The rise of Digital Challengers

How digitization can become the new growth engine for Latvia and Central and Eastern Europe (CEE) Production Productivity Labor Capital (GDP) ALβ Kα

Productivity GDP per hour Unemployment, Hours worked per Capital stock Capital expenditures Latvia, worked, 2017, EUR 1 2017, % year per employee, per employee, for fixed assets, 2017 EUR mln 2, 2016 average growth similarly to in %, 2012-16 other CEE markets, Northern EU Digital 646.1 1573 23 1.1 cannot count Frontrunners 3 on traditional growth levers any more and should look for Latvia 28 8.7 1875 4 -1.7 the next growth engine Productivity lags behind Latvia has limited work capacity reserves – Economy in Latvia is under-capitalized Europe a declining unemployment rate, with working and the gap is growing hours above EU average

1 EUR current prices and purchasing power parities in current prices 2 Net assets per employee, at prices of 2010 3 Belgium, Denmark, Estonia, Finland, the Netherlands, Ireland, Luxembourg, Norway, Sweden SOURCE: Eurostat; OECD McKinsey & Company 2 Digital CEE Digital Frontrunners – Latvia Challengers EU Big 5 2 Sweden example

Share of digital economy 1 6.5 6.5 6.9 9.0 An acceleration is % GDP, 2016 needed for Latvia to catch up to Growth of digital Europe’s Digital economy 4.6 6.2 3.1 9.9 Frontrunners %, 2012-16

Growth of non-digital economy %, 2012-16 2.2 2.6 1.2 2.2

1 Digital economy is calculated as sum of sectors: ICT, e-commerce and consumer spending on digital equipment (e.g., computers, smartphones, smartwatches) 2 Spain, France, Germany, UK, Italy SOURCE: Eurostat; Local institutes of statistics; McKinsey Global Institute McKinsey & Company 3 2025

Digital economy growth potential for the CEE Digital Challengers & Latvia in the aspirational scenario EUR bn 276 The digital 16% GDP +1 percentage point of GDP economy in growth each year 2025 can bring up to 200 billion 2016 +200 EUR in GDP in CEE and 4.9 CEE Digital 76 Challengers 6.5 6% GDP billion in Latvia, 18% GDP +1.4 percentage point of GDP adding up to growth each year 1.4 p.p. to GDP +4.9 growth per year Latvia 1.6 Capturing digitization potential in business and public sector 1 6.5% GDP Acceleration of e-commerce

1 Productivity growth captured by increase of traditional ICT usage (software, hardware, telecommunications) to the level of Sweden – representation of Digital Frontrunners

SOURCE: Eurostat; Local statistical offices; IHS; McKinsey Global Institute McKinsey & Company 4 Latvia Digital Challengers Sweden as a digital frontrunner benchmark

Digitization level of selected sectors Low: <~3% Averagei 1: 3-10% High: >10%

Finance and insurance Latvia’s digital potential Manufacturing can be achieved Professional and by addressing business services gaps in the Energy, digitization Utilities level of private Wholesale trade and public and retail trade sectors Transportation and warehousing

Government and other services

1 Average level of all sectors (excluding the most advanced ICT sector and finance)

SOURCE: Eurostat; Local institutes of statistics, McKinsey Global Institute McKinsey & Company 5 Good overall quality of the primary and secondary education systems (mathematics, reading and science literacy PISA 1 average of 487, close to Digital Frontrunners’ score of 505)

Well educated workforce entering the job market 4.8% of all graduates are ICT graduates, higher than Digital Frontrunners benchmarks Four strengths supporting Latvia’s Digital Challenger Well developed digital infrastructure status Approx. 98% of the population with 4G access, above the level of Germany and France

A favorable structure of economic growth – Based on the competitiveness of work, openness to the development of new sectors and the implementation of ambitious goals in the area of digitization

1 Program for International Student Assessment (PISA)

SOURCE: Eurostat, OECD McKinsey & Company 6 Gap to Digital Frontrunners

Scores in Math, Reading, Science Literacy & English Proficiency, PISA (OECD) Synthetic scores, 2016

482 477 505 Math -4.6% 505

Overall primary and secondary 488 507 education quality 473 -3.7% 507 gap between Latvia Reading and digital frontrunner countries is very small 490 506 477 -3.2% 506 Science

Avg. Digital Challengers Avg. Digital Frontrunners

1 Digital Frontrunners: Belgium, Denmark, Estonia, Finland, Holland, Ireland, Norway, Luxemburg, Sweden

SOURCE: OECD, PISA, World Bank McKinsey & Company 7 Information and Communication technology graduates, % of all graduates

