The case for digital reinvention
Digital
technology, despite its seeming ubiquity, has only begun to penetrate
industries. As it continues its advance, the implications for revenues,
profits, and opportunities will be dramatic.
As new markets emerge, profit pools shift, and digital technologies pervade
more of everyday life, it’s easy to assume that the economy’s digitization is
already far advanced. According to our latest research, however, the forces of
digital have yet to become fully mainstream. On average, industries are less
than 40 percent digitized, despite the relatively deep penetration of these
technologies in media, retail, and high tech.
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As digitization penetrates more fully, it
will dampen revenue and profit growth for some, particularly the bottom
quartile of companies, according to our research, while the top quartile
captures disproportionate gains. Bold, tightly integrated digital strategies
will be the biggest differentiator between companies that win and companies
that don’t, and the biggest payouts will go to those that initiate digital
disruptions. Fast-followers with operational excellence and superior
organizational health won’t be far behind.
These findings emerged from a research
effort to understand the nature, extent, and top-management implications of the
progress of digitization. We tailored our efforts to examine its effects along
multiple dimensions: products and services, marketing and distribution
channels, business processes, supply chains, and new entrants at the ecosystem
level (for details, see sidebar “About the research”). We sought to understand
how economic performance will change as digitization continues its advance
along these different dimensions. What are the best-performing companies doing
in the face of rising pressure? Which approach is more important as
digitization progresses: a great strategy with average execution or an average
strategy with great execution?
The research-survey findings, taken
together, amount to a clear mandate to act decisively, whether through the
creation of new digital businesses or by reinventing the core of today’s
strategic, operational, and organizational approaches.
More
digitization—and performance pressure—ahead
According to our research, digitization
has only begun to transform many industries. Its impact on the economic
performance of companies, while already significant, is far from complete.
This finding confirms what many executives
may already suspect: by reducing economic friction, digitization enables
competition that pressures revenue and profit growth. Current levels of
digitization have already taken out, on average, up to six points of annual
revenue and 4.5 points of growth in earnings before interest and taxes (EBIT).
And there’s more pressure ahead, our research suggests, as digital penetration
deepens.
While the prospect of
declining growth rates is hardly encouraging, executives should bear in mind
that these are average declines across all industries.
Beyond the averages, we find that performance is distributed unequally, as
digital further separates the high performers from the also-rans. This finding
is consistent with a separate McKinsey research stream, which also shows
that economic performance is extremely unequal. Strongly performing industries,
according to that research, are three times more likely than others to generate
market-beating economic profit. Poorly performing companies probably won’t
thrive no matter which industry they compete in.
At the current level of digitization,
median companies, which secure three additional points of revenue and EBIT growth,
do better than average ones, presumably because the long tail of companies hit
hard by digitization pulls down the mean. But our survey results suggest that
as digital increases economic pressure, all companies, no matter what their
position on the performance curve may be, will be affected.
Uneven
returns on investment
That economic pressure will make it
increasingly critical for executives to pay careful heed to where—and not just
how—they compete and to monitor closely the return on their digital investments.
So far, the results are uneven. Some players in every industry are earning
outsized returns, while many others in the same industries are experiencing
returns below the cost of capital.
These findings suggest that some companies
are investing in the wrong places or investing too much (or too little) in the
right ones—or simply that their returns on digital investments are being
competed away or transferred to consumers. On the other hand, the fact that
high performers exist in every industry (as we’ll discuss further in a moment)
indicates that some companies are getting it right—benefiting, for example,
from cross-industry transfers, as when technology companies capture value in
the media sector.
Where
to make your digital investments
Improving the ROI of digital investments
requires precise targeting along the dimensions where digitization is
proceeding. Digital has widely expanded the number of available investment
options, and simply spreading the same amount of resources across them is a losing
proposition. In our research, we measured five separate dimensions of
digitization’s advance into industries: products and services, marketing and
distribution channels, business processes, supply chains, and new entrants
acting in ecosystems.
How fully each of these dimensions has
advanced, and the actions companies are taking in response, differ according to
the dimension in question. And there appear to be mismatches between
opportunities and investments. Those mismatches reflect advancing digitization’s
uneven effect on revenue and profit growth, because of differences among
dimensions as well as among industries. Exhibit 4 describes the rate of change
in revenue and EBIT growth that appears to be occurring as industries progress
toward full digitization. This picture, combining the data for all of the
industries we studied, reveals that today’s average level of digitization,
shown by the dotted vertical line, differs for each dimension. Products and
services are more digitized, supply chains less so.
To model the potential effects of full
digitization on economic performance, we linked the revenue and EBIT growth of
companies to a given dimension’s digitization rate, leaving everything else
equal. The results confirm that digitization’s effects depend on where you
look. Some dimensions take a bigger bite out of revenue and profit growth,
while others are digitizing faster. This makes intuitive sense. As platforms
transform industry ecosystems, for example, revenues grow—even as
platform-based competitors put pressure on profits. As companies digitize
business processes, profits increase, even though little momentum in top-line
growth accompanies them.
The biggest future impact on revenue and
EBIT growth is set to occur through the digitization of supply chains. In this
dimension, full digitization contributes two-thirds (6.8 percentage points of
10.2 percent) of the total projected hit to annual revenue growth and more than
75 percent (9.4 out of 12 percent) to annual EBIT growth.
Despite the supply chain’s potential
impact on the growth of revenues and profits, survey respondents say that their
companies aren’t yet investing heavily in this dimension. Only 2 percent, in
fact, report that supply chains are the focus of their forward-looking digital
strategies (Exhibit 5), though headlining examples such as Airbnb and Uber
demonstrate the power of tapping previously inaccessible sources of supply
(sharing rides or rooms, respectively) and bringing them to market. Similarly,
there is little investment in the
ecosystems dimension, where hyperscale businesses such as Alibaba, Amazon, Google,
and Tencent are pushing digitization most radically, often entering one
industry and leveraging platforms to create collateral damage in others.
