In enterprise technology, digital transformation is a hot topic. But what does it really mean? Overused by vendors and consultants, the phrase has become nearly meaningless.
This needs to change. Digital transformation should be something practical and tangible, something in reach of all organizations—provided business leaders make a sustained effort.
This post provides a simple definition of digital transformation, breaks down the main types of digital transformation, and recommends an approach for developing a digital transformation strategy.
What Is Digital Transformation?
Our overall definition is simple:
Digital transformation is the use of digital technologies to enable an organization to improve or evolve into something new.
In other words, digital transformation means using digital technologies to do something better or to create something that did not exist previously, as shown in Figure 1.
Although the term may be new, the concept is not. Digital transformation has its roots back into the 1950s, when digital computers were first introduced in business. Digital transformation began then, although the technologies available today are obviously far better and more powerful than what was available back then.
Now, in practical terms, what does it mean for an organization to improve or evolve into something new? To make our definition tangible, it will help to understand that there are five types of digital transformation, also as shown in Figure 1.
1. Transforming Business Processes
The first and simplest type of digital transformation is to transform business processes. This is clearly in the category of “doing something better,” and it goes back to the first days of the commercial use of computers. Retailers were early adopters, using computers from companies such as National Cash Register (NCR) to computerize paper-based processes for daily flash sales, inventory, accounts receivable, payroll, and other functions. All of these early systems were developed by in-house programmers: There were no packaged software providers at the time. Although they took legions of developers, they had a huge payoff in productivity.
Digital transformation of business processes continues today, but with new and more powerful technology. A retailer that is still running computerized daily sales reports developed 15 or 20 years ago now needs more digital transformation. The bar has risen. The competition is applying big data analytics to transform the pricing decision process, allowing buyers to set pricing and markdowns every day, store by store, SKU by SKU.
2. Transforming Business Relationships
The next type of digital transformation is to transform an organization’s relationships with its customers, suppliers, employees, and partners. E-commerce is the most obvious example. E-commerce not only improves the business processes between trading partners, whether B2C or B2B, but it can also improve the nature of the business relationship, from one that is largely transactional to one that is more strategic. On the customer side, it means gaining a deeper understanding of the customer and all customer interactions, whether online or offline.
This transformation is not limited to product-based businesses. Services organizations are also transforming their business relationships. Online banking is one example. Patient portals for healthcare providers are another. With ubiquitous access and electronic notifications, digital technology can create a closer relationship between the service provider and the customer. Ultimately, if done correctly, it makes it easier for customers to do business with the service provider.
3. Transforming Business Insights
The third type of digital transformation is in gaining deeper insights into the business and its markets. Businesses have always sought this understanding, but today’s technology allows them to gain insights more deeply and more quickly. Massively faster computing speed and larger data sets, along with artificial intelligence and machine learning, are enabling business leaders to understand customers and the market landscape as never before. Moreover, these capabilities are not limited to large companies. Cloud computing makes these capabilities available to even the smallest businesses.
Big data analytics can be applied to any source of data, whether click-stream data from the organization’s website or sensors on the company’s products. Retailers analyze point-of-sale data to quickly spot trends in demand from store to store and SKU by SKU, to avoid stockouts while minimizing inventory levels and optimizing pricing. Medical imaging devices today throw off enormous amounts of data regarding device performance. Among other uses, device makers analyze this data to provide feedback to product development on how the devices are being used in the field. SaaS providers use click-stream data flowing through their systems to understand what features and functions are being used the most, and where opportunities exist to make the system more intuitive.
Analytics can also be applied to data sets originating outside the organization. The U.S. government website data.gov offers nearly 250,000 files to all takers, including data sets on climate, consumers, energy, health, manufacturing, and much more. Weather data, for example, can be used to fine-tune demand planning for supply chain and retail applications. Sentiment analysis from social media streams is another example.
4. Enabling New Products and Services
The fourth type of digital transformation is to transform an organization’s products and services. Now we are getting beyond “doing something better” into the category of “doing something new.” For example, digital technology in the 1960s allowed the transformation of machine tools from purely mechanical devices to computerized numerical control (CNC) machines. Machine tools before that time took hours or days to set up and typically ran very large batch sizes to justify the set up time. In contrast, CNC machines could be set up in less than an hour and, through programming, could combine multiple operations into a single step, allowing smaller lot sizes, more flexible production schedules, and greatly lower inventory levels. Machine tool makers were transforming their products through incorporation of digital technology.
