SOLVING THE PRODUCTIVITY

PUZZLE: THE ROLE OF

DEMAND AND DIGITAL

JAANA REMES
June 4, 2018

CONFIDENTIAL AND PROPRIETARY

Any use of this material without specific permission of McKinsey & Company is strictly prohibited
Productivity growth has been declining since the 1960s and
today stands near historic lows
Trend line of labor productivity growth, total economy Europe1 USA

% year-over-year
WWI Great WWII Great
7 Depression Recession

0
1870 80 90 1900 10 20 30 40 50 60 70 80 90 2000 10 2020
-1
Focus of the
study
-2
1 Simple average across France, Germany, Italy, Spain, Sweden, UK.
NOTE: Productivity defined as GDP per hour worked. Calculated using Hodrick Prescott filter. Drawn from similar analysis in Martin Neil Baily and Nicholas Montalbano, “Why is productivity
growth so slow? Possible explanations and policy responses,” Brookings Institution, September 2016
SOURCE: Bergeaud, A., Cette, G. and Lecat, R. (2016): "Productivity Trends in Advanced Countries between 1890 and 2012," Review of Income and McKinsey & Company | 2
Wealth, vol. 62(3), pages 420–444.; McKinsey Global Institute analysis
We conducted six industry deep dives to shed light on the causes
behind productivity growth decline from 2000-04 to 2010-14

Auto Finance Retail

Tech Tourism Utilities

McKinsey & Company

3
We find patterns of a productivity-
weak, job-rich recovery with too few
accelerating sectors

McKinsey & Company | 4

In many countries, exceptionally low productivity growth post-recession
reflects slowing value-added growth despite faster growth in hours-worked
1985-2005 2010-2016
Compound annual growth rate, %
Labor productivity Value-added Hours-worked
-1 0 1 2 3 4 -1 0 1 2 3 4 -1 0 1 2 3 4

Germany

Sweden

United Kingdom

France

United States

Italy

Spain

Average1

NOTE: Ordering based on fastest to slowest productivity growth in the 2010-2016 period
1 Weighted average using the 2016 share of real PPP GDP.
SOURCE: The Conference Board (May 2017 release); McKinsey Global Institute analysis McKinsey & Company | 5
Shifts in aggregate productivity growth are the result of individual sectors
accelerating and decelerating; today we have too few jumping sectors
United States example Time periods with top two and bottom two number of jumping sectors

50
42
Jumping
31
sectors1;
Share of 23 23
19 19
total; Total 15 15 15 15 Ø 18
12 12
sectors = 26 8 8
4
0
1998 99 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 2014

Share of
value- 21 21 16 14 12 14 29 24 18 13 5 8 14 17 11 0 4
added2
% of total
nominal VA

(1) sector is classified as "jumping" in year Y if its compounded annual growth rate of productivity for years Y-3 through Y is at least 3 pp higher than it was
for years 1995 to 2014 as a whole.
SOURCE: EU KLEMS; BLS; McKinsey Global Institute analysis McKinsey & Company | 6
Slow productivity growth was accompanied by a decline in capital intensity growth, as
well as declining total factor productivity growth in some countries

Contribution to the decline in labor productivity growth, 2010–14 vs. 2000–04, Percentage
points1 Decreases productivity growth Increases productivity growth
2 3 4

Labor productivity
growth, 0.0 1.5 1.7 2.9 0.0 3.6 2.3
2000–04 (%)

Change in capital
1.4 -0.9 -0.7 -1.2 -0.2 -1.5 -0.5
intensity growth

Change in labor
0.3 0.2 -0.4 0.5 0.0 -0.2 -0.5
quality growth

Change in total
factor produ- -0.2 0.2 0.5 -1.2 0.8 -2.3 -1.2
ctivity growth

Change in sector
0.0 0.1 -0.1 0.0 0.0 0.2 -0.4
mix shift

2010–14 (%) 1.4 1.0 0.9 0.9 0.6 -0.2 -0.2

NOTE: Ordering of countries based on fastest to slowest productivity growth in 2010–14. Numbers may not sum due to rounding

