The Nature of Digital Disruption
By Kellsey Ruppel-Oracle on Jul 29, 2014
Digital Disruption – The change that occurs when new digital technologies and business models affect the value proposition of existing goods and services or bring to market an entirely new innovation.
Why is the shift to digital so disruptive?
As a global society, we are currently in the process of digitizing everything. We are wrapping our physical world with a digital counterpart, a world of information, which parallels and reflects our own. We want to know everything we can think of about everything we can think of.
This whirl of digital information changes the playing field for businesses, because digital information does not abide by any of the rules that we are used to in business.
In a digital world, products and services have no physical substance. There are no distribution costs. A single prototype can generate an infinite number of copies at no cost. And since the products and services are so different, the environment around them becomes unstable; as the digital layer interacts with the physical layer, everything in the ecosystem is up for grabs. Suddenly new products become possible and established ones become obsolete overnight.
Science-fiction writer Arthur C. Clarke once said that “Any sufficiently advanced technology is indistinguishable from magic.”
In the business world today, you are competing with sorcerers. You need to learn magic.
Let’s take the music industry as an example of how technology changes the playing field. Music used to be very expensive to record and distribute. Every time a new technology comes along, the music industry has had to adjust.
The graph on the left shows units sold in the music industry, by media, since 1973. See the overlapping curves? Each technology has a lifecycle – early in the lifecycle sales are low, but they rise as more people adopt the technology. When a new technology comes along the older technologies suffer. But not to worry, people still need their music, right? Typically the lifecycle curve for “units sold” closely echoes the revenue curve.
But when the product becomes purely digital – when it enters the realm of magic – the cost of making and distributing the product plummets to nearly zero. This means more people can produce and distribute music, more cheaply and easily. More music becomes available to the public and purchases skyrocket – but the price per unit drops precipitously.
Take a look at the two graphs below. The left chart is units sold and the right one is revenue. Note how digital downloads (units sold) have skyrocketed, while the revenue curve is the smallest in years.
The core issue is that even though unit sales rise rapidly, the price per unit drops so much faster that the revenue from sales fails to make up the difference. The industrial-age company, which has built its business model on the high costs of producing and distributing physical products, now has a high-cost infrastructure which is suddenly obsolete. What was once an asset is now a critical liability. This opens the entire industry to new players who can offer services to this new world at a dramatically lower cost.
The product is now digital. So the album, which you once charged $15 for, now retails for about $10. Ouch. You just lost a third of your revenue. But it gets worse. In the old days you sold music by the album, because the cost to make and distribute single songs on CD kept the cost of singles relatively high. So people would buy albums which contained a lot of songs, it now appears, that they didn’t really want. The chart below compares the typical mix between album and single sales on CD vs. downloads. The product mix has flipped completely, from most people buying albums for $15, to most people buying songs for $1.
So the revenue per unit drops once again. Even with some people buying albums, the average revenue per unit is about $1.50. That means your entire industry has lost about 90% of your revenue, almost overnight.
In the world of manufacturing we talk about efficiency and productivity. You look to efficiency to decrease your costs and productivity to increase your revenue. In between you seek to make a profit. But you can’t streamline yourself to profits when the world is changing around you so profoundly. You need different strategies, different tactics.
The digital revolution is the biggest shift in the music industry since the 1920’s, when phonograph records replaced sheet music as the industry’s profit center.
What’s going on here? First, the means of making and distributing the product change. Suddenly the costs are so low that thousands of new competitors enter the market. Every artist can now compete with you from his or her garage, bringing new meaning to the word “garage band.”
But as if that weren’t bad enough, this also changes the things that people buy and the way they buy them. It’s a cascading effect.
So who wins and how do they win? Let’s look at Apple’s iTunes strategy. Apple looked at the entire industry as an ecosystem – people buy music and they play it on a device. If they like the experience they buy more music. In time they might buy another device, and so on, and so on. This is not a business process, it’s a business cycle.
Sony had everything that Apple had – in fact, much more. They had a powerful music-player brand, the Walkman, the established industry leader for portable music players. They had more engineers. They had a music division with 21 record labels.
Sony’s divisions, which worked in their favor for efficiency and productivity, worked against them when it came to collaboration and innovation. The company was divided into separate operating units which competed with each other internally, making it difficult to collaborate on projects that spanned across multiple units. Sony was a classic industrial-age company, focused on productivity and efficiency.
What did Apple do that Sony didn’t? They focused on the system, not the product.
If you want to record your own music, Apple makes the software for that. If you want to sell your music, you can sell it on iTunes. If you want to play it, Apple makes the device. In case you hadn’t noticed, Apple had to look at the entire ecosystem of the record industry through a new, digital lens, including:
- Understand the digital infrastructure and how it changed the playing field.
- Relentless focus on user experience – simplicity, “just works” design, delight customers.
- Smart partnerships: Apple began by giving away the money: Record companies made 70 cents on every 99 cent purchase, with the rest split between artists and merchandising costs.
- Interoperability: Apple chose to support an open format that would work with any player, while Sony chose a proprietary format for their first digital media player.
Think creatively. Understand, provide for, and support the entire ecosystem. Fill in the gaps when you can. Eliminate middlemen if you can – partner with them if you must. Partner with value providers (like artists and record companies that own large repositories of music). Be fearless about cannibalizing your own core business – if you’re not doing, it somebody else is.
The core difference is between an industrial, manufacturing-based model which focuses on efficiency and productivity – making more widgets more efficiently, and an information-based model which focuses on creativity and innovation. The industrial model thrives on successful planning and logistics, while the information model thrives on systems thinking, rapid learning and adaptation to a changing environment.
What can you do? As a company, you will need to innovate differently. That’s the subject of my next post, which we will discuss next week.
In the meantime, you can hear more from Dave on Digital Disruption in our Digital Business Thought Leaders webcast "The Digital Experience: A Connected Company’s Sixth Sense".