Today’s digital world is organized around two centers of gravity: the U.S. West Coast and the east coast of China. These gold coasts are home to nine of the top 10, and 18 of the top 20, internet companies, as measured by market capitalization. The leading companies in online search, social media, and e-commerce are all based in one or the other of these two regions. But as the digital revolution continues to spark widespread disruption in other industries — automotive, financial services, health care, and retail — who will win? As other nations consider their own stakes in the game, and as incumbents engage with digital disruption, will the two centers of gravity hold, or will the gains be more widely distributed?
A Concentration of Wealth, Value, and Power
By default, the two gold coasts have a self-sustaining edge: They have accumulated massive value, wealth, and power through the winner-take-all economics that govern many digital business models.
Winner-take-all economics favored the companies in the U.S. and China that were able to take advantage of large domestic markets to achieve scale and to surround themselves with rich ecosystems of startups, suppliers, complements, and customers. Thus, companies on the gold coasts of the U.S. and China have essentially won in the arenas of online search, social media, and e-commerce.
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The contest is now shifting toward more-traditional industries, like transportation (Lyft and Uber, for example) and hospitality (Airbnb). Google’s restructuring as Alphabet is one sign of its entry into several new vertical markets, including driverless cars, smart homes, smart cities, and health. Alibaba, the Chinese e-commerce leader, manages the world’s largest money market fund, and now plays an important role in financial and payment services. Amazon’s acquisition of Whole Foods Market is perhaps the purest expression of the blending of the digital and physical worlds of retail. Unsurprisingly, Amazon’s potential move into drug retailing hurt pharmacy stocks, and is thought to be a trigger for CVS’s bid for Aetna. Most of the digital giants in both countries are investing in artificial intelligence and other technologies that will facilitate their entry into yet other industries.
The so-called tech unicorns, private companies in the tech sector whose value exceeds $1 billion, are playing the same game. According to CB Insights, these companies are active in more than 20 industries. In fact, the median value of unicorns in financial services, such as Lufax and Stripe, is larger than the median value of consumer internet unicorns.
For the 274 companies started in 2003 or later that have reached unicorn status, half are in the U.S., and nearly two-thirds of the 148 U.S. unicorns are based in California. China has more than twice as many unicorns as Europe (69 and 33, respectively), and the Chinese companies have much higher average valuations. What’s more, Silicon Valley has often scooped up the promising digital startups that Europe has produced — Skype and AI pioneer DeepMind, for example. Indeed, from 2011 to 2017, the GAFAM companies (Google/Alphabet, Amazon, Facebook, Apple, and Microsoft) acquired more than 65 leading-edge European technology companies. In many cases, as with Skype, the size of the European operation shrank after the acquisition.
The concentration of digital activity in a handful of companies in these two regions has tremendous spillover effects on wealth, value, and power. Most of these companies’ employees are located in their home countries: 75% in the case of Google and Facebook, and more than 95% in the case of Baidu, Alibaba, and Tencent, the big three Chinese online companies. These employees are well paid in terms of both salary and stock options and are much more likely to jump to another digital giant or a nearby startup than to a company outside the region. Wealth also tends to stay in-region, as outside investors tend to be locally based. And the amounts involved are huge. From 2010 to 2017, the market cap of GAFAM companies increased by $2.6 trillion. In contrast, the value of the 28 non-GAFAM companies that make up the Dow Jones Industrial Average rose $2.1 trillion. In China, meanwhile, Alibaba and Tencent are among the 10 most valuable companies in the world and, along with Baidu, are collectively worth more than $1 trillion.
Will digital companies from other countries find ways to scale up and break in? Or will Chinese and American companies face a future of protectionist backlash and digital Balkanization? Much depends on the answers to three major questions:
Will Governments Build Digital Walls?
