Booz co profit-migration-digital-economy


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Standridge, David; Pencavel, Christopher

Profits for digital economy players have grown from US$498 billion on $3.7 trillion in revenue in 2002 to $726 billion on $4.3 trillion in 2010. But the benefits have not been distributed equally. This Perspective analyzes the relative changes in profitability among the six segments of the digital economy’s value chain.

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Booz co profit-migration-digital-economy

  1. 1. Perspective David Standridge Christopher PencavelProfit Migration in theDigital Economy
  2. 2. Contact InformationBeirut Dubai/Frankfurt New York São PauloRamez Shehadi Olaf Acker Philip Minasian Ivan de SouzaPartner Partner Principal Senior Partner+961-1-985-655 +49-69-97167-453 +1-212-551-6098 ivan.desouza@booz.comCanberra Düsseldorf Fabian Seelbach ShanghaiDavid Batrouney Jens Niebuhr Senior Associate Andrew CaineyPrincipal Partner +1-212-551-6073 Partner+61-2-6279-1235 +49-211-3890-195 ParisChicago Düsseldorf/Stockholm Pierre Péladeau SydneyMike Connolly Roman Friedrich Partner Vanessa WallacePartner Partner +33-1-44-34-3074 Partner+1-312-578-4580 +49-211-3890-165 San FranciscoDelhi Florham Park, NJ David J. StandridgeSuvojoy Sengupta Barry Jaruzelski PartnerPartner Partner +1-415-281-4995+91-124-499-8700 +1-973-410-7624 Chris PencavelDubai Houston AssociateKarim Sabbagh Kenny Kurtzman +1-415-627-3308Senior Partner Partner Booz & Company
  3. 3. EXECUTIVE The digital economy has made great strides over the past decade as a result of evolving social trends and advancesSUMMARY in technology. Profits for digital players have grown at an average pace of 5 percent a year, from US$498 billion on $3.7 trillion in revenue in 2002 to $726 billion on $4.3 trillion in 2010. But the benefits have not been distributed equally. We performed an analysis of the relative changes in profitability among the six segments of the digital economy’s value chain, and the results are clear. Companies in the segments furthest from consumers—the content and service providers—are losing profit share to those closest: the equipment providers and the software, Internet software and services, and devices segments. The factors driving this migration of business value of this “network value are many. A principal cause lies effect” is overtaking economies of in the growing power of consumers scale as a way of capturing value. compared with producers. The And cloud computing is rewriting the rise of Web 2.0 technologies over way software is delivered throughout the past decade has increased the the tech ecosystem. power of companies that organize the Web, while multiplying the ways Armed with an in-depth understand- in which consumers receive content ing of shifting profit pools, digital and enabling them to create their economy players can make more own content and thus compete with informed decisions about where content providers. Another factor has to invest and which capabilities to been the growing power of consumer- develop to ensure their continued oriented companies that have built relevance in the fast-moving digital huge networks of customers; the landscape.Booz & Company 1
  4. 4. A DECADE OF Much has changed in the digital economy over the past decade. The and wireless connectivity, and the development of a raft of new devices,EVOLUTION dot-com bubble burst in 2000–01, including smartphones and now but soon after that came a host tablet computers. of new technologies, often col- lectively called Web 2.0. These, in Given the many changes that have turn, generated a resurgence in the taken place, it is worthwhile to pause digital economy, manifested in the and examine precisely how the digital rise of companies like MySpace and economy has evolved over the past then Facebook, as well as YouTube, decade. How has the distribution of Twitter, and others. At the same revenues and profits changed? Which time, the power of somewhat older players are gaining share, and which companies, such as Apple and are losing it? And finally, why have Google, continued to grow. Much these shifts occurred, and what might of this activity came about through it mean for the future of the digital the ongoing spread of broadband economy and its many participants?2 Booz & Company
