The Quest for Financial Impact: Four Years of Research Behind the Book
Literally hundreds of books, articles, and presentations on digital transformation. Most are terrible and repetitive or self‐refencing, but there are also quite a few good ones.
Most of them have one of three major shortcomings.
- First, there are many inspiring ideas out there but the advice is mostly based on subjective experience, interviews, and conceptual thinking with some traits of an almost religious common belief system.
- Second, and potentially as critical as a shortcoming, the digital transformation recipes are typically inspired by famous digital‐born companies, singular transformation examples, and successful digital platform strategies.
- Third, even though the “planned digital shock to what may be a reasonably functioning system” is considered to be “no [ … ] sure salvation.”
There seems to be almost no focus on proven financial outcomes for corporates (or any other companies) with the exception of the analysis on EBIT and profit margins by Westerman.
The worry about a “digital paradox, i.e. being unable to capture value from [ … ] digital investments” remains .
Will Your Digital Transformation (Ever) Pay You Back?
The Bad and Good Reasons for Your Digital Transformation
So why do around 70 % of digital transformation efforts still fail? Taking the perspective of a methodology geek, you might argue that this number is mostly based on biased questionnaires designed to convince people they need a new approach to digital transformation.
With such risky digital transformation portfolios and a high share of invested capital likely wasted without plannable payback, many companies will struggle to generate measurable value, whether in sustainable profits or in market capitalization in their respective marketplace. To prevent this, companies should not leverage digital transformation as an objective in and of itself but, rather, as a management tool.
I have seen countless uncoordinated digital transformation projects held together with duct tape and described in consultant ‐ developed presentations. Too often, these so‐called transformations lack strategy and have no understanding of complex dependencies. Digital transformation alone is no formula for winning.
Whatever you do, you should be very aware of the business reasons and expected impact of what you are planning to achieve before you engage them seriously. That is your job and it requires that the business has a sufficient understanding of what these technologies can do. This should never be outsourced to your IT departments and becomes a key skill for any successful business unit.
Always ask the question of what you want to achieve strategically in your business first, before you even consider selecting a single software or a best‐of‐breed solution and project portfolio.
Do not forget politicians, governments, and public institutions, who happily follow the digital transformation trend and therefore influence how companies transform digitally either by setting the tone for a market or by regulation and subsidies for investments. For them the beauty of including the word digital everywhere is that they are suddenly sounding much more modern.
Why Digital Transformation Advice Can Get You Off the Payback Track
Among practitioners, clear definitions of digital transformation are not of much interest.
To stand out and stake their claim, each consultant offers a seemingly unique framework built on different terminologies, elements, and definitions.
At this point, the only common ground seems to be that digital transformation is more than a technology implementation — rather, it is a business transformation triggered by substantial or even disruptive market drivers, and it affects the entire firm’s scope of business in fundamental ways.
I have seen different vendors working together on a digital transformation program needing months to finally understand that everyone has been working based on different assumptions about what is meant by the different teams, with dire consequences for the progress of the program.
- Digitization, in its most basic form, is defined as “the process of converting analogue signals into a digital form”
- Digitalization refers to the transformation of products or services into digital variants to offer benefits versus the original tangible products.
- Digital transformation, on top of being driven by digitalization‐related elements, also needs to clarify what it takes to be transformational.
We cannot afford to leave tens of years of research aside based on the bold (and wrong) hypothesis that the basic rules of technology economics are now void just because we have added the word digital all over the place.
The digital transformation all by itself does not guarantee value, but at least under certain carefully managed conditions it can generate the payback you are looking for.
Under the assumption that digital transformation shares at least some similarities with IT and innovation investments, there must be a measurable path toward financial payback, if done right.
Technology creates value under certain conditions. You must identify and include all key elements of value creation for digital transformation success. Technology‐based value manifests itself in many ways and on many levels. IT (and comparably also innovation) can create value in the form of productivity like other forms of capital, in the form of process improvements, profitability, or consumer surplus. Technology based value is not the same as technology‐based competitive advantage. Technology‐based value could be latent [and] can also create (real) options to reap benefits at later stages of the development. The causal relationship of technology investments and payback “is elusive”. Difficult to fully capture does not mean “impossible”. So far, the favorite tool of many advisors to prove a need for action and lead toward impact has always been the so‐called maturity model.
