Why digital
strategies fail
Most
digital strategies don’t reflect how digital is changing economic fundamentals,
industry dynamics, or what it means to compete. Companies should watch out for
five pitfalls.
The processing power of today’s
smartphones are several thousand times greater than that of the computers that
landed a man on the moon in 1969. These devices connect the majority of the
human population, and they’re only ten years old.
In that short period, smartphones have become
intertwined with our lives in countless ways. Few of us get around without the
help of ridesharing and navigation apps such as Lyft and Waze. On vacation,
novel marine-transport apps enable us to hitch a ride from local boat owners to
reach an island. While we’re away, we can also read our email, connect with
friends back home, check to make sure we turned the heat down, make some
changes to our investment portfolio, and buy travel insurance for the return
trip. Maybe we’ll browse the Internet for personalized movie recommendations or
for help choosing a birthday gift that we forgot to buy before leaving. We also
can create and continually update a vacation photo gallery—and even make a few
old-fashioned phone calls.
Then we go back to work—where the recognition and
embrace of digital is far less complete. Our work involves advising the leaders
of large organizations. And as we look at this small device and all the digital
change and revolutionary potential within it, we feel the urge to send every CEO
we know a wake-up call. Many think that having a few digital initiatives in the
air constitutes a digital strategy—it does not. Going forward, digital strategy
needs to be a heck of a lot different from what they have today, or they’re not
going to make it.
We find that a surprisingly large number underestimate
the increasing momentum of digitization, the behavioral changes and technology
driving it, and, perhaps most of all, the scale of
the disruption bearing down on them. Many companies
are still locked into strategy-development processes that churn along on annual
cycles. Only 8 percent of companies we surveyed recently said their current
business model would remain economically viable if their
industry keeps digitizing at its current course and speed.
How can this be, at a moment when virtually every
company in the world is worried about its digital future? In other words, why are
so many digital strategies failing? The answer has to do with the magnitude of
the disruptive
economic force digital has become and its
incompatibility with traditional economic, strategic, and operating models.
This article unpacks five issues that, in our experience, are particularly
problematic. We hope they will awaken a sense of urgency and point toward how
to do better.
Pitfall 1: Fuzzy
definitions
When we talk with leaders about what they mean by
digital, some view it as the upgraded term for what their IT function does.
Others focus on digital marketing or sales. But very few have a broad, holistic
view of what digital really means. We view digital as the nearly instant, free,
and flawless ability to connect people, devices, and physical objects anywhere.
By 2025, some 20 billion devices will be connected, nearly three times the
world population. Over the past two years, such devices have churned out 90 percent
of the data ever produced. Mining this data greatly enhances the power of
analytics, which leads directly to dramatically higher levels of
automation—both of processes and, ultimately, of decisions. All this gives
birth to brand-new business models.2Think
about the opportunities that telematics have created for the insurance
industry. Connected cars collect real-time information about a customer’s
driving behavior. The data allow insurers to price the risk associated with a
driver automatically and more accurately, creating an opportunity to offer
direct, pay-as-you-go coverage and bypassing today’s agents.
Lacking a clear definition of digital, companies
struggle to connect digital strategy to their business, leaving them
adrift in the fast-churning waters of digital adoption and change.
What’s happened with the smartphone over the past ten years should haunt
you—and no industry will be immune.
Pitfall 2:
Misunderstanding the economics of digital
Many of us learned a set of core economic principles
years ago and saw the power of their application early and often in our
careers. (For more on the changing economics of digital competition, see the
infographic below.) This built intuition—which often clashes with the new
economic realities of digital competition. Consider these three:
Digital
is destroying economic rent
One of the first concepts we learned in microeconomics
was economic rent—profit earned in excess of a company’s cost of capital.
Digital is confounding the best-laid plans to capture surplus by creating—on
average—more value for customers than for firms. This is big and scary news for
companies and industries hoping to convert digital forces into economic
advantage. Instead, they find digital unbundling profitable product and service
offerings, freeing customers to buy only what they need. Digital also renders
distribution intermediaries obsolete (how healthy is your nearest big-box
store?), with limitless choice and price transparency. And digital offerings
can be reproduced almost freely, instantly, and perfectly, shifting value to
hyperscale players while driving marginal costs to zero and compressing prices.
