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EPSC Strategic Notes Issue 7 / 2015

06 October

Integration of Products
and Services
Taking the Single Market into the 21 Century st

Three factors combine to reshape the foundations of the modern economy. First, the digital revolution
dramatically augments the reach, flexibility and agility of companies, big and small, creating new economic
actors, such as ‘micro-multinationals’: technology-intensive companies that are born global. Second,
international competition draws millions of new workers and consumers into what is increasingly a ‘race
to the top’, rather than a ‘race to the bottom’, with emerging countries becoming champions of innovation,
engineering ingenuity and skills acquisition. Third, cultural and structural trends change the nature of
socio-economic interactions by transforming people’s aspirations and preferences, such as the expectation
of instant gratification offered by one-click services or the seamless interoperability between products and
electronic devices.

Blurring Lines Between Products A New Paradigm for Investment

and Services Investment patterns and value creation are changing
A pronounced distinction between product and profoundly: business expenditure in intangible assets
service markets is fictitious: value creation – databases, software, design, training or branding –
and innovation increasingly take place at their grows significantly in size and importance compared to
intersection. Business-related services are often tangible assets - such as machines, buildings or land.
decisive in making products attractive to the Within intangible investments, innovation levers need
consumer and they generate most of the value to be supported: scientific R&D for instance accounts
added in growth and employment. for only 17% of firm investment in innovation, inviting
policy makers to recognise and encourage other types of
Introducing the investments (Figure 5, p. 5).
Interoperable Economy A Single Market for Global Advantage
A new, horizontal economy is emerging A modernised single market can place Europe
beyond traditional value chains, opening novel a step ahead of its global competitors by
opportunities for those who master a more more quickly removing barriers to cross-border
‘systemic’ presence across sectors such as energy exchanges of products and services. But to match
provision, modern transport and mobility, food the demands of the new economy, the single
production or travel facilities. Interoperable data market needs to become more dynamic and agile,
will be the ‘glue’ that connects the different fields, shift the focus from producer to consumer and
while platforms will be the ‘bridge’ between drive disruptive innovation.
providers and users.

EPSC Strategic Notes are analytical papers on topics chosen by the President of the European Commission. They are produced by the European Political
Strategy Centre (EPSC), the European Commission’s in-house think tank.
The views expressed in the EPSC Strategic Notes series are those of the authors and do not necessarily correspond to those of the European Commission.

EPSC Strategic Notes

Future historians may well look at our time as equally determinant in redesigning the economic rules
of the game as the 19th century industrial revolution. The consumer and user is ever more central to
the new economy, by virtue of being more active and responsive, hence shaping the manufacturing
value chain and leading the way towards tailor-made, personalised ‘production on demand’ and the
emergence of hyperconnected services. If the industrial age was marked by standardisation, the
digital era is about customisation. These tectonic shifts go hand in hand with other developments of
seismic proportions: the blurring distinction between products and services; the birth of the ‘prosumer’
who combines elements of consumption and production; and the growing importance of investments in
intangibles – such as software or design - which increasingly outstrip investments in tangibles - such as
machines or buildings - in the leading economies.

A Hyperconnected Economy: The EU goal of increasing the share of manufacturing to

20% of GDP by 2020 is a vivid reminder of the importance
The New Landscape that policy makers attribute to industry.

What is less often realised is that achieving this

Deindustrialisation has moved hand in hand with an increasing target is inherently dependent on making Europe’s
importance of services in advanced economies. When incomes services sector more dynamic, productive and
rise, demand for services grows at a more than proportional integrated. More than ever before, the highest value
rate. The manufacturing sector, however, remains important:1 added of a product comes from service integration
• as a source of productivity growth, which is higher than (Figure 2). The OECD, for instance, has shown that
in other sectors in most countries; an increase of 1% in business services content in
• as an engine for R&D and innovation, since most manufacturing exports is associated with an increase of
R&D investments are concentrated in manufacturing 6 to 7.5% in prices.2
(Figure 1);
• as a strong factor behind the internationalisation of Figure 2: Service Value Added Embodied in
economies through trade and investment. Manufacturing Goods
Percentage of value added of manufacturing goods in final demand
1995 2011
Figure 1: Share of Manufacturing and United States
Services in Total Business R&D, 2012 Estonia
100 Russia
Manufacturing Services Luxembourg
Czech Republic
80 Greece
60 Italy
40 Portugal
United Kingdom
20 Brazil
0 Austria
United Kingdom


