The Imagination Gap
Business leaders in at least 16 sectors are still not fully prepared for the digital transformation of their industries.
For the most part, when the future becomes the present, it bears little resemblance to how we had imagined it. Yet it is often similar enough to resonate, if only just a bit, with the expectations of the past. For example, flying cars, which have been anticipated in science fiction for years, still don’t exist. But some autos drive themselves and run entirely on non-polluting hydrogen. Clothing made of aluminum with embedded radios and telephones may never see the light of day. But wearable technology has given us shirts woven with sensors that detect movement, heart rate, breathing pattern, and GPS location. And although the movie Back to the Future most likely erred in predicting that the Chicago Cubs would win the World Series in 2015 (in a sweep of a nine-game set), the Boston Red Sox, the other paradigm of a perennial loser, has won the title three times.
This notion of a future that hasn’t quite conformed to prior expectations is perhaps the most striking facet of Strategy&’s recent series on industry trends, an in-depth analysis of the prospects for 16 of the world’s bellwether sectors. A single surprising conclusion is common to all of them: To profit — indeed, to survive — in 2015 and beyond, companies must not just adopt new, unanticipated, and more decentralized forms of digitization and technological innovation, but must use them to reshape their business models. These advances are rapidly changing the commercial environment, inside and outside companies, but many business leaders are still unprepared for them. Companies in every industry are confronting an imagination gap between the established and safe — but rapidly aging — way of doing business and the opportunities and challenges of the technologies emerging today.
For example, computers are no longer relegated to desks. They can be found in pockets and purses, and are increasingly embedded into every aspect of daily life. A growing number of buildings, automobiles, enterprises, and communities are becoming computers themselves, controlled in shared fashion (and not always consciously) by the people inside them. People increasingly use technological devices to gain unprecedented kinds of control over and engagement with their personal and work lives, actively managing appliances, transportation, entertainment choices, homes, shopping forays, manufacturing processes, and equipment maintenance, among many other activities. This new machine age is affecting virtually every industry — B2B and B2C — by producing a multiplicity of purchasing and behavioral pathways for individuals and firmly shifting the balance of power to consumers. End-users, not upstream companies, increasingly dictate the bespoke shape of the products and services they are offered, as well as the price they pay, their suppliers, their deadlines, and the channels they use.
Buildings, automobiles, enterprises, and communities are becoming computers themselves.
For every sector, it is essential to close the imagination gap by incorporating technology into business models in more creative ways. To be sure, technology as a strategic tool has been a corporate mainstay for many years. But it has often taken on a solipsistic tint: Company strategists presumed a world in which computers everywhere would let customers more expediently and seamlessly access their own business offerings. In this view of the future, the companies themselves were the center of the transaction, determining what products or services to offer, when and where to offer them on the digital grid, how much to charge, what form these items would take, and how quickly they would be delivered. Whether purchasing electricity from a utility or a CD from Amazon, consumers in this vision were, in effect, bystanders, getting limited value out of the deal (generally, some level of convenience and discounts). The largest gains — in efficiency, an expanded customer base, marketing outreach, the sheer number and variety of products and services offered, and lowered costs — would always accrue, in this scenario, toward the companies that used digital technology purely to enhance their existing way of doing business.
As shown by the recent Strategy& analysis of industry prospects, this approach to the kinetic landscape will never work. The most innovative firms can close the imagination gap by rebuilding their businesses, rethinking products and services for a more powerful and more widely networked customer base. By dint of their digital capabilities, these companies will be able to deftly follow the money as their customers, be they manufacturers or shoppers, continuously alter their purchasing needs and choices.
For most companies, this undertaking will require simultaneously scaling and customizing operations. That’s an extremely tall order, underscored by this statement by John Cahill, the CEO of Kraft Foods Group, one of the world’s largest consumer packaged goods companies: “It’s clear that our world has changed and our consumers have changed, but our company has not changed enough.” (Cahill may have had the pending Heinz–Kraft merger in mind when he made this statement, in an earnings conference call in February 2015, about a month before the merger was announced.)
