The Imagination Gap

21/04/2015 14:00

Published: April 20, 2015

Strategy & Leadership

The Imagination Gap

Business leaders in at least 16 sectors are still not fully prepared for the digital transformation of their industries.
by Jeffrey Rothfeder

For the most part, when the future becomes the present, it bears little resemblance to
how we had imagined it. Yet it is often similar enough to resonate, if only just a bit,
with the expectations of the past. For example, flying cars, which have been
anticipated in science fiction for years, still dont exist. But some autos drive
themselves and run entirely on non-polluting hydrogen. Clothing made of aluminum
with embedded radios and telephones may never see the light of day. But wearable
technology has given us shirts woven with sensors that detect movement, heart rate,
breathing pattern, and GPS location. And although the movie Back to the Future most
likely erred in predicting that the Chicago Cubs would win the World Series in 2015 (in
a sweep of a nine-game set), the Boston Red Sox, the other paradigm of a perennial
loser, has won the title three times.
This notion of a future that hasnt quite conformed to prior expectations is perhaps the
most striking facet of Strategy&s recent series on industry trends, an in-depth
analysis of the prospects for 16 of the worlds bellwether sectors. A single surprising conclusion is common to all of them: To
profit indeed, to survive in 2015 and beyond, companies must not just adopt new, unanticipated, and more decentralized
forms of digitization and technological innovation, but must use them to reshape their business models. These advances are
rapidly changing the commercial environment, inside and outside companies, but many business leaders are still unprepared for
them. Companies in every industry are confronting an imagination gap between the established and safe but rapidly aging
way of doing business and the opportunities and challenges of the technologies emerging today.
For example, computers are no longer relegated to desks. They can be found in pockets and purses, and are increasingly
embedded into every aspect of daily life. A growing number of buildings, automobiles, enterprises, and communities are
becoming computers themselves, controlled in shared fashion (and not always consciously) by the people inside them. People
increasingly use technological devices to gain unprecedented kinds of control over and engagement with their personal and work
lives, actively managing appliances, transportation, entertainment choices, homes, shopping forays, manufacturing processes,
and equipment maintenance, among many other activities. This new machine age is affecting virtually every industry B2B and
B2C by producing a multiplicity of purchasing and behavioral pathways for individuals and firmly shifting the balance of power
to consumers. End-users, not upstream companies, increasingly dictate the bespoke shape of the products and services they are
offered, as well as the price they pay, their suppliers, their deadlines, and the channels they use.

Buildings, automobiles, enterprises, and communities are

becoming computers themselves.
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For every sector, it is essential to close the imagination gap by incorporating technology into business models in more creative
ways. To be sure, technology as a strategic tool has been a corporate mainstay for many years. But it has often taken on a
solipsistic tint: Company strategists presumed a world in which computers everywhere would let customers more expediently and
seamlessly access their own business offerings. In this view of the future, the companies themselves were the center of the
transaction, determining what products or services to offer, when and where to offer them on the digital grid, how much to
charge, what form these items would take, and how quickly they would be delivered. Whether purchasing electricity from a utility
or a CD from Amazon, consumers in this vision were, in effect, bystanders, getting limited value out of the deal (generally, some
level of convenience and discounts). The largest gains in efficiency, an expanded customer base, marketing outreach, the sheer
number and variety of products and services offered, and lowered costs would always accrue, in this scenario, toward the
companies that used digital technology purely to enhance their existing way of doing business.
As shown by the recent Strategy& analysis of industry prospects, this approach to the kinetic landscape will never work. The most
innovative firms can close the imagination gap by rebuilding their businesses, rethinking products and services for a more
powerful and more widely networked customer base. By dint of their digital capabilities, these companies will be able to deftly
follow the money as their customers, be they manufacturers or shoppers, continuously alter their purchasing needs and choices.
For most companies, this undertaking will require simultaneously scaling and customizing operations. Thats an extremely tall
order, underscored by this statement by John Cahill, the CEO of Kraft Foods Group, one of the worlds largest consumer packaged
goods companies: Its clear that our world has changed and our consumers have changed, but our company has not changed
enough. (Cahill may have had the pending HeinzKraft merger in mind when he made this statement, in an earnings conference
call in February 2015, about a month before the merger was announced.)
Heres how this new customer dynamic is roiling some of the most rapidly changing industries.

