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Why Digital Strategies Fail – Part 2 of 3

This article first appeared on McKinsey&Company.

Most digital strategies don’t reflect how digital is changing economic fundamentals, industry dynamics, or what it means to compete. Companies should watch out for five pitfalls. Read part 1 here.

Pitfall 3: overlooking ecosystems

Understanding the new economic rules will move you ahead, but only so far. Digital means that strategies developed solely in the context of a company’s industry are likely to face severe challenges. Traditional approaches such as tracking rivals’ moves closely and using that knowledge to fine-tune overall direction or optimize value chains are increasingly perilous.

Industries will soon be ecosystems

Platforms that allow digital players to move easily across industry and sector borders are destroying the traditional model with its familiar lines of sight. Grocery stores in the United States, for example, now need to aim their strategies toward the moves of Amazon’s platform, not just the chain down the street, thanks to the Whole Foods acquisition. Apple Pay and other platform-cum-banks are entering the competitive set of financial institutions. In China, Tencent and Alibaba are expanding their ecosystems. They are now platform enterprises that link traditional and digital companies (and their suppliers) in the insurance, healthcare, real-estate, and other industries. A big benefit: they can also aggregate millions of customers across these industries.

How ecosystems enable improbable combinations of attributes

Can you imagine a competitor that offers the largest level of inventory, fastest delivery time, greatest customer experience, and lower cost, all at once? If you think back to your MBA strategy class, the answer would probably be no. In the textbook case, the choice was between costlier products with high-quality service and higher inventory levels or cheaper products with lower service levels and thinner inventories. Digital-platform and -ecosystem economics upend the fundamentals of supply and demand. In this terrain, the best companies have the scale to reach a nearly limitless customer base, use artificial intelligence and other tools to engineer exquisite levels of service, and benefit from often frictionless supply lines. Improbable business models become a reality. Facebook is now a major media player while (until recently) producing no content. Uber and Airbnb sell global mobility and lodging without owning cars or hotels.

This will all accelerate. Our research shows that an emerging set of digital ecosystems could account for more than $60 trillion in revenues by 2025, or more than 30 percent of global corporate revenues. In a world of ecosystems, as industry boundaries blur, strategy needs a much broader frame of reference. CEOs need a wider lens when assessing would-be competitors—or partners. Indeed, in an ecosystem environment, today’s competitor may turn out to be a partner or “frenemy.” Failure to grasp this means that you will miss opportunities and underplay threats.

While it’s true that not all businesses are able to operate in nearly frictionless digital form, platforms are fast rewiring even physical markets, thus redefining how traditional companies need to respond. Look around and you will see the new digital structures collapsing industry barriers, opening avenues for cross-functional products and services, and mashing up previously segregated markets and value pools. With vast scale from placing customers at the center of their digital activity, ecosystem leaders have captured value that was difficult to imagine a decade ago. Seven of the top 12 largest companies by market capitalization—Alibaba, Alphabet (Google), Amazon, Apple, Facebook, Microsoft, and Tencent—are ecosystem players. What’s not encouraging is how far incumbents need to travel: our research shows that only 3 percent of them have adopted an offensive platform strategy.

Pitfall 4: overindexing on the ‘usual suspects’

Most companies worry about the threats posed by digital natives, whose moves get most of the attention—and the disruptive nature of their innovative business models certainly merits some anxiety. Excessive focus on the usual suspects is perilous, though, because incumbents, too, are digitizing and shaking up competitive dynamics. And the consumer orientation of many digital leaders makes it easy to overlook the growing importance of digital in business-to-business (B2B) markets.

Digitizing incumbents are very dangerous

Incumbents are quite capable of self-cannibalizing and disrupting the status quo. In many industries, especially regulated ones such as banking or insurance, once an incumbent (really) gets going, that’s when the wheels come off. After all, incumbents control the lion’s share of most markets at the outset and have brand recognition across a large customer base. When they begin moving with an offensive, innovative strategy, they tip the balance. Digitization goes from being an incremental affair to a headlong rush as incumbents disrupt multiple reaches of the value chain. Digital natives generally zero in on one segment.

Our research confirms this. Incumbents moving boldly command a 20 percent share, on average, of digitizing markets. That compares with only 5 percent for digital natives on the prowl. Using another measure, we found that revved-up incumbents create as much risk to the revenues of traditional players as digital attackers do. And it’s often incumbents’ moves that push an industry to the tipping point. That’s when the ranks of slow movers get exposed to life-threatening competition.

The b2b opportunity

The importance of B2B digitization, and its competitive implications, is easy to overlook because the digital shifts under way are less immediately obvious than those in B2C sectors and value chains. However, B2B companies can be just as disruptive. In the industries we studied, more B2B companies had digitized their core offerings and operations over the past three years than had B2C players. Digitizing B2B players are lowering costs and improving the reach and quality of their offerings. The Internet of Things, combined with advanced analytics, enables leading-edge manufacturers to predict the maintenance needs of capital goods, extending their life and creating a new runway for industrial productivity. Robotic process automation (RPA) has quietly digitized 50 to 80 percent of back-office operations in some industries. Artificial intelligence and augmented reality are beginning to raise manufacturing yields and quality. Meanwhile, blockchain’s digitized verification of transactions promises to revolutionize complex and paper-intensive processes, with successful applications already cropping up in smart grids and financial trading. Should the opportunities associated with shifts like these be inspirational for incumbents? Threatening? The answer is both.

The Red Tree is the UK’s leading international beauty brand consultancy and a powerhouse of ideas, insight and inspiration. For an informal discussion on how we might help you, please contact us.

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