How the evolution of digital services is shaping strategy and M&A

• Mar 4: Wipro acquires consulting firm Capco.
• Feb 12: WPP acquires marketing technology consultancy Xumak.
• Feb 1: Accenture acquires Imaginea, a platform engineering firm.
• Jan 20: Mckinsey acquires Candid Partners, a cloud consulting firm.

What is driving the increased M&A activity in digital services? What strategies can we expect industry participants to adopt?

As we look at acquisitions in the digital services space over the past 10+ years, we find two themes:

1. Consolidation: Agency holding companies acquired smaller – usually more digitally centric - agencies, and large IT services firms acquired technology players with a more modern capability.
2. Cross-category extension: Agencies, consulting firms and IT services firms have acquired new capabilities that give them an ability to compete outside of their traditional category boundaries.

To understand why and where exactly this is happening, we have to roll back the years a little and understand how we got here.

The Digital Services Space

Broadly, there have been four entry points into the digital services space. Different types of services firms enjoyed natural advantages in each of these entry points. But these four entry points have increasingly been coalescing, creating the need and the opportunity for services players to expand beyond their traditional areas.

Entry Point 1: Customer Acquisition and Engagement

Primary Buyer: CMO

For many organizations, their journey towards digital transformation started with the need to acquire and engage with customers who were increasingly spending more time on digital channels. So these organizations had to shift their media spend to digital, and experiment with new forms of engagement across different social platforms, mobile, OTT, AR/VR to keep up with their customers’ changing behaviors. 

Typical services required by organizations during this stage included data driven strategy and insights, customer journey modeling, performance marketing, programmatic buying, content creation and production, social and search, customer analytics, marketing automation, etc. This space has always been the dominion of advertising  agencies. With the significant exception of Accenture Interactive, it’s been hard for most consultancies and IT services firms to compete with agencies for these services. What this shift to digital has done, and continues to do, is drive rapid consolidation in the space as the large advertising holding companies acquire digital and data assets to advance both capability and credibility.

One key outcome of the consumer shift to digital was that it gave the CMO and her team a better, and more real time, understanding of consumer challenges. This caused organizations to focus on the overall customer experience to make the pain and friction go away. Which brings us to the next entry point.

Entry Point 2: Customer Experience Redesign

Primary Buyer: CMO/CDO

With an improved understanding of customer pain points, CMOs started shifting spend to solve for these. The initial emphasis was admittedly somewhat cosmetic (albeit non-trivial) like driving consistency in content presentation (e.g. responsive and adaptive web design) or consistent presence across the many social and digital channels. Over time, driven by the dual pressures of continuously rising consumer expectations, and innovation by new startups, organizations started experimenting with new transaction/fulfilment/service models. Think of the number of experience innovations we have now come to expect as normal – customer self service, direct to consumer, subscriptions, buy online pickup/return in store, mobile banking, curbside pickup, etc.

(Photo: Patrick Tomasso on Unsplash)

To deliver these experiences, organizations look for partners who can help them in areas including customer journey modeling and analytics, experience and service design, data integration, customer experience platforms, ecommerce implementation and optimization.

The thing about this particular space is that no traditional player had all the skills required to serve these needs. Agencies – who were better placed to understand and solve for consumer pain – needed deep technology capabilities, while technology companies had to learn experience design, and understand the consumers and the brand.

This particular opportunity space became very attractive for two reasons a) the size of the spend in an area where buyers were willing to try out new players, and b) the growing strategic importance of customer experience and the access it provided into the enterprise. This led to a lot of cross category acquisitions as all service providers tried to gain a share of this growing pie.

The efforts during this period changed the landscape in a few fundamental ways:

• Pulling off these changes was possible only through cross-departmental collaboration within client organizations. More than ever before, the CIO and the CMO became collaborators, the COO was involved as many of these innovations required significant changes in middle/back-office systems and processes. This increased the complexity in decision making and required services firms to understand and navigate multiple C level stakeholders, tilting the scales in favor of larger players.
• This created a spirit of experimentation within organizations as they embraced multiple “little bets” to try and figure out what would resonate with their customers. This in turn created a need for service providers to embrace more agile ways of working.
• A lot of this change required modernization of core technology (using cloud, containers, microservices) – which drove the demand for a different type of industry player – the large IT services company. More on that later in the article.

