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,,,,The battle for digital disruption

The battle for digital disruption: startups vs incumbents

Which do executives perceive as their main threats?

Michael R. Wade

By Professor Michael R. Wade and Jialu Shan
The Global Center for Digital Business Transformation, an IMD and Cisco initiative, surveyed nearly 1000 executives across 15 industries about their attitudes and behaviors towards digital disruption. One objective for this research was to identify the source of digital disruption – startups or incumbent firms. Many of the popularized stories of digital disruption come from startups, like Uber, Skype, iZettle, and Spotify. However, there are also plenty of examples of incumbents pursuing digitally disruptive strategies, like GE, Disney, Nike, and BBVA. We were interested to learn what executives regarded as the main threats of digital disruption.In general, executives saw a bigger threat from incumbent firms than they did from startups, but this difference varied substantially by industry. As Figure 1 shows, more than half of the executives in media and entertainment, consumer packaged goods, telecommunication, and retail sectors regarded startups as the most likely source of digital disruption. By contrast, startups were seen as a much smaller threat for companies within the healthcare, utilities, oil and gas, and pharmaceuticals sectors, perhaps due to high entry barriers in these industries.

Figure 1: Large differences in the perceived source of disruptive threats across industries

Source: DBT Center, 2015


The relative advantages of startups vs incumbents

Respondents were asked about the relative advantages of startups vs incumbents. The results are shown in Figures 2 and 3. Not surprisingly, the advantages differed significantly. The top 5 advantages for startups were: faster innovation capability; greater agility; a culture of experimentation and risk-taking; highly digitalized products and services; and the vision of company leaders. By contrast, the advantages of incumbents were: greater access to capital; strongly trusted brands; a large customer base; high quality of customer relationships; and faster innovation capability.

Figure 2: The top 5 relative advantages of startups

Source: DBT Center, 2015

Figure 3: The top 5 relative advantages of established companies

Source: DBT Center, 2015

These advantages are largely off-setting. Startups compete by being agile, innovative, and active experimenters. Unencumbered by legacy systems and heavy bureaucracies, they adapt and move quickly. Incumbents may be less agile or innovative, but they compete due to strong asset bases, well established brands, along with deep and longstanding relationships with customers and other stakeholders. Ironically, when we talked to incumbents, they were envious of the agility of the startups; when we spoke with startups, they were envious of the stability of incumbents.

Recently, however, this relative balance has shifted in favor of startups. They are maintaining their advantages in innovation and agility, while quickly gaining in the areas of traditional strength for incumbents. Let’s take each of the three top incumbent advantages in turn.

Access to capital

Traditionally, access to capital has been the domain of large, established companies with solid balance sheets, stable revenues, and large asset pools. These organizations are able to tap into debt and equity markets with relative ease. Startups, on the other hand, have traditionally struggled to access capital. This is changing.

We have seen a dramatic rise in venture capital (VC) funding over past decade. According to CB Insights, $100 Billion of VC funding deals were made just in the first three quarters of 2015. The number of Unicorns – private companies valued at US$1 Billion or more – has jumped dramatically in the past 5 years, as shown in Figure 4.

Figure 4: A sharp rise in the number of unicorns

Source: CB Insights and Credit Suisse, 2015

For startups, access to capital is not as much of a constraint today as it was in the past. Low interest rates, large pools of available capital, and competition among lenders lead to generous funding opportunities. While this level of investment is probably not sustainable in the long term, at least for now, the access to capital is not a big constraint for startups.

Strong brands

Brands have traditionally taken decades to build. Yet, today this is changing. New brands are appearing all the time, and it is not taking them long to become household names. Most people had not heard of WhatsApp 5 years ago, Uber 3 years ago, or WeChat 1 year ago, and yet these brands are now global powerhouses. The speed by which brands can rise is paralleled by the speed at which they can fall. Iconic brands in the 1990s like Dell, Nokia, Morgan Stanley, Avon, and Sony have seen their reputations and valuations fall dramatically.

Large customer base

The speed at which new companies are acquiring customers is astonishing. It took Snapchat and Instagram only three years to reach 200 million users and 30% penetration of smartphone users, according to ComScore. Fast customer acquisition and instant brands are not just restricted to Internet companies. Witness the rapid rise in brands such as Uniqlo in fashion, Tesla in automobiles, Xiaomi in telecommunications, and Square in financial services.