Competition of this nature already has siphoned off 40
percent of incumbents’ revenue growth and 25 percent of their growth in
earnings before interest and taxes (EBIT), as they cut prices to defend what
they still have or redouble their innovation investment in a scramble to catch
up. “In-the-moment” metrics, meanwhile, can be a mirage: a company that tracks
and maintains its performance relative to its usual competitors seems to be
keeping pace, even as overall economic performance deteriorates.
There are myriad examples where these dynamics have
already played out. In the travel industry, airlines and other providers once
paid travel agents to source customers. That all changed with the Internet, and
consumers now get the same free services that they once received from travel
agents anytime, anyplace, at the swipe of a finger—not to mention
recommendations for hotels and destinations that bubble up from the “crowd”
rather than experts. In enterprise hardware, companies once maintained servers,
storage, application services, and databases at physical data centers. Cloud
service offerings from Amazon, Google, and Microsoft, among others, have made
it possible to forgo those capital investments. Corporate buyers, especially
smaller ones, won because the scale economies enjoyed by these giants in the
cloud mean that the all-in costs of buying storage and computing power from
them can be less than those incurred running a data center. Some hardware
makers lost.
The lesson from these cases: Customers were the biggest
winners, and the companies that captured the value that was left were often
from a completely different sector than the one where the original value pool
had resided. So executives need to learn quickly how to compete, create value
for customers, and keep some for themselves in a world of shrinking profit
pools.
Digital
is driving winner-takes-all economics
Just as sobering as the shift of profit pools to
customers is the fact that when scale and network effects dominate markets,
economic value rises to the top. It’s no longer distributed across the usual
(large) number of participants. (Think about how Amazon’s market capitalization
towers above that of other retailers, or how the iPhone regularly captures over
90 percent of smartphone industry profits.) This means that a company whose
strategic goal is to maintain share relative to peers could be doomed—unless
the company is already the market leader.
A range of McKinsey research shows how these dynamics
are playing out. At the highest level, our colleagues’ research on economic
profit distribution highlights the existence of a power curve that has been
getting steeper over the past decade or so and is characterized by big winners
and losers at the top and bottom, respectively (see “Strategy to beat the
odds,” forthcoming on McKinsey.com). Our research on digital revenue growth,
meanwhile, shows it turning sharply negative for the bottom three quartiles of
companies, while increasing for the top quartile. The negative effects of
digital competition on a company’s growth in earnings before interest, taxes,
depreciation, and amortization (EBITDA), meanwhile, are twice as large for the
bottom three-quarters of companies as for those at the top.
A small number of winners—often in high tech and
media—are actually doing better in the digital era than they were before. They
marshal huge volumes of customer data drawn from their scale and network
advantages. That triggers a virtuous cycle in which information helps identify
looming threats and the best partners in defending value chains under digital
pressure. In this environment, incumbents often find themselves snared in some
common traps. They assume market share will remain stable, that profitable
niches will remain defendable, and that it’s possible to maintain leadership by
outgrowing traditional rivals rather than zeroing in on the digital models that
are winning share.
This phenomenon of major industry shakeouts isn’t new,
of course. Well before digital, we saw industry disruptions in automobiles, PC
manufacturing, tires, televisions, and penicillin. The number of producers
typically peaked, and then fell by 70 to 97 percent.3The
issue now is that digital is causing such disruptions to happen faster and more
frequently.
Digital
rewards first movers and some superfast followers
In the past, when companies witnessed rising levels of
uncertainty and volatility in their industry, a perfectly rational strategic
response was to observe for a little while, letting others incur the costs of
experimentation and then moving as the dust settled. Such an approach
represented a bet on the company’s ability to “outexecute” competitors. In
digital scrums, though, it is first movers and very fast
followers that gain a huge advantage over their competitors. We found that the
three-year revenue growth (of over 12 percent) for the fleetest was nearly
twice that of companies playing it safe with average reactions to digital
competition.