4.8 4.5

3.9 3.6 3.7 3.6

3.0 Latvia has a relatively very high share of ICT graduates as part of 1.0 its student population Digital Digital Frontrunners Challengers Average 1 Average

Number of STEM graduates 164 244 296 303 143 226 215 221 per 100.000 inhabitants, 2016

1 Digital Frontrunners: Belgium, Denmark, Estonia, Finland, Holland (data for 2015 assumed), Ireland, Norway, Luxemburg, Sweden

SOURCE: Eurostat, Unesco Institute for Statistics McKinsey & Company 8 Gap to Digital Frontrunners Percentage of populated areas coverage by 4G – measured as the average coverage of telecom , % of the country -0.3% 98 87 98

In addition to fixed Household covered by the standard fixed broadband (availability) and mobile internet % of the households -5.10% coverage in Latvia 93 94 98 being on a par with Digital Frontrunners, the Share of ultra fast broadband subscriptions >= 100Mbps country exhibits % of the households one of the highest 35 +34.49% 26 shares of ultrafast 20 broadband subscriptions in Price index of broadband price Europe (synthetic score) 87 83 87 +0.3%

Avg. Digital Challengers Avg. Digital Frontrunners

SOURCE: DESI 2018, World Economic Forum McKinsey & Company 9 Development of digital and soft skills among the general population

Additional work needs to be done The adoption of digital tools in public and private sectors in three major areas

Support innovation and entrepreneurship developments and further ease of running a digital business

McKinsey & Company 10 1 Citizens with advanced digital skills by age groups, North EU 2 Latvia vs. Northern Europe 2 Latvia %

100

Across all age 80 groups in Latvia, 12% the percentage of 60 people with 24% advanced digital 40 skills is below 47% Northern European 53% 20 benchmarks 50%

0 16-24 25-34 34-44 45-54 55-64

1 Advanced digital skills - analysis and data collection using digital tools, the use of online tools such as banking or e-commerce, use of online communication 2 Belgium, Denmark, Estonia, Finland, the Netherlands, Ireland, Luxembourg, Norway, Sweden SOURCE: Eurostat, McKinsey & Company analysis McKinsey & Company 11 Selected digital tools S SME L Large Corporates % of enterprises using the tool, 2016

Cloud Paying to The private Using CRM computing Selling advertise sector in Latvia is systems services online online less advanced in L 50 32 20 35 the use of digital Latvia tools than the S 16 8 11 23 countries of L 48 31 31 34 Northern Europe; Avg. Digital Challengers SMEs do not fully S 20 13 14 24 use the potential L 67 63 43 43 of digitization Digital Frontrunners S 36 35 21 32

1 Belgium, Denmark, Estonia, Finland, Netherlands, Ireland, Luxembourg, Norway, Sweden

SOURCE: Eurostat McKinsey & Company 12 Public sector Private sector

Build skillset for the future by developing a Actively adopt technology and innovation 1 wide-ranging reskilling strategy, updating youth 6 (e.g., adapt your business model to meet the education for the future and actively demands of the digital economy) counteracting brain drain Embrace a pro-digital organizational Support technology adoption in the public 7 culture 2 sector (e.g., speeding up the development of 10 online public services and its adoption) recommendations 8 Invest in human capital (e.g., prepare your to digitize talent strategy for the digital economy) Support technology adoption among 3 businesses (e.g., promote digitization benefits Latvia and digital transformation)

Strengthen regional cross-border digital Individuals 4 collaboration ( e.g., create a strong digital pillar within regional collaboration platforms)

Improve startup eco-system through e.g., Prepare for the digital economy – invest in 5 improving entrepreneurial talent pool and 9 life-long learning increasing access to capital) Take advantage of digital tools in all 10 aspects of your life

McKinsey & Company 13 Digital economy annual growth in Sweden – Digital 10% Challengers countries and Latvia may aspire to such a growth dynamic in the future

Faster growth of the Digital Additional GDP potential can be Economy compared to the The digital 5 achieved by digital economy in 2x bn Non-Digital economy opportunity euro Latvia by 2025 in Latvia – summary

Adoption of digital tools in public and private sectors and development of digital skills among the general population are essential to fully realize the potential of the digital economy in Latvia

McKinsey & Company 14 Available at: Digitalchallengers.mckinsey.com Thank you