Digital transformation is a hot topic but what exactly is it and what does it mean for companies?
Isn't it fascinating how fast technology is evolving over time? When I was a kid, no one around me had a cell phone. We had one landline, only reserved for important or urgent uses. We listened to FM radio and recorded music on audio cassettes. Internet was still a theoretical idea at that time. And, now, not that many years later, everyone has a smartphone. We shop, we chat, we play and we learn online. We cannot imagine our lives without the internet. Within 15, 20 years, digital has not only changed our personal lives but has also fully transformed the business world, and no industry was immune.
But before talking about this evolution, let's go back in time, a few centuries actually. I want to share with you an old legend about the game of chess, not only because chess is the strategist preferred game but because the story around the game creation will help us understand what digital is all about. Surprising, isn't it? So, once upon a time, there was an Indian king, a fighter, who went into many battles. One day, coming back from an exhausting fight, he learned that he lost his son in the field. He felt immense sadness and decided to withdraw into his castle. This lasted for months then years until one of his subjects named Lahur Sessa offered him a chessboard. The king liked the game so much that he decided to grant the man whatever, whatever he asked for. Sessa kindly and humbly explained that he would like to have one grain of rice for the first square of the chessboard, two grains for the second square, four grains for the third then eight grains, and so on until the 64 squares are exhausted. Before telling you the end of the story, I want you to estimate how much rice did Sessa ask for. First, without doing any actual calculation, what is your intuitive guess? Would it be as heavy as a soccer ball for example? A dairy cow or a Boeing 747 fully loaded? You can pause for a few seconds to really see in your mind what is the intuitive answer. Now, if you do the calculation, you would see it was about two multiplied by 10 to the power of 19 grains, which is in the same order of magnitude as the total Earth biomass. Well, I cheat a little bit on the options but the reality is, almost everyone's intuition would have been massively underestimating the amount. This is because our minds are more adapted to estimating linear change than exponential change. Linear change is when we move from 1 to 2 to 3 or to spice it up, from 2 to 4 to 6. At step number n, we are at 2 multiplied by n. This, our intuition can estimate pretty accurately. Exponential change, however, is when at step number n, we are at 2 to the power of n. So we move from 2 to 2 to 4 to 8, 16, 32, 64.
Exponential Evolution Of Technology
Why start with this story? Because interestingly, digital technology in the last few decades has progressed just in the same way as the number of grains along the chessboard, exponentially. To see that, we will boil the progress down to three fundamental laws that made all that possible. These laws are addressing core concepts, the core aspects of digital information management: processing, communication, and storage.
What this law says is that every 18 months, your computer will have twice as much power to process information. Originally, it was formulated slightly differently. It says that on a given silicon chip, every 18 months, you can double the number of transistors you fit in there. The reality is this law in this original formulation is being challenged because the more transistors you fit within the surface at some point, you get to such a high density that quantum effects take place and stop the way the processor is designed to work. More responses to this are to say it is a temporary challenge, not a permanent one. We can change the way we design the chips from 2D to 3D. We can change the material we use, instead of silicone, use graphite, or even we can radically change the approach and go to quantum computing.
It states that the amount of data communicated through a single optical fiber doubles every nine months. If you plot the typical speeds and megabytes per second on a log scale again, we see a straight line, which means an exponential increase over the years. There's a variation of this law for other communication media, whether wireline like ADSL, VDSL, or wireless like 3G, LTE, and more recently, 5G.
This law looks at hard drive storage capacity and states that the amount of data stored per centimeter square of a hard drive will double every 13 months. At least, this was the case in the late '90s and early 2000s, when Mark Kryder formulated his observation. The trend has actually slowed down to double every 16 or 17 months. But, anyway, this remains faster even than Moore's law. Maybe some of you remember the large blocks almost the size of CPUs in the early 2000s, which even required us to plug in a power supply, and this all to store half a terabyte or a terabyte of data. Now, an external terabyte storage device is one centimeter thick, the size of a passport. Of course, this law describes the theoretical technology potential. Only part of that potential goes into performance improvement for the mass market devices. The other part, however, will go into consumer cost reductions so that computers, internet connection, and storage capacity become not only better but also cheaper and cheaper.
Company Development and Technology Gap
However, as human intuition is tuned to seeing linear developments, we tend to always underestimate progress. It is not surprising, therefore, that companies also tend to underestimate or even be completely blind to the impact of digital technology. If companies develop linearly and technology evolves exponentially, we see a gap between the two, a gap between the company's actual value delivery and what would be possible technology-wise. And this gap is widening very quickly over time. The gap is often filled by innovative startups using technology to satisfy customer needs in a very different way, a way incumbent players were unable to see or even worst, saw and couldn't fully understand. Companies like Kodak, Nokia, or Blockbuster paid a heavy price for this tendency to underestimate the trend.
Deconstruction of the Value Chain
Technological evolution changes the traditional model of business architecture from a vertically integrated value chain to a stack-based structure. The stack structure reflects the fact that players can compete on different key success factors in different layers; scale at the bottom, innovation at the top. In this new model, new players can disrupt incumbents by attacking only a specific portion of the whole value chain.
The most fundamental impact which information technology has is to radically transform our ability to transact. Specifically, it massively lowers transaction costs. This has enormous implications for strategy because the economic organization is fundamentally around economizing on transaction costs. So, therefore, if transaction costs become lower, there is less to economize on, and therefore, in some fundamental sense, there is a lesser need for economic organization.
Technology Makes the Difference
Solow Computer Paradox
We will start with the famous paradox, usually called the Solow Computer Paradox, for Robert Solow. He's a Nobel Prize laureate in economics, and he has been quoted saying, you can see the computer age everywhere but in the productivity statistics. This is a very powerful claim. Very controversial, but it is not completely unjustified. In fact, when you look at the productivity growth in the last decades, you see that it has not kept pace with the growth in information technology spending. What I mean by information technology spending here is the total corporate investments in hardware, software, data centers, networks, and related human resources. This amount is nearly $6 trillion per year. And it grew by a factor of almost 20 between 1980 and 2015. In the same time frame, global GDP barely tripled. This is exactly what the paradox refers to. Inferring that technology investments didn't help us create more economic value. For any company or any rational economic agent, this would mean they should stop such investments. And I guess you see why the initial claim is a paradox. Because both intuition and practice are going against their natural conclusion.
In the first attempt, maybe technology had a beneficial impact, just not on economic productivity, not on GDP, which is a very narrow measure.
The second attempt, maybe it had a positive impact on GDP, but it will only show after a long time lag.
The third attempt, maybe it had a positive impact on GDP and in the short term, but it was neutralized by some other business phenomenon.
Although we don't necessarily see it in productivity numbers, digital technology does have a visible impact on business performance. Some of this impact can be neutralized by the increased complexity generated by competition, customer demand, or regulation. Lastly, in practice, making the right technology investments translates into higher profitability and higher revenue growth double-digit higher.
In my next article, we will talk about the Competitive Lifecycle in detail and the Liability of Incumbency.
Thanks, Hope you enjoy reading how Digital Transformation Evolved.