Insights for Digital Transformation

Excerpt from "All World's a Sound Stage..." - article by me and Bogumi? Kamiński published by Cutter Inc, in Cutter IT Journal Issue on Business Driven Digital Transformation (September 2016).

Whether you are a decision maker who sees “the digital” as a strategic necessity or a mid-tier enterprise innovator who wants help her company become a "digital champion" of its industry, do not start your digital transformation journey by merely replicating some action you see emerging in successful digital businesses — be it omnichannel, big data, or agile processes. Exactly this kind of attitude exhibited on a large scale led to the growth and subsequent crash of dotcom investment bubble at the turn of the century.

What you need as a solid foundation and driving force of your digital transformation is a realistic stakeholder’s consensus about the purpose, expected results (for your customers, or your organization) and a roadmap of actions delivering those results. Such consensus requires you to create a shared understanding about the nature of digital business economic environment.

Arguably, one the best foundation for “educated intuition” supporting such consensus comes from the industry which has been for at least four decades a nexus of intense hypercompetition, deregulation, fast technology adoption, business convergence, and shifting business models: entertainment and media.

There is a couple of noteworthy research attempts and insightful speculations relating hypercompetitive business and entertainment. First one is a model or rather a strategic planning framework labeled “Experience Economy,” coauthored by Jim Gilmore and Joseph Pine II. At the centre of their work is a model relating economic value to the progression of value proposition categories — from commodity goods (e.g. coffee beans), to a product (coffee), to a service (a cup of coffee offered in a cafe), to an experience (a cup of select coffee offered in an exceptional environment). Gilmore and Pine argue that this progression of offerings is correlated with growth of unit margins/transaction profitability. This is due to the fact that the pricing mechanism moves from “objective,” based on sheer balance of demand vs supply and established externally by the market, to personalized “value pricing,” which rewards those who provide premium experiences. The authors argue that most businesses should adopt a metaphor where a market is a stage on which service providers orchestrate experiences that — if well executed — are rewarded with better margins.

If you believe that such a metaphor has little to do with your digital business transformation, we suggest to think twice. Is customer experience an important factor affecting the conversion of leads to loyal customers in your business? Are the digital touchpoints, such as web page, a mobile application or a social networking service, becoming essential for your customer relationship? Are you competing for the attention of your clients (or potential clients) with myriads of other offerings trying to squeeze their messages and services into the same time-space of casual smartphone interactions? Are these offerings often unrelated to what you used to call your core business? You have just discovered that every business affected by digital transformation becomes a “show business” — sometimes literally. While your customer is holding a tablet or a smartphone in an Uber car, your mobile commerce application may be competing with Netflix or CNN. Every second less spent on shopping is a shorter opportunity to influence buying decisions, and execute upselling tactics, one second less opportunity to monetize your application through mobile advertising. In the digital world, the heavily standardized mobile devices become the ultimate hubs of “business convergence.” They aggregate thousands of services across all possible industries, allocating the scarcest resource — customer engagement — to those that have the capability to stand out in the crowd.

If you find this picture familiar, then we strongly recommend you pay at least some attention to the findings of Hollywood Economics, a book by UCLA professor Arthur DeVany, who uses some serious mathematical statistics and rigorous research to analyze how the American movie industry actually generates its profits. The book, published in 2003, had a meaningful subtitle: How Extreme Uncertainty Shapes the Film Industry.

The life expectancy of a Hollywood movie is short. According to De Vany, “a movie has less than a 25 percent chance of lasting 7 weeks or more in the Top-50 and less than a 15 percent chance of lasting 10 weeks or more. A film [...] surviving more than 15 weeks on the charts, is an aberration when compared to the population of motion pictures that breaks into the Top-50.” Actually, the movie life expectancy is significantly shorter than the time it takes for the complex process of movie creation.

