The success of technology companies depends not just on seizing these disruptive opportunities but also on managing their existing businesses for productivity and growth. With technology companies’ shift to services, digitally enabled value chains are critical to achieving better margins and sales growth.
It is not surprising that software companies have taken the lead in digitizing their value chains. As they move to the cloud, their margins shrink, so their core business of writing code needs to be efficient. Even at software companies, however, many other elements of the value chain, such as sales and customer service, are not yet on the cutting edge. In fact, technology companies need to innovate all elements of their value chain:
- Product Development. AR and VR collectively provide possibilities for device companies to engage in advanced market research. Rather than building prototypes, companies can give consumers VR headsets that will allow them to envision a product. AR and VR can also be combined with 3D printing and CAD software to accelerate prototyping. In the cloud, blockchain could prove to be a massive source of disruption and growth.
- Supply Chain and Production. Companies now have an unparalleled opportunity to rebuild core logistical and production processes, leveraging AR, VR, and self-learning robots, for example.
- Marketing and Sales. Just as the retail and banking sectors have embraced connected channel strategies, technology companies must also shed old-school sales models. Companies can drive personalized digital engagement, create frictionless transactions, and build data-driven sales and marketing tools. Companies such as Microsoft and Cisco are moving in this direction.
- Distribution and Delivery. The move to subscription services and away from one-time purchases is in full swing at many companies. (Adobe’s Creative Cloud is described on the next page.) Companies are changing not only their pricing but also their product release schedules and partnership and ecosystem strategies. In a cloud-based world, software must integrate with other services and work seamlessly across laptops, handsets, tablets, and even wristwatches.
- Customer Support. Technology companies need to provide sophisticated customer support options that take advantage of data analytics and AI. These preemptively solve potential problems, and they enable frictionless, fully aware, and efficient interactions.
More broadly, two of the most prevalent transformations in the technology industry are those that involve hardware to software and software to software-as-a-service (SaaS).
Hardware to Software Transformation. This is not a new story—we titled the 2013 edition of this report The Great Software Transformation: How to Win as Technology Changes the World—but it remains highly relevant for hardware companies that aim to create greater value for themselves and their customers. IBM, for example, increased the share of its revenues from software sales and licensing from 14% in 2000 to 28% in 2015 and increased margins from 12% to 22% in the same time frame.
Compared with hardware, software offers greater flexibility, ease of customization, and ability to upgrade. One reason why Nvidia enjoys a 76% share of the market for graphic processing units is that its investments in software development allow it to frequently release new drivers and updates geared toward specific games and apps, catering to the needs of AI and game developers.
The transition, however, is not easy. In the software industry, the barriers to entry are low, so market shares can shift dramatically. In addition, a hardware to software transformation has profound implications across the entire value chain.
Companies that have made the transition embrace agile software development, create new sales and support approaches, and modify their talent requirements and partner relationships. These companies recognize how software, data, and connectivity can create value for specific customer segments, because they understand their customers’ experiences, pain points, and needs. Finally, they use metrics appropriate for software businesses to measure success and enable growth.
Software to Software-as-a-Service Transformation. SaaS is both a blessing and a curse for traditional software companies. The SaaS market is growing at nine times the speed of the broader software market. Despite their lower margins, pure-play SaaS companies generally have higher multiples than their more traditional competitors. At the same time, the SaaS model requires radically different engineering, marketing, and selling skills.
Adobe Systems, number nine in the technology top ten, has done a strong job of moving its customer base of photographers, artists, and designers to a pay-as-you-go Creative Cloud model. In 2015, Adobe generated two-thirds of its revenues from subscriptions, compared with just 11% in 2011. Revenues are tracing an upward trajectory.
Shareholders have rewarded Adobe’s move toward the cloud. Adobe’s stock generated a 25% annual TSR from 2011 through 2015, and its multiple expansion is the largest of all companies in the technology top ten.
Adobe wisely built a “value bridge” that gave investors confidence that the transition to a pay-as-you-go world would work. (See Exhibit 4.) Executives communicated clearly with analysts and shareholders, publicized new metrics, and limited new development activities to the cloud-based offerings—all strong signals that the company was committed to, and confident in, the new approach.
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