Why digitalisation fails and how to avoid it

Digitalization is a controversial topic. It evokes strong emotions ranging anywhere between fear and euphoria across global boardrooms. It is an evolutionary event that will leave both corporate extinction and survival in its wake. What side will you be on?

Digitalization is a subject that has now evolved far beyond the realm of the mechanical and ITC. Just as with the telephone in the early 20th century, it is stretching our understanding of how we live and work to the limit.  

I came across a really interesting article by McKinsey, titled “Why digital strategies fail". I wanted to share it with you because - as is often the case with this publisher - the piece is delicious food for thought and a great template for discussion. It's helpful to see it all lined up and written by people who are well known for their in-depth research capabilities.

The piece is quite the long read so, if you're pressed for time, I wrote up an executive summary for you:

Executive summary

I've highlighted the points that stood out to me most and that I believe are or should be the subject of strategic conversations in the finest boardrooms about digitalization and what it means for the future of their businesses.

It's hard to ignore that our world has already been altered by this new digital order. Think about how your smartphone increasingly runs your life and how it prompts your behavior.  However, despite the fact that these devices have only been around for just over a decade, it is quite surprising that many businesses still underestimate the potential of the access they provide for both sides. 

Another thing that stood out to me in the report is that while the cadence of evolution just keeps on accelerating, most businesses are still locked into strategy development processes that churn along on annual cycles.

In fact, according to McKinsey's study, only 8% of companies in the survey recently said that their current business model would remain economically viable if their industry keeps digitizing at its current course and speed!

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In other words, most businesses know that they need to reinvent the way they run their businesses, but there’s an alarmingly low level of concern or urgency, despite the fact it isn't the first time this is happening: only 12% of the Fortune 500 companies have survived since 1955 thanks to the creative destruction that fuels prosperity

The article outlines 5 pitfalls that typically stand in the way of digitalization:  

Pitfall #1: Fuzzy definitions

Mackenzie reveals that when they talk with leaders about what they mean by ‘digitalization’, many still think it's all about an upgrade of IT systems and infrastructure. What is lacking is a more broad view of what digital really implies. It's about looking beyond the mechanics towards the more holistic impact digital has on the way we live and work. 

Then again, I guess what truly defines innovation is the willingness to explore the paths that lead out of difficult and challenging questions rather than obsessing about coming up with answers that feel more comfortable.

The article brings up an interesting example of the insurance industry where it will soon - if not already -  be entirely possible to directly connect to real-time information from automobiles and understand an individual's driving behavior. This data would allow insurance to price the risk associated with each driver automatically and more accurately. This could redefine the way insurance is sold. It might well result in a pay as you go coverage and eliminate many of today's intermediaries.

Pitfall #2: Misunderstanding the economics of digitalization

The focus here is on how digital is destroying economic rent, a traditional microeconomic concept that measures profit earned in excess of a company's cost of capital.

The point is that while before businesses would have an easier time predicting what the profitability would be of a certain product or service, today they are faced with an ongoing rebellion within existing earnings models. 

One of these major changes is an increasing shift towards digital unbundling which means that customers increasingly want to access only what they need when they need it. 

The main point of discussion around this pitfall is that executives need to learn quickly how to compete by creating value for nimble customers and keep some of it for themselves in a world with shrinking profit pool.

Digital is also driving us towards a winner takes all economy. Mckinsey suggests that there's a trend in place in which large incumbents that are ready to move and adapt to this new reality will only continue to get bigger. It also means that a company whose strategic goal is to maintain share relative to peers could be doomed unless that company is already the market leader.  So, unless you create your own different niche, the business will just gravitate towards the incumbent industry leaders. 

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My own takeaway from this argument is that, as a market challenger, it matters more than ever to understand very well exactly who your customer is and the importance of making a choice and a commitment to who exactly you want to do business with. This is obviously a very uncomfortable place for many companies who are used to try to create messages that appeal to all.

McKinsey's research shows that things are turning sharply negative for the bottom three-quarters of companies while there is a notable increase in market share and profitability in the top quartile.  Not surprisingly, the research reveals that in digital scrums, the first movers and very fast followers gain a huge advantage over their competitors.  

One of the main reasons why this is happening is due to the fact that first movers and the fastest followers develop a learning advantage because they get to relentlessly test and learn from deploying early prototypes into segments of the market and then refine those results in real time.

To illustrate this idea, they use Tesla as an example of being a first mover in the electric vehicle industry. It once again offers a lesson in the cost of a wait-and-see posture because only four years ago, incumbent automakers could have bought Tesla for about $4 billion.  While nobody made that move, Tesla just sped ahead to redefine the electrical vehicles space. Since then, all the capital that companies poured into their own electric vehicle efforts over the past two years alone adds up to around US$ 20 billion on sensor technologies and research and development alone. 