This disproportion between complexity of the investment and short market life is a major source of risk in digital economy, especially for mature organizations. European telecoms failed in competition with OTTs not because they did not understand the opportunities. The maturity of their business processes, supported by complex IT architecture turned into cost multiplicator, when compared to the cost of greenfield approach to building new services by startups like WhatsApp, or more established new entrants like Netflix, Google or Apple. Risk aversion made them incapable of investing in small niches with high growth perspectives — there were simply too many of them. And their long history of monopolistic position made them difficult business partners for those willing to take the risks. As a result the revenues of European telcos are systematically falling losing more than 10% over last 5 years. In the same booming mobile applications ecosystem, value-added services revenues are shifting to OTT providers, which CSPs carry on their expensive infrastructure.

In Hollywood the profit distribution is extremely skewed. It is a winner takes all game where “less than 20 percent of movies earn 80 percent of gross and less than 5 percent earn about 85 percent of all profit in the business.” [DeVany] The accumulated movie audience which is the primary revenue and profit driver grows over time following non-linear patterns. Initial, small differences between the results of a movie run to extremes. The results are affected by dynamic amplification of the viewers’ sentiment — the outcome of movie experience — which affects the behavior of potential consumers. Word of mouth, social rankings, and retransmitting opinions through social media are forces that trump marketing after the product is launched. This is further magnified by the fact that upselling opportunities, such as movie theme franchises or related merchandise, make sense primarily for titles that gained substantial popularity, increasing the jackpot for the winners.

Similar, non-linear (or “longtail”) patterns of growth are common for digital offerings. Where an innovative consumer-oriented service defines some successful new category of value proposition (e.g., social network platforms, media streaming services), after some initial turmoil, a few clear category winners remain in business with one or two reaping most of the profits.

DeVany proves mathematically that the success of an individual movie cannot be predicted. Marketing or “star power” cannot influence its fate What remains is the quality of the product. DeVany concludes: “None of our results is more surprising than finding that, hard-headed science puts the creative process at the very center of the motion picture universe. […] There is no reason for management to get in the way of the creative process. Character, creativity, and good storytelling trump everything else.” As a caveat, DeVany observes that the quality of a movie is highly subjective and depends on expectations shaped by previous movie experiences. This is why the content components such as storytelling patterns, action dynamics, or quality of special effects need to evolve. Successful movies set new benchmarks which again are crossed in the quest for success. This phenomenon has been also captured by Gilmore and Pine in their model as the continuous erosion of value of offering – force of commoditization effected by market on experience and relationship based offerings. In digital business technology serves as yet another powerful force that speeds up the commoditization – best ideas can be automated and easily replicated in new solutions.

Finally, apart from focusing on product quality, DeVany advocates that investors should focus their attention on movie portfolios rather than try optimizing the economic outcome of an individual project: “the difficulties of predicting outcomes for individual movies are so severe that a strategy of choosing portfolios of movies is more sensible than the current practice of ’greenlighting’ individual movie projects.” Such strategies are routine for venture capitalists, or financial institutions in ther approach to management of credit risk. DeVany’s research suggests that they should also become routine for Hollywood investors, and — if you accept the idea that Hollywood is a valuable metaphor of digital business — a portfolio approach should be an essential element of digital strategies.

Summarising – when defining consensus about the expected results of your digital transformation you need to take into account the following factors:

• Every business in digital era becomes a (sort of) show business — a “tournament” of customer value propositions, business models, and brands competing head to head for customer attentions and appreciation. This tournament is less and less “contained” in product category related market niches, as digital offering becomes more and more convergent.
• Sustainable (non-ephemeral) digital business strategies come either from outstanding customer experience leadership (“top end” approach focused on customer value) or from significant share and influence over an attractive business ecosystem (“bottom end” approach focused on business ecosystem platforms).
• Continuous innovation becomes an essential digital business capability, and should be considered a hygiene factor, not a differentiator. In “top end” strategies the critical innovations are related to customer experience, customer value propositions, and business models of customer engagement monetization. In “bottom end” the innovations are related to operations, and improved “collaboration architecture.”

In markets shaped by extreme uncertainty, you need to manage a portfolio of options. The casino always wins — the more opportunities you can afford to own and test, the more likely you are to win.