Experts

Smart city, fast payback?

‘Smart city’ is a vogue term, but it means different things to different people, involves multiple stakeholders with differing perspectives and often requires a combination of public and private investment, which is appraised in different ways. This article summarises some of the main difficulties that arise, and then more positively considers a series of specific investments more likely to offer attractive returns.

But first, just what is a smart city? The British Standards Institute, in PAS180, defines it as “The effective integration of physical, digital and human systems in the built environment to deliver a sustainable, prosperous and inclusive future for its citizens”. The focus on integration and interfaces is natural for a standards-setting institution and there can be no doubt that standards are important in containing whole-life costs. The UK’s Department of Business Innovation & Skills (2013) has a different definition: it cites three ‘hard’ criteria: modern digital infrastructure (providing access to re-usable data), citizen-centric services, and intelligent physical infrastructure (Internet of Things). It also lists three ‘soft’ criteria, namely openness to learn from others, transparency of outcomes, and a clear and consistent vision.

At this point, alarm bells may be ringing. Investment in infrastructure is expensive, and investment in ICT (Information & Communication Technology) in particular can have a short lifespan. Also, intangible outcomes can be very difficult and slow to bring about. All this adds up to a difficult business case, with large investment up front and slow, uncertain payback subsequently. So, are there any investments with more rapid payback that justify the label ‘smart’? There are a few.

The head of budget for a very wealthy Gulf state surprised me one day by telling me that traffic violations (as registered by legions of road cameras) were the third most important source of revenue to the state, after hydrocarbon and alcohol sales (the state did not levy income or sales taxes). From a theoretical point of view, this is a win-win – technology is assisting with fewer accidents and increasing revenue. However, it comes with a political price of unpopularity. For example, in the UK, there has been controversy as the police seek to raise revenue from speed cameras by offering safety courses, for a fee, as an alternative to black marks on a driving licence.

Another related payback is parking revenues coupled with enforcement of fines for illegal parking. Here again, there is win-win, with less congested roads (with fewer obstructions and less circling of cars as drivers seek spaces), higher occupancy of car parks and higher revenue. For authorities who already make use of this revenue stream, there is potential for raising revenue further by demand-responsive pricing, so that scarce parking spaces attract a higher charge (an approach well-rehearsed for airline seats).

Demand-responsive pricing is facilitated by technology that allows price-setting to be done remotely. Similar arguments apply to dynamic road-pricing: ancillary benefits include reduced congestion and pollution, and increased security from tracking of vehicle numbers. These systems can produce counter-intuitive results. In Minneapolis, drivers were more willing to pay higher prices because they presumed these indicated higher congestion on non-toll rods; furthermore, they priced their time for time saved at $60-$120 per hour, far higher than assumed in most value-of-time calculations in transport planning exercises.

Even street furniture can be made smart. Replacing traditional lamps with LED equivalents not only saves energy but wireless connectivity can be provided at the same time. This allows more flexible control of lights and a canopy of wireless connectivity over a built-up area. In Copenhagen, smart streetlights can even increase lighting intensity as pedestrians or cyclists move past.

Metering is also an opportunity to reduce operating costs. In many water distribution systems, up to 30% of water is lost through leaks – remotely readable meters allow problems to be quickly identified, whether in public or private networks. Smart energy meters also identify potential for energy reduction by detecting trends in energy use and comparing usage between nominally similar spaces.

In many business cases, the focus is not simply on the reduction of operating and capital costs but also on identifying new streams of revenue. Revenue for private companies is also crucial, as the private sector may be willing to make capital contributions to obtain it, or pay licensing fees. Sometimes revenue can come from unlikely sources; for example, when Copenhagen replaced half its streetlights with smart equivalents, the city was able to auction off the old lights to private buyers who viewed them with nostalgia!

While broadening the sources of funds for an investment seems an obvious benefit, it can create challenges in investment appraisal. Private appraisals are usually based on a discounted cash flow basis, i.e. calculating the net present value of a cash stream, whereas public investments consider costs and benefits (and their net present value), reserving examination of cash to assess affordability. Many benefits are non-cash, e.g. reduction in travel time, and investment needs to be made by parties whose appraisal methods recognise the benefits, with private sector focusing on cash-generating assets and public authorities considering the non-cash economic costs, as well as the social or environmental gains, that might justify a public investment. Another difference is that discount rates used in the public sector are typically much lower than in the private sector, increasing the significance of costs and benefits in the distant future.

These considerations are of particular relevance to consultants and system vendors who are trying to develop a business case for the investment from various sources. In some cases, the private sector partners consider gain-sharing arrangements, performance-related payments or impact fees to facilitate investment, and these arrangements require an appraisal to confirm that the return on investment meets corporate thresholds.

What are the implications of all this for contractors? I recall listening to a senior figure in a major programme management contractor for an expressway programme in the Gulf region, as he was speaking to potential bidders. He remarked that although many of the road designs were large by any standard, he was unconcerned about the ability of the bidding contractors within that room to build them. What kept him up at night, to use his words, was the increased level of ICT-systems in the designs, i.e. intelligent transport systems. He perceived these to be a source of risk.

This mix of technologies, of the old and the new, also creates issues regarding procurement strategies: should one tender be placed for all sub-systems of particular technologies, to maximise the potential for standardisation and scale within that technology? Or alternatively, should the packages focus on a self-contained physical system, to minimise interface management complexity by limiting the interfaces to those within a single system and therefore within the remit of a single main contractor? The answer of course is that it all depends, not least on the completeness of the technical standards for particular technologies.

Finally, from the point of view of the owners of the systems, whether municipal or private, it is important to avoid lock-in to particular suppliers wherever possible and instead to adopt open standards that appear set to last. The aim should always be to minimise whole-life costs rather than initial outlay, when choosing between options.

Dr Rupert Booth is chief economist at Faithful + Gould.

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