Archive for March, 2011

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Rise of the Service Economy

March 19, 2011

According the Organisation for Economic Co-operation and Development (OECD), post industrial economies (i.e. Western developed economies) are now solidly ‘service’ oriented. By some estimates over 75% of US GDP is composed of services, the UK comes in at 71.6%, Switzerland at 72.1%, and Luxembourg at 79.4%.

Unfortunately this transformation of economies from industrial to service presents a series of problems. Economists, being economists, describe it in terms of productivity. For instance, according to the UK Treasury:“The service sector is at least one third less productive than manufacturing.” In some sectors, services reach only 50% of the productivity per head of old line manufacturing. Many believe that services processes have not been designed with the ‘rigor’ applied to such activities as engineering.

But, of course, that’s not all. The old industrial economy was underpinned by tangible assets, which had a number of advantages. First of all tangible assets are given formalized treatment by management and important social institutions. For instance, there are reliable valuation standards for these assets, they qualify under GAAP (Generally Accepted Accounting Practices) which means these assets appear on company balance sheets and are accepted by banks, securities regulators, investors and others as legitimate value. More importantly, businesses can leverage an asset, something that is NOT possible with a service.

With upwards of 80% of our economy now in ‘services’ our economic leverage is vanishing, and with it our ability to reliably finance growth.

Banks (which leverage assets on a 10-1 basis) are desperately trying to increase their asset bases to meet the demands of regulators and shareholders; however many are trying to do so with thinly disguised ‘services’ which at present don’t have the collateral value of older class assets. Public companies are able to leverage their service businesses through their multipliers, most importantly their price to earnings multiples in the stock market. However for the 90% of knowledge-rich small to medium sized companies today there is no financial leverage and therefore these businesses are swimming against the tide – many underperform or simply fail.

It is a fact that civilizations rest upon their asset foundations, solid assets allow them to mobilize their human networks to all kinds of productive purposes, investment in new business opportunities, building systems of education, health and or security. The growth of the service economy is very exciting and it is delivering an economic benefit, generating its fair share of GDP. But presently constituted services are not building solid dependable assets which individuals, companies and society can leverage efficiently to build a sustainable future.

Things to Think About

1.  We all need to take a leaf out of Bill Gates book. In the early days of Microsoft Bill converted his MS-DOS operating software from a ‘service’ to an asset by treating it differently than other software developers. Bill ring-fenced his software with a license agreement and leased it to IBM and others instead of selling it outright. This allowed Microsoft to gain both earnings from the sale of software but also to gain from the accumulating asset value of this valuable source of wealth.

2.  Its time for leaders to look very closely at their businesses and try and understand the sources of value more clearly. And then act to build real asset disciplines, value, and leverage in their non-traditional assets.

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