Do Not Just Transform Value Chain. Build a Digital Value Loop.
Why traditional firms fail in digital transformation?
With the rapid development of digital technology, including artificial intelligence, wearables, and sensors, firms are undergoing a transformation in the way they create value. Digital-native firms such as Apple, Google, Amazon, Tesla, and Facebook have achieved exceptional growth over the past two decades. Despite this, traditional firms are still struggling to find ways to transform their value chain.
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Traditional firms are now offering smart connected products with the objective of transforming their value chains. Rather than conventional refrigerators, TVs, washers, and dryers, they offer smart refrigerators, smart TVs, smart washers, and smart dryers. Traditional OEMs are launching new electric vehicle models, challenging Tesla, who still dominates the EV market. Smart tractors are equipped with sensors and actuators that can be controlled precisely by cloud-based AI engines. Industrial machines are being connected to the Industrial Internet of Things. The ever-growing set of digital trace data enables firms to optimize their value chains and gain sustainable competitive advantages. Firms are also creating digital platform ecosystems or participating in larger ecosystems. These platform ecosystems can harness the generative power of digital technology and create powerful network externalities.
Despite the importance of earlier investments in smart connected products and platforms, many firms still struggle to capture the value created with these investments. Companies must develop a digital value loop, not just transform their value chain. The basic concept of a digital value loop is deceptively simple: sensing users' activities through various digital tools and trace data and shaping their activities and experiences through algorithmic engagements via digital touchpoints. These digital value loops must be deliberately designed and supported by key capabilities to be effective. Once created, a digital value loop must be intentionally and strategically managed to extract unique value from digital assets.
Netflix: A digital juggernaut with a humble beginning
The success of Netflix exemplifies how firms can create a digital value loop. The Netflix algorithm decides whether the user will prefer closed caption or dubbing based on how they have watched foreign-language content in the past. Netflix uses a vast trove of digital trace data to create personalized offerings. Although Netflix began by renting physical DVDs via the US Postal Service and did not have a set of sophisticated algorithms, it was building the foundation of its value loop. Netflix asked each individual user to create their own queue of DVDs and, in doing so, users had to create their accounts and reveal their preferences. Netflix gained deeper insights into users' preferences by examining how long users kept different DVDs. Based on past behavior, Netflix started recommending which DVDs users should rent. Netflix created value through a digital value loop by sensing and shaping users' recurring behaviors, even though they were renting physical DVDs. By the time online streaming became viable, Netflix was ready to take its digital value loop to a higher gear. Netflix's first iteration of the digital value loop was built on delivering physical DVDs. It had neither smart connected products nor two-sided markets with powerful network effects when it first began building its digital value loop.
Many established firms with physical offerings often fail to build a digital value loop. Although they introduce smart connected products, mobile apps, and platforms, they often neglect to create a digital value loop. Just as a value chain was necessary for industrial-age firms, a digital value loop is essential for all digital-age firms. Companies can start building a digital value loop from where they are by emulating Netflix's humble beginning.
What is a digital value loop?
A digital value loop is a recurring set of interrelated discrete activities that firms perform to transform digital assets into valuable digital offerings through ongoing and dynamic engagement with customers as users. Digital native firms like Netflix and Amazon, and a growing number of traditional firms like Disney and Walmart, sense and shape the experience of customers-as-users by using a set of digital tools. These experiences are not limited to pure digital experiences but computationally augmented experiences.
Activities that shape value loop
As shown in the Figure, a digital value loop has two parts: sensing and shaping. The sensing part happens in the physical world. Using the first-party, second-party, and third-party data, a firm can sense the dynamically changing contexts a user is in. Mobile and embedded hardware assets equipped with various sensors tethered to the cloud play a crucial role in building the sensing part of the digital value loop.
Inferring, the first activity in a digital value loop, involves using data and analytics to make informed guesses or interpretations about users' needs, preferences, and behaviors. This requires the use of algorithms and machine learning models to uncover patterns and insights from data, such as identifying which features of a product are most appealing to customers. A well-known example of inferring in action is Netflix's recommendation system, which uses a viewer's past viewing history to suggest other titles they may enjoy.
Predicting, the second activity in a digital value loop, involves using data to forecast future trends, behavior, or events. This often involves the use of predictive analytics, which employs data mining, machine learning, and other statistical techniques to generate a forecast. For example, online retailers like Amazon use predictive analytics to suggest products that a customer may want to buy based on their browsing and purchasing history. By predicting the likelihood of a customer's future behavior, firms can tailor their marketing efforts and personalize the customer experience.
Generating, the third activity in a digital value loop, involves creating and delivering digital content or products that meet the needs and preferences of users. This requires a deep understanding of user needs and an ability to transform data and insights into valuable digital offerings. For example, Nike's digital platform, Nike Training Club, generates personalized workout plans for users based on their fitness goals and past workouts. By generating digital content tailored to each user's unique needs, Nike creates a valuable digital experience that helps them stand out in a crowded market.
Orchestrating, the fourth and final activity in a digital value loop, involves coordinating and integrating different parts of the organization to deliver a seamless, end-to-end customer experience. This requires the use of digital tools and platforms to facilitate communication and collaboration across departments and functions. A well-known example of this is Uber's app, which orchestrates a complex set of activities that connect riders with drivers, from real-time mapping to payment processing. By effectively orchestrating these activities, Uber creates a seamless and hassle-free experience for users.
Together, these four activities form a digital value loop that enables firms to sense and shape the experience of customers-as-users, creating valuable digital products and experiences. By inferring and predicting user behavior, generating personalized digital content, and orchestrating a seamless end-to-end customer experience, firms can build sustainable competitive advantages and capture new sources of value. However, to be effective, these digital value loops must be deliberately designed, supported by key capabilities, and strategically managed to extract unique value from digital assets.