THERE ARE NOT many global social phenomena that can be observed during your commute to work but urbanization is one of them. Whether in Los Angeles, Lagos, Bangkok or Bogotá, stinking traffic congestion or the crush of public transport are a daily reminder of urbanization. In case the message is not clear, try finding a parking space, or exiting the subway at leisure, in a crowded peak-hour business district.
That congestion and crush will only get worse based on current trends. According to the UN, baby number 7 billion was born at the end of October this year – probably in a developing country. Before that child comes of age, a majority of her compatriots across the entire developing world, including Asia and Africa, will be living in urban rather than rural areas, according to the UN.
As a result, the nasty side effects of living in cities are fast multiplying and creating challenges for city authorities, which are strapped for cash but hemmed in by the increasing expectations of internet-savvy citizens for service provision and transparency. Meanwhile, those same city authorities are jockeying to win the attention of clever individuals and footloose firms, which they hope will boost their economies.
The race to meet the needs of these city authorities is creating a bandwagon of enormous proportions around the concept of so-called smart cities. A Google search of smart cities conferences throws up a bewildering 59.4 million results, with inspirational speakers pledging to help you "seize smart city opportunities", create "intelligent infrastructure for the information age" and "manage mega-trends for mega-cities".
Meanwhile, several companies have launched initiatives or businesses referencing urbanization. GE is committed to ‘Building smarter cities’; IBM also believes in ‘Smarter cities’; Cisco wants to create ‘Smart+connected communities’; Samsung provides Smart infrastructure engineering services; Siemens has just launched its Infrastructure & cities business unit and Citi has created the punningly titled Citi for cities.
Local and global
A change in mindset at city authorities began in the 1980s with regeneration schemes such as London’s Docklands, now home to the Canary Wharf financial district. It gathered pace dramatically in the past decade as the scale of the ambitions of cities in emerging markets – exemplified by the gaudy new towers of Shanghai, Dubai and a hundred other cities – began to be understood and emulated elsewhere.
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| "Smartness defines the future in terms of technology, people, ways of managing services, sustainability and use of information" |
Baldomero Falcones, chairman and chief executive of FCC, a Spanish construction, infrastructure and environmental services firm that describes itself as a "global citizen services company", says that firms that provide infrastructure and technology to cities have recognized the extent of the change in mindset at city authorities – as they have come to appreciate the scale of their predicament – and changed strategies accordingly.
"Cities are competing to get the best people and companies," says Falcones. "At the same time, politicians that manage cities are responding to a clear message about what is important to citizens: 30 years ago people thought nationally; now they think locally and globally at the same time. As a result, there is this focus on quality of life and provision of higher-quality services, which cities are increasingly taking responsibility for."
A clue to how cities are responding to these challenges is provided by the ubiquity of the tag ‘smart’ used by many infrastructure and technology companies. "To adapt to this new situation there is a requirement for intelligence and smartness," says Falcones. "Smartness defines the future in terms of technology, people, ways of managing services, sustainability and use of information."
The need for smartness is one of necessity in many cases, according to Gerry Mooney, general manager at IBM Global Smarter Cities. "As cities grow they face a challenge in each of the 17 industries – from banking to government and education to transport – that we serve," he says. "In transit, for example, it is clear that in many cases it is no longer possible simply to build more infrastructure. Instead, there is a need to use existing infrastructure more effectively, by using real-time information management."
To be sure, the requirement for physical infrastructure remains paramount. A study published in September by RBS, Roots of growth – projecting EM infrastructure demand to 2030, suggests that Asia will have the highest aggregate demand for infrastructure spending of $15.8 trillion in the next 20 years. However, research by IDC Government Insights estimates the smarter cities IT market at $34 billion in 2011 and expects an 18% a year increase to $57 billion by 2014 – a figure not to be sniffed at. The financial services market related to cities, which overlaps both the technology and infrastructure sectors, is unquantifiably vast.
Do mayors dream holistic dreams?
For companies seeking opportunities in urban areas, the focus on cities – rather than individual city departments such as transport – is not just a convenient label for their marketing efforts: it reflects how cities want to address their infrastructure challenges. "Our experience is that municipalities are increasingly taking a more holistic approach to transport and social facilities, environmental services and renewable energy," says Falcones.