Here’s how this new customer dynamic is roiling some of the most rapidly changing industries.
The Biggest Industry Shake-Ups
The commercial transportation industry is facing perhaps the most radical technology-inspired change in customer behavior. Manufacturers, the sector’s biggest customers, are rapidly adopting 3D printing, which lets companies produce finished goods from a single piece of equipment and minimal amounts of raw material, rather than assembling them from dozens, hundreds, or thousands of parts procured globally. A good example is General Electric’s jet fuel nozzle. Under traditional production methods, this component contained 18 separate parts made from a variety of raw materials. All of these parts had to be machined, cast, brazed, and welded before final assembly. Now, the nozzles are made by 3D printers using a single alloy, in a process known as additive manufacturing, in which successive layers of the alloy are melted, shaped, cut with lasers, cooled, and then laid down in sequence to produce the finished part.
The implication is dramatic: As the need to purchase parts from multiple global sources diminishes, component and materials shipments, a substantial portion of the commercial transportation sector’s revenue stream, will be eliminated or greatly reduced. In fact, as much as 41 percent of the air cargo business and 37 percent of the ocean container business is at risk because of 3D printing. Roughly a quarter of the trucking freight business is also exposed, owing to the potential decline in goods that start as air cargo or as containers on ships and ultimately need some form of overland transport.
The electric power sector is also on the threshold of major change. Smart metering and the smart grid, as well as products like Google’s Nest thermostat, afford consumers fine-grained control over the way they use energy. This control encourages them to demand more say in choosing their energy suppliers. A growing number of nontraditional competitors — including solar companies, Internet firms, and even cable operators — are poised to provide energy and communications services to utilities’ traditional customers.
Many power utilities have enjoyed virtual monopolies, constrained more by regulation than by competition. But the boom in energy innovation — including renewable energy sources, off-the-grid installations and distributed power systems —is rewriting this business equation. In certain regions of the U.S., such as California and the Northeast, localized power generation systems, primarily solar photovoltaic panels chosen by commercial and residential customers, are rapidly becoming common. Much of this grassroots change is being driven by federal and state subsidies, but even when it isn’t, power supplied locally is often cheaper than power supplied via the traditional electric grid. Relatively low amounts of customer-sited generation can significantly affect utility financial performance. According to one study, a market penetration rate of just 5 percent could lead to an earnings reduction for utilities of between 4 and 9 percent.
In the retail and consumer goods spheres, shoppers’ behavior has become wildly pluralistic. People want to move easily across online and offline purchasing channels while demanding an ever-increasing number of product options and full visibility into inventory and pricing. In the past, it was not unusual, for example, for spirits buyers to purchase a premium brand in a bar, a less-costly label at home for personal consumption, and yet another when entertaining guests. But this type of variegated shopping has now spread throughout consumer retail. Fewer consumers are making one big stocking-up trip each week. Instead, many shoppers are visiting premium stores, discounters, supermarkets, and online shops multiple times a week, often deciding where to buy items after researching the best prices on smartphones and tablets. A growing number of shoppers also make frequent repeat purchases through e-tailer “subscription” programs that automatically ship household staples on a predetermined timetable. These shifts in consumer behavior are likely to evolve further in unpredictable, organic ways as people continue to create their own paths to purchase.
Similar consumer-driven disruptions can be seen in healthcare, as individuals use digital channels to obtain more personalized information about their well-being from their providers and as they demand bundled, transparent programs that allow them to pay a single fee for tests and treatments related to a condition or procedure. In the chemicals industry, innovation is moving away from the blockbuster breakthroughs of the late 20th century and toward more incremental advances that address particular customer problems. In the automotive sector, consumers — awash in easily accessible information about vehicle specifications, prices, discounts, quality, and performance — are less loyal to individual brands than in the past and are seeking more sophisticated features at a low cost. They also want a seamless online/offline car-buying experience that simplifies the purchase decision, financing, and insurance. And digital and mobile payment options abound as technology companies such as Apple, Google, and PayPal piggyback on new electronic devices to lure business away from traditional credit card companies by streamlining the buying process.
