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Are you ignoring the most important digital playing field?

By neglecting digital supply chains and ecosystems, companies risk irrelevance.
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– Apple. Google. Tencent. Alibaba. What do these companies have in common? Yes, they’re all fast-growing global behemoths closely watched and emulated by competitors. But they also share a key characteristic: Each created and leads an entire digital ecosystem.

These days, traditional companies preparing for a digital future focus mainly on how they market and distribute their products and services. That’s sensible. However, such initiatives no longer provide any competitive advantage; they’re merely the table stakes for staying in the game. The aspect that makes the biggest difference in successful digital reinvention is morphing from products to platforms, which means adapting supply chains and leveraging ecosystems.

Exhibit

However, incumbent companies have largely ignored this dimension to date, putting themselves at risk of missing key changes to their industries. This finding, along with others I discussed in two earlier posts, comes from a major research effort my McKinsey colleagues and I undertook to study the progress and implications of digitization’s spread. We found that for incumbents standing still, digital disruption exacts a dramatic cost, reducing revenue growth almost in half, on average, and shaving a third off earnings. We also identified two strategic approaches that put companies on the best footing for addressing digital change.

The case for digital reinvention

The supply chain difference

Digitization of supply chains has a more powerful impact on performance than any other digital initiative. In fact, this dimension of digitization accounts for up to two-thirds of the impact on incumbents’ revenue growth, and more than 75% of the impact on their profit growth. The reason is that a fully digital supply chain often involves the creation of a new ecosystem, which opens the door to a fundamental re-shuffle of how value is distributed among industry players. This, in turn, affects incumbents’ ability to sustain their revenue and profit models.

Digitization of supply chains accounts for more than 75% of the impact on incumbents’ lower profit growth

Think of how new technology, and the resulting digital ecosystem, restructured the music industry’s traditional supply chain. Digital music providers have allowed consumers to “unbundle” albums that were the major source of record companies’ revenues, and search and recommendation tools have shifted power away from record labels’ marketing efforts. Record companies no longer control the music supply chain, nor do retailers control distribution. (For a fuller explanation of the dynamics, please watch this short video.)

A digital-strategy framework

Another example is the impact of advanced robotics and sensors on the retail supply chain. With RFID, retailers can easily track and anticipate stock needs, helping them optimize inventory. Robotics, meanwhile, can double productivity per square meter through more efficient stock organization. As a result, stocking efficiency has become a key differentiator for retailers that adopt these supply-chain technologies.

The ecosystem effect

Digital attackers often combine a digital supply-chain play with a platform-based business model. As my colleagues pointed out in a recent article, companies like Tencent, and Google are blurring traditional industry definitions by spanning product categories and customer segments. “Owners of such hyperscale platforms enjoy massive operating leverage from process automation, algorithms, and network effects created by the interactions of hundreds of millions, billions, or more users, customers, and devices,” they write.

Such platforms have the power to radically alter the value chain, and their numbers are growing. A recent global survey examining the rise of platform-based businesses shows that pure digital players have already created close to 180 such ecosystems, but only a few incumbents — Johnson Controls, Daimler, India’s Apollo Hospitals, Samsung and GE among them — have reacted by building sizeable ones of their own.

Barely 1 in 8 digital plays initiated by incumbents focus on building digital platforms

Our research confirms these findings: Barely one in eight of the digital plays incumbents have initiated focus on creating a platform-based business. Of course, some industries are more progressive on this front than others, with telecom and high-tech twice as likely as banks, for example, to launch a digital platform.

Why haven’t more incumbents tried to preempt such attacks? I think there are three main reasons.

  1. Launching a digital platform requires a willingness to disrupt your industry, and your own business. To date, only 10% of companies have dared to take that route; the majority fear self-cannibalization and the loss of their current dominant position — even though this position may prove short-lived as digitization advances.
  2. Moving into the platform game is hard for companies with legacy IT investments. Building a digital platform requires an agile and scalable IT architecture — something for which most few incumbents prepared in their past technology investments.
  3. The platform game requires an allo-centric rather than ego-centric approach. When investing in a new industry ecosystem, the primary focus should be on growing that ecosystem’s total value. That’s not a natural mindset for traditional companies. Most incumbents worry mainly about their own share of the pie, not about growing the pie for everyone. This is a strategic mistake, as I argued in a 2015 article in the Journal of Digital & Social Media Marketing. The best way to ensure a high share of the digital ecosystem is to both shape it and distribute value fairly in the network, which helps ensure that others adopt the platform and make it sustainable.

Nokia learned this lesson the hard way. It was an ecosystem pioneer when it created a platform for developing mobile applications for the Symbian operating system. However, when it acquired 49% of the OS, it focused on vertically integrating the system and started to reduce its technology and commercial support to the broader network. Many players felt the ecosystem no longer offered them fair value, and moved to other mobile platforms, hastening Nokia’s mobile-phone downfall.

So, what does our research — and my three posts — ultimately add up to? The incumbents that succeed in the digital future are those that cultivate organizational agility, an ecosystem mindset and willingness to self-disrupt. These ingredients will encourage them to engage in offensive strategies rather than just defensively reacting to incursions from digital newcomers, and to experiment with the more radical business models needed to thrive in the digital future.

Jacques Bughin is a senior partner in our Brussels office and a director of the McKinsey Global Institute.

Originally published on LinkedIn.