How to evaluate “digital” transformations?

If you ask the business leaders of the top companies across the globe, “how do they define digital?”, you will definitely get different answers. For some, digital might refer to the use of tools and technologies to make their processes efficient, introduce productivity improvements or to transform their organizations. For some, digital can mean the things their IT Functions already do, only better.

Given the vague definition of digital, it is understandable that business leaders across the top companies are often unsure how to evaluate the digital transformation initiatives being presented to them and how beneficial are these for their organizations.

In a 2018 survey of 1,733 managers conducted by McKinsey, about eight in ten managers said their organizations were pursuing digital initiatives. Out of these, 14 percent of the managers said that they realized significant benefits from digital initiatives and only 3 percent said that they could sustain the changes brought through the digital initiatives.

So, what should the business leaders do?

The first thing they should do, is to not get confused with the term digital. 

What the business leaders should do, is to treat these digital transformations same as any investment decision. That is, to evaluate digital transformations on the basis of the cash flows they generate, making sure to factor the “do-nothing scenario” or the base case scenario as well as the intangible benefits that these digital transformations bring in.

This is easier said than done! Getting this right requires a thoughtful strategic analysis.

There are two ways to go this done!

Getting the base case right

Digital transformations should be analyzed against the option to do nothing, but in these scenarios do nothing does not mean no change, it may actually mean value erosion.

Consider the decision that the restaurant industry may have faced over the years to invest in an Restaurant Ordering System which enables them to deliver food at home to their consumers. Now, if a restaurant "X" does nothing in this scenario, it means that they will keep running business as usual, serving customer as an when they come. While, their competitors, who have invested in Restaurant Ordering System, have tapped into both the markets, dine-in as well as home delivery. Restaurant X will likely lose market share over time and maybe fail to attract new customers. Therefore, the base case here is not doing anything, the base case here is losing market share and declining profits.

Potential Benefits from Digital Transformations

It is important to analyze the benefits that you can get out of these Digital Transformations. The companies’ digital transformations typically fall under two categories.

• The first category is the use of digital tools and technologies to fundamentally disrupt an industry, requiring a major revamp of a company’s business model some of which may even cannibalize the company’s core strengths.
• The second category is when companies use digital to simply do the things they already do, only better—in service to, for instance, cost reduction, improved customer experience, new sources of revenue, and better decision making.

Business leaders should take into consideration the above factors while making the decision, keeping in mind that the definitions may be vague for digital, but the principles of valuation are still the same.