By Paul Shetler

This blog first appeared on paulshetler.com

When any service can be virtualised, or held to the standards of the best digital companies, then it doesn’t make sense for companies to think of ‘digital’ and ‘the business’ as two separate things: digital is the business.

Keeping digital separate means putting the rest of the business on a path towards decline.

It’s easy for organisations in Australia to be complacent about their future – especially when they’ve reached a level of size and success that allows them to become bureaucratised.

Sandy Plunkett belled the cat back in 2014 in her piece Board to death: Our fat, dumb corporations are clueless on innovation. Sadly, at the time, few appeared to be listening. Too many organisations dismiss the cautionary tales and are only now beginning to respond to digital change, if at all. “Evolution not revolution” appears to be the preferred strategy. Organisations ignore the disruption in entire industries like retail (Amazon), travel (Expedia), hospitality (Airbnb) or in businesses like Kodak or Blockbuster.

For many Australians, changes to the economies in the USA and the UK are things that happened ‘over there’ with limited impact on our economy. In fact, Australian consumers have been beneficiaries of the change.

In the USA, UK, Israel, China, Estonia, Singapore and other digital economies, organisations are embracing the new economics of IT. There is a realisation that the old strategies that organisations relied on – outsourcing, heavy governance, incremental evolution towards digital – will not help them be competitive. Organisations in these economies understand they need to embrace radical transformation if they want to survive and thrive in the digital era.

In Australia, there remains a belief that there is still time, that we can take a decade to manage change, that digital offerings are not going to have an impact on our businesses. Too many of our largest institutions remain in denial.

Nothing could be further from the truth. The Australian retail sector is about to see first hand the devastation that Amazon can have on its industry. Take for instance the impact that online shopping has had on traditional retail in the USA. Recently, it was reported that:

“Macy’s has already said that it’s planning to close 100 stores, or about 15% of its fleet, in 2017. Sears is shuttering at least 30 Sears and Kmart stores by April, and additional closures are expected to be announced soon. CVS [a shopping centre owner] also said this month that it’s planning to shut down 70 locations. Mall stores like Aeropostale, which filed for bankruptcy in May, American Eagle, Chicos, Finish Line, Men’s Wearhouse, and The Children’s Place are also in the midst of multi-year plans to close stores.” More.

EVERYTHING HAS CHANGED

The rise of the digital economy isn’t new, it’s been happening for a while. The economics of IT have fundamentally changed. Take storage costs. In 1980, it cost $438,000 to store a GB of data; in 2000, it cost $11; in 2012, it cost $0.10. Now, you can have your first 15 GB of data stored free on Google Drive. This is the result of a virtuous cycle of cloud computing.

Network effects established early leaders, who invested billions in capital that drastically drove down per unit storage and compute costs. This encouraged more users to consume the cloud leading to more investment by the early leaders. Now, there are really only three players, of which Amazon Web Services is dominant, with Google and Microsoft in close pursuit. It is highly unlikely that any other competitors will replicate the success of the early entrants who made the most of network effects with fast and massive continuous investment. The new economics of IT has radical implications for how organisations should think about their business.

Every company is becoming a software company. We used to think some industries were not under threat, but look at what’s happened in transport (Uber), storage and compute (Cloud), media (Buzzfeed, Huffington Post and Breitbart), payments (PayPal), car share (goGet), publishing (Kindle), music (Spotify and iTunes), education (Moocs and Khan Academy) and recruitment (LinkedIn) – all of these industries have been impacted by hyper digital competition.

Users are demanding more products and services that can be consumed online, anytime. Even businesses with digital offerings are finding they have to continually improve their services to keep competitors at bay. Amazon now has Prime, Fresh and Go. Google is buying, developing, refining and retiring offerings to remain relevant.

Everyone is on the same network for the first time in history

This means that everyone has access to all available products. Every market is now global. This allows for both rapid growth and scale-up as a result of network effects and the fulfilment of niche user needs which has resulted in the growth of internet subcultures and patterns of consumption.

You only need to look at Tumblr, 4chan and YouTube to see the growth of niche subcultures online. Think of Vaporwave as a music genre – it only exists on the internet. The same holds true for blogging, where there are specialised blogs that can reach big audiences because the entire addressable market is global – with this trend being exploited by LinkedIn and Medium.