The Biggest Industry Shake-Ups

The commercial transportation industry is facing perhaps the most radical technology-inspired change in customer behavior.
Manufacturers, the sectors biggest customers, are rapidly adopting 3D printing, which lets companies produce finished goods
from a single piece of equipment and minimal amounts of raw material, rather than assembling them from dozens, hundreds, or
thousands of parts procured globally. A good example is General Electrics jet fuel nozzle. Under traditional production methods,
this component contained 18 separate parts made from a variety of raw materials. All of these parts had to be machined, cast,
brazed, and welded before final assembly. Now, the nozzles are made by 3D printers using a single alloy, in a process known as
additive manufacturing, in which successive layers of the alloy are melted, shaped, cut with lasers, cooled, and then laid down in
sequence to produce the finished part.
The implication is dramatic: As the need to purchase parts from multiple global sources diminishes, component and materials
shipments, a substantial portion of the commercial transportation sectors revenue stream, will be eliminated or greatly reduced.
In fact, as much as 41 percent of the air cargo business and 37 percent of the ocean container business is at risk because of 3D
printing. Roughly a quarter of the trucking freight business is also exposed, owing to the potential decline in goods that start as air
cargo or as containers on ships and ultimately need some form of overland transport.
The electric power sector is also on the threshold of major change. Smart metering and the smart grid, as well as products like
Googles Nest thermostat, afford consumers fine-grained control over the way they use energy. This control encourages them to
demand more say in choosing their energy suppliers. A growing number of nontraditional competitors including solar
companies, Internet firms, and even cable operators are poised to provide energy and communications services to utilities
traditional customers.
Many power utilities have enjoyed virtual monopolies, constrained more by regulation than by competition. But the boom in

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energy innovation including renewable energy sources, off-the-grid installations and distributed power systems is rewriting
this business equation. In certain regions of the U.S., such as California and the Northeast, localized power generation systems,
primarily solar photovoltaic panels chosen by commercial and residential customers, are rapidly becoming common. Much of this
grassroots change is being driven by federal and state subsidies, but even when it isnt, power supplied locally is often cheaper
than power supplied via the traditional electric grid. Relatively low amounts of customer-sited generation can significantly affect
utility financial performance. According to one study, a market penetration rate of just 5 percent could lead to an earnings
reduction for utilities of between 4 and 9 percent.
In the retail and consumer goods spheres, shoppers behavior has become wildly pluralistic. People want to move easily across
online and offline purchasing channels while demanding an ever-increasing number of product options and full visibility into
inventory and pricing. In the past, it was not unusual, for example, for spirits buyers to purchase a premium brand in a bar, a lesscostly label at home for personal consumption, and yet another when entertaining guests. But this type of variegated shopping has
now spread throughout consumer retail. Fewer consumers are making one big stocking-up trip each week. Instead, many
shoppers are visiting premium stores, discounters, supermarkets, and online shops multiple times a week, often deciding where to
buy items after researching the best prices on smartphones and tablets. A growing number of shoppers also make frequent repeat
purchases through e-tailer subscription programs that automatically ship household staples on a predetermined timetable.
These shifts in consumer behavior are likely to evolve further in unpredictable, organic ways as people continue to create their
own paths to purchase.
Similar consumer-driven disruptions can be seen in healthcare, as individuals use digital channels to obtain more personalized
information about their well-being from their providers and as they demand bundled, transparent programs that allow them to
pay a single fee for tests and treatments related to a condition or procedure. In the chemicals industry, innovation is moving away
from the blockbuster breakthroughs of the late 20th century and toward more incremental advances that address particular
customer problems. In the automotive sector, consumers awash in easily accessible information about vehicle specifications,
prices, discounts, quality, and performance are less loyal to individual brands than in the past and are seeking more
sophisticated features at a low cost. They also want a seamless online/offline car-buying experience that simplifies the purchase
decision, financing, and insurance. And digital and mobile payment options abound as technology companies such as Apple,
Google, and PayPal piggyback on new electronic devices to lure business away from traditional credit card companies by
streamlining the buying process.

