F E B R UA RY 2 013

Jon Krause
b u s i n e s s t e c h n o l o g y o f f i c e

Competing in a digital world:

Four lessons from the software industry
Software is becoming critical for almost every company’s performance. Executives
should ask what they can learn from business models employed by software providers
themselves—and consider the implications for their IT function.

Hugo Sarrazin and About 20 years ago, software’s use within and standardization can lower cost and boost
Johnson Sikes organizations was largely confined to big performance significantly, while social enter-
trans­actional systems in the data center. prise tools can facilitate collaboration and
Now, it underpins nearly every function in provide greater agility.
every industry. Software spending has grown
accordingly, jumping from 32 percent of total The strategic as well as operational challenge
corporate IT investment in 1990 to almost is that software is not static. Many have come
60 percent in 2011.1
to think of it like electricity—something that
can be wired in and mostly forgotten about.2
The allure is plain. On the front end, software- But software and the processes and applications
1“Private fixed investment enhanced products and services can lead to it touches are, in fact, constantly changing.
in equipment and software entirely new offerings—for example, turning
by type,” Concepts and
Methods of the US National an ordinary running shoe into one that also That reality introduces new competitive dynamics.
Income and Product Accounts, tracks your mileage. And as the surge in Managers have to worry about competitors
US Bureau of Economic
Analysis, November 2011, social techno­logies shows, software permits leap­­­frogging them with ever-faster cycle times,
table group 5.5.5. a host of new marketing and communications courtesy of such software-enabled techniques
2In fact, this is no longer true,

even for electricity, as develop­­ channels that consumers have been quick to as rapid prototyping and real-time testing. They
ments in smart grids and smart
embrace. The back-end benefits are equally must also be mindful of network effects, since
metering infrastructures are
changing the power industry. compelling. Greater automation, integration, customers can become accustomed to working
 2

Takeaways

Software underpins
nearly every function in
every industry, but it is
not static; the reality that
it is constantly changing
with a certain platform and be slow to switch. where product development is almost exclusively
has created new compe­
titive dynamics. That can be good news for incumbents but a major an in-house activity and kept under strict control.
barrier for those trying to break into a certain But some, like consumer-goods giant P&G, have
Organizations must find
ways to broaden their category. Another challenge is that an organiza- flung their doors open to include a wide range
ecosystems and become tion may be swimming in data but exploiting of partners in developing and tailoring the next
more responsive— only a fraction of available information. big thing. Instead of “not invented here,” the
managers would do well
mind-set is shifting to “proudly found else-
to study leading players
in the software industry To effectively respond to these new dynamics, where.” P&G, for instance, launched a “connect
as they consider how companies must begin thinking about ways and develop” platform that has secured more
software may transform to broaden their ecosystems and revenue than 1,000 partner agreements on innovation.
their businesses.
streams while becoming more responsive
Reflecting on four questions and agile. These are issues that software By opening innovation processes to outside
can help companies as they
providers have been addressing for a number voices, organizations not only gain a broader
address their business and
operating models. of years. Given the increasing importance of range of perspectives to enrich the innovation
software for almost every company’s perfor- gene pool, they also gain valuable scale—more
mance, executives in all industries should resources at a fraction of the price. And it’s not
consider how software may fundamentally just the front end that stands to gain: greater
change their businesses. Managers would connectivity with suppliers and buyers can be
do well to study leading software-industry a win-win situation when it comes to managing
players and discuss a set of questions to inventory, budgeting and forecasting, allowing
understand whether and how they can learn organizations to access better—and more—
from the business and operating models that real-time data, and refining production and
these companies employ. The answers will supply-chain processes on the spot. In a
vary for different industries and companies, McKinsey Quarterly interview,4 Bob McDonald,
but we believe the exercise is a useful step P&G’s CEO, said his organization looks to
toward making the most of large and rising increase integration with retail partners because
software investments. “getting the data becomes part of the currency
of the relationship.” In some cases, P&G is even
1. M
 oving from products to platforms using its scale “to bring state-of-the-art techno­l­
ogy to retailers that otherwise can’t afford it.”
Success in the software industry has long been
3Software companies often influenced, and often driven, by the ecosystem Question: What new opportunities are
provide software-development of developers, plug-ins, software-development unlocked if we move from products to
kits to external programmers
to help better integrate
kits and application-programming interfaces platforms?
systems and functionality. (APIs), and add-ons that drive added value
3