Competition is growing as the barriers to entry fall

Cheap cloud computing has flattened barriers to entry, allowing new competitors to challenge incumbents. It’s also opened the door to global digital companies, who no longer obey geographic boundaries: they rapidly acquire market share in new countries. That means for instance, Australian retailers are competing against efficient and low cost providers. Amazon is able to track and respond to demand shifts quickly, because of the data it collects – with extremely efficient processes for payments and delivery.

This is competition the likes of which local retailers have never dealt with before. The threat posed by new competitors is even more acute because of the nature of platform economics: the first digital movers – think eBay, Amazon and Uber – have set up rapidly scalable platforms that allowed them to grab huge market share. Companies that wait too long are now being left behind or, worse, are locked out.

Soon, analysts will measure the value of a company’s share price based on the size, scale and pace of their digital transformation programs and boards will be scrutinised for their success in overseeing radical transformation. The smarter analysts will also be examining the type of investment in digital and quizzing CEOs on the scope, speed and outcomes of their transformation efforts.

We’re shifting from CAPEX to OPEX

Twenty years ago, when you needed to spend enormous amounts on licences and physical computers just to get started, it made sense to have heavy governance and lengthy contracts with specialised vendors. Today, you can avoid paying for licenses altogether if you elect to use open source software.

Startups no longer need physical servers, physical firewalls, physical routers, database management system licences, operating system licences – they don’t need to buy any of the software or the hardware required to run their business. They pay by consumption. This is a radical shift that has levelled the playing field and made it easier for new competitors to enter markets.

Institutions can take advantage of the same opportunities. They can begin to act like the very startups trying to disrupt them. They can run experiments, they can do things quickly, they don’t have to go through long CAPEX cycles. Today, they can go onto AWS and quickly experiment to test their ideas. They don’t have to wait for the boxes to arrive before starting, significantly reducing cycle times and cost.

Consider the opportunities for large employers who were paying millions for Solaris, Oracle RDMBS, WebSphere, Oracle SOA Suite, Microsoft Windows servers, SQL servers, BizTalk servers, not to mention the physical servers, routers and firewalls. These days, you might lose your job if you do buy proprietary software, or spend money on physical servers and the facilities to host them. With the change to procurement, existing governance structures suited to the age of CAPEX also need to be upgraded.

The low cost of computing means companies can afford to use a credit card to buy services. This provides the single greatest opportunity for established businesses of any size to streamline procurement processes and access the service offerings of lower cost competitors.

The pace of change is fast – and getting faster

The low cost of IT is encouraging experimentation and rapid learning. That means the rate of automation is intensifying. It’s not just Amazon that’s rapidly increasing its robot workforcefrom 1,000 to 45,000 units in three years. Machine learning and mechanised processes are playing a greater role in white-collar professions like law and accounting. Consumers consistently demonstrate they want cheap and reliable services, and don’t have much interest in engaging with their advisers, with offshoring customer enquiries to call centres being superseded by cognitive interfaces and voice command.

The economics of IT have changed

Business processes and products need to change with the new economics. Digital transformation means:

• Responding in real time to consumer needs, not waiting six months for the next release cycle
• Expanding the market for a product to everyone with a network address, not just people in geographic proximity to shopfronts
• Applying cheap modern technology to build great products, not relying on ancient legacy systems
• Reducing risk as teams experiment with products to see what works, rather than aiming for perfection at the end of a project, before finding out users don’t want what’s been delivered
• Delivering faster, simpler, better products that meet user needs and create increased profitability.

COPING MECHANISMS AREN’T ENOUGH

Organisations are gradually coming to realise this is a new industrial revolution. It is not a phase. It doesn’t require change management. It does require fundamental and radical change, quickly.

A Sloan Management Review survey found that 90% of executives anticipate their industry will be digitally disrupted to either a great or moderate extent. But taking action is much harder; in the same study, only 44% of executives thought their company’s preparation for disruption was adequate.

