“Digital is coming and it’s coming fast”; “No industry sector is immune to disruption”; “One thing is certain about digital transformation: It will be a big change for your entire organization”; “Every company is a technology company now”; “Digital will disrupt your industry.”
This is just a small selection of the headlines and opening paragraphs of the plethora of recent articles and business books about how business models based on digital technology will, sooner rather than later, usurp your industry and you with it – unless you act now! (and buy the book).
And, in fact, I don’t disagree – at least not entirely. It would be terribly naïve to assume that nothing in your business will need to change although all of us, consumers, are seeing our daily habits and preferences evolve as a result of products and services enabled by digital technology. However, several of the most common beliefs about how this will happen, repeated by conference speakers, self-proclaimed technology gurus, and digital consultants, are oversimplified, not supported by academic research, or plain wrong – barring the most eye-catching of extreme scenarios such as Google, Amazon or Facebook. In most “normal businesses,” the impact of digital will be different than for these big disruptors. Yet, through the haze of the hype, several misconceptions have emerged.
1. Network effects: “does the winner take it all?”
The first common misconception is that in a digital world, the winner takes it all. Many business models that make extensive use of digital technology, especially the internet, have network-type properties. This means that the more users and content-providers you sign up, the better the business model will work. People flock to Facebook, for example, because most of their friends and family are on it, which in turn allows Facebook to collect a large amount of data about us, and attract advertisers. Similarly, people browse eBay because there is a lot on offer and in turn people are eager to market their goods on eBay because there are so many users browsing. Given these network effects – as many proclaim – markets get “winner takes all properties”: the largest network will win, crowding out all remaining competitors. That’s the reason why a company like Uber needs to grow big, fast – and not worry about spending tons of money early on; its investors (who are hammering billions of dollars at present) will reap the rewards later. And sometimes that’s true.
But more often it is not. That is because networks do not need to be exclusive – in fact, they are non-exclusive more often. That’s true even for Uber: Uber’s losses in the first half of 2016 totaled in excess of $1.27 billion. Its investors accept this assuming the profits will follow later, once the network effects kick in, as they for example did for Facebook. However, the crucial distinction is, is Uber’s network exclusive? And it is not.
A network is exclusive if users, for example, sign up to only one network. For Facebook, for instance, that’s largely true. Once you post your updates and news on Facebook few people would go to another Facebook-type site and post the same details there as well. That’s why Facebook ended up pushing MySpace out of the market and a rival product such as Google+, which arguably offers a superior product on various dimensions, has been unable to make a dent in Facebook’s market share. But Uber is not like this, and most networks aren’t.
Travel to Singapore, for example, and you will see why. Every taxi driver has at least two mobile phones in her window: if a ride comes in on one network, she will click “accept” and “off” on the other. Taxi drivers are invariably part of multiple competing networks. Similarly, most users have at least two apps on their smartphone. When they require a ride, they will quickly check both apps and then use the one where a taxi is available quickest and at the best rate. Apparently, both suppliers and customers experience little hassle being part of multiple networks. What does this mean? It means networks are not exclusive and hence there is “no winner takes all” effect. Therefore, in such a business, you need a very different strategy – and a very different investment strategy – if you want to create competitive advantage and reap revenues bigger than your costs.
It is a misconception to think that network effect inevitably and always lead to a winner-take-all market. Sometimes that may be true, but there are at least as many network-type markets that can easily sustain a variety of players. In fact, having a big incumbent network may actually help additional entrants into the market! Misjudge the characteristics of your network effects and your sizeable investments in scaling up rapidly could equally rapidly end up as money down the drain.
2. Complements, not substitutes
A second misconception about how digital technology could disrupt a business, which could lead to a serious misallocation of a company’s resources, is that it will inevitably substitute for the old model, rendering it obsolete. And indeed, we have witnessed e-mail replace the fax machine, flash memory supersede diskettes and Wikipedia supplant the Encyclopaedia Britannica. However, industries with perfect substitutes are the exception to the rule; more often than not, digital will offer a new complement, rather than be a substitute. And this leads to a very different dynamic in the market.
Consider my own field of higher education. Many have been proclaiming that online learning will make lectures obsolete, physical colleges will be replaced by online universities, and MOOCs will be the new norm. However, this is not what seems to be happening. In fact, I have little doubt that when in the 15th century the printing press was invented, many people proclaimed the end of lectures too, since all you had to do now, given the new technology, was buy the book and you could just read what you wanted to know, rather than that you had to listen to boring old Socrates or some other obsolete lecturer. But, clearly, that’s not what happened.
Business models and competitive advantages are complex systems. This means that they consist of multiple elements – some of them tangible; some intangible – which interact with one another, meaning that it is their combination that makes it work. In many markets, digital will just add one new element to the mix or replace one of them, but not often all of them. This means that in many businesses, digital technology will complement and alter the incumbents’ existing resources and capabilities, but it certainly won’t always entirely replace them altogether. Therefore, when making strategy, the focus should be on identifying complements, rather than assuming complete substitution.
