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This chapter is from the book

Toward a Customer-Value Fitness Function

One of the most uncomfortable changes for leaders, especially executives and managers, undergoing digital transformation is the change in performance measures. The most profound of these is the switch from internal ROI to external customer value. While this is a measurement change, it is more fundamentally a change in perspective, a change in your gut-level basis of decision making. It means the first and foremost question an executive leader asks is not “How will this impact our bottom line?” but “How will this impact the value we deliver to our customers?” This change means believing that improving customer value is the key driver that will lead to improved ROI. But ROI isn’t the objective; instead, it is a constraint. You need to make a profit to continue delivering customer value. As explained further in Chapter 5, ROI is a business benefit (internal) but not a measure of customer value (external).

The year 2007 was an epic inflection point that has caused turmoil in both the economy and specific enterprises. In his book Thank You for Being Late,6 Thomas Friedman anointed 2007 as the year when multiple technologies came to fruition and kicked “digital” acceleration into high gear. Apple introduced the iPhone, Hadoop ushered in the big data era, GitHub multiplied software development capabilities, Facebook and Twitter expanded the reach and influence of social media, Airbnb showed what small companies could do with these new technologies, the Kindle changed book reading and the publishing business, and Google launched the Android operating system for phones. The confluence of all these technologies enabled new companies, such as Airbnb (which doesn’t own a single bed), to become much bigger (more beds than all the major hotel chains—combined). Thus 2007 was the inflection point that separated the pre-digital and digital worlds.

Complexity theory7 includes a concept called a fitness function.8 A fitness function summarizes a specific measure to evaluate how close a solution is to achieving a stated goal. In other words, it drives an organism (biology) or an organization (economics) to achieve its purpose—survival and procreation for an organism, thriving and continuation for an organization. As opportunities expand exponentially, you need a process, and a fitness function, to focus investments now and in the future. You need to build capabilities, modern technology platforms, and learning and adaptive practices—all driven by a set of values and principles. As you will see in subsequent chapters, EDGE addresses the challenges of both opportunity and capability. The challenges for enterprises moving from a pre-digital to a digital world are two-fold. First, you must change your fitness function. Second, you must leverage resources to make that change quickly. Both of these will challenge the best organizations.

  • “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”

  • —Charles Darwin, English naturalist

The fitness functions or business goals (Table 1-1) from pre-digital to digital times have changed from focusing on ROI to focusing on customer value. In a world characterized by greater certainty, ROI goals made sense. In today’s world filled with growing uncertainty, they don’t. In a post-2007 world, customer value works better. The switch from an ROI goal to a customer value goal is profound, and experience has shown the transition to be very difficult. Furthermore, trying to change the technology fitness function without changing the business fitness function is a lost cause, as many organizations have discovered to their great chagrin.

Table 1-1 Changing Fitness Functions

Fitness Function

Pre-Digital

Digital

Business

Return on investment

Customer value

Technology

Cost/efficiency

Speed/adaptability

Critics may say that customer value is too intangible, that ROI is a tangible measure and therefore better. In the book How Leaders Build Value,9 the authors suggest that 85 percent of a company’s market capitalization can be attributed to intangible factors such as leadership, culture, and patents. Investors look at the stream of earnings volatility over time to determine a price they will buy at (which drives market capitalization), and intangibles drive that stream—you just have to look at an intangible like Steve Jobs’s leadership at Apple to prove the point. Look at the market capitalization of high-tech firms today versus that of traditional firms—how much of their capitalization is due to intangible factors?

Given the turbulence and uncertainty of today’s business environment, picking the right measures of customer value and other intangible factors can be daunting. Nevertheless, one of the key capabilities required is the ability to discover and capitalize on the opportunities that this turbulence creates. A company’s ability to take advantage of opportunities requires a number of intangible factors critical to sustaining a flow of earnings. Customer value has both tangible (financial) and intangible components, intangibles are critical to long-term success, and the ability to deliver customer value is a critical capability for most companies.

