share of firms switching primarily to services activity is correlated with servitization in a prior period. These findings suggest that servitization could possibly pave the way for fuller structural transformation.

The paper is organized as follows. Section 2 reviews the relevant literature and evidence on servitization, Section 3 presents a simple framework for the underlying motivations, as well as the data and estimation strategy. Section 4 presents the overall and industry-level patterns in servitization. Section 5 takes a regression approach to delve deeper into the correlates of servitization. Section 6 seeks to understand the importance of servitization for innovation and structural transformation, and section 7 concludes.

# **Section 2: Servitization across the World: Some Evidence**

The term “servitization” was coined by Vandermerwe and Rada (1988) to describe the phenomenon of bundling services with manufacturing. These services could be an extension of a firm’s productive abilities or allow the manufacturer to differentiate its product from its competitors. Neely et al. (2011) study this phenomenon over the more recent years 2007, 2009 and 2011 in 23 countries. Their work suggests that on average 30 percent of manufacturing firms are servitized across the sample of 23 countries, and this average did not change much over the period they study.<sup>6</sup> This average level masks heterogeneity across countries. For example, 55 percent of firms in the United State, and 19 percent in China were servitized in 2011. In France, the share of servitized firms remained stable at 69 percent over the 10-year period 1997-2007 (Crozet and Milet, 2015), while in Sweden nearly all firms are servitized (Lodefalk 2013, 2015).

Data challenges complicate the analysis of servitization at the intensive margin. For instance, many firms do not report services revenues separately in their accounts due to differences in accounting standards. Industry-level supply-use tables suggest that selling services is still a comparatively limited phenomenon with only 5 percent of revenue in European Union (EU) manufacturing being generated from services (Figure 1). However, industry-level data on services output may not fully measure the extent to which manufacturers sell services. For example, industry-level data from 2011 suggests that services output contributes to about 11 percent output of manufacturing firms in Sweden, while firm-level analysis finds this share to have increased from 13.6 to 20.3 percent of total sales over the 1997-2006 period (Lodefalk 2013, 2015).<sup>7</sup> In France, industry-level figures in 2011 suggest a small contribution of services (2 percent), while firm-level data suggests that this share was close to 18 percent during 1997-2007 (Crozet and Milet, 2015). In the United Kingdom, Figure 1 suggests services share in total revenue to be around 7 percent, while a firm-level study finds this share to have increased from 5 percent in 1997 to slightly over 20 percent in 2007 (Breinlich et al., 2014).<sup>8</sup> In advanced countries, high-tech manufacturing seems to be leading this trend towards servitization. In France, the mechanical and electrical equipment industries are the most servitized with a service intensity of 5 percent, in contrast to food, beverages and tobacco, which have the lowest service intensity, close to 1 percent (Crozet and Milet).<sup>9</sup> In the EU, supply-use tables also suggest that the share of revenue generated from selling services is 6 percent in the more technology intensive industries compared to 3 and 4 percent in medium- and low-tech manufacturing. This can be understood in light of the Dachs et al. (2012) and

> 6 Neely et al. (2011) cover over 10,000 manufacturing firms with over 100 employees in 2007, 2009 and 2011.

> 7 Notice that a 6% increase is considered a significant increase for a country like Sweden where most services are skill-intensive and high value add services. Additionally, many of these manufacturing services are also sold in international market.

> 8 Over and above the evidence detailed below, there are related studies for Austria (Walter and Dell'mour, 2010) and Italy (Federico and Tosti, 2012).

> 9 By comparison, in Sweden Lodefalk (2013, 2015) finds that Medicines; Coke, refined petroleum, nuclear and chemicals; Rubber and plastic products are the most servitized ones while ITC equipment; Paper, pulp, publishing and printing and Basic metals; fabricated metal products are the least servitized. Some of the differences across countries could be explained by differences in definitions of servitization – for instance, in Sweden servitization includes both the use and sale of services, while in France and other countries the definition includes only sales of services.

4