This Senate Fiscal Agency issue paper was prepared with data collected from the Michigan Department of Transportation. Special thanks are due to all involved for their diligent efforts. Bill Bowerman and Suzanne Lowe lent welcome editing skills and particular thanks go to Pat Stinton-Harper who formatted the report and designed the report tables.

Background -- The "Pilot Program in Highway Maintenance"
 
Cost Comparisons

Figure 1 -- MDOT Maintenance Districts
 
Comparison of ABC Paving, State, and County Road Maintenance Costs
 
ABC Paving and State Maintenance Contracts: Part Two
 
Conclusion
 
 
Tables:
 
Table 1 -- MDOT Direct Maintenance Costs per E-Mile
 
Table 2 -- Contract County Maintenance Costs per E-Mile
 
Table 3 -- Comparison of County and MDOT Maintenance Costs per E-Mile
 
Table 4 -- Comparison of maintenance Costs by Contract Provider
 
Table 5 -- Comparison of Second Private Maintenance Contract Costs
 
 

This Senate Fiscal Agency Issue Paper is the second in a series that examines Michigan's recent privatization initiatives. It surveys the Michigan Department of Transportation's (MDOT's) effort to privatize road maintenance on Michigan's highways and compares that undertaking with ongoing State and county maintenance programs.
 

Privatization of State services gained prominence in 1992 with the creation of the Michigan Public-Private Partnership Committee. The Partnership Committee, and the Privatization Division that ensued, examined ways in which private contractors could be used to enhance the quality and reduce the cost of government services.⁽¹⁾ As noted in a (January, 1998) Senate Fiscal Agency Issue Paper, departmental participation in the privatization process varied widely. This study uses MDOT experiences as a case study to provide a better understanding of the opportunities and pitfalls of Michigan's recent privatization initiatives.
 

Background -- The "Pilot Program in Highway Maintenance"
 

Currently, both the State and local road authorities maintain the 9,606-mile State trunkline highway system. The MDOT is directly responsible for approximately 3,600 miles of this network. The remainder is maintained by county road commissions, as well as city and village governments, which work under a standard maintenance contract with the MDOT. This paper is limited to a comparison of highway maintenance performed by the State and county authorities. City and village trunkline maintenance contracts are not included in this discussion.
 

Highway maintenance encompasses a wide variety of activities including: pothole patching, grass mowing, culvert cleaning, sign and guardrail repair, and winter snow removal. In fall 1992, the MDOT initiated a plan to contract highway maintenance services through open competition, analogous to the way in which private firms are chosen to construct Michigan roads. This comprehensive contract included all required maintenance services on one section of State trunkline road. Bids were solicited to provide maintenance services on a 27-mile section of I-94 between Rawsonville Road and M-10 (Lodge Freeway) in Detroit previously maintained by the Wayne County Road Commission. After an open bidding process, the Wayne County Road Commission was named the low bidder and in October 1992, was granted a contract to continue these maintenance services.
 

Nonetheless, the effort to shift trunkline maintenance responsibilities to private sector contractors continued throughout the next year. In early 1994 the State solicited bids for another highway maintenance contract, this one near Lansing. The State proposed a two-year contract that covered maintenance activities on 20 miles (121 lane miles) of I -496 and US-27 in Ingham, Clinton, and Eaton Counties. The Eaton County Road Commission expressed an interest in submitting a bid for this project, but its efforts were refused by the Department. Three different private companies eventually submitted bids for this contract. In April 1994, the Department rejected all three bids because the lowest was more than 50% higher than the MDOT engineer's estimate ($2,147,945 compared with an estimate of $1,430,229).⁽²⁾
 

The proposed contract was re-released in September 1994, and four companies submitted new proposals. ABC Paving Company of Trenton, Michigan was the low bidder with a cost of $2,065,375. This figure was $266,581 (14.8%) higher than the now updated MDOT engineer's estimate of $1,798,794. Bids submitted by the three other contractors ranged from $2,145,517 to $2,591,030. ABC was awarded the contract in October 1994.⁽³⁾
 

