Strategic Analysis

Digitization: A challenge not well understood by non-digital natives

In a previous article on disruption and servitization from a few weeks ago we noted that sometimes technology transitions shift paradigms. As Willy Shih, a professor at Harvard Business School (HBS), explained on analog to digital transitions:

“Such transitions are competency-destroying because the capabilities, tacit knowledge, and experience base of the incumbent firms are rendered irrelevant… While the firms may still possess valuable complements like brands or sales and distribution channels, such transitions are immensely challenging because of the exposure to commoditization… Digital technologies often cause barriers to entry to fall and competition to become cutthroat”.

We then asked, but did not answer, the question “where does this leave manufacturers and servitization?  As we have argued in other posts manufacturers are indeed confronted with difficult challenges in a digitizing, servitizing world. What is the value of winning to them? Which companies are more likely to succeed? And are there companies for whom the price to win is probably too high, who should, as it were, accept to irreversibly decline?”

One thing to understand at this point is that the world is not really digitizing and servitizing, but is servitizing,  because it is digitizing, at least to a large extent. The enabling of servitized business models -Everything as a Service– is a consequence, a by-product if you will, of digitization. So for manufacturers (and other service providers) to be able to figure out what they should do in this respect, it is important to get some strategic perspective on digitization itself. We’ll try to provide this in a few relevant posts before looking again at the questions posed above.

Something to note in advance: Judging by surveys as well as discussions, the intuitive management understanding and responses/strategies to digitization are usually quite wrong, mainly because economics of markets change radically through network effects and growth rates of successful disruptors are explosive and often too fast for incumbents to react to. Given that management is quite an intuitive business (“management by gut feel”), this should be quite a scary time.

  1. Digitization perceptions are not really clear, nor is what to do about it (and how)

In a Nov 2014 survey by Accenture, a management consultancy, C-suite executives were asked, among other things, about their views on digitization. A rather slight majority (52%) expected that it will change or completely transform their industry, nevertheless cited operations efficiency (69%) and customer experience (61%) as the areas of highest importance for digital investments, with most (59%) focusing more on process efficiencies and cost cutting than revenue generation.

Importance of investments in digital technologies

                                                                              Source: CEO-Briefing Competing in a Digital World. Accenture 2014

Other surveys have produced similar results and the first quick observation must be that while there is significant expectation of change or even complete transformation, the management and investment focus is primarily on operational issues.

Executives were also asked about the difficulties they faced in digitization efforts and, its transformative nature again notwithstanding, cited issues such as insufficient funding, lack of senior executive support and, in particular, insufficient customer demand.

 

Challenges implementing investments in digital business

                                                                              Source: CEO-Briefing Competing in a Digital World. Accenture 2014

These findings are rather surprising: If digitization is so important why is it that there is a perceived lack of demand for digital products (after all senior executives are buyers as much as sellers) and how does that chime with the idea that digitization will help to grow sales? Or why would there be lack of executive support and funding? There is an element of contradiction here and the range of difficulties listed, is derivative rather than independent. After all if there is insufficient demand, then top management will not support, investment funding will not be forthcoming and it will be difficult to hire expensive skill sets. So upon closer look it seems that perceived lack of demand and its causes are the key limiting factor here (In fact the issue is, is lack of demand real and if yes what are the causes? Or is lack of demand only perceived and what are the causes for that?).

Inconsistencies and contradictions are quite natural in times of major change which happens quickly and under considerable uncertainty. What is evident is that there exists a widespread feeling that digitization is something quite significant with transformative potential, but people cannot fully nail down what it really is, what the impact will be, how the transformation will happen and how the process will play out. Operational efficiencies and customer experience are low hanging fruit and seem the safest way to embark on a digitization process. But they are probably the wrong way.

