Resource Reorganization and Service Sector Growth in Highly Interconnected Society
This paper demonstrates how modern technologies, especially the Internet, are transforming the nature of the service sector, leading to extensive resource reorganizations and integrations, and fundamentally challenging traditional theories on service-based economy, e.g., the assumption that the service sector is inefficient no longer holds true, it is difficult for the neoclassical price theory to explain service price formation and people’s consumption rationality has changed. Meanwhile, economic issues associated with the Internet, such as Internet economics, platform economics and information product pricing, also need to be investigated. Theoretical research and innovations also need to be carried out to investigate questions like how to protect privacy without preventing the use of data, as well as the complexities of “cultural and psychological consumption.”
service sector, Internet, resource reorganization, theoretical innovation JEL Classification Codes: L83; L86; O47
DOI: 1 0.19602/j .chinaeconomist.2018.09.01
In 2015, the service sector accounted for over 50% of the Chinese economy for the first time, opening a new chapter for service- based economy. Given the technological, economic and social transformations, traditional analytical methods like cultural change, trend extrapolation and international comparison are far from being sufficient to reveal China’s service sector trends, and many new important factors need to be incorporated into the analytical framework.
Among various new factors, the influence of the Internet is the most important. Featuring a high degree of economic and social interconnections, new-type services have emerged as mainstream services in the market with transformative effect on traditional services. In today’s world, the service sector exhibits new patterns of business model, competition, incentives and evaluative perspective. Services are increasingly embedded into agricultural and manufacturing sectors, and more broadly into every aspect of life and society. However, new problems and challenges have also emerged. Since traditional service theories cannot effectively explain realistic questions, theoretical innovation becomes urgent and important.
1. Consumption Characteristics and Service Supply in the Internet Era
In the current stage, Chinese people’s consumption demand is continuously expanded from material to non- material demand, particularly cultural and psychological demand. Such demand is greatly
unleashed by rapidly growing Internet consumption and innovations. For instance, online gaming, which is more entertaining and exciting than off-line gaming products, has enjoyed rapid development. In 2015, China’s online gaming industry exceeded 120 billion yuan in output value. Launched in 2011, China’s most popular instant messaging app WeChat had had 500 million active users by the end of 2015. Entertainment made up 53.6% of consumer spending through WeChat payments. The music market also has a similar pattern. Digital music supported by the Internet has become the mainstream market for music consumption, which far exceeds the three traditional markets of music performances, records and music books combined. See the following Table 1.
The Internet has transformed the basic nature of the service sector. According to traditional economic theories, the service sector is a low-productivity sector, as many service processes require production and consumption to take place at the same time and the same place. These service sectors include education, health care, on-site art performance and security services. In these processes, human capital is the primary factor of supply. Without using efficiency-enhancing machinery, economies of 1 scale are lacking, and labor productivity remains constant on a long-term basis.
In recent years, network- based services demonstrate three new important characteristics that transform the basic nature of services. First, significant economies of scale. This stems from the exorbitant initial cost of online services and very low marginal cost, particularly for reproducible cultural and information services. For instance, whether an online drama is watched by one viewer or a hundred million viewers, the cost of production remains the same, while the marginal cost for additional
viewers is minimal. Second, significant economies of scope. After a huge platform takes shape, it will be able to distribute various products and services and explore new products and services with its brand advantage. By logging onto a platform, consumers will have access to almost everything they want. One-stop access provides companies with opportunities to maximize their use of platform assets, reduce cost, and improve efficiency. Third, significant long-tail effect. “Long-tail effect” is a special academic term developed in the Internet era and may be classified as a type of economies of scale with distinct Internet characteristics. Long-tail effect (Anderson, 2006) means that when the cost of product and service diversification is small enough, individualized products and services in limited demand and sales volumes still manage to find their way to the market. The aggregate market share of these niche demands may even be on a par with the market share of a few products with booming sales.
2. A Highly Connected Society and Extensive Resource Reorganization
The Internet era is characterized by rapid information communication, a high degree of economic and social interconnections, and low costs of transaction and resource allocation. These fundamental changes will lead to extensive resource reorganizations and integrations.