  5. 5. THE DIGITAL The digital economy is fundamentally different from the value chain. What does it look like? What exactly are the elements in VALUE CHAIN traditional bricks-and-mortar the value chain? And who are the economy. Unlike the standard value participants? chain for physical goods, where a product is literally handed off from We define the digital value one participant to the next, digital chain broadly as the creation, goods take a more nebulous path dissemination, delivery, and from producer to customer, and the consumption of digital content. For handoffs through the supply chain the purposes of our analysis, the are less clear. This poses a challenge value chain encompasses six distinct when trying to identify the digital segments (see Exhibit 1). Exhibit 1 Segments of the Digital Value Chain Segment Description Company Examples Industry Examples 1. Content Providers Creators and originators of digital - McGraw-Hill, News Corp., - Movies and entertainment content, such as music, pictures, Time Warner, Walt Disney, - Publishing videos, news, and information Washington Post 2. Service Providers Firms that build and maintain - AT&T, Comcast, - Alternative carriers the networks that deliver content Deutsche Telekom, - Broadcasting Time Warner Cable, Verizon - Cable and other pay-TV services - Integrated telecommunication services - Wireless telecommunication services 3. Equipment Providers Producers of infrastructure - Cisco, EMC, Juniper Networks, - Cable and satellite hardware and networks through NetApp - Computer communications which content is delivered equipment - Computer storage and peripheralseting 4. Software Producers of software needed - Adobe Systems, - Application software to run devices that access content CA Technologies, - Systems software Microsoft, Oracle, Symantec 5. Internet Software & Producers of online services -, eBay, - Internet retail Services that broadly aggregate and Google, Netflix, Yahoo - Internet software and services disseminate digital content 6. Devices Producers of the devices - Apple, Dell, Hewlett-Packard, - Communications equipment through which content is viewed Motorola, Nokia, Research in - Computer hardware Motion, Toshiba Source: Booz & Company analysis Booz & Company 3
  6. 6. CHANGING Back in 2002, following the bursting of the dot-com bubble, the digital trillion in total revenues. Service providers captured fully 58 percentVALUE POOLS economy began to rebound. When of the revenues and 76 percent of the six segments of the digital the profits. At the other end, the value chain are plotted on a “profit Internet software and services pool” chart for that year, a picture segment took in just 1 percent of emerges of the size of the share of the revenues while losing $658 profits of each segment (see Exhibit million that year (all figures 2). The width of each box along the are adjusted for inflation; see x-axis indicates the segment’s total “Methodology,” page 9). revenues, while the height along the y-axis indicates the segment’s By 2010, total revenues in the digital average profit margin (operating economy were up 17 percent, to free cash flows, defined as EBITDA $4.3 trillion, and total profits had less capital expenditures). Thus, grown to $726 billion, a 46 percent the area of each box represents the increase or a compound annual total dollar profits earned by that growth rate of 5 percent. But the segment. relative value of the six segments in the value chain had shifted In 2002, the digital economy’s considerably, making the picture profits totaled $498 billion on $3.7 look very different (see Exhibit 3). The relative value of the six segments in the value chain shifted considerably between 2002 and 2010.4 Booz & Company
  7. 7. Exhibit 2 Profit Pools in the Digital Value Chain, 2002 Profit Margin 35% Software 30% $22B Equipment 4% Providers 25% Service Providers $6B 1% Internet $380B Software & 20% Content Services 76% Providers -$1B 15% $66B -1% 13% 10% Devices $25Beting 5% 5% 0% -5% $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 Revenues (US$ trillion) Source: Capital IQ; Booz & Company analysis Exhibit 3 Profit Pools in the Digital Value Chain, 2010 Software Profit Margin 35% $52B 7% 30% Internet Equipment Providers Software & Service Providers Services 25% $28B Content $482B 4% $25B Providers 66% 4% 20% $61B 8% 15% Devices $78B 10% 11%eting 5% 0% -5% $0.0 $0.5 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5 Revenues (US$ trillion) Source: Capital IQ; Booz & Company analysis Booz & Company 5
  8. 8. WINNERS Over the eight years between 2002 and 2010, the digital economy the largest single winner across all segments in terms of absoluteAND LOSERS experienced a sustained shift in profit gain. But the biggest gainer profits and revenues toward the in terms of both revenue and profits consumer end of the value chain. was Internet software and services, The content providers, the segment which went from a loss in 2002 to a furthest from the customer, saw their gain of $25 billion in 2010. Again, revenues and profits actually fall. And much of this is attributable to one while the service providers continued company—Google—which accounted to earn by far the most profits, $482 for 28 percent of the segment’s profit billion, their share of total profits fell growth. These companies—Apple 10 percentage points, to 66 