Why is that? First movers and the fastest followers
develop a learning advantage. They relentlessly test and learn, launch early
prototypes, and refine results in real time—cutting down the development time
in some sectors from several months to a few days. They also scale up platforms
and generate information networks powered by artificial intelligence at a pace
that far outstrips the capabilities of lower-pulsed organizations. As a result,
they are often pushing ahead on version 3.0 or 4.0 offerings before followers
have launched their “me too” version 1.0 models. Early movers embed information
across their business model, particularly in information-intensive functions
such as R&D, marketing and sales, and internal operations. They benefit,
too, from word of mouth from early adopters. In short, first movers gain an
advantage because they can skate to where the puck is headed.
How Tesla captured first-mover value in electric
vehicles offers a lesson in the discomfiting effects of a wait-and-see posture.
Four years ago, incumbent automakers could have purchased Tesla for about $4
billion. No one made the move, and Tesla sped ahead. Since then, companies have
poured money into their own electric-vehicle efforts in a dash to compete with
Tesla’s lead in key dimensions. Over the past two years alone, competitors have
spent more than $20 billion on sensor technologies and R&D.
Pitfall 3:
Overlooking ecosystems
Understanding the new economic rules will move you
ahead, but only so far. Digital means that strategies developed solely in the
context of a company’s industry are likely to face severe challenges.
Traditional approaches such as tracking rivals’ moves closely and using that
knowledge to fine-tune overall direction or optimize value chains are
increasingly perilous.
Industries
will soon be ecosystems
Platforms that allow digital players to move easily
across industry and sector borders are destroying the traditional model with
its familiar lines of sight. Grocery stores in the United States, for example,
now need to aim their strategies toward the moves of Amazon’s platform, not
just the chain down the street, thanks to the Whole Foods acquisition. Apple
Pay and other platform-cum-banks are entering the competitive set of financial
institutions. In China, Tencent and Alibaba are expanding their ecosystems. They
are now platform enterprises that link traditional and digital companies (and
their suppliers) in the insurance, healthcare, real-estate, and other
industries. A big benefit: they can also aggregate millions of customers across
these industries.
How
ecosystems enable improbable combinations of attributes
Can you imagine a competitor that offers the largest
level of inventory, fastest delivery time, greatest customer experience, and
lower cost, all at once? If you think back to your MBA strategy class, the
answer would probably be no. In the textbook case, the choice was between
costlier products with high-quality service and higher inventory levels or
cheaper products with lower service levels and thinner inventories. Digital-platform
and -ecosystem economics upend the fundamentals of supply and demand.
In this terrain, the best companies have the scale to reach a nearly limitless
customer base, use artificial intelligence and other tools to engineer
exquisite levels of service, and benefit from often frictionless supply lines.
Improbable business models become a reality. Facebook is now a major media
player while (until recently) producing no content. Uber and Airbnb sell global
mobility and lodging without owning cars or hotels.
This will all accelerate. Our research shows that an
emerging set of digital ecosystems could account for more than $60 trillion in
revenues by 2025, or more than 30 percent of global corporate revenues. In a
world of ecosystems, as industry boundaries blur, strategy needs a much broader
frame of reference. CEOs need a wider lens when assessing would-be
competitors—or partners. Indeed, in an ecosystem environment, today’s
competitor may turn out to be a partner or “frenemy.” Failure to grasp this
means that you will miss opportunities and underplay threats.
While it’s true that not all businesses are able to
operate in nearly frictionless digital form, platforms are fast rewiring even
physical markets, thus redefining how traditional companies need to respond.
Look around and you will see the new digital structures collapsing industry
barriers, opening avenues for cross-functional products and services, and
mashing up previously segregated markets and value pools. With vast scale from
placing customers at the center of their digital activity, ecosystem leaders
have captured value that was difficult to imagine a decade ago. Seven of the
top 12 largest companies by market capitalization—Alibaba, Alphabet (Google),
Amazon, Apple, Facebook, Microsoft, and Tencent—are ecosystem players. What’s
not encouraging is how far incumbents need to travel: our research shows
that only 3 percent
of them have adopted an offensive platform strategy.
