How
tech giants deliver outsized returns—and what it means for the rest
of us
Networks and platforms reign within high
tech, media, and telecom. Understanding the sector’s dynamics is increasingly
important for executives in all industries.
The ability of technology, media, and telecommunications (TMT)
companies to create value is extraordinary. TMT companies generate more
economic profit (net operating profit less the cost of capital) than any other
sector of the global economy—more than the combined economic profit of
companies in aerospace and defense, automotive components, and food products.
What makes TMT so profitable is a
combination of unique factors, notably continuing advances in digital
technology that open new markets, stimulate growth, and provide opportunities
for companies that seize leadership positions to capture an enormous value.
Yet a closer look at value creation across
TMT also reveals a distinctive pattern: significant concentration of economic
profit at the top, a rapidly rising middle tier of value-creating companies,
and considerable turnover among top players.
As more industries adopt digitally enabled
business models—consider, for example, the impact of Amazon in retail, Uber in
transportation, and Airbnb in lodging—will this pattern be repeated in other
sectors? While it is too early to say for sure, the way value is created in
TMT, as well as how digital technologies shape value pools, is increasingly
relevant to leaders across the global economy.
An astounding
record of value creation
Based on our research of more than 2,400
publicly traded companies around the world, we estimate that the economic
profit generated by TMT companies grew 100-fold, or by $200 billion from 2000
to 2014. Some 70 percent of the companies in our sample generated economic
profits in the 2010–14 period, up from 45 percent in the 2000–04 period.
Moreover, each of the five subsectors that
make up TMT (software, consumer electronics, media, telecom and cable
operators, and tech infrastructure and services providers) was among the most
profitable of the 59 industries analyzed.
The fastest profit growth was among
software companies and companies with software-enabled business models, such as
Amazon, Tencent, and other “platform” enterprises. The economic profit of
value-creating software companies grew nearly sixfold from the 2000–04 period
to the 2010–14 period (rising from $5.8 billion to $33.7 billion).
Winners
take most
Economic profit across TMT is
concentrated, reflecting greater benefits of scale than in other sectors. This
is seen in a range of TMT products and services, from smartphones to social
media. In the 2010–14 period, the top 20 percent of companies captured 85
percent of the economic profit in TMT industries. The top 5 percent of
companies—including tech giants such as Apple, Microsoft, and Alphabet
(Google’s parent)—generated 60 percent .
Increasingly the ranks of top players in
TMT are populated by companies that have managed to create and scale successful
platforms that benefit from network effects. These can be technology platforms
(for example, Apple’s iOS), marketplaces (for example, Apple’s app store), or
platforms of another type—but in each case these winning platforms increasingly
exploit “network effects,” which means the value of the product, service, or
the underlying technology increases when more people use it. The more you use
Facebook, for instance, the more your friends will use it. There are also
indirect network effects, which involve the creation of complementary products
or services—the app markets that have grown up around smartphones and tablets,
for example, or social gaming that is enabled by social networks.
Network effects contribute to
concentration by creating barriers to entry and tying customers to the largest
players: it’s much harder to switch to a different smartphone if doing so means
you have to give up all your apps, for example. However, it should also be
noted that scale and network effects do not confer permanent advantages, and
large companies can lose their leads if they don’t keep up with technological
shifts and innovation.
The
rising middle tier
While the largest companies in TMT capture
the majority of the economic profit, they also nurture a middle tier of
companies that benefit from their networks. A growing group of middle-tier
companies (in the 20th to 80th percentiles in terms of economic profit) is
leading the sector in profit growth. Middle-tier companies’ economic profits
grew by a factor of ten between the 2000–04 period and the 2010–14 period, or
more than three times the growth rate of technology giants.
The rising middle tier includes software
and cloud services companies, as well as many players with software-enabled
business models. Middle-tier players include Box, Baidu, Netflix, and WeChat.
