Leading companies invest more in digital than their less well-performing counterparts do, according to McKinsey’s latest digital survey. They also invest by targeting each dimension in which digitization is rapidly advancing.

The forces of digital have yet to become fully mainstream.

On average, industries are less than 40 percent digitized, despite the relatively deep penetration of these technologies in media, retail, and high tech.

 

Digital strategies will be the biggest differentiator between companies that win and companies that don’t, and the biggest payouts will go to those that initiate digital disruptions.

These findings emerged from McKinsey’s latest research, setting to understand the nature, extent, and implications of the progress of digitization. The research is framed by 5 dimensions: products and services, marketing and distribution channels, business processes, supply chains, and new entrants at the ecosystem level.

The model’s first input, from the survey itself, conveyed the current level of digitization (as reported by companies) in each of the five dimensions. The second input from the survey was the level of response companies had taken, and planned to take, on those dimensions, through the creation of new digital businesses or by reinventing the core of today’s strategic, operational, and organizational approaches.

According to the research, digitization has only begun to transform many industries.

Digital is penetrating all sectors, but to varying degrees.

Some operatives in every industry are earning outsized returns, while many others in the same industries are experiencing returns below the cost of capital.

Some digital initiatives generate attractive returns, while others don’t return their cost of capital.

 

These findings suggest that some companies are investing in the wrong places or investing too much (or too little) in the right ones—or simply that their returns on digital investments are being competed away or transferred to consumers.

How fully each of these dimensions has advanced, and the actions companies are taking in response, differ according to the dimension in question.

There appear to be mismatches between opportunities and investments. Those mismatches reflect advancing digitization’s uneven effect on revenue and profit growth, because of differences among dimensions as well as among industries.

The biggest impact on revenue and EBIT growth, is set to occur through the digitization of supply chains. However despite the supply chain’s potential impact on the growth of revenues and profits, survey respondents say that their companies aren’t yet investing heavily in this dimension. Only 2 percent, in fact, report that supply chains are the focus of their forward-looking digital strategies; examples such as Airbnb and Uber demonstrate the power of tapping previously inaccessible sources of supply (sharing rides or rooms, respectively) and bringing them to market.

Where are companies focusing their forward-looking digital strategies?

Similarly, there is little investment in the ecosystems dimension, where hyperscale businesses such as Alibaba, Amazon, Google, are pushing digitization.

The survey indicates that distribution channels and marketing are the primary focus of digital strategies (and thus investments) at 49 percent of companies.

In general, companies that strategically shift resources create more value and deliver higher returns to shareholders. 

What are the best-performing companies doing?

 

Structuring your digital reinvention

 

Since industry effects account for two-thirds of a company’s variation from average economic profit, according to McKinsey analysis, this reinvention phase requires executives must discover the insights in supply-and-demand shifts needed to identify sources of disruption as markets evolve.

The survey research suggests that the more aggressively they respond to the digitization of their industries, the better the effect on their projected revenue and profit growth.

Digital reinventions entail an end-to-end design of business processes, with close attention to customer use and customer touchpoints.

McKinsey urges executives to embrace DevOps, develop an ecosystem of external teams, partners, suppliers, and customers, including a mix of platform players, delivery specialists, and niche outfits with specific industry expertise and capabilities.

Winners tend to respond to digitization by changing their corporate strategies, since many digital disruptions require fundamental changes to business models.

49 percent of leading companies are investing in digital more than their counterparts do, compared with only 5 percent of the laggards, 90 percent of which invest less than their counterparts. It’s unclear which way the causation runs, of course, but it does appear that heavy digital investment is a differentiator.

 

What leading companies do differently from the rest

This is a critical element of success, given the different rates at which these dimensions are digitizing and their varying effect on economic performance.

Strengths in organizational culture underpin success.

Winners were less likely to be hindered by siloed mind-sets and behavior or by a fragmented view of their customers. A strong organizational culture is important for several reasons: it enhances the ability to perceive digital threats and opportunities, bolsters the scope of actions companies can take in response to digitization, and supports the coordinated execution of those actions across functions, departments, and business units.

A digital-strategy framework

A digital-strategy framework

 

How to make sense of digital disruption

Forward-thinking companies harness new technologies, and rethink their business models— exploiting data, reimagining customer experiences, since digital “makes everything new”— supply, demand, and market dynamics, giving new market makers an opportunity to connect consumers and customers by lowering transaction costs while reducing information asymmetry.

Digitization can disrupt industries

Airbnb has not constructed new buildings; it has brought people’s spare bedrooms into the market. In the process, it uncovered consumer demand—which, as it turns out, always existed—for more variety in accommodation choices, prices, and lengths of stay. Uber, similarly, hasn’t placed orders for new cars; it has brought onto the roads (and repurposed) cars that were underutilized previously, while increasing the ease of getting a ride. 

Consumers have grown to expect best-in-class user experiences from all their online and mobile interactions.

On the demand side, consumers are embracing technology and connectivity, they use apps and information to find exactly what they want, as well as where and when they want it—often for the lowest price available. They no longer have to get photos developed and can instead process, print, and share their images instantly. They can book trips instantaneously online, thereby avoiding travel agents, and watch television shows on Netflix or Amazon rather than wait a week for the next installment.In this sense, technology alters not only the products and services themselves but also the way customers prefer to use them.

