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Services are eating the world – the “shift” to the services Economy

 Work In Progress
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  This article is work in progress - it will probably change (improve ) between visits, so please come back often

All aboard the relentless “shift” to services and the service economy!

We’ve come a long way from Adam Smith’s 1776 view that services are not wealth generators. Today we find many of our economies are 80% (and growing) based on services.

Why do we see this shift? And, further, what are the implications? Let’s find out!

Key take-aways

  • Services are the larger part of our economies (predicted to be 80% of US economy by 2050; already 79% of UK economy in 2017)
  • The shift from product- to service-based economies can be traced to:
    • Economic reasons – shifting manufacturing abroad and cost disease hypothesis
    • Consumer Behaviour reasons – we have more spare income and a hierarchy of needs; there are structural changes such as moving from one-income to two-income families; and we are changing our view of ownership
    • Asset reasons – how we manage underutilised assets; how we are adding services to products to enhance value and differentiate
    • The value of data we can collect from a service
  • The implications of this shift: you will be left behind or made irrelevant if you don’t get onboard

The growing importance of Services in our economies

We usually experience the world as being dominated by tangible products (or “goods” as marketers call them). This is not surprising. They are what we see and touch every day. And this view stayed long ago. Way back in 1776 Adam Smith (Wealth of Nations) viewed manufactured items- things that could be stored and exchanged for money – as wealth-generating. Services, he felt, could not contribute to wealth generation. This concept of goods being good and of value exchange is entrenched and colours all of our current thinking.

Jump forward to 2017, and we find a different story. Food delivery service Just Eat’s revenue was £546Mn. Uber a revenue of $11.3Bn. Apple’s 2018 revenue from services was $37.2Bn (14% of overall revenue). Security services company Securitas had 92Bn SEK revenue. Handelsbanken – the best growing (bank) equity in history – had revenue of 41Bn SEK in 2017.

Haskell and Westlake’s Capitalism without Capital (2018) highlights intangibles, which we can loosely categorise services as are a (large) hidden component of economies. To borrow a phrase, rather than software, it is services that are eating the world.

Services are eating the world (often enabled by software). Click To Tweet

What do the figures say?

Hopefully, we agree that services can no longer be seen the same way as in 1776. Nowadays services are wealth creators. They are a substantial and growing component of our economies. Let’s back this point up a little more. Back in 2000, the Organisation for Economic Co-operation and Development (OECD) was saying:

“manufacturing [is] slipping to less than 20% of GDP and the role of services rising to more than 70% in some OECD countries”

OECD, 2000

Later, in 2013, Chesbrough’s Open Service Innovation book was projecting that by 2050 the US economy would be 80% service-based (Figure 1 is based on that data).

We are shifting to service economies - by 2050 it is predicted to be greater han 80%
Figure 1: The Shift to Service Economies as a percentage of overall Economy over time

Later still, in 2017, the UK reported its economy was already 79% service-based (products: 14%, agriculture: 1% and the remaining 6% was construction).

Services in UK Economy make up 79% in the year 2017
Figure 2: Breakdown of the UK Economy in 2017 (Services made up 79%)

Is this a “developed” world phenomenon? Let’s just pick Nigeria at random. In 2010 the Nigerian economy was 50% service based. By 2017 it had risen to be 55.8%. (agriculture fell from 23.5% to 20.85%).

If services are becoming so important, what are they?

What are Services?

I have a whole article that explores what services are from definitions, attributes (marketing and economics) through to the modern interpretations of job-to-be-done and non-ownership. But in short, my preferred definition is shown in Figure 3.

Grönroos defined services a solutions to customer problems; processes made up of a sergers of activities that the customer may interact with
Figure 3: Grönroos’ (and my preferred) definition of services

This definition covers all the services I can think of. Additionally, it recognises there is a continuum between products (or goods as marketing people will call them) and services.

In reality Goods live on a continuum between Products and Services
Figure 4: The Products-Services continuum

Simplistically, the shift to the service economy is the appearance of moving along this continuum, from left to right. And we can see that in action in Figure 5 where we see a shift from purchasing and owning CDs (a complete tangible product) to the widespread use of streaming services such as Spotify. We can discuss if this is a pure service or a major service with supporting products (it depends on your view of digital goods). I would suggest it is a pure service as you own nothing.

Example of the Shift to Service Economy
Figure 5: An example of the shift to Service Economy

But why are we shifting to service economies?

Why are we shifting to services economies?

We saw back in Figure 1 that economies shift from agriculture- to product-based (sometimes called manufacturing-based or industrialised). And subsequently shifting to being service-based.