Entry Point 3: Business Model Reimagination

Primary Buyer: CEO/Board

As consumers started embracing some of these experience innovations, many firms decided to step back and consider the possibility of using that innovation to uncover completely new ways of value creation. This was partly by choice, and partly due to the threat of irrelevance as a new breed of startups challenged long held assumptions around what customers valued.

Expectedly, this has been, and will be, a very Board/CEO driven exercise. While this stage is still playing out, we are seeing a range of actions like

• taking one of those little bets and reshaping the existing business around it (e.g., QSR firms significantly reducing store footprint and promoting drive throughs and curbside pick-ups)
• expanding into a completely adjacent area (e.g. Goldman Sachs’s entry into consumer banking through its online only bank Marcus)
• collaborating with ecosystem partners creating completely new revenue models (e.g., European telco Telefonica partnering with healthcare companies to develop services for remote patient management leveraging its IOT infrastructure).

(Photo: Simon Bak on Unsplash)

Given their traditionally strong relationships with CEOs and Boards, consulting firms have enjoyed a natural advantage here, particularly as it relates to strategy. However, it has required them to acquire design, digital and product development capabilities to bring ideas to fruition. At the same time, given that most of these innovations were made possible by new technology paradigms such as cloud computing, this space has brought technology into the boardroom and elevated the role of traditional technology providers in firm strategy. These firms, who have forever harbored the ambition to get closer to the CEO, have started acquiring consulting capabilities to earn the right to advise on business models and value creation.

A fascinating concurrent shift that this has enabled is helping traditional software product development companies (who have typically focused on the Independent Software Vendor market) find a considerable foothold in the digital services space. As organizations look to reimagine their value proposition, they often end up incorporating digital technologies within their existing products and services creating so-called “digital products”. Many product development companies realized that they could position their robust software engineering capabilities to force an entry into this conversation.

This has resulted in the creation of a new industry category – the digital product engineering services firms. Today, they happen to be among the most valued and sought-after companies who can help Global 1000 organizations build digital products and services and embrace modern software engineering practices. This has caused traditional product development firms to shore up their design and consulting skills, while traditional IT services firms have jumped into the bandwagon by building product development capabilities. As usual, M&A has been a favored approach for bridging this capability gap.

Entry Point 4: Enterprise Digitalization

Primary Buyer: CIO/COO

Unlike the previous three entry points, which for some time at least had a sequential relationship between them, the efforts to digitalize the enterprise have been happening for as long as organizations have used technology. Two things have changed 1) newer computing and software development paradigms (like cloud, containers, devops, microservices) are allowing for a complete re-architecture of enterprise systems enabling speed and experimentation, both highly sought-after qualities today, and 2) all the transformation efforts mentioned previously have accelerated the recognition within organizations that the biggest impediment to realizing their possible future is often their current technology infrastructure and their culture (subject for another post).

This has resulted in organizations significantly ramping up their investments in modernizing the enterprise. These investment areas include

• Cloud migration
• Engineering automation
• Data modernization, privacy and security
• AI/ML
• Robotic Process Automation
• Agile ways of working

Naturally, large IT services firms are the dominant players here. Agencies and consulting just do not have the capabilities at scale to be credible alternatives. The pursuit of this opportunity has driven consolidation in the IT services landscape as the global majors acquire emerging technology companies in an attempt to acquire cutting age technology skills.

Takeaways

I believe there are four things to take away from this fascinating evolution of the digital services space:

1. Given the pace of technological development and adoption by today’s consumers, this evolution will not stop any time soon. Organizations will continue to figure out how to engage with and acquire new consumers on ever new platforms (Clubhouse, anyone?), how to enable new experiences with new technologies, how to collaborate with partners to create new products and services, and how to continue to modernize their applications, infrastructure and organization.
2. As much as customer and business model transformation is driving the need for technology modernization, modernization is enabling previously unachievable experiences (e.g., by realizing better customer insights through cloud analytics) and business models (e.g., by better data sharing with partners through cloud APIs). Together these four spend areas have created a virtuous cycle of transformation, which in turn is continuing to fuel service provider opportunity and ambition.
3. Firm boundaries in the services space will continue to blur. This is both deliberate and inevitable as services firms acquire/develop new capabilities to extend their propositions and increase their relevance. This in turn will continue to drive vigorous M&A.
4. Given the pace and volume of M&A activity over the past 4-5 years, I believe there will soon be a paucity of attractive meaningfully sized assets to be acquired. This will cause acquirers to further increase their involvement and investment in the startup ecosystem to catch ‘em young. More on that another day.