3 Digital strategies for companies that have fallen behind

We estimate that companies which follow this strategy of digital reinvention increase revenue growth by 0.9% and add 1.8% to their EBITDA growth annually on average compared with peers, write Jacques Bughin and Tanguy Catlin in Harvard Business Review.

You’d think by now that digital technology would be a central part of almost every business’s strategy. Yet, our latest research, based on results of a McKinsey global survey of companies across sectors and geographies, finds that only a minority of companies is fully embracing digital today: in only 15% of firms are digital technologies entirely embedded in more than half of all their businesses. At the other end of the spectrum, we found that about 20% of firms are barely leveraging these technologies at all. The remaining two-thirds of firms generate only 10% to 15% of revenue through digital.

This low intensity, visible across a range of metrics, means that digitization remains a work in progress. (According to the most recent survey of 1,600 companies worldwide conducted in mid-2018 by McKinsey & Company and the McKinsey Global Institute, just 26% of worldwide sales have been made through digital channels. At the same time, only 31% of operation volume are being digitally automated and 25% of interactions in supply chains are being digitized.) What, then, does the future hold for those firms not in the top tier and who have not moved first? Are they inevitably at risk? Or can they still find a way to catch up?

In earlier research, published in HBR and elsewhere, we have documented how digital typically squashes the top- and bottom-line growth of traditional companies, as digital attackers take market share and competition increases. We have also discussed the importance of adopting a digital reinvention strategy that includes investing faster and more in digital than incumbent peers and rebalancing the product portfolio on new digital products and services, to tap into new sources of growth.

About the research

Our analysis is based on the latest results of a regular survey we conduct among a global sample of companies across sectors and geographies. For this research, we analyzed answers provided by more than 1,500 C-suite respondents about their digital operations, including the status of their digitization and how they allocate resources to that digitization. We also asked questions that probed their speed of action (agility), their M&A activities, their practice in regard to digital platforms, and so on. We analyzed the answers and explored how they correlated with measures of financial performance. We found that the six categories we discuss were statistically significant in their correlation with revenue and EBITDA growth, based on a regression analysis. We then ran a principal component analysis which clustered companies based on practices such as their agility and M&A activity, enabling us to correlate those practices with financial performance.

In our latest research, we estimate that companies which follow this strategy of digital reinvention increase revenue growth by 0.9% and add 1.8% to their EBITDA growth annually on average compared with peers.

To study firms’ approaches to digital change, we categorized their strategies into six types, which build different revenue and EBITDA momentum. The different approaches companies adopt with respect to these six categories explains 73% of the variance in profitability that we find across firms, countries, and sectors. Digital reinvention, as described in our earlier work, is one of these plays, and likely the most powerful one. But others have also been deployed, including by firms who are not among the first movers, and they have proved their ability to generate attractive returns. However — and this is why our “yes, it is possible to catch up” is a cautious yes — these approaches can also backfire if executed poorly or in isolation. Indeed, one of our key findings is that certain types of approach need to go together to be effective.

  • Time to market: Whether a company is an early, middling, or late adopter of digitization.
  • Velocity and agility: How effectively a company adjusts core decisions in reaction to digital turbulence.
  • Digital efficiency and effectiveness: This is the degree to which digital could be used for additional benefit for new services and/or increased productivity.
  • M&A engagement: To what degree a company is willing and able to buy or merge with digital ventures.
  • Product and market diversification: The extent to which firms can develop digital offerings beyond their core markets and products.
  • Attitudes to ecosystem competitors: In a time of new digital competition, and digital platforms in particular, does a company adopt a hostile attitude of resistance or look to cooperate?

Incumbents in the middle and even bottom tier of digitization have usually not made early moves. But they have made other strategic choices. For example, about 25% of firms in our survey tell us that they have engaged in digital M&A over the past three years. Some are building more or less agile organizations, while others — as many as 45% — are experimenting with new digital ecosystems, either building their own platforms or looking to cooperate with established ones.

Whereas digital reinvention fundamentally is about high speed of actions and product portfolio diversification, we find additional sub-flavors of this posture that pushed the digital frontier even further. For the best in breed, digital reinvention more often than not focuses on core market diversification and beyond as well as the use of digital M&A. Those companies add a full point of extra revenue and EBITDA growth per year more than “generic” digital re-inventors.

By contrast, the 20% of companies with no (or very low) digitization are paying the price. Our latest data set shows that revenue and especially earnings growth are largely negative for companies that neglect, fail, or refuse to embrace digital innovation; EBITDA can shrink by as much as 8% per year. This is a very large decline — and the main reason for it is that those companies not engaging in digital business transformation are often responding inadequately to the six categories listed above. Companies late to market are also insufficiently agile; they tend to take two to three times as long to make key digital adoption decisions as more digitized competitors. They are also centered on themselves, with limited interest or even resistant to cooperating with other digital native players. When they adopt an M&A strategy, it is defensive, an attempt to defend their boundaries by merging with other analog incumbents. The strategy is often ill-designed, with productivity gains from the merger often lower than the ones they could have gained through digitization and automation.

What, then, should those in the middle do? Among the six categories, we see three as being significant differentiators, but they need to be combined to be truly effective. The three are focusing on agility, embracing digital M&A, and cooperating with digital natives rather than trying to fight or resist them.

Of these three, agility is the glue for ensuring positive revenue and EBITDA success in digital adoption — even if the growth is lower than the potential from an all-out digital reinvention. Agility seems easier to achieve than speed: more than twice as many companies in our survey (35% of the total) are agile than those that are fast moving.

Second, digital M&A can be a way to get back into the race. Merging with or buying digital firms can enable firms to catch up on scale and add missing digital competencies. Currently, when engaged in M&A, more than half of incumbents are still thinking about doing analog M&A. This can simply slow down transformation efforts. But of those looking to use digital M&A, 45% say they are doing so for scale, and 55% are doing so to acquire crucial missing digital capabilities. The latter is especially accretive to profitable growth.

Finally, there is the question about how to react to the emergence of digital native platforms: resist them or cooperate. Our survey results show that, even though digital natives are making inroads into their businesses, more than 55% of incumbents have not yet developed a plan for interfacing with digital platforms. Among those that have a plan, 40% are looking to fight back, while 60% choose to cooperate. Fighting back remains risky; only one in 10 companies claims to have been able to reverse losses and restore growth. Cooperation is a more promising way to rebuild growth, adding an incremental one percentage point of profitable growth. The downside is that if you try a platform play and fail, your performance will tend to be as poor as those without a strategy.

In aggregate, for the companies that were not first-movers, we find that a company can rebuild a profitable growth path by blending the three postures of agility, digital M&A, and cooperation with digital platforms. The latter two postures allow companies to “borrow scale” in digital; the first posture allows them to test multiple options quickly. Only a combination of these three postures leads to positive growth even if, in total, it may not fully compensate for the absence of a digital reinvention. In our research, the number of companies that adopt the three approaches is about as large as those carrying out a full digital reinvention, and about two in three are successful.

In our research, those companies that adopt the three approaches is about as large in number as those carrying out a full digital reinvention, and about two in three are successful.

This article appeared first in Harvard Business Review.

About the author(s)

Jacques Bughin is a director of the McKinsey Global Institute based in Brussels. Tanguy Catlin is a senior partner in McKinsey’s Boston Office and leads McKinsey’s Digital Quotient initiative.