Background
 

Next Stop – the shift to the services Economy

 Under Dev
Please note: this article is under development - it may change (improve ) between visits

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 important of Services in our economies

Writing in 1776’s Wealth of Nations, Adam Smith considered products as the basis of creating wealth. Services he saw as a noble effort, but ultimately unproductive labour.

Jump forwards 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.

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).

Figure 1: Growth of Services as Percentage of the Economy

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

Figure 2: Breakdown of the 2017 UK Economy into component parts – services was 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 show in Figure 3.

Figure 3: 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.

Figure 4: The Goods-Services continuum

Simplistically, the shift to the service economy means moving along this continuum from left towards the right.

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 hypothesis 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
  • The value of data beyond simple number of sales
Figure 5: Some reasons for the shift to the Service Economy

Kim (2006) summarised the academic view on this shift from product- to service-based economies. She highlights two passive and two active reasons.

Figure 6: Four hypotheses as to why economies shift towards services as they advance

Shifting Passively

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 by 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 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!

I have chosen to refer to these as the economic reasons for the shift in my framework (Figure 5). There is little we can do to affect these, but they are help foster an environment for service opportunities.

Shifting Actively

The active reasons are the Hierarchy of Needs hypothesis and the Exogenous Demand Shock hypothesis. The hierarchy of needs is simple. As your income grows, so you start to want to have more free time and push of tasks to services. Thus the service sector grows as incomes grow. Kim mentions conflicting studies when trying to confirm this as fact.

Exogenous Demand Shock sounds complicated. 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 demand for services increases.

I have chosen to group these two together with the next topic of non-ownership in the category of User Behaviour in my framework (Figure 5).

Shifting due to 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 (sunk cost).

But non ownership can also benefit in getting 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.

Shifting to use underutilised 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 Formum’s “4 big trends for the sharing economy in 2019” article has some intersting 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 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.

Shifting to enhance (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.

Shifting to harness data

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

A shift to 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 invasion in a product way? If you do, you probably recognise the innovation problem.

Examples of the product-service continuum and how we shift towards services over time
Figure 7: The shift towards services over time in various industries

The shift is not always for the same reasons. In Figure 8 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.

Figure 8: Exploring the reasons behind several shifts from product to services

Examples of the shift

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

Wrapping it up

Hits: 271

There are 2 thoughts on “Next Stop – 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….

Join the conversation, co-create some value!

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes:

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>