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Digital Disruption: When to Cook The Golden Goose

The question for most companies isn’t whether to adopt new digital business models alongside their legacy businesses. It’s how to survive the transition.

2016_Q1_feature_1_cover_02Everyone remembers how Netflix imploded in 2011. To cement its growing commitment to streaming video, the company tried to spin off its DVD-only plans into a separate company while hiking prices for plans that combined the two by 60%. Customers responded with howls of outrage, Gigaom reported at the time.

The choice to prioritize streaming wasn’t the problem. That was the right strategic choice at the right time, as proven by Netflix’s subsequent industry-leading expansion into original content, not to mention its tripled valuation. The company’s error lay in shifting its business model too abruptly. Instead of nudging its customers away from DVDs in gradual steps, Netflix tried to force a significant and unexpected change upon them—with disastrous effects. CNNMoney reported that roughly 800,000 customers, or 3.25% of the customer base, cancelled their accounts between July and October 2011, and the company’s market capitalization plummeted 75%. Companies that ignore digitization entirely are the modern era’s equivalent of the last buggy whip manufacturer: their doom is already sealed. Most organizations today need to worry about how to add or change to a digital model without damaging their existing business or customer base so much that they don’t survive the transition. Netflix could easily have become one of the 40% of global companies Cisco CEO John Chambers predicts will be crushed under the pressure to undergo digital transformation. Instead, it bounced back to join the 30% Chambers says will make that transformation successfully. Where will your organization land?

A Companion for the Cash Cow

Legacy companies are often blinded by the ease of milking their long-established cash cows and they overlook insurgent companies that are changing how the game is played, says Michael Liebhold, a senior researcher and distinguished fellow at the Institute for the Future, an independent, nonprofit strategic research group with more than 40 years of forecasting experience.

2016_Q1_feature_1_cover_03With a résumé that includes stints as director of Atari Research Labs, senior scientist at Apple, and chief technology officer at the Times Mirror Company, Liebhold sees the digital economy as a succession of waves: records giving way to CDs giving way to downloads and audio streams, for example. Businesses must either move to the next wave as it emerges or compete with themselves by starting a next-wave company from within, he says. Either way, “You make the change as quickly as you can but as solidly as you can,” says Liebhold. “And that calls for a really crisp vision of the future—not only a possible future or a probable one, but a future that you want to make happen.”

Scott Anthony is managing partner at global innovation and strategy firm Innosight, which was founded by Clayton M. Christensen, the Harvard Business School professor who coined the term disruptive innovation. Ask Anthony about disruption, and he’ll refer to it as both a threat and an opportunity, a chance to strengthen what a business is doing today while enabling new markets. “It’s not either/or,” he insists. “If you’re forward-thinking, you should figure out how you can do both.”

He cites Amazon as a prime example. Ten years ago, it was an e-tailer—a large and influential one, to be sure, but that was its core business. Today, while Amazon continues to sell products, it’s also the world’s largest provider of cloud computing services, according to Fortune magazine.

Another example is activewear company Under Armour, which recently bought two free fitness apps, calorie-counter/food log MyFitnessPal and workout planner MapMyFitness. Under Armour has no plans to stop manufacturing performance gear. However, by extending its brand to include the growing popularity of fitness trackers and other wearable devices, it’s adapting its business model for the age of the quantified self.

Indeed, some industry disruptions will cause no upheaval to the customer base of an existing business. In manufacturing, for example, disruptions expand and enhance the business model, but the end result—the product being manufactured—remains essentially the same, says Lars Bastian, industry principal for manufacturing for SAP Germany.

“It’s the customer who’s forcing manufacturing companies to add digital services such as predictive maintenance,” Bastian says. “Not disrupting the business and failing to enhance the current business model is what damages the business.”2016_Q1_feature_1_cover_04-2

Fine Young Cannibals

While the previous examples show how it’s possible to develop new business models without threatening existing ones, it’s often necessary to cannibalize your legacy business in order to modernize it. If you tear down your legacy business yourself, you can do it at a pace that allows the new business model to compensate for the losses. Otherwise, you risk a having a competitor dictate the terms and timing for you. “If you don’t disrupt, someone else will,” says R. “Ray” Wang, principal analyst and founder at Constellation Research Inc, which helps organizations build digital business models. “Companies that cannibalize their own business are the ones that survive.”

Not Seeing the Truth

Unwillingness, or inability, to recognize that truth did irreparable harm to one of the most recognizable brands of the 20th century. Kodak invented the digital camera but failed to commercialize it for fear of eating into the film portion of its business, reports The New York Times. That gave other companies the opening to create a market for digital photography that quickly shunted film out of the mainstream. Kodak’s sales plummeted from US$19 billion in 1990 to $2 billion in 2015. What remains of the company’s film business is now almost entirely in niche markets like the movie industry.