Three Strategic Solutions

A lot of talk and advice will be offered about the new environment during the next year or two. Indeed, all of the 2015 analyses of
industry trends presented by Strategy& provide a great deal of guidance for leaders, most of it carefully tailored to the particular
sectors under discussion. But a smart business observer should be most intrigued by three particular suggestions, each of which
cropped up multiple times. On the surface, these ideas seem relatively straightforward: Who could argue with better business
models, more effective use of digitization, or more highly tailored product lines? But there are reasons that few companies find it
easy to put these strategic responses into practice. Each one embodies a contradiction or reflects a challenge that business leaders
are struggling to resolve. The three key strategies for companies in all sectors:
Reimagine operations in light of new digitally enabled opportunities. Many companies are so caught up in their
existing methods and practices that when industry disruption occurs, they find it difficult to bring new ideas, products, and
services to the market. In the process, they cede substantial market share to more innovative entrants. Ongoing R&D and market
initiatives that question the viability of the companys current profit streams and that continually explore other possible directions
for the business are crucial, but often missing. The very dynamism that makes a company great in the first place frequently gives
way to inertia as company leaders become enamored of established products and services and afraid of the novel. Equally
problematic, employee innovation is not rewarded or encouraged sufficiently, while fear of risk taking feeds operational myopia
and paralysis. Significant opportunities to benefit from internal creativity are squandered.
The financial-services industry provides an apt illustration. Established companies are so dependent on credit card revenue that
they are shortsightedly ignoring an entirely new, lucrative business channel: mobile money products and services. As a result,
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they are falling dangerously behind new players often players from other sectors such as technology and telecommunications
in what will be the highest-growth part of the payments market, especially in developing regions with large poor populations.
To distinguish themselves and compete with disruptors from outside the industry, financial-services companies will also have to
revisit ideas about such traditional practices as credit scoring and lending programs. Startups are already offering new, more
granular, and more accurate models for assessing creditworthiness, even using social media as a data metric by, for example,
determining a persons maturity and reliability from their Facebook and LinkedIn pages. At the same time, new companies are
offering commercial loans to entrepreneurs who would typically be turned away by banks and venture firms through
crowdlending sites that aggregate small investments and charge a slightly higher interest rate than traditional loans.
Establish two-way digital relationships with customers. New devices and channels offer always-on interactions with
consumers that can keep them informed and empowered, as well as connected to a companys products and services. For
example, rather than investing heavily in physical supercenters or mega-websites, retailers can now offer convenient omnichannel
shopping experiences that combine in-store and digital access on all types of computing equipment. People should be able to
search, review, and compare products on a tablet; buy these items at their leisure on a smartphone; and have them delivered the
same day; and if they need to exchange goods, they should be able to do it at a store. Although retailers have for many years
attempted to integrate the Internet into their operations, they have usually done so while neglecting to assimilate omnichannel
capabilities into their business model. The greatest effect of the Internet on retail, in the long run, will not have been establishing
e-commerce but raising customer expectations for immediate satisfaction in every channel, offline or online. In other words, the
two-way digital relationship will not exist solely in the digital world.
Some retail categories, such as automobile dealerships, are particularly slow to change. Many have almost no connection between
what they display on their websites and the sales process in their physical stores. As the popularity of eBay Motors and other
vehicle auction sites proves, traditional dealerships will not be able to avoid enhancing their digital relationships with their
customers much longer. And some are already taking steps in the right direction. For example, a new service piloted by General
Motors hopes to attract car buyers who do research online before making their purchase in a dealership, as the vast majority of
car shoppers now do. Under the GM program, consumers can search for, select, arrange financing for, and purchase a car over the
Internet and have it delivered to their doorstep by a GM dealer.
Other creative digital interactions are slowly evolving in every sector, often goaded by the presence of startups that are
threatening the revenue and profits of old-line companies. For instance, the emergence of new power distribution firms for
either renewable or fossil fuels and smart grid technologies is forcing some power utilities to become so-called distribution
system operators, shedding their image as monolithic power suppliers. This shift involves incorporating new technology into the
grid to bring solar or wind power generated at customer sites onto the network and then distributing it efficiently to homes and
businesses as power needs arise. With this technology, customers power usage is determined solely by their behaviors if
residents, the hours they are home; if a company, the hours they are open for business; in both cases, the interior climate they
prefer, room by room. However, some utilities continue to resist this change and instead are fighting in the courts and among
regulators to maintain the outmoded monopolistic protections that made the industry ripe for disruption in the first place.
In their own way, industrial companies are confronting the same necessity to connect more closely with their customers and
their customers customers. Some of the more advanced firms in this sector have already begun to incorporate digital sensors and
data-gathering equipment into products that are linked to one another and the industrial firm via the Internet of Things (IoT).
With this burgeoning network, industrial companies can offer customers real-time performance monitoring, quality management,
and rapid response to product failures.
Focus more on the medium-term future needs of consumers. The opportunity to interact and communicate more
effectively with customers (and glean more about customer preferences than ever before) gives smart companies an advantage
that they lacked in the past. They can use what they learn to anticipate the next wave of demand and avoid getting trapped in the
treadmill of near-term line extensionstyle innovation.

