Networks and platforms reign within the high tech, media, and telecom industries—here’s a look at the leading profit spinners across the globe.
The ability of companiesin the so-called TMT industries (technology, media, and telecommunications) to create value is extraordinary. Companies in tech, media, and telecoms generate more economic profit (net profit less opportunity cost) 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 these industries so profitable is a combination of unique factors, including continuing advances in technology that open new markets, stimulate growth, and provide opportunities for companies that seize leadership positions to capture an enormous value (Exhibit 1).
Yet value creation across TMT is distinct, with the concentration of economic profits (net profit less opportunity cost) at the top, a rapidly rising middle tier, and significant turnover among top players. Our ongoing research seeks to explain how large tech companies, such as Google and Apple, and also “software-enabled” services companies, such as Uber, Facebook, or Netflix, that build businesses on technology platforms—generate economic profit and how they can continue to do so. As more industries adopt digitally enabled business models, the way value is created in TMT industries—and how digital technologies shift value pools—may be relevant to leaders across the 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 technology, media, and telecommunications 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 2010–04 period, and the share of companies that are not generating economic profit—that is, losing value—dropped (Exhibit 2).
At the subsector level, we see that profits of all the sectors that make up TMT (i.e., software, consumer electronics, media, operators, and tech infrastructure and services) generate profit, and they are among the highest of the 59 industries we analyzed (Exhibit 3). The fastest growth in economic profits were in software companies and in companies with software-enabled business models, such as Amazon and Tencent and other “platform” enterprises. The economic profit of such companies grew by nearly six-fold from the 2000–04 period to 2010–14 (from $5.8 billion to $33.7 billion).
Winners take most
Economic profit across the sector is concentrated, reflecting the 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 profits in TMT industries, and the top 5 percent of companies alone—including tech giants such as Apple, Microsoft, and Alphabet (Google’s parent)—generated 60 percent of economic profit (Exhibit 4).
Two factors amplify the benefits of scale for larger players in TMT: the power of technology platforms and network effects. Increasingly, the ranks of top players are populated by companies that shape technology platforms—Facebook in social media, for example. Even more than other companies, platform players benefit from network effects, which mean the value of the product or service increases when more people use it. The more you use Facebook, the more your friends will use it, for example. There are also indirect network effects, which involve the creation of complementary products or services—the apps market that has grown up around smartphones and tablets, for example.
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 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. Importantly, there is a growing group of middle-tier companies (in the 20th to 80th percentiles in terms of economic profit) that are 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 as much as profits for tech giants (Exhibit 5).
The rising middle tier includes software and cloud services companies as well as many players with software-enabled business models. These companies succeed by latching onto existing platforms and designing business models that scale rapidly. They also use programmatic M&A to move into adjacent industries and often make their money by disrupting non-TMT profit pools—retail, for example. Middle-tier players include Box, Baidu, Netflix, and WeChat.
Success can be fleeting: More profits, but also more flux and less stability
One reason why more companies in TMT industries generate economic profit and those profits are typically higher than in other industries is because of the dynamic nature of the markets. 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 can also come under attack. While the top 20 percent of companies consistently capture an outsized share of profits, life at the top can be short. In other industries, nearly 60 percent of companies that were in the top quintile in terms of economic profit in 2000 were still in that quintile 15 years later. In TMT industries, only 45 percent of top players from 2000 remained in the top quintile in 2015. The flip side to the slippery slope is that 25 percent more players that started at the bottom ended up in the top quintile in the same period (Exhibit 6).
This churn may be at least partially explained by changing dynamics within the profit pools themselves. For example, within telecommunications, value capture has shifted decisively to mobile connectivity, and in media traditional profit pools are evaporating while mobile and online advertising soars. In consumer electronics, virtually all the economic profit has shifted to two smartphone companies—Apple and Samsung—and the product segment is starting to show signs of vulnerability with Apple experiencing its first decline in iPhone sales in 2016.
Today, some of the biggest value shifts are occurring in software and in software-enabled services. In software, value is shifting to players that work at the application layer and away from infrastructure players on a per-user or per-instance basis. And profit pools are expanding rapidly for software-enabled businesses, such as Uber or Airbnb.
Implications for tech, media, and telecommunications companies
We remain convinced that the TMT sector will, in the aggregate, continue to outperform other sectors of the global economy. Yet as this research shows, there are significant challenges that individual companies need to manage. TMT leaders will need to work hard and plan carefully to keep up with shifting profit pools and remain among the companies that generate outstanding levels of economic profit. While answers to why TMT is different in some ways and what winning players need to do is still emerging, we have some strong hypotheses. We believe companies need to be building capabilities in four areas: establishing a strong position in one or more software or services platforms and building ecosystems around their platform offerings; continuously evolving business models to avoid being disrupted; replicating successful platforms in underpenetrated or ring-fenced areas (markets or white spaces); and finally, using programmatic M&A to continually reinforce and broaden their capabilities.
However, this research also suggests that success—and the strategies and assets to achieve it—will be an ever-shifting target in this rapidly-moving space, and pole positions are hardly assured. In the TMT sector, companies that start at the top have a 15 percent greater chance of slipping off the top than companies in other sectors. Thus, leaders need to perpetually monitor the strengths of their platforms and ecosystems and learn to bob and weave with nimbler attackers, lest they disrupt their incumbent business models. For above all, the eventual winner in TMT is, and will likely remain, the customer.