Digital Transformation – How traditional businesses need to adapt

11 Jun

My colleague Edward Tse and I wrote the following article that was published today. If you are interested in a PDF version with nice layout, let me know.

Preface

Digital businesses, fusing technology with new business models, are thriving and their valuations are reaching levels often surpassing their traditional counterparts. New entrants appear in century-old industries and disrupt entire ecosystems, sometimes in less than 12 months. What can traditional businesses learn from these players?

In this viewpoint, we will analyze the success factors of digital companies and describe the fundamental differences between these agile, fast-moving firms and their traditional incumbents. We will outline why technology is an important enabler but hardly sufficient by itself to create disruptive innovation. With a business model focused on consumer needs at their core, these new players typically leverage their flat organizational structure and entrepreneurial style to adjust to a rapidly changing market environment.

For traditional businesses, it is not easy to overcome the hurdles of their own legacy organizational style and structure. Finding the right talents and empowering them in an environment that allows for fast prototyping, quick decision-making and even failure, will determine if traditional businesses can compete with these new “digital disruptors”.

Understanding shifting consumer demand

Rapid evolution of consumer needs is creating new opportunities for entrepreneurs and requires traditional companies to continually re-invent themselves. Increasing complexity and frequent changes in market dynamics are also placing massive pressure on traditional business models. Many large companies attempt to tackle such challenges by jumping half-heartedly onto the digital bandwagon. They introduce digital enterprise solutions, assign a Chief Digital Officer, launch a new company website or move parts of their communication to online social media.

Successful digital businesses, however, take a different approach. They typically focus on the business model first. Technology is an important enabler but it is not sufficient and certainly not core for the success of most digital businesses. Start-ups and smaller companies often have a better starting position as they don’t have to “unlearn” existing behaviors or reengineer their processes. The lack of legacy makes these companies more nimble and agile to respond quickly to the constantly changing external environment. In contrast, many traditional businesses will have to overcome inertia in order to transform themselves fast enough to stay abreast of rapidly changing market conditions and competitive dynamics.

Agility, flexibility and speed are the new attributes that must be reflected in the company’s go-to-market approach and decision making capabilities. Fast prototyping will become a predominant method to develop and test new products, keeping the product development cycles short by a combination of business-hypothesis-driven experimentation, iterative product releases, and validated learning. True disruption, however, does not have to come from the digital or technical arena only. In fact, real game-changing innovation often arises from understanding and leveraging the evolution of consumer demand and embracing them swiftly and rigorously.

A new breed of private companies in China

A digital business could disintermediate traditional value chains. Boundary-leaping internet players, which often appear irrelevant at first, can fundamentally disrupt the value chain of an industry in a short period of time. These disruptors are often invisible until they have taken a major market share away from traditional players.

In a pattern that is not unlike Silicon Valley in the U.S., China has spawned many digital companies that demonstrate such disruptive behavior. The largest and most successful Chinese digital companies (leading examples: Baidu, Alibaba and Tencent) have become large tech groups that have formed collaborative ecosystems to leverage complementary capabilities across multidisciplinary business partners.  These ecosystems often span across different industries and stretch industry boundaries. These platforms attempt to create additional value through synergistic relationships and co-evolution.

With this high level of “biodiversity” (diverse forms of business models and industries coexisting in one ecosystem), these firms could create high entry barriers, making it more difficult to be disrupted by other new or traditional market players. These digital businesses are often asset-light, but data/information-heavy, furthering the use of big data analytics to build new, adjacent businesses complementary to their core and enhancing their ecosystem.

Another leading example is Xiaomi, a Chinese company valued at US$46 billion  in early 2015. Rather than being “only” a smartphone maker, it is actually an innovative internet company that is aggressively building a global Internet-of-Things ecosystem, involving all kinds of smart devices from TVs, wearable devices to air purifiers and mobile healthcare devices. By selling its products at cost or near at cost, Xiaomi provides customers with a convincing value proposition and aims at making money rather through its bundled services. In terms of software, all products run on Xiaomi’s MIUI operating system, which is highly customizable and features a user-friendly interface. By leveraging social media and its impressive loyal online community, Xiaomi is able to receive direct user feedback on their products and release weekly updates, thus shortening the product development cycle drastically. In addition, this close interaction deepens the level of engagement with its “mi fen”, which literally means “fans of Xiaomi”, who have become followers of Xiaomi, forming a loyal “user community”. These fans also play a crucial role in spreading the online word-of-mouth of Xiaomi’s brand.

Digital transformation challenging for traditional companies

Whereas Xiaomi started its entire operations only about 5 years ago, more traditional companies with legacy businesses face steeper challenges in undertaking the digital transformation. Suning, a long-time leader in China’s retail industry for electronics and other household products, struggles with its digital transformation. In 2009, Suning recognized the importance of digitalization in retail and initiated a digital transformation, including launching an e-commerce site. At around the same time, a small start-up called Jindong (which later was renamed as JD.com) was formed as an online consumer retail business. In 2010, Suning ranked first on China’s Retail Top 100, with sales of 80 billion yuan and profits of 4 billion. JD’s sales at the same time were around 10 billion yuan, incurring a loss. JD was essentially a nobody compared to Suning then. By 2014 only 4 years later, Suning’s sales have grown to 109 billion yuan while JD has surpassed Suning with sales at 115 billion. JD’s number would be even higher at around 260 billion, if “third party services” (third-party products sold and delivered over JD’s platform) were also included.

