Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
Executive summary: with 1.3m people moving into cities globally each week, by 2050 ~70% of the world will live in urban locations. Our cities therefore need to become better and improve their infrastructure to be smarter. Smart cities will use different types of data collection to supply information to manage assets and resources more efficiently. Doing so can improve quality of life, increase productivity and reduce environmental damage. Many examples of smart deployment (from transport to utilities) can be found around the world at present, but the market is forecast to expand at an 18% compound annual growth rate through to 2023, reaching some $700bn in size. More people living in cities will have an impact on all sectors and investors should expect large transfers of value. We believe specialist designers of better city architecture and IT integrators look best-placed to benefit.
Almost everyone reading this note will either work, live or do both of these things in a city. We take their efficient functioning for granted. Yet whether this will remain the case in the future, especially in the context of rapid urbanisation, is open to debate. This note focuses on the changing nature of cities and incorporates many themes we have discussed in previous commentaries including the Internet of Things (July 2014), energy storage (September 2015) and transport as a service (February 2017). We have also regularly advocated the notion that technology is an enabler. Against this background, a ‘smart city’ is not a goal in and of itself, but ‘smartness’ is simply a tool to help cities better serve the people who live and work in them.
The world is already highly urbanised but is going to become even more so. Statistics bear this assertion out: just 3% of the world’s population lived in cities in 1800. It took until 2008 for this figure to pass 50%, but it is forecast to reach 65% in 2040 and 70% by 2050. Put another way, by the middle of this century, some 7.2bn people will be living in cities. The rate of change is also impressive: some 1.3m people are currently moving into cities each week (all data per the United Nations, or ‘UN’ as referenced later in this report). Why are people moving to cities? The answer is simple: this is where the money is at. The top-600 urban centres globally generate 60% of world GDP, while in the emerging world, as much as 80% of future economic growth will occur in cities (per the UN).
The above dynamics clearly imply a need for smarter cities. As cities become an even more important driver of the global economy and wealth, it will be crucial that they are optimised to maximise efficiency and sustainability (cities use 70% of the world’s annual energy needs, with lighting alone representing 19% of global energy consumption, per the UN), while enhancing the quality of life in each urban conglomeration. Mass migration means the need for new infrastructure and services.
The best way in which to resolve this conundrum is to make cities smarter. There is no formally agreed definition on exactly what this concept means, but a smart city can be considered as an urban area that uses different types of electronic data collection to supply information which is used to manage assets and resources efficiently. Thought of another way, the city becomes a platform through a combination of sensors, networks and citizen engagement.
Smart cities add digital intelligence to existing urban systems making it possible to do more with less. The benefits from such an approach could include: increased resource efficiency, higher productivity, improved quality of life and positive environmental effects. McKinsey, for example, estimates that the introduction of smart technologies has the potential to improve some quality of life indicators by 10-30%, such as reducing fatalities by 8-10%, cutting commutes by 15-20% and shrinking greenhouse gas emissions by 10-15%. Research from another consultant (Juniper) suggests that smart cities have the potential to ‘give back’ to each dweller three working weeks’ worth of time each year via improved mobility (equivalent to 60 hours), public safety (35 hours), productivity (21 hours) and healthcare (9 hours).
Policymakers around the world have, unsurprisingly, embraced the smart city concept and put funding initiatives and pilot programmes into place. Almost every city lays a claim to being smart and/or doing smart things. McKinsey reports that over 500 locations have in place some form of smart initiative. Meanwhile, Juniper’s most recent (2017) list of smart cities ranks Singapore first, followed by London, New York and San Francisco. Elsewhere, when it comes to building new cities from scratch, no other country in the world can match China’s expertise. The country has adopted an ‘infrastructure-first’ approach, investing in roads, subways, railroads and fibre optics. To tackle over-crowding in Beijing, China is currently building a new city 100km southwest of the capital. When operational in 2021, it is expected to be twice the size of Manhattan (per the US edition of China Daily).
So what exactly is meant by the smart city in practical terms? Relevant applications can be applied to almost every realm including buildings and infrastructure, energy (water and utilities), waste, mobility, security and healthcare. Begin with buildings and infrastructure and it is easy to see how heating, energy use, lighting and ventilation can be managed and optimised by technology. Solar panels, for example, could be more actively incorporated into building design, replacing traditional materials, while LED lighting could reduce significantly energy costs. The US Department of Energy estimates that the widespread adoption of such lighting could save the US around 300 terawatt hours of energy by 2030, the equivalent of powering 24m new homes. At the same time, it would reduce America’s annual energy bill by $30bn, saving over 200m tonnes of carbon emissions. Domestically, devices such as Nest (owned by Google) and Hive (a product launched by British Gas in the UK) allow users to alter automatically ambient conditions within their households, while also monitoring them remotely. Smart water and electricity meters (tracking usage) are also becoming increasingly ubiquitous.