Neither the Department nor ABC had experience with comprehensive contractual highway maintenance projects. Though the MDOT had long used private contractors for road construction, it had never contracted for comprehensive highway maintenance services with private companies. On the other hand, ABC Paving was a construction firm that had not previously been involved in highway maintenance activities. As a result, the MDOT Director described this effort as an "experiment . . . to determine the viability of developing private sector involvement in road maintenance." The Department, he said, would release a "financial analysis" comparing maintenance costs between the State and the private sector at the conclusion of this pilot project.
 

The first months of this program revealed several serious technical and administrative deficiencies. For example, a March 8, 1995, MDOT memo cited problems with the contractor's calibration and preservation of snow removal equipment. As a result of these deficiencies, the MDOT Contract Administrator recommended that "spot inspections be done in the future" to maintain service quality.
 

These and other problems continued throughout the first year. In February 1996, the MDOT District Contracts Engineer noted that:
 

The Contractor (ABC) tends to concentrate on a few, easy-to-perform, high profit items, especially those items that do not require approval of the Contract Administrator. This list included routine patrol patching and the replacement of guardrails with minimal damage or small dents.

Nonetheless, the Department maintained its commitment to the original contract. In late 1996 the option for an additional third year was exercised and ABC's contract now ran through September 1997. This extension was granted to give the Department time to create a more "comprehensive analysis that (would) more accurately compare ABC costs to MDOT costs." Despite this extension, that analysis has not yet been completed.⁽⁴⁾
 

Why has this report been delayed? The reasons are three-fold. First, the Department lacks a unit cost accounting system that can be used to compare activity costs on MDOT and contract county maintenance projects. For example, each MDOT maintenance garage maintains a budget for its areas of responsibility. These funds are used to pay for snow plowing, pothole repair, guardrail replacement, and so forth. However, not all districts track the time, material, and personnel costs for each of these particular activities in detail. For example, a maintenance crew may work on three different projects in a single day, but few records are kept to allocate the time spent on pothole patching versus guardrail replacement, or to compare how the costs of repairing a single pothole differ between county road commission road crews, the MDOT, and, in this case, the ABC Paving Company.
 

These problems are exacerbated by the distribution and assignment of MDOT maintenance crews. Many MDOT maintenance facilities provide regional services as needed. These garages are maintained by State forces whose areas of responsibility cross county boundaries. Consequently, it is sometimes difficult to compare trunkline maintenance costs in Ingham County with those in Eaton County. The Department is in the process of creating a more comprehensive data tracking system. It is anticipated that more detailed cost accounting data will become available as the new Office of Information Management develops.⁽⁵⁾
 

Second, the nature of highway maintenance makes accurate cost comparisons more difficult. Maintenance activities can be separated into two simple categories, "routine" and "emergency" activities. "Routine" activities are planned, predictable projects, often unrelated to season or traffic volume. These include grass mowing, curb sweeping, and culvert cleaning. "Emergency" maintenance activities include projects such as repairing potholes and winter snow removal, neither of which can be planned in advance. The unpredictability of these activities makes it more difficult to create accurate unit cost allocations. District maintenance budgets, for example, cannot fully account for variation in the number of potholes filled, their depth, location, or difficulty.
 

Finally, emergency maintenance procedures can vary by location, often dramatically. For example, because of differences in climate and land availability, snow removal procedures in the Upper Peninsula are different from those used in the Detroit metropolitan area. In the Upper Peninsula accumulated snow is plowed to open areas and allowed to melt naturally. Because similar space is not available in the Detroit metropolitan area, snow is chemically melted or hauled to a different location. As a result it is difficult to make an accurate comparison of seemingly similar maintenance activities across regions or projects.
 
