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!
- 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).
Later still, in 2017, the UK reported its economy was already 79% service-based (products: 14%, agriculture: 1% and the remaining 6% was construction).
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.
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.
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.
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
…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).
Economies can shift passively due to actions happening elsewhere in the economy. Kim (2016) looks at two passive hypotheses: Deindustrialisation and Cost Disease.
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.
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.
Remember when we looked at defining services we saw the following:
- a whole range of services can be categorised as relating to non-ownership.
- using services can move substantial investment costs to be manageable sunk costs.
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).
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
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.
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
In the following series of case studies I explore these shifts:
- Electrolux – vacuum cleaning as a service
- [Add articles when completed]
Wrapping it up