In our series on the digital economy we favor an alternative approach to measuring the size of the digital economy. We believe we should measure not just the value of digital goods and services but rather the digital value add. This gives a much better insight in how far digital technology has entered our economy. Moreover it would show what the expansion path of the digital economy is. In existing reports on the digital economy, such as BCG’s The Internet Economy in the G-20 (2012), the digital economy is rarely defined but usually sized as an x % of GDP. In the BGC report the Internet economy in 2012 is 4.1% of GDP in the G-20 countries.
A similar approach is made by McKinsey in its 2011 report “Internet Matters”. Therein it states “…where the Internet economy is simply the sum of Internet consumption (service, access, e-commerce, etc.), private investment, public expenditure, and the trade balance in Internet-related goods and services”. More in particular it sizes all the activities linked to both the creation and usage of Internet networks as well as Internet services including web activities using Web as a support (e.g., e-commerce, content, online advertising), telecommunication on IP or linked to IP communication (mainly Internet service providers), software and services activities linked to Web (e.g., IT consulting, software development), and hardware manufacturers or maintenance providers of Web-specific tools (e.g., computers, smartphones, hardware equipment, servers used for the Internet). As a result McKinsey estimates the Internet economy to be 3.4% of the GDP of the 13 analyzed countries. To be clear, the report does acknowledge that its definition likely underestimates the total impact of the Internet.
Both reports focus on the demand and supply side of the Internet economy. It is a simple and accurate approach but it doesn’t quite capture the digital economy. The problem is that both reports focus on the necessary infrastructure and the production of digital goods and services but neglect the value add of companies that do not operate in a sector that primarily engages in internet (related) activities. So the outcome of the Internet economy being 5% of the GDP is just an absolute minimum. Yet, it is difficult to defend that the lighting division of Philips is not part of the Digital Economy. Moreover, a company such as Boeing could not exist without digital enabled production processes. Yet airplane manufacturing is not recognized as part of the digital economy. But digital technologies increasingly define the future of existing industries and as such most already contribute to the digital economy. In the case of Boeing we can argue that an increasing share of the value of airplanes is in applying digital technologies in the manufacturing process. But how can we capture this digital value add on a sector by sector basis?
One way to look at it is to analyze the use of digital technologies and explore how and how much they contribute to the value add of a product or service and in what way a product or service can be characterized as being a digital service or product. More in particular we should characterize economic activities by looking both at the digital footprint of the product or service and its value chain (see Figure above). From these two characteristics we can typecast four categories of economic activities with respect to their contribution to the digital economy:
- Digital Embedded: Sectors that offer highly digital products and services and that have a strongly digital driven value chain: these sectors, such as the hosting or the software sector, can be characterized as the digital natives of the digital economy. The naturals. They typically have a relatively very high digital value add.
- Digital Faced/Framed: Sectors that offer products and services that have strong digital components but which value chain is not highly digitized. Depending on the size of the value chain companies in this category have a relatively medium digital value add. Her we can find sectors such as the on-premise IT industry.
- Digital Powered: Sectors that offer traditional physical goods but which value chain is highly digitized. Retail, wholesale and healthcare are typical digital driven sectors. These are most often high volume, low margin activities. Depending on the size of the value chain companies in this category typically have a medium to high digital value add. This category contains sectors such as retail, wholesale, healthcare etc.
- Digital Supported: Sectors which products are physical by nature and of which the larger part of its value chain is non-digitized. Sectors such as agriculture and mining are very much digital supported sectors. Typically companies in this category have a very low digital value add such as agriculture, mining, traditional bulk industries.
Economic activities will rarely fall into one category. In reality a company will fall somewhere in between the extremes of the typecast.
Adding up all digital value add of economic activities will result in what The METISfiles calls Gross Domestic Digital Product. By using the above definition calculating the GDDP will no doubt result in a much bigger number for the Digital Economy than other studies. However we feel the aforementioned studies are underestimating the current size of our digital economy as they miss out on the digitization of the value chain of non digital goods. To asses our digital economy we need to get a grip on the digital value chain.
Next in our series on the digital economy: taking a stab at the Dutch Gross Domestic Digital Product (GDDP)