Like “disruption”, digitization is a rather fuzzy concept. To different people it may mean different things. Originally it was about converting signals into digital format. One of the earliest and strongest proponents of digitization, Procter & Gamble, stated the following in the company’s 2010 annual report:

“With digitization, our goal is to standardize, automate and integrate systems and data so we can create a real-time operating and decision-making environment. We want P&G to be the most technology-enabled company in the world.”

This appears to be a definition around the objective of fulfilling executive requirements for data (evidence) based decision making in “real time”. This must cascade then throughout the organization because to achieve it requires radical transformation in the way the data are defined, captured, prepared and analyzed in itself requiring pretty wholesale corporate re-engineering. Since the change of CEOs at P&G the ambition seems to have moderated.

McKinsey & Co, a management consultancy, specifies digitization also ambitiously and more explicitly on the basis of customer requirements and what a company’s response should be.

“Customers have been spoiled. Thanks to companies such as Amazon and Apple, they now expect every organization to deliver products and services swiftly, with a seamless user experience.

Customers want to log in to their online electricity account and see a real-time report of their consumption. They expect to buy a phone from their telecommunications provider and have it activated and set up immediately out of the box. They want bank loans to be preapproved or approved in minutes. They expect all service providers to have automated access to all the data they provided earlier and not to ask the same questions over and over again. They wonder why a bank needs their salary slips as proof of income when their money is being deposited directly into the bank every month by their employer.

Many traditional organizations can’t meet these expectations. As a result, attackers born in the digital age can swoop in and disrupt the market through rapid delivery of digital products and services combined with advanced algorithms and full access to information.

Customers wouldn’t phrase it this way, but they are demanding from companies in many industries a radical overhaul of business processes. Intuitive interfaces, around-the-clock availability, real-time fulfillment, personalized treatment, global consistency, and zero errors—this is the world to which customers have become increasingly accustomed. It’s more than a superior user experience, however; when companies get it right, they can also offer more competitive prices because of lower costs, better operational controls, and less risk”. (Italics mine)

And this is what McKinsey says companies should do:

“To meet these high customer expectations, companies must accelerate the digitization of their business processes. But they should go beyond simply automating an existing process. They must reinvent the entire business process, including cutting the number of steps required, reducing the number of documents, developing automated decision making, and dealing with regulatory and fraud issues. Operating models, skills, organizational structures, and roles need to be redesigned to match the reinvented processes. Data models should be adjusted and rebuilt to enable better decision making, performance tracking, and customer insights. Digitization often requires that old wisdom be combined with new skills, for example, by training a merchandising manager to program a pricing algorithm. New roles, such as data scientist and user-experience designer, may be needed.”

The McKinsey approach therefore also advocates rapid and wholesale re-engineering and automation of virtually all business operations to fulfill perceived customer expectations, quite similar, in fact, to the Accenture survey results (possibly no coincidence). Nevertheless one thing it does not do is hark back to Willy Shih and ask whether a company’s business model or, in fact, its entire business is still relevant in a digital world and whether it is worthwhile, even rational, to undertake this effort and, if yes, how to prioritize. Because it is surely correct that over the past 20 years the internet (digitization) has disintermediated, disrupted or transformed entire industries. The disruption started at the market facing end of the value chain (it started with retailing), but now reaches deep into core production and design and the whole value chain structure and configuration. In the process many companies, business models, even entire industries became obsolete, shrank drastically or changed radically, as what once were core competencies were digitized (not necessarily automated) away.

To illustrate: In the Accenture study some participants explained or gave examples of their own digitization efforts and experience. and an executive from Hertz, a car rental company, said that it recently launched digital signage at airport locations, providing customers with the latest flight information, thus improving the customer experience and, hopefully, strengthening customer loyalty. In itself this is good. However the rationale (the point) of such activities can be questioned when the car rental industry’s business model is heavily under attack. A recent Certify sharing economy report shows “ride-sharing” (Uber, Lyft) making extraordinary gains on both taxis and car rental companies in less than two years to Q3 2015, attesting to both rapid market expansion and increased market share. In two regional US markets (San Francisco and Boston) the new business model is now dominant, while in additional four markets quarter on quarter ride-sharing growth rates top 25%. Furthermore Uber and Lyft score significantly higher in terms of customer satisfaction relative to both their competitor classes.