As you can see, I am critical toward these models, if applied with the wrong intentions. Still, they deserve some reflection given their prominence under the wider term of “future readiness” or most prominently “digital maturity”.
To better grasp the different variations and concepts of the digital maturity idea, clustering them in three different types turned out to be helpful.
- The first type I call abstract digital maturity. This idea of being future ready is easily stated, but most difficult to validate. These defining characteristics remain mostly abstract. They can be beneficial when you encounter digital‐unsavvy companies or managers in initial discussions.
- The second type is functional digital maturity. This type of digital maturity is specific to limited functional areas. These models also have their uses, usually as one qualitative element of very clearly defined optimization programs.
- The third type, aggregated digital maturity, is the most prominent but unfortunately often also untransparent approach in the market.
This should help you to better put all current and future models you might be confronted with into some perspective.
Most of these models share the same problems. Digital maturity surveys can never be more than a subjective internal view without a reliable correlation or even causality to externally measurable payback parameters.
Digital Transformation Payday
Before going broader and deeper into the book, the underlying perspective is of particular importance for digital transformation definition and scope. In the micro category, the individual’s impact on the digital transformation is the lowest level of aggregation; it is followed by a project‐level perspective.
At the top is a firm‐level perspective. The empirical parts of this book focus on the firm and industry aggregation levels.
Five Key Elements of Digital Transformation Payback. Digital transformation as we see it is the business transformation of a firm/ corporation. These transformations have as explained before five characteristics; they are:
- Based on a design/strategy aiming at new winning ways of doing business.
- Triggered proactively or reactively to capture or mitigate already visible or future expected (digital) technology related supply‐ and demand‐side catalysts/drivers.
- Starting with the reactant/scope either in the core business, the adjacent business, or at the frontier beyond the existing business and spreading from there to other areas.
- Planned and implemented sequentially (“waterfall”), “agile,” or in “hybrid” reaction mechanisms/processes.
- Leading on overall firm level to abstract or concrete products/outcomes, which ultimately should lead to competitive advantage and measurable payback.
Leveraging — similar to established innovation research — the distance to the core business, the distinction between “core,” or the “center” business, the “adjacent” business, and the “frontier” business, also called the “edge” is applied to define your starting point or current transformation focus.
Outcomes (products) are structured in two different categories with distinct characteristics: abstract outcomes and concrete outcomes.
One dimension lays out whether the item is more an accelerator or a decelerator of your digital transformation payday; the other just separates the more tangible (easier to measure and quantify) and intangible (more challenging to measure and quantify) items.
Two empirically tested formulas are applied to identify statistically relevant relationships of externally observable digital transformation proxies (the earlier mentioned “replicable references”) to selected value parameters: The first one is for market capitalization (MARKETCAP), to better understand shareholder returns, and the second one is for three‐year average future return on assets (ROA3Y) to better comprehend lagged future earnings.
Residual income valuation‐based models, and specifically the Ohlson model seemed to be the best tool for the objectives of this book.
Asset prices embody the present value of all future dividends expected. The Ohlson model “… replaces the expected value of future dividends with the book value of equity and current earnings… based on the… clean surplus principle, which holds that the change in book value of equity will be equal to earnings less paid‐out dividends and other changes in capital contributions”.
While this market value impact of digital transformation is of major interest for this book, it seemed advisable to look at least into one more directly accounting‐driven parameter as well. Future earnings were the most obvious choice, given their relevance also in the market value considerations. Instead of developing one’s own customized model for future earnings analysis, it seemed best to follow Muhanna and Stoel and their approach. It uses the forward average of return on assets (ROA3Y) over three years (current plus the next two) as the measure of future earnings to allow for a possible lag between digital transformation parameters and the realization of potential value.
Five Key Elements Drive Digital Transformation Payback
Supply‐Side Catalysts: Digital Technologies Alone Do Not Do the Trick.
On the supply‐side we find the following catalysts:
- Technology capabilities
- Workforce skills
- Abundance of funding
In this new world, not a single technology as such becomes a success factor, but rather the capability of a firm to monitor, evaluate, and capture beneficial technology breakthroughs at the right time. The “triple tipping point,” where the technology, the regulatory environment, and social developments play together for maximum strategic impact.
