Five ways to fund a smart city
The scramble for technology to create cleaner, safer, richer cities has intensified as funding models have started to take root. The fashion for smart city pilot tests has finished. The technology works, we are told. The last challenge is how to pay for them, when so many of their benefits are hard to calculate financially.
How do you make money from sensors in car parks, really? How much, exactly, is information about air pollution worth?
In a new report, Navigant Research has looked at the smart city market, and identified the five key funding models that have started to make it tick. Here, we consider each, as means to solve 21 century urban challenges, and ask obliquely if any of them will bring intelligence to cities, beyond just a few noisy outliers
1 | PUBLIC-PRIVATE PARTNERSHIPS (PPPs / 3Ps)
A public-private partnership, declined as PPP in Europe and 3P / P3 in North America, is a cooperative arrangement between two or more public and private sector entities, where the financial risk is loaded on one side of the deal, typically towards private enterprise.
PPP / 3P deals have been employed as a standard financing instrument by governments across the globe, particularly as a way to fund major public infrastructure projects during the last 30 years. The structure of the model, and the allocation of risk, varies considerably, depending on partners and applications.
In the smart cities space, it is the most common and, as yet, most effective tool for governments and suppliers to push forward with their projects. “They are all over the place, in many smart-city application areas, and they come in many different flavours,” says Ryan Citron, senior research analyst at Navigant Research.
“It is essentially just a contract between a public authority and private supplier that defines a way to work together, but the definition is pretty loose.” The financial risk is largely assumed by the private sector, he notes, so tax payers “aren’t on the hook” if something goes wrong.
In smart city deployments in the US, the financial burden assumed by the private sector has been greater, simply as state funding has been less. In Europe, most smart city projects have retained a stream of funding from the European Union, typically via its Horizon 2020 programme, pushing research and innovation in the region through to 2020.
The upside for the private sector is the chance to secure major regional and national infrastructure deals, only with the sting of bank-rolling such projects through their formative years. Key incentives are built into PPP / 3P deals by governments in order to justify the investment for the private sector.
“Governments typically guarantees some level of service, or offers subsidies, grants or tax breaks,” notes Citron.
PPP / 3P arrangements have helped many smart city technologies take root. However, they require a clear business case with a reliable return-on-investment. The problem for the smart city movement, and vendors pushing novel solutions in the space, is so many of the applications and use cases are either completely untested, or else they only offer a kind of ‘soft’ ROI.
In the end, the financial risk for both sides is too high. “For many smart-city applications, the return is less clear for investors,” comments Citron.
2 | ENERGY SAVINGS PERFORMANCE CONTRACTS (ESPCs),
As discussed above, PPP / 3P models are hugely varied; at one extreme, they effectively result ‘energy savings performance contracts’ (ESPCs), where the financial incentives are effectively swapped for a share of the energy savings achieved by the tech upgrade.
In the smart city space, ESPCs have become the default tool for getting smart buildings and smart street-lighting projects off the ground. The model works so buildings are retro-fitted with energy control and management systems, and whole cities are afforded brand new lighting infrastructure, without making any capital investment.
Instead, they relinquish their energy savings until the supplier recovers their own costs. “It uses the future energy savings to fund the investment. Once the energy savings pay off the initial fee, the city starts to reap the benefits,” explains Citron.
For street lighting, vendors reckon cities can save 70 per cent of their energy and maintenance costs by combing connected LED lights and control systems, and make the money back in a few years.
Citron explains: “A lot of companies are telling cities they don’t have to pay anything. They’re saying: ’Your paying $10 million per year in electricity costs for lighting; put our system in and save $7 million. You can have it paid off in three years, and save a tonne of money every year after that.’”
The ESPC model has effectively made street-lighting the poster child for smart city applications. Cities like the model, too, because the supplier is the one penalised if targets are not met, removing risk almost completely.
But, like with PPP / 3P master deals, ESPCs work because the ROI is well understood. The energy savings from other smart city applications – including even popular point solutions, like connected waste bins, weather sensors, and parking systems – are murkier, and riskier for investors.
“The challenge with all of these models is how to apply them to other smart city applications,” says Citron.
