Digital Transformation: Defying Definition – CFO
If your company is not in the midst of a “digital transformation,” it’s an outlier.
McKinsey estimates that 80% of large companies are, or at least believe themselves to be. Ditto many smaller organizations.
But what exactly is digital transformation?
Depending on a company’s circumstances and vision, something as innocuous as a website makeover could be called a digital transformation. But that doesn’t mean it is one.
McKinsey outlines four digital transformation archetypes (the labels are CFO’s):
1. Portfolio Transformation. “It’s too hard to really transform, so we’re just going to buy stuff,” is how McKinsey senior partner Peter Dahlstrom characterizes the mindset that gives rise to this most basic of the archetypes. A company’s business model is threatened, so the company buys other companies that are operating their own technologies “and that’s their digital transformation,” he says. “They don’t transform their core but rather their portfolio of activities.”
2. Digital Doppelganger. A company creates a new digital version of itself and cannibalizes its existing business. “Lots of businesses create second brands and attack themselves with digital and become digital-mostly businesses,” says Dahlstrom. A change in customer behaviors and preferences usually necessitates the shift.
3. Functional Digitalization. The company finds broad digital transformation appealing, but rather than take on the difficult task of formulating a plan that encompasses everything IT-related, it starts with a great e-commerce site and instills some digital capabilities into the sales force and supply chain.
4. The Real McCoy. A wholesale revamping of infrastructure, systems, and software along with new intelligent automation and analytics capabilities. Most casual observers perceive this as true digital transformation—yet, acknowledges Dahlstrom, “there aren’t that many great cases.”
Of course, there are some. Because of competitive and market realities, the following three companies have invested a large amount of people and resources to effect digital change.
Among companies in the “Real McCoy” category is Dell Technologies. Dell finance chief Thomas Sweet agrees that there are several definitions of digital transformation, but he points to a common denominator.
“There’s an evolution or transformation happening within companies as they think about the role of technology in enabling their business models,” says Sweet, “whether that’s a change-the-business type of approach, or moving into an adjacency, or a competitive dynamic.”
Like many tech companies, Dell’s transformation encompasses changes to both its internal infrastructure, systems, and solutions, and the products and services it provides to customers that are themselves digitally transforming.
Filling both roles is the Dell Technologies cloud platform, an infrastructure modernization launched in 2019. Developed jointly with VMware, the platform lets users migrate workloads seamlessly between public and private clouds.
The product is a boon for companies that want to create a hybrid cloud environment. For example, a company might move a number of workloads to a public cloud, then later pull them back inside its private cloud as part of a cost-reduction initiative.
With a huge mass of installed hardware and systems at customer sites, Dell also is increasingly digitalizing its services business.
“We’re using real-time tool sets with artificial intelligence algorithms that feed data back from those installations — not customers’ private data, but system performance data,” says Sweet. From that data, Dell can predict which systems show signs of stress and may fail.
Dell is also using AI to optimize how its storage solutions are compressing, cleansing, and organizing data in real-time.
Within Dell’s finance area, AI-driven functionality predicts which customer orders are most likely to be subject to past-due payments. Meanwhile, a machine learning model draws from a number of data sets to establish pricing parameters that factor in, for example, customer size and geographic location.
At Dell, digital transformation also includes upgrading team members’ skill sets and providing them with new collaboration tools and mobile capabilities.
“The journey we’ve been on for the past two or three years has been all about improving the business and the experiences of customers and team members,” says Sweet. “What we’ve done has given us a more productive culture, and we’re seeing real improvements in each of our businesses.”
Flowing With The Customer
At consumer facing firms, digital change is often sparked by innovations in web platforms.
Take Pizza Hut U.K. A few years ago, it had a big problem: a clunky website. It had outsourced the site’s development and management a few years earlier, but more and more customers — accounting for 45% to 50% of total business — were ordering home delivery online. On busy weekend nights, the site crashed.
“I don’t think we had anticipated how important online would become,” says Neil Manhas, who was CFO of Pizza Hut U.K. at the time and is now general manager of the business as well as finance chief of Pizza Hut Europe.