Czech Republic
Slovak Republic


0 5 10 15 20 25 30 35 40 45
Source: STAN Research and Development Expenditure in Industry
Database, OECD.
Source: Trade in Value Added (TiVA) 2015 Database, OECD

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EPSC Strategic Notes

With the blurring line between goods and services, The slow adoption and use of digital technologies has
international and national, on- and offline, an entirely been a drag on Europe’s productivity growth, not to
new economic paradigm is emerging, powered by three mention its ability to innovate and move up the global
transformative developments. value chain. And it has impacted manufacturing and
services alike, particularly the integrated, high value-
Technological Revolution added segment. But the EU is starting to address this
challenge: completing the Digital Single Market will
The internet and digital communications are general incentivise technology adoption through higher network
purpose technologies, transforming economies as effects, while prioritising areas where competitive
profoundly as the printing press, steam engine or advantages can still be reaped, such as Industry 4.0. At
electricity have done in the past. Against this backdrop, the same time, formulating a unified data framework
it is important to understand that there is no such for a market of half a billion consumers can set a global
thing as a ‘digital economy’ – the economy standard, provided it is user-friendly and workable.
is digital. Far from being the exclusive domain of Speed of delivery and implementation is of utmost
technology startups, every company, particularly in importance if Europe is to regain lost ground, and
traditional industries, needs to prepare for digitisation. the high-end nexus of integrated manufacturing and
Yet, on balance, European companies have been slow to services is of particular importance for future growth,
adapt: 41% of enterprises are still classifiable as ‘non- sustained innovation and quality jobs.
digital’ – meaning they do not use digital technologies
and have no digital strategy – while only 2% take full
advantage of digital opportunities.3

The Digital Car

Cars have become computers on wheels. Software The cost of the electronic parts of each vehicle
is revolutionising the car industry, until recently one are expected to rise from 20% in 2004 to 40%
of the most traditional and hierarchically organised this year, Boston Consulting Group estimates,4
industries in the world. For example, Tesla - a with a premium class car now containing 100
company founded as recently as 2003 - has shown microprocessors and running on 100m lines of
that there is no reason why a technology company software code. In the future, a car will likely be
cannot become a car company, with the design a combination of mobile office and source of
coming from California, modules being delivered entertainment. The vehicle will interact seamlessly
by suppliers from around the world and the final and exchange data with the driver’s electronic
product being put together in contract factories. devices, and possibly also with the manufacturer or
Electronics and automation have become key insurance company if the driver wants to document
components of the assembly line. safe driving.

Competition in the Tellingly, China’s 12th Five-Year Plan for 2011-2015

explicitly shifts the focus to R&D and high-end
Higher Value-Added Segment manufacturing and services. This means that China and
In spite of the slowdown of growth in emerging markets, Europe will increasingly compete in the same markets,
the next decades are likely to be marked by a continued such as clean energy, aerospace, telecom equipment
convergence process. As emerging countries move or broadband networks. Studies have shown that the
up the value chain, they increasingly rival complementarity of European and Chinese export offers
producers and service suppliers from advanced has dropped from 85% in 2000 to 65% in 2010, which
economies. Instead of developing powerful industrial means that 35% of exports tended to overlap, compared
sectors locally, they can now leapfrog more advanced to only 15% ten years earlier.5 Intensifying global
economies by adopting the latest technologies and competition means that competitive advantages are more
sourcing products and services globally. As a result, fluid than they used to be, requiring dynamic approaches
OECD countries’ share in world manufacturing dropped to competitiveness and productivity.
from 82% in 1990 to 56% in 2013 (Figure 3, p. 4).

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EPSC Strategic Notes

Figure 3: Share in World Manufacturing Figure 4: US Manufacturing Sectors That

Value Added Buy More Business Services Record Greater
1990 2013
Productivity Growth
Percentage, 2002-2011 average
2% 3% 2%
4% Computer and

Annualized growth in multifactor productivity

5% 5% electronic products
9% 11% 20%

8% 8 Apparel and
17% leather products
6 Miscellaneous
11% 23%
4% 23% 3%
17% 2 Transport


China South and Central America -4
United States Other Europe -10 -8 -6 -4 -2 0 2 4 6
Other Asia and Oceania Africa Change in business services intermediate inputs
Japan Source: United States International Trade Commission

