A Global Village
Issue 6 » Internet

Turning Local: From Madrid to Moscow, the Internet Is Going Native

David Dean & Paul Zwillenberg, The Boston Consulting Group

The Internet is heralded as a global ‘network of networks’, but it is increasingly acquiring a local character that springs from national heritage as well as economic, political, and social influences. It has helped to digitally knit the world closer together but has also spawned many local offspring.

As the Internet becomes increasingly enmeshed in commerce and society, its evolution is being influenced by the physical world – for instance, the rise of secure-payment mechanisms through credit cards and strong logistics infrastructure. At the same time, traditional companies that embrace digital technologies such as social networking can enhance their existing strengths. We are witnesses to a real-time blending of the real and online worlds that has nothing to do with online games, virtual reality, or other entertainment. The winners will be the companies and countries that can successfully marry bricks and clicks.

In some countries, such as the U.K., consumers have become avid online shoppers, but this has not happened in the Netherlands, even though the fixed-broadband infrastructure is much stronger there. The reason lies largely in the physical world: the Dutch are light credit-card users. Hong Kong, which also has a strong Internet infrastructure, has relatively weak business-to-consumer activity. Traditional merchants in this densely populated ‘shoppers’ paradise’ have an easier time holding onto nearby customers. But strong business-to-business Internet activity exists. Pioneering trading companies such as Li & Fung Limited, a global supply-chain manager, have leveraged the strong Internet infrastructure to become global giants, relying on the Internet to enable efficient and cost-effective information flows among trading partners. In Indonesia, mobile Internet usage is skyrocketing as consumers bypass fixed-broadband Internet access and jump to mobile services. The same is true in India, where, for many customers, their first bank account could well be a mobile one.

Although Facebook has had remarkable success in Western Europe, it faces stiff local competition in China, Brazil, and Russia from firms such as Renren, Orkut, and VKontakte, respectively. Likewise, Amazon.com and Google have strong local competitors in countries such as Japan and Russia.

It should not be surprising that the Internet is evolving differently in different places. The way in which technology and media take root has depended on each country’s local characteristics. Cable television, for example, has been much more successful in the small high-density Benelux countries than in Italy, where satellite providers skimmed the best customers while cable companies were still digging ditches. In Eastern Europe, magazine publishing is a growth business because the nations there are still developing the consumer economy upon which magazines depend for advertising revenue. Not so in the U.S.

These observations emerge from several strands of research conducted by The Boston Consulting Group, including an initiative commissioned by Google.

BCG e-Intensity Index
To generate a more nuanced picture of the depth and reach of digital activity across countries, the BCG e-Intensity Index analysis compares different measures of Internet activity for 50 countries. These include all Organisation for Economic Co-operation and Development (OECD) members, the BRICI nations, and other noteworthy economies such as Hong Kong, Saudi Arabia, Singapore, and South Africa. It measures three key characteristics:

Enablement. How well built is the infrastructure and how available is access? (This has a weighting of 50%)
Expenditure. How much money is spent on online retail and online advertising? (25%)
Engagement. How actively are businesses, governments, and consumers embracing the Internet? (25%)

BCG e-Intensity Index captures a nation’s supply of Internet infrastructure (enablement) and the demand for Internet services (expenditure and engagement), providing a clearer understanding of a nation’s strengths and weaknesses than other global rankings.

From Natives to Aspirants
We analysed the strengths and weaknesses of the 50 nations and found that, based on the level of their digital activity, the nations break down into five
clusters.

Natives. The seven nations that top the index are from Northern Europe and the advanced economies of Asia: Denmark, Iceland, Japan, the Netherlands, South Korea, Sweden, and the U.K. Strong infrastructure and broadband penetration help power these nations to the top of the index, but many of them have more than just better pipes. South Korea, the top-ranked nation, placed in the top four across the board: in enablement, expenditure, and engagement. Denmark, the nation with the second-highest overall ranking, scored fifth in enablement, first in expenditure, and eighth in engagement.
The lesson for executives and stakeholders in developing nations and other countries that want to improve their Internet profile is clear: investments in infrastructure need to be accompanied by other strengths such as a favorable regulatory environment, strong payment systems, and consumer protections for e-commerce transactions.