3. Place (still) matters.
A third common misconception about how digital technology will disrupt businesses is that people assume that geographic distance loses relevance. However, research tells us that people tend to underestimate the relevance of face-to-face communication and the tacit understanding that we develop of other humans when we directly interact with them. To understand if and how digital may disrupt your industry, you need to understand the nature of the interactions that your business requires.
Consider the management consulting industry. It has been a stable and quite homogeneous industry for many decades. The top firms are what they are and have long been, and they have been doing pretty much the same type of thing for many years. In essence, management consulting is a matching business: firms like McKinsey match consultants with clients. As a firm, McKinsey finds consulting projects and then matches them with people they have recruited and trained. And that’s how they have always done it.
Recently though, companies have entered the scene that figured that, in today’s digital age, there are other and perhaps more efficient ways to match clients with consultants: on-line, through search terms, and by building rich databases. Some started digital platforms where supply and demand could meet – just as they do on eBay, Betfair or Match.com. Others began databases of freelance consultants where they searched for suitable people for the projects they secured. However, most haven’t been able to grow beyond a viable size. What they have underestimated is the relevance of human interaction.
Humans have evolved for 200,000 years, interacting with each other face-to-face intensely in order to cooperate effectively. The skills we have developed as a result of human evolution that enable us to read each other’s emotions, intentions and personalities are largely unconscious but very extensive. In consulting work, this is paramount, not only in terms of how consultants work with clients, but also for who gets matched with whom. In fact, you cannot successfully do consulting without them.
A company that understood this well is Eden McCallum. They too developed a business model based on a pool of freelance consultants, but rather than rely on a database, a matching platform or some other digital search function, they understood that in their business – high end strategy consulting – there was no substitute for really knowing people. Therefore, they made the strategic decision to not rely on digital technology, but rather invest heavily in old-school getting-to-know-people: they developed a team of about 20 partners who maintain relationships and interact on a regular basis with about 700 consultants and over 300 major clients. They have opened up offices in London, Amsterdam and Zurich and were recently highlighted in the Harvard Business Review by Professor Clay Christensen as the prime forerunner of a pending wave of disruption in the consulting industry – albeit with a completely non-digital business model. Eden McCallum shows that not all disruption need to be digital. Digital technology is more likely to make headway in industries and parts of your industry’s value chain where face-to-face interaction is less relevant.
4. Speed? Not so fast.
One of the characteristics of the digital era, people continue to say, is that change is ample and change is fast. And because the world is changing so fast, companies have to change fast too.
The first part of this claim – that the world is changing faster than ever – is in fact already dubious. Academic research suggests that the rate of change has not been increasing at all. Yet, even if your business is undergoing rapid change, this does not mean your company has to change rapidly too – quite the contrary probably.
If in a fast-changing industry you change equally fast, you’re likely be jumping onto all sorts of hypes and fads all the time. Remember, for example, “Second Life”? The virtual world in which people could live through an avatar. It was supposed to be the next big thing. Dutch bank ING decided to act swiftly, and rapidly assembled a large team of dedicated executives who would explore the new technology, develop applications and market its products in the virtual world. ING was determined to not miss the boat. But the boat never took off; Second-Life turned out to be a short-lived fad, which disappeared again after a few bleak years, and ING’s big investment came to nothing.
Sometimes it is better to deal with contextual change and uncertainty by not changing at all – at least not immediately – but give it time to see how things play out. Legendary Intel CEO Andy Grove remarked about this: “you have to be able to be ambiguous sometimes.” What he meant by this, is that top managers sometimes must resist the temptation and the pressure to change quickly, in response to swift environmental change, and not let themselves be cajoled into making a choice too early. A good leader, Grove thought, sometimes needs to resist jumping on a new development hastily and, instead, allow the situation to continue to remain ambiguous, at least for the time being.
If, as a company, you are in an environment where new technologies come and go quickly, you may need to slow down, rather than speed up in an attempt to match that environmental pace. Given market uncertainty, you will really only be able to distinguish the fads from the more substantial developments after several years at least. It may sound paradoxical, but in an environment of ample rapid change, sometimes you need to give it time to see how things play out – and only then act swiftly.
“Digital” is changing the nature of competitive advantage in many businesses – just like major technological developments have done before. However, the change is bound to be not uniform across all industries. Digital technology is affecting and will affect different businesses in different ways. I have highlighted four issues – winner-takes-all networks; complements versus substitutes; issues of distance; the pace of change – that have led to generally-held yet largely inappropriate beliefs about the impact of this new technology. Get these issues wrong and your strategic decisions could lead you seriously astray in the new world of digital.
Freek Vermeulen is an Associate Professor of Strategy and Entrepreneurship at the London Business School. His latest book is Breaking Bad Habits: Defy industry norms and reinvigorate your business (Harvard Business Review Press, 2017).