Today, CNC machines are a given in the machine tool industry. But there are new ways to digitally transform products. Smart products are the latest development. There is hardly a product today that cannot be transformed by the addition of digital technology, whether sensors in kitchen appliances or internet connectivity in household thermostats and doorbells.
Digital transformation can also be applied to an organization’s services. Once digital technology is embedded in a smart product, it can be used to enable smart services. Think of the medical device that alerts a field engineer that a replacement part is needed based on hours of operation, or a machine tool that is trending out of specification. In some cases, repairs or adjustments can be performed remotely, further transforming the after-market services.
5. Enabling New Business Models
The fifth type of digital transformation is to transform an organization’s business model to make money in new and different ways. Many of these involve complementing product sales with new services that are enabled by digital technology. Caterpillar is well known for its heavy equipment sold into industries such as construction, mining, and forestry. Its equipment has long been digitized with sensors gathering data throughout the operational life of the product. But Caterpillar is now using this data to deliver its job site solutions, such as fleet management services, which are a value-add to Cat’s traditional product sales. Cat is not just selling equipment: It is selling project success.
There are even new business models emerging in agriculture. Farming is truly a prehistoric industry, dating to the Neolithic age. But today, it is a high-tech industry. “Precision farming” puts sensors among crops to optimize irrigation, minimize pesticide use, and measure crop maturity. Some agricultural service providers are using this technology to offer new services based on the resulting data.
In the B2C realm, a new business model might mean turning ad-hoc buyers into subscribers, on a regular replenishment schedule. The resulting predictability of demand might enable the seller to reduce inventory and justify lowering prices, further enhancing its competitive advantage.
The five types of digital transformation are not mutually exclusive. In fact, a digital initiative becomes more strategic when it can lead to multiple types of transformation. For example, a big data analytics initiative might deliver deeper insights into customer behavior or preferences and, as a result, it might lead to new services that are based on those insights. That, in turn, might allow the organization to establish a new business model that leverages those new services. Or, a manufacturer might build intelligence into its products, which might generate data that give the manufacturer deeper insights into how customers are using those products and might allow the manufacturer to automate business processes in customer service.
A Journey, Not a Destination
With this view, it is clear that digital transformation is not a project, with a start and an end. Rather, it is a vision that guides the organization’s strategy. Moreover, it’s difficult to say that an organization is ever done with digital transformation. What qualified as digital transformation 20 years ago (e.g. loyalty clubs, web commerce) is now table stakes. Digital transformation, therefore, is a journey, with a destination that is continually moving.
Even digital businesses—those born in the internet age, delivering digital products—need digital transformation from time to time. Ironically, when they do it is most often in the first and most basic form: in their business processes. Although entirely digital in their products, services, and business model, digital businesses too often can be “old school” in their back-office processes. Scratch the surface and you will find many of them suffer under back office processes that are siloed and held together by Excel worksheets, Access databases, and email correspondence. They too need digital transformation.
Formulating a Digital Transformation Strategy
It goes without saying that digital transformation should be a business imperative, not an IT initiative. Just because it involves information technology does not mean that it has to be under the direction of the IT department.
Some organizations, understanding that digital transformation is bigger than the IT group, appoint a “chief digital officer.” Although it may be helpful to have a focal point for accountability, such a position should only be to oversee and coordinate the various digital transformation initiatives, like a chief quality officer might oversee all quality initiatives. Just as everyone in the organization has a role to play in ensuring quality, so everyone must get behind digital transformation.
How can business leaders identify opportunities for digital transformation? Here are several starter questions that business leaders can use to stimulate strategic thinking:
Where can we use digital technology to develop smart products and smart services?
Does the data we collect enable any new services that we can offer to our existing customers?
Does the data we collect have value to individuals or organizations that are not our customers today?
How can we use digital technologies to make our relationships better and deeper with our customers, suppliers, employees, and partners?
What data do we have, or can we acquire externally, to give us deeper insights into our business or markets?
How are organizations in our industry—and those in other industries—using digital technologies to transform their businesses, and what can we learn from their experiences?
What kind of internal systems would we need to support these smart products/services, data analytics, new business models, and transformed business relationships?
Which of our business processes are most in need of improvement, and how can digital technology enable that?
Use these questions to stimulate discussion and to identify a path forward for digital transformation. But remember that each digital journey is different, because every company is different. You can start wherever you see immediate opportunities, for example, with business process improvement. Or you can start with something more strategic, say smart products, that lay the groundwork for a number of digital initiatives. Or, you can lay out a road map to do some of both. Either way, find the path that is right for your organization and get started.
Frank Scavo is president of Computer Economics and also of our sister management consulting firm, Strativa.