How incumbents become digital disruptors

How Incumbents

Established companies are often late to spot mortal threats to their business model. Here’s how they should respond when industry disruption strikes. Here is a portion of a podcast transcript of a program sponsored by McKinsey & Company. To listen to the podcast and/or read the complete transcript as well as learn about the firm and sign up for email alerts, please click here.

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Digital disruption isn’t just for hip start-ups. Incumbents can not only compete but actually lead radical industry change if they pay attention to the way their business model is shifting and act boldly in response. In this episode of the McKinsey Podcast, McKinsey partner Chris Bradley and senior partner Angus Dawson talk to Cam MacKellar about the life cycle of digital disruption, what it means for incumbents, and how executives should react. An edited transcript of their conversation follows.

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Hi, I’m Cam MacKellar, from McKinsey’s Sydney office, and I’m delighted to be speaking today with Angus Dawson, a senior partner of the firm’s Strategy Practice throughout Asia; and Chris Bradley, a partner here in Sydney.

Both Angus and Chris have recently published articles on digital strategy for McKinsey Quarterly. Chris, along with his colleague Clayton O’Toole, coauthored an article published in May called “An incumbent’s guide to digital disruption.” The article looks at how companies can avoid becoming victims of digital disruption by recognizing crucial thresholds and acting in time. Angus and Chris, thank you very much for spending time with us today.

Cam MacKellar: Chris, it’s clear that the champions of disruption are more often attackers than incumbents. Why is that? And why is it so difficult for incumbents to respond rapidly to disruption?

Chris Bradley: I think companies are well geared for running their business at current course and speed or responding to a very immediate and real crisis. But disruption is in between those two goalposts because it’s uncertain, and it plays out over a very, very long period of time, and we get the proverbial boiling-frog problem in a company where the pressures of the short term and what’s real and what’s in front of your face are so all encompassing that the disruption gets underplayed.

Angus Dawson: There’s nothing that a CFO dislikes more than a business case that’s based on preventing decline. When you put a business case up, if you’re going to get investment you’ve got to show how it’s going to add to growth and profitable growth, and disruption is actually saying we’ve got a different baseline and that’s one of decline, and that conversation often just gets shut down.

Bradley: Psychologically accepting a declining baseline in a business that you’ve grown up in and that you love and that you’ve actually got to take as the status quo or as the default reality, the idea that this business will decline, other things being equal, inference being big investment and big effort to maintain today’s position, that’s a big bridge to climb, and that’s why often you won’t see the response until that baseline doesn’t become a counterfactual; it becomes the factual.

MacKellar: For incumbents who may realize disruption is out there, it’s perhaps lurking on the horizon, and they know that it exists, how should they determine what’s a real trend and what’s just noise? How can they work out which digital trends are going to influence their business and which ones are simply hype?

Dawson: We’ve got to have a bit of empathy here for executives who are being hammered every day with trends and reports of how the whole world is going to change, threats on the horizon both from people outside the organization as well as from people inside. To be honest, most of them aren’t going to eventuate. We’re starting from a position of trying to pick the few things that really matter and the approach that we advocate is to come back to the fundamentals of the industry and how money gets made. We’ve got all the economic essentials to understand and to unpack what will change and why it will change and what are the markers of that to try to get through all the noise.

Bradley: When these disruptions affect some of the deep wiring in the industry, you know it’s real, but a lot of the trends operate at this surface level. The other point I would add is that it’s nonlinear, so the world changes slowly until it doesn’t. That’s why when I look back through my career, most of these big changes, we’ve underestimated the impact of them but overestimated how quickly they would happen. I started my career around the time of the first dot-com boom, and I don’t think anyone at the time realized how profound the real Internet revolution would be, but that it would be pretty well 20 years later that we’re talking about it, with real depth. It’s that nonlinearity that’s important and why we’ve made the S-curve one of the central analytical ideas in there, because it’s nonlinear and because at any point where you extrapolate on an S-curve linearly, you’re going to get it completely wrong because you get this everything goes slow until it happens really, really quickly.

Dawson: The other thing that’s going on, of course, is that it’s not like you come in with an idea of a source of disruption and a good executive in a well-managed company says, I never heard of that, or, I never thought of that. They’re thinking about these things. They’ve got lists of them, they’ve got workshops that they do as part of their strategy process every cycle, and there’s usually some things that are mapped to it in terms of initiatives or responses. The question is one of adequacy and being ready to scale those things up when it becomes clear that these trends are fundamentally reshaping the business rather than just mosquitoes around the edge.

MacKellar: Which is a strong point. Good executives are going to be aware of the trends at play in their field. But once they’ve seen the trends and are aware of them and are reviewing them on a regular basis, how does an incumbent make the move to action?

Dawson: It comes down to the very simple idea of resource allocation and the resources that we talk about having to allocate are obviously financial resources in terms of budget and capital and also talent and where management teams spend their time. So it’s recognizing that the response to these trends needs to be substantially elevated on all those dimensions, and spend real time on it because it’s still not like in the midst of all that you know exactly how it’s going to play out. You’ve got to stay continuously vigilant and pick up all the signals and work out when the acceleration is going to happen.

Bradley: We think about it like you need to do a venture capital–style growth plan for the new business, which is aggressively driven on growth and doing everything you can to make it work, while at the same time you do have to do a private equity–style workout on the older business where cash flow is king. Unfortunately, given the power structures in most companies and the mind-set, the very opposite actually ends up happening. You get a huge amount of scrutiny and cash-flow pressure on the new growth business and the existing business is presumed innocent before guilty. There are some compounding factors, though, because once that disruption starts hitting and it’s no longer a theory but it’s real, the resources you have start declining. This resource allocation that Angus is talking about, you have to do that in the midst of a declining resource pool, which basically means that the new businesses for them to get this venture capital–style push for growth, the old businesses have to decline.

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Here is a direct link to the complete article.

Chris Bradley is a partner in McKinsey’s Sydney office, where Angus Dawson is a senior partner. Cam MacKellar is a digital content expert also based in Sydney. The authors would like to thank Jacques Bughin, Dilip Wagle, and Chris Wigley for their valuable contributions to this article.

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