1 Analysis based on the Solow growth accounting framework. We have also calculated the contribution from productivity growth of each sector (a “within” effect, which weights the contribution of
a sector’s labor productivity growth by its share of nominal GDP) and the impact of labor movements across sectors with different productivity levels (a “mix” effect). 2 EU KLEMS data on TFP
presents a relevant discrepancy with other data sources such as Conference Board or Penn World Tables. Hence, we take the average TFP of the three databases and calculate L quality as a
residual 3 In Italy, the period analyzed is 2010-2013 instead of 2010-2014 due to data limitations 4 Data for US is only for the private business sector.
SOURCE: EU KLEMS (2016 release); BLS Multifactor Productivity database (2016 release); McKinsey Global Institute analysis McKinsey & Company | 7
Three waves collided to drag
down productivity growth

McKinsey & Company | 8

Three waves explain these patterns and the low productivity growth of
today
Contribution to the decline in productivity growth Wave 1 Wave 2
First ICT revolution Sectors experiencing a boom/bust (finance, real estate, construction)
from 2010-14 vs 2000-04, Percentage points
Financial crisis-related hours contraction and expansion
(Average across France, Germany, Sweden ,UK Restructuring and offshoring
Excess capacity, slow demand recovery, uncertainty
and US)

2000-04 productivity growth 2.4

Wave 1: Waning of a mid-1990s

-0.8
productivity boom

Wave 2: Financial crisis aftereffects

-0.9
including weak demand and uncertainty

Residual1 -0.2

2010-14 productivity growth 0.5

Wave 3: Digital disruption ???

1 Includes impact of labor movement across sectors (‘mix effect”) and sectors not considered in our analysis. May include some of the impact from
transition costs of digital.
SOURCE: EU KLEMS (2016 release), BLS Multifactor Productivity database (2016 release), McKinsey Global Institute analysis McKinsey & Company | 9
The impact of each wave varies across countries

Percentage point contribution to the decline in productivity growth from 2010-14 vs. 2000-04
Sectors experiencing a boom / bust (finance, real estate, construction)
First ICT revolution Financial crisis-related hours contraction & expansion Other support on productivity growth
Restructuring and offshoring Excess capacity, slow demand recovery, uncertainty Other drag on productivity growth

Financial crisis
Waning of a mid-1990s aftereffects Impact of labor
productivity boom Mfg., Retail, Utilities, movement across
Manufacturing, ICT, Retail, Finance, Real estate, sectors Total change in
Utilities Construction Residual1 (“mix effect”) productivity growth

-2.0 -1.1 -0.9 0.2 -3.8

-0.4 -1.3 -0.5 -0.4 -2.5

-1.1 -0.9 0 0.01 -2.0

-0.2 -1.2 0.7 -0.1 -0.7

-0.1 -0.3 -0.1 0.1 -0.5

Average -0.8 -0.9 -0.2 -0.04 -1.9

1 Includes impact of sectors not considered in our analysis NOTE: US data includes only private business sector
SOURCE: EU KLEMS (2016 release), BLS Multifactor Productivity database (2016 release), McKinsey Global Institute analysis McKinsey & Company | 10
Retail case

McKinsey & Company | 11

Wave 1: Between 1995-2004, effective IT investments in
retail were sequenced and took a decade to mature
Enhancement of customer
experience solutions

Optimization Improve-
of core ments in store
processes presentations
tools tools

Revenue management
applications

Merchandise planning
applications

“Premium” VCS/VMS

“Simple” usage data “Complex” usage data

warehouse warehouse

Distribution and
logistics applications
Warehouse Core in-store
management operations
system solutions