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Cost Comparisons
 

Despite these difficulties, several interesting comparisons of highway maintenance costs in Michigan can be made. The following section presents a methodology to accomplish this task. Though comprehensive maintenance costs are unavailable by county, it is possible to compare district-level maintenance costs among State maintenance garages. For example, are maintenance costs greater in the Upper Peninsula or are urban highways more expensive to maintain? One can then compare comprehensive maintenance costs in contract counties with State maintenance costs within the same district. Finally, both State costs and contract county costs can be compared with those incurred on the ABC Paving contract, especially within the same, or similar, districts.
 

Figure 1 shows the nine MDOT maintenance districts.⁽⁶⁾ The majority of trunkline miles covered by the ABC contract lie within MDOT District 8. Consequently, most comparisons will be made to other maintenance providers within this region. However, the ABC contract covers a unique combination of high traffic Interstate and highway road miles that might not accurately reflect the distribution of road miles within the State trunkline. Therefore it is also necessary to compare results of the ABC contract with other, more urbanized districts, especially Districts 5 near Grand Rapids and 9 in the Detroit metropolitan area.
 

The following tables compare maintenance costs across these regions. Table 1 examines State maintenance costs in the nine MDOT districts. Tables 2 and 3 compare maintenance costs among contract counties and then between these counties and the State. First, however, two assumptions need to be highlighted. The Senate Fiscal Agency (SFA) is assuming that the scope of services provided in each of these districts is directly comparable. In no cases of which the SFA is aware are there significant differences in the range of maintenance services provided. State garages, contract counties, and ABC Paving were responsible for similar, comprehensive maintenance activities throughout the year, including those discussed earlier such as grass mowing, culvert cleaning, guardrail repair, sweeping, and snow removal. Small-scale and/or project-specific maintenance contracts have been excluded from the figures shown below.
 

While it is recognized that there are differences in the types of maintenance services each agency provides, it also is assumed that those differences do not prevent the SFA from making the general cost comparisons presented below. For example, because of environmental conditions snow removal procedures are often different across regions, as was discussed earlier. These service variations can, in fact, be used to help explain variations in observed costs.
 

Second, it is assumed that State maintenance garages and contract maintenance counties provide service of equal quality. The SFA did not attempt to measure regional performance variations, though they might exist. This assumption is supported by two factors: The MDOT maintains materials and maintenance standards that contract counties and State garages are supposed to follow. These specifications are contained in the annual county road maintenance contract. Second, district MDOT engineers work with county road commissions to maintain performance standards. These engineers remain in close contact with county road maintenance teams throughout the year and monitor the work of contract commissions.
 

Table 1 compares MDOT maintenance costs on the State trunkline system within each district. Column two shows the total maintenance budget for each district in fiscal year (FY) 1996-97. Trunkline maintenance in District 5 (Western Michigan) and District 9 (Detroit metropolitan area) is exclusively performed by county road commissions. Therefore, the annual direct maintenance budget for these areas is zero. The third column lists the total number of Equivalent Miles (E-miles) maintained in each district. The final column compares maintenance costs per E-mile in each district. Equivalent miles, unlike lane miles, are used by the Maintenance division to describe the length of trunkline roads. These measures account for maintenance services required on ramps and interchanges not included in lane mile measurements on the State trunkline.
 
 

Table 1 shows that MDOT direct maintenance costs averaged $8,823 per E-mile in FY 1996-97. The MDOT's maintenance costs were greatest in the Upper Peninsula, which is covered by Districts 1 and 2. District 8 in the south central Lower Peninsula had the lowest average maintenance cost per E-mile, $8,055. The Direct Maintenance Costs for District 7 exclude $725,920 for an experimental winter maintenance contract for portions of I-69 in Branch and Calhoun Counties, recently signed with each respective county road commission. If this figure is included as part of the total, the Direct Maintenance budget would increase to $33,477,600, or $9,019 per E-mile.
 

