Contract Design Principles: Additional Teachings from Aghion, Bolton, and CalabresePrinciples for allocating control rights and risks Principles for deciding whether to bundle services and maintenance Control rights specify who makes decisions (who “calls the shots”) Control rights should be allocated according to who makes the more efficient decision (Aghion & Bolton, 1992) Risk should be allocated according to who can mitigate it at least cost (Calabrese Principle – 1972) With deep uncertainty, control rights should be allocated to who can manage it best (Aghion & Tirole, 1994) A private partner will not invest in services and maintenance of infrastructure unless it is rewarded for doing so in the contract Bundling helps internalize the benefits made during construction; e.g., a provider will build an infrastructure right if he also has to maintain and manage it; i.e. less likely to “cut corners” (Hart, 2003) However, if the quality of service cannot be specified, unbundling may be best © Teece 2016 36
37 A PPP’s Central Contract Design and Administrative Unit in KSA to Implement Design Principles Articulated by Nobel Laureates? All agencies and authorities need some understanding of design and incentive issues. However, an elite cadre of experts is necessary to navigate complex issues. Training will be required to enhance public officials’ understanding of design with respect to the functioning of PPPs. E.g., for infrastructure projects, basic groundwork needs to get done to enable an open bidding process to succeed. To allow innovative capabilities and experience of private sector to be harnessed, government should generally specify desired outcome, not required inputs. There will be exceptions. Executive education and transactional advisors will be needed to assist in capability building with respect to Saudi contract design and administrative work (perhaps Aramco can do it?). © Teece 2016 37
38 Indirect—and Often Hidden— Benefits of PPPsWell-designed PPPs can improve capabilities and national competitiveness and save resources by attracting top foreign companies with transferable skills, using best practices. PPPs can trigger regulatory and governance changes that create an investment climate that not only attracts investment but reduces future funding needs. © Teece 2016 38
39 Indirect—and Often Hidden— Benefits of PPPs (cont.)PPPs create an opportunity for KSA to institute necessary merit-based systems in business and government. As PPPs grow in number, they will change the business culture, thereby invigorating competition, spreading best practices, and raising productivity, while stimulating innovation. © Teece 2016 39
40 PPPs Facilitate Capability Transfers and Ongoing Capability Development in KSAOrdinary capabilities Dynamic capabilities Foreign firms often possess “best practices” that they are willing to share These “best practices” support technical efficiency that: May be unknown in the Kingdom Involves “doing things right” Can be accessed at low cost through PPPs Involve “doing the right things”; i.e., picking and choosing where and when to invest Are much harder to transfer than best practices (they are in fact “beyond best practice”) Cannot be obtained absent close engagement with a dynamically capable partner Engagement with partners will trigger learning through osmosis involvement. © Teece 2016 40
41 Success Can Build on ItselfVIRTUOUS CIRCLE VICIOUS CIRCLE © Teece 2016 41
42 V. Sector Focus: The Role of PPPs in A: Education and Research and B: Healthcare42
43 A: Education and ResearchTwo Key Questions: Can PPPs succeed in this sector? Can PPPs succeed in KSA? 43
44 Can PPPs Succeed in Education?PPPs have been used in the secondary education sector, particularly in the UK, Canada, and the US. Physical infrastructure School buildings and facilities School buses Social infrastructure Administration services Enrollment, collections, reimbursements Support services Cleaning, security, food services, transportation Professional services Teaching, curriculum development Ease of implementation decreases as performance measurement becomes more ambiguous For teaching services to be provided by PPPs, agreement is first necessary on curriculum and standards © Teece 2016 44
45 Performance Assessment Is Harder with Social Infrastructure ProjectsPhysical infrastructure Social Infrastructure Ease of Performance Assessment (KPI) Buildings & Facilities Support Services Administrative Services Professional Services © Teece 2016 45
46 Comment with Respect to Research-Oriented Tertiary EducationSimilar issues apply. Adding a research component does not make the problem much harder, as metrics (KPIs) with respect to scientific output now exist (e.g., Google Scholar). © Teece 2016 46
47 Private-Public Research Partnerships (PPRPs)PPRPs are designed to leverage research so as to capture commercial value and assist with economic development. University PPRPs engage faculty and graduate students (but not undergrads) in agreements between the university and private firms. This does not “corrupt” the university career choices, as undergrads are usually excluded. In the West, there have been good PPRPs along with poorly structured ones… much learning has occurred. Academic integrity can be compromised and public resources misdirected when partnerships are poorly designed and don’t have appropriate contractual protection. PPRP can turn universities into innovation ecosystem champions © Teece 2016 47