I see several reasons for this shift, including:

  • Economic reasons – also known in academia as Passive hypotheses
  • User behaviour reasons – including the academic active hypotheses plus the shift in societies view of ownership/non-ownership
  • Asset reasons – such as using services to differentiate products as well as how to use underutilised assets
  • Leveraging data – the value of data beyond a simple number of sales
Figure 6: Some reasons for the shift to the Service Economy

…due to Economic reasons

Granted, we could call all reasons for the shift economic in some sense. But here I’m thinking of, I guess, macro-economic reasons. Or put another way, things that are happening in the economy that we do not control.

Kim (2006) highlights two passive and two active reasons in her academic review of the shift (see Figure 7). There is little we can do to affect the passive reasons, but they help foster an environment for service opportunities. So, I’ll categorise them in this category of economic reasons (and the active ones I put as part of my user behaviour category).

Economic reasons for the shift to services
Figure 7: Economic reasons for the shift to services

Economies can shift passively due to actions happening elsewhere in the economy. Kim (2016) looks at two passive hypotheses: Deindustrialisation and Cost Disease.

Deindustrialisation

We find the Deindustrialisation hypothesis observes that advanced economies move manufacturing to cheaper countries (and then trade). As a result, there is a gap in the advanced economy. That gap is filled with services. Whilst sounding plausible, Kim discusses the evidence of deindustrialisation is not conclusive.

Cost Disease

Baumol’s cost disease hypothesis, on the other hand, can be backed up with empirical evidence. However, it can feel a little counter-intuitive. Here’s what it essentially says: salaries rise in industries that have no productivity increases in response to rising salaries in industries that have increased productivity. Baumol’s original work looked at why classical musician’s earn more today than in, say, the 19th century. Yet it still requires the same number of musician’s to play a classical tune. For us, this translates as wage increases in the product industry leads to increasing wages in services. And of course, rising wages attracts (service) workers and increases opportunities. Here is a good and further explanation!

…due to User Behaviour

The active reasons are the Hierarchy of Needs hypothesis and the Exogenous Demand Shock hypothesis.

Hierarchy of needs

The hierarchy of needs is simple. As your income grows, so you start to want to have more free time and push off tasks to services. Thus the service sector grows as incomes grow. Kim mentions conflicting studies when trying to confirm this as fact. But think of your own lifestyle and are you using more services as your income has grown? Probably.

Exogenous Demand Shock

This sounds terrible – what calamity have we introduced? But simplistically it means demand for services increases as a result of structural changes in the economy. What could these structural changes be? Kim references two examples. First the spinning out of manufacturing companies those services they used to do in-house. Now once hidden services become visible. Second, the change from one-income families to two-income families. Now time is tight and so the demand for services increases.

Non-ownership

Remember when we looked at defining services we saw the following:

These together contribute, I believe, to the growth of services in an economy. Amazon cloud service is a good example. You can use Amazon’s computing power to host your businesses IT. You don’t own the servers. But rather than have to build a data centre yourself (large investment) you pay a more manageable monthly/usage fee (a sunk cost).

5 categories of on ownership that are fuelling services
Figure 8: Five categories of on ownership that are fuelling services

But non-ownership can also be a benefit. We can get greater access to a wider range of assets. For example, we can look at Spotify. Rather than owning a small number of CDs that I have bought, for a small subscription fee, I get access to millions of CDs.

The next category in my framework has two reasons, and I have called them Asset reasons since they deal with the products that may lie behind a service.

…due to Assets

Under-utilised assets

Chesbrough (2013) points out that services are growing due to making use of underutilized assets. And let’s be general here and say assets are physical things you own but also more abstract things, such as your time.

Here we can find many examples, mostly in the sharing economy and gig economy.

The World Economic Forum’s “4 big trends for the sharing economy in 2019” article has some interesting points. It covers revenue projection, for example, that the Chinese government wants the sharing economy to account for 10% of national GDP by 2020. But also, refreshingly, the article covers the challenges such as the struggles of sharing economy companies (like China’s Ofo bike share and Uber IPO) as well as the role of regulators.

Another article by the same author as above has a very helpful terminology guide to help clarify the terms often used. It usefully clarifies the gig and the sharing economy. Usefully, it includes the freelance economy and how that relates to the other terms.

Enhancing (product) offerings.

Products/manufacturing is becoming commoditized and harder to tell differences between companies’ offerings. A way out, according to Chesburgh (2013), is to enhance product offerings with services. We can take here examples such as digital twins. In particular how aircraft engine manufacturers such as Rolls-Royce now monitor engines in real-time to provide additional services to airlines. This Harvard business school summary on this is interesting.

…due to leveraging data

We are collecting vast quantities of data. If we free that, then an explosion of services should occur. We will see this over the next few years as open banking API cores into force in the EU.