2.1 Integrating Demand Resources: Fighting for Attention
In the Internet society, people are inundated with tremendous volumes of information, and companies compete for their attention. New business models also emerge to attract users.
(1) Free use. Internet service methods are easy to imitate, and innovative business models need to be applied rapidly on an extensive scale. Otherwise, early opportunities will be lost if the user base increases slowly. When a new service appears on the Internet platform, its basic functions can be used free of charge to gain a large user base in a short time and generate positive feedback: More users means greater attention and business opportunities that come with free services. WeChat is a typical example. At the beginning, WeChat was launched as a social networking tool for free download and use. After acquiring a large number of users, its commercial functions were developed, such as mobile payment, wealth management, gaming, map and e-commerce, thus creating an ecosystem of services. By the end of 2015, the number of active WeChat users had reached 560 million who were from over 200 countries and speak more than 20 languages. By the same time, WeChat payment users had reached about 400 million.
(2) Fans, Internet celebrities and live streamers. In fighting for attention, the key is to develop loyal consumers or fans. Fans refer to loyal followers of a celebrity, product or service (Wu and Zhang, 2014). The number of fans determines the viewing rate of a program, while the viewing rate in turn determines advertising revenues. After Yao Ming joined the NBA, a large group of Chinese fans started to follow the Houston Rockets and the NBA. As a result, the NBA’s revenues in the Chinese market increased to 1.2 billion US dollars. In addition to big data, fans also generate tremendous derived commercial value. Through data mining, Internet firms push all types of information to potential consumers, thus evolving new business systems and models.
Fighting for attention also leads to the emergence of cyber celebrities, who monetize their wellknownness by showing and marketing products to their fans or selling social networking traffic to advertisers. On May 20, 2016, Lancôme conducted an interactive photo campaign on WeChat featuring Lu Han, a popular Chinese singer and actor, which resulted in an increase in sales by 30% on the same day. While brands used to be represented by companies and commodities, the emergence of cyber celebrities means that individuals are also developing brand names that occupy the market. Cyber celebrities entertain their fans by interacting with them and sharing their lifestyles, emotions, fashions and dreams.
Fighting for attention also gives rise to a new profession: live streamers. Live streamers specialize
in fields like news, sports or entertainment. For instance, Six Rooms (6.cn) is a Chinese live streaming broadcast platform where people show their talents, knowledge and wit and interact with their fans. More than 40,000 live streamers have signed agreements with Six Rooms. On the Six Rooms live streaming platform, singers and live streamers stage performances, give speeches and answer questions from their fans and receive virtual gifts. These virtual gifts and rewards are the sources of profits for live streaming platforms and live streamers. Some influential live streamers may run advertisements in various ways.
(3) Search. As the most important and widely used Internet function, search engines help people find information at zero cost from an ocean of webpages about products and services. Search engines attract users by providing diverse sources of information with just a few clicks, and the market is dominated by a few successful search engine companies like Google and Baidu. When people want to know more about something, they tend to search it on the Internet. Search engines provide a key channel for companies to get the attention of users, thus giving rise to various business models like paid listings. The more companies pay search engine companies, the higher they are listed in the search results. Paid listings are the equivalent of advertisement auctions on TVs and in newspapers. But the listings have misguided users in some key sectors such as the pharmaceutical sector. In 2015, a Chinese young man named Wei Zexi searched on Baidu after being diagnosed with a rare type of cancer and chose to go to a hospital ranked the highest on the list of search results. After his medical treatment failed, he realized that the ranking was paid for. This case triggered public outcry against paid listings. We will discuss this issue in the following section.
(4) Information push. In an environment of information overflow, each and every consumer faces the dilemma of information filtering and selection, and personalized access to information has become a universal demand. Media organizations that precisely match the content of transmission with public attention will be able to gain market share and create value. By tracing the Internet behavior of users, online advertising agencies push individualized services to consumers, which is a business model innovation. In the era of mobile devices, “push” services combine content distribution networks with location-based services. For example, anywhere in China, one may access Dianping.com, China’s online review website, to look for the nearest restaurants or cafes.