Cloud Technology. The most relevant enterprise technology and supply‐side technology catalyst for digital transformation during the last decade was cloud technology.
In a lot of companies, even if the business‐strategy link does exist, it is then not correctly translated into IT‐strategy implications.
I almost never see cloud transformations designed to target and measure what really matters to the business (as a strategic business objective).
The cloud paradox. The splendors of all the payday accelerators described in the following sections may not remain valid if you are not growing at the same pace as your exploding cloud costs.
A major source of concern remains finding solutions for the issue of massive technical and technology debt.
When you are embarking on or continuing your journey to take workloads into the cloud you must make sure that the long‐term business rationale and approach behind doing so is very clear.
Cloud Technology Payday Accelerators. Your new cloud solutions can ideally be integrated with your digital experience technologies (explained later) and better support end‐to‐end customer journeys. This indirectly can increase related revenue and efficiency drivers. These you can model, target, and measure in your cloud migration business case. More agility and faster time to market in order to react to upcoming market needs. Your cloud solution can provide greater scalability and close‐to‐instant availability. This generates better capacity utilization versus cost ratios. Moving to the cloud can free you up from previous capex constraints, by moving the majority of spending into the opex bucket.
Cloud Technology Payday Decelerators. These decelerators start with (multi‐) cloud strategy design cost, a crucial investment, which is often overlooked, leading to a purely technology‐driven cloud transformation program, followed by the often substantial cost.
For selecting the best fitting vendor or vendor portfolio in the light of the previously developed strategy, license, and usage cost.
Digital experience technology has become an umbrella term for architectures integrating a complex range of marketing, sales, CRM, and service technologies and platforms. It is now envisioned to cover the entire enterprise either by one technology platform or by a tightly integrated portfolio of best‐of‐breed solutions, often combined with paradigms like microservices and headless approaches. Implementing digital experience technology effectively is a multiyear journey.
Digital Experience Technology Payday Accelerators. Once you have all your digital experience platforms up and running, then you can expect incremental revenues from many sources of new customers and within your existing customer base. These could take the form of:
- Higher conversion rates from your campaigns.
- Lower acquisition costs.
- Incremental revenue uplifts from better matching customer needs and (next best) offers when upselling and cross‐selling.
- More successful identification and retention of valuable at‐risk customers.
- Phase‐out or migration of lower‐ or negative‐profit customers to other services.
Digital Experience Technology Payday Decelerators. What you should factor in are the often‐unaccounted‐for cost for a preproject and a feasibility study to be surer of what you are doing prior to starting into the larger exercise. Often overlooked are also the substantial cost (if done right, as usually external neutral expertise is required over a long selection period) for selecting the best fitting vendor or vendor portfolio in the light of the previously developed strategy.
Also, to be considered are:
- Success ‐ critical hiring and training.
- Onboarding cost to replace the inevitable externals you had to onboard in the early parts of your journey with very scarce and highly paid full‐time expert staff (either for implementation or for backfilling, as you still have a business as usual to run in parallel).
- Retention packages for skilled users, developers, and architects you might already have on board.
- Change management cost for the broader organization to actually appreciate and use the new technical, process, and innovation capabilities in line with your overall strategic goals.
Intelligent Automation Technology. The third increasingly relevant supply‐side technology catalyst is more a group of technologies than a single innovation.
Intelligent Automation Technology Payday Accelerators. Rarely have I seen the intelligent automation solutions lead to full headcount reductions as the naivest and, from a worker’s perspective, most feared benefit of adding “intelligent robots” to the workforce. For real transformational personnel cost impact, processes cannot just be painted over with new intelligent automation tools but need to be completely redesigned as part of the overall digital transformation effort.
Intelligent Automation Technology Payday Decelerators.
Analytics Technology Leveraging the massively growing supply of continuously generated data is the obvious next step for value creation.
Analytics Technology Payday Accelerators. Unfortunately, until recently, most analytics efforts have struggled to deliver on the simplest version of that potential.
Analytics Technology Payday Decelerators. On the other side of the equation, analytics payback decelerators are not to be forgotten.