The BCG e-Intensity index highlights Internet prowess across economies

Players. The next group is the largest, comprising 17 nations, mostly from Western Europe and rounded out by other developed economies such as Australia, Canada, Hong Kong, Singapore, and the U.S. These nations generally have what might be termed ‘good enough’ Internet infrastructure, commerce, and civic activity.

A lack of consistency across the three Es is what keeps these nations from rising to the top. Hong Kong, for example, had the highest enablement score but fell to twelfth overall by ranking in the 20s in both expenditure and engagement. Belgium could move up in the rankings if companies and consumers embraced online shopping. Seventy-five percent of all Internet users go online nearly every day. But they are engaged more in social than in commercial pursuits. In 2010, the annual volume of online retail sales per capita was approximately $200, one-third that of the U.K.

The U.S. – the birthplace of the Internet – proves that nations need more than great infrastructure to do well on the index. The U.S. has only the fifteenth-highest enablement score but the top engagement score and the eighth-highest score in expenditure, giving it an overall ranking of ten.

In the future, however, weak infrastructure may start to hobble U.S. performance. Innovative services that require high bandwidth will have a hard time finding a mass-market home in the U.S. outside of high-speed corridors. Less than 40 percent of U.S. Internet connections exceed 5 megabits per second, according to Akamai’s most recent State of the Internet report.

A large share of the U.S. population is simply priced out of the market. “The poverty problem provides a new and sobering lens for any serious analysis of the telecom and media sectors,” says Craig Moffett, an analyst at research firm Sanford Bernstein, in The Poverty Problem. “At the low end, customers aren’t just choosing between one provider and another. They’re often choosing between these services and a third
meal.”

Nascent Natives. The third group consists of a cluster of seven nations from Southern, Central, and Eastern Europe. They generally underperform in at least one dimension. But there are also examples of leading-edge innovation within these nations, and they could advance quickly if they make the right moves.
The Czech Republic, in particular, manages to overcome a low enablement score by doing well on the expenditure index. More significantly, that nation is using the online environment to replace immature or undeveloped retail channels. Planet Retail, an analyst firm, estimates that the German and U.K. markets have 35 to 75 percent more retail space per capita and 20 to 30 percent lower relative prices in some categories.

Rather than build out retail space and the accompanying logistics systems, Czech companies are moving online. While the share of online sales varies among product categories, 17 percent of domestic appliances and 14 percent of sports equipment were bought online in 2009.

The challenge for stakeholders and companies is to understand the constraints on Internet activity and remove them. Czech consumers, for example, pay cash on delivery for nearly one-half of online sales. Their unwillingness to accept online payment will eventually constrain growth.

Laggards. Four countries – Greece, Italy, Saudi Arabia, and the United Arab Emirates – should have stronger Internet profiles than they do. They all rank lower on expenditure and engagement than they do on enablement and perform worse on the BCG e-Intensity Index than predicted by their per capita GDP. These nations have the ability and potential to exploit the Internet more fully and could move quickly up in the rankings with focused effort.

The contrast between the Czech Republic and Italy – a country with higher per capita GDP and a longer history of market economics and modern retailing – is stark. Although Italy has a higher enablement score, its overall score is lower. Italian companies and consumers have not yet embraced the Internet to the same extent as their Czech peers. Traditional retailers, for example, have been reluctant to sell online: some 70 percent of online apparel sales are conducted by companies without physical stores.

On the Internet, time often moves at warp speed, and Italy may be overcoming its slow start. Online retail sales in Italy grew by 18 percent last year, according to Euromonitor International, and online advertising also grew by 18 percent – more than twice the rate in France (8 percent), according to Magnaglobal.

Aspirants. The final group of 15 nations consists of developing economies that trail far behind on several key dimensions. Most of these countries are physically large. On average, the quality and reach of their infrastructure are inadequate, and broadband penetration, online spending, and usage rates are low. But averages belie the fact that many of these nations are truly on the move. Indeed, in some of their metropolitan areas, the Internet experience is virtually indistinguishable from that in London, New York, or Tokyo.

By 2015, the BRICI nations, for example, will have more than 1.2 billion Internet users, more than three times the total in Japan and the U.S. combined. Internet penetration is surging in most of the BRICI countries, with projected annual growth rates ranging from 9 to 20 percent from 2009 through 2015. In China, the average Internet user spent 2.67 hours per day online in 2009, more than the average U.S. user (2.27 hours) and close to the mark of the average user in well-connected Japan (2.87 hours). The number of Internet users in China is projected to grow from 384 million in 2009 to 650 million in 2015.