2.2 Integrating Marketing Resources: Platform Companies
In the Internet era, large firms may operate as “platforms.” These platforms integrate mutually independent groups to form point- to- point connections at low cost and with high efficiency ( Wu and Zhang, 2012). US firms Amazon and eBay and Chinese firms Taobao and JD.com are all typical examples. Platform companies are nothing new. In fact, they even preceded many Internet services. Large supermarkets and shopping malls are all platform companies, where buyers and sellers engage in point-to-point transactions. Unlike brick-and-mortar platforms that are limited in size, Internet-based platforms can be very large and interconnected at low cost. They boast technical support of automatic matching algorithm based on the principle of decentralization and are very competitive (Rochet, Tirole, 2003).
China has a tremendous market and rapidly growing platform organizations. In 2015, more than 40,000 T-mall merchants, 30,000 brands and over six million commodities were involved in China’s Singles Day e-commerce carnival (Tang, 2015). On the Singles Day (November 11) in 2015, online netizens peaked at 45 million and 468 million express parcels were generated. Transaction volume hit 91.2 billion yuan (13.5 billion US dollars), exceeding the single-day sales volume of all consumer goods in China in 2014, or 1.57 times the sales volume of 9.1 billion US dollars on Black Friday in the US in 2014. This staggering sales performance has refreshed the world’s biggest shopping day transaction record.
From an academic view, Internet platforms have the following characteristics.
First, platform companies change the conditions for firms to generate economies of scale (Jay,
2015). Through the Internet, producers and consumers engage in direct transactions with each other, thus eliminating the multi-layer marketing systems from production to consumption in the traditional business model. This has significantly reduced the cost of transaction. Small and micro businesses, in particular, may overcome the adverse impact of being small, and provide services to consumers worldwide through extensive platforms free from geographical limitations. For example, while small companies develop mobile games for niche markets, the aggregate number of players around China and the world at large is still rather significant.
Second, platform companies asymmetrically share costs. Fees charged by platform companies to consumers and suppliers are usually asymmetrical. In most cases, the cost of platforms is entirely covered by suppliers for consumers to use free of charge and even with subsidies. This is true for most e-commerce websites. However, examples to the contrary also exist, i.e. some platform companies collect fees from consumers but provide suppliers with free access. An example is CNKI, a Chinese website that provides academic paper search and download services. Despite free upload, users have to pay a fee to download papers. Under capital market operations, investors are sometimes not sensitive to whether or not large platform companies are profit-making and can be extremely patient. While JD.com made no profits over the decade since its inception, it still managed to raise tremendous capital to maintain operations, rather than using its own profits to offset operating costs.
Third, platform companies adopt a four-party business operation model. Real-economy companies follow a two-party business model featuring supply and demand relations, where supply chain and marketing are considered part of the whole process of business operation (Koren, 2016). In comparison, Internet firms, especially search engines, mainly provide free search services, and both parties of supply and demand are not typical buyers and sellers (Wang, 2013). Because advertisements are the primary source of revenues for those companies, advertisers are considered the fourth party. All large search companies achieve an effective four-party business model consisting of the search company, free users, suppliers and advertisers.
2.3 Integrating Quality Signals: Feedback Mechanism and Big Data
For commodities with repetitive transactions on a long-term basis, price is a fundamental quality signal. In addition, there are many other quality signals, such as warranty, refund and replacement and quality inspection. But many services are one-on-one and offered on a one-time basis as a process, which contains a lot of information and makes it difficult to assess service quality. The Internet provides a myriad of new quality signals, or in other words, integrates scattered and individualized signals (David and Henry, eds, 2011). For instance, many websites have created user review, rating, credit inquiry and accountability systems to address information asymmetry, help consumers make informed choices, and provide good companies with more opportunities. Big data can provide more quality signals (Dong and Zhao, 2012). The used car market and labor market are both typical examples. Before a used car is sold, a large amount of information such as mileage, oil consumption, maintenance, traffic violations, insurance cost and claim settlement is generated. With minimal cost, buyers are able to acquire such information from a professional company to assess the car’s conditions and bid a price accordingly.