percent. and Google—represent the major All of the other segments grew their winners in their respective segments. shares, collectively capturing 14.7 percentage points from the declining It is worth noting that despite the segments (see Exhibit 4). large gains made by a few large companies such as Apple and Much of the profits gained at the Google, those organizations alone consumer end of the value chain do not account for the shifts in profit came in the form of growth in the pools. An analysis of the changes devices segment, whose share of in profit pools that excludes the 10 the profits grew by 5.7 percentage largest companies in each segment points. Apple alone accounted for leads to essentially the same result 47 percent of the profit growth in (see Exhibit 5). this segment. Indeed, Apple was6 Booz & Company
  9. 9. Exhibit 4 Change in Profit Share by Segment, 2002-2010 5.7% 3.6% 2.7% 2.7% -4.9%eting -9.8% Content Providers Service Providers Equipment Providers Software Internet Software & Devices Services Source: Capital IQ; Booz & Company analysis Exhibit 5 Change in Profit Share by Segment, 2002-2010, Excluding 10 Largest Companies in Each Segment 3.0% 3.0% 1.1% 1.1% $4.5 -3.3% -4.9%eting Content Providers Service Providers Equipment Providers Software Internet Software & Devices Services Source: Capital IQ; Booz & Company analysis Booz & Company 7
  10. 10. TILTING THE dissemination of all sorts of content, including music, movies, news, and benefited from the positive network effects of their vast customer bases.BALANCE the like. Service providers, too, have Apple’s network of programmers suffered as further advances have in its App Store and Facebook’s whittled away at their pricing power enormous network of users, for and business models. Thanks to Hulu example, afford these companies and Apple TV, for instance, many greater bargaining power, engender consumers are opting to drop their user loyalty, and create significantThe shifts in the profit pools of the cable TV subscriptions. Cellphones switching costs for users. Suchdigital economy since 2002 are the have significantly reduced the need companies, all of which are in theresult of a number of technological for landlines. Netflix encourages software, Internet software andchanges that have shifted power moviegoers to stay at home, services, and devices segments, andfrom the forces of production to watching movies in groups rather thus closest to the consumer, havethose of consumption, and of the than paying for high-priced cinema enjoyed stronger pricing power andstrong positive network effects tickets. Together, these advances are influence as their networks havethat are accompanying—indeed, in continually chipping away at the grown. In contrast, the upstreammany ways causing—that shift, as bargaining power of equipment and segments typically benefit primarilycompanies such as Facebook and service providers. from traditional bricks-and-mortarTwitter build massively powerful economies of scale, the benefits ofnetworks of consumers. These User-created content: In a similarly which lie largely in their ability tochanges include the following: significant shift, the means of bring down costs. Since 2002, the consumption on the Internet are companies closest to the consumerThe filtered Web: The core asset of literally becoming the means of have disproportionately exploitedthe digital economy in 2002 was the production. In the bricks-and- network effects to grow faster thancontent itself—thus the conventional mortar economy, consumers do not their production counterparts,wisdom at the time that “content have the ability and resources—or capturing a greater share of theis king.” Since then, however, the the desire—to produce the goods profit pool.onslaught of information, news, they consume. In today’s digitalmedia, and entertainment available economy, however, anyone with an Software in the cloud: Finally, theon the Internet has become relentless, Internet connection and a computer, advent of cloud computing hasto the point where the more filtered or even a smartphone, can create created a struggle between theand categorized it is, the more and write blogs, editorials, and user software segment and the Internetmeaningful—and valuable—it reviews, or post pictures and videos. software and services segment. Inbecomes. Thanks in great part to the Social networks such as Facebook 2002, software boasted a profitrise of Web 2.0, the segments closest and services such as YouTube margin of 26 percent and profitsto the consumer, including devices organize and screen the content for of $22 billion, towering over aand Internet software and services, users, and thus replace the role of tiny Internet software and serviceshave gained in influence, since they traditional content providers. The segment, which had approximatelyare the ones that are most