Three Strategic Solutions
A lot of talk and advice will be offered about the new environment during the next year or two. Indeed, all of the 2015 analyses of industry trends presented by Strategy& provide a great deal of guidance for leaders, most of it carefully tailored to the particular sectors under discussion. But a smart business observer should be most intrigued by three particular suggestions, each of which cropped up multiple times. On the surface, these ideas seem relatively straightforward: Who could argue with better business models, more effective use of digitization, or more highly tailored product lines? But there are reasons that few companies find it easy to put these strategic responses into practice. Each one embodies a contradiction or reflects a challenge that business leaders are struggling to resolve. The three key strategies for companies in all sectors:
Reimagine operations in light of new digitally enabled opportunities. Many companies are so caught up in their existing methods and practices that when industry disruption occurs, they find it difficult to bring new ideas, products, and services to the market. In the process, they cede substantial market share to more innovative entrants. Ongoing R&D and market initiatives that question the viability of the company’s current profit streams and that continually explore other possible directions for the business are crucial, but often missing. The very dynamism that makes a company great in the first place frequently gives way to inertia as company leaders become enamored of established products and services and afraid of the novel. Equally problematic, employee innovation is not rewarded or encouraged sufficiently, while fear of risk taking feeds operational myopia and paralysis. Significant opportunities to benefit from internal creativity are squandered.
The financial-services industry provides an apt illustration. Established companies are so dependent on credit card revenue that they are shortsightedly ignoring an entirely new, lucrative business channel: mobile money products and services. As a result, they are falling dangerously behind new players — often players from other sectors such as technology and telecommunications — in what will be the highest-growth part of the payments market, especially in developing regions with large poor populations.
To distinguish themselves and compete with disruptors from outside the industry, financial-services companies will also have to revisit ideas about such traditional practices as credit scoring and lending programs. Startups are already offering new, more granular, and more accurate models for assessing creditworthiness, even using social media as a data metric by, for example, determining a person’s maturity and reliability from their Facebook and LinkedIn pages. At the same time, new companies are offering commercial loans to entrepreneurs who would typically be turned away by banks and venture firms through “crowdlending” sites that aggregate small investments and charge a slightly higher interest rate than traditional loans.
Establish two-way digital relationships with customers. New devices and channels offer always-on interactions with consumers that can keep them informed and empowered, as well as connected to a company’s products and services. For example, rather than investing heavily in physical supercenters or mega-websites, retailers can now offer convenient omnichannel shopping experiences that combine in-store and digital access on all types of computing equipment. People should be able to search, review, and compare products on a tablet; buy these items at their leisure on a smartphone; and have them delivered the same day; and if they need to exchange goods, they should be able to do it at a store. Although retailers have for many years attempted to integrate the Internet into their operations, they have usually done so while neglecting to assimilate omnichannel capabilities into their business model. The greatest effect of the Internet on retail, in the long run, will not have been establishing e-commerce but raising customer expectations for immediate satisfaction in every channel, offline or online. In other words, the two-way digital relationship will not exist solely in the digital world.
Some retail categories, such as automobile dealerships, are particularly slow to change. Many have almost no connection between what they display on their websites and the sales process in their physical stores. As the popularity of eBay Motors and other vehicle auction sites proves, traditional dealerships will not be able to avoid enhancing their digital relationships with their customers much longer. And some are already taking steps in the right direction. For example, a new service piloted by General Motors hopes to attract car buyers who do research online before making their purchase in a dealership, as the vast majority of car shoppers now do. Under the GM program, consumers can search for, select, arrange financing for, and purchase a car over the Internet — and have it delivered to their doorstep by a GM dealer.