The Internet also helps consumers learn about very specialized disciplines ( Edward, 2006). Take medicine for instance. The Internet allows patients to participate in diagnosis and treatment by exchanging therapeutic methods and experiences about drug efficacy through the Internet. Launched in 2004, PatientsLikeMe is a social networking website specifically for patients. It was funded by the Robert Wood Johnson Foundation with an investment of 1.9 million US dollars and provides mutualassistance online consultations among patients. Currently, about 200,000 users have created and shared their medical records at PatientsLikeMe. Normally, they conduct self-examinations through standard questions and tests. Through this website, patients are able to find other patients with similar conditions and exchange views. Their discussions cover 1,800 diseases, and for each of those diseases, they may
learn from hundreds or thousands of other patients with similar conditions and their treatment methods and adverse drug reactions.
2.4 Integrating Production Resources: All-Inclusive Industrial Chain
In recent years, the Internet industrial chain has expanded to all manufacturing, service and information feedback processes. In a typical situation, a consumer places an order with his mobile phone, and the Internet automatically transmits the order and customized requirements to a smart factory, which will purchase raw materials and conduct design and manufacturing. In each and every stage, consumers will be informed about the process and express their suggestions. After the final product is made, it will be delivered to the consumer through the Internet, and consumer feedback will be given to the industrial chain processes. In this manner, the Internet creates a network-based manufacturing organization encompassing demand information, raw material procurement, intelligent manufacturing, IoT distribution and customer experience, which can be referred to as an all-inclusive industrial chain. Such all-inclusiveness is also manifested in the service provision process. Take healthcare services for instance. Healthcare service providers offer wearable health monitoring devices, and data is automatically analyzed. Any problems identified will be reported to consumers, who may opt for remote diagnosis or make an appointment with their physicians. Prescription issued by a physician will be automatically uploaded and delivered by the pharmaceutical company to the consumer’s home. If the condition is complex and requires long-term treatment, the patient may purchase remote monitoring services, upload his medical conditions and seek timely guidance. By reshaping the delivery of goods and services, the all-inclusive industrial chain has greatly increased resource allocation efficiency.
2.5 Integrating Fragmented Resources: The Sharing Economy
The sharing economy refers to a special type of platforms where individual and corporate consumers sell their time, services or idle funds. The Internet brings together these fragmented resources at almost zero cost to create value and maximize resource utilization efficiency (Cao and Chai, eds, 2015). The examples of Uber and Airbnb are well known to all. The sharing economy emerged in a short period of time but has developed rapidly thanks to its brand-new business model that brings additional revenues to service providers. When someone drives a car and there is an empty seat, he may accept a passenger to make money. The sharing economy also provides consumers with low-cost services, as those who share their belongings, service capabilities or idle time usually charge less. In addition, the sharing economy also saves social resources. In Beijing, there is only one person in over 80% of the cars on the road and seeking a passenger to share the ride helps reduce energy and congestion. China enjoys special advantages in developing the sharing economy: China’s mobile Internet penetration rate is among the highest in the world, and the smartphone payment function is widely used among the average Chinese citizens. China has a huge population with a tremendous domestic tourism market, short-term rental market and other sharable market. Chinese investors are enthusiastic about the sharing economy. In 2015 alone, a few sharing economy start-ups such as Tiantian Yongche (ridesharing) and Tujiawang (tujia.com) each raised funds worth over 100 million yuan. Given the significant income gaps between urban and rural areas, there is a large group of people who are willing to share their spare time, allowing shopping agent and goods delivery services to be offered at low costs.
3. Theoretical Challenges and Innovative Development 3.1 Challenges Facing Traditional Theories of Service-Based Economy
(1) The service sector is not a low-productivity sector. Cultural and psychological demands are natural demands of human beings. But the cultural and entertainment industry did not emerge until after the contemporary era. A fundamental reason is that the Internet provides diverse and low-cost forms of
entertainment, unleashing great consumer demand through supply innovation. According to traditional economics, middle- and high-income people will more often attend music concerts, watch films or theatrical performances, subscribe to books, etc., and their consumer behavior will lead to the rapid growth of cultural consumption. With the Internet, middle- and low-income consumers will have access to tremendous entertainment consumption at very low costs, and service providers have also developed a business model based on click rate to incentivize service provision.