That holistic approach is coming about because cities are being forced to think about their infrastructure needs across all scales – from LEDs in traffic lights to big rail projects. "It makes sense to think about the technical challenges and commercial benefits in a similar way," says Johannes Schmidt, chief executive of project and structured finance, infrastructure, cities and industry at Siemens Financial Services, which supports the activities of Siemens and the infrastructure financing requirements of cities through the provision of letters of credit, risk management and financing for projects.
Schmidt says that cities require frameworks that help them to establish how projects should be contractually framed and who should take how much risk and why. "Establishing such principles is key to getting things done," he adds. "What delays projects are not technical factors but more usually contractual issues or the absence of experts to conduct a tender or determine risk sharing."
One of the most important factors in pushing the idea of a city-wide focus on infrastructure requirements is the growing power of cities relative to national government. Mei Li Tan, global head of franchise initiatives, GTS, at Citi, is happy to concede that "local government cannot exist in isolation from central government". However, she says that "national governments recognize that cities are the seat of their economic power, and it is also where there are large concentrations of citizens in need of social assistance".
Increasingly, power at a city level is being invested in an individual – a mayor. This change creates a further imperative to transfer best practice and transformational thinking across different sectors of government. "At mayoral level, there is definitely appetite for looking across silos and encouraging dialogue across departments to see how they can work more effectively together," explains Mooney at IBM.
The ability to capture headlines with dramatic projects that deliver tangible results and improve the daily lives of citizens clearly resonates with mayors. Not only do many have sizeable egos to maintain – politics in most big cities is a rough-and-tumble business that is not for wallflowers – they also need to win votes (in democratic countries) or retain authority and control (in non-democratic ones).
As a result, mayors like the concept of smart cities because the benefits are compelling, according to Wim Elfrink, chief globalization officer and executive vice-president at Cisco. "The ability to reduce energy consumption by 50% in a decade or water consumption by 70% – Singapore is the world’s first water-neutral city – is clearly attractive," he says. "Politicians want these solutions because citizens want them."
How to make money in a smart world
As cities’ departments become more intra-connected, so companies seeking to service them must necessarily agglomerate in some way. While the origins of Cisco’s Smart+Connected Communities are starry – it started six years ago because chief executive John Chambers was asked by former president Bill Clinton, through his Clinton Foundation, what role technology can play in creating cities with sustainable economies and environments – most of the smart city wave of ventures are rooted in prosaic business logic.
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"The most important thing cities can do is learn to understand what IT and analytics can do for them and how it can help them do things differently" |
In June, IBM announced its ‘Intelligent operations center for smarter cities’ – the culmination of its approach to the urban infrastructure and technology market. "IBM’s Intelligent operation center takes best of breed software and makes it specific to traffic management, public safety (predictive policing), water management and many other services," explains Mooney.
IBM contends that its centre can reduce costs, increase uptime and improve planning and logistics. For the company it offers a unique way to bring together its product offerings. "Although the centre starts with software, services are also important in connecting the offerings, as is hardware and storage – it brings together every aspect of IBM," says Mooney. "Certainly, Smarter cities is a lot more than just a marketing strategy: it reflects our organizational structure and delivers something tangible to customers."
While the attractions of smart cities and holistic thinking may be irresistible to companies serving the public sector, the imperative to reorganize structurally is not shared by all. "FCC is changing to reflect how cities are changing," says Falcones. "We are developing a smart city approach for the marketing and performing of our services. We are making the change more because of the possibilities opened up by smart use of information rather than changes in the organizational structure of cities themselves. Generally, cities continue to think about different services separately, and our delivery approach reflects that. We are still organized in divisions covering infrastructure, environmental services and renewable energy."
The opportunity for banks
Citi, almost alone among the world’s leading banks, is pushing the cities agenda. Francesco Vanni d’Archirafi, chief executive of global transaction services at Citi, says that the bank is committed to a strategic, company-wide initiative that focuses its solutions and capabilities across the bank. "Citi for cities embodies our response to a strategically important sector in the world economy," he explains.
| "Cities are home to the companies that power our economy and have a multiplier effect on the growth of world trade. Citi for cities enables the bank to increase its relevance to private- and public-sector clients" |
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Perhaps the most crucial aspect of Citi’s initiative is the way it highlights the bank’s firepower in many of its key markets. "Cities are home to the companies that power our economy and have a multiplier effect on the growth of world trade," says Vanni d’Archirafi. "Citi for cities enables the bank to increase its relevance to private- and public-sector clients, and to partner with them and their supply-chain companies."