Source: United Nations Statistics Division These three factors – digitisation, globalisation and
socio-cultural transformations – combine to produce a
Behavioural and Structural Change more versatile, creative and interactive economy
where value increasingly lies in the interoperability
The rationale of the emerging new economy is greatly between products and services. Combining products and
influenced by ongoing cultural and structural shifts, some services has become the new normal as design, marketing,
of which are induced by technology, while others result insurance and after-sale servicing are inseparable parts
from broader societal trends. Their effect is profound, of the offering that the consumer demands and expects.
from the changing nature of work and its growing fluidity As a result, manufacturing firms have incorporated strong
to the emergence of a sharing economy. In particular, the service components into the way they operate while
consumer and user perspectives – already central to services firms have sought to benefit from economies of
current economic relations – will become dominant scale, traditionally more characteristic of the manufacturing
even in business-to-business transactions. world. Business models that contribute to the integration
of products and services are increasingly crucial for
Products are increasingly tailored to individual competitiveness and productivity (Figure 4).
consumers’ needs and desires through processes such
as ‘additive manufacturing’. Consumers will move from
being objects of economic exchanges to active agents.
This trend is already underway, as exemplified by the
growing importance of ‘prosumers’. To illustrate, the
energy system is shifting from a centralised, supply-
Disrupt or Be Distrupted
side approach to a demand-oriented model. New
digital products and technologies are progressively From Static to Interactive
modernising the energy system by easing the way The fusion of product and service markets will continue
for a novel nexus between production, transportation, to have a profound impact. The world economy will
distribution and consumption. Increasingly, energy will move from static products and services to smart
become a service and not just a supplied commodity, and interactive ones. This means that new ways need
providing new opportunities for energy service to be explored with respect to the design and labelling
providers and aggregators, and giving life to new digital of products. Products are becoming ‘smarter’, more
products, such as smart meters. These developments capable of autonomously addressing and responding
will transform the business model of energy utilities, to evolving consumers’ needs. ‘Smart’ coffee machines,
bringing new, innovative and disruptive companies to for example, have built-in sensors that automatically
the fore. signal to the local brand store the need for repair. The
user therefore does not only purchase a product – a
coffee machine – but also a service, the promise of
maintenance whenever necessary.

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EPSC Strategic Notes
New business models will develop with packaged offers From Tangible to Intangible Investment
combining the provision of both goods and services in
ever more hybrid forms. Network effects will become The move from a bricks-and-mortar economy, marked
more important as a result. ‘The sharing economy’ and by incremental innovation, towards a hyperconnected
‘the circular economy’ are two emerging concepts which world, characterised by disruptive innovation, is mirrored
reflect the interactive character of modern economic in investment patterns (Figure 6, p. 6). Often referred to
exchanges. They are part of the broader phenomenon of as Knowledge-Based Capital, these hitherto marginal
hyperconnectivity, in which different segments interact areas are becoming key features of corporate success:
and many products and services prove complementary. design, software, data, organisational capital, firm-
specific skills and branding and marketing, to name but
Technologies such as virtual reality have the potential a few. Within intangible investments, new innovation
to radically transform entire industries through the levers need to be supported: scientific R&D, for instance,
remote discovery of products and services: the ability accounts for only 17% of firm investment in innovation,6
to ‘touch’ and ‘feel’ products in a virtual store from your inviting policy makers to recognise and encourage other
living room may well disrupt the sector by making price types of investments (Figure 5).
comparison easy, enabling 24-hour online shopping and
compelling companies to offer delivery services. The overriding goal of intangible investments is to live
up to a new ‘constant innovation paradigm’ in which
enterprises reinvent themselves on a continuous basis to
The ‘Learning’ Thermostat keep track of the technological frontier, user preferences
and developments in global value chains. Successful
When home appliances company Nest was acquired
by Google for $3.2 billion in 2014, there was much firms make the interplay between constant innovation
hype about the ‘learning thermostat’, one of its and targeted investment in Knowledge-Based Capital
flagship products. But did the value really lie in the a key feature of their business models. It becomes
thermostat? Hardly, one might conclude, as the real part and parcel of their day-to-day operations, with
worth that warranted the exorbitant price tag lay managers persistently fine-tuning processes to ensure
in the sensor-driven, Wi-Fi enabled, self-learning that the firm operates at the leading edge in comparison
and programmable devices the company produces. with global competitors. Understanding the centrality
The interoperability between the device and the of Knowledge-Based Capital is crucial, especially for
internet, as well as a user’s smartphone and tablet, European policymakers, given the traditional bias of
is key to making these types of manufactured public investment towards physical infrastructure.
goods attractive and can offer considerable first-
mover advantage to the pioneering company.
Europe, with its sizable single market and strong
From Macro- to Micro-Multinationals
tradition in manufacturing state of the art Today’s small and medium-sized companies are often
products, could be the perfect breeding ground for in a different league from their predecessors. Born
innovative companies, using the Internet of Things global thanks to the internet, which gives them instant
to make devices smarter, more user-centered and access to world markets, enterprises no longer have to
interactive. go through the traditional trajectory of slowly building
up a local presence and then expanding over the course