 

ridesharing

                                                                                             Source: Certify.com Q32015 SpendSmart report

 

Uber and Lyft are, of course, not only fully digitized, but digital native companies. The very existence of their business model was brought about by the evolution of digital technology, including mobile, connectivity, cloud and data analytics, much in the same way as Amazon’s business model was initially enabled by personal computers and the internet. As a consequence conventional car rental companies are probably facing an existential crisis and/or may be forced down the value chain as vehicle suppliers to Uber or Lyft drivers with significantly lower margins. In the meantime both Uber and Lyft are expanding into product and food deliveries.

Well known examples of digital offerings upending industries and taking down incumbents are many:

Blockbuster Inc. went from being the world’s premier video rental chain with 9,000 store locations and 60,000 employees in 2004 to bankruptcy in 2010 and subsequent closure as a result of competition from Netflix and Redbox, both companies with digitized, though different, business models. Whatsapp, an instant messaging app acquired by Facebook (for US$ 22 billion in 2014, on revenues of $ 10 million and 55 employees) and other “over-the-top” services are expected to drain telecommunication companies (themselves significantly digitized, but not native) of $ 386 billion between 2012 and 2018 from the use of OTT mobile voice calling alone. According to Dan Bieler, a Forrester analyst based in Germany: “Ultimately, telcos may be left selling flat-rate data plans. The heyday of big profits from high SMS margins is coming to a close, and there’s little reason to assume that telcos are regaining ground in the battle for closer customer relationships.”

There is increasing evidence that Airbnb is putting pressure on hotel pricing during major events in large cities in the US and other countries, when hotels earn the bulk of their profits, by significantly (and flexibly) increasing the supply of accommodation. And another startup, Liquide Space, is trying to “liquefy” or monetize (excess) office space in a somewhat similar fashion.

This implies that the central issue for companies is not (just) to change and automate processes, as necessary as that may be, but to first find out and understand whether and why the way they operate and generate value and revenue is viable in a world in which digitization enables completely different approaches and if not what, if anything, to do about it. Because it is evident that simply digitizing operational systems (with significant investment and upheaval) when the business model itself is not viable, cannot sustain margins or competencies are made irrelevant, is the wrong call (and the key question is whether the business model plays to the particular economics of digitization: “network effects” and “winner takes all markets” -more on that later however).

This is not an easy task. In a survey of over 800 executives across industries by the Global Center for Digital Business Transformation (GCDBT –  a Cisco-IMD Lausanne cooperation), respondents expected that on average 40% of today’s top 10 incumbents in any industry would be displaced within five years and the majority believed that the risk to be put out of business altogether had substantially increased. In spite of this 45% said digitization is not a board level concern and only 25% thought their organization was actively responding. A main reason for this is uncertainty about sustainability of the business model, how to respond and how to assess associated risks, costs and benefits.

Transformation is about changes in kind (not merely in degree) in consumption preferences and patterns, in allocation of resources and new products/services or production and delivery systems enabled by new technology rapidly reducing costs and expanding markets.  In short transformation is about paradigm shifts in the way things get done, cascading down the supply chain: Electricity as a power source transformed the world, so did the internal combustion engine, the microprocessor, the internet, and Google’s search engine is in the process of doing so. Arguably the Amazon.com ecosystem, Apple’s iPhone and its imitators and Uber’s mobility platform are work-in-progress transformations. Transformation therefore is characterized -much like a vortex- by rapid, quasi-chaotic attraction of demand dollars and investment resources. And digitization may be a direct trigger or an indirect catalyst and enabler.

Part 2 follows

 

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