Instead, the survey indicates that
distribution channels and marketing are the primary focus of digital strategies
(and thus investments) at 49 percent of companies. That focus is sensible,
given the extraordinary impact digitization has already had on customer
interactions and the power of digital tools to target marketing investments
precisely. By now, in fact, this critical dimension has become “table stakes”
for staying in the game. Standing pat is not an option.
The question, it seems, looking at exhibits
4 and 5 in combination, is whether companies are overlooking emerging
opportunities, such as those in supply chains, that are likely to have a major
influence on future revenues and profits. That may call for resource
reallocation. In general, companies
that strategically shift resources create more value and deliver higher returns to
shareholders. This general finding could be even
more true as digitization progresses.
On the
front foot
Our survey results also suggest companies are not
sufficiently bold in the magnitude and scope of their investments (see sidebar
“Structuring your digital reinvention”). Our research suggests that the more aggressively they
respond to the digitization of their industries—up to and including initiating
digital disruption—the better the effect on their projected revenue and profit
growth. The one exception is the ecosystem dimension: an overactive response to
new hyperscale competitors actually lowers projected growth, perhaps because
many incumbents lack the assets and capabilities necessary for platform
strategies.
As executives assess the scope of their
investments, they should ask themselves if they have taken only a few steps
forward in a given dimension—by digitizing their existing customer touchpoints,
say. Others might find that they have acted more significantly by digitizing
nearly all of their business processes and introducing new ones, where needed,
to connect suppliers and users.
To that end, it may be useful to take a
closer look at, which comprises six smaller charts. The last of them totals up
actions companies take in each dimension of digitization. Here we can see that
the most assertive players will be able to restore more than 11 percent of the
12 percent loss in projected revenue growth, as well as 7.3 percent of the 10.4
percent reduction in profit growth. Such results will require action across all
dimensions, not just one or two—a tall order for any management team, even
those at today’s digital leaders.
Looking
at the digital winners
To understand what today’s leaders are
doing, we identified the companies in our survey that achieved top-quartile
rankings in each of three measures: revenue growth, EBIT growth, and return on
digital investment.
We found that more than twice as many
leading companies closely tie their digital and corporate strategies than
don’t. What’s more, winners tend to respond to digitization by changing their
corporate strategies significantly. This makes intuitive sense: many digital
disruptions require fundamental changes to business models. Further, 49 percent
of leading companies are investing in digital more than their counterparts do,
compared with only 5 percent of the laggards, 90 percent of which invest less
than their counterparts. It’s unclear which way the causation runs, of course,
but it does appear that heavy digital investment is a differentiator.
Leading companies not only invested more
but also did so across all of the dimensions we studied. In
other words, winners exceed laggards in both the magnitude and
the scope of their digital investments. This is a critical
element of success, given the different rates at which these dimensions are
digitizing and their varying effect on economic performance.
Strengths in organizational culture
underpin these bolder actions. Winners were less likely to be hindered by
siloed mind-sets and behavior or by a fragmented view of their customers. A
strong organizational culture is important for several reasons: it enhances the
ability to perceive digital threats and opportunities, bolsters the scope of
actions companies can take in response to digitization, and supports the
coordinated execution of those actions across functions, departments, and
business units.
Bold
strategies win
So we found a mismatch between today’s
digital investments and the dimensions in which digitization is most
significantly affecting revenue and profit growth. We also confirmed that
winners invest more, and more broadly and boldly, than other companies do. Then
we tested two paths to growth as industries reach full digitization.
The first path emphasizes strategies that
change a business’s scope, including the kind of pure-play disruptions the
hyperscale businesses discussed earlier generate. As Exhibit 8 shows, a great
strategy can by itself retrieve all of the revenue growth lost, on average, to
full digitization—at least in the aggregate industry view. Combining this kind
of superior strategy with median performance in the nonstrategy dimensions of McKinsey’s digital-quotient framework—including
agile operations, organization, culture, and talent—yields total projected
growth of 4.3 percent in annual revenues. (For more about how we arrived at
these conclusions, see sidebar “About the research.”)
Most executives would fancy the kind of
ecosystem play that Alibaba, Amazon, Google, and Tencent have made on their
respective platforms. Yet many recognize that few companies can mount
disruptive strategies, at least at the ecosystem level. With that in mind, we
tested a second path to revenue growth.
Companies in this profile lack a
disruptive strategic posture but compensate by being in the top 25 percent for
all the other elements of digital maturity.2This
fast-follower profile allows more room for strategic error—you don’t have to
place your bets quite so precisely. It also increases the premium on how well
you execute. The size of the win is just slightly positive at 0.4 percent in
annual revenue growth: 5.3 percent from good (but not best-in-class disruptive)
strategy and an additional 7.1 percent through top-quartile digital maturity.
This is probably good news for incumbents, since many of them are carefully
watching tech start-ups (such as those in fintech) to identify the winning
plays and then imitating them at their own bigger scale. That approach, to be
sure, demands cutting-edge agility to excel on all the operational and
organizational aspects of digital maturity.
In the quest for coherent responses to a digitizing
world, companies must assess how far digitization has progressed along multiple
dimensions in their industries and the impact that this evolution is having—and
will have—on economic performance. And they must act on each of these
dimensions with bold, tightly integrated strategies. Only then will their
investments match the context in which they compete.
By Jacques Bughin, Laura LaBerge, and Anette Mellbye
http://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/the-case-for-digital-reinvention?cid=reinventing-eml-alt-mkq-mck-oth-1702
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