The encumbered incumbent

All in all, our analysis does not paint a pretty picture for large, legacy businesses. The strengths that traditionally protected them from smaller and more agile competitors are being whittled away. Startups are maintaining their agility edge, but with easier access to capital, strong brands, and rapid customer acquisition.

However, the future does not need to be bleak for incumbents. In many industries where they are under threat of digital disruption, like financial services, telecommunications, retail, and technology, incumbents lead from a position of strength. They are mostly well capitalized, strongly managed, and profitable. At the moment, many of them struggle to appropriate the advantages traditionally reserved for startups, such as being agile and innovative. However, this need not be the case. If they are able to improve their sensing capability for digital treats and opportunities, their digitization of products, services, and processes, and their speed of execution, then they should be well placed to compete with startups.

Michael Wade is the Cisco Chair in Digital Business Transformation, and Professor of Innovation and Strategic Information Management at IMD. His interests lie at the intersection of strategy, innovation, and digital transformation.

He is Director of the Global Center for Digital Business Transformation and co-Director of IMD’s new Leading Digital Business Transformation program (LDBT) designed for business leaders and senior managers from all business areas who wish to develop a strategic roadmap for digital business transformation in their organizations.

He is also co-director of the Orchestrating Winning Performance Program (OWP).

Jialu Shan is a Research Associate at the Global Center for Digital Business Transformation.

The digital business agility imperative

How companies can fight digital disruption

Michael R. Wade

By Professor Michael R. Wade and Andrew Tarling
Digital disruption has the potential to overturn incumbents and reshape markets faster than at any time in history.Many companies will benefit enormously from digitization. Others will not. The real question then is which organizations will succeed. More than anything, agility and speed of innovation determine ‘digital business agility’.

Disruption for all

The difference between the digital disruption of the Vortex and traditional competitive dynamics comes down to two main factors: the velocity of change and the high stakes involved. Disruptors employ their digital business agility to innovate rapidly, and then use their innovations to gain market share and scale far faster than challengers still clinging to predominantly physical business models.

Digital disruption though is not just an issue for firms in high-technology sectors. The impact of digital disruption is being felt across industries. The relatively traditional high-end fashion sector, for example, has been disrupted by digitally savvy incumbents such as Burberry, as well as new entrants such as Net-A-Porter. Meanwhile, the hospitality and travel business has been disrupted by upstarts like Airbnb, LiquidSpace, and trivago. Re-intermediators such as Kayak and RentalCars have rapidly established huge businesses without the necessity of acquiring physical assets.

To counter these potentially existential threats companies need to change, but not just change, they need to transform. Digital business transformation is a journey to adopt and deploy digital technologies and business models to improve performance quantifiably. The first step of this journey is to grasp the need for transformation – an imperative driven by the inevitability of digital disruption.

How to respond?

This is the issue that preoccupies market incumbents today as they contemplate digital disruption. The three most common questions leaders ask about digital disruption are: 1) “How are digital disruptors going to attack my company?”; 2) “What steps should I take?”; and 3) “What capabilities do I need, not only to respond but to go on the offensive and disrupt others?”

The answer, difficult though it may be, is that no single strategy will guarantee success. Why? Because individual moves tend to focus too much on tweaking the company’s existing value chain in order to compete with traditional foes, rather than transforming how the company delivers customer value.

Meanwhile, digital disruptors focus on precisely that: supplying the cost value, experience value, and platform value customers want – frequently, and most dangerously, in combination. When a company’s most formidable competitor might be a start-up or a firm from another industry that uses digital technologies and business models to create ‘combinatorial disruption’, minor changes to existing processes and models will not be sufficient.

To win, companies must be dynamic enough to understand and respond to the risks disruptors pose. As margins from core models decline, the percentage of revenue from new businesses needs to increase. This puts pressure on companies to improve the ‘hit rate’ of marketable innovation, an area in which nearly all incumbents struggle. Incumbents are frequently less able to innovate and adapt at speed than the start-ups that are disrupting their core businesses.

Digital business agility

Companies need to develop ‘digital business agility.’ Companies that possess digital business agility respond quickly and effectively to emerging threats to their business, and seize new market opportunities before their rivals even notice them.

Digital business agility has three main pillars: hyperawareness, informed decision-making, and fast execution. These pillars are not technologies, but rather technology-enabled capabilities. Moreover, while they can be understood as discrete, they actually build upon one another.

Hyperawareness is a company’s ability to detect and monitor changes in its business environment. By ‘business environment’, we mean both the internal and external factors that impact the company’s opportunities and risks.