Many countries believe that they have a legitimate interest in receiving tax revenue from digital giants for business conducted within their borders. These steps, however, can easily cross over into protectionism. The Information Technology Industry Council has identified at least 22 laws in 13 European countries that regulate the localization of data. Other studies have found nearly 300 regulations in 95 countries. And the numbers grow each year. While such measures are often enacted in the name of privacy and security, they can also create digital borders that inhibit economic activity. A 2014 study by the European Centre for International Political Economy discovered that recently enacted or proposed barriers could reduce GDP modestly in India (0.1%) and more substantially in other markets, such as the EU (0.4%) and Vietnam (1.7%).
Will Other Nations Develop Local Champions and Innovation Hubs?
Many have tried but few have succeeded in developing substantial innovation hubs. Perhaps the most notable exception is the success of Israel’s Yozma (Hebrew for “initiative”), a $100 million venture capital fund that was initially state-owned but is now privately run.
AnnaLee Saxenian, Michael Porter, and others have identified a mix of raw ingredients — such as great schools, venture capitalists, strong talent pools, job mobility, and a motive — that encourage entrepreneurs to come together and take risks. Aspiring governments should double down on approaches that encourage this entrepreneurship and local ownership. For example, governments could make it easier for companies to choose to stay independent rather than to be acquired. These policies could help create local digital giants. If Europe could produce more companies such as Spotify to serve as role models, for instance, then other entrepreneurial executives may be less likely to sell early.
Governments could also work with the private sector to reduce “e-friction,” forces that prevent countries from developing strong digital economies. Countries with low e-friction scores have internet economies that, as a share of overall GDP, are twice as large as countries with high scores. Friction-reducing measures include infrastructure, such as access and internet speeds; skilled labor; online payment systems; data security; and government policy. Of course, in the absence of appropriate policy changes, a push to reduce e-friction could solidify the hold of U.S. digital giants in these countries.
Efforts to create a digital single market in Europe and elsewhere could also make sense. Meetic, the French dating site, offers a case study in the difficulties of managing across digital borders. The company was created three years earlier than its U.S. counterpart, Match.com. But, unlike that company, Meetic struggled with the varying regulations and consumer behaviors of 15 European countries. Match.com eventually bought out the company.
Will China’s Digital Giants Expand Overseas?
Digital giants in China have the scale, expertise, and stated aspiration to expand overseas, but largely have yet to do so. With just 56% online penetration in China in 2017, there is still room for domestic growth, but these companies could also achieve growth by going abroad.
Some Chinese digital giants have begun to shift their demographic emphasis. They have often partnered with local businesses, merging their partners’ intimate knowledge of the local market with their own strong technology. Two collaborations in India embody this approach: Tencent’s investment in Hike Messenger, and Alibaba’s investment in, and partnership with, Paytm. The Alibaba partnership helped Paytm become the third-largest global mobile payment platform in less than two years.
By partnering with companies in other markets, Chinese giants could help balance the global competitive environment now largely under the sway of U.S. giants. This type of alliance could be especially powerful if the EU and other regional economic organizations work with their counterparts in China to facilitate access to the Chinese market and its ecosystem of digital innovation. But China has a long way to go to play this role. Alibaba’s share of overseas-to-total revenue is higher than that of either Baidu or Tencent — and it’s only around 10% as of the end of 2017. The company, however, is aiming to achieve half of its gross merchandise value from overseas sales by 2025.
The current highly concentrated power map is reminiscent of the second industrial revolution era prior to World War I, though the actors have swapped roles. Now, the U.S. is exerting global power instead of European superpowers; digital China, a rising challenger focused mostly on its domestic market, is playing the role of the U.S.; and Europe is replacing China as the millenary civilization potentially leaving history. The current global digital power map could also be reshaped completely, depending on the actions of incumbent and challenger nations and companies.
The role and strategy of the U.S. will also be pivotal in that process. The U.S. currently benefits from the status quo, but if it presses its advantage too far, it may precipitate backlash from other nations, which have an understandable desire to ensure that they too extract value from digital revolution. Preemptively sharing the benefits of digital business more broadly could be a smart strategy for avoiding protectionist backlash, which could be counterproductive for all.