Table 2 compares contract county maintenance costs in each of the same MDOT maintenance districts. Column two lists the total payments to contract counties within each district. Under the terms of the standard maintenance contract, counties are reimbursed only for actual costs incurred on legitimate maintenance activities. This column represents the total of payments made to county road commissions in FY 1996-97 under the terms of these contracts. Column three lists the Equivalent miles maintained by each county road commission, and column four shows the cost per maintained E-mile. Comprehensive maintenance services in District 7 are exclusively provided by the MDOT. Several County road commissions have project-oriented maintenance contracts with the State, but none provide the comprehensive maintenance services discussed here.
 

As this table illustrates, average county road commission maintenance costs varied dramatically across the State. These costs ranged from $5,929 per E-mile in District 4 (northeastern lower Michigan) to $17,260 in District 9 (Detroit metropolitan area). The average county maintenance cost is $9,561 per E-mile. However, this total is strongly influenced by the high cost of highway maintenance in District 9. Excluding District 9 results in a total cost of $59,760,578, or $7,317 per E-mile over the remaining 8,167 E-miles.
 

One possible reason for the wide differences in contract county maintenance costs is the number and type of miles maintained by the respective road commissions. These figures do not account for such variables as traffic level, weather, or existing road conditions. For example, the Detroit metropolitan area is unique in the volume of traffic it receives and the proportion of multi-lane highway miles maintained by each road commission. As a result, one might expect that annual maintenance costs in this District would be higher than those elsewhere. Data presented above would support this hypothesis.
 

How do these figures compare with MDOT direct maintenance costs? Table 3 compares average contract county and MDOT maintenance costs within each of the nine maintenance districts.
 

Column two lists average contract county maintenance costs per E-mile. Column three lists the same figure for the MDOT. The final column lists the difference between MDOT and county road commission maintenance costs per E-mile. The data show that the average difference in maintenance costs between the MDOT and contract county road commissions is $3,715 in the six comparable districts. (This figure excludes data for Districts 5, 7 and 9 in which either the MDOT or contract counties exclusively maintain State trunkline roads.)
 

However, this figure is a mean calculation of previously averaged data. A more accurate calculation is as follows: In Districts 1-4, 6, and 8 the MDOT maintained 1,944 State trunkline E-miles at the cost of $18,228,360, or $9,377 per mile. In the same districts county road commissions maintained 6,359 E-miles at the cost of $44,568,678, or $7,009 per mile. This figure is$2,368 less that the MDOT cost per mile, rather than the $3,715 figure presented above.
 

Regardless of which figure is used, the data indicate that there is a difference in maintenance costs per mile between the MDOT and contract county road commissions. What might explain these cost differences? One possibility is that county road commissions have lower overhead and managerial costs. For example, many commissions have a limited scope, staff, and geographic area of responsibility. Rather than develop their own administrative systems, these commissions might rely on county-wide human resource, public relations, or accounting personnel. This creates cost savings that cannot accrue to a dynamic, State-wide department.
 

The Department often argues that these "outside" costs are not fully reflected in contract prices. However, to the degree that these costs can be defined as maintenance-oriented, they can be included as part of the standard overhead reimbursement from the State and, thus, reflected in the figures presented above.⁽⁹⁾ By ignoring the costs associated with these activities, county road commissions would be, in effect, subsidizing the maintenance costs of State trunkline roads.
 

Two other explanations for these variations are more likely. First, MDOT district garages provide additional maintenance services not included in standard county road contracts. One such activity is bridge inspection and repair. This and other additional responsibilities likely increase MDOT maintenance costs compared with those of contract county road commissions.
 

Second, county road commissions are also active proponents of privately subcontracted labor, especially for routine maintenance activities such as grass mowing. Road commissions that win maintenance contracts often rely on materials, equipment, and temporary labor from local subcontractors. This likely contributes to counties' reduced costs compared with those of the MDOT, which has a large number of full-time maintenance personnel, dedicated equipment, and materials storage facilities.⁽¹⁰⁾
 

How, then, do these costs compare with those of the ABC contract? Did the State's experiment in maintenance privatization result in cost savings similar to those experienced by county road commissions?
 
