Undocumented digital services (29/12/17)
WTO, the global trade-rule-making body, appears to be in some crisis. The most recent WTO ministerial meeting ended without any multilateral agreements, or even a joint communication. On the one hand is the growing ‘bilateralism’ led by United States that is weakening multilateralism? On the other, divergence of views on what constitutes trade—both free and fair—and different countries’ agendas have ensured that successful conclusions leading to multilaterally-agreed ‘rules of the game’ are becoming more and more difficult to negotiate.
The most recent impasse at WTO comes despite global trade continuing to be in a slowdown mode since 2012 when the global trade intensity, a measure of trade as a percentage of GDP, peaked at almost 60%—up from below-25% in the 1960s. Since then, it has remained roughly stagnant and the global GDP lost its growth ‘multiplier’. At the same time there is profound change taking place in the model globalisation, driven by the growth of an interconnected world in which digital technologies and services are redefining our products and customer experiences. As an observer of this profound shift and a consultant to global firms driving this, I am starting to ponder: Are we thinking about trade correctly?
When economists and political leaders talk about a nation’s trade, they typically mean the value of goods and services that cross national borders. Measuring trade has, for long, been quite straightforward, in a sense. Say, a diesel engine manufactured in England and valued at $50,000 is shipped to an installation in Texas. That transaction would count as a $50,000 export from England to the US. But today, with digital technology connecting more and more equipment, processes and businesses, global firms are moving from selling assets to selling ongoing streams of revenue from services and pay-for-performance solutions, a shift that we at the Boston Consulting Group have termed ‘servitisation’.
One consequence of this new global paradigm is that companies are looking at “products” in entirely different ways. Even many traditional hardware manufacturers are increasingly viewing themselves as providers of digitally-enabled services, rather than just physical goods. What’s more, these companies are transforming the ways they deliver their products and services, often in ways that traditional metrics of cross-border trade do not accurately capture. Rather than just loading goods onto crates and then onto a ship for a price, for example, more value—connected to even physical products—is being delivered via digital platforms.
Let’s return to the diesel engine example above to understand the statistical dilemma. Under the manufacturer’s old way of doing business, the sale of the asset was often the end of its direct relationship with the buyer, except for any follow-on sales in the form of OEM parts and supplies. With the advent of connected devices, the manufacturer can now offer value-added services beyond the sales of the engine and parts. Sensors collect data that is used to analyse usage and performance. This analysis, moreover, may not be done in the UK or the US—but in a third country like India, Sweden, or China.
The engine manufacturer can develop services and solutions businesses, such as predictive maintenance and proactive replacement of critical parts, to deliver more value and generate new revenue streams. How do you capture these digitally delivered services in trade data? Although the analytics work is done in one country, the revenue resulting from it may be booked elsewhere. And since the value delivery is entirely digital, there is no “chain of custody” to track and record such transactions, much less get these reflected in trade statistics.
A senior executive at a global firm told me that tracking contributions to global trade will be increasingly challenging. His company is setting up a global analytics centre in India to perform advanced analytics of data transmitted from its growing portfolio of connected devices. The analysis will support its services offerings to customers globally through predictive analytics and value-added digital offerings, as well as the company’s country-specific marketing and sales efforts in its various markets. In each instance, there will be cross-border transfers of value. But as this executive noted, it remains unclear how this value transfer will be captured in trade statistics, both in terms of services delivered to the end-user (such as add-on purchases and new features) as well as the value of such information (in the form of marketing strategies) that is traded internally at the organisation.
The so-called Internet of Things is projected to grow five-fold from an installed base of about 15 billion connected devices to 75 billion by 2025. As connected devices become ubiquitous across industries, cross-border flows of digitally enabled services will become a significant part of the global economy. Servitisation examples in traditionally asset-heavy industries already abound. In the transportation/equipment sector, for example, they include Tesla cars, trucks connected to Volkswagen’s Rio platform, and John Deere tractors that are loaded with sensors and digital connections used to develop value-added services.
Many of these services are delivered through smartphone apps to any part of the world.The implications of these trends for global trades are huge. Using cross-border shipments of physical goods as a barometer of trade balance will have to be revised. So will conventional approaches to measuring trade in services. As more one-off transactions turn into extended, long-term contracts, the share of undocumented digital services will increase as a percentage of services trade.
Governments need to understand this paradigm shift and the multiplier effect that the growing contribution of digital services in global trade can have on economic growth. They then must align their national economic trade strategies accordingly. Instead of shadow-boxing each other over trade balances based on trade in physical goods, they must work towards embracing this new paradigm that global firms are shaping with or without WTO rules. The prize is significant—the return of the ‘trade multiplier’ in global GDP growth in the first half of 21st century in same way that WTO agreements governing physical trade built achieved in the second half of 20th century.