By Jonathan Woetzel, Jeongmin Seong, Kevin Wei Wang, James Manyika, Michael Chui, and Wendy Wong
China, already a global force in digital technologies, is set to experience huge shifts in revenue and profits as businesses digitize, boosting the economy’s international competitiveness. China has become a force to be reckoned with in digital technologies at home and around the world. As a major worldwide investor in digital technologies and one of the world’s leading adopters of the technologies, it is already shaping the global digital landscape and supporting and inspiring entrepreneurship far beyond its own borders.
But there is much more to come. As China digitizes, industries will experience huge shifts in revenue and profit pools across the value chain. This creative destruction is happening globally as the world digitizes, but it is likely to happen more quickly and on a relatively larger scale in China given a combination of inefficiencies in traditional sectors and massive potential for commercialization.
In this report, the McKinsey Global Institute assesses the strengths of China’s digital system, the degree of digitization of industries, and the scope for value shift and creation. Part 1 looks at China’s position in the global digital landscape. Part 2 introduces the MGI Industry Digitization Index for China, which reveals large variations among sectors in terms of their digitization. Part 3 takes a more detailed look at how three digital forces (disintermediation, disaggregation, and dematerialization) can restructure value chains and increase the magnitude of disruption in four sectors (consumer and retail; automotive and mobility; healthcare; and freight and logistics) and discusses how much scope there is for digitization to shift (and create) value. In Part 4, we look at what policy makers can do to encourage China’s digital economy, and, finally, in Part 5, we discuss what choices companies can make to prepare for the impending wave of change and why digital strategy matters more in China.
1. China is home to dynamic digital innovators and is a leading global investor in the latest technologies
Digital China is already more advanced than many observers appreciate. In e-commerce, China accounted for less than 1 percent of the value of worldwide transactions only about a decade ago; that share is now more than 40 percent. The current value of China’s e-commerce transactions is estimated to be larger than in France, Germany, Japan, the United Kingdom, and the United States combined. Penetration of mobile payments among China’s Internet users grew from just 25 percent in 2013 to 68 percent in 2016. In 2016, the value of mobile payments related to individuals’ consumption was $790 billion, 11 times that of the United States. One in three of the world’s 262 unicorns is Chinese, commanding 43 percent of the global value of these companies (Exhibit 1).
Exhibit 1
China’s venture capital industry is increasingly focused on digital. Overall, China’s venture capital sector has grown rapidly, from just $12 billion, or 6 percent of the global total, in 2011–13 to $77 billion, or 19 percent of the worldwide total, in 2014–16. The majority of venture capital investment is in digital technologies such as big data, artificial intelligence (AI), and financial technology companies. China is in the top three in the world for venture capital investment in key types of digital technology including virtual reality, autonomous vehicles, 3-D printing, robotics, drones, and AI.
Three factors suggest that there is huge upside for digital in China:
The big and young Chinese market is enabling rapid commercialization of digital business models on a large scale.
Three of China’s Internet giants—Baidu, Alibaba, and Tencent, or BAT—are building a rich digital ecosystem now growing beyond them.
The government gave digital players space to experiment before enacting official regulation, and it is becoming an active supporter as an investor and consumer.
The impact of digital China on the global economy has been increasing. China ran an annual surplus in digital services of $10 billion to $15 billion over the past five years. Its outbound venture capital totaled $38 billion in 2014–16, up from $6 billion in 2011–2013.
2. Chinese industries lag behind their counterparts in advanced economies on digitization, but the gap is rapidly closing
China is already a global leader in the consumer-driven digital economy. The next wave of digital transformation in China is likely to come from broader adoption of digital technologies by businesses in different sectors that will restructure value chains and boost productivity.
Overall, digitization of industries in China still lags behind that of the United States by a considerable margin, but that gap is narrowing rapidly. In 2013, the United States was 4.9 times more digitized than China; in 2016, that figure had fallen to 3.7 times.
The new MGI Industry Digitization Index for China (using the same methodology as in MGI research on digitization in Europe and the United States) assesses where its sectors stand on digitization relative to each other and reveals that Chinese industries are at very different stages (Exhibit 2).
Exhibit 2
As in other economies, the most digitized sectors in China include information and communications technologies (ICT), media, and finance. In ICT, China’s Internet companies are rapidly ramping up investment in digital infrastructure. To give an idea of the size of this investment, demand for servers from China’s tech giants is as large as the entire national demand of countries such as Brazil and South Korea.