Get Your Inspiration at the Mall

When you talk about disruption and technology, you have to talk about retail. Retailers are no strangers to change. Over time, the center of the industry has morphed from general stores to department stores to discounters to category-killing big-box stores, and now to the thousandpound gorillas of online shopping. Today, traditional retailers are spending a lot on digital initiatives in hopes of recouping their investment later through improved customer experience that boosts sales. But success seems to depend heavily on how well these initiatives align with the overall brand experience.

2016_Q1_feature_1_cover_05Luxury brand Burberry, for example, has prioritized a digital agenda in refreshing its brand to pursue the young and affluent digitalnative Asian market, as CEO Angela Ahrendts tells Capgemini Consulting. The company was a pioneer in introducing digital catwalks, social media participation, and handheld devices that allow store associates to look up customer history and get crosssell and upsell recommendations in real time on the shop floor. Forbes reports that the company’s successful transformation has kept its sales high even as the world economy has wobbled.

On the other hand, Walmart operates its digital business, walmart.com, from the San Francisco suburb of San Bruno, CA, keeping it entirely separate from the main retail organization in Bentonville, AR, with its own technology team and organizational structure. Although operating an e-commerce Web site looks on the surface like digital transformation, in essence, Walmart created an online version of one of its supercenters without leveraging its store network and data.

Still, as The Wall Street Journal recently reported, Walmart recognizes that it is behind the curve and it is investing heavily, aggressively developing new features to try to catch up to Amazon. Part of this push is a project that has integrated in-store and online transactions so Walmart can leverage that data for other applications. However, this digital transformation is still very much in progress, and the retailer doesn’t expect to generate any profits from e-commerce for several years to come.

Many organizations talk about getting a single view of the customer. For retail, digital disruption has to be about allowing the customer to have a single view of the brand.

Kodak then proceeded to miss another boat by failing to follow the direction of its corporate motto: “Share Moments. Share Life.” It foresaw digital photo sharing, but only in a limited way, as Scott Anthony points out. “Kodak could have created something like Facebook before Facebook did, but it wasn’t able to envision it, because that kind of foresight is brutally hard,” says Anthony.

Today, the company is desperately trying not to make the same mistake a third time as it frantically reviews its intellectual property to see whether it can generate another disruptive technology and actually bring it to market.

Similarly, the digital economy has upended the greeting card industry. When digital-only e-card companies emerged in the early days of the Web, legacy names such as American Greetings, Hallmark, and Carlton Cards were slow to rise to the challenge. The big brands have long since rolled out their own e-card sites, but an April 2015 market research report from Global Industry Analysts indicates that they aren’t so much clawing customers back from the digital competition as they are eating into their own remaining market for paper cards.

Survival Tips

Digital transformation involves a lot of change, not just in how you interact with your customers but also in how you function internally. Let these five tips from experts in innovation be your guide:

2016_Q1_feature_1_cover_061. Let customers rule. Customers need to be at the center of all your initiatives. Put them there by appointing a chief customer officer or chief digital officer whose job it is to know who the customer is and to align all silos to that customer.

2. If you can’t find it, invent it. If you can’t simply adopt an existing disruptive technology, compete with yourself by creating an internal startup to invent and implement it, says Michael Liebhold, senior researcher and distinguished fellow at the Institute for the Future.

3. Consider bringing others in. If you can’t create an internal startup, find an external one with which you can launch a partnership, joint venture, or white-label arrangement, says R. “Ray” Wang, principal analyst and founder at Constellation Research Inc.

4. Have the right platform. Make sure you have an infrastructure capable of supporting the new business model, a budget with room for innovation, and an IT department capable of being agile with your existing technology, says Lori Mitchell-Keller, SAP’s global general manager, consumer industries.

5. Let employees bloom. Technology requires people, so train, recruit, and grow your own workforce for the new business model, says Liebhold. Existing employees have the cultural alignment and tactical point of view you need. After you have a critical mass of competency in the newenterprise skills necessary for your digital transformation, you can start recruiting external hires to build on them.

That said, the core business of the industry remains the same: sending people good wishes for significant occasions or just for fun. It turns out that the proliferation of free e-cards makes some people willing to pay for premium options—and that, combined with brand recognition, may be the point on which the major brands can pivot.

The Balancing Act

Before introducing a new business model that supplements or supplants the old one, companies need to understand how their customers will compare the old and new business models. Is the new digital strategy so obviously superior that customers will welcome it? Or will customers consider the digital business model inferior to the legacy product or service, whether or not it actually is? The answers will shape both the strategy itself and its implementation over time.

Where the digital strategy is clearly superior, it makes sense to pursue further disruption immediately. However, if there’s any question about how it might be received, companies need to move cautiously and introduce the digital offering gradually to keep pace with its maturation and its perception in the market. If the old business model is on its way to obsolescence, companies must be prepared to add the new business model, or switch to the new one, fast enough to beat the collapse of the old business model but not so fast that they alienate their customers.

A Methodology for Disruption

For companies confronting the challenge of growing new businesses before their old ones sputter out, one core question is “How do we determine what our new businesses should be, and how do we pursue them?” Increasingly, the answer is “design thinking.”