Cyber‐and (Data) Security Technology. All technology capability catalysts come at a substantial risk. Hostile security attacks plus regulatory data security and privacy boundaries from numerous stakeholders start to play an increasing role in any digital transformation.
Cyber‐ (and Data) Security Technology Payday Accelerators. The general problem of estimating cybersecurity and data protection technologies as a digital transformation payday accelerator is that they are abstract.
Cyber‐ (and Data) Security Technology Payday Decelerators.
Digital Reality Technology. The sixth supply‐side technology catalyst for digital transformation is more a cluster of technologies than a technology itself. No matter what the use case is, the abstract benefit claim is always the same — these technologies will generate new sources of revenue, increase productivity, or improve safety.
Digital Reality Payday Accelerators. Unfortunately, scaling up digital reality solutions in a meaningful way first requires a sufficiently large hardware user base in your organization.
Digital Reality Payday Decelerators.
Blockchain/Distributed Ledger Technology. On the blockchain phenomenon, you will find two different views among strategists and technologists. They either see it as an overhyped longtail phenomenon or, and this is the growing faction and includes me, as a potential longer‐term solution to business challenges in highly interconnected ecosystems (for example, supply chains), that is across multiple entities; as a new answer when other technologies have never succeeded.
The core of what business leaders really want to know: When, if ever, is the payback on blockchain implementation happening at scale?
Blockchain/Distributed Ledger Technology Payday Accelerators. The primary abstract benefit of blockchain applications in an ecosystem will always be trust.
Blockchain/Distributed Ledger Technology Payday Decelerators.
Longtail Technologies. As always in the digital transformation age, the attitude of looking for the next big thing and the opportunities underlying these trends becomes crucial.
Next‐Generation Infrastructure. Technology You could argue that fiber rollouts, 5G/6G networks, IoT, and smart infrastructure are already here today and therefore should not be put as a future prospect here.
Quantum Technology. Quantum is expected to transform technology in major areas like computing, sensing, and communications.
Exponential Intelligence. The next generation of AI aims to generate a better understanding of human emotion and intent.
Ambient Computing. Ambient computing will make technology ubiquitous in all our lives.
Workforce Skills. Digital transformation discussions have recently been accompanied by a focus on supply‐side workforce skills in general and the importance of the specific capabilities of digital talent.
Workforce Skills Payday Accelerators. A sufficiently skilled workforce will bring the ability to apply new ways of working in a much more agile and therefore higher‐paced way, which can allow faster time to market of new products and customer‐centric journey improvements with potentially positive implications on revenues.
Workforce Skills Payday Decelerators. However, the benefits of a more capable workforce also come at a price.
Abundance of Funding and New Financing Vehicles. Not surprisingly, many of the described developments under the digital transformation umbrella would not have been/will not be possible if not for “vast amounts of funding”.
Funding Payday Accelerators. First and foremost, new sources of funding open additional sources of capital that can potentially be even cheaper than traditional funding mechanisms.
Funding Payday Decelerators. Unfortunately, the new funding mechanisms do not come without any risks. Beyond the obvious fluctuations in any bitcoin‐related instrument any partnership and new source of capital might lead to very different payback expectations between partners.
Demand‐Side and Overarching Catalysts
Areas that influence your digital transformation. We see:
- Customer needs
- Workforce expectations
- Spending patterns
If one needs to single out the publicly most visible catalyst category driving the need for firms to digitally transform, it would be the apparent changes in business‐to‐consumer (B2C) and in business‐to‐business (B2B) demand.
Customers’ expectations have increased substantially. Long‐term loyalty of customers to firms is at risk. Customers can and will switch and choose services instantly, every time and everywhere. The same is even more relevant for B2B.
They need to adjust their vertically integrated model to a B2B2C model without “endangering third‐party distribution models which have been successful for years”.
Many accelerators, but also — on the downside — decelerators evolve from this key catalyst.
Customer Needs Payday Accelerators. The changing customer behavior and more digital transaction can allow for significantly lower cost to serve if addressed with the proper technical solutions and customer‐centric journeys.
Customer Needs Payday Decelerators. The other side of the coin is that customers are either less loyal or additional cost must be planned in to ensure that loyalty is remaining at similar levels.
