The essence of market economies involves destroying the old and celebrating the new. Joseph Schumpeter, a 20th-century Austrian economist, called it “creative destruction”, saying it was the only route to innovation and sustained growth. This has seen CDs scrapped for music streaming, Blockbusters for Netflix, Blackberry’s demise and iPhone’s rise and Uber upturning taxi services.
Right now, digital solutions are cheaper and more democratised than at any point in human history. From manufacturing to finance, retail to healthcare, vast tranches of the global economy are adopting them, making it easier for businesses to adapt.
It means you can take bad habits and scrappy data from old analogue firms and make them more digital- and data-led. You can reconcile old data silos and deploy AI to make sense of legacy systems. Because you’ve got an established customer base, often little or no creative destruction occurs.
“Building digital capabilities is easier than ever. But getting enterprise-wide adoption of digital remains incredibly difficult– change is difficult. Businesses find it tough to evolve old paradigms when there isn’t an existential threat forcing them to do so,” explains Jet Lali, chief digital officer at State Street Global Advisors.
“A digital transformation that does not lead to business transformation is an IT project,” he adds. Michael Hamer, a renowned US engineer, echoed this in the 1990s, saying that instead of “embedding outdated processes in silicon and software, we should obliterate them and start over, we should re-engineer our businesses.” Fast forward to 2022, and many are still failing to do just that.
Many failures, many lessons
Disruptive innovation is a tricky business. Schumpeter’s so-called ‘perennial gale of creative destruction’ is a mere light breeze today. Rolls-Royce’s power servitisation model and Domino’s Pizza Tracker technology are overused examples. So why aren’t more firms touting transformative offerings to the marketplace, especially with the trillion-dollar uptake of digital services going on worldwide?
We used to see that excess profits in a market would attract new firms to enter and compete for them. This used to be a good predictor of entry. But that link has now broken
“Most transformation efforts fail, digital and conventional. Some of the common reasons involve not attending to soft factors, or businesses just digitising existing processes and business models. Then there’s digitising for efficiency alone, or pursuing technology for its own sake,” states Martin Reeves, chairman of the BCG Henderson Institute.
“However, take John Deere, Apple or Walmart and what they’ve done differently is to focus on transforming their business for competitive advantage,” he points out.
Today, most firms are starting their digital transformation journey, adopting piecemeal solutions. They haven’t yet experienced the full benefit of joining up the data dots. Full digital- and data-led visibility across a business is rare, which results in a pale imitation of digitally native firms. The ability of legacy incumbents to offer something disruptive is therefore limited.
Professor Chander Velu, professor of innovation and economics at the University of Cambridge, believes businesses aren’t gauging the right metrics either: “The challenge of business-model innovation following the adoption of digital technology can be exacerbated by a primary focus on profitability. This emphasises performance activities as opposed to transformative activities,” he states.
It doesn’t help that progress for businesses is neither linear nor inevitable. There is no definitive blueprint or profit model for every transformed business deploying disruptive digital tools. This means there’s a question mark on how much firms should pay for such innovation.
“A customer cannot always tell us how new technologies can potentially change things,” explains Christian Pedersen, chief product officer at IFS, an enterprise software firm. “Companies also still fundamentally want predictability around the financial year with costs. They want to know how much they’re going to spend.”
Incremental change doesn’t make the news
The media and business-model wonks also like to focus on big market displacements – creative destruction makes headline news. Elon Musk’s takeover of Twitter being a recent example. Yet a lot of transformation right now involves slow, incremental change. Dr Carl Benedikt Frey is director of the Future of Work programme at the Oxford Martin School, a research and policy unit based at the University of Oxford. He comments that there are also parallels with past industrial revolutions.
“When electric motors first arrived, factories replaced the steam engine as the central power source. It took time for factory owners to figure out that you can equip every single machine with its own motor and get rid of all the power shafts in the factory. It then took more time to sequence these machines with the natural flow of production. This eventually paved the way for mass production, which spread from one industry to another.”
The challenge of business-model innovation after the adoption of digital technology can be exacerbated by a focus on profitability
Schumpeterian academics talk of creative accumulation. Firms have been quietly adding the digital building blocks during the economic good times. When a fresh global recession lands, that might be the time to unleash a new wave of disruptive innovation. This was seen in the wake of the global financial crisis.
“Think about electric cars and how long it’s taking the public to find them more appealing than vehicles with an internal combustion engine. We still need more powerful batteries that are charged faster, better designed or with cheaper costs of production. All these are incremental innovations that add up to a radical technology. The same can be said about AI and its applications, or many biotech innovations,” comments Diego Comín, professor of economics at Dartmouth College.
Creative destruction should also be more prevalent now since the barriers to market entry for digitally native startups appear low. Anyone can buy cheap data-driven tools off the shelf and get their business up and running. So why aren’t there enough plucky ‘one-person and a PowerPoint’ teams upending markets? It’s because there are other forces at play now.
“We used to see that excess profits in a market would attract new firms to enter and compete for them. This used to be a good predictor of entry. But that link has now broken. Why is that? I think the answer that more economists are coming to is that there are significant barriers to entry, which aren’t necessarily technological,” says Frey.
Several reasons are touted, whether it’s conforming to digital regulations such as GDPR, and other legislation for specific sectors which might be costly to adopt. Then there are incumbents which buy up startups that pose a threat to them, or political lobbying by firms to push through legislation, making it difficult for creative players on a shoestring budget to disrupt incumbents.
So, what’s next? “The need for more discipline, given the new cost of money. We are entering an era of ‘disciplined innovation’ when businesses will redouble the need to be systematic about digital innovation,” says Reeves. Certainly, the future is uncharted.