China’s consumer-facing industries and sectors associated with government rank higher relative to other sectors compared with their counterparts in Europe and the United States. Chinese consumers are enthusiastically embracing digital technologies, and the industries that serve them have had to respond by investing in digital assets and processes. There has been massive investment in government-associated sectors, too. In utilities, China was already the world’s largest market for smart grids by investment in 2013. In 2015, about 310 million households were using smart meters, a penetration rate of more than 80 percent, compared with 56 percent in 2013.
3. Three digital forces can potentially shift (and create) 10 to 45 percent of the industry revenue pool across players by 2030
As China digitizes, industries will experience huge shifts in revenue and profit pools across the value chain, doubtlessly involving a degree of disruption that will create losers and winners—and disproportionate value for the latter.
Digital disruption is likely to be on a relatively large scale in China due to a combination of the rapid pace of economic growth and changes in the economy, the prevalence of inefficiency across sectors, and massive potential for commercialization at scale.
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We simulated the potential impact of three digital forces in China:
Disintermediation. This is a major trend in China. Alibaba and others have disrupted the retail industry by cutting out a middle layer and linking suppliers and consumers directly through digital platforms. Industries with high margins on offline channels, a lack of information transparency due to multiple layers between suppliers and customers, and a highly fragmented landscape are ripe for this type of digital disruption.
Disaggregation. Digital attackers are disrupting traditional business models and reinventing industries by disaggregating huge assets into many pieces, turning them into services, and serving fragmented consumer bases. Industries that have high value, high durability, and fluctuating utilization are the main territory for this type of disruption. Digital disruption through disaggregation is increasingly prominent in China, shared mobility being a prime example.
Dematerialization. This digital force changes products or processes from physical to virtual, unbundling demand with digital delivery and enabling consumers to receive products or services anywhere, anytime. In China, the pace of this conversion has been faster than elsewhere in categories such as music and e-books, and the upside for digital attackers far larger than in other countries.
We analyzed about 300 use cases in four key sectors that offer different opportunities: consumer and retail, automotive and mobility, healthcare, and freight and logistics.
Our simulation suggests that by 2030, digitization can potentially shift (and create) value equivalent to 10 to 45 percent of the industry revenue pools in the four sectors analyzed (Exhibit 3). Digital forces will shift value from old business models to new ones, from slow-moving incumbents to nimble digital attackers, and from one part of the value chain to another. For large traditional companies, this means that a substantial portion of their revenue could be at risk, lost to new products, services, and business models from digital attackers. This is especially the case if incumbents operate in vulnerable areas of the value chain and industries and companies are slow to react due to organizational inertia. Nevertheless, they can actively embrace digital, offer digital solutions, and become sources of new competition.
Exhibit 3
The pattern of impact of the three digital forces varies by sector. Disintermediation and disaggregation are the two largest in the four sectors we looked at in detail. In both cases, digital platforms play an important role. Dematerialization has the smallest overall impact in our simulation.
Consumer and retail. This wave of digitization in China was largely driven by the e-commerce revolution, but we expect an even more significant transformation to unfold in the years ahead. Our simulation finds that digitization can shift and create value—on the order of 13 to 34 percent of industry revenue pool. The major force in play is disintermediation to deliver a new retail experience. In addition to continued growth of e-commerce as online sales penetrate further into rural areas, into smaller cities, and across borders, three additional trends are unfolding and transforming this sector: the continued evolution of an integrated omnichannel experience for consumers mixing offline and online, a transition toward data-driven business models, and a possible move upstream by digital platforms. The impact of disaggregation (the sharing of goods and services, and the rental of secondhand or used goods) and dematerialization is relatively small. These forces are likely to occur as companies meet demand in specific categories and niche markets.
Automotive and mobility. The digitization of cars is gathering pace, and digital solutions will reshape the mobility of China, which is now the world’s largest automotive market. Our simulation finds that digitization can shift (and create) value equivalent to between 10 and 30 percent of the automotive-industry revenue pool. Disaggregation, notably through shared mobility, can facilitate an ongoing shift from an ownership model to a service-driven one. Disintermediation enables OEMs and component and technology suppliers to establish direct relationships with consumers, influencing their decisions. Car connectivity can enable component suppliers or providers of technology solutions to bypass OEMs and establish direct relationships with customers through offerings such as in-car entertainment, operating systems, and other value-added services.
Healthcare. Digital solutions can be used to build a patient-centric system. China has substantially improved its healthcare services, but the system faces a range of challenges that digital technologies can help to address. Our analysis finds that digitization can shift and create value on the order of 12 to 45 percent of healthcare spending. If a “big bang” scenario were to happen, combining significant developments such as healthcare big data, AI-empowered treatment, and Internet of Things–enabled services, the impact could be the largest of the four sectors we analyzed.
