Do Companies Get a Digital Home Field Advantage?

Michael S. Goldberg and Vivek Ravishanker

sap_Q316_digital_double_charted_inforgraphicThe digital technologies that are transforming the world economy have converted once-solid industry boundaries into permeable membranes through which new players may enter—or exit. But for established firms, the smartest move right now may be to reinvent their existing markets rather than pursue ventures in unfamiliar business segments.

We used S&P Global Market Intelligence’s Compustat database to examine the diversification behavior of 1,932 companies in 10 industries between 2007—the year the Android operating system and the iPhone debuted—and 2015. Only a handful of firms reported entering a new market segment or exiting an existing one. Analyzing the overall returns showed companies entering new business segments (as defined by the North American Industry Classification System) increased their revenue by an average US$437 million.

However, the companies that charged into new segments were less profitable on average, as measured by return on assets, compared to companies that made no changes or that consolidated into fewer segments (the consolidating firms were the most profitable).

Given that diversification requires investment, it’s possible that companies making strategic moves into new segments have not yet realized the payoff from doing so. Nevertheless, the findings align with the conclusions of a 2015 Economist Intelligence Unit survey (sponsored by SAP) in which more than half (57%) of executives said digital disruption by established competitors posed a greater threat than new industry entrants.


In the Digital Era, Disruption Comes from Within

Companies that stay focused on core business segments are most profitable



Comparison of average rates of change in company-level returns on assets, 2007—2015

Find the New Business Models Within

sap_Q316_digital_double_charted_images1Digital technologies are now fundamental to creating new business opportunities, observes Pontus Siren, a partner at innovation consulting firm Innosight. Companies are finding profitable ideas close to home by using new technologies to transform processes or capitalizing on data they capture from their existing businesses. For example, Disney’s MagicBand, the chip-enabled bracelet that patrons use to buy passes, food, and souvenirs, “is a great example [of] where they are not fundamentally changing the business, but they are transforming the experience,” Siren says.

Using digital technologies to become more efficient or to create a better customer experience should ultimately lead to higher revenue and profits. But companies pursuing digital transformation need to constantly reevaluate their strategies, how they use data and innovate, how they win customers and compete, and how they define their value proposition, says David Rogers, a professor at Columbia Business School and author of The Digital Transformation Playbook.

sap_Q316_digital_double_charted_images2“The traditional idea of putting up barriers to entry and creating a unique, sustainable competitive advantage is not a winning approach anymore,” says Rogers. He argues that tying value generation to meeting evolving customer needs means that executives must be open to making investments that serve this value.

The porous boundaries of the traditional auto industry illustrate this dynamic. Personal transportation is an evolving concept with a bevy of new players: smartphone-hailed ride services from the likes of Uber and Lyft; driverless cars backed by Google; and high-performance electric vehicles with software-based support services from Tesla. These disruptions have prompted a tide of investments from incumbents. As Reuters recently reported, Toyota will invest $1 billion over the next five years in artificial intelligence to enhance driver safety. GM has taken a $500 million stake in Lyft, according to Bloomberg. And Ford, like firms in banking, retail, and industrial manufacturing, has opened an R&D center in Silicon Valley.

Keep an Eye on the Exits

Rogers notes that transformation may also lead to divestments as companies pour their efforts into digital initiatives. He points to GE, which has been working to shrink its GE Capital unit as it beefs up investment in a new business devoted to services for industrial customers using analytics and the Internet of Things. Verizon, Rogers, adds, spun off the famous Yellow Pages business telephone directory business 10 years ago when it decided to invest heavily in its high-speed fiber optic cable network for television and internet services.

“The stock market was really annoyed,” Rogers says. But it was a good call because while the unit still had market value, it was not core to Verizon’s strategy. “That takes leadership,” he says. “‘This is a cash cow, but we can see this is declining in relevance to our market. We’re not going to turn it around, so let’s take money out of it while we can.’ And then they put it in a new opportunity to create value for customers and be a growing area for them.”

Today’s strategic choices involve the same criteria. “Looking to use digital technologies, through the lens of ‘How can I use this to create a new offering and additional value to my existing customers?’ sometimes opens doors to additional customers,” Rogers says. “And sometimes that involves building novel business models that are new to your company.” D!