The New Elements of Digital Transformation

Since 2014, when our article “The Nine Elements of Digital Transformation” appeared in these pages, executive awareness of the powerful and ever-evolving ways in which digital technology can create competitive advantage has become pervasive.1 But acting on that awareness remains a challenging prospect.

It requires that companies become what we call digital masters. Digital masters cultivate two capabilities: digital capability, which enables them to use innovative technologies to improve elements of the business, and leadership capability, which enables them to envision and drive organizational change in systematic and profitable ways. Together, these two capabilities allow a company to transform digital technology into business advantage.2

Digital mastery is more important than ever because the risks of falling behind are increasing. In 10 years of research, we have seen digital transformation grow increasingly complex, with a new wave of technological and competitive possibilities arriving before many companies mastered the first. When we began our research, most large traditional enterprises were using digital technologies to incrementally improve parts of their businesses. Since then, this first phase of activity has given way to a new one. Advances in a host of technologies, such as the internet of things, artificial intelligence, virtual and augmented reality, and 5G, have opened new avenues for value creation. More important, leaders now recognize the need for — and the possibility of — truly transforming the fundamentals of how they do business. They understand that they have to move from disconnected technology experiments to a more systematic approach to strategy and execution.

Some companies have successfully graduated from the first phase of digital transformation and are diving into the second. But many are still floundering: In 2018, when we surveyed 1,300 executives in more than 750 global organizations, only 38% of them told us that their companies had the digital capability needed to become digital masters, and only 35% said they had the leadership capability to do so.3 This has become more worrisome than ever: As COVID-19 accelerates the shift to digital activity, digital masters are widening the gap between their capabilities and those of their competitors.

These conditions prompted us to reexamine the elements of digital transformation that we proposed in 2014. While strong leadership capability is even more essential than ever, its core elements — vision, engagement, and governance — are not fundamentally changed, though they are informed by recent innovations. The elements of digital capability, on the other hand, have been more profoundly altered by the rapid technological advances of recent years.

Accordingly, we’ve revisited the elements of digital capability to reflect the opportunities and impact of new digital technologies. Some of the original elements remain relatively unchanged, some have been reconfigured, and some new elements have emerged. (See “The New Elements of Digital Capability.”) The elements aimed at improving customer experience and internal operations remain important. Employee experience has expanded from a single element to its own set of elements, since employees make the business run and have firsthand insights on where processes need to improve. The elements of business model innovation have expanded, too, with the rise of multisided platform businesses and the increasing dominance of global platform players, such as Alibaba, Amazon, and Google. Last, we’ve given more prominence to the digital platform that underpins all the other elements in a company.

Transforming the Customer Experience

Seeing the business from the outside in — from the customers’ perspective — is as relevant and necessary today as it was in the first phase of digital transformation. But while the focus on customers has not radically changed, the elements needed to create compelling experiences have changed. Today, the three elements are experience design, customer intelligence, and emotional engagement.

Experience design: Customer experience has become the ultimate battleground for many companies and brands. While compelling experiences are easy to recognize, they are hard to design and deliver. That’s because this work requires equal measures of empathic creativity and technological prowess. The former requires tools such as journey mapping, “a day in the life” ethnographic studies, and customer personas, as well as practices such as design thinking. These tools and practices provide an intimate understanding of human behaviors and the ability to surface customer insights through careful observation, skilled listening, and constant experimentation. The latter is powered by the ability to digitally reengineer customer experiences, by integrating front-office technologies and processes with back-office operational infrastructure to instantaneously deliver an uninterrupted service experience, for instance.

Sephora transformed long-standing customer pain points around sampling and purchasing cosmetics into a compelling, digitally powered customer experience. Using AI to match a customer’s skin tones to the most appropriate products and virtual reality to sample the products, the company created a convenient, at-home shopping experience that rivals the personalization of an in-store experience. Sephora’s approach, embedded in an app, attracted 8.5 million user visits between 2016 and 2018, and it has helped the company as the pandemic disrupted the in-store experience.4

Customer intelligence: Integrating customer data across silos and understanding customer behavior — efforts undertaken in the first phase of digital transformation — have become table stakes in customer experience. Now, as machine learning has begun to deliver on its initial promise, real-time customer intelligence is enabling highly personalized interactions and making it possible to deliver accurately focused, proactive customer services, such as “next best offers.”

