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McKinsey - Competing in Digital World Four Lessons From the Software Industry - Feb 2013

McKinsey - Competing in Digital World Four Lessons From the Software Industry - Feb 2013

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Published by Jacques Kim Maeda

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Published by: Jacques Kim Maeda on Mar 14, 2013
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04/30/2014

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 About 20 years ago, software’s use within
organizations was largely conned to bigtransactional systems in the data center.Now, it underpins nearly every function inevery industry. Software spending has grownaccordingly, jumping from 32 percent of totalcorporate IT investment in 1990 to almost60 percent in 2011.
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The allure is plain. On the front end, software-enhanced products and services can lead toentirely new offerings—for example, turningan ordinary running shoe into one that alsotracks your mileage. And as the surge insocial techno logies shows, software permitsa host of new marketing and communicationschannels that consumers have been quick toembrace. The back-end benets are equally compelling. Greater automation, integration,and standardization can lower cost and boostperformance signicantly, while social enter-prise tools can facilitate collaboration andprovide greater agility.The strategic as well as operational challengeis that software is not static. Many have come
to think of it like electricity—something that
can be wired in and mostly forgotten about.
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But software and the processes and applicationsit touches are, in fact, constantly changing.That reality introduces new competitive dynamics.Managers have to worry about competitorsleapfrogging them with ever-faster cycle times,courtesy of such software-enabled techniquesas rapid prototyping and real-time testing. They must also be mindful of network effects, sincecustomers can become accustomed to working
Competing in a digital world:
Four lessons from the software industry
Software is becoming critical for almost every company’s performance. Executivesshould ask what they can learn from business models employed by software providersthemselves—and consider the implications for their IT function.
   J  o  n   K  r  a  u  s  e
Hugo Sarrazin andJohnson Sikes
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“Private xed investmentin equipment and software by type,”
Concepts and  Methods of the US National  Income and Product Accounts
,
US Bureau of Economic Analysis, November 2011,table group 5.5.5.
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In fact, this is no longer true,even for electricity, as develop-ments in smart grids and smart
metering infrastructures are
changing the power industry.
FEBRUARY 2013
business
 
technology 
 
office
 
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 with a certain platform and be slow to switch.That can be good news for incumbents but a major
 barrier for those trying to break into a certain
category. Another challenge is that an organiza-tion may be swimming in data but exploitingonly a fraction of available information.To effectively respond to these new dynamics,companies must begin thinking about waysto broaden their ecosystems and revenuestreams while becoming more responsiveand agile. These are issues that softwareproviders have been addressing for a numberof years. Given the increasing importance of software for almost every company’s perfor-mance, executives in all industries shouldconsider how software may fundamentally change their businesses. Managers woulddo well to study leading software-industry players and discuss a set of questions tounderstand whether and how they can learnfrom the business and operating models thatthese companies employ. The answers will vary for different industries and companies, but we believe the exercise is a useful steptoward making the most of large and risingsoftware investments.
1. Moving rom products to platorms
Success in the software industry has long beeninuenced, and often driven, by the ecosystemof developers, plug-ins, software-developmentkits and application-programming interfaces(APIs),
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and add-ons that drive added valueand increase stickiness for products. Similarly,companies in other industries need to think expansively and include upstream suppliersas well as downstream vendors or consumers,and focus on how each part of the value chainintegrates into the new platform. Many compa-nies still stick to the business models of the past, where product development is almost exclusively an in-house activity and kept under strict control.But some, like consumer-goods giant P&G, haveung their doors open to include a wide rangeof partners in developing and tailoring the next big thing. Instead of “not invented here,” themind-set is shifting to “proudly found else- where.” P&G, for instance, launched a “connectand develop” platform that has secured morethan 1,000 partner agreements on innovation.By opening innovation processes to outside voices, organizations not only gain a broaderrange of perspectives to enrich the innovationgene pool, they also gain valuable scale—moreresources at a fraction of the price. And it’s not just the front end that stands to gain: greaterconnectivity with suppliers and buyers can bea win-win situation when it comes to managinginventory, budgeting and forecasting, allowingorganizations to access better—and more—
 
