How to navigate the disruption economy

Published on the 04/08/2016 | Written by Chris Bradley, Clayton O’Toole

Guide to digital disruption
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Incumbents needn’t be victims of disruption if they recognise the crucial thresholds and act in time, write Chris Bradley and Clayton O’Toole (McKinsey & Company)...

As powerful technological capabilities are taken advantage of by agile new market entrants, existing companies are facing up to a fate shared by Kodak and the dodo. It doesn’t have to be that way. In this synopsis of a recently published research paper from the Sydney branch of consulting company McKinsey & Co, sound advice is presented that can help old businesses survive the onslaught of the new.

Things are murky in the midst of disruption’s uncertain, oft-hyped early stages. Often, incumbents find themselves on the wrong side of a big trend. No matter how strong their ingoing balance sheets and market share—and sometimes because of those very factors—incumbents can’t seem to hold back the tide.

The good news for incumbents is that many industries are still in the early days of digital disruption. Print media, travel, and lodging provide valuable illustrations of the path increasingly more will follow. For most, it’s early enough to respond.

What’s the secret of those incumbents that do survive—and sometimes even thrive? One aspect surely relates to the ability to recognise and overcome the typical pattern of response (or lack thereof) that characterises companies in the incumbent’s position.

This most often requires acuity of foresight and a willingness to respond boldly before it’s too late, which usually means acting before it is obvious you have to do so. As Reed Hastings, the CEO of Netflix, pointed out (right as his company was making the leap from DVDs to streaming), most successful organisations fail to look for new things their customers want because they’re afraid to hurt their core businesses.

We are all great strategists in hindsight. The question is what to do when you are in the middle of it all, under the real-world constraints and pressures of running a large, modern company?

There are four stages of disruption from an incumbent’s perspective, with barriers to overcome, choices and responses at each one.

Stage one: Signals amidst the noise
In 1998, Cornelis Boonstra, CEO of PolyGram’s Dutch parent, Koninklijke Philips, flew to New York, met with Goldman Sachs, and arranged to sell PolyGram to Seagram for $10.6 billion. Why? Because Boonstra had come across research showing that consumers were using the new recordable CD-ROM technology (which Philips coinvented) largely for one purpose: to copy music.

Boonstra detected the first signs of transformational change and decided to act swiftly and decisively. Within a decade, compact-disc and DVD sales in the United States dropped by more than 80 percent. Similarly, Telecom New Zealand foresaw the deteriorating economics of its Yellow Pages business and sold its directories business in 2007 for $2.2 billion.

The newspaper industry had no shortage of similar signals. As early as 1964, media theorist Marshall McLuhan observed that the industry’s reliance on classified ads and stock-market quotes made it vulnerable: “Should an alternative source of easy access to such diverse daily information be found, the press will fold.”

Schibsted was one of the earliest media companies to both anticipate the threat and act on the opportunity. As early as 1999, the company became convinced that “The Internet is made for classifieds, and classifieds are made for the Internet.”

Gaining sharper insight, and escaping the myopia of this first stage, requires incumbents to challenge their own “story” and to disrupt long-standing (and sometimes implicit) beliefs about how to make money in a given industry.

Stage two: Change takes hold
With disruption’s impact still not big enough to dampen earnings momentum, motivation is often missing. Even as online classifieds began to take off, most newspaper publishers lacked a sense of urgency because their own market share remained largely unaffected. But Schibsted did find the necessary motivation. “When the dot-com bubble burst, we continued to invest, in spite of the fact that we didn’t know how we were going to make money online,” recalls then-CEO Kjell Aamot. “We also allowed the new products to compete with the old products.”10 Offering free online classifieds directly cannibalized its newspaper business, but Schibsted was willing to take the risk. The company didn’t just act; it acted radically.

Most incumbents dabble, making small investments. Usually, they focus too heavily on finding synergies (always looking for efficiency) rather than fostering radical experimentation. Many newspapers built online add-ons to their classified businesses, but few were willing to risk cannibalising the traditional revenue streams, which at this point were still far bigger and more profitable.

Stage three: The inevitable transformation
By now, the future is pounding on the door. The new model has proved superior to the old and the industry is in motion toward it. At this stage of disruption, to accelerate its own transformation, the incumbent’s challenge lies in aggressively shifting resources to the new self-competing ventures it nurtured in stage two. Think of it as treating new businesses like venture-capital investments that only pay off if they scale rapidly, while the old ones are subject to a private-equity-style workout.

Further complicating matters, incumbents with initially strong positions can take false comfort at this stage, because the weaker players in the industry get hit hardest first. The narrative “it is not happening to us” is all too tempting to believe. The key is to monitor closely the underlying drivers, not just the hindsight of financial outcomes. As the tale goes, “I don’t have to outrun the bear . . . I just have to outrun you.” Except when it comes to disruption, that strategy merely buys time. If the bear keeps running, it will get to you, too.

The typical traditional newspaper operator, likewise, wasn’t blind to a shift taking place, but it rarely managed to mount a response that was sufficiently aggressive.

When incumbents lack the in-house capability to build new businesses, they must look to acquire them instead. Here the challenge is to time acquisitions somewhere between where the business model is proved but valuations have yet to become too high—all while making sure the incumbent is a “natural best owner” of the new businesses it acquires.

Stage four: Adapting to the new normal
The disruption has reached a point when companies have no choice but to accept reality: the industry has fundamentally changed. For incumbents, their cost base isn’t in line with the new (likely much shallower) profit pools, their earnings are caving in, and they find themselves poorly positioned to take a strong market position.

This is where print media is now. The classifieds have dried up, making survival the first priority, and sustainability and growth the second.

In 2013, the CEO of Australia media company Fairfax Media told the International News Media Association World Congress, “We know that at some time in the future, we will be predominantly digital or digital-only in our metropolitan markets. True, some legacy mastheads have created powerful online news properties with high traffic, but display advertising and paywalls alone are for the most part not enough to generate a thriving revenue line, and social aggregation sites are continuing to drive unbundling. Typical media firms have had to undertake the multiple painful waves of restructuring and consolidation that may be needed while they seed growth and look for ways to monetise their brands.

In some cases, incumbents’ capabilities are so highly tied to the old business model that rebirth through restructuring is unlikely to work, and an exit is the best way to preserve value. The simple fact is that new profit pools may not be as deep as prior ones (as many newspaper publishers have come to believe). The challenge is to adapt and structurally realign cost bases to the new reality of shallow profit pools.

The reality is, most industries are still in stages one, two, and three.

That’s why the early experiences of media, music, and travel companies can prove so valuable. These first industries to transition to a digital reality highlight the social and human challenges that by their nature apply to companies in most every industry and geography.

This is a synopsis of a research paper on digital disruption published by McKinsey & Co (Sydney). Read the full article here.

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