Application-programming
interfaces are structured or and increase stickiness for products. Similarly, • What is our industry equivalent of an API
prebuilt interfaces to help companies in other industries need to think that will encourage involvement and increased
applications interact with one
another (for example, allowing expansively and include upstream suppliers interaction across the ecosystem (including
a dynamic map of local stores as well as downstream vendors or consumers, suppliers, partners, vendors, and users)?
to be embedded on a Web site).
4Michael Chui and Tom and focus on how each part of the value chain
Fleming, “Inside P&G’s digital
integrates into the new platform. Many compa- • How can we align the different parts of the
revolution,” mckinseyquarterly
.com, November 2011. nies still stick to the business models of the past, ecosystem to adopt more points of integration?
3

The right role for IT

IT will undoubtedly play a more significant role costs. Enabling IT focuses on helping organi-
as software becomes a larger part of the com­ zations respond more effectively to changing
pany and the product. This will require structural business needs and gain a competitive
changes for both leadership and operations. advantage by spurring innovation and growth.
CIOs will increasingly have a greater voice in
strategic discussions. Operationally, there will Enabling IT also requires technology leaders
be more cross-fertilization among specialties, to think more expansively about their role and
with IT employees placed directly in the line of how the systems they manage affect the busi-
business to help push through desired product ness as a whole. They need to keep in mind that
and process changes. software assets are ubiquitous and span every
part of their organization—and in some cases
Some executives are beginning to experiment its business partners and customers—which
with a new management model consisting influences the organization in not-so-obvious
of two categories1: “factory IT” and “enabling ways. The CIO of a social-media company recently
IT.” Factory IT encompasses the bulk of an told us, for example, that his role includes being
1See Roger Roberts, Hugo
organization’s IT activities. It applies lessons the guardian of the company culture, which is
Sarrazin, and Johnson Sikes,
“Reshaping IT management from the production floor on scale, standard­ characterized by speed, transparency, and
for turbulent times,” ization, and simplification in order to drive flexibility, and making sure that the software
mckinseyquarterly.com,
December 2010. efficiency, optimize delivery, and lower unit the company rolls out supports these tenets.

•O
 f the new value that is created with this beyond a simple licensing model. Companies
integration, how are the gains shared across like LinkedIn and Skype have thrived using the
members of the ecosystem? What are the “freemium” model. Both cultivated a large base of
5As-a-service and consumption- critical control points that we must own to users with their basic, no-cost platform, and then
based pricing leverages cloud
protect our position and maximize rents? introduced several paid-for options, ranging from
computing to unbundle
computing products and recruiting services and tiered access and net­work­
software so that users can
economically purchase a
•H
 ow can we create a cadre of evangelists ing privileges in the case of LinkedIn and landline
subscription to online software (internally and externally) to encourage the calling in the case of Skype. They were able to
(for example, e-mail services,
customer-relationship- adoption of our platform? tap an audience that was loyal to their brand to
management systems, or boost revenues. Other revenue models include
productivity suites) rather
than buying and operating 2. A
 ccelerating revenue by creating using as-a-service and consumption-based
the separate hardware and new business models pricing5 and creating new integrated services.
software components. This
also allows these services to
be “turned off” on demand
Software and Internet companies have developed Innovative companies in other industries are
and often shifts them from
capital to operating expenses. multiple avenues to generate revenue, going experimenting with ways to combine products,
 4

services, and data to create entirely new busi- • What is the real lifetime value of our customers,
nesses—often with software playing a critical and how does this change our approach to
role in knitting together or enabling these setting prices?
new models. Industries from manufacturing
to consumer goods have stitched information • Are our internal systems able to handle these
assets into their traditional product offerings shifts? Are incentives in our organization
and have come away redefining the category (especially in the sales force and channels)
and raising the bar for competitors. in place to make the right trade-off?

Nike took this approach with one of its shoe • What are the ancillary assets our company
lines. It created Nike+, a sensor compatible has (for example, brands or data), and how
with Apple iOS devices (for instance, the iPod could we deploy them without harming our
or iPhone), to be used with its running shoes. core business?
The sensor allows the wearer to track mileage
and running habits and upload data onto a Web 3. Accelerating cycle time and
site to manage workouts, connect with fellow cocreating with customers
runners, and share routes. The line not only
launched a profitable new revenue stream Empowered by constant connectivity, the rise
but also helped boost Nike’s market share and of social networks, and an increasing amount
created a community of highly engaged users. of software in products, companies are seeing
new options in the way they interact with
In addition to creating new revenue streams customers and develop and release products.
by amping up traditional product and service They are speeding up cycle times and shortening
offerings, organizations have been mining learning curves by testing new products or ideas
“exhaust data”—information that is a by-product with consumers using mockups, computer-
of normal business operations—for use in generated virtual products, and simulations.
developing new products. Such by-products,
for instance, allow credit-card companies to The software world was one of the first to
monetize transactional data from cardholders roll out new products before all the planned
by analyzing and selling these data to mer- features and capabilities were built. It started
chants. Similarly, Intuit is beginning to use with a basic model, or minimum viable product,6
data amassed from its QuickBooks software that customers could upgrade over the life
to provide new benchmarking and reporting of the product with just a few clicks. New
services for small businesses. features were introduced when ready rather
than stalling the base product launch. This
Question: What business model could we allowed companies to get to market faster,
borrow from the software industry to acceler- enable new features (or fix bugs), and improve
6Eric Ries, The Lean Startup: ate adoption? their ability to respond to competitors’ changes.
How Today’s Entrepreneurs Apple launched its first iPhone, for instance,
Use Continuous Innovation
to Create Radically • How do we trade off one-time revenues without an app store or the ability to add new
Successful Businesses, first (for example, a license fee or outright sale) applications. It added those features in a
edition, New York, NY:
Crown Business, 2011. to capture recurring subscription revenues? software update one year later.
5