Additionally, services get launched specifically (or with a focus) on getting as much data as possible. This might be for resale later, or to feed deep learning algorithms. You know Facebook/Instagram gives you free storage for photos and encourages you to tag/describe them. Think of all that free data it is getting to train its Artificial Intelligence…

A shift too far?

Of course, things can go too far.  As we now know (and probably really knew all along) the world does not need a monthly subscription-based juicing packs system!

Implications of the shift

All these reasons are driving the shift to the service economy.

However, I don’t believe products and service are the same. As you can read here. It follows that innovating in services is different than innovating in products. If your economy is mostly service-based, why would you restrict yourself to just thinking about innovation with a product mindset? If you do, you probably recognise the innovation problem.

Examples of the product-service continuum and how we shift towards services over time
Figure 9: The shift towards services over time in various industries

The shift is not always for the same reasons. In Figure 10 I show a matrix exploring some of the shifts we have seen and the main reasons behind them. It is interesting to note that in the modern shift, data is a common reason.

Examples of the shift to services and which main reasons for the shift they address
Figure 10: Examples of the shift to services and which main reasons for the shift they address

Examples of the shift

In the following series of case studies I explore these shifts:

Wrapping it up

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There are 2 thoughts on “Services are eating the world – the “shift” to the services Economy”

  • Figure 5 – Economic – I think you need to contemplate an emerging socio-political pressure which is the increasing pressure against consumption based economics (and the fact that it has reached beyond user behaviour drivers towards the levels of city and state actors) and the search for new models that have less impact on society, infrastructure and the environment. We are seeing investigations and policies that promote shared resource behaviours by providing these as a shared service.

    For example, the provision of bicycles in cities on a daily rental basis (transportation service) is not so much driven by User Behaviour (people still like to own bikes but find themselves in a city where their bike is not) but instead is championed by the cities themselves seeking to alleviate traffic congestion (caused by ownership), demonstrate socially aware politics and meet environmental targets.

    • Hi Elliot, thanks for the thought. I’ve “ummed and ahhed” about it quite a bit in my head – and it has been a long conversation!

      Where I think I have landed is that there is room to add an “externalities” reason for some moves to services. Though, what impact it has could be questioned about the present, and is unknown about the future…

      I went back to think about local transport services, such as bus, underground train, or even local train services. These are often policy/city/government driven. Quite probably as they would not be commercially viable otherwise, e.g. general taxes part-subsidising the costs of service provision. If the policy driver is not there, then the service would most likely degrade/disappear. Or the service would be too expensive and people would revert to other actions that the policy is trying to minimise (i.e. everyone driving and creating even more congestion).

      Then these city bikes are an interesting topic. They haven’t replaced the subsidised local transport services. (OK, some people might use bike service instead of catching a bus, but not the majority; and probably not on rainy days…)

      Are they provided by the city for such socio-political reasons as you mention? Or are they a good commercial solution to i) a “hierarchy of needs” shift, i.e. rather than walk I can afford to spend a little money on a bike to get from A to B (and the added speed means I can also get to C and D in the same day), and/or ii) ownership, i.e. I don’t have to take my bike with me/worry about keeping my bike safe and iii) using underutilised assets? Or simply are they fulfilling a “me-too” need by tourist authorities?

      Docked bikes need space to be allocated for the docking stations. That space is something only the city can provide in a useful manner. And so there is a dependency between the provider and the policy makers. In some cities I’m sure the provision of docked-bike service is driven by the city/socio-political pressure. For others, I suspect it is commercial opportunity driven.

      If we take away the need for docking stations, then the truth reveals itself a little more. Now there’s no policy involved. It’s a wild west of commercial providers and a race to the bottom on price/supply. Cities become overrun with dockless bikes and electric scooter services littering pavements. And we know where that ends: for example Chinese Ofo (https://www.forbes.com/sites/ywang/2018/12/20/how-chinas-bike-sharing-startup-ofo-went-from-tech-darling-to-near-bankruptcy).

      Healthcare is another interesting example. You could just buy products to cure yourself. The service equivalent is using the knowledge of a doctor/pharmacist/nurse to identify the right product. An externality has decided what service each of those can provide through required training and licensing and also limits your access to certain products without being prescribed by the correct knowledgable person. Thus driving three distinct career paths and protecting you in the process. Each of those 3 services can change in the future based on new legislation or new services created. I’m thinking here of the decriminalisation of cannabis in the US/Canada – and the opportunities for new services that is creating. Which does not fit neatly into the categories I have at the moment (although I might argue this is not creating a shift, rather just expanding an existing service area).

      All that is a long-ish way of saying that yes an extra category of “reason for shift” is probably needed to reflect where some entity (perhaps artificially) drives the shift. I still have some thinking to do here….

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