Pitfall 4:
Overindexing on the ‘usual suspects’
Most companies worry about the threats posed by digital
natives, whose moves get most of the attention—and the disruptive nature of
their innovative business models certainly merits some anxiety. Excessive focus
on the usual suspects is perilous, though, because incumbents, too, are
digitizing and shaking up competitive dynamics. And the consumer orientation of
many digital leaders makes it easy to overlook the growing importance of
digital in business-to-business (B2B) markets.
Digitizing
incumbents are very dangerous
Incumbents are quite capable of self-cannibalizing and
disrupting the status quo. In many industries, especially regulated ones such
as banking or insurance, once an incumbent (really) gets going, that’s when the
wheels come off. After all, incumbents control the lion’s share of most markets
at the outset and have brand recognition across a large customer base. When
they begin moving with an offensive, innovative strategy, they tip the balance.
Digitization goes from being an incremental affair to a headlong rush as
incumbents disrupt multiple reaches of the value chain. Digital natives
generally zero in on one segment.
Our research confirms this. Incumbents moving boldly
command a 20 percent share, on average, of digitizing markets. That compares
with only 5 percent for digital natives on the prowl. Using another measure, we
found that revved-up incumbents
create as much risk to the revenues of traditional players as digital attackers
do. And it’s often incumbents’ moves that push an industry
to the tipping point. That’s when the ranks of slow movers get exposed to
life-threatening competition.
The
B2B opportunity
The importance of B2B digitization, and its competitive
implications, is easy to overlook because the digital shifts under way are less
immediately obvious than those in B2C sectors and value chains. However, B2B
companies can be just as disruptive. In the industries we studied, more B2B
companies had digitized their core offerings and operations over the past three
years than had B2C players. Digitizing B2B players are lowering costs and
improving the reach and quality of their offerings. The Internet of Things,
combined with advanced analytics, enables leading-edge manufacturers to predict
the maintenance needs of capital goods, extending their life and creating a new
runway for industrial productivity. Robotic process automation (RPA) has
quietly digitized 50 to 80 percent of back-office operations in some
industries. Artificial intelligence and augmented reality are beginning to
raise manufacturing yields and quality. Meanwhile, blockchain’s digitized
verification of transactions promises to revolutionize complex and
paper-intensive processes, with successful applications already cropping up in
smart grids and financial trading. Should the opportunities associated with
shifts like these be inspirational for incumbents? Threatening? The answer is
both.
Pitfall 5: Missing
the duality of digital
The most common response to digital threats we encounter
is the following: “If I’m going to be disrupted, then I need to create
something completely new.” Understandably, that becomes the driving impetus for
strategy. Yet for most companies, the pace of disruption is uneven, and they
can’t just walk away from existing businesses. They need to digitize their
current businesses and innovate new models.
Think of a basic two-by-two matrix such as the exhibit
below, which shows the magnitude and pace of digital disruption. Where
incumbents fall in the matrix determines how they calibrate their dual
response. For those facing massive and rapid disruption, bold moves across the
board are imperative to stay alive. Retail and media industries find themselves
in this quadrant. Others are experiencing variations in the speed and scale of
disruption; to respond to the ebbs and flows, those companies need to develop a
better field of vision for threats and a capacity for more agile action. Keep
in mind that transforming
the core leads to much lower costs and greater customer
satisfaction for existing products and services (for example, when digitization
shrinks mortgage approvals from weeks to days), thus magnifying the impact of
incumbents’ strategic advantages in people, brand, and existing customers and
their scale over attackers.
Beyond this dual mission, companies face another set of
choices that seems binary at first. As we have indicated, the competitive cost
of moving too slowly puts a high priority on setting an aggressive digital
agenda. Yet senior leaders tell us that their ability to execute their
strategy—amid a welter of
cultural cross-currents—is what they worry about most. So
they struggle over where to place their energies—placing game-changing bets or
remaking the place. The fact is that strategy and execution can no longer be
tackled separately or compartmentalized. The pressures of digital mean that you
need to adapt both simultaneously and iteratively to succeed.
