Is 2018 the Tipping Point in Digital Transformation?
“Survival, in the cool economics of biology, means simply the persistence of one’s own genes in the generations to follow.” —Lewis Thomas
A recent article in The Economist titled “The Year of the Incumbent” postulates that 2018 is the year that the incumbents “get back into the game” by stealing the momentum from technology startups to reclaim their spots atop the market valuation charts.
Tech firms have captured 42% of the rise in the value of America’s stock market since 2014 as investors forecast they will win an ever-bigger share of corporate profits.
As technology, and its role in our economy, has expanded, incumbent firms have struggled to embrace new innovations out of fear of upsetting profit streams, cannibalizing existing business lines, and disrupting established management structures. The McKinsey article “Why Digital Strategies Fail” explains why incumbents fail when embracing digital transformation:
Most digital strategies don’t reflect how digital is changing economic fundamentals, industry dynamics, or what it means to compete.
Understanding the Economics of Digital Transformation
Most digital transformations fail because organizations misunderstand the economics of a digital business. The incumbents, despite long histories of revenue growth and profitability, have an economic blind spot when it comes to digital transformation. Let’s drill into the finer economic details that incumbents need to contemplate as they embark on their digital transformations.
- 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 destroying this equation by creating more value for customers than for firms. For example, digital competitors with niche products and agile delivery offerings are forcing organizations to unbundle profitable product and service offerings. This results in more freedom of choice for customers to buy only what they need (and not being forced to buy what they don’t need). This is shifting the profit pools and decision making away from the firms and towards the customers. Digital also renders physical distribution intermediaries obsolete. Consider, how healthy is your nearest big-box store? With digital distribution providing limitless choice and price transparency (thanks Google Search), digital offerings can be reproduced freely, instantly, and perfectly, shifting value to hyper-scale players while driving marginal costs – and product margins – towards zero.
- Digital is driving winner-takes-all economics. Just as sobering as the shift of profit pools to customers is rising economic value of scale and network effects increasingly dominating markets. Profits are no longer distributed across a 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 ALL the 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 and prepared to pay the price to remain the market leader.
- Metcalfe’s Law , while not exactly an economic theory, enables first-movers to build “economic moats” around their business models via an exponentially growing web of interconnected users and businesses. But first movers don’t always win; just ask AOL and MySpace. Consequently, first movers also must be aware of the economic impacts on their business models or a fast second mover will disrupt their business models by disintermediating their customer base (see the blog “The New Normal: Big Data Business Model Disintermediation and Disruption” for more details on business model disruption and customer disintermediation).
- Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve), and the total amount that they actually pay (i.e. the market price). Digital economics is moving the demand curve towards perfect price elasticity, where the consumer surplus approaches zero because the price that people pay more closely matches what they are willing to pay (see Figure 1).
A new, terrifying phrase has entered the lexicon of business jargon: being “Amazoned.” What does it mean? Ever since Amazon acquired Whole Foods, companies across a wide swath of industries have received a wake-up call. Traditional brick and mortar industries, like grocery stores, are susceptible to purchase by digital giants.
Let’s say that you are in the retail industry and are looking to digitally transform your business model. The scenario outlined in Figure 2 provides an example of what one might to expect (pulled from my blog “The 4 Laws of Digital Transformation”):
The scenario in Figure 1 isn’t just optimizing the ordering process. The scenario in Figure 1 requires the complete re-wiring of the organization’s business model and value creation process: from demand planning, to procurement, to quality control, to logistics, to inventory management, to distribution, to marketing, to store operations.
And the entire value creation and capture process starts with understanding, optimizing and simplifying the customer experience; to create a more compelling, differentiated customer experience that builds loyalty and ultimately advocacy.
Summary: Digital Transformation and Data Monetization
Organizations are going to have a hard time ignoring the “siren song” of digital transformation. Economic pressures, market demands, and customer expectations are forcing businesses, particularly legacy corporations that have yet to see the breaking digital wave, to embrace digital transformation. However, market pressures alone shouldn’t spur action. There are plenty of positives resulting from a transformed business, namely new data monetization opportunities, new customer acquisition methods, and new sources of customer, product, and operational market value.
Right now, we are helping clients understand the role and impact of data monetization in their digital transformation strategies, which includes a “Data Monetization Workbook” to guide their understanding of how to create new sources of customer, product and operational value.
Watch this space for more details as we test, learn and refine the workbook.
 Metcalfe’s law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2).