Hyperaware companies are less likely to be taken by surprise and are hard to disrupt because they can sense their vulnerabilities and adjust models and processes accordingly. For example, hyperaware companies understand when their customers are dissatisfied and why – zeroing in on what customers truly value about their products, as opposed to how those products are delivered through the current value chain. Likewise, when a company is hyperaware of its competitive landscape, it understands the strength and weaknesses of traditional rivals, and the potential impact of new lines of business or acquisitions. They also anticipate which non-traditional competitors could threaten their market position, and the models they could use to disrupt.

Informed decision-making is a company’s ability to make the best decision possible in a given situation. To do this, data collected as part of company hyperawareness processes must be analyzed, scaled, packaged, and distributed throughout the organization. To excel in informed decision-making, companies must develop mature data analytics capabilities that augment human judgment. However, many companies fail despite having the information they need to make the right moves. Often, this is because assumptions held by top management were not tested or questioned. Decisions based purely upon “gut feeling” or past experience have little chance of success.

Instead, companies must make decisions based on insights gleaned from data analysis, and ensure that experts from within and outside of the organization have access to these insights. Experts must be brought into the decision-making process at appropriate stages, regardless of their location, role, or rank. Diversity of perspective is a major contributor to informed decision-making but is only one element of a larger imperative of corporate inclusion.

Fast execution is a company’s ability to carry out its plans quickly and effectively. Unfortunately, it is a rare capability, especially in large companies where execution is slowed by organizational complexity, cultural inertia, turf wars and a reluctance to invest in resources needed to get the job done.

As it grows, complexity becomes the bane of the incumbent. Time and again that start-ups out-execute incumbents in areas such as time to market, experimentation, and risk-taking that are essential to success. To cut through complexity and accelerate execution, incumbents can emulate the strategies of start-ups. For example, while most large firms struggle to launch innovative new products and services at speed, GE operates lean start-up principles in its FastWorks program. FastWorks accelerates the time from concept to ‘minimum viable product’, which customers can test.

Conclusion

Digital business agility – creating hyperawareness, informed decision-making, and fast execution capabilities is at the heart of competitive success in the Digital Vortex.

Younger companies are not inherently more competitive than older companies. As disruptors themselves mature, and take on the encumbrances of incumbents, they too fall prey to the next generation of disruptive players who benefit from the relentless march of technology-driven innovation. And as innovation costs plummet, agile disruptors of all stripes—and this includes incumbents—get more opportunities to create disruptive offers and business models. As a result, incumbents can tap into exciting new paths to customer value. Whether this is good or bad for an individual firm comes down to how effectively and efficiently it can create these models. And this in turn hinges on the level of digital business agility it possesses: the more it has, the greater its ability to “reset” its position and survive.

Michael Wade is the Cisco Chair in Digital Business Transformation, and Professor of Innovation and Strategic Information Management at IMD. His interests lie at the intersection of strategy, innovation, and digital transformation.

He is Director of the Global Center for Digital Business Transformation and co-Director of IMD’s new Leading Digital Business Transformation program (LDBT) designed for business leaders and senior managers from all business areas who wish to develop a strategic roadmap for digital business transformation in their organizations.

He is also co-director of the Orchestrating Winning Performance Program (OWP).
Andrew Tarling is Research Associate at the Global Center for Digital Business Transformation, an IMD and Cisco initiative.

Four types of businesses where technology is speeding up change

Knut Haanaes

By Professor Knut Haanaes
In most industries, the competitive landscape is rapidly changing and as a result, companies speed through their life-cycles at an unprecedented pace (actually twice as fast as 20 years ago, according to recent BCG research).Not only are whole industries being disrupted – media and entertainment, energy and retailing, to mention a few – but the changes within industries are also faster than ever.The figure below shows the massive changes in the media industry in North America from 1950 to 2010. It illustrates a more general picture of what we see across most industries. We see that companies are jostling within industries at an ever-increasing pace.

Digital is the main driver of the current changes upending the business world. Digitization affects all aspects of our lives; the way we work, the way we live and the way we consume. Much has already been said about digital. However, in the midst of all the technological hype/fantasizing/speculation, we believe that business leaders need to clearly understand how digital enables more effective business models.