Furthermore, the level of experimentation and innovation is especially high in these countries. In India, Internet-enabled mobile services are meeting people’s agricultural, health, and educational needs. Nearly half of China’s digital consumers use their mobile phones for multimedia messaging, photos, and streaming or downloading music. Nearly 40 percent of China’s users play games on their mobile phones, and around one-quarter use mobile video, Internet, and news services. Brazil is a hub of online commercial activity, ranking in the top half for business engagement.

In China and Russia, in particular, developments largely resemble the early days of the Internet in the U.S., with vast experimentation, innovation, and imitation. By contrast, Internet activity in many parts of Western Europe has been more a matter of paving over wagon trails – digitizing traditional businesses rather than creating new ones.

Eight of China’s ten most popular sites are local. Local companies have succeeded by tailoring their offerings to Chinese preferences. They have deep understanding of the consumer population, localized product offerings, and the ability to work flexibly with Chinese regulators. The top ten sites include search engine, news portal, Web video, business-to-business e-commerce, and instant-messaging sites.

The BCG e-Intensity index correlates with per capita GDP

Companies such as Tencent and Alibaba.com have come to dominate the market. Now among the largest digital companies in the world, they have global ambitions. Alibaba.com has 65 million registered users in more than 240 countries and regions, and Tencent – a provider of the instant-messaging platform QQ, online games, and social networking – recently invested in Digital Sky Technologies, a Russian company with significant stakes in Facebook and other global online platforms.

In Russia, also, local companies are leading the way. Yandex is the largest search-engine company and Ozon.ru, the largest online store. Ozon.ru has more than 4.8 million users and is adding 90,000 new users each month. The company generated around $140 million in revenues in 2010. Customers can choose from 18 methods of payment and 14 methods of delivery.

The Economic Impact of the Internet
The size and nature of the Internet economy provides another lens through which it is possible to explore capabilities and online activities.

BCG analyzed and determined the size of the Internet economy in 12 European countries, Egypt, and Hong Kong. In these countries, the Internet economy ranges from 7.2 percent of GDP in the U.K. to 1.2 percent in Turkey. The size of the Internet economy in each of these countries roughly tracks the country’s performance on the BCG e-Intensity Index. In the future, the Internet will also be a major contributor to performance, providing a large share of growth in nations struggling to find economic traction.

The Czech Republic and Hong Kong, both net exporters of Internet-related equipment, have larger Internet economies – measured as a percentage of GDP – than the BCG e-Intensity Index analysis would suggest.

In most markets, consumption makes up the largest share of the Internet economy. In around two-thirds of markets such as Denmark, the Netherlands and Sweden, corporate investment was responsible for 60 to 70 percent of investments, while in less developed countries, this percentage was larger – up to around 90 percent in Russia. Telecom operators in countries with less developed infrastructure, especially Egypt and Turkey, are investing heavily in Internet-related technology – largely 3G and 4G mobile networks that facilitate access to Internet services. These investments could pay dividends down the road by providing infrastructure that will enable e-commerce and other Internet activities to flourish. To get an idea of the future size and contribution of the Internet economy, we made several projections about its size in 2015. The most important projections were broadband adoption and consumers’ enthusiasm for online shopping, both of which drive consumption. Looking forward, we tried to be conservative. Still, several underlying trends – and the response of governments, businesses, and consumers – will be strong and unpredictable influences on growth and value.

The three nations with the smallest Internet economies, in relative terms, Egypt, Russia, and Turkey, have the fastest projected growth rates. Online retail sales account for most of this growth. Although these nations are starting from a smaller base – thus amplifying future gains – their progress is nonetheless encouraging.

With many nations still struggling with the aftershocks of the Great Recession, the Internet can meaningfully contribute to GDP growth. The higher the nation’s current score, the larger the likely contribution will be.

In the top-ranking nations on the BCG e-Intensity Index – for example, Denmark, the Netherlands, and the U.K. – the Internet is likely to contribute as much as 15 to 20 percent to GDP growth from 2009 through 2015. In countries in the next tier – for example, Germany and Hong Kong – it will contribute around 10 percent to GDP growth. Among Aspirants such as Russia and Turkey, the Internet is expected to contribute less than 5 percent to overall GDP growth.