Figure 5: Investment in Innovation by European Firms, 2010

Billion euro

Scientific R&D 134 17%

Computer soſtware 133
New architectural and engineering designs 98
Entertainment, artistic and literary originals + mineral explorations 21
New product development costs in the financial industry 13
Advertising expenditure 56
Market research 33
Training 95
Organisational capital 194
Total 777
0 100 200 300 400 500 600 700 800
Source: INTAN-Invest

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EPSC Strategic Notes

Figure 6: Business Investment in Tangibles Policy Opportunities:

and Intangible Assets in the United States
Percentage of GDP Walk the Talk – and Fast
18% Traditional policy tools are often obsolete in the face of
Investment in KBC Investment in tangibles market integration of products and services. The single
16% market has lost none of its importance – if anything, the
14% growing value of cross-border markets, given product-
service integration, makes it all the more valuable.
12% But the single market alone will not guarantee future
success. Broader framework conditions - ranging from
the ease with which companies can switch from one
8% business model to the next to the user-friendliness of
the emerging data protection regime - are under careful
scrutiny by companies that have more choice than ever:
4% digitisation gives companies agility in terms of location,
outsourcing, and using global value chains to their














maximum advantage.
Source: Unpublished update on Corrado, C.A. and C.R. Hulten (2010),
‘How do you Measure a ‘Technological Revolution?’ The single market must not be seen in isolation. The
European Commission’s flagship initiatives already
of decades into a global firm. This fundamentally underway - such as the Energy Union, Capital Markets
alters the rules of the game and the very architecture Union and the Digital Single Market - all add up to
of the corporation – with a definite competitive edge more than the sum of its parts. Provided that Europe
for younger firms, which are often better at pursuing succeeds in making a quantum leap in unleashing
disruptive innovations, not bound by organisational the potential of its product and service markets,
legacy, allowing them to flexibly shift from one business there are numerous opportunities to be reaped.
model to the next. The relentless pursuit of productivity
and the closer proximity to users complete the picture
and explain why many large corporations, especially
Reshoring of Manufacturing
in manufacturing and industry, feel threatened and 3D printing – also referred to as ‘additive
insecure about their place in the 21st century economy. manufacturing’ – could lead to reshoring or nearshoring
of industry, as it increases production speed while
Slow to adapt to the new paradigm of the digital age, reducing costs and meeting consumer demand with
many macro-multinationals are now actively pursuing more speed and greater influence over production. Both
relations with younger firms, hunting for new ideas can make production at or near headquarters cheaper
and trying to import new skills and entrepreneurial than production overseas. What it calls for are decisive
talent by acquiring startups. This is not a marginal policy actions that incentivise technology adoption by all
phenomenon, nor is it an altruistic act on the side of corporate players competing internationally. The picture
the large companies. More than policy makers realise, will not be black or white, since reshoring will take
the relationship between large, industrial firms and place alongside continued outsourcing and relocation
young, tech-savvy startups is becoming symbiotic and to emerging markets. However, the reshoring of some
of crucial importance for Europe to sustain a global high-end production processes is likely in connection
lead in innovation. That is why a modern industrial with building a stronger product-services nexus.
policy needs to put technology adoption and an
innovation-friendly ecosystem at the forefront, Develop Not-Easy-to-Replicate
a definite departure from the more traditional
conceptions. The German Chancellor Angela Merkel Innovations
picked up on this theme when she used a recent speech Adding sophisticated business services to advanced
at the Day of German Family Firms to warn against manufactured goods leads to innovations that are not
‘digital anxiety’, especially in using big data, and called easy to replicate by competitors and therefore gives
on participants to occupy the ‘intersection between significant competitive advantage. In comparison,
consumers and the product. That’s where future profit it would be difficult to maintain such a competitive
will be made’.7 advantage with a standard manufactured good void of
an additional service component. This story also plays out

