Scaling digital: what can we learn from digitally native companies?

December 2, 2022

Dr. Jacques Bughin

Technology digitization has been an important theme for many years now, and the technology set that defines digitization keeps expanding into more potent, so-called “deep” technologies such as virtual reality, blockchain and artificial intelligence (in short, AI).

Digital diffusion into economies continues to spread across the globe, as demonstrated by the results of this year’s Network Readiness Index, and is giving rise to multiple socioeconomic changes, from the rise of social media to mobile data revolution, or the rise of the so-called FAANG companies as new global firms. 

Technology has demonstrated its potential as a cross country equalizer, or as an important, resilient platform of exchange at times of social restrictions at the peak of the pandemic. But it is important not to be only digital optimists: digitization is good to the extent that it is used with the right purpose. For example, social media has been a means to mobilize society and initiate new types of country revolutions as much as it may have contributed to the rise of more political polarization. The rise of the superstar digital natives firms may raise questions as to whether their business concentration still reflects fair competition as much as those companies which have built products and services used by the majority of our citizens.

Yet digitization is here to stay. In the context of FAANGs as digital native firms, these companies give us a clear blueprint of a crucial industrial reinvention process, called digital transformation (DT)  that is forming the backbone for markets, organizations, and the future growth trajectories of the world economy.

In effect, digital native companies such as the FAANGs have typically invested more in digital technologies than other companies. But this is not what sets them apart. What sets them apart is their ability to create new operating models as well as new disruptive strategies, which explains their massive success. Using a conservative accounting return on invested capital (ROIC) metric, which omits the benefits of intangible assets, the average ROIC of FAANGs was 33 percent in mid-2021, nearly four times their weighted average cost of capital (WACC), and three times the average ROIC of public companies in US and Europe. In fact, in this later case, the return on invested capital has remained essentially flat over the past two decades at 10 percent among U.S. and European firms, despite the massive adoption of digital technologies.

Two important characteristics of digital technologies have possible major consequences on likely returns to investing in digital technologies. The first feature is that digital capital is much less expensive than physical capital, meaning that most firms can engage in DT; in turn, this means that firm competition is highly exacerbated under digitization. The second aspect of digital technologies is that they are “strategic” in nature (i.e., their inherent properties can be best exploited as part of an effective digital transformation to create new competitive advantages while insulating from more intense competition). FAANGs in particular are truly innovative in leveraging digital technologies. Amazon reinvented commerce by integrating online marketplaces with their own retail; later, the operating model shifted radically to smart automation and robotics (e.g. Amazon’s Kiva robots that can handle parcels faster than humans and in a space that is half the size of traditional human–heavy logistics center). Google makes the world’s information searchable in one click via algorithmic queries, and is now exploiting its data processing capabilities for further major innovation development in AI, including DeepMind’s AI innovation in protein structures that might radically change the future of biology and medicine

In contrast to FAANGS, DT success has been more elusive among incumbents, which calls to leverage FAANGs as a benchmark of powerful practices for succeeding in digital transformation. Hereafter, I provide a few of those lessons, especially in the context of the new frontier technologies like AI, leveraging a set of recent work combining work collaborations at the Portulans Institute, the Free University of Brussels and elsewhere, for DT success. 

Success 1: Jump in and experiment with digital transformation. The case for waiting to launch digital transformation was that technologies keep evolving, compensating delay of not investing by better tech performance. But this is a fallacy, as technology is only one part of the returns to DT. The key return comes from the reinvention of the strategic and operating model for better competitive advantage. 

The most digital economies, including Singapore, Sweden, the Netherlands, Switzerland, Denmark, and the United States, are also those with firms more involved in DT, and with large integrated start ups and local large firm ecosystems.

Success 2: Expand rather than specialize in digital transformation-induced use cases. If digital technology powers automation efficiency, DT is foremost a game changer as a tool for innovation. Digital innovative products and services are prevalent among FAANGS, and beyond their core products— think Google and Waymo self-driving cars, or Deep Mind inroads into new drug discovery. 

Innovation is not only good for a company, it is really good for the economy at large. The most advanced countries leading the pack in terms of adoption of emerging technologies (e.g. China and the United States), are also responsible for most AI-related innovative research activities and investment. 

Success 3: Digital transformation opens the gate for powerful new business models. When Netflix uses AI for video, it does not use it for a traditional pay per use model, it uses it to support a new on-demand flat-fee video model; when Amazon supplies third party products on its web site, it is not to only increases the available set for users, it proposes also that third parties be integrated into its separate cloud platform. FAANGs are typically platform based, but most continents are now witnessing  the rise of  their own digital platform darlings too, eg in  retail transactions South America’s MercadoLibre, Jumia in Africa, or Lazada in East Asia, and in B2B, Zoodel in the Arabic world, and ECPlaza in South Korea.

Success 4: The future of work is mostly a future of skills. It is a fact that FAANG have revolutionized HR practices, (e.g. Google recruiting based on HR analytics). FAANG companies also anticipate new skills and integrate effective on-the-job training to sustain their best returns to labor.  We also know that DT roll out will disrupt work practices. But the baseline scenario is more about new skills that complement DT rollout. In particular, human skills such as creativity, social and emotional skills such as communication and empathy will grow as fast as demand for many advanced technological skills. Automation will also spur growth in the need for higher cognitive skills, particularly critical thinking, or complex information processing. In this environment, companies have no choice but to redefine their HR strategy. 

Not surprisingly, the Scandinavian countries as well as top ranking economies like the United States have the largest portion of population with digital skills

Success 4: Digitally transform with a purpose. Last but not least, DT is not only a process of profit maximization by transformation. More and more, DT requires us to go beyond pure use of technologies, and go for Tech for Good. For example, FAANGs have been the first to (but not always the best at) look at ethical and responsible AI. They were also the first to recognize the risk of AI biases and the dangers of non-transparent AI. The shift towards digital transformation for a broader purpose is only starting, but must continue. Technology should help, not take over, our lives.    

Dr. Jacques Bughin is a senior advisor to Fortino Capital, a VC firm specializing in B2B Saas, the CEO and owner of MachaonAdvisory, and a venture partner at Antler. He is currently teaching business strategy at Solvay Business School and serves as a member of the Portulans Institute Board of Advisors. Dr. Bughin was a director in McKinsey’s Brussels office and supported clients in their Media and Entertainment, Corporate Finance, and Strategy Practices, in addition to co-leading the Digital Economy Initiative. He also acted as director of the McKinsey Global Institute (MGI), the firm’s business and economics research arm. He worked for McKinsey for 28 years. Dr. Bughin received a PhD in economics, operations research, and strategy from Université Catholique de Louvain in Belgium.