DIGITAL TRANSFORMATION
How digital has disrupted businesses
The rapid pace of digital technological change has unbundled traditional value chains and disrupted industries, rapidly improving business performances
Disruption is nothing new and arguably a natural product of market economies. In recent years digital technologies have enhanced our information processing, communication, and storage capabilities, leading to disruptions in industry value chains. These disruptions have led to new competitive dynamics and even the construction of new markets. With these disruptions, those that make correct technology investments should expect to gain measurable returns on both revenue growth and profitability levels.
The rapid pace of digital technological change
The exponential evolution of digital technology can be the foundation for a massive change for any organization.
The drivers: three exponential laws
In the last few decades, digital technology has progressed exponentially, disrupting lives globally in previously unimaginable ways. And there are three laws, all exponential in mathematical-nature, that explain this progress and rapid growth:
- Moore’s law or the law of processing power — says that every 18 months, our computers will have twice as much power to process information. We can achieve this by increasing the number of transistors in chips, change the way we design chips from 2D to 3D, change the material we use to make chips from silicone to graphite, or move towards using quantum computing.
- Butter’s law or the law of communication — states that the amount of data communicated through a single optical fiber doubles every nine months. There’s a variation of this law for other communication media, whether wireline like ADSL, VDSL or wireless like 3G, LTE and more recently, 5G.
- Kryder’s law or the law of storage — states that the amount of data stored per centimeter square of a hard drive will double every 13 months. The trend has recently slowed down to double every 16 or 17 months but remains faster than Moore’s law.
These laws describe the theoretical technological potentials and only part of that potential goes into performance improvement for the mass market while the other part, goes into consumer cost reductions so that computers, internet connection, and storage capacity become not only better but also cheaper for the average consumer.
The impact of rapid technological change — a widening gap
Our minds are intuitively tuned to view and forecast the world as linear developments, we tend to underestimate exponential technological progress. Therefore, companies also tend to underestimate or become blind to the impact of digital technology and transformations. If companies develop linearly and technology evolves exponentially, there will be an ever-widening gap between the company’s value offering and what would be possible technology-wise. Both individuals and companies need to overcome the challenge of linear perception and to understand how digital technology is evolving exponentially.
This widening gap is often filled by innovative startups that use technology to satisfy customer needs in different and disruptive ways — ways that incumbents are unable to see or can’t fully grasp. For example, companies such as Kodak, Nokia or Blockbuster paid a heavy price for their tendency to underestimate exponential technological trends.
Digital technology and the value chain
Technological disruptions impact industry and company value chains, unbunlding and deconstructing estanblished norms and creating new competitive layers, shifting economies of scale towards new effecincies.
Unbundling of the vertically integrated value chain into layers
Traditionally, industries were organized via a vertically integrated value chain, the succession of many suppliers, producers, and distributors, transforming raw input to market-ready material, all that one step at a time. Companies would integrate multiple steps in the value chain to become a member of an oligopoly with a couple of other vertically integrated competitors.
Vertical integration was the right strategic answer to traditionally managing the flow of goods and information for two reasons:
- High transaction costs — a company required lots of resources to operate and manage its value chain or coordinate with suppliers and distributors to figure out the best price or the right quality standards. A vertically integrated value chain meant lower costs and faster time to market.
- Scale of operations drives competitive advantage — for example, the more smartphones a company manufactures, the more its gathered experience and know-how translates into efficiency, and the more profitable it becomes.
Both incentives to reduce transaction costs and scale of operations require the accumulation, exchange, and processing of information to happen, and this is where digital technology has increased capacities and reduced costs to store, process, and communicate information in digital form. For example, in practice, it became much cheaper for companies to directly check the inventory of their distributors through an ERP integration or to instantly compare prices between suppliers through an online portal.
Consequentially, links in the vertically integrated value chain became looser and started to unbundle as functionally specialized and independent layers with a multiple number of players.
