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How to win the digital race by coming in second, and other (often surprising) ways to reinvent for the digital world

A new data-driven study on digitization identifies which digital strategies work, and quantifies how well they work.
How to win the digital race by coming in second

– Companies tend to treat digital strategy as more an art than a science. They know they need to do something but aren’t sure what actions will produce the most, or the right, impact. New insights my McKinsey colleagues and I recently gleaned from a major study of digitization for the first time identify what approaches actually work, and quantify how well they work.

As I noted in my earlier post in this series, our findings suggest that digital disruption hits incumbent companies hard, on average cutting 45% of their revenue growth and 35% of their earnings. The reason for this dramatic effect is that digital entrants tend to pursue business models which directly undermine those of traditional players, and often offer better value for customers’ money.

Consider Netflix: Its offering of TV series and movies consumers could watch at their leisure for a few dollars a month with no contractual commitment easily trumped traditional cable and satellite, which came with higher cost and lower convenience. Such disruptive models enable digital attackers to quickly gain market share at the expense of incumbents. In a rush to defend their turf, traditional players often turn to measures that intensify competition among themselves — think how traditional TV providers now offer subscribers streaming services at no additional cost or run aggressive promotions to win subscribers away from existing competitors — further eroding their industry’s profitability.

Our research also found that while all industries are at risk of digital disruption — even those yet to be significantly affected — the impact on individual incumbents is unequal. Companies in the top quartile of revenue growth see only a 20% drop-off in their growth trajectory, as opposed to a 70% plunge for those in the lowest quartile. Clearly, the high performers are doing something that makes them more resistant of attack from digital entrants.

Companies that strategically go on a digital offensive generate 3 times more revenue and profit growth than their more defensive counterparts

So what are the winners doing right? When we looked how companies approach digitization, we found that most do so without changing their overall corporate strategy — i.e., they develop a digital plan without radically transforming their capabilities, portfolio of activities or allocation of resources. Their strategies are essentially defensive.

About 30% of companies, however, approach the digital challenge more comprehensively, revising their entire corporate strategy by going after new market segments and taking more risk. The companies that go aggressively on the offensive, we found, manage to generate three times as much revenue and profit as their more defensive counterparts.

The upshot is that companies that go on the digital offensive are the ones less affected by digital disruption. These companies also tend to score high on the “digital maturity” scale: they out-invest their peers in shifting their portfolios, they ensure that leadership and culture are aligned to help drive the changes digitization requires, and they rewire their organizations to replace siloed mindsets with the agility needed to keep pace with digital evolution.

2 ways to win the digital game

Our next challenge was to see if some digital strategies not only succeed better than others, but actually make companies better off with digitization than without it. Consider Netflix again. You may remember that this company originally rented DVDs by mail, a model on which Netflix built a profitable billion-dollar business in its first decade. However, realizing this model would soon be disrupted by streaming technologies, CEO Reed Hastings decided to pre-empt the entrants and disrupt his own business by launching a streaming service. It was a gutsy move. The change initially spawned a user backlash and slashed the company’s income, but Netflix rapidly made up those losses and exceeded its past revenues within a few years.

Netflix isn’t the only company that managed to rebuild its growth momentum. We found, in fact, that there are two promising ways to successfully reinvent for the digital world.

First mover: the Netflix way

Those who adopt this approach see where the industry is going and aim to get there first. By developing new digital businesses — with sufficient investments to gain a secure footing — they can actually win more revenue and profit from their markets than they had before digitization. Netflix didn’t try to defend its existing franchise; by pursuing a new business model, it managed to extend its original marketplace, going from a regional player to a global streaming service. In fact, most of its subscribers add Netflix to their existing cable or satellite subscriptions, which expands the broader industry’s revenue pie.

We find that roughly 10% of companies apply a similar strategy: they invest up front and dare to cannibalize their own legacy businesses. Now, assume a future that is fully digitized. A company that takes the first mover approach and pairs it with even average performance in such areas as operations, culture and talent yields a 30% increase in revenue growth over what it would have otherwise, or 4.3% of extra revenue a year.

Disruptive strategies are a powerful response to intense digitization

Fast follower: the digitally astute organization

Initiating disruption isn’t the only way to maintain growth, we discovered. The alternative is to take the fast follower route. Under this approach, the company retains the existing corporate strategy, continuing to focus on its existing products and market segments, but aggressively moves to build more digital revenue through cutting-edge organizational agility. In other words, instead of investing heavily in digital businesses, it invests in digital organizational capabilities. It reorganizes to adopt end-to-end digital processes; it taps digital tools and big data to improve efficiency; and it makes sure that management, from the CEO down to front-line managers, is aligned fully on building a digital organization.

Roughly 20% of companies adopt this approach. Assuming again a world of full digitization, we can see that the win for fast followers is smaller than for first movers, but it’s still a win, at 0.4% in annual revenue growth.

Fast-following and great execution are the next best thing to disruption

Most of the companies ranked in the top 25% of revenue growth are using one of these two approaches. So why are they more immune to digital disruption than others? First, agile organizations tend to better anticipate shocks, are more resilient and react quickly with new plans. Second, companies that exploit digital technologies to reinvent themselves tend to be more focused on growth than average.

In my next posting, I’ll explore the aspects of digitization that companies have largely ignored to date — supply chains and digital ecosystems — and why this may prove to be a costly mistake.

Jacques Bughin is a senior partner in our Brussels office and a director of the McKinsey Global Institute. This blog was originally published on LinkedIn.