Needless to say, the organizational implications are
profound. Start with people. Our colleagues
estimate that half the tasks performed by today’s full-time
workforce may ultimately become obsolete as digital competition intensifies.
New skills in analytics, design, and technology must be acquired to step up the
speed and scale of change. Also needed are new roles such as a more diverse set
of digital product owners and agile-implementation guides. And a central
organizational question remains: whether to separate efforts to digitize core
operations from the perhaps more creative realm of digital innovation.
While the details of getting this balance right will
vary by company, two broad principles apply:
·
Bold aspiration. The
first-mover and winner-takes-all dynamics we described earlier demand big
investments in where to play and often major changes to business models. Our
latest research shows that the boldest companies, those we call digital
reinventors, play well beyond the margins. They invest at much higher
levels in technology, are more likely to make digitally related acquisitions,
and are much more aggressive at investing in business-model innovation. This
inspired boldness also turns out to be a big performance differentiator.
·
Highly adaptive. Opportunities
to move boldly often arise as a result of changing circumstances and require a
willingness to pivot. The watchwords are failing fast and often and innovating
even faster—in other words, learning from mistakes. Together they allow a
nuanced sensing of market direction, rapid reaction, and a more unified
approach to implementation. Adaptive players flesh out initial ideas through
pilots. Minimum viable products trump overly polished, theoretical business
cases. Many companies, however, have trouble freeing themselves from the
mind-sets that take root in operational silos. This hinders risk taking and
makes bold action difficult. It also diminishes the vital contextual awareness
needed to gauge how close a market is to a competitive break point and what the
disruption will mean to core businesses.
As digital disruption accelerates, we often hear a sense
of urgency among executives—but it rarely reaches the level of specificity
needed to address the disconnects we’ve described in the five aforementioned
pitfalls. Leaders are far more likely to describe initiatives—“taking our
business to the cloud” or “leveraging the Internet of Things”—than they are to face
the new realities of digital competition head-on: “I need to develop a strategy
to become number one, and I need to get there very quickly by creating enormous
value to customers, redefining my role in an ecosystem, and offering new
business-value propositions while driving significant improvement in my
existing business.”
Such recognition of the challenge is a first step for
leaders. The next one is to develop a digital strategy that responds. While
that’s a topic for a separate article, we hope it’s clear, from our description
of the reasons many digital strategies are struggling today, that the pillars
of strategy (where and how to compete) remain the cornerstones in the digital
era. Clearly, though, that’s just the starting point, so we will leave you with
four elements that could help frame the strategy effort you will need to
address the hard truths we have laid out here.
First there’s the who. The breadth of
digital means that strategy exercises today need to involve the entire
management team, not just the head of strategy. The pace of change requires
new, hard thinking on when to set direction. Annual strategy
reviews need to be compressed to a quarterly time frame, with real-time
refinements and sprints to respond to triggering events. Ever more complex
competitive, customer, and stakeholder environments mean that the what of
strategy needs updating to include role playing, scenario-planning exercises,
and war games. Traditional frameworks such as Porter’s Five Forces will no
longer suffice. Finally, the importance of strategic agility means that, now
more than ever, the “soft stuff” will determine the how of
strategy. This will enable the organization to sense strategic opportunities in
real time and to be prepared to pivot as it tests, learns, and adapts.
By Jacques Bughin, Tanguy Catlin, Martin Hirt, and Paul Willmott McKinsey Quarterly January 2018
https://www.mckinsey.com/business-functions/digital-mckinsey/our-insights/why-digital-strategies-fail?cid=other-eml-alt-mkq-mck-oth-1801&hlkid=febfc56fabd543da93a4ef0cf3beb341&hctky=1627601&hdpid=e70307fb-9793-4b95-940b-39c37a611815
No comments:
Post a Comment