Stitch Fix is an online styling service that curates personalized collections of clothes, shoes, and accessories for each of its subscribers. The curation is based initially on an extensive customer style survey and then improved and personalized through data such as returns, preferences, and a Style Shuffle feature that invites subscribers to rate clothing images each day. Some 120 data scientists support the stylists at Stitch Fix, which has grown to $1.6 billion in annual sales and $37 million net income since its founding in 2011.5

Emotional engagement: Emotional connections with customers are as essential as technology in creating compelling customer experiences. In one study, emotionally engaged customers were shown to be 52% more valuable than highly satisfied customers.6 This is why companies are using digital technology to solicit and enable customer participation across their value chains: in R&D and product development (for example, Starbucks’ MyStarbucksidea.com), content creation (LinkedIn profiles), logistics (UPS MyChoice), and services (iStockphoto inspectors).

Giffgaff, a U.K. virtual mobile operator owned by Telefonica, has a business model that is powered by its member (customer) community. With a staff of fewer than 250 people, the company has no call center and no customer service department. Essentially, customer service has been outsourced to its more than 3 million members — and it works.7

Transforming Operations

As ever, well-managed operations are essential to converting revenue into profit, but now we’re seeing a shift in the focus of digital transformation in this arena. Advances in sensors, cloud, machine learning, and IoT are allowing companies in every industry to transform their operational capabilities. In addition, leaders are seeing how operational excellence can move beyond back-office efficiency to enable engaging customer experience and business models that competitors cannot copy. This operational transformation is occurring in three elements of digital capability: core process automation, connected and dynamic operations, and data-driven decision-making.

Core process automation: Even as some companies are still implementing traditional automation approaches such as enterprise resource planning, manufacturing execution, and product life cycle management systems, other companies are moving beyond them to digitally reinvent operations. Amazon’s distribution centers deliver inventory to workers rather than sending workers to collect inventory. Rio Tinto, an Australian mining company, uses autonomous trucks, trains, and drilling machinery so that it can shift workers to less dangerous tasks, leading to higher productivity and better safety.

In rethinking core process automation, advanced technologies are useful but not prerequisites. Asian Paints transformed itself from a maker of coatings in 13 regions in India to a provider of coatings, painting services, design services, and home renovations in 17 countries by first establishing a common core of digitized processes under an ERP system. This provided a foundation to build upon and a clean source of data to generate insights. Later, the company incorporated machine learning, robotics, augmented reality, and other technologies to digitally enable its expansion.8

Connected and dynamic operations: Thanks to the growing availability of cheap sensors, cloud infrastructure, and machine learning, concepts such as Industry 4.0, digital threads, and digital twins have become a reality. Digital threads connecting machines, models, and processes provide a single source of truth to manage, optimize, and enhance processes from requirements definition through maintenance. Engineers at Raytheon Technologies, for example, model machine tools at the cutting face — enabling them to design components right the first time, with desired tolerances, surface features, and defect rates. Construction companies link drone-based observations to blueprints to identify and correct problems before they require expensive rework.

The ramifications reach far beyond the manufacturing process. Schindler, a maker of elevators, escalators, and other transport systems, used to manage each of its products separately, making it difficult to understand and manage overall traffic flows in real time. But, by connecting its products and adding analytics, the company is able to optimize transportation across an entire office building or campus — anticipating when people will be moving from one location to another, changing operating speeds and routes accordingly, and responding to mechanical issues before they become outages.9

Data-driven decision-making: In recent years, the basis for operational decisions has increasingly shifted from backward-looking reports to real-time data. Now, connected devices, new machine learning algorithms, smarter experimentation, and plentiful data enable more-informed decisions. This capacity is spreading to strategic and marketing decisions, too. Digital masters are taking advantage of this by integrating operational and strategic decision-making in new and powerful ways.

Flex, a global provider of manufacturing and supply chain services, created Flex Pulse to deliver analytics-based management capabilities.10 Pulse tracks and optimizes inventory usage and supply chain status across more than 1,000 of Flex’s enterprise customers, with each customer able to see its own supply chain information via apps. When a disruption occurs or a risk emerges in one part of the world — a volcano, political turmoil, or a disease outbreak — Flex can adjust its supply chain processes in response. Pulse also provides Flex with deep data-based insight into broader geographic, industry, and supply chain trends so that it can better choose, manage, and negotiate with its sourcing partners.