Other creative digital interactions are slowly evolving in every sector, often goaded by the presence of startups that are threatening the revenue and profits of old-line companies. For instance, the emergence of new power distribution firms — for either renewable or fossil fuels — and smart grid technologies is forcing some power utilities to become so-called distribution system operators, shedding their image as monolithic power suppliers. This shift involves incorporating new technology into the grid to bring solar or wind power generated at customer sites onto the network and then distributing it efficiently to homes and businesses as power needs arise. With this technology, customers’ power usage is determined solely by their behaviors — if residents, the hours they are home; if a company, the hours they are open for business; in both cases, the interior climate they prefer, room by room. However, some utilities continue to resist this change and instead are fighting in the courts and among regulators to maintain the outmoded monopolistic protections that made the industry ripe for disruption in the first place.
In their own way, industrial companies are confronting the same necessity to connect more closely with their customers — and their customers’ customers. Some of the more advanced firms in this sector have already begun to incorporate digital sensors and data-gathering equipment into products that are linked to one another and the industrial firm via the Internet of Things (IoT). With this burgeoning network, industrial companies can offer customers real-time performance monitoring, quality management, and rapid response to product failures.
Focus more on the medium-term future needs of consumers. The opportunity to interact and communicate more effectively with customers (and glean more about customer preferences than ever before) gives smart companies an advantage that they lacked in the past. They can use what they learn to anticipate the next wave of demand and avoid getting trapped in the treadmill of near-term line extension–style innovation.
This notion could be viewed as a mass customization version of what was described in The Innovator’s Dilemma, the well-known 1997 book by then Harvard Business School professor Clayton Christensen. Christensen argued (and still argues) that most companies are tempted to rely too long on maturing successful operating strategies, leaving themselves open to competition from creative upstarts that offer the same products more efficiently and cheaply. Today, markets are more complex than they were in the late 1990s. So many industries have been disintermediated in so many ways that there may be a dozen new rivals feeding customer subsegments and niches. It behooves more established incumbents to pick the parts of the consumer base they understand best, and build the capabilities they will need to provide those consumers what they want — today, five years from now, and conceivably five years after that. That doesn’t mean losing flexibility. Building capabilities is not like offering new products; it’s a permanent way to maintain both relevance and flexibility.
The software industry illustrates this balancing act well with its traditional products for the mainstream market and its newer, more technologically tailored cloud offerings, which are set up to serve the specific requirements of companies that use these Web-based applications and storage systems. By contrast, the chemicals industry has, to its harm, not moved quickly toward change. Many major chemicals companies are suffering from being overly invested in specialty chemicals that initially delivered higher margins but are now rapidly commoditizing. They offered these items as virtually finished goods and ignored the need to invest in their own capacity for innovation and commercialization of new products.
To find their route out of this strategic dead end, chemicals companies must find new ways to keep manufacturing costs low enough to be competitive while tailoring their product lines to provide customers with the balance of variety and customized solutions that they want (and can probably purchase elsewhere). More robust technological communications with these customers and their product development plans is critical in this scenario to give the chemical companies a window into customers’ shifting needs and the ability to respond quickly to unexpected deviations.
No industry is exempt from the significant marketplace changes that are agitating the global commercial environment, or from the pace of digitization that is driving these shifts away from the control of the producing companies themselves. And most companies are prevented from addressing these obstacles head-on by their own imagination gaps. The solutions to this dilemma require creativity and will. But the best approach starts with one idea: Although companies don’t have to know how to predict the future, they must have the foresight to navigate the present.
- Jeffrey Rothfeder is the former editor-in-chief at International Business Times and national news editor at Bloomberg News. He is the author of eight books, including Driving Honda: Inside the World’s Most Innovative Car Company (Portfolio, 2014).