For non-financial-sector companies, gaining access to the pool of businesses around city administrations – rather than the business emanating from them – is of peripheral importance. However, for a bank such as Citi – which already has relationships with most of the leading engineering companies in the world, for example – the Citi for cities strategy offers access to two distinct but equally lucrative opportunities.
"Our industrial clients are increasingly focused on this space, so it makes sense for Citi to be thinking about these issues in the same way through Citi for cities," says David Aldred, EMEA sector head for industrials, client sales management, GTS, at Citi. "It means we can discuss projects, initiatives and partnerships, and it gives Citi a lot of credibility. Clients want to understand what their next challenge will be and our collaborative strategy helps them with that. For the bank it creates a huge opportunity to cross-sell."
Although other banks recognize the potential growth of cities and their centrality to the global economy in the coming decades – in May, Deutsche Bank announced a £5 million ($8 million) endowment to the London School of Economics to create an international centre for urban excellence – none has invested as much effort in coordinating its business units to focus on this perceived opportunity. Other than improving marketing and communications within the bank it remains to be seen if Citi for cities will effectively link up the bank’s efforts in a new way (and deliver a greater slice of the cities pie to Citi). Certainly its rivals will be paying close attention.
Show me the money
The sums required to meet the demand for infrastructure are phenomenal: RBS’s Roots of growth study shows that Asia will account for the largest share of infrastructure demand in the period to 2030, with around $15.8 trillion of spending needs, followed by emerging Europe ($1.3 trillion), Latin America ($1.2 trillion), Africa ($0.7 trillion) and the Middle East ($0.2 trillion). Aldred at Citi estimates that $20 trillion is committed to infrastructure projects globally in just the next decade.
As Aldred notes: "Doing nothing is not an option for cities: they have a major need for infrastructure and the public sector has to act." Timothy Ash, one of the authors of the RBS study, agrees. "Given the trend of demographics and urbanization there is a basic demand for infrastructure," he says. "Those countries that fail to meet that demand could effectively go backwards in terms of growth given that those trends are unstoppable."
Who will fund this unprecedented spending? Certainly, there are established markets for financing infrastructure, such as project finance and public-private partnerships. However, as Aldred notes: "Long-term financing is a challenge for infrastructure projects: Basle III has implications for project finance, for example, and there is a continuing dislocation in capital markets."
Schmidt at Siemens Financial Services agrees: "Before the financial crisis, projects were typically financed by three or four banks, which then syndicated the debt: it was efficient and rapid. Since the crisis, projects have been financed by club deals, which banks buy and hold. As a result, 12 to 15 banks now need to agree documentation, and therefore it is a longer process."
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"The equity available for infrastructure investment has increased markedly as the infrastructure sector is increasingly viewed as stable, which has encouraged new funds to be established and sovereign wealth funds to enter the market" |
Meanwhile, PPP and private finance initiative financing, which is a huge source of funding for infrastructure projects, is under pressure as never before. The World Bank’s Private participation in infrastructure database shows that private activity in infrastructure in developing countries continued to be highly selective in 2010 (the last year for which figures are available).
Moreover, as Falcones of FCC acknowledges, there are concerns about the sustainability of PFI and PPP in the UK (where they originated and are most prevalent) and growing political opinion that the model of private finance participation is more costly than state funding in the long term. "The current concerns could affect other markets where private finance is used and could ultimately jeopardize the feasibility of many projects," he says. "As a tool, PFI is well developed, with a large number of bankers, lawyers and investors that understand it. The worry is that current concerns will mean it loses its attractiveness. Given market volatility, it could be difficult to stabilize the situation."
Schmidt says that it is unclear if current uncertainties about PFI/PPP will spread outside the UK, despite the prevalence of the model in emerging markets. "Certainly it could become increasingly portrayed [by politicians] as more expensive," he says. "However, the benefits of these structures are evident: risks are dealt with more diligently in the private sector and that is reflected in lower cost overruns and improved delivery time."
Schmidt believes that more nuanced discussion is necessary. "There is a role for both the public and private sector and the important thing is to ensure risk is correctly apportioned," he says. "It might be tempting to say either that the public or private sector should take all the risk but it is not efficient – it just increases costs to the detriment of the project."
Alternative funding
While there may be question marks over project finance and PPP, other potential sources of funding for infrastructure have increased markedly in recent years. Export credit agencies, such as Coface of France and CESCE of Spain, are more frequently involved in financing projects, as are multilaterals such as the European Investment Bank and the Asian Development Bank.