A business model articulates how a company creates value for its customers and manages the costs of production and delivery. There are many different business models out there. In some way every business has its own. However, there are four important archetypical business models that are most affected by digital:

Resource sharing platforms

First, resource sharing platforms insource physical, informational, and human resources. Classical examples include shared facilities or labor pools, but this is a current fast growing set of services covering all business functions ranging from IT and HR to facility management and contract manufacturing.

The logic of resource sharing is compelling – by leveraging the total scale in the delivery of a given process across clients, the provider can drive up value through reliability, development and quality at the same time as they can drive down costs through shared technology platforms. Digital is a major enabler because the firm can build global delivery at scale, while also offering relevant data and higher delivery quality. Services through resource sharing is a scale and platform game where the winner will be the one who is able to drive scale in customers and utilize technology platforms to deliver. IBM has been there for a long time, so has ISS, Securitas and all large Enterprise Resource Planning players. Whereas the early 20th century was the era of mass production of products (from cars onwards), the early 21st century is the time of mass “production” of services. Digital is the game changer as it enables scale, quality, data processing, machine to machine communications and sensor based surveillance. And we are just seeing the beginning!

Networking services

As interesting, and perhaps even more important, is the explosion in networking services enabled by digital technologies. Networking services are often found in established industries such as transportation, banking, and the operation of market places and exchanges. But now, digital technologies have enabled incredibly effective development and operations for these types of services. Networking services is probably the business model most often associated with disruption because it allows for completely new ways of delivering value. Think about the following famous disruptors: Spotify, Netflix, Uber, AirBnB, Amazon, eBay, Facebook, and Google – to name a few. Despite appearing at different times, they all have many similarities. They all outcompeted incumbents without producing end products or services. They created highly efficient networking mechanisms that allowed for large scale sharing and involvement by multiple product or service suppliers. In a way, they created clubs that became huge and whose network effects are a key part of their value. They connected people, companies, and places. Their users, or “members”, wanted to be part of the largest network because it provided the best connectivity, the richest offerings, access to the most people and places. These network service firms also all completely outcompeted the incumbents in the technology arena, providing platforms that reach huge global scale fast and drive cost to deliver equally fast. And finally, don’t be surprised that Uber subsidizes drivers. Network rollout is the largest investment in networks, and they know so well that these are “winner takes all” games!

Problem solving companies

Another group of service firms known as problem solving companies, is also being transformed by digital. These are the law firms, the management consultants, the architects, the engineers, the health care services, the certifiers, the analysts, and more. All these professional services are becoming much more efficient through the use of digital tools, global databases, collaboration platforms, and communication solutions. Digital technologies can augment, and in some cases, replace professionals. But more often, they allow one-man firms to be efficient, by allowing virtual networks to form instantly and enhance the efficiency of the operations of global players like EY and Deloitte in area of auditing, consulting and taxes, McKinsey and BCG in top management consulting, as well as DLA Piper and Baker & McKenzie in the law and compliance sector. They all know that if they don’t quickly become fully digital, they will decline rapidly and be overtaken by competition and become irrelevant. Digital is a necessity inside such firms and a requirement in their markets. Their clients expect to be working with companies that are one step ahead, not two steps behind.

Manufacturing firms

Finally, are manufacturing firms less influenced by digital? Not at all. Most would say that manufacturing, robotics, automation, 3D printing, sensors and digital platforms will allow for a fourth industrial revolution that brings about mass customization – an economy that transcends the traditional trade-off between scale and customization. This revolution also breaks down the traditional ideas driving globalization, allowing for instant local production and development at low cost. The challenge for industrial firms is twofold. First they need to embrace digital fast, like GE is doing. Second, they need to embrace disruption and not be defensive, like the car producers were with electric and self-driving cars.

These are the four business models which will be the most affected by digital. In other sectors we also see that digital allows firms to develop new business models (like Amazon branching out into cloud services), or transform business models entirely (as IBM did in moving from products to services and now again into analytics). We also see that digital allows firms to disrupt themselves (Netflix continuously moving to the next delivery platform is a good example).

In sum, the overriding challenge for all firms is to recognize that digital will transform the way they create value very fast, not “hope it will pass” or “not be that important”. We need to recognize that:

  • All Business models will be digital.
  • Digital will accentuate the core logic and make business models even more important.
  • Digital will also affect the organizational design in different business models in specific ways.
  • Finally the process of digitization has to be aligned with the logic of the business.

Knut Haanaes is Professor at IMD.

Øystein D. Fjeldstad is professor and Telenor Chair of International Strategy and Management at BI Norwegian Business School.