Pitfall #3: Overlooking ecosystems,

There's obviously a need to understand new economic rules.  When you do so it will help you move ahead but only to a certain extent because digital means that strategies developed solely in the context of a company's industry are going to face severe challenges because a focus on keeping up with rivals is going to be increasingly perilous as a business strategy.

While it's already in full swing, industries will become entire ecosystems. We've seen how the tech giants have managed to build diversified hegemonies across a variety of industries, propelling them into the upper percentile of market capitalization. 

If you think back to your MBA strategy class 20 years ago, it would have seemed very difficult to defend the idea that you could build a competitor that offers the largest level of inventory, the fastest delivery time, the greatest customer experience and the lowest cost all at once. However, today it has become the norm and ecosystems economies have altered the fundamentals of supply and demand.

The best companies will have the skill to leverage artificial intelligence and other technologies such as virtual reality, 3D printing, and even blockchain to engineer exquisite levels of service and benefit from frictionless supply lines. 

McKinsey's research shows that an emerging set of digital ecosystems could account for more than $60 trillion in revenues by 2025. To put this in perspective that would be 30% of global corporate revenues of today!

The C-suite is going to need a wider lens when assessing competitors or partners because most of the time they wouldn't even know where to start looking for them. Today's competitor may turn out to be a partner or what they call a 'frenemy'. A failure to adjust strategic thinking to these new rules will mean that you will miss opportunities and be oblivious to potential threats.

The bad news is that traditional industry players have a far road ahead as McKinsey's research shows that only 3% of them have adopted an offensive platform strategy.

Pitfall #4: Over indexing on the usual suspects.

So most companies worry mostly about the threats posed by the new challengers that recently emerged from their 'garage origins'.  This group of digital natives gets most of the attention because they come with visibly disruptive and fresh innovative business models. 

The problem is that excessive focus on these usual suspects is dangerous because it takes the attention away from what incumbents may be up to behind the scenes. Their innovative initiatives, when unleashed, will play out on a scale that spells disruption with a capital 'D'. As the article says: 'Once an incumbent really gets going, that's when the wheels come off.'

McKinsey's research confirms that, on average, incumbents own around 20% market share on of digitizing markets. That is much more to work with than the typical 5% for digital natives at the gates.

A good example of a potentially disruptive move from a large incumbent in the financial services industry would be the switch to blockchain technology for mortgage approvals. Once it becomes fully functional, it could shrink the turnaround time for credit checks and approvals to only a fraction of what it is today. That would severely shake up an entire global industry.

Pitfall #5: Missing the duality of digital

The article states that 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. 

The duality is about striking the balance between digitalizing the current businesses while innovating with new models. Here's a two-by-two matrix featured in the article that plots the magnitude and pace of digital disruption:

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So each company really has to calibrate or configure what their dual strategy is going to be. The competitive cost of moving too slowly can turn out to be expensive in loss of market share while a too aggressive digitalization may pose a cost in terms of loss of focus if the ability to execute becomes too much of a challenge. 

McKinsey reports that leaders tell them 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 deploy their focus and their resources. 

It is becoming increasingly clear 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.

The organizational implications are also profound as half the tasks that are performed by today's workforce may ultimately become obsolete as digital competition intensifies. New skills and analytics, design and technology must be acquired to step up the speed and the scale of the change. To make it all work, you're also going to need a more diverse set of digital product owners and agile-implementation guides. Then there are the ongoing questions of whether to separate efforts to digitize core operations from the more creative realm of digital innovation.

My own personal takeaways from the article:

There seems to be a sense of urgency amid top executives of large groups, but it rarely reaches the level of specificity or granularity needed to actually get to work and get it done.

What it probably all boils down to is that the right questions are not always being asked. This could be because executives don't really know what the right questions are in the first place or that an overly defensive attitude has turned the executive suite into a bunker rather than a laboratory.

The predators are all over the place. They will eventually force you out of the comfort of the lodge to venture deep into the wilderness. It helps to go out there prepared...

Provided that leaders understand what is at stake, finding the answers to these questions have now become their job description. Best of all, they don't need to come up with the answers themselves!

I read somewhere that Walt Disney had a wall where he would put up ideas, scripts and anything else he felt needed fresh input with the questions "How can we improve this?". Anybody in the organization was welcome to scribble their ideas on that wall. Apparently, some of the best ideas came from that place! I don't know if this story is actually true (I can't find anything about it online), but it is a wonderful idea, isn't it?

Innovation is usually seen as a threat. Change faces pushback. It triggers debates that consume unnecessary energy and motivation. But if you really want to give innovation a chance, you might want to turn it into an adventure people can be a part of. We all love adventures, that's why we read books, line up for movies and binge-watch TV shows.

Could it really be as simple as turning innovation into a story to get people to adopt the uncertainty as a thrilling adventure?  

If we get the script right, could it make resistance give way to the anticipation of 'what happens next?'

Could it be like that wall at Disney? 

This was my own summary of this thought-provoking article. If you have the time for a 20-30 minute read, I highly recommend it as time well invested.

Here's a link to the McKinsey article