real-time data, and rening production andsupply-chain processes on the spot. In a
 McKinsey Quarterly
interview,
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Bob McDonald,P&G’s CEO, said his organization looks toincrease integration with retail partners because“getting the data becomes part of the currency of the relationship.” In some cases, P&G is evenusing its scale “to bring state-of-the-art techno l-ogy to retailers that otherwise can’t afford it.”
Question:
What new opportunities areunlocked if we move from products to platforms? 
• What is our industry equivalent of an APIthat will encourage involvement and increasedinteraction across the ecosystem (includingsuppliers, partners, vendors, and users)?• How can we align the different parts of theecosystem to adopt more points of integration?
Takeaways
Sotware underpinsnearly every unction inevery industry, but it isnot static; the reality thatit is constantly changinghas created new compe-titive dynamics.Organizations must indways to broaden theirecosystems and becomemore responsive—managers would do wellto study leading playersin the sotware industryas they consider howsotware may transormtheir businesses.Relecting on our questionscan help companies as theyaddress their business andoperating models.
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Software companies oftenprovide software-developmentkits to external programmersto help better integratesystems and functionality. Application-programminginterfaces are structured orprebuilt interfaces to helpapplications interact with oneanother (for example, allowinga dynamic map of local storesto be embedded on a Web site).
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Michael Chui and TomFleming, “Inside P&G’s digitalrevolution,” mckinseyquarterly 
 
.com, November 2011.
 
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• Of the new value that is created with thisintegration, how are the gains shared acrossmembers of the ecosystem? What are thecritical control points that we must own toprotect our position and maximize rents?• How can we create a cadre of evangelists(internally and externally) to encourage theadoption of our platform?
2. Accelerating revenue by creatingnew business models
Software and Internet companies have developedmultiple avenues to generate revenue, going beyond a simple licensing model. Companieslike LinkedIn and Skype have thrived using the“freemium” model. Both cultivated a large base of users with their basic, no-cost platform, and thenintroduced several paid-for options, ranging fromrecruiting services and tiered access and net work-ing privileges in the case of LinkedIn and landlinecalling in the case of Skype. They were able totap an audience that was loyal to their brand to boost revenues. Other revenue models includeusing as-a-service and consumption-basedpricing
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and creating new integrated services.Innovative companies in other industries areexperimenting with ways to combine products,
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 As-a-service and consumption- based pricing leverages cloudcomputing to unbundlecomputing products and
software so that users can
economically purchase asubscription to online software(for example, e-mail services,customer-relationship-
management systems, or
productivity suites) ratherthan buying and operatingthe separate hardware andsoftware components. Thisalso allows these services to be “turned off” on demandand often shifts them fromcapital to operating expenses.
The right role for IT
IT will undoubtedly play a more signiicant roleas sotware becomes a larger part o the com-pany and the product. This will require structuralchanges or both leadership and operations.CIOs will increasingly have a greater voice instrategic discussions. Operationally, there willbe more cross-ertilization among specialties,with IT employees placed directly in the line obusiness to help push through desired productand process changes.Some executives are beginning to experimentwith a new management model consistingo two categories
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: “actory IT” and “enablingIT.” Factory IT encompasses the bulk o anorganization’s IT activities. It applies lessonsrom the production loor on scale, standard-ization, and simpliication in order to driveeiciency, optimize delivery, and lower unitcosts. Enabling IT ocuses on helping organi-zations respond more eectively to changingbusiness needs and gain a competitiveadvantage by spurring innovation and growth.Enabling IT also requires technology leadersto think more expansively about their role andhow the systems they manage aect the busi-ness as a whole. They need to keep in mind thatsotware assets are ubiquitous and span everypart o their organization—and in some casesits business partners and customers—whichinluences the organization in not-so-obviousways. The CIO o a social-media company recentlytold us, or example, that his role includes beingthe guardian o the company culture, which ischaracterized by speed, transparency, andlexibility, and making sure that the sotwarethe company rolls out supports these tenets.
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See Roger Roberts, HugoSarrazin, and Johnson Sikes,“Reshaping IT managementfor turbulent times,”mckinseyquarterly.com,December 2010.

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