While Suning apparently had good intentions and a focused strategy, it has recently been stumbling. Why?

It turns out, making a fundamental shift in an organization that is built with a top-down “military” organizational style is extremely difficult. Especially, if the shift requires a fundamentally new organizational style and culture as is the case of a digital business. A “military” style organization might have been the core reason why a traditional company like Suning was successful building its brick-and-mortar business, but it became a barrier for change in the new world. In addition, placing a new business (online) and an existing business (offline) side-by-side together within one organization is rather challenging given the different cultures, approaches, mindset and even the measurements between the two sides. Empowering staff and promoting initiative-taking are critical in driving new digital business models, yet the prevailing culture and mindset in a “military” organization is often rather order-taking and executional. In Suning’s case, the gap between both worlds was wide and became a real challenge.

Digital transformation not limited to B2C

Digital business models are not limited to B2C industries. They extend also to B2B industries, affecting how suppliers and service providers work together. On a contractual basis, agreements adopt a more flexible pay-per-use model, instead of fixed multi-year contracts.

Collaboration with partners, suppliers, customers and other stakeholders along the value chain involves deeper and more comprehensive exchange of information, including data for planning and production purposes. This will impact the supply chain and enable better and faster coordination of resources with less waste produced.

Within an organization internally, digital businesses allow more connectivity and flexibility. On-demand staffing and leveraged assets lead to higher operational efficiency and fewer required resources. Ownership is no longer a success factor. On the contrary, fixed assets can even become a liability. The notion of “sharing economy” extends across both the consumer and corporate worlds, with companies of complementary capabilities partnering to leverage resources rather than relying solely on their own or having to build resources that are not fully utilized.

Talent and mindset critical for success

The most critical success factor operating in this digitally inspired environment is access to talent with the right mindset. Hand in hand with the need for such talent is the requirement for empowerment, which more often than not is only really possible in flat, non-hierarchical organizations. In this aspect, start-ups have a natural advantage over traditional businesses as they demand more ownership and acceptance of responsibilities from their employees.

For larger companies, breaking away from long-standing, traditional organizational structures is often only possible by setting up a separate entity outside of the corporate “fence”. There is a growing trend where large corporates form spin-off organizations for explorative purposes to incubate intrapreneurship. The implementation can be accomplished in a number of different ways and needs to fit the corporate culture of the company. Haier, the Chinese consumer electronics and household appliances giant, for example, encourages their own employees to form independent micro-organizations allowing them to address evolving consumer needs more swiftly. One of such units developed a WeChat-enabled air-conditioner involving a crowdsourcing campaign with over 600,000 consumers. Xiaomi, in contrast, relies rather on investing in innovative start-ups that complement their capabilities and help expand their Internet-of-Things ecosystem. These ventures follow Xiaomi’s own philosophy and management style, in particular that of its CEO Lei Jun. Xiaomi teams up with a venture capital firm to identify and manage the engagement and investment process.

If successful, such explorative units could create new streams of revenue or even self-disrupt the core business. A later
(re-)integration of these units (back) into the corporate structures will both require, yet also facilitate, the overall adoption of an internet mindset across all divisions and business units of the legacy company.

Interesting developments are already emerging in different industries. In the automotive industry, OEM brand owners such as Ford and VW are being challenged by “Mobility on Demand” internet players like Uber or Kuaidi/Didi (Alibaba/Tencent). These new players with their online platforms ride on the wave of the “sharing economy” and enable better utilization of existing cars. Mobility on-demand consumers are freed from the need to own vehicles and the pain of costly maintenance and depreciation. Instead, they enjoy the flexibility and convenience of a concierge service when it’s needed. Such business model innovations by digital players might directly and indirectly affect automakers, leading to fewer new cars being sold and influencing the type and configuration of “shared” cars.

Another area of major digital disruption can be found in print media, with digital versions of newspapers, websites and social media replacing classic printed products. Publishing and disseminating content has become very easy with blogs and social media at the fingertips of every smartphone user. Traditional publishers are migrating online to connect and engage with the new generations of readers, offering ad-hoc news coverage combined with in-depth analyses and richer multimedia content, e.g. video or audio versions. Successful examples are The Huffington Post, The Economist, and TIME.

Educational institutions are also embracing digital business models. Top universities such as Harvard University and Stanford University are launching more and more online courses on Mass Open Online Course (MOOC) platforms such as Coursera and EdX to tap into the growing pool of global learners.

Digital transformation key to every organization

In summary, it is critical for traditional businesses to realize that digitalization is not a new tech-phenomenon that will go away over time, but rather will affect – sometimes even disrupt – entire industries, and that it is necessary to re-position their digital activities from fringe to core.

Building a customer-centric business using digital technology to gain more proximity and intimacy with all partners throughout the ecosystem will lead to a fundamental transformation of traditional businesses. The best way to start is by finding suitable talent with the right mindset, empowering them to take necessary actions and break with some of the sacred traditions – even if it hurts!

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