8 ways to wake up from the digital nightmare and succeed

The pages of diginomica are replete with stories that demonstrate the impact of new business models from insurgent and relative newcomers to certain markets. We've also got plenty of Red Queen stories.

Retail is one of the best examples, amply covered by Stuart Lauchlan in his regular review of High Street happenings alongside the many customer stories which now amount to around 800 diginomica stories.

In an among this phenomenon and the incessant talk about Amazon, Uber, and Facebook, I've been left with a smoldering question. If a business knows and sees competitors coming out of nowhere, then why is it so hard for them to respond?

Markets rule - OK? No.

Part of the answer came in a recent briefing where I strongly advised the company to abandon a particular course of action because it was hurting their efforts to instill trust into their customer base at a time when they are pivoting away from their long-held (and successful) business model. The answer was staggering. "The markets won't allow us." I contest that argument because I view the alternative as a 'death by a thousand cuts,' slow, painful but inevitable as savvy customers see the disconnect between the rhetoric and the reality.

There is no doubt that financial markets wield much more power than they used to in the 1980s and the rise of the activist investor has not helped. The focus on the short term was well expressed by Mark Hurd, co-CEO at Oracle when in 2015 he warned:

This is what CEO’s care about. Most of the time you’re thinking about survival. You have zero friends and investors? Well, nobody cares about you. They only want your performance. Make me money and if you don’t do it fast we’ll get the next person in line to do it. It’s about execution. It’s in the head of everyone who’s in the corner office. It's the reality.

Earlier in the week, Ben Thompson provided his analysis of how Intel has fallen from grace and with it, the head of Brian Krzanich resigned as the CEO of Intel. While Intel is far from down and out, Thompson said (my emphasis added):

The company’s integrated model resulted in incredible margins for years, and every time there was the possibility of a change in approach Intel’s executives chose to keep those margins. In fact, Intel has followed the script of the disrupted even more than Microsoft: while the decline of the PC finally led to The End of Windows, Intel has spent the last several years propping up its earnings by focusing more and more on the high-end, selling Xeon processors to cloud providers. That approach was certainly good for quarterly earnings, but it meant the company was only deepening the hole it was in with regards to basically everything else. And now, most distressingly of all, the company looks to be on the verge of losing its performance advantage even in high-end applications.

This is all certainly on Krzanich, and his predecessor Paul Otellini. Then again, perhaps neither had a choice: what makes disruption so devastating is the fact that, absent a crisis, it is almost impossible to avoid. Managers are paid to leverage their advantages, not destroy them; to increase margins, not obliterate them. Culture more broadly is an organization’s greatest asset right up until it becomes a curse. To demand that Intel apologize for its integrated model is satisfying in 2018, but all too dismissive of the 35 years of success and profits that preceded it.

Thompson's words reminded me of what happened at IBM in the early 1900s when it took a near-death experience for the company to rid itself of its fat, happy past and pivot the whole business to reflect an emerging reality. Some 30 years later and do we still have to relearn those lessons? It appears so but how is that manifesting?

Does it have to be this way?

In 2017, McKinsey produced a little-discussed report with the title: The best response to digital disruption. In it, the authors concluded that (my emphasis added):

Digital disruption is unavoidable, and companies need to react. Those that do not — or that do so in a half-hearted way — are likely to take a major hit on revenue and profits. Those that respond boldly, at scale, and in a way that is fully embedded in their corporate strategy will be positioned to steal revenue and profits from the laggards and emerge from disruption with higher trajectories in both areas.

As background, the report was an elaboration of a much more detailed and number strewed research report from 2016 entitled The case for offensive strategies in the face of digital disruption. But is that happening? The 2016 report identifies four modes of response per the following illustration:

McKinsey's 2017 report says that:

• Across countries, digitization has a significant negative impact on the profits of incumbents through two loop effects: digital entrants competing with incumbents through disruptive models, and incumbents responding to disruption and creating more intense competition with each other.
• These two loop effects suggest that organizations should go on the offensive: A successful digital strategy built on a scale larger than that of the rest of the industry yields the largest returns and may offset the full competitive impact of digitization.
• Our research further suggests companies should consider at least two dimensions when devising the type of bold reactions needed to compete: (1) concentrating on new customer segments rather than exclusively on current customers, and (2) focusing on new ways to resegment the market, instead of relying solely on cost cutting and labor saving through automation.