Transforming Employee Experience

If we’ve learned anything during the past decade of digital transformation, it’s that employees can be either the greatest inhibitors or the greatest enablers of transformation success. Accordingly, companies have begun to focus on the employee experience as intently as they do on the customer experience. Three elements of employee experience transformation have emerged in recent years: augmentation, future-readying, and flexforcing.

Augmentation: Warnings that robots will replace humans have given way to a more nuanced and productive discussion. Now, companies are considering how robotics and other digital technologies can augment employee productivity and performance — enabling people to work faster, smarter, and more safely.

Workers in Huntington Ingalls Industries’ Newport News, Virginia, shipyard use augmented reality to help build giant complex vessels such as aircraft carriers and submarines. They can “see” where to route wires or pipes or what is behind a wall before they start drilling into it. This system and others improve team performance and worker satisfaction by reducing trips to get blueprints and paperwork, managing handoffs across shifts, and showing workers how their work fits within a project as a whole.11

Future-readying: The dynamism of today’s competitive environment highlights the urgency of providing employees with the skills they need to keep up with the pace of change. In the past few years, this has given rise to new models of managing learning and development in organizations, led by a new kind of chief learning officer, whom we call the transformer CLO.12 Transformer CLOs reshape corporate capabilities and culture by revamping learning goals to help employees develop the mindsets and capabilities needed to perform well now and adapt smoothly in the future; learning methods to create learning experiences that are more atomized, digitized, and personalized; and learning departments to make them leaner, more agile, and more strategic. By transforming the learning and development function, these leaders ensure that employees have the capabilities they need to embrace digital technology and drive business transformation.

Julie Dervin, global head of corporate learning and development at Cargill, told us, “Unintentionally, we were creating a learning culture where only a select few got access to high-quality training. … We’ve been fundamentally changing how we design, deliver, and shape those learning experiences to be able to reach exponentially more learners with high-impact learning.”13 The food and agriculture company is shifting its mix to incorporate more digital than in-person experiences — even for senior executives — and learners appreciate the change. It is also introducing new learning opportunities such as “application challenges” where workers receive a short lesson, apply it immediately, and then receive immediate feedback from their peers.

Flexforcing: To respond to fast-paced digital opportunities and threats, companies also need to build agility into their talent sourcing systems. In the past decade, outsourcing provided a partial answer to the challenge but with mixed results. Ecosystems of partners also have been used to provide talent on demand, but managing such ecosystems requires heavy investments in resources and attention. Now, we see some companies seeking talent agility in new ways.

As automation and AI applications take over tasks once performed by humans, some companies are multiskilling employees to make the organization more agile. For instance, oil and gas companies have broadened the occupational scope of their geoscientists using intensive multiskilling training in topics like geology, geophysics, reservoir engineering, and geochemistry to develop a cadre of agile specialists.14

Other companies are using contingent workers, which may represent as much as 40% of the U.S. workforce, to supplement their talent on a variable cost basis.15 Some of them, including UPS and Target, are building their own pools of gig workers by encouraging ex-employees and retirees to boomerang back on a contingent basis to fill important skill gaps.16

Transforming Business Models

In 2014, despite much talk about business model transformation, we found that only 7% of companies were using digital initiatives to launch new businesses and only 15% were creating new business models with digital technology.17 Times have changed. Now, executives in every industry are paying closer attention to how digital prowess can yield business model innovation. Without falling victim to the “everything is being disrupted” mantra, it is clear that the extent of business model transformation is broadening.18 We see three elements supporting business model transformation: digital enhancements, information-based service extensions, and multisided platforms.

Digital enhancements: Business model transformation doesn’t always require disrupting a company or industry. Increasingly, companies are finding ways to digitally enhance their existing business models without requiring major changes to the business. For instance, nearly 80% of traditional retailers in the U.K. are now meshing digital and physical channels through click-and-collect services.19

Others are turning product sales into service offerings. For example, Hilti, a construction tools and products provider, created a tools-on-demand program for its construction clients. Rather than selling tools, it makes a variety of tools available through a subscription service that includes repairs and customized services.20

Information-based service extensions: More and more companies are expanding their product-based business models with information-based services, combining sensors, communication networks, apps, and analytics to create value for customers and new sources of revenue for themselves. This requires advanced analytic capabilities, end-to-end service design, and tight integration with customers’ devices and business processes.