Table 1-1 outlines the pre-digital and digital fitness functions. Industrial-era competitive advantage came from efficiency, optimization, and economies of scale. In the digital era, success comes from capabilities such as innovation, adaptability, personalization, customization, and quick response. In Table 1-1, business and technology are functional areas, not organizations. Business and technology organizations don’t have separate fitness functions; instead, both have customer value as a primary fitness function. If you are in the technology “organization,” your primary fitness function is customer value and your secondary fitness function is speed/adaptability.

Looking at the table, you should not conclude that ROI and cost/efficiency are now unimportant—in fact, they are very important. They are not the primary drivers, but they are secondary, but still critical measures. You might think of customer value and speed/adaptability as the primary objectives and ROI and cost/efficiency as guardrails (constraints).

At the same time the business fitness functions have been transitioning, the technology transition has been moving from cost and efficiency to speed and adaptability (of course, customer value is everyone’s primary fitness function). This transition is illustrated by an article and a book published 10 years apart. In 2003, Nicholas Carr wrote a controversial article in the Harvard Business Review titled “IT Doesn’t Matter,”10 which argued that IT had become a commodity and, therefore, could not contribute to sustainable competitive advantage. This article emphasized the focus on cost reduction, as it is the path to success for a commodity product. IT organizations were constantly admonished to reduce costs, a focal point that caused ballooning technical debt further impeding their digital transformation.

Ten years later, Rita McGrath,11 professor at Columbia Business School, wrote that in today’s fast-paced, uncertain world, sustainable competitive advantage itself was no more, being replaced by transient competitive advantage in which learning and adapting quickly was the ticket to success. In Carr’s world, IT should be governed by cost considerations. In McGrath’s world, responsiveness and customer value should drive IT.

The 2007 technological inflection point has exacerbated the difference between the rate of opportunity growth and the building of capabilities to take advantage of those opportunities. Opportunities are expanding so fast that you need ways to accelerate your ability to identify which opportunities to invest in and whether your organization has capabilities necessary to deliver on those investments. In short, you need more leverage. Leverage amplifies the results from a given set of inputs. Many enterprises are facing an existential crisis. They see a world of opportunities, but lack the capability to take advantage. They’re being outpaced and outfought by the competition. This growing opportunity–capability gap has become a critical issue for executive leadership (Figure 1-3). Overcoming this gap requires innovative thinking and putting tech at your business’s core, from strategy to delivery.

FIGURE 1-3

FIGURE 1-3 The widening gap between opportunities and the capability to explore or exploit these opportunities.

Switching fitness functions, either business or technology, has proved much more difficult than expected. When all of your processes, practices, accounting methods, and performance measures are ROI-driven, and have been for many years, switching to a customer value focus requires courageous business leaders. Similarly, switching IT from a cost/efficiency driver to one of speed/adaptability requires courageous technology leaders.

Making it to, and over, the next horizon requires that you be faster than the competition, adaptable enough, iterative, and driven by customer value. Being faster than the competition requires knowing the competition, which you often don’t until late in the game. Being adaptable enough includes understanding the rate of change in your market segments and what new market segments might impact yours. Being iterative means getting quick feedback to steer toward your ultimate vision. Having a customer-value focus means looking from the outside in, rather than the other way around.

A product (or service) is what you deliver to a customer to capitalize on an opportunity. A capability is how you build the what. You need specific strategies and plans for both product and capabilities to narrow the opportunity–capability gap. Your capability development plans should answer the question, “Can we make what we want to sell—in the future?” In this book the authors will address these two aspects: capitalizing on opportunities in the form of delivering customer value by investing wisely and increasing the speed of building the capabilities (especially technological capability) necessary to achieve that.

The core question is how you make this fitness function transition fast enough to close the gap between opportunities and capabilities. How do you gain leverage, multiplying your capabilities? How do you combine components, both technological and intellectual, in a way that significantly increases your capabilities?

Customer value is key to the present. Adaptability is key to the future. When ROI and efficiency dominated the fitness function, adaptability suffered. In the technology realm, for example, IT software assets accumulated technical debt that severely impacted future development. Time and time again, when priority decisions were made the emphasis was on schedule and cost, not value and adaptability. Over time, software assets degraded to the point that many organizations’ abilities to become digital enterprises were severely compromised.

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