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This notion could be viewed as a mass customization version of what was described in The Innovators Dilemma, the well-known
1997 book by then Harvard Business School professor Clayton Christensen. Christensen argued (and still argues) that most
companies are tempted to rely too long on maturing successful operating strategies, leaving themselves open to competition from
creative upstarts that offer the same products more efficiently and cheaply. Today, markets are more complex than they were in
the late 1990s. So many industries have been disintermediated in so many ways that there may be a dozen new rivals feeding
customer subsegments and niches. It behooves more established incumbents to pick the parts of the consumer base they
understand best, and build the capabilities they will need to provide those consumers what they want today, five years from
now, and conceivably five years after that. That doesnt mean losing flexibility. Building capabilities is not like offering new
products; its a permanent way to maintain both relevance and flexibility.
The software industry illustrates this balancing act well with its traditional products for the mainstream market and its newer,
more technologically tailored cloud offerings, which are set up to serve the specific requirements of companies that use these
Web-based applications and storage systems. By contrast, the chemicals industry has, to its harm, not moved quickly toward
change. Many major chemicals companies are suffering from being overly invested in specialty chemicals that initially delivered
higher margins but are now rapidly commoditizing. They offered these items as virtually finished goods and ignored the need to
invest in their own capacity for innovation and commercialization of new products.
To find their route out of this strategic dead end, chemicals companies must find new ways to keep manufacturing costs low
enough to be competitive while tailoring their product lines to provide customers with the balance of variety and customized
solutions that they want (and can probably purchase elsewhere). More robust technological communications with these
customers and their product development plans is critical in this scenario to give the chemical companies a window into
customers shifting needs and the ability to respond quickly to unexpected deviations.
No industry is exempt from the significant marketplace changes that are agitating the global commercial environment, or from
the pace of digitization that is driving these shifts away from the control of the producing companies themselves. And most
companies are prevented from addressing these obstacles head-on by their own imagination gaps. The solutions to this dilemma
require creativity and will. But the best approach starts with one idea: Although companies dont have to know how to predict the
future, they must have the foresight to navigate the present.
AUTHOR PROFILE:
Jeffrey Rothfeder is the former editor-in-chief at International Business Times and national news editor at Bloomberg News. He is the author of eight
books, including Driving Honda: Inside the Worlds Most Innovative Car Company (Portfolio, 2014).

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