The traditional service sector was a low-productivity sector since many service processes required face-to-face production and consumption at the same time and the same place and cannot be stored or traded over a long distance. For instance, education, healthcare services, art performances and security services all needed to be provided face- to- face and at the same time and place. Since efficiencyenhancing machines and equipment cannot be employed to increase the economies of scale, service sector productivity stagnated at a constant level over the years. However, the Internet has transformed the method of service provision as well as the nature of services ( Kevin, 2015). Many traditional service sectors have developed new business models and are able to provide services on a large scale. Long- distance education, MOOC ( massive open online course), telemedicine, videoconferencing and electronic security system enable the services that could only be provided at the same place to be provided across time, space and even countries. Overall, productivity of the service sector as a whole has improved significantly and even outpaced the level of modern manufacturing sector in some cases. For instance, online video programs and text information can be replicated numerous times at minimal cost with remarkable economies of scale and increased benefits almost without boundaries. No manufacturing product managed to achieve such remarkable efficiency gains.
As shown in the above analysis, the development of information and Internet technologies has transformed service sector productivity. From the perspective of academic research, however, it entails comprehensive and systematic data accumulation and quantitative analysis to verify the conclusion that “the service sector is not inefficient.” Interested scholars are encouraged to pursue in-depth research.
(2) Pricing of information products. According to the neoclassical price theory, product price is determined by a multitude of factors such as utility, average cost, marginal cost and the supply-demand relationship. Price will fluctuate within a certain band according to the supply-demand relationship and gradually reach the “equilibrium price,” i.e. the price when supply and demand are equal. In the Internet economy, the conditions of the traditional price theory have transformed. For instance, in traditional business activities, the average costs of products and services can be calculated through total input and total output. Yet such calculation is difficult for information services. Information services are usually associated with high fixed costs, while marginal cost is extremely low and even close to zero. Given the difficulties to estimate the average cost, marginal cost and total demand, as well as rapid market update, price volatility will be frequent, and convergence to the equilibrium point is difficult to observe. Hence, it is difficult for the traditional price theory to explain the reality of information services.
The question is how to price information products. After the 1980s, this question became a major topic of research for information and Internet economics. A common view is that the unique cost structure of information products means that the pricing method in classical economics no longer applies (King, 1983; Lamberton, 1996; Huber and Rubin, 1986). In his Economics of Network Industries, Shy (2001) clearly indicated that given the negligible marginal cost of Internet information products, it makes no sense for Internet information products to be priced on the basis of their cost and adopting differentiated pricing or selling products at low prices may yield higher profits. Afterwards, people started to investigate the pricing strategies of different types of Internet products. Studies in this field reached the following conclusions. First, the price of the final product is subject to the influence of value, cost, and market supply and demand, and Internet information products are no exception. Hence, they are subject to similar pricing factors with other products. Second, the price of Internet information product is subject to unique factors of influence, including product lifecycle, consumer preferences, sales methods,
long-tail structure, derived industry chain and differences in perceived value. Third, pricing strategies vary for different information products. While a few “pricing rules” can be followed, the pricing of each product is uncertain and related to the understandings of firms on the market, risk tolerance, long-term development strategies and marketing strategies.
(3) Trade-off between privacy protection and data use. In August 2016, the college admission information of a girl in Shandong named Xu Yuyu was leaked to a telecom fraud group, resulting in her death in anguish. This incident aroused strong public condemnations. In the big data era, people’s information gets uploaded to the Internet whether they are aware or not. Such information creates great business opportunities for companies. But even if such information is not used to make a profit, most people do not want their private information to be leaked to the public. Privacy protection thus becomes a common social concern. Personal medical information, for instance, is highly private information that patients do not want to share with others, and still less do they tolerate the use of such information by others to make a profit. Baidu sold the moderator positions of some Baidu Tieba patient mutualassistance forums such as Haemophilia Bar to pharmaceutical companies, and the latter posted disguised forms of medical and pharmaceutical advertisements in the forums. Since such information could mislead patients, the fact that Baidu profited from its online forums became a scandal. Although Baidu made a formal apology by the end of 2015 and promised not to make any profit from its online forums, its public reputation and image has suffered great damages.