Demand‐Side Workforce Expectations. Quite logically, the shift in consumer demographics just described goes hand in hand with rapidly changing demand‐side workforce expectations.
Workforce Expectations Payday Accelerators. The new type of workforce, however, does not only come at a different cost structure (less need of office space, less travel), but it also provides some key benefits as accelerators for your digital transformation payday.
Workforce Expectations Payday Decelerators. On the other side, you cannot just integrate this new type of employees without any cost.
Demand‐Side Spending Patterns One catalyst, closely intertwined with the aforementioned changing customer needs and the later‐described blurring industry boundaries, is the fact that — at least on the consumer side — demand‐side spending patterns seem to converge.
Spending Patterns Payday Accelerators.
Spending Patterns Payday Decelerators. The downside is that as spending patterns converge, it becomes less clear which wallets are addressable, meaning you will face more competition.
Overarching: Industry Barriers Are Blurring, Whether You Like It or Not. Especially for incumbent firms, this combined supply‐ and demand‐side driver is often a key catalyst for venturing into a digital transformation. They are urged to consider a platform play. These catalytic effects of eroding barriers include (heavy) asset infrastructure and products and services that can be digitally substituted and access to capital that can be sourced via new digital‐born financing vehicles.
Industry Barrier Payday Accelerators. Eroding industry barriers simply present the opportunity to diversify.
Industry Barrier Payday Decelerators. Unfortunately, attacking other industries’ profit pools comes at a price, no matter how low you believe the previously relevant entrance barriers have become. It requires you to invest in specific skills, know‐how for verticalization, and make‐or‐buy decisions.
To make this dimension of digital transformation more tangible, I find it to be very helpful to cluster the potential reactants in a simple two‐by‐two scope matrix. One axis defines whether you focus on your existing, incremental, or new markets and customers; the other decides whether you leverage existing, incremental, or new products and relevant.
Depending on how far you go in each of these dimensions, you either transform:
- The core of your business, the heart of your current business model and operations.
- The adjacencies of your business, which are still closely related to your business model and operations today but leverage incremental add‐ons.
- The frontier of your business, which is most often a greenfield approach that has little relation to what you are doing today.
Putting your core (or, as others call it, the center or legacy business) into focus when first embarking on the digital transformation journey is certainly a daring choice to make.
In your core business’s idealized future, all catalysts play their strengths together in a virtuous network to make their sums more than just a simple addition of benefits. And not only that. At the same time, you build a sustainable platform for all your future growth dreams, your real option on your future success.
Unfortunately, my hard‐learned experience shows this only works in flashy presentations.
Digital‐Adjacent Businesses Will Never Be Family Without Proper Reintegration.
Your option of scoping a digital transformation for the adjacent business is comparable to making targeted investments in a few lighthouses outside of the core, serving as a starting point for further transformation.
Over the years, I have seen the effect of a defensive reaction of a core business when the adjacencies are pulled back for scaling. The effect can be so strong, that the adjacent successes are quicker killed than built.
The beauty of adjacent businesses is that the accelerators can usually be siloed and clearly defined.
While the decelerators in a ring‐fenced adjacent transformation are usually easier to plan along the catalysts explained earlier, one major decelerator I have seen has been mostly forgotten — namely, the previously described need for a reintegration.
The most disruptive scope decision for digital transformation is probably completely starting anew and breaking away from the past, which is often most difficult to explain. This is particularly true for established companies in noncrisis situations.
Business benefits for this frontier transformation approach are usually difficult to quantify due to their high volatility of outcomes.
What are the decelerating factors of a frontier business transformation? None, at least if you forget the fact that you are not actually transforming anything.
Agile is easier to implement at the edges of your business, that is, in frontier or adjacent business models (e.g., a new product) or functionally (e.g., in front‐end website design).
If not set up correctly from the beginning, most agile transformations will be doomed to fail before they even start. Agile also requires a far more professional, timely, and customized risk management compared to a waterfall environment.
As usual, the first approach taken to address the weaknesses of two opposite concepts in practice is trying to define a compromise. For digital transformation practice, this is usually summarized under the name of “hybrid” or “bimodal”. Compared to fully “agile” approaches, “hybrid” transformation would admittedly slow you down, but it gives you some more control than pure agile.
