How To Understand Your Digital Transformation

While a few firms—the digital giants—are winning big from digital technology, many large firms are investing heavily in digital, by recruiting IT specialists and spending on digital technology—including artificial intelligence, cloud computing, machine learning, and algorithmic decision making, yet getting disappointing returns.

What firms need to realize is that digital transformation is only partly to do with technology. Equally important is the fundamental change in the way the firm is managed.

Industrial-era Management

Let’s first take a glance backwards at the history of management. Towards the end of the 20th century, business thinking tended to converge on a generic “right way to run an organization.” This thinking comprised a set of internally-focused principles including a goal of making money for the firm and its shareholders; hierarchical-work structures with individuals reporting to bosses; and key indicators being short-term profits and current stock price.

These principles were supported by processes, including leadership that was top-down; strategy that was backward looking and defensive; innovation that protected the existing business; sales that induced customers to buy; HR that controlled workers as the firm’s resources; operations that delivered output targets at lower cost; a budget process that was a battle for resources among the silos; and compensation where gains mostly went to the top.

Each of these processes had its own set of rules and sub-processes, that supported both the overriding principles, and the other processes, and that were administered by people who specialized in the process, and built their careers within that function.

Although there were exceptions, most big successful firms in the 20th century were run in this way. And many still are. That’s what business schools mostly taught, and many still teach. In 1997, the Business Round Table endorsed it. Many people in big firms continue to believe that this is “the right way to run an organization.”

This set of ideas can become so deeply embedded in the systems, habits, attitudes, and assumptions that they are almost invisible to those within the firm. It is “the way we do things around here.” Silent acceptance and support of running the firm this way can become almost a condition of membership in the firm.

This way of running an organization had no specific name. It is mostly known simply as “management.” It was, and often still is, assumed to be the only coherent and internally consistent way to run an organization. Let’s call this way of running an organization “industrial-era management,” as shown below in Figures 1 and 3.

It can thus be useful to view an organization as a kind of complex adaptive system i.e. “a system that is complex in that it is a dynamic network of interactions, but the behavior of the ensemble may not be predictable according to the behavior of the components. It is adaptive in that the individual and collective behavior mutate and self-organize corresponding to the change-initiating micro-event or collection of events.”

The principles and processes of a firm function together like the immune system of the human body, and view industrial-era processes and practices as anomalies to be resisted and eliminated.

Digital-era management is different

Although industrial-era management was financially successful in the 20th century, and still is today for many big firms, in the first two decades of the 21st century, the context changed and another way of managing has begun to emerge. At first, little serious attention was paid it. The relevant firms were seen as anomalies or mocked for having a name like a piece of fruit.

Nevertheless, beginning in 2011, the financial world began recognizing that firms run in this different way were becoming more financially successful than firms run with industrial-era management.

As the new way became more and more financially successful, a decade-long process of inquiry began as to what exactly was this different way of running an organization? How did it relate to industrial-era management? That inquiry is still ongoing, but the main elements are becoming steadily clearer.

Over time, it has become increasingy apparent that the most successful of these firms have a different set of principles that include a goal of co-creating value for customers, an accompanying business model that generates profits as a result; team-based and network structures. The key indicator is long-term growth of market capitalization.

It also emerged that these principles are supported by processes that are quite different from those of industrial-era management. Leadership now occurs at every level, not just the top; strategy is dynamic, interactive, value-creating; innovation enhances existing businesses and creates new businesses; sales is now about making a difference for customers and users; HR is about attracting and enabling talent; operations is about exceeding expected outcomes at lower cost; budget is driven by strategy; compensation is becoming more based on value created. (See Figures 2 and Figure 3)

While no individual company observes all these principles and processes in every detail, the convergence towards this pattern among the digital winners is striking.

Because firms being run in the new way have been out-performing industrial-era firms in their core value—making money—the new way of running a firm has come to seen as an irresistible evolution of industrial-era management.

“Transforming the organization to reap the benefits promised by advanced digital technologies,” writes London Business School professor Julian Birkinshaw and colleagues “is no longer a question of ‘if’ or ‘when’ it’s a question of ‘how.’”

Needless to say, people who had devoted their careers and lives to industrial-era management were not happy with these developments and strenuously denigrated the new way. For industrial-era management practitioners and theorists, an alternative to industrial-era management was almost a logical impossibility.

Two types of management

So in 2022, we now have two strikingly different ways of running a corporation in a coherent and internally consistent fashion—industrial-era management and digital-age management.

We can also see that the principles and processes in the two management systems are polar opposites of each other.

The key challenge in transforming an industrial-era firm into digital-age organization is convincing tens, or even hundreds, of thousands of staff that “the way we do things around here” needs to be upended in almost every important respect.

Given that many of those who have to change their views are highly educated and experienced executives who have been very successful in operating in the industrial-era mode for decades, it is no surprise that most big firms experience difficulty in making the transition. Some even wonder whether transformation is possible.

In Part 2 of this article, I will examine principal paths that successful transformations have followed.

In Part 3, I will examine ways of diagnosing progress in conducting the transformation journey.