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EPSC Strategic Notes
on the jobs front: in advanced economies 30 to 55% of First Mover Advantage Up for Grabs
manufacturing jobs have become service functions, and
20 to 25% of manufacturing output is represented by in Key Sectors
service inputs.8 In the pursuit of high-quality jobs,
While there is much moaning in Europe about lost
the nexus between manufacturing and services offers
dominance in certain areas, there are many fields where
many opportunities, especially in countries that have
European companies can lead globally by operating at
world-class training and apprenticeship systems geared
the intersection of products and services. Industry 4.0
towards industry.
is commonly known, but other areas are up for grabs
as well: medical technology, smart cities, the circular
Figure 7: High Skills in Services and economy, ‘learning’ home appliances, and intelligent
Manufacturing transport systems. The integration of goods and services
Annual growth rate, average 1998-2008 is almost always powered by data and enabled by
interoperability, making technology adoption by all
8 companies, including in traditional sectors, an urgent
Services Manufacturing policy priority.

Are ‘Great Depression Statistics’

Fit for the Digital Age?
At the behest of Chancellor George Osborne,
2 the United Kingdom is currently undertaking a
comprehensive review of its economic statistics.
0 It is led by former Deputy Governor of the Bank of



United States
Czech Republic

Slovak Republic

England Sir Charlie Bean, who remarked that the

United Kingdom

framework of current accounts ‘was developed in


-2 the aftermath of the Great Depression’. Using Rolls-


Royce, which is ostensibly a manufacturer but in

-4 reality generates most revenue with services, as an
Note: Slovenia: 1997-2007; Sweden: 1997-2007; USA: 2003-08; example, Sir Charlie concluded that speaking about
Japan: 2003-08. manufacturing and services as distinct concepts
Source: ANSKILL Database 2011, OECD ‘is often not a helpful way to think about economic
activity.’ 9

Productivity Growth and High-Skilled

Jobs in Services Conclusion
For a long time, services have been perceived as inferior
in comparison to manufacturing. Weak in productivity Europe has everything going for it in this new,
growth vis-à-vis industry, and with jobs that are often hyperconnected, interoperable economy: traditional
seen as low in quality, the service sector has been strength in manufacturing must now urgently be
prioritised by few countries in Europe. Yet, the potential complemented by world-class services.
is enormous. Precisely because productivity in services
is comparatively low, quick wins could be reaped in As the European Commission ponders the future of the
terms of growth and innovation by integrating markets single market, a more holistic and all-encompassing view
and increasing cross-border competition, for instance must guide the upcoming strategy. Building on the global
in business services. And far from being the domain of reputation that European goods are superior in quality,
the low-skilled, the service sector actually employs more there is a unique opportunity to provide additional value
highly skilled workers than manufacturing (Figure 7). For – and gain international competitive advantage –
policy makers, it is time to understand that a healthy and by accelerating the integration of technology, services
thriving industry sector is inherently dependent on the and design.
quality and integration of Europe’s service markets.
It is the only way that Europe can succeed and excel
in the ‘race to the top’ that leading competitors are
pursuing in a quest for sustainable prosperity and high-
quality jobs.

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EPSC Strategic Notes

1. OECD Publishing, ‘Manufacturing or Services – That is (not) the 6. OECD Publishing, ‘Manufacturing or Services – That is (not) the
Question’, Policy Paper No. 19. Question’, Policy Paper No. 19.
2. Nordas and Kim, ‘The Role of Services in Competitiveness in 7. ‘Rede von Bundeskanzlerin Merkel anlässlich des Tags des
Manufacturing’, OECD Trade Policy Papers, 2013. deutschen Familienunternehmens am 12. June 2015.’ http://www.
3. European Commission, Enterprise and Industry, ‘Digital bundeskanzlerin.de/Content/DE/Rede/2015/06/2015-06-15-merkel-
Entrepreneurship’, http://ec.europa.eu/enterprise/sectors/ict/digital- familienunternehmen.html
enterpreneurship/index_en.htm 8. McKinsey Global Institute, ‘Manufacturing the Future: The Next Era
4. Cited in Gapper, John, ‘Software is steering the car industry’, of Global Growth and Innovation’, November 2012.
Financial Times, 18 February 2015. 9. Financial Times, ‘UK’s official statistics out of date, says Bean‘
5. Holslag, Jonathan, ‘Unravelling Harmony: How Distorted Trade. August 5, 2015. http://www.ft.com/intl/cms/s/0/69b31022-3ac1-
Imperils the Sino-European Partnership’, Journal of World Trade, 11e5-bbd1-b37bc06f590c.html#axzz3k1rHpBXO
April 2012.

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