Case example: deconstruction of the operators’ value chain
In the beginning, telephony was offered as an end-to-end service with a single company providing the physical wiring to homes the homes, manufacturing handsets, and operating the switch inboard. But gradually the industry was unbundled allowing players in each layer to compete on what matters for their specific functionality.
At the bottom, the key success factor was scale in operations with fewer players but enough scale to optimize investment and utilization of expensive assets and the top layer was all about innovation. New services could emerge and try their luck, either prospering or dying without any impact on the lower layers.
Impact of value chain unbundling
The strength of the layered architecture is that over time, it has allowed new and innovative business models to emerge benefiting end-users, but also attacking the bread and butter of incumbent players, changing the competitive landscape and market dynamics. For example, over the top service providers such as Skype or WhatsApp, have destroyed the SMS market value and are also eating into voice revenue, further pressuring the incumbent mobile operators’ cost structures.
Traditionally, telcos were worried about other telcos and today, they’re worried about WhatsApp or Netflix, both players use the telecommunication infrastructure but use it in a way that destroys a traditional value pool of the infrastructure operators themselves. Examples of other industries that are currently getting unbundled by digital technology are bank, media, and energy.
Technology and business performance
Global productivity growth in the last decades has not been in par with the growth in information technology spending including hardware, software, data centers, networks, service, new tech, and the related human resources. This amount is nearly $6 trillion per year and grew by a factor of almost 20 between 1980 and 2015. However, in the same time frame, global GDP barely quadrupled. This is referred to as the Solow Computer Paradox inferring that technology investments didn’t help us create more economic value. There are three theoretical explanations for this pattern:
- Technology has beneficial impacts, just not on economic productivity or the GDP, which is a very narrow measure. Technology has changed efficiencies in the workplace such as communication via Skype or numerical modeling to design mechanical parts in only minutes. These advancements have led to more efficiency, stronger risk management, and more value-adding products. All these efficiencies will at some point have trickled down to the GDP and helped it grow.
- Technology has beneficial impacts on the GDP, but will only show after a long time lag. In every massive change, we should expect that only a small fringe of a company or society would be early adopters, therefore creating a delayed bump in productivity growth and this would mean that we are already in times where technology impact is visible.
- Technology has beneficial impacts on GDP and in the short term, but it was neutralized by some other negative business phenomenon. One major factor could be complexity, for example, in 1955 CEOs committed to between 4 and 7 performance imperatives, while today it’s between 25 and 40, with many of those requirements being contradicting. When it was enough for a car to be safe in the 50s, today it needs to be also innovative, cheap, have a good brand name, easy to maintain, and have tons of functionalities.
Despite the Solow Computer Paradox, investments in technology have shown to reap economic returns. A study found that technology adoption leaders outperformed laggards by 13 percentage points in yearly revenue growth in developed markets and by 15 percentage points in developing ones. In the financial services industry, digital leaders outperform digital laggards in customer loyalty and revenue growth. There is also a positive correlation between technology investments and gross margins whereby top-performing companies tend to have higher technology intensity index compared to the industry average.
Therefore, although we don’t necessarily see it in productivity numbers, digital technology has a visible impact on business performance. Some of this impact could be neutralized by the increased complexity generated by competition, customer demand, or regulation. In practice, making the right technology investments translates into higher profitability and higher revenue growth.
Technology evolves faster than what the human intuition can capture. In the last three decades, information processing power, communication speed, and storage capacity have all grown exponentially, consequently, delivering faster, better, and cheaper technological innovations. These technological advancements have rendered the transaction costs to become cheaper and cheaper and therefore disrupting value chains in many industries. While once industries and companies were vertically integrated to gain economies of scale, today, they organize in multiple interoperable layers. Some layers remain scale sensitive, becoming sometimes near-monopolies, but others remain more fragmented with many niche players competing on innovative offerings. With these changes, companies that make the correct technology investments should expect to gain measurable returns on both revenue growth and profitability levels.