McKinsey gets both good and bad press and on this one, I believe companies should sit up and take notice. I say that for two reasons:

1. The underpinning research was based on a methodology that draws from both Schumpeter's and Christensen's disruption theories but with some nuance. The researchers took into account the likelihood of common method bias and noted the potential for cognitive bias. In short, the research is reliable and has been supported by results in the field.
2. The McKinsey recommendations are the inverse of what is generally (but not always) happening. In my experience, 'thinking different' is an absolute requirement for the kind of creativity that takes a business forward.

Results speak loud

The 2017 report demonstrates that:

Incumbent companies are usually better off reacting than not reacting. Digital initiatives tend to exploit latent demand in an industry, creating a positive market expansion effect. For example, people may spend more time watching videos or listening to music because online delivery is more accessible, or they may be more likely to buy an extra product online because the seller recommends it based on previous purchases. However, this benefit from digital initiatives is compensated for by the depressive effect of the two loops, and, as a result, the net effect of digital reactions tends to be very modest overall.

On average, bold, at-scale responses pay off twice as much as semi-bold reactions and three times as much as medium reactions. There is some variation by industry, but it is not dramatic. In telecom and high tech, for instance, bold, at-scale reactions have 2.5 times greater payoff than medium reactions. In manufacturing, it is 2.2 times greater, and in retail and media, it is 1.9 times greater. Given that we estimated a medium reaction is worth 1.5 points of EBIT growth a year and about 2 points in revenue growth per year, the effect of a successful bold, at-scale move is roughly 4.5 points in EBIT and 6 points in revenue — the same positive payoff as the original negative impact of digital entry.

To do better than just break even on digital disruption, companies must also integrate digital strategy into their corporate strategy. Companies whose responses met our criteria for being both bold and integrated produced 3 to 4 points more annual revenue growth and the same EBIT growth as before digitization.

Success strategies?

McKinsey then talks about three strategies with examples:

1. Develop new customer segments
2. Introduce new business models
3. Redefine the value chain

McKinsey's conclusions look self-evident on their face but are companies taking heed? I will likely find out more next week at FORA at Cambridge University but from the reports coming out of Horses for Sources,  companies are still focusing on the very things that McKinsey warns against - cost-cutting and efficiency. See below. It's an easy win but doesn't solve for the insurgent business problem.

My take and advisory

1. Short-termism has to end. Financial sharks need killing off with a dose of their own medicine. Can you short the shorts but then ask yourself, does the activist investor have a point?
2. Bold moves McKinsey style are not easy and they likely mean taking a hit from investors in the short term, unless carefully communicated. A WTF? analysis as part of an investor presentation might serve to assuage the jitters that financial markets often feel. In the long haul, bold moves and the results they bring will be rewarded.
3. McKinsey's conclusions are self-evident and I hear them on the lips of many business leaders. But then when you examine what they mean, it's often a highly diluted version of the ideal. No-one likes being outside their comfort zone but that's where leaders have to go. Insurgents won't wait for you to bring your A-game.
4. Reliance on past success and the continuance of an addiction to the 'same brand of champagne' is a sure sign you've got your head firmly established where the sun doesn't shine.
5. The nature of disruption forces thinking down a series of what-if? and outcomes route. Paradoxically, this is the exact reverse of what the Anchorage story tells us.
6. Experimentation is critical. Absent of strategy clarity, this might be the one way that incumbents discover the 'new new' that invigorates the business.
7. Get on the XaaS train. We have a growing library of content on this topic. Start here.
8. Media is ripe with shiny new tools and technology yet that should be the last decision you take. It sure as heck is a noise to which you should shut your ears.