Transportation is another area of crucial importance in the conception of the smart(er) city. Through sensors embedded in roadways and streetlights, real-time transit and traffic could be managed for reducing travel time and fuel efficiencies. Transport-as-a-service (taxi hailing services such as Uber or Lyft) is evolving to mobility-as-a-service. In the future, it is possible that cities may offer subscription of pay-as-you-go access to an entire transportation infrastructure including taxis, buses, trains, ride-sharing, bike-sharing and so on. These could be accompanied by intelligent and adaptive fast and slow lanes, aimed at optimising traffic flows. Mobility innovation could result in 28% fewer vehicles, 30% shorter travel times, 44% fewer parking spaces, 66% lower emissions and 87% fewer accidents, per Delphi Automotive. Initiatives along these lines are already underway in Helsinki, London, Rio de Janeiro and San Francisco to name but a few examples.
Overall, the global smart cities market (which incorporates transportation, buildings, utilities, citizens and services) is expected to grow from $308bn in 2018 to $712bn by 2023, equivalent to an 18% compound annual growth rate, per Markets & Markets Research. Regionally, it forecasts South East Asia to have the fastest rate of growth, with video surveillance and connected vehicles being the most significant segments. China, for example, already has 250m facial recognition cameras in operation, with this figure forecast to rise to 450m by 2021 (per Hikvision, a leading provider). Smarter cities also imply an increased spend on IT. IBM forecasts that annual spending on smart city technology will reach $16bn by 2020, while Cisco estimates that the smart cities IT market could reach as much as $34bn annually within the next ten years. IBM, for example, is already working with the authorities in Rio to unify the IT infrastructure of its 30 different transport agencies, while it is also deploying in a trial some 250,000 interactive water/power meters in Malta to improve energy consumption.
As can clearly be seen, there is no shortage of smart city ideas, but commercialising them is a very different prospect. Urban planning is a notoriously bureaucratic process while old cities have many legacy structures. The designs and costs of building around these are often prohibitive, particularly relative to a blueprint which assumes building from scratch. Moreover, there is no one-size-fits-all approach. Cities are not homogenous entities. Equally, they cannot (or will not) be defined by one application or central organising body responsible for setting pre-programmed limits. More prosaically, there is no golden bullet: the entry of, say, pervasive computing into a city is not a panacea, an outcome that will solve all problems from pollution to traffic management; at best, such systems will likely just provide greater visibility into urban problems. Other factors to consider are what the impact of smarter cities might have on employment (automation replacing jobs) and civil liberties. Consumers might – justifiably – be right to worry about further incursions of privacy.
More people living in cities will have an impact on all sectors. Investors should expect large transfers of value. Transport (or mobility) as a service is a clear example of this dynamic at work, with traditional auto manufacturers to face increasing pressure/ cannibalisation from platform providers who will likely control the consumer relationship. Elsewhere, consider that until the turn of this century, population growth generated more than half of all global consumption, but between 2015 and 2030, some 75% of global consumption will be driven by individuals spending more (per McKinsey). Such a shift has major ramifications for all companies. There is, for example, a clear correlation between beer consumption and urbanisation (per Diageo). Elsewhere, businesses within the healthcare, real estate and utilities sectors among others will likely be impacted. Space does not permit to mention all potential beneficiaries and losers.
Our approach is twofold, to focus on the architects or designers of smart infrastructure and on the integrators. Within the former category, we are less excited about the providers of power networks and telco/utility infrastructure and see potentially more interesting opportunities in relatively niche areas such as industrial real estate (Prologis, Segro), lift manufacturers (Kone, Schindler), providers of access solutions (Assa Abloy, Allegion) or surveillance equipment (Hikvision). In terms of the latter category, we see many technology areas such as sensors and micro-controllers as relatively commoditised and would prefer to focus on the potential merits of leading integrators such as IBM, Cisco and Intel. Data storage is also clearly going to matter, and we would be highly surprised were the mega-cap technology platforms (Apple, Amazon, Google, Microsoft etc.) not to seek involvement within the smart city opportunity.
Alexander Gunz, Fund Manager, Heptagon Capital
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