Lord Francis Maude, who drove the transformation of government services in the UK between 2010-2015 recently reflected:

“… I was sadly disillusioned by the extent of sheer inertia and obstruction, often passive but sometimes active obstruction in the civil service. The worst thing is when civil servants don’t give advice, saying ‘minister, this is a really stupid thing to do’ and rather go along with it but then don’t do it. That is just intolerable and there was far too much of that. So for me it was a disillusioning experience.”

The old strategies for outsourcing, governance, procurement and IT, that organisations think are helping them are in fact often holding them back to the detriment of their shareholders, customers, suppliers and most significantly, to their employees.

Applying the old model of outsourcing to the new economics of IT won’t suffice

Outsourcing to large vendors made sense in the age of CAPEX, when it was expensive to experiment with IT. Now that organisations are competing against firms iterating thousands of times a day, it doesn’t make sense to wait six months for every release cycle, or to put up with exorbitant fees for changes in scope. Even so, too many organisations still apply the old model of outsourcing to the new economics of IT. This outdated strategy creates an opportunity for new entrants to grab market share from industry leaders. As Jeff Bezos famously observed “your margin is my opportunity”.

Companies are being held hostage to the Triangle of Despair

I’ve written before about how any bureaucracy holds back digital transformation. When I worked to fix government services in the UK, we used to call it the ‘Triangle of Despair’:

• inappropriate procurement practices that made it impossible to change course
• heavy governance from the era of CAPEX, even when dealing with the novel, user-facing problems that suit Agile
• using ancient, proprietary IT systems with far too much manual processing.

Each of these problems feeds off a deskilled workforce that encourages a company to rely on vendors and apply heavy governance to manage risk, rather than building in-house capacity and trusting in their ability to deliver. Transforming a company today means re-skilling every layer, from the boardroom to the call centre.

Organisations think they still have time to move

Just last month, Myer’s CEO said that he was confident the company was already well-placed to compete with Amazon. That’s the same thing Macy’s CEO was saying last year, before the company was forced to close 100 stores and cut over 10,000 jobs. We’ve already seen digital disruption in the media industry, with Fairfax announcing another $30 million worth of cost cutting just this week.

The pace of change is slower in highly-regulated industries like financial services, but we can already see FinTech start-ups undermining incumbents’ margins. Insurers are said to be preparing for a radical reduction of their advisor network. The world’s equity crowdfunding market is doubling in size every year, and continues to be dominated by start-ups. Consumer financial services are now ranked by executives as the third most likely sector to experience significant disruption in the near future. These startups may not kill off the banks but they’ll focus on the most profitable parts of the business, and leave behind those lines that are unprofitable for the incumbents to manage.

While the Australian Competition and Consumer Commission chairman Rod Sims in the AFR recently challenged the pace of change in Fintech, Jost Stollman at Tyro made it clear where he thought the challenges lay and more importantly what the future might hold if the industry doesn’t transform itself: “One day we might not be talking about the Big Four but AT&T Financial Services and Alibaba owning banking services in Australia.”

Take a moment to consider that the existing financial institutions employ over 420,000 Australians and may be left with the least profitable parts of their current business having moved too slowly to protect their interest from digital competitors to new platforms. Financial institutions that have twigged to the opportunities have moved quickly. Take for instance JP Morgan and Goldman Sachs. Both institutions are applying digital solutions to transform themselves. They’re becoming different businesses, they’re changing their workforces and their offering:

“At JPMorgan Chase & Co., a learning machine is parsing financial deals that once kept legal teams busy for thousands of hours. The program, called COIN, for Contract Intelligence, does the mind-numbing job of interpreting commercial-loan agreements that, until the project went online in June, consumed 360,000 hours of work each year by lawyers and loan officers. The software reviews documents in seconds, is less error-prone and never asks for vacation.” More.

Goldman Sachs has built an enormous data lake and is applying machine learning to it, with plans to make that information available via APIs: “Historically, the API has been human beings talking to other human beings over the telephone, and all the tools, the content, the analytics, is on the internal platform only. We are shifting this radically and shifting this fast, and we’re packaging everything we do, and actually, we’re redesigning the whole company, around APIs,” he said.” More.

What transformation requires

If companies are to survive, they need to accept the fact that they are now a software company: that they must own and deliver their digital services, and take full responsibility for their digital offerings. To do that, they’ll need to take three steps.