able to result: increased competition among two-thirds the revenue and negativefilter and categorize content. traditional content providers in the profits. By 2010, Internet software early stages of the value chain—and and services had grown to becomeEasier access to information: with increased competition come larger than the software segment inMeanwhile, technological advances lower profits. terms of revenue, while boosting itsin data storage, digitization of profit margin to 15.5 percent andcontent, and communications have Network effects: Over the past bringing its total profits to half of themade it far easier to copy, share, and decade, companies such as eBay, software segment’s total. We expecttransfer content. Content providers Amazon, Google, Apple, and more this transition, from software on thehave struggled to control the recently Facebook and Twitter have desktop to the cloud, to continue.8 Booz & Company
  11. 11. About the Authors METHODOLOGY David Standridge is a partner with In producing our research, we Booz & Company based in San Francisco. analyzed the financial results for He works with leading hardware and more than 6,000 companies from software companies in the digital and high- 2002 through 2010. We began tech industries, focusing on strategy and our analysis in 2002 in order to operations. exclude the volatile effects of the Christopher Pencavel is an associate with 2000 dot-com crash, and that year Booz & Company based in San Francisco. also represents the approximate He focuses on strategic issues of beginning of Web 2.0. companies in the digital and technology We used standard industrial clas- industries. sification (SIC) codes as a simple, uniform method of categorizing companies into segments and analyzing the profitability of each of the segments. We are aware, however, that in some cases this can be an oversimplification. THE CONSUMER Hewlett-Packard, for example, has IS KING an SIC code that places it in the devices segment, even though the company sells products that might also place it in the equip- ment provider segment. In determining each company’s Further technological advances and profits, we used EBITDA minus social trends will likely continue capital expenditures. EBITDA to tilt the balance of power in the serves as a measure of free cash digital economy toward the consumer. flows from operations, and capital Certainly, capturing the new value cre- expenditures were subtracted because the profit pools analysis ated in the digital space over the next compares companies in very several years will depend on the ability different industry segments. of companies—even those currently For some companies, such as furthest from consumers—to develop equipment providers and service strategies that bring them closer. providers, capital expenditures are an essential aspect, whereas in the software segment, they are less relevant. EBITDA less capital expenditures takes these impor- tant differences into account. All figures have been adjusted according to the GDP implicit price deflator, which was approximately 20 percent higher in 2010 than in 2002. It is available in the 2011 Economic Report of the President, Department of Commerce, Bureau of Economic Analysis ( eop/tables11.html). Please note that the 2010 price deflator figure is preliminary as of the writing of this Perspective.Booz & Company 9
  12. 12. The most recent Worldwide Officeslist of our officesand affiliates, with Asia Middle Eastaddresses and Beijing Brisbane Helsinki Abu Dhabi Detroittelephone numbers, Delhi Canberra Istanbul Beirut Florham Parkcan be found on Hong Kong Jakarta London Cairo Houstonour website, Mumbai Kuala Lumpur Madrid Doha Los Seoul Melbourne Milan Dubai Mexico City Shanghai Sydney Moscow Riyadh New York City Taipei Munich Parsippany Tokyo Europe Paris North America San Francisco Amsterdam Rome Atlanta Australia, Berlin Stockholm Boston South America New Zealand & Copenhagen Stuttgart Chicago Buenos Aires Southeast Asia Dublin Vienna Cleveland Rio de Janeiro Auckland Düsseldorf Warsaw Dallas Santiago Bangkok Frankfurt Zurich DC São PauloBooz & Company is a leading global managementconsulting firm, helping the world’s top businesses,governments, and organizations. Our founder,Edwin Booz, defined the profession when he estab-lished the first management consulting firm in 1914.Today, with more than 3,300 people in 60 officesaround the world, we bring foresight and knowledge,deep functional expertise, and a practical approachto building capabilities and delivering real impact.We work closely with our clients to create and deliveressential advantage. The independent White Spacereport ranked Booz & Company #1 among consult-ing firms for “the best thought leadership” in 2010.For our management magazine strategy+business,visit to learn more aboutBooz & Company.©2011 Booz & Company Inc.