As can be seen from similar cases, personal information from the Internet must be strictly protected and cannot be used without permission. This is what regulatory authorities are striving to achieve as well. In 2012, the European Union underscored the right of data owners to delete their personal data (“right to be forgotten”). This clause gives data owners the right to control their online information. When they do not want their personal data to appear on the Internet, it has to be deleted by the relevant companies or organizations. However, the “right to be forgotten” also triggered a great deal of controversy among legal experts, Internet firms, scholars and the public. The value of big data lies in the fact that data can be shared. Capturing and aggregating huge volumes of data are the foundation of big data. Big data cannot develop if data collection is prohibited. For instance, drug manufacturers need to learn about drug effectiveness through inquiries and purchase information of patients, and health authorities need to know about the incidence of a communicable disease through public online inquiries. These “data capture” activities are conducted without informing the persons whose information is acquired by others. In a nutshell, how to protect data and privacy without stifling the big data industry is a dilemma. Amid the controversies, the European Commission enacted the General Data Protection Regulation (GDPR), which sets forth the principles and regulatory methods for the protection of personal data. It includes the right of data owners (users) to delete personal data. This reflects an effort of the public and regulatory authorities to protect data privacy without preventing the use of data.
(4) Contradictions between economic and social values of “joy consumption.” In the Internet era, “joy consumption” or consumption that meets cultural and psychological needs has become an important industry. But controversies have always existed in respect of such consumption. First, people doubt whether it is worthwhile to pay to get a sense of joy. Pursuit of psychological satisfaction from luxury goods is considered “vanity” and detrimental to fostering a frugal way of life2. In many cases, people spend money to satisfy their psychological needs, which may not be rational needs. For instance, while it is easier to find jobs with higher pays for graduates of vocational schools and colleges, parents are still sending their children to formal colleges and universities. The reason is that Chinese culture puts a great premium on getting a college degree. Being able to receive a formal college education represents
a psychological need for many parents and students alike, because they believe that a formal college education will satisfy their intellectual pursuit and provide greater career potentials despite limited initial job prospects and incomes upon graduation. This paper believes that if goods and services are equally important in economic development, cultural and psychological consumption must be considered equally important with material consumption. While cars and home appliances improve people’s quality of life, online games give people a sense of joy, and higher levels of education give people a sense of psychological satisfaction. Satisfying cultural and psychological needs has become an important purpose of consumption. Cultural and psychological consumption will create value as long as consumers receive a satisfactory and joyful experience and are willing to pay for it.
However, people’s cultural and psychological needs are highly complex. In addition to the abovementioned positive and controversial needs, people like to show off their wealth, hunt for novelty, engage in conspicuous consumption and even become jealous of others. Negative psychological needs induce people to pry into others’ privacy, fabricate and disseminate rumors, and mock and vilify others. Whether people like it or not, such psychological needs exist extensively. It is common for netizens to follow people who are wealthy, powerful and celebrated. Advertisements have been intensively placed to seek attention, creating all kinds of business operations, particularly in the entertainment industry (Johnson and Christensen, eds, 2008). However, it is theoretically difficult and ethically doubtful to include such information services in economic analysis and GDP accounting. How to deal with those needs in service sector research and whether such output should be excluded from service sector statistics are controversial questions3.
This paper shows that the development of modern technology, particularly Internet technology, is transforming the nature of the service sector and posing fundamental challenges to the theory on traditional service-based economy. The theory itself requires innovation and development. In the big data era, people have access to tremendous sources of information, making it easy to carry out empirical studies such as case analysis, survey statistics and quantitative analysis. In this field, numerous studies have been carried out with different conclusions. Many large firms created in-house research institutions with their own research findings. It is by no means easy for the government to judge whether new things and business models are reasonable or not. In this sense, theoretical research must be carried out to provide assessment criteria, interpret the significance of events, identify various options, reveal public interests and shed light on future trends. These represent new requirements for theoretical research in the information era.