Site outages were hardly the only problem. “There were long lead times for updates. It wasn’t particularly cost-efficient, it offered a poor user experience that was quite hard to change, and what little data it had was very hard to extract or do anything with,” says Manhas. Franchise owners were not happy.
A transformation was sparked in 2016, when the company’s then-IT director by chance met some McKinsey consultants through a friend of a friend. Soon there were formal meetings, which led to a proposal from McKinsey for Pizza Hut to develop and manage a website in-house. The consulting firm provided talent-recruitment, research, and site-testing expertise.
“Those guys really challenged our preconceived notions,” Manhas says. “It became a very customer-led, data-driven process that was highly iterative. They spun up a lot of hypotheses, did the research, and tested elements of the new site in real-time.” By 2018 Pizza Hut U.K. emerged with a site that represented a complete turnaround for customers and franchisees.
Manhas says he’s “obsessed” with the new site’s data capabilities. He now knows things like where traffic to the site is coming from, how traffic on a particular day compares with a year ago, how much the company is paying for traffic (by channel), how customers are purchasing online, and the impact of all of that on return on assets.
A particular highlight has been a feature called “DealBot.” Online customers can click on DealBot while placing items in their shopping cart. It gives them access to relevant deals without having to search around the site.
Conversion rates are highest for customers using DealBot. However, for unknown reasons, the conversion rate for customers that see DealBot but don’t click on it is higher than for those who don’t see it. The feature is quite dynamic; deals can be ramped up and down daily depending on how aggressive or generous the company wants to be.
“I’ve learned to be slightly less rigid in my desire to have a very clear plan, and to sometimes just see where the data takes us,” Manhas says. “We just flow with what the customers seem to be wanting.”
McKinsey’s Dahlstrom suggests that Pizza Hut U.K. has had strong gains in revenue and market cap since the new site was launched. Manhas declines to confirm that, but notes that the share of sales via the site has reached 75%.
Getting funding for the project from Pizza Hut parent Yum! Brands was conditioned on a commitment to take the concept global. Pizza Hut Digital Ventures, a separate business unit formed to design, build, market, and operate digital platforms, is in the process of expanding the U.K. success to Europe, Asia, and beyond.
“We’re an entirely digital business now,” says Manhas.
Front and Back
Banking is an industry in which becoming a digital business is paramount. The race is on to digitalize both the front end and the back end.
Citizens Bank is in the “early innings” of a digital transformation, says CFO John Woods. He intends to be careful about what things get transformed, though.
“Our objective is to be more innovative and agile in responding to rapidly changing customer needs,” says Woods. “Digitalization is one of the tools we use, and a big one, but I hasten to add that if a highly manual process is not well-optimized and not delighting customers, merely digitalizing that process won’t magically begin to delight them.”
A centerpiece of Citizens’ transformation so far is Citizens Access, an online platform launched in 2018. Through it, the nominally regional bank can take deposits nationwide. The platform also provides savings products and certificates of deposit. By early 2021 the platform will offer checking accounts and loans. At some later point it may provide fee-based services, such as mortgage originations and sales and wealth advisory.
“In terms of activities we’re now a national bank, and you have to be in a digital world,” Woods says.
Citizens has earmarked $50 million over the next two years to migrate its data, applications, and back office infrastructure to a cloud environment. Part of that large investment is to deploy AI in the digitalization of end-to-end, previously manual processes. Anticipated benefits of the cloud migration include long-term cost savings and more efficient data processing and risk mitigation.
The AI-driven process digitalization has already begun. For example, in the commercial loan underwriting process, the traditional use of long narrative analysis and spreadsheets has given way to more concise digital analysis. The use of more tools that organize, aggregate, and leverage available data throughout the loan origination process provides a broader set of data to decision-makers earlier.
Combining automated and standardized data visualizations with discrete and consumable narrative analysis enhances the speed and accuracy of underwriting decisions, Woods says.
In addition, advancements in robotics, natural language processing software, and AI allow electronic files to be read, organized, and stored in a virtual environment with minimal need for manual intervention. Virtual data libraries staffed by bots continue to “learn” as they index, organize, and maintain millions of electronic records with speed and accuracy.
Citizens Bank is also using advanced analytics and machine learning to personalize offers to customers. In platform marketing, a customer browsing a home furnishings website might receive a digital home equity loan offer from Citizens.
