According to the McKinsey report, the second key element is embodied in a special type of investment that participants are motivated to make, known as "upgraded investment". This type of investment has two mutually reinforcing consequences. First, their returns increase with scale. These expenditures not only increase production, but also fundamentally change the way businesses produce, resulting in improved product quality, not just quantity. As a result, this type of investment not only boosts profit margins, but also rapidly expands market share, as consumers tend to choose better products. In contrast, some underlying investments, such as simply opening a new plant or branch, have less impact on the market position, as these new facilities are not fundamentally different from existing facilities.
Second, companies will be caught in an "arms race" to expand their scale by increasing investment, and then use the economies of scale to further drive investment. When one company gains more profit and market share by improving quality, other companies respond by investing more resources to improve the quality of their own products to remain competitive. The more investment each company makes, the more competition becomes, creating a self-reinforcing cycle.
Upgrade investments typically involve certain types of expenditures, such as marketing, research and development, and certain capital expenditures. These investments can enhance the capabilities of the business and help improve long-term profit margins. For example, e-commerce platforms can invest in marketing to attract more consumers and create higher platform value for merchants. As the user base grows, the cost of large-scale marketing gradually decreases relative to the potential revenue, increasing the profit margin per user. Biopharmaceutical companies often invest in new R&D methods, such as AI-based bioinformatics technologies, to improve the success and ROI of clinical trials. Once the drug is successfully marketed and begins to be sold, R&D costs are spread over sales. In addition, acquisitions can also be seen as a form of R&D investment, where a company's competitive advantage is enhanced when it acquires the target company's unique capabilities and patented assets.
Figure: 2005-2020 Increased investment by tech giants
In many cases, network effects are a significant factor in motivating companies in the industry to make such investments. Moreover, these investments are not one-time actions, but are continuous and increasing. Of course, not all capital-intensive industries exhibit this escalation dynamic. In the steel industry, for example, a new plant may increase overall profits, but primarily through capacity and sales, rather than by changing the production method itself. However, e-commerce giants like Amazon have not only expanded their scale but also improved their unique operational capabilities by optimizing their last-mile delivery services.
To illustrate this dynamic more visually, McKinsey looked at four major players in the cloud services industry between 2015 and 2020 to analyze whether the level of capital expenditures (as an indicator of upgraded investment) correlates with ultra-high market share. In 2015, Amazon AWS topped the industry with a 23% revenue market share, followed by Microsoft with 16%. In 2020, AWS's market share further grew to 37%, continuing to maintain its leading position, while Microsoft ranked second with a 21% share. The trend for these companies to continue to invest is clear: AWS and Microsoft have strengthened and at least maintained their market share by expanding their investments to differentiate themselves from their competitors.
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