Freight and logistics. Players can reach customers faster and cheaper through digital. The cost of logistics as a percentage of GDP is around double the figure in the United States, reflecting operational and structural challenges. Our simulation finds that digitization can shift and create value equivalent to between 23 and 33 percent of the industry’s revenue pool. Disintermediation (or digital intermediation) through e-forwarding in ocean shipping and establishment of direct channels in road transportation and express delivery can improve operational efficiency. Disaggregation through crowdsourcing can improve matching of demand and supply. Dematerialization through 3-D printing and paperless solutions can reduce the flow of shipments.
In addition to restructuring value chains, adoption of digital technologies by businesses can boost sector productivity and generate impact equivalent to between 3 and 14 percent of the industry revenue pool. Some digital tools boost top-line growth, and others reduce cost. There is a significant opportunity for Chinese companies both to catch up with best practices and use the strengths of China’s digital ecosystem.
4. Policy makers can continue to facilitate the digital economy in a number of ways
Local and national governments in China have already done a significant amount to encourage the expansion of the digital ecosystem. They can continue to act in four areas:
Continue to be an important investor in, and consumer of, digital technologies and infrastructure. The government can create a market for frontier technologies such as robotics and AI, encouraging long-term investment and innovation by companies, and continue to invest in expanding the infrastructure needed to address the divide between China’s digital haves and have-nots. Digitizing government operations could make a substantial contribution to China’s consumption of digital technologies.
Promote dynamic and healthy competition to fuel innovation and serve the interests of consumers. Although market concentration enables China’s digital giants to invest at scale in cutting-edge technologies, there are concerns that digital monopolies offer a good deal to consumers. It is important that the government acts to counter any abuse of market power and to ensure dynamic and healthy competition through legislation and ensuring that entry barriers are low so that new players can compete with incumbents. Opening up government data can help to set a level playing field.
Manage labor markets during digital disruption. Job churn will inevitably increase as new digitized sectors undermine traditional ones. In our base-case simulation, we found that 176 million to 253 million jobs can be created due to macroeconomic factors, and 161 million to 281 million jobs can be destroyed due to digital forces and automation. Given that China’s labor supply might decline from 773 million today to 757 million by 2030, the digital shock to the labor market appears manageable—as long as government, companies, and individuals all contribute to making the transition as smooth as possible through education reform, skills training, job-redeployment programs, and measures to increase labor mobility.
Contribute to global debates on digital governance to reach consensus.There is intense debate around the world about how to react to and govern the digital world. It benefits all governments to collaborate on issues such as cybersecurity, digital standards, intellectual property rights, and digital sovereignty. China is already involved in many discussions on such topics, and it should continue to play its full part to reach global consensus.
5. Best practices suggest six priorities for businesses as china digitizes
Given the scale of China and the pace of transformation into a digital economy, companies that are slow to respond face a great risk of being left behind. Conversely, widespread inefficiencies in China’s sectors and huge opportunities for commercialization mean that those who act boldly can reap considerable rewards. McKinsey’s experience working with companies around the world suggests that six approaches are vital and effective in China:
Adopt bold strategies. Previous MGI research has found that bold, large-scale responses to digital disruption pay off three times as much as less aggressive reactions. Widespread inefficiencies in China’s sectors (where productivity is only 15 to 30 percent of the Organisation for Economic Co-operation and Development (OECD) average) suggest very large upside potential for disrupters.
Use the power of China’s vast digital ecosystem. The influence of digital giants is bigger in China than in other economies because they not only have massive user bases, but also are active investors and providers of cross-sector digital solutions. Companies can be in a stronger position if they are part of an ecosystem, creating their own if necessary. Companies should consider how best to collaborate with large digital platforms.
Maximize value from analytics by using China’s massive data pools.Gathering and using data is increasingly a core competitive advantage for companies. China is superbly positioned because of the huge scale of data gathered every day. There are also arguably more opportunities to monetize data given that Chinese consumers are more willing to share their data than many of their international counterparts.
Build an agile organization for digital transformation. Digital disruption is accelerating, and businesses need to be agile to respond rapidly. Chinese companies tend to be hierarchical, which arguably makes them inflexible. One way to address this is to reorganize in smaller teams.
Digitize operations based on a solid transformation program. The scope for transformative digitization programs in Chinese companies is extremely large given the fact that the economy is still growing robustly, digital technologies are transforming the economy so quickly, and so many businesses are unprepared. The largest impact can be achieved through a comprehensive and structured transformation program.
Engage with China’s policy and regulation. The government has made it clear that digitization of the economy is a major priority. It is in companies’ interest to keep abreast of policy and regulatory developments, understand how they may affect business, and determine what business opportunities may be available from working with government.
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