As the metaphorical products of our digital transformation reaction process, these outcomes are structured in two different categories with very distinct characteristics:
- Subjective digital maturity status.
- Objective digital impact information.
To give you an overview of some current state‐of‐the‐art research, the following summary tries to cluster objective digital transformation impact products (that is outcome proxies and outcomes) in three groups with increasing tangibility:
- Replicable references
- Operational KPIs
- Financial KPIs
Replicable references have one main advantage. They have turned out to be the easiest to capture as an outcome proxy.
However, given the lack of measurability of these stories and the implied subjectivity of their impact implications, all findings must be taken with a grain of salt.
Operational KPIs can bring one additional advancement to digital transformation value analysis on top of what even the most sophisticated replicable reference analysis can deliver.
The most relevant downside of trying to leverage operational KPIs for systematic digital transformation value analysis is that, externally, this information is not available in any systematic way.
Our third category, financial KPIs (e.g. , data from profit and loss (P&L) statements, balance sheets, cash flow statements) quickly turn out to be the least covered outcome cluster for digital transformation and, even if so, only as part of niche qualitative text analysis.
Apparently, conventions on how to capture digital transformation successes have not found their way into research and practice.
The journey to developing a better understanding of the internal value relationships (in the form of value driver trees and causal models) in your organization is still worthwhile. While this might not help you to find a link to market value, as such, you certainly need to go down this route, no matter what internal resistance you might be facing.
Find something unique that your competitor did not see coming, which will give you the ultimate sustainable advantage in the game you have chosen to play. After all, you are in this game to win. For me, design/strategy is the most important success factor in digital transformation practice.
Only through strategy can you reach the goal of developing a lasting competitive advantage rather than some incremental improvements that cannot ever set you apart.
A true strategy is: A creative exercise leading a clear, target‐state ambition and a fitting configuration of your integrated business and operating model that cannot easily be copied by competitors of whatever current or future flavor.
You do not need an extra for your digital transformation to succeed, it is the other way round. You need to design your digital transformation so that it fits your overall strategy choices for winning. Digital strategy is utter nonsense. You might need to revise your strategy for the digital age, but you certainly do not need and should not have a separate digital strategy. It becomes even worse when firms try to develop multiple “strategies” for each and every catalyst we have discussed before — cloud strategy, AI strategy, RPA strategy, cognitive strategy, and so many more.
Three Predictors in Your Business That Influence Your Digital Transformation Payday
Some Groundwork for Prediction
In Germany we have the nice saying that “everything you say before the ‘but’ is a lie”.
We are looking for signals that an improvement of digital transformation replicable references (DIGITALPROXY) leads to a change in our chosen value variables like market capitalization (MARKETCAP) and future earnings (ROA3Y), ceteris paribus (other things being equal). This is especially so because we do not have the gold standard of causal analysis (experiments) in our hands, so we must instead purely rely on very noisy observational market data.
There is at least some comfort in knowing that the higher a sector or firm scored on DIGITALPROXY, the more this could help to explain higher MARKETCAP, no matter which statistical model you apply.
On average, for all industries/sectors and reports analyzed, there is a somewhat statistically relevant relationship between DIGITALPROXY, and future earnings as measured in logROA3Y. But statistical explanation power is very low, with a shotgun‐like spread meaning that there are many other noncovered influences having a stronger impact. For the firm‐level view, the impact was even more random, ranging from negative to positive, therefore statistically not significant, with even worse explanation power behind the results.
But do we really have to give up on our quest for causality? Even for market capitalization where statistically significant and relevant correlations are at least visible? Fortunately, not yet.
To manage the complexity of potentially infinite digital transformation payday predictors they were, based on the extensive underlying research, clustered in three simple groups, which are explained in more detail in the following chapters:
- Markets: Your sector/industry
- Financials: Your balance sheet and P & L
- Communications: Your communication approach
The obvious candidates for being more digital (e.g., computer hardware, computer software and services, consumer durables, internet, media, and telecommunications) show very different trends and higher means than more traditional industries (e.g., automotive, chemicals, drugs, utilities, insurance, and energy).