3 | AS-A-SERVICE OFFERINGS (aaS)
Subscription-based models offer another way for cities to avoid making upfront payments for tech infrastructure and service offerings. They appear to cities rather like ESPCs, insofar as the cost is spread over a set period. The difference is the outcome for the city is not written into the bargain at the start.
Typically it is attached to more conventional service offerings, rather than infrastructure projects. Certain lighting companies, for example, require cities to pay a subscription to make use of their control and management functions. “It’s good model – the city doesn’t have to pay upfront; just on an ongoing basis. It makes it easier to bear,” says Citron.
Increasingly, smart city providers are aspiring to get their capital costs down to the point they can also offer as-a-service schemes. Street parking, says Citron, has been expensively rolled out in cities like Los Angeles, with every single space fitted with a sensor to create a parking map for drivers.
But the sheer cost of such an exercise has stopped cities from copying, and suppliers from pushing. Instead, they are seeking to redesign their tech and rewrite their algorithms to make the service more affordable, if also more approximate, and to eke out a subscription model for partners,
Despite increasing interest and adoption, however, as-a-service models are hard to offer when material costs are high in the first place. The five models are discussed here are less popular, by degrees, as we go through them. Subscription based offerings have found less traction than standard PPP / 3P models or energy savings contracts. “They’re not very common, at this point.”
Citron explains: “It’s hard in some realms for companies to come in and provide the service without charging upfront for some of the tech.”
4 | INVESTMENT RECOVERY THROUGH ADVERTISING / MARKETING
From here, we are scraping the barrel. The idea cities and enterprises will be able to monetise the data gathered on their city streets remains just that – an idea, locked in pilot mode in most cases. The idea an open data platform, in a smart-city control centre, will spark a new economy of local innovators is appealing, but hard to grasp.
Either way, these more expansive smart city concepts invariably hinge on the a hard ROI, probably realised by upgrading the street lights. Most experiments in the market only exist because the business case for street lights is so clear.
There is one alternative, however; the well-trailed LinkNYC project in the US, which is seeking to convert 7,500 old pay-phone booths across the five boroughs of New York City into digital kiosks. The plan was to spend $200 million. City Hall did not have to pay a dime. The cost – and then some – would be recovered through advertising, to the tune of $500 million over 12 years. “That’s what’s paying for the project,” says Citron.
Around 1,600 kiosks are in operation, offering free, fast and secure (gigabit) Wi-Fi to passers-by, push-button connections to emergency services, free USB charging, tethered Android handsets for free calls, and touchscreen access to city info and services. Five million people have stepped into the kiosks so far, reckons CityBridge, the consortium behind the project.
The payback for the city is connectivity and accessibility. The model has been picked up by electric vehicle (EV) charging companies, too, notes Citron, offering advertising space on their charging stations to be able to make a return and offer free charging.
5 | SOCIAL IMPACT BONDS (SIBs)
A recent phenomenon, social impact bonds (SIBs), also known as pay-for-with the pay-out contingent on agreed social outcomes. Issued by the public sector and funded by private sector, while they operate over a fixed period of time, they do not offer a fixed rate of return.
The first social impact bond was announced by the UK government in 2010 to finance a prisoner rehabilitation programme, bringing together innovators to generate idea to develop social action. In a smart-city context, it has been used here and there for healthcare projects, and other applications related to the criminal justice system
“It’s an interesting model. It hasn’t been used much. The contracting arrangements can be kind of complex, and difficult to finance. But it really targets social oriented investors, and people interested in alternative measures of financial performance,” comments Citron.
“It’s not going to be a major model, but it’s innovative and a little different – and it does focus on improved social outcomes, which is really the goal of most smart city projects. It could be used in transportation a bit more, for instance.”
This article is a forerunner to a report and webinar, titled How to buy / sell a smart city – procurement models to make every city smart, to be published on November 5. Sign up to the Enterprise IoT Insights newsletter here to get updates about the report, and related news. Register for the webinar here to hear from speakers from AT&T, the City of Cardiff, Cisco, Cradlepoint and Navigant.