Shaping the Future
From Boston to Beijing, from Madrid to Moscow, the Internet is reshaping economies and lives. The Internet is still very young, and in order for it to reach its full potential, several factors will need to come into play.

Advanced Internet services, such as high-quality video and mobile data services, need to run on a rock-solid infrastructure. The popularity of the iPhone and other smartphones, for example, has already taxed the capacity of mobile carriers in many markets. The ability of carriers to create additional capacity – and to set adequate prices – is critical to long-term growth in the Internet economy. Carriers will also need to make tough choices about the share of investments they devote to fixed rather than mobile technologies. Although businesses will depend on fixed infrastructure, the consumer experience will increasingly be a mobile one.
In every country, there is a significant minority of adults who do not use the Internet, forfeiting its benefits. In the U.K., 1 in 5 adults – about 9 million – has never been online.

Advanced Internet services,
such as high-quality video
and mobile data services,
need to run on a rock-
solid infrastructure. The
popularity of the iPhone
and other smartphones, for
example, has already taxed
the capacity of mobile
carriers in many markets

Universal access and adoption of the Internet are laudable goals and would provide a tremendous boon to national economies as well as new Internet users, who would benefit from better information, lower prices, and a greater range of entertainment choices. These goals, however, have proved difficult to achieve in developed markets, although some countries such as Finland are adopting supportive legislation. In developing markets, stakeholders will need to make tough decisions on the basis of the tradeoffs associated with access, speed, and investment.

If the government is engaged, consumers and businesses are somewhat more likely to follow. Denmark has created a public portal for individuals and businesses to interact with public authorities, and the Netherlands has developed the DigiD authentication system in order, among other things, to improve the efficiency of tax collection and benefits disbursement. The Hong Kong Hospital Authority has taken the lead in encouraging hospitals and clinics to use the Internet for sharing patients’ electronic medical records.

The vitality of e-commerce depends on users’ confidence in systems that protect privacy and consumer data and that prevent fraud. A failure in any of these systems could fundamentally alter consumers’ willingness to make online purchases.

To fully exploit the Internet’s potential, a multidisciplinary approach to regulation is necessary. Whether nations vest authority in a single body or several, they need to ensure that regulation is coordinated to encompass telecom, banking, commerce, and consumer affairs. This, though easier said than done, is nonetheless necessary. India, for example, has recently instituted a biometrics-based national identification system that could dramatically expand the ability of banks and merchants to offer Internet-enabled mobile banking and commerce and that could also improve government’s ability to deliver social services.

Openness has been a cardinal strength of the Internet, driving innovation and inclusiveness. Some people wonder whether this openness is under threat. The open-versus-closed debate can be polarizing and frequently unproductive. Few truly open systems generate significant economic value. Put differently, the closed nature of a system is what allows its owner to generate profits. Navigating these issues is tricky. Although the Internet’s founding fathers may fret over its evolution, regulators would be wise to be guided by restraint in trying to control these complex and fast-moving developments. Government should intervene only when market forces are not working to correct imbalances.

The Internet has created vast wealth for some and changed the destinies of many companies and industries. In many emerging economies, it is contributing to economic growth and, as the recent Arab Spring uprisings so vividly demonstrate, enabling societal change. A century ago, electricity jolted economies and societies in a similar way, and it will not be too long before the Internet is as pervasive as electricity.

The rise of electricity created some industries, destroyed others, and transformed most of the rest. The Internet is doing the same, so it is not unnatural for stakeholders to be inclined to intervene and attempt to chart the Internet’s future. But they need to tread with caution. Picking winners is fraught with difficulty, and incubating the next Google, Facebook, or Twitter is unlikely to be successful. Instead, stakeholders – especially those in the developed economies – should ensure that market conditions encourage both existing companies to fully exploit the Internet and startups to create Internet businesses that play to a nation’s core strengths. This approach will provide a platform for growth and societal benefit greater than wishing upon an Internet star.

David Dean is a senior partner and managing director in the Munich office of The Boston Consulting Group.
Paul Zwillenberg is a partner and managing director in the firm’s London office.

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