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Market Insight

Reducing financial risk of smart cities

August 27, 2019

Maggie Shillington Maggie Shillington Senior Analyst, Smart Cities IoT Intelligence Service, IHS Markit
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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 of a smart city project, but nothing has the singularity of 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, the financial risk of projects. Because these projects are often focused on introducing new technologies and new applications to a city there is more uncertainty surrounding these projects than routinely completed projects, like repairing streets.

Smart city investment types

IHS Markit’s analysis of over 1300 smart city projects shows there are some common tactics to mitigating risks for Smart City Projects. 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. The shared interest in completing the project is crucial because successful smart city projects are long-term projects, typically spanning several years. Of the projects where investment type has been recorded, nearly 70% of projects used public-private partnerships.

Smart city funding strategies

The second way cities mitigate risk is by using multiple funding strategies for a single project. By analyzing projects in the IHS Markit Smart City Project Database, there are five common funding strategies for smart cities.

The five common funding strategies:

  • 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% of the fine and the company receives 50% of the fine.
  • 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 predefined 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 to 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 monetization - Instead of paying a company to implement a project. A company may be incentivized 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.  

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 defunded in the second year of the project, the city could fall back on a shared revenue stream, like advertisement, or data monetization where the city gives local businesses sensor data that provides more insight to foot traffic in a commercial area. By using multiple funding strategies in a single smart city project, cities mitigate risk, thus ensuring its longevity.

Looking for more insight to the funding models for smart cities?

For more information, see our report, Funding models for smart cities – 2019. The report is part of our Smart Cities IoT Intelligence Service, which provides a complete and thorough assessment of the various technologies, major players, and overall market dynamics underlying smart cities. The intelligence service also gives subscribers access to our proprietary database containing information on over 1,300 smart city projects in more than 300 cities.

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