The Internet Value Chain

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THE INTERNET VALUE CHAIN

• Looking at the top 15 internet sites in the United

States as an example (and judging by the number

of unique visitors), there are only four sites that were

not on the same list in 2009, suggesting less

disruption and innovation than might be expected.

• We also see a growing trend for the leading

internet companies to expand into multiple

categories, usually via acquisition. Notable

examples include Facebook buying WhatsApp,

Instagram, and Oculus; Google buying Nest home

automation systems; and Baidu acquiring television

and advertising service providers.

• In terms of economic performance, the largest players

in any given segment are able to deliver higher

returns and profit margins, benefiting from the

inherent network and scale effects of the internet.

However, we also see convergence across categories

in terms of financial performance, with all of them

delivering returns on capital in the range of 5 to 25 per

cent. This represents a narrower range than in 2008,

and the number of outliers has also decreased. In fact

only gambling, gaming, and the new wearables

categories have ROCEs of more than 20 per cent.

The stock market valuations of online services

companies have risen as a result, delivering a

compound annual growth rate of 45 per cent since

2009, versus 6 to 22 per cent for the other segments

and 15 per cent for the S&P 500.

Our updated analysis shows that while the internet has

continued to grow strongly in terms of absolute size,

there has been less change and disruption than might

have been expected. Innovation and technical development

still proceed at pace, as has been happening in

the computing, software, and network equipment

sectors for decades. Yet from an economic perspective,

the internet is showing signs of an industry maturing

after an initial period of dramatic growth. The leading

players have established strong positions within their

respective segments, and the new developments in

product and service model innovations are as much

defensive plays to further cement these positions as

they are genuine disruption. As players such as Google,

Facebook, and Baidu expand into adjacent segments,

their rationale is based on leveraging scale and on

integrating services and features into their core

products and platforms. Facebook’s purchase of

WhatsApp for $22 billion was not justified by traditional

valuation multiples but rather in terms of enhancing the

Facebook platform and arguably removing a potential

substitute. The fact that ROCE has declined in certain

segments for the majority of players is also a sign of an

industry where competition is leading to a stabilisation

of returns, whose absolute level is likely linked to the

barriers to entry and degree of genuine competition

they face from online and offline firms.

This report’s focus is primarily to describe and

explain the development of the internet value chain.

The implications for industry participants and for

policymakers are profound but too varied to discuss

in a single paper. There are three general conclusions

that we would consider valid for most corporate or

policy contexts:

1. It is no longer appropriate to develop corporate

strategies, or to assess policy situations, with a

narrow focus on a single segment of the value chain.

The interdependencies between segments, as well as

between online and offline versions of products and

services, are too powerful. Decisions based on a

narrow view could be seriously flawed, either for a

company that may miss broader competitive threats,

or for a regulator misjudging the true nature of

competitive dynamics.

2. While the internet has empowered tremendous

change, it is no longer the case that it is always

creating growth. The deflationary impact on some

segments of the economy is substantial. It is likely

that the global impact is a positive one of boosted

productivity, but at a national or sector level there

can be overall losses. The consequences of this are

not yet fully discernible. We may be seeing

short-term disruption that will unlock widespread

wealth creation in the long term. Ongoing scrutiny is

warranted, for while one sector being eroded by a

modernising technology is generally considered

progress, multiple sectors being eroded simultaneously

can require countermeasures in economic and

social policy.

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