The Challenge of Digital Transformation

Digital Transformation

By Nicolas van Zeebroeck and Jacques Bughin

The typical rationale put forward for failing digital transformation is linked to ill-designed processes, absence of organizational commitment, and poor digital skills. There are obvious operational mistakes– but one more insidious form of failure is not that the digital transformation launched by a traditional incumbent blows to bits because of lack of skills; it is that the digital transformation is only half baked and its returns are far from distinctive.

Consider that the returns of failed digital transformations, out of hundreds of digital transformations we researched, are indeed negative or less than a few percentage points, but it is clearly troubling that the median return barely reaches between 7-10% of return on digital capital deployed, –a return that is really not at all distinguishable from the weighted cost of capital of incumbent companies. The digital investment, in other words, does not create value.

But our research1 also demonstrates that a portion of companies may build up truly outsized returns, above 50% and more. Those companies have understood that if digital technologies are disruptive enough to kill their on-going business, their internal use may also require a re-thinking of the original corporate strategy, along with applying digitization best practices into the business systems of a corporation.

Digitization is about growth options

The majority mindset of companies is alas that their original strategy is good enough. Should their strategy ever be adapted, it can only be done at the edge, -and only for defense. As our research1 demonstrates, this thinking can be short-sided, –not to say that it is often wrong. In fact, digital “is strategy” in the sense that digitization implies that companies must adapt their strategy for the upside — that is, geared towards securing growth options “in the money”, as they emerge from the use of digital technologies.  This is where digitization pays off and brings the good “bucks”. By the way, this is a luxury problem as options are often many: they can facilitate the exploitation of new business model opportunities (e.g. B2C subscriptions for newspapers and videos); they can initiate the set-up of platform-based ecosystems (Deere’s service platform in agriculture), they can get change old market conduct toward softer coopetition (e.g. Walmart’s open marketplace, or IBM’s Red Hat open source code sharing), or they can bring new products and services.   

This is not theory, –but real business life. Netflix3, once a US-only DVD rental distributor, successfully invested in streaming to expand globally and to produce its own series. Volvo4, as a car producer, adopted mobile technology to invest in telematics and become the first connected truck related service company. Schibsted, a publishing company, leveraged web services technologies to pivot its strategy from a regional news media to a digital classified and an e-commerce platform rivalling E-bay. Cisco5, an IP router provider, recently invested in the Internet of Things to successfully expand its hardware business to software via its Fog platform.  Inditex6, the retailer owning the Zara brand, quickly adopted digital social media technology to reposition itself as a fashion brand for generation Z, with fashion products co-created on-demand. As a result, Inditex has built its digital sales at twice the rate of new digital entrants such as Asos. 

The key for success: get rid of the traditional excuses

A few other points are worth having in mind to deconstruct arguments often made by some incumbent firms:

1. “Offensive strategy may work but the cases above are too good to be true –they are exceptions and are difficult to replicate”. Our statistical analysis shows that strategic renewal leads to up to 5 points extra of revenue growth versus other companies—looking at the evidence, firms engaged in strategic renewal have grown at 8.8% a year, versus 3.8% for others stuck in their old corporate strategy. Inditex is a case in point- which was able to grow its top line at 9.5% in the recent decade, while the typical fashion retail incumbent only managed to grow at about 3.5%.

2. “Returns may develop, but may take time- meanwhile, risk is that self-cannibalisation hurts and destabilizes the organisation”. We concede that cannibalisation is material with digitization. Yet its negative effect is systematically compensated by the strategic renewal above, and in a rather short time frame. As a case in point, Netflix revenues went down for two years after pivoting from DVD distribution to a digital streaming platform, but since then, Netflix has increased its net revenue tenfold. Its stock price evolution is even more spectacular, with the stock price moving from 30 USD by April 2011 to 570 USD by now.  

3. “We are to prioritize our game plan –we are first to be Covid-19 resilient”. Corporations have indeed been facing large stress, out of the covid-19 pandemic. But one key factor of resilience7 out of the covid-19 crisis, we found in parallel research, has precisely been to invest in digital technologies quickly (e.g. to enable remote work), and especially to operate dramatic pivots in strategy enabled by digital technologies. As a case in point, Future Retail9 in India had followed an expansive brick-and-mortar strategy to differentiate from  major  e-commerce players like Flipkart, but alas got too vulnerable to the sudden fall of in-store shopping out of covid, and had no choice but to sell itself to Reliance. Contrast this to China Merchants Bank, which quickly expanded its online mobile banking application to morph into a platform for life services. Its strategic shift during Covid time led to an extra 100 million visits from access to food delivery, online course ridesharing, online doctor counselling, and hospital location search, in less than a month.

Getting ready

If convinced to pivot strategy and go for new growth enabled by digital, we often still hear a last mile fear, that is “Digitization kills jobs, especially new digital technologies such as smart automation and AI will replace jobs—we are to face strong organizational resistance”.

We may not deny that this argument has some substance. But, by the same logic of the above, it is often inadequate, because it again misses the growth option story. In general, successful digitization is precisely about growing faster—thus increasing the “pie” and thus calls for more needs. And here is the fact: in our research, we found that for one job loss out of digitization, companies with outsized success in digital transformation  have created at least two other jobs. Second, outsized digital returns are not from investing in digital architecture, and software tools, – they originate from also investing in new digital capabilities for the organization. As this extra human capital10 is necessary, we learn, successful incumbent transformers have also massively invested in training and skill building. Remember Inditex, with powerful fashion retail brands like Zara? Along their successful digital journey, Inditex is investing in its base11:  more than 2/3 of store management jobs arise from rank of file promotions, while the full workforce received no less than 3 million hours of training last year.   

About the Authors

Nicolas van Zeebroeck

Nicolas van Zeebroeck is a professor of digital economics and strategy at the Solvay Brussels School of Economics and Management at Université libre de Bruxelles (ULB). He serves on Belgium’s High Council for Employment and as Advisor to the President and Rector of ULB for IT and Digital.

Jacques Bughin

Jacques Bughin is Professor, Chaire Gillet of Management Practice, at the Solvay Business School at the Université libre de Bruxelles (ULB). He is also the CEO of MachaonAdvisory, a top management strategy consultancy. He serves as the Senior Advisor for Fortino Capital and Antler, Knowledge Board Member at Portulans Institute, and Accenture Research, and STOA European Parliament. He retired from McKinsey & Company as senior partner and director of the McKinsey Global institute.

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