Global tire maker Michelin connected its products using embedded sensors that collect and transmit valuable data on usage, distance, and maintenance needs. Its Fleet Solutions business now provides its customers with comprehensive and convenient tire management services that deliver better cost control, fewer breakdowns, and less administrative work. Essentially, the company has moved to an outcome-based business model, selling problem-free kilometers instead of tires.21 These as-a-service offerings are appearing in every industry and are particularly compelling for large, expensive items such as power turbines and aircraft engines.

Multisided platforms: Multisided platforms have disrupted a range of industries including taxi services, hospitality, and retail, and they are spreading further afield. In 2018, for instance, German steel and metal distributor Klöckner launched XOM, a proprietary online platform to distribute its products. Moreover, the company invited its competitors to join the platform. This positioned Klöckner’s platform as an independent digital marketplace for anyone buying or selling steel, metal, and other industrial products. To ensure fair and transparent access to competitors, XOM is run independently of the core business.22

Launching a successful multisided platform ecosystem requires specific economic conditions, heavy investment, and a strong dose of luck to reach profitable scale. So not every company should try to become the platform leader for its industry. But companies that cannot create their own multisided platforms can still use platform economics to partially transform their business models or find an economically viable role to play in platforms operated by others. For example, global brands including Kenzo, Burberry, and Versace joined Luxury Pavilion, a subset of Alibaba’s Tmall.com, as an entry channel into the lucrative Chinese luxury market at lower risk and cost rather than trying to build their own platform ecosystems.23

Transforming the Digital Platform

The foundation for digital transformation is a clean, well-structured digital platform — the technology, applications, and data that power a company’s business processes. None of the other digital elements can achieve their full promise without it.

Advances in technology and methodology in recent years have made the challenge of building a solid digital platform simultaneously easier and tougher. Cloud computing, agile development methods, external code libraries, and easy-to-use development tools enable developers to build new functions rapidly but can also lead to the proliferation of inconsistencies and complex tangles of tech spaghetti. On the other hand, Agile, GitHub, DevOps, as well as containers and microservices, make it easier to coordinate changes; innovate quickly, safely, and smartly; and avoid reinventing the wheel. The digital platform has three interrelated but distinct elements that work together to power your company.

The first element is the core platform, a strong foundation for operational and transactional systems (back-office systems, systems of record, etc.) that power a company’s key processes. This core platform — an organization’s technology backbone — should be well structured, well managed, and only as complex as it really needs to be.

The second element is an agile externally facing platform that powers the websites, apps, and other processes that connect to customers and ecosystem partners. This platform is more than a pretty front end. It needs to work with the core platform to perform key transactions such as payments and serve as an attractive and agile platform for conducting customer-facing experiments and delivering personalized experiences.

The third element is a data platform that provides the ability to perform intense analytics, as well as build and test algorithms, without disrupting the company’s operational systems. In recent years, we’ve seen a tremendous increase in algorithms that use unstructured data — such as text, images, and voice — to improve customer experience or internal operations, making data platforms a key component of digital innovation.

Along with these technology and architecture elements, we’ve seen the dawning of a hard-won recognition of the importance of the IT function in making digital transformation work. Many first-wave digital transformations did not include IT as a partner and failed as a result. Now, IT leaders are driving digital transformation in some companies. In other companies, IT and digital and business leaders are working more closely together to make the digital transformation faster, more innovative, more comprehensive, and more effective than before.

Digital transformation has risen much higher on the corporate agenda since our article and book in 2014, and the drive to maintain operations disrupted by COVID-19 has made it an even higher priority. But even as companies have had to move quickly to adjust to the realities of a global pandemic, their leaders also need to take a longer view. They need to consider how digital technologies can be used not only to enhance their products and processes but also to reinvent their businesses. In this article, we have shared examples that can help executives identify opportunities to increase digital capability across the business. This digital capability and the leadership capability to envision and drive organizational change are the key ingredients for meeting this challenge.