1/ Re-design their internal structure – It doesn’t make sense to split services between a Chief Digital Officer responsible for the front-end and a Chief Information Officer working on the back-end. Great services rely on a front-office and back-office that work together. Both functions should fall underneath a Chief Digital and Information Officer with responsibility for digital service delivery, while highly commoditised systems like ERPs are handled by shared services centres. Switching to digital also means thinking about the aptitudes and skills of a digital workforce.

In Simon Wardley’s parlance Pioneers who are comfortable with Lean and Agile methodologies shouldn’t be allocated tasks involving absolute stability like processing platforms; they need to work on novel, user-facing problems where experimentation and rapid learning is essential. Settlers with the skills to turn MVPs into broader-based products should be encouraged to steal the things Pioneers build, and industrialise them. Town planners skilled in scaling up and perfecting products should be tasked with commoditising existing services. That creates a conveyor built to move products from ideation through to platformization.

2/ Tackle the Triangle of Despair of inappropriate procurement, heavy governance, and broken IT – Procurement should be fast and unbundled, so that companies can reduce costs and access innovative solutions from startups and SMEs; that’s the reason why government agencies are flocking to Australia’s Digital Marketplace and the UK’s G-Cloud. Governance of agile developments don’t involve heavy business cases, which stop teams from changing course based on what they’ve learned; organisations should trust the internal governance built into regular experimentation with users. Legacy systems that leave employees waiting for external systems integrators to give them access to their own data should be retired, in favour of state-of-the-art modern technology they can adapt themselves.

Tackling the Triangle of Despair also means solving the deskilling of the workforce on which it feeds. You can’t improve digital capability in a hothouse like an Innovation Lab, and then expect the business to change around it. The small number of employees who get introduced to modern ways of working become frustrated with the bureaucracy around them, and head elsewhere. Instead, there needs to be digital training at every level of the organisation. That includes in the executive suite.

The people running a software company need to know about the software market they are competing within.

3/ Demonstrate political will – Transformation can be painful, especially for people in an organisation’s legacy areas. Too often, that’s an excuse for digital leaders to pull back and create the theatre of transformation – halfway-house solutions they hope will be enough. A range of these is described in my earlier post. Transformation requires the political will to see these solutions for what they are: a pretence of digital, that will leave the whole organisation vulnerable to disruption.

Instead, leaders need to articulate the need for transformation, and understand that it requires sustained and decisive action, rather than incremental transition. It requires change, not change management. The alternative is to watch the decline of their organisations and plan the transition of workers onto the unemployment queue.

NOW IS THE TIME TO ACT

Australian organisations are unaccustomed to crisis or intense competition. Twenty-six consecutive years of GDP growth have allowed many Australian companies to prosper; but this has also meant that the current generation of Australia’s business leadership has never had to deal with widespread adversity or a serious challenge. Something they have in common with many ‘smashed avocado’ eating millennials.

The leaders of the economy’s oldest, largest organisations – the brownfields – where expansion, redevelopment, or reuse may be complicated by hazardous legacy IT/culture – cannot compete with greenfield startups by doing the same thing they’ve always done.

And it’s not just Silicon Valley we need to worry about. A rising digital China has 800m users, it spends $369bn on research and development each year and only last year filed 1.3 million patent applications. Its universities are graduating over 600,000 engineers. How do Australian companies survive when faced with this level of competition?

Waiting any longer to embrace the change driven by the digital economy and its impact means exposing Australia’s leading employers to the great risk of being unable to compete. In time, it will mean putting an organisation on a Receiver’s watch list. Organisations that want to survive and thrive in the digital age need to embrace the changed economics of IT and take decisive, sustained action to transform themselves immediately. This means redesigning their internal structure, tackling the Triangle of Despair, and having the political will to transform themselves, even where it’s painful.

Only by taking these steps now can an organisation hope to have a future.

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Paul Shetler is an adviser to governments and organisations around the world who are transforming their business. He is a speaker on digital transformation and organisational change. Paul was the CEO of the Digital Transformation Office and the Chief Digital Officer of the Australian Government’s Digital Transformation Agency.

You can follow Paul on LinkedIn, on Twitter at @paul_shetler and stay in touch with his work at paulshetler.com