Your business model may be vulnerable if:

  • Your customers have to cross-subsidize other customers.
  • Your customers have to buy the whole thing for the one bit they want.
  • Your customers can’t get what they want where and when they want it.
  • Your customers get a user experience that doesn’t match global best practice.

When these indicators are present, so are opportunities for digital transformation and disruption. The mechanisms include improved search and filter tools, streamlined and user-friendly order processes, smart recommendation engines, the custom bundling of products, digitally enhanced product offerings, and new business models that transfer economic value to consumers in exchange for a bigger piece of the remaining pie.

(An example of the latter is TransferWise, a London-based unicorn using peer-to-peer technology to undercut the fees banks charge to exchange money from one currency into another.)

On the supply side, digitization allows new sources to enter product and labor markets in ways that were previously harder to make available. P&G uses crowdsourcing to connect with formerly unreachable sources of innovation. Amazon Web Services provides on-the-fly scalable infrastructure that reduces the need for peak capacity resources. Number26, a digital bank, replaces human labor with digital processes.

You may be vulnerable if:

  • Customers use the product only partially.
  • Production is inelastic to price.
  • Supply is utilized in a variable or unpredictable way.
  • Fixed or step costs are high.

These indicators let attackers disrupt by pooling redundant capacity virtually, by digitizing physical resources or labor, and by tapping into the sharing economy.

Also you must (among other things) analyze how difficult transactions are for customers. You may be vulnerable if you have any of these:

  • high information asymmetries between customers and suppliers
  • high search costs
  • fees and layers from intermediaries
  • long lead times to complete transactions

Companies must understand a number of radical underlying shifts in the forces of supply and demand that blur the boundaries and definitions of industries.

More radical shifts may occur through new or significantly enhanced value propositions for customers, sometimes through reimagined business systems, and sometimes through hyperscale platforms at the center of entirely new value chains and ecosystems.

Attacks may emerge from adjacent markets or from companies with business objectives completely different from your own, so that you become “collateral damage.”

Established companies relying on existing barriers to entry—such as high physical-infrastructure costs or regulatory protection—will find themselves vulnerable.

User demand will change regulations, companies will find collaborative uses for expensive infrastructure, or other mechanisms of disruption will come into play.

New and enhanced value propositions

Companies meet heightened expectations with new value propositions that give people what they didn’t realize they wanted, and do so in ways that defy conventional wisdom about how industries make money.

Giving consumers the ability to choose their own songs and bundle their own music was an early stage revolution. But enabling people to share music with everyone via social media was an enhanced proposition consumers never asked for but quickly grew to love once they had it.

Many of these new propositions, linking the digital and physical worlds to create new ways of delivering value.

Philips gives consumers apps as a digital enrichment of its physical-world lighting solutions. Google’s Nest improves home thermostats. FedEx gives real-time insights on the progress of deliveries.

You may be vulnerable if:

  • Information or social media could greatly enrich your product or service.
  • You offer a physical product, such as thermostats, that’s not yet “connected.”
  • There’s significant lag time between the point when customers purchase your product or service and when they receive it.
  • The customer has to go and get the product—for instance, rental cars and groceries.

These factors indicate opportunities for improving the connectivity of physical devices, layering social media on top of products and services, and extending those products and services through digital features, digital or automated distribution approaches, and new delivery and distribution models.

Reimagined business systems

Delivering these new value propositions in turn requires rethinking, or reimagining, the business systems underlying them.

Liberty Mutual developed a self-service mobile app that speeds transactions for customers while lowering its own service and support costs. The New York Times virtualized newspapers to monetize the demand curve for consumers, provide a compelling new user experience, and reduce distribution and production costs. And Walmart and Zara have digitally integrated supply chains that create cheaper but more effective operations.

Digital channels and virtualized services can substitute for or reshape physical and retail networks.

The forces present transform the scalability of cost structures—driving marginal costs toward zero and, in economic terms, flattening the supply curve and shifting it downward.

Indicators of disruption in this zone include these:

  • redundant value-chain activities, such as a high number of handovers or repetitive manual work
  • well-entrenched physical distribution or retail networks
  • overall industry margins that are higher than those of other industries

Hyperscaling platforms

Companies like Apple, Tencent, and Google are blurring traditional industry definitions by spanning product categories and customer segments. Owners of such hyperscale platforms enjoy massive operating leverage from process automation, algorithms, and network effects created by the interactions of hundreds of millions, billions, or more users, customers, and devices. In specific product or service markets, platform owners often have goals that are distinct from those of traditional industry players.

Moreover, their operating leverage provides an opportunity to upsell and cross-sell products and services.

When incumbents fail to plan for potential moves by players outside their own ecosystems, they open themselves up to the fate of camera makers, which became collateral damage in the smartphone revolution.

Hyperscale platforms also create new barriers to entry, such as the information barrier created by GE Healthcare’s platform, Centricity 360, which allows patients and third parties to collaborate in the cloud. Like Zipcar’s auto-sharing service, these platforms harness first-mover and network effects. And by redefining standards, as John Deere has done with agricultural data, a platform forces the rest of an industry to integrate into a new ecosystem built around the platform itself.

What are the indicators that hyperscale platforms, and the dynamics they create, could bring disruption to your business? 

  • Existing business models charge customers for information.
  • No single, unified, and integrated set of tools governs interactions between users and suppliers in an industry.
  • The potential for network effects is high.

These factors invite platform providers to lock in users and suppliers, in part by offering free access to information.

Crossing the Digital Frontier