Design thinking reverses the idea of starting with a product and then finding a market. Instead of creating a product, service, or business model and then trying to find a market for it, start with a market—the ultimate user—and shape the product, service, or business model accordingly. It fosters “the idea that what matters isn’t a new technological breakthrough or business model for its own sake, but whether it addresses what people like, what they need, and what they don’t know they need,” says Leon Segal, specialist in user-centered and experience design and director of innovation at Interface Analysis Associates.

Designers tend to question the underpinnings of the challenge put in front of them, which is why so many companies are adopting that way of thinking as they develop a strategy for digital transformation, Segal says. It’s not enough to decide to implement a disruptive technology. It’s necessary to define what you mean by disruption, why you want to disrupt existing processes, and how you might do it.

“If you asked me to design a toaster, my response would be ‘What is a toaster? Where does it sit in the kitchen? What is toast? What is breakfast?’ so that we could find a new way to solve the problem,” says Scott Underwood, partner at Innovationship, a consulting firm that guides organizations through the process of learning and integrating design thinking. “Design thinking asks you to question the parameters of the problem you’re trying to solve before you try to solve it.”

In other words, design thinking isn’t just about making products and services attractive and easy to use. It’s about redefining problems in order to generate solutions a company might not otherwise give serious thought to—or think of at all. As a methodology, it’s highly collaborative, focused on brainstorming, prototyping, and multiple iterations, and it’s dedicated to the idea that it’s OK to experiment and even fail spectacularly.

“If Netflix had started the process [of splitting its DVD and streaming businesses] by going out to people’s homes to see how people watch their movies and what their experiences were, it might have arrived at a very different solution for changing their business model,” Underwood says. “How do we transition customers to this new technology without them leaving in droves? What will they want as they make this transition? You have to make the people whose experience is being disrupted a part of the planning process.”

There’s no reason to force your current customers into the new business model unless you can afford to lose them, and few companies can. R. “Ray” Wang, principal analyst and founder at Constellation Research Inc.

The strategy is simple but not easy. It calls for careful attention to the amount of change customers can tolerate at once, as well as a plan for keeping them happy while the change occurs. “There’s no reason to force your current customers into the new business model unless you can afford to lose them, and few companies can,” Wang points out. In other words, while you spin up the growth of your new revenue model to attract new customers who are innovators and want to take advantage of new trends, you still have to manage your existing revenue stream, even though it’s shrinking.

Netflix, having learned from its mistakes, is doing an admirable job of that. Though the company now has nearly 70 million members worldwide, 5 million of them remain DVD subscribers— and according to the Netflix Q3 2015 shareholder letter, those subscribers generated $80 million in profit for the quarter. With numbers like that, it’s no wonder the company apparently plans to continue offering the DVD option for the foreseeable future, even as profits from it dwindle 11% year over year.

This long-tail approach may have been inspired by the software industry, which has a similar need to continue supporting legacy customers with on-premise options even as they introduce new cloud-only and subscription-based products. Anthony singles out Intuit, which dominated the personal finance software market for decades with its Quicken product line. Even after purchasing cloudbased Mint in 2009, it continued to support and update Quicken. It wasn’t until August 2015 that Intuit announced its plans to sell off its flagship brand and focus on cloud services. Even then, Anthony says, it’s notable that Intuit intends to sell the brand rather than simply wind it down.

Andreas Schulze, industry principal for automotive for SAP Germany, offers another surprising example: Daimler. As carsharing, private-ride, and other mobility services become more popular, the German automotive giant behind Mercedes-Benz and Smart is investing heavily in promising mobility app startups and forming partnerships with service providers. It also created car2go, its own subsidiary, to provide one-way car sharing using Smart cars. The idea, Schulze says, is to maintain consumer awareness of Daimler vehicles and the Mercedes-Benz and Smart brands, even as car ownership becomes less common.

2016_Q1_feature_1_cover_01Segmentation Is Needed

Moving carefully calls for market segmentation that aligns with the product’s evolution. Perhaps your earliest adopters should be your newest customers, or your most innovative ones, or your lowest-value customers whom you wouldn’t mind driving back to the legacy product if the new digital offering doesn’t appeal to them. As you achieve greater market penetration or add features and functionality, you can then expand into other market segments.

Unfortunately, there’s no magic mathematical formula to apply to determine just how much time you have to roll out a new offering or disruptive technology, and to whom, before your legacy customer base or income stream collapses. In the end, you simply have to begin, says Liebhold. “Let’s give ourselves a break and admit that this is hard and that we’re going to make mistakes, but don’t let that stop us making the moves.”

Digital transformation is not about a specific product or service as much as it is about preparing your company and its infrastructure for both the immediate changes that you know are necessary and for the unknown challenges that inevitably await in the future.!

About the author:

Merijn Helle is SAP’s Vice President of Industry Value Engineering for Retail.

Fawn Fitter is a freelance writer specializing in business and technology.

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@Top Executive Research, Cover Story, Digital Disruption, Executive Quarterly, Feature 1, Q1 2016