We see the growth of these and other middle-tier companies as fueled by a
number of factors. Some have latched onto existing platforms and designed
business models that scale rapidly. Others are disrupting non-TMT profit pools,
such as retail. Many are using programmatic M&A to move into adjacent
industries.
Success
can be fleeting: More profits, but also more flux and less stability
When a new technology appears or
technology enables a new business model—ordering a ride from your smartphone
using Uber, for example—new profit pools open up. But old ones also come under
attack. While the top 20 percent of TMT companies consistently capture an
outsized share of profits, life at the top can be short.
Taking our data set as a whole, across all
industries, nearly 60 percent of companies that were in the top quintile in
terms of economic profit in 2000 were still in the top quintile 15 years later.
In TMT industries, though, only 45 percent of top players from 2000 remained in
the top quintile in 2015. The flip side is that over the same period 25 percent
more companies that started at the bottom ended up in the top quintile.
This churn is explained in part by rapidly
changing dynamics within TMT profit pools. For example, within
telecommunications, value capture shifted decisively from fixed line to mobile
connectivity. In media, print and TV advertising evaporated, while mobile and
online advertising soared. In consumer electronics, virtually all the economic
profit shifted to two smartphone companies—Apple and Samsung—although the
smartphone segment now could be showing signs of vulnerability.
Today some of the biggest value shifts are
occurring in software and in software and Internet-enabled services.
Traditional software players, such as Adobe, Symantec, and SAP, have high
profit but low market-cap growth. Compare this with the medium growth in market
cap of software-as-a-service players, such as Box, Salesforce, Slack, and
Splunk, or with the more than 100 percent market-cap growth from 2012 to 2015
of companies such as Alibaba and Amazon that are providing digital services
beyond TMT. Additionally, we see value shifting from the infrastructure layer
to applications providers as software applications increasingly enable and
monetize the unique functionality demanded by customers.
Implications
for tech, media, and telecommunications companies
Against a background of rapid innovation
in digital technologies, ranging from artificial intelligence and automation to
the Internet of Things, we remain convinced that the TMT sector will, in the
aggregate, continue to outperform other sectors. The digitization of the global
economy has only just begun.
Yet our research underlines that TMT
leaders need to monitor carefully how profit pools are shifting. And they must
be willing to act decisively if they want to remain among those generating
outstanding levels of economic profit.
In particular, we believe TMT companies
need to build capabilities in four areas:
·
Establishing a strong position in one or
more software or services platforms and building ecosystems around platform
offerings to ensure access to the fastest- growing profit pools.
·
Continuously evolving business models to
avoid being disrupted by well-funded start-ups or existing TMT leaders
expanding to new markets.
·
Replicating successful platforms in
underpenetrated or ring-fenced areas (markets or white spaces), taking proven
business models to markets with greater headroom.
·
Using programmatic M&A to develop
capabilities to quickly attack new, rapidly growing profit pools or cannibalize
profit pools in other industries. Companies will need to continually reinforce
and broaden their capabilities and have limited runway to develop such talent
organically, particularly in areas like cloud and analytics, where competition
for talent is intense.
It’s no secret that the gales of creative
destruction blow with singular strength in technology, media, and telecom. Our
analysis sheds light on how this relentless turbulence shapes the sector, how
companies can harness its energy, and what leaders must do to avoid being
knocked off course by unexpected gusts. As digital technologies and business
models reshape more and more sectors of the global economy, the lessons are
increasingly relevant beyond the blurring boundaries of TMT.
By Tushar Bhatia, Mohsin Imtiaz, Eric Kutcher, and Dilip Wagle September 2017
http://www.mckinsey.com/industries/high-tech/our-insights/how-tech-giants-deliver-outsized-returns-and-what-it-means-for-the-rest-of-us?cid=other-eml-alt-mip-mck-oth-1709&hlkid=ef4f2630be6c4e3795cba50bd1d6b780&hctky=1627601&hdpid=5b97a841-179a-4fec-a8b5-f2cbd44952a0
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