Digital Transformation: How to Scope and Execute Strategy

Digitalization isn’t a monolithic strategy. The executive team must frame its digital ambitions to set strategy — defining the type and extent of desired business outcomes. This is what drives investment priorities and the relative timing of digital initiatives.

Outcomes from digitalization fall into two broad categories:

• Digital optimization outcomes from improving existing processes and customer experiences

• Digital transformation outcomes from reinventing how the organization serves its market through net-new products, services or business models

Optimization and transformation do not present a binary choice. The most successful digital ambitions and their resulting digital strategies include an optimum mix of both types of initiatives across functions and business units. Despite the hype about “digital transformation,” it is rare for a traditional enterprise to fully transform. Wholesale attempts to do so often fail.

A more successful digitalization strategy pursues transformation and optimization in parallel: Focus on digital business transformation initiatives in a small number of high-potential product/service lines, business units or corporate functions; and digital business optimization initiatives to achieve nearer-term benefits in complementary functions.

How heavily a given organization weighs each depends on a number of factors, including the state of disruption in that industry and on the organization’s culture.

For instance, those operating in stable industries without signs of imminent disruption should prioritize optimization, as transformation risks becoming an expensive distraction too far ahead of customer adoption. By contrast, those operating in disrupted sectors must prioritize transformation in key business areas, as waiting risks irrelevance, leading to the erosion of revenue and margin. 

Organizations that embrace transformation want to do more with digitalization than just build a better version of their current selves. They want net-new opportunities — and possibly to disrupt the status quo — through new revenue streams, new digital products/services and new business models.

The emergence of a disruptive technology often triggers the need to prioritize transformation over optimization. Think of those disruptions as new market paradigms unfolding along an S-curve. At the bottom of the curve, a new technology or a major advance makes a new product, service or business model possible. That innovation experiences a stable period of growth until a still newer technology disrupts it, initiating a new paradigm and starting the cycle over again.

A good example of this dynamic is the music industry, which was one of the first markets forced to transform when Internet 1.0 enabled digital music, changing  listeners’ habits and annihilating the market for physical cassettes and CDs. Within 10 years, music consumers were primarily downloading MP3s in an a la carte business model that allowed for the economically viable sale of the whole (an entire album) and of its component parts (individual songs). When streaming capabilities emerged years later, listeners began consuming music and other audio products — like podcasts — through subscription-based businesses like Audible and Spotify.

Digital transformation initiatives aim to capitalize on that S-curve progression by capturing new revenue or value through:

• Net-new digitally enabled products and services.
  
  Digital products allow established organizations with an existing installed base to add or capitalize on existing digital capabilities that transform their value proposition. For example, a white-goods manufacturer may develop a connected version of their washing machine that allows an owner to remotely adjust the water temperature or receive a notification when a cycle has finished. In commerce, a farm equipment manufacturer may add IoT sensors that analyze soil moisture, pH or mineral balance.
  
  Digital services may emerge as revenue opportunities after the business has connected its products. The same farm equipment manufacturer, for example, could develop a new revenue stream of data insights as value-added services. For example, by offering customized yield improvement analytics that marry details like local soil profile data (from the IoT sensors) with third-party climate data and proprietary yield patterns.
  
  Revenue-generating digital services aren’t just limited to physical products. Financial services such as wealth management leverage roboadvisors and other technologies to deliver a digitally enabled, low-fee alternative to one-on-one advising. In the public sector, mobile parking payment systems are automating the collection of government revenues while improving efficiency and convenience for users.

Seventy-nine percent of strategy leaders expect their business models to fundamentally change as a result of digital technologies. Digital business models reflect how an organization creates, delivers and captures value based on four key dimensions:

1. Value proposition. The value customers derive from a product or service.

2. Customers. The customer segment served by the product or service.

3. Capabilities. The physical and digital assets, people, culture, information sources and strategic partners that deliver the value proposition

4. Finance. The revenue and cost models that capture economic value.

Yet few organizations perform business model assessments as a regular management exercise. Instead, they wait until major economic changes or disruptive competitors force change. In the context of digital transformation, it’s better to conduct a business model analysis to identify strengths, weaknesses and opportunities, and from them explore more effective strategies to create value.

As part of the analysis, assess gaps in the existing business model in core and noncore markets; assess environmental shifts likely to drive major industry changes; prioritize the most promising opportunities to develop future capabilities, leverage firm assets or to build technological capabilities.

Twelve digital business value model:

Examples of digital business models that may enable the organization to capture identified sources of value include the following:

Subscription model
Build a repeat customer base by charging a subscription fee for continued access to a product or service that is traditionally purchased ad hoc (e.g.,, Netflix, Ipsy, Dollar Shave Club).

Razor and blades model
Sell the base product at low cost while selling add-on or complementary components at a higher margin (e.g., Amazon Kindle, Nespresso, Sony PlayStation).

Ecosystem model
Sell an interconnected and interdependent suite of products and services that increase in value as more participants (buyers and sellers) engage with them (e.g., Apple, Google, Samsung and their app developer communities).

Access-over-ownership model
Provide temporary access to goods or services for participants in the rental and sharing economy (e.g., Airbnb, Spinlister).