The technology stories coming out of this week’s World Economic Forum’s event in Davos share a common theme, one of anxiety. As technology continues to become a bigger part of our personal and work lives, we’re being faced with some equally big challenges: the impact of artificial intelligence on jobs, big tech and the role of antitrust laws, facial recognition and personal privacy, etc. But the problem is that many of the governmental frameworks that we use to analyze and legislate are holding us back. They’re still stuck in the 20th Century. A good example is the main way we measure our economy — GDP.
While it remains everyone’s favorite economic stat, there is a pretty broad consensus that GDP, which the Bureau of Economic Activity calls a “comprehensive measure of U.S. economic activity,” was designed for a post-war, industrial-based world, and fails to capture much of the value generated by today’s digital economy. GDP is a measure of production — it seeks to answer the question: “What is the economic value of the goods that we produce?” That’s all fine and well, but these days the question increasingly seems to be: “What is the value of the digital services that we consume?”
Former Fed Chairman Alan Greenspan used to estimate GDP by counting railcar loadings. That’s a pretty simple metric to calculate if you visit a freight depot. But how do you calculate the value of uploads to the cloud? As NYU business professor and author of The Sharing Economy, Arun Sundararajan tells me, “GDP is an aggregate measure that ignores how value is distributed, and furthermore, focuses on money transfers rather than value creation. It was designed for a world of physical assets, of steel and concrete, and falls short on many dimensions in today’s digital and on-demand economy.”
So where is GDP falling short?
I’m no economist, but Subscribed readers represent hundreds of digital service providers around the world, spread across dozens of different industries, and talking to them, I know for a fact that the shift away from products to services is happening at scale. This is going to have significant implications for the way we measure the economic health of our economies. Fixating on GDP as the primary indicator of a country’s overall economic health ignores several important areas of value that are being generated by the Subscription Economy. Here are four that come to mind:
One common complaint about GDP is that it doesn’t do a very good job of accounting for the fact that products are getting better and better. The appliance or phone you buy today is much much more powerful and capable than the appliance or phone you bought just five years ago, so you’re getting more value for roughly the same amount of money. But in the Subscription Economy, this is happening with everything, and it’s happening at a huge scale.
Think of how all the services you use at home and work have dramatically improved for the better over just the last year: streaming media, software as a service, online shopping, ride-sharing. Media platforms like DAZN, Netflix and Spotify add hundreds of hours of new content every week. SaaS platforms like Box, Zendesk, Workday and my own company Zuora add significant new features on a monthly basis. In a digital subscription business model, prices may linearly increase over time, but the value that the service provides increases exponentially.
Our digital services are improving themselves so fast that the government inflation estimators can’t really keep up. They are probably underestimating the inflation-adjusted GDP growth that results from all these continually improving services in our lives: IoT, transportation as a service, software as a service, etc.
To be fair, there are estimates that suggest that these adjustments would only account for less than one percent of total GDP. But my point is that most of all this new value sits outside of GDP entirely. We’ve all seen how our lives and businesses have vastly improved thanks to digital services, but we still don’t have an adequate way of measuring those improvements.
Lower Service Costs Versus Large Up-Front Purchases
In many parts of the country, an automobile used to be considered a mandatory purchase. But today the wide-spread availability of rideshare services means that more people are opting to pay for the ride instead of the car. After all, buying a car frequently entails a significant financial burden. It’s not surprising that car ownership is on the decline, and high school kids today are one-third less likely to bother getting a driver’s license than in the 1980s.
Now, at this point my economist friends will point out that all we’re doing is substituting the produced car in the GDP calculations with the revenue from the service. And if the service costs less, the “freed up resources” in the economy will likely be spent elsewhere, so it’s simply a shift.
But as a consumer, aren’t I benefiting enormously from the fact that a new low-cost digital service has freed up so much more of my spending power? And what if I’m actually getting more value, in terms of the convenience and efficiencies I gain from using these digital services, versus having to deal with the hassles and maintenance issues that come with ownership. The same dynamic applies to a business that chooses a low-cost SaaS provider over a large, expensive on-premise installation. That business now has so much more resources at its disposal.
Just looking at GDP fails to capture the advantages of a world in which we’re not obligated to spend vast amounts of money on automobiles and houses and software installations.
Recurring Revenue is Worth More
Last year when Salesforce announced its Fiscal 2019 results, it stated full year revenue of $13.28 billion and remaining performance obligation (or future revenues that are under contract but have not yet been recognized) of $25.7 billion. In other words, their next two years of revenue are pretty much guaranteed. Heck, today the folks at Salesforce could probably take a year off and come back in 2021 to a healthy book of business (though I wouldn’t recommend this!).
That’s a pretty remarkable number. It’s even more remarkable when you consider the fact that companies that sell products hardly have any remaining performance obligations at all. To them, a dollar is just a dollar. A sale is just a sale. And that’s the kind of business model that GDP was built to capture.
GDP offers a snapshot in time, and is only concerned with formally recognized economic activity. It’s not supposed to be a crystal ball. But as more sectors of the economy shift towards recurring revenue models and “push their money out in the future,” should they really be valued exactly the same as the ones operating on traditional asset transfer models? Why should we value an economic sector that is primarily based on recurring revenue the same as one that is not?
Asset Efficiency and Sustainability
Think about all the stuff that you’ve acquired over your lifetime, how you used it, and where it all wound up after you finished with it. Chances are that a lot of those physical assets were under-utilized (lawn equipment, furniture, automobiles, etc), and probably weren’t repurposed responsibly after you were done with them, except perhaps for that fancy treadmill you hang your clothes on. In other words, only a small percentage of your stuff’s value was actually utilized, and the majority of that value wound up in a landfill.
Today, all that is changing. Companies are now selling access to assets, as opposed to the assets themselves. Volvo wants half of its cars to be sold on a subscription basis by 2025. Ikea just launched a new furniture subscription program. Husqvarna is experimenting with consumer services that let people rent heavy gardening equipment by the hour or the day.
In other words, today we’re using our physical assets in way more efficient and sustainable ways (sustainability isn’t just important to our environment, it’s a measure of how effectively a business is handling its assets). But according to GDP, assets are simply indicators of economic output. GDP misses the fact that in today’s service-based economy we’re getting much more value out of the things that we produce.
In conclusion, try to pick a sector of the economy that’s not being transformed by low-cost digital services: education, finance, manufacturing, media, etc. You can’t. Economic value is shifting from ownership to access, and GDP fails to account for much of the new value that is being generated by that global economic shift. This has major implications for the way we legislate and accord resources.
GDP works fine if you’re still buying CDs, but most of us have moved on to Spotify.
I’d like to thank the following for their helpful input: Todd Buchholz (former White House Director of Economic Policy, MD of the Tiger hedge fund, economist, and author), Bart van Ark (EVP & Global Chief Economist at The Conference Board), and Arun Sundararajan, (NYU business professor and author; listen to our podcast with him here).
For more insights from Zuora CEO Tien Tzuo, sign up to receive the Subscribed Weekly here. The opinions expressed in the Subscribed Weekly are his own, not those of the company. The companies mentioned in this newsletter are not necessarily Zuora customers.
And check out his book SUBSCRIBED: Why the Subscription Model Will be Your Company’s Future – and What to Do About It.