Networks and platforms reign within high tech, media, and telecom. Understanding the sector’s dynamics is increasingly important for executives in all industries.
The ability of technology, media, and telecommunications (TMT) companies to create value is extraordinary. TMT companies generate more economic profit (net operating profit less the cost of capital) 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 TMT so profitable is a combination of unique factors, notably continuing advances in digital technology that open new markets, stimulate growth, and provide opportunities for companies that seize leadership positions to capture an enormous value (Exhibit 1).
Yet a closer look at value creation across TMT also reveals a distinctive pattern: significant concentration of economic profit at the top, a rapidly rising middle tier of value-creating companies, and considerable turnover among top players.
As more industries adopt digitally enabled business models—consider, for example, the impact of Amazon in retail, Uber in transportation, and Airbnb in lodging—will this pattern be repeated in other sectors? While it is too early to say for sure, the way value is created in TMT, as well as how digital technologies shape value pools, is increasingly relevant to leaders across the global 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 TMT 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 2000–04 period (Exhibit 2).
Moreover, each of the five subsectors that make up TMT (software, consumer electronics, media, telecom and cable operators, and tech infrastructure and services providers) was among the most profitable of the 59 industries analyzed (Exhibit 3).
The fastest profit growth was among software companies and companies with software-enabled business models, such as Amazon, Tencent, and other “platform” enterprises. The economic profit of value-creating software companies grew nearly sixfold from the 2000–04 period to the 2010–14 period (rising from $5.8 billion to $33.7 billion).
Winners take most
Economic profit across TMT is concentrated, reflecting 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 economic profit in TMT industries. The top 5 percent of companies—including tech giants such as Apple, Microsoft, and Alphabet (Google’s parent)—generated 60 percent (Exhibit 4).
Increasingly the ranks of top players in TMT are populated by companies that have managed to create and scale successful platforms that benefit from network effects. These can be technology platforms (for example, Apple’s iOS), marketplaces (for example, Apple’s app store), or platforms of another type—but in each case these winning platforms increasingly exploit “network effects,” which means the value of the product, service, or the underlying technology increases when more people use it. The more you use Facebook, for instance, the more your friends will use it. There are also indirect network effects, which involve the creation of complementary products or services—the app markets that have grown up around smartphones and tablets, for example, or social gaming that is enabled by social networks.
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 doing so means 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. A growing group of middle-tier companies (in the 20th to 80th percentiles in terms of economic profit) is 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 the growth rate of technology giants (Exhibit 5).
The rising middle tier includes software and cloud services companies, as well as many players with software-enabled business models. Middle-tier players include Box, Baidu, Netflix, and WeChat. We see the growth of these and other middle-tier companies as fueled by a number of factors. Some have latched onto existing platforms and designed business models that scale rapidly. Others are disrupting non-TMT profit pools, such as retail. Many are using programmatic M&A to move into adjacent industries.
Success can be fleeting: More profits, but also more flux and less stability
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 also come under attack. While the top 20 percent of TMT companies consistently capture an outsized share of profits, life at the top can be short.
Taking our data set as a whole, across all industries, nearly 60 percent of companies that were in the top quintile in terms of economic profit in 2000 were still in the top quintile 15 years later. In TMT industries, though, only 45 percent of top players from 2000 remained in the top quintile in 2015. The flip side is that over the same period 25 percent more companies that started at the bottom ended up in the top quintile (Exhibit 6).
This churn is explained in part by rapidly changing dynamics within TMT profit pools. For example, within telecommunications, value capture shifted decisively from fixed line to mobile connectivity. In media, print and TV advertising evaporated, while mobile and online advertising soared. In consumer electronics, virtually all the economic profit shifted to two smartphone companies—Apple and Samsung—although the smartphone segment now could be showing signs of vulnerability.
Today some of the biggest value shifts are occurring in software and in software and Internet-enabled services. Traditional software players, such as Adobe, Symantec, and SAP, have high profit but low market-cap growth. Compare this with the medium growth in market cap of software-as-a-service players, such as Box, Salesforce, Slack, and Splunk, or with the more than 100 percent market-cap growth from 2012 to 2015 of companies such as Alibaba and Amazon that are providing digital services beyond TMT. Additionally, we see value shifting from the infrastructure layer to applications providers as software applications increasingly enable and monetize the unique functionality demanded by customers.
Implications for tech, media, and telecommunications companies
Against a background of rapid innovation in digital technologies, ranging from artificial intelligence and automation to the Internet of Things, we remain convinced that the TMT sector will, in the aggregate, continue to outperform other sectors. The digitization of the global economy has only just begun.
Yet our research underlines that TMT leaders need to monitor carefully how profit pools are shifting. And they must be willing to act decisively if they want to remain among those generating outstanding levels of economic profit.
In particular, we believe TMT companies need to build capabilities in four areas:
- Establishing a strong position in one or more software or services platforms and building ecosystems around platform offerings to ensure access to the fastest- growing profit pools.
- Continuously evolving business models to avoid being disrupted by well-funded start-ups or existing TMT leaders expanding to new markets.
- Replicating successful platforms in underpenetrated or ring-fenced areas (markets or white spaces), taking proven business models to markets with greater headroom.
- Using programmatic M&A to develop capabilities to quickly attack new, rapidly growing profit pools or cannibalize profit pools in other industries. Companies will need to continually reinforce and broaden their capabilities and have limited runway to develop such talent organically, particularly in areas like cloud and analytics, where competition for talent is intense.
It’s no secret that the gales of creative destruction blow with singular strength in technology, media, and telecom. Our analysis sheds light on how this relentless turbulence shapes the sector, how companies can harness its energy, and what leaders must do to avoid being knocked off course by unexpected gusts. As digital technologies and business models reshape more and more sectors of the global economy, the lessons are increasingly relevant beyond the blurring boundaries of TMT.
About the author(s)
Tushar Bhatia is a consultant in McKinsey’s Seattle office, where Dilip Wagle is a senior partner; Eric Kutcher is a senior partner in the Silicon Valley office; and Mohsin Imtiaz is a partner in the Houston office.
The authors wish to thank Saurabh Sanghvi and Jackie Roche for their contributions to this article.