48 Strategies for PPRP CooperationUniversities and public research institutions can take the strategic initiative and generate RFPs, allowing private parties to respond, guided by the university’s principles and goals, and available financial resources. The process can go the other way, too, but only if the university is world class will it be able to compete as a supplier of inventions/innovations. Particular areas of interest (i.e., robotics, solar technology) can be specified. In the US, MIT, Stanford, UC Berkeley, and UCSF have been very successful with PPRPs. © Teece 2016 48
49 PPRP Issues to Manage: Conflicts and ColocationConflicts are not a reason to eschew PPRPs; rather, they call for conflict management machinery Potential conflicts need to be recognized up front, and contract should anchor a framework for resolution At their core, PPRP contracts should promote collective decision making that maximizes social welfare and gain to the parties to the agreement Partners need to expect to be on campus, but should not get special privileges Campus researchers will also need to colocate with the private partner Colocation and collaboration will increase both the quality and quantity of university research, if US and UK experience is a guide © Teece 2016 49
50 Relevant Vignettes Lockheed Martin, Babson College, and King Abdullah Economic City (KAEC) and the Saudi Arabia Economic offset program Goal is to advance education and entrepreneurship skills. Degree programs to be launched 2017. Aim is to eventually have up to 1,400 students in graduate and UG entrepreneurship program. PPPs can be focused on a particular deliverable; e.g., Cisco Networking Academy Programs is a PPP operation in over a dozen countries funded in part by Cisco to prepare students for entry-level jobs in ICT. 50
51 B: Healthcare Healthcare expenditure in KSA is approximately $20 billion and rising Better patient outcomes and much lower costs could be achieved with PPPs Management contracts could be entered into to help cut costs and improve patient care Additional international healthcare providers could be attracted to KSA Key benefits are efficiency, greater Saudi employment, and improved care, all of which are possible Education standards in the Kingdom for medical and nursing degrees will need to be raised… which can itself be facilitated by PPP © Teece 2016 51
52 Relevant Vignettes Government of Egypt did PPP in healthcare sector for the design, construction, financing, equipping, and facilities management for two teaching hospitals at Alexandria University. Local and international partners included Bareeq Capital (Egyptian private equity firm), Siemens, G4S, and Detac won both 20-year concessions. BRG partnered with Yale-New Haven Hospital System and used data analytics to subtract $200 million in annual costs from a $2 billion system, all while improving patent care as determined by agreed-upon KPIs. 52
53 VI. Conclusions and Next Steps53
54 Concluding ObservationsWith our framework, we have addressed the themes of the ADEC conference. BRG has used experts, experience, and the research of Nobel Laureate economists to help create a new framework to inform policymakers with respect to designing and governing PPPs and PPRPs. © Teece 2016 54
55 Concluding Observations (cont.)PPPs can help bring to the Saudi Arabia private sector technological and organizational/managerial capabilities and, if necessary, financial capital. More importantly, PPPs can drive efficiency and lower costs. PPPs can be used to both: Build new projects/progress Take over and transform existing activities, such as the provision of healthcare and education © Teece 2016 55
56 Concluding Observations (cont.)PPPs do involve some loss of government direct control but will enhance consumer/user/citizen satisfaction. While PPPs are not a silver bullet, they can address many critical economic development questions besides financing. While benefits of PPPs with respect to physical infrastructure are somewhat well understood, their benefits with respect to social infrastructure are not. We believe our framework can help. © Teece 2016 56
57 Schematic Summary of PPP BenefitsTRADITIONAL NON-TRADITIONAL Fiscal Reduce governmental capital outlays and outgoing budgetary outlays Risk Allocated to the party best able to manage it Technological Facilitate technological Transfer Capabilities Facilitate transfer of best practices Social Improve service coverage, quality, and timeliness while simultaneously changing attitude, lowering costs, and stimulating innovation Enhanced innovation, diffusion of merit-based systems productivity improvement, cost reduction, and service quality enhancement © Teece 2016 57
58 Next Steps Stumbling forward is not the answer.There is a body of scholarship and international experiences with respect to capability theory and contract theory that is available. It can be married to an understanding of strategy and business ecosystems. If properly designed and aggressively championed by KSA, PPPs can be a catalyst that can make Vision 2030 a reality. BRG is equipped to assist with this critical mission. 58