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Reducing the financial risk of smart cities

Opinions28 Aug 2019by Maggie Shillington: Senior Analyst, Smart Cities IoT Intelligence Service, IHS Markit

Maggie Shillington, IHS Markit, outlines how to create a multi-stream financing model to fund smart city initiatives.

The number-one challenge for smart cities is securing funding for projects.

Implementing technology, coordinating disparate stakeholders and determining return on investment are all major challenges, but nothing has the singular power to kill a smart city proposal like lack of funding.

Although there is not a single solution to this problem, there is one common cause – financial risk. Because these projects are often focused on introducing new technologies and new applications to a city, there is more uncertainty surrounding them than about routinely completed initiatives such as repairing streets.

Smart city investment types

IHS Markit’s analysis of over 1,300 smart city projects shows there are some common tactics to mitigating risks.

The first way to mitigate risk is by using a public-private partnership investment.

There are three main investment types for smart cities:

Private: The funding for the smart city project comes from a private enterprise
Public-private partnership (PPP): Private companies and the government both provide funding for the smart city project
Public: The government is the sole provider of funding for smart city projects

In a public-private partnership, both parties have a financial stake in the success of the project, which reduces the risk and increases both parties’ interest in completing the project.

Nothing has the singular power to kill a smart city proposal like lack of funding.

The shared interest in completing the project is crucial because successful smart city initiatives are long-term undertakings, typically spanning several years. Of the projects where investment type has been recorded, nearly 70 per cent of projects used public-private partnerships.

Source: IHS Markit

Smart city funding strategies

The second way cities mitigate risk is by using multiple funding strategies for a single project. Analysis of projects in the IHS Markit Smart City Project Database shows that there are five common funding strategies for smart cities:

Shared revenue stream: For smart city projects that generate revenue, like smart ticketing or smart parking, the city and company implementing the project can agree to split the revenue that results from the project. For example, for every parking ticket issued, the city receives 50 per cent of the income and the company receives the other half.
Contract: Another way a city can pay for a smart city project is via a contract with a company. The company, or the group of companies, provides the hardware, software and often services to support the operation of the smart city project. The city then pays the company a yearly or monthly fee for the use of the devices and services.

A growing trend for smart city project contracts is adding in service-level agreements. For these contracts, the provider must meet a pre-defined measure of service – typically a measurement of uptime or response time.
Upfront investment: Some cities can pay for an entire smart city project upfront. Typically in these cases, the cities are receiving funding from a higher-level government entity. For example, a state may have a grant available for cities to invest in a particular area.

In these cases, cities are motivated to pay for the project upfront to take full advantage of the grant.
Data monetisation: Instead of paying a company to implement a project, a company may be incentivised to provide all or some components (hardware, software or services) because of the potential value of the data collected in the smart city project.
Reduction in expenses (less personnel): Another way cities can afford a smart city project is by reducing other costs. For example, if a city-operated utility does not use smart meters, they have to pay a city worker to manually read and report the meter readings every billing cycle. With smart meters, an area previously covered by numerous meter readers only needs a single person to cover it.

Source: IHS Markit

By using multiple funding strategies, cities reduce the financial risk of large, and often expensive, projects.

For example, if a city begins a project using a country-level grant that is de-funded in the second year of the project, the city could fall back on a shared revenue stream, like advertisement or data monetisation where the city gives local businesses sensor data that provides more insight to foot traffic in a commercial area.