"The increased involvement of ECAs is a return to the situation in the mid-1990s," notes Schmidt at Siemens Financial Services. "In some cases, ECAs had almost shut down – some are now rehiring."
ECA involvement, in addition to providing finance and ensuring that political risk is minimized for longer tenors, can be helpful for discussing terms with governments. Moreover, the involvement of ECAs is advantageous for banks because they have to hold less capital for ECA-backed debt than regular debt. "Most countries recognize the importance of ECAs and support them: ultimately they back projects that create jobs," says Schmidt.
Meanwhile, in addition to acting as facilitators of ECA financing, banks are considering a wide range of alternative models for funding infrastructure projects, according to Citi’s Aldred. "Bank-led structures, such as construction milestone payments, supplier finance programmes or schemes such as the Delaware energy efficiency initiative can be used to bridge part of the gap," he says. In July, Citi acted as underwriter for the sale of $70 million of energy efficiency revenue bonds by Sustainable Energy Utility. Proceeds from the bond were used to improve the energy efficiency of buildings occupied by Delaware’s state and local government agencies.
More generally, all market participants remain optimistic about the long-term availability of funding for infrastructure. "There are plenty of investors interested in medium- to long-term investment in infrastructure projects, so a way will be found for them to participate," says Falcones, who adds that there has been a proliferation of green investment funds that could also prove important for financing of projects for cities.
Schmidt adds: "The equity available for infrastructure investment has increased markedly as the infrastructure sector is increasingly viewed as stable, which has encouraged new funds to be established and sovereign wealth funds to enter the market. Currently, most are focused on OECD countries because emerging markets require political risk insurance and these funds have yet to develop the necessary expertise in this area. However, given the scarcity of OECD opportunities, it seems likely that these investors will start to look at emerging markets."
A survey of more than 30 fund managers by Deloitte in April showed that infrastructure funds might be up to this challenge. As well as confirming that infrastructure is now clearly seen as a separate and distinct asset class within the alternative investment market, it revealed that infrastructure funds are becoming more flexible and evolving in response to broader changes in financial markets.
"The infrastructure funds market has developed to be less reliant on highly leveraged structures for its returns," says James Riddell, infrastructure funds partner at Deloitte. "Rather the market has almost uniformly as a sector shifted focus back to core infrastructure assets that can deliver the stable secure long-term cashflows desired by their traditional pension fund investors.
How cities can get smarter Prepare a masterplan
"Cities must think holistically and create a masterplan for the next decade," says Wim Elfrink, chief globalization officer and EVP at Cisco. "They must commit to smart regulation that enables them to achieve their objectives and gain citizen buy-in. And they must embrace technology as a key enabler. For many cities that will take a decade or more: some don’t even have a masterplan. But it will happen if cities are to remain competitive."
Understand what IT can do for you
"The most important thing cities can do is learn to understand what IT and analytics can do for them and how it can help them do things differently," says Gerry Mooney, general manager at IBM Global Smarter Cities. "Every other industry – in order to effectively service their customers, improve the quality of output and lower costs – has been through a similar process. The cities that are aggressively approaching these challenges are the ones that will succeed and grow."
Be willing to use outside expertise
"It can be difficult for someone in a city administration to understand their technical and financing options and the corresponding outcomes," says Johannes Schmidt, chief executive of project and structured finance, infrastructure, cities and industry at Siemens Financial Services. "Therefore [there needs to be] a consultative approach – albeit one that also recognizes the importance of a transparent procurement process. [Our role is to] point to efficient solutions that will deliver commercial benefits sufficient to pay off debt, for example."
Share experiences with other cities
"There is a need to share best practice and transfer ideas," says Baldomero Falcones, chairman and chief executive of FCC. "Cities are open to private-sector ideas and are also increasingly joining associations with other cities. Although cities are in competition, they are willing to share information – especially when they are not geographically close."
Keep an open mind
"We believe there are opportunities to create new operating models and improve services at every level," says Mei Li Tan, global head of franchise initiatives, GTS, at Citi. "For example, our work with the UK government to electronify benefit payments is a nationwide undertaking. [In March, the UK’s Department for Work and Pensions announced that it would phase out cheques for welfare payments from 2012.] We are also working with a number of local authorities to eliminate cash and cheques for benefit payments to their constituents."