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Comparison of ABC Paving, State, and County Road Maintenance Costs
 

ABC Paving signed its first highway maintenance contract in October 1994. This contract was valued at $2,065,375 for two years, or $1,032,688 per year. It covered 121 lane miles of State trunkline roads or approximately 60 maintenance E-miles.⁽¹¹⁾

Table 4 compares trunkline maintenance costs under this contract with those of the roads maintained by the State and county road commissions.⁽¹²⁾
 

As Table 5 indicates, maintenance costs under the first ABC paving contract were 96% higher than those of the MDOT and 80% more than the average maintenance cost of county road commissions. Within District 8, ABC Paving maintenance costs were $9,156 (114%) more per E-mile than the costs of MDOT maintenance garages, and $10,148 (144%) more per mile than the costs to contract county road commissions.
 

Though this figure is significantly more than the average State or county road commission cost, it is roughly comparable to the average contract maintenance cost in the Detroit metropolitan area. Table 3, above, showed that contract maintenance costs in District 9 were $17,260 in FY 1996-97. This is only $50 more than the average cost under the ABC contract.⁽¹³⁾ Nonetheless, it is clear that the initial ABC Paving contract did not result in a cost saving to Michigan taxpayers when compared with other service providers.
 
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ABC Paving and State Maintenance Contracts: Part Two
 

The MDOT used the initial comprehensive maintenance contract to help "determine the viability of private sector participation in highway maintenance." Though the MDOT never publicly reported on the success of this experiment, the Department issued a second trunkline maintenance contract for the same section of I-496 and US-27 in mid-1997. Bids were solicited in August and the contract was awarded in September 1997. Both the Eaton and Ingham County Road Commissions expressed an interest in submitting a bid for this project. However, they were prevented from bidding since neither was on the MDOT's list of "pre-qualified" contractors. In the end, only two private contractors submitted bids. ABC Paving won the 43-month contract with a bid of $3,247,466, $794,056 (32%) more than the engineer's estimate of $2,453,410.⁽¹⁴⁾
 

Part of this $3.2 million contract was an up-front "mobilization" payment of $793,000 or 24.4% of the total contract. Mobilization payments are usually used to provide companies with capital to purchase equipment and materials necessary to begin work. This payment was allowed, despite the fact that ABC had been performing identical maintenance tasks for three years on the same section of State trunkline.⁽¹⁵⁾
 

The second contract results in an average monthly cost of $75,523, or $902,276 per year. This is an annual reduction of $126,412 (14%) compared with the previous contract. However, per mile costs are still significantly greater than those of either the State or contract counties, as Table 5 indicates.
 

Table 5 shows that ABC Paving's average cost per maintained mile fell from $17,211 under its first contract to $15,038 in the new contract. However, per mile maintenance costs under the second contract with ABC Paving are still 87% more than MDOT costs within District 8 and 113% more than the cost of contract road commissions within the same area.
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Conclusion
 

This paper has highlighted a unique problem in the Department of Transportation's efforts to provide high quality road maintenance services at low cost.
 

A comparison of State and county road commissions showed that many county road commissions were able to provide comprehensive highway maintenance services at a much lower cost than the MDOT. Several explanations were put forward for this difference, including lower overhead costs for county road commissions and the additional responsibilities of MDOT district garages.
 

In an attempt to develop private sector highway maintenance providers the Department entered into a pair of comprehensive maintenance contracts with the ABC Paving Company. The second portion of this paper compared highway maintenance costs between the State, county road commissions, and ABC Paving under these contracts. The data presented above showed that private maintenance contracting has not yet resulted in a cost saving when compared with the services provided by either the State or county road commissions.
 