Corporate Perpetual
ERP inventory
systems
“Basic”
VCS/VMS

Infrastructure systems

Move products from Deliver right product Deliver right product to right
suppliers to customer to right place at right customer at right price with
price right experience
McKinsey & Company | 12
 Wave 2: Deceleration of real sales growth and VA per unit of real sales
growth both drove the productivity growth decline (retail example)
CAGR, percent

Real sales per hour

4.4
2.1 2.3
Productivity growth
3.7
2000-04 Gap 2010-14
3.3 X
0.4 VA per unit of real sales

2000-04 Gap 2010-14

-0.7
1.2

-1.9
2000-04 Gap 2010-14

Source: BEA; BLS; Census; MGI analysis McKinsey & Company | 13

Wave 3: Online sales are more productive than offline, but they still
represent a small segment of total sales (retail example)

Productivity (Sales- COGS/employee)1 Share of online sales1

In $K % of total retail sales (excl. sales tax)
~105
3

4
~2.0x
7
~50
8

10

14
Online retail Store-based retail

This transformation also comes with lags and transition costs (e.g., initial
duplication of structures and investment, cannibalization of incumbent’s business)
1 For 2016
SOURCE: Company financials, Euromonitor McKinsey & Company | 14
Automotive case

McKinsey & Company | 15

Wave 1: The post-2000 downturn and regionalization of production led to
significant restructuring and operational changes in the automotive industry

Hours worked
Average annual growth, %

2000–04 2010–14
Spain -4.3 -1.0

United States -4.3 4.5

United Kingdom -4.1 1.5

Italy -2.1 -2.3

France -1.6 -1.7

Germany -0.5 2.8

Sweden -0.2 -0.9

SOURCE: BLS Multifactor Productivity database (2016 release); EU KLEMS (2016 release); McKinsey Global Institute analysis
McKinsey & Company | 16
Wave 2: Shift in demand composition boosted productivity growth; but
this slowed during and post the crisis (auto example)
ESTIMATES
Premium SUV Premium Car Value SUV Value Truck Value Car

Productivity per
Share of total hours worked vehicle Productivity growth from mix effect:
Percent of total hours Premium SUV = 100 Percent CAGR

High 0 3 0.5
8 6 9 9
productivity 6 12 100
5 15
5 3
3 0.4
4 81
33 0.3
34
39 42
39
42 78
40

26
29
28 25 24 75
19
22

34
28 65
21 21 22 22 19
-0.1
Low
productivity 1995 2000 04 07 10 14 2016 1995-00 2000-04 2007-10 2010-14

SOURCE: IHS Automotive, Wards Annual Yearbook 2017, McKinsey automotive profit pool McKinsey & Company | 17
McKinsey & Company | 18
Boosting productivity growth will require a
dual focus on promoting sustained demand
growth and digital diffusion

McKinsey & Company | 19

Unlocking demand growth and promoting digital diffusion may deliver annual
labor productivity growth above 2 percent
United States and Western Europe, Productivity growth potential, Percentage points

~0.8+ 2.0+

~1.2+

Digital opportunities Non-digital opportunities Productivity growth

potential (2015-2025)

NOTE: Our estimate for the productivity growth potential builds on extensive past MGI research on sector opportunities for improving productivity through
technologies that are already implemented today or have a clear path to deployment at scale by 2025. These include benefits from digitization (e.g., Big
Data, Internet of Things, automation, AI) as well as non-digital opportunities such as mix shifts in products and channels, continued consolidation, etc.

SOURCE: McKinsey Global Institute analysis McKinsey & Company | 20

While other explanations are also highly relevant, we did not find
evidence for their role in the recent slowdown
Alternative explanations

Mix shift to low

Mismeasurement productivity
sectors

Financial
Increasing
constraints and
business
rise of zombie
concentration
firms

Declining firm
Techno- dynamism and
pessimism divergence of
the frontier

SOURCE: McKinsey Global Institute analysis McKinsey & Company | 21

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