The approach has led to significant increases in market share for some products that have “outpaced some of the banks’ other channels by multiple times,” Woods says.
Machine learning and analytics also are reducing costs by automating the loan-approval process for the majority of loans that don’t require escalation to elevated screening. Meanwhile, the defect rate—referring to underwriting mistakes a human might make — is decreasing.
Applications of the same principle for fraud management, money-laundering prevention, and delinquent account collections (identifying borrowers who are likely to self-correct their delinquency) are expected to be implemented later in 2020.
Citizens has told investors that these moves are going to generate $200 million to $300 million of run-rate savings by the end of 2021.
Citizens is also reaping big benefits from having switched product development coding to Amazon Web Services and Microsoft Azure. Previously, it would have taken months for the bank to procure and receive from IBM the physical servers needed to create such a production environment.
Now developers can start innovating “in a matter of minutes,” Woods says. Transitioning to the cloud environment enabled Citizens to also create a library of genericized application programming interfaces that can be reused over and over as the team develops new software applications.
“If a developer wants to pull interest-rate information from our databases into a production environment, they don’t have to type out queries and develop code to do that,” explains Woods.
Where do people fit in these large-scale digital initiatives at Dell, Pizza Hut, Citizens Bank, and other companies? Front and center, according to Klemens Hjartar, a McKinsey senior partner. However, he adds, finance chiefs may not fully understand the crucial role that people play in a successful transformation.
“CFOs understand the strategic context,” Hjartar says. “A retail CFO, for example, understands that consumers are going to different channels and the economic consequences of that. Where they lack sometimes is in just saying, ‘OK, we have to invest in new solutions and systems.’”
“For most companies,” he continues, “the big question is not about buying new technology. It’s building an organization that can continuously use the new technology to pursue the company’s strategy and become more productive. You’re really investing more in people that will operate a new platform than you are buying a new IT system.”
One slight problem in some organizations, he adds, is that the CFO has been trained in a management system that requires strict business cases and rigorous request-for-proposal processes for large-scale procurements.
Not that those are bad things. But for digital transformation, “the most brilliant thing you can do is attract the people with the right skills or train people, and allow them to work in the right way,” Hjartar says.
David McCann is deputy editor of CFO.
No End to Change
Finance chiefs still await the payback they anticipated from digital transformation.
A new PwC report, “2020 Global Digital IQ: Payback Ahead,” suggests that many companies thought the return on investment they were looking for would have more robustly materialized by now.
The survey asked more than 2,300 executives globally to rate their organizations’ “digital IQ” on a 1 to 100 scale, with 100 being the highest intelligence. The average response was 55.8.
That number could be viewed as a rather shocking result. When PwC asked executives the same question in 2015 and 2018, the average response was 71.8 and 65.6, respectively.
You’d think companies that have been engaged in “digital transformation” for years would be getting better at it, wouldn’t you?
“Companies expected a certain return in a certain time, but digital is bigger and broader than companies imagined, and the level of confidence in mastering it is slipping,” says David Clarke, global chief experience officer at PricewaterhouseCoopers.
Not that there hasn’t been any payback; just not nearly as much as had been expected.
A vast majority (91%) of executives surveyed expected that implementing digital initiatives would “create better customer experiences.” As it turns out, though, only 71% said that expectation has been realized.
In fact, the disappointment in the effectiveness of digitalization applied across the board—for improved decision-making (90% expected that result; 66% say it has happened), increased profits (80% vs. 45%), and improved talent retention and recruitment (75% vs. 49%).
Another alarming survey result was that only 25% of respondents said they believed digital transformation would “never” be completed. In other words, the other 75% either believed digital transformation had an endpoint or they weren’t sure.
Digital transformational efforts aim to maximize technology’s capability to raise up the business and set it on a new, more productive course. But technology development isn’t going to come to a halt at any point. That any executive would expect the transformation imperative to cease in the future is puzzling.
“The 25% [figure] is a bit shocking, because we’re at a point where there’s no real end anymore to how we’ll have to change,” Clarke says. “The question really is, ‘How aggressively are we willing to change? How fast are we willing to change our operating models or how we engage customers?’”
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