Why digital strategies fail PART I
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.
Why do digital strategies fail?
In our experience these are the
five common digital strategy pitfalls companies must avoid.
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.2 Think 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. This built intuition—which often
clashes with the new economic realities of digital competition.
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. The 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.
Continues in PART II
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