The SFA analysis indicates that county road commissions are, at the present time, able to offer highway maintenance services to the State at a significantly lower cost than either the State or private contractors can provide, including the costs of State-provided materials such as salt, sand, and chloride. Based on this finding the SFA recommends that the State open bidding to allow all interested parties, including both private contractors and local municipalities, to compete for future highway maintenance contracts. Second, the SFA also recommends that the State distinguish between emergency and routine maintenance activities and continue to explore ways to reduce trunkline costs by using private contractors for routine maintenance activities, as some county road commissions have done in the past. Ongoing experimental winter maintenance contracts in Branch and Calhoun Counties will help determine the viability of these, more targeted contracts.

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2. Prior to the release of any large road construction or maintenance project, MDOT engineers prepare an estimate of expected costs on each activity within the proposed contract. This is known as an "engineer's estimate." This is a confidential estimate and is not used by potential contractors in the preparation of their bids. For example, a survey of contracts recently released by the Department shows that final prices are often above, and below, these MDOT engineer's estimates.

3. It is important to recognize that the contract price did not reflect the total cost to one State. A February 26, 1996 memo from the District Operations Engineer noted that in the first year the Department provided ABC Paving with a salt storage building (including utility and maintenance costs) worth $344,014.

4. In a July 23, 1997, radio broadcast, MDOT spokesman Gary Naeyaert said he anticipated completion of that report "by the year's end."

5. This is part of an on-going staff reorganization program. One dimension of this reorganization is the development of a computer technology unit called the Office of Information Management. This unit is supposed to enhance the support, operations, and use of computer technology across all MDOT departments, including the finance division.

6. The MDOT no longer uses the district-based scheme described here. Instead, it has shifted to a seven-region scheme by combining Districts 1 and 2 and Districts 3 and 4. However, the data presented here were collected under the former nine-district system.

7. Data provided by the Michigan Department of Transportation.

8. Data provided by the Michigan Department of Transportation. Figures include "stores" items not included in standard maintenance contracts, such as MDOT-provided salt, sand, and chloride, signs, and guardrails.

9. The standard overhead rate is 8.5% of the value of the annual maintenance contract, unless the county road commission chooses to have its overhead rates audited to cost.

10. The MDOT is currently expanding its use of temporary and "on-call" employees used for routine maintenance services as well.

11. In order to compare costs with figures presented in Table 3, one must translate the contract area (approximately 20 miles of State trunkline) into maintenance E-miles. One E-mile is roughly equivalent to 16 feet of highway surface. The roads maintained by ABC were all two-lane highways, each of which was 12 feet wide. This is equal to 48 feet of road surface per mile, or three E-miles per mile. Since the contract covers approximately 20 route miles of State trunkline, one can use this calculation to approximate the 60 E-mile figure used above.

12. This contract excluded the cost of salt, sand and chloride provided by the State and used by ABC for winter snow removal. As was discussed above, this is a common practice in county road commission trunkline maintenance contracts as well. During the first two years of the ABC contract these materials cost the State $175,958. However, these costs were, in effect, offset by the difference between the value of the original contract and the amount actually spent by ABC. The total expenditure during the first two years was $1,869,440, or $195,935 less than the original contract, but only $19,977 more than the cost of State-provided road salt. Consequently, the cost comparisons presented above will use original contact values rather than adding salt costs and adjusting for expenditures over the contract period. Similar data for the third contract year were not made available.

13. Within the Detroit Metro district maintenance costs varied from $11,092 per E-mile in St. Clair County to $21,700 per E-mile in Wayne County in FY 1996-97.

14. It is important to note that the second contract included greater MDOT control over the type and timing of maintenance services performed on State trunkline roads. These changes resulted from failures identified in the first contract, some of which were discussed above, such as equipment maintenance and calibration problems.

15. The 1994 ABC contract included a $270,000 mobilization payment, equivalent to 13.1% of the $2,065,375 price.