• Should we establish a beta program with

consumers? How else can we collaborate
with them?

• What is too soon to ship? And how tolerant

of potentially incomplete or buggy products
will our customers be?

• What cultural changes are needed in our

orga­nization to encourage it not only to listen
Other industries are learning from this example. to customers but also to give them control?
Many digital cameras, for instance, can receive
firmware upgrades to fix bugs or enable new • How much product control are we willing
capabilities. But this is not just a phenomenon to give up?
for digital gadgets. In early 2012, Ford released
an upgrade for its Sync communications and 4. Creating an agile organization
entertainment system by mailing USB keys
7

to customers eligible for an upgrade. No dealer The three lessons above involve accelerating
visit is required. the clock speed of the enterprise and thinking
differently about the structures across the
Crowdsourcing is an example of cocreation: business or boundaries with customers or
companies use social tools to engage customers users. Adopting these behaviors will require
or partners in solving problems, which rein- a more agile and flexible organization.
forces engagement and a sense of community
in the process. For instance, Coca-Cola used Software creation is inherently team based;
crowdsourcing to develop new designs for as a result, the vast majority of software com­
bottle crates in Germany and marketing ideas panies have built teamwork into their ethos.
for Coke Zero in Singapore. GE has crowd- Teams assemble and reassemble based on specific
sourced green business ideas under its “eco­ projects, often resulting in flatter organizations
magination” challenge. This engagement model than may be seen in other industries. To the
has even been flipped, with companies like uninitiated (and sometimes even to those in
Kickstarter providing a platform for entrepre- the industry), this way of working feels like
neurs to presell product ideas as a way to solicit barely controlled chaos. Companies that do this
funding based on early prototypes or ideas. well depend on core organizational elements,
including increased transparency, a laser-like
Question: What is the right way for us to focus on aligning culture and mind-set, and
engage with and learn from our customers? clearly defined, common goals.

•H
 ow can we embed test-and-learn and rapid- In the past decade, many software organiza-
7“Ford Sync software upgrade iteration principles in our product-develop- tions have built on these elements and further
adds new features to MyFord
ment process? Where else can these principles increased their productivity by using agile
Touch,” media.ford.com,
January 2011. be used in our company? programming techniques—where teams run
 6

in sprints of two to three weeks to develop a place, in which economic value is driven increas-
workable prototype or new functionality. It is ingly by information-based services.
very different from the traditional planning
and budgeting model used by many organiza- Question: What new organization models can
tions. IT shops are beginning to employ agile we adopt from software to support a more agile,
methodologies, but often their counterparts flexible business?
across the business still operate with traditional
models. This causes friction and slows down • How do we create flatter and more fluid
the process. In the future, though, it’s clear that organizations?
accelerated cycles, increased transparency, and
teaming outside the typical organizational bound- • How must we change our organizational
aries (both within and outside the company) will processes to account for increased collaboration,
have great impact on how executives organize transparency, and new behaviors within teams?
and manage their teams. There are already tools
ready for this challenge. Rypple, for example, is • Organizationally, how should we prepare
a software platform that allows companies to take for more porous company boundaries and
a new approach to HR management and perfor- increased partnering or sourcing across
mance evaluations by using ongoing feedback, the value chain from R&D to delivery?
more public recognition, and social goals such as
more dynamic team or individual objectives that • What is the best way to incorporate new
change or evolve organically rather than through behaviors (like an increased tolerance for
an annual top-down process. failure) into our corporate culture?

IT and business have tended to operate as

separate functions in many organizations,
...
making it harder for those groomed in one Almost every company is becoming a software
discipline to cross over to the other. The software company. By considering business and operating
shift described in this article has the potential models pioneered by the software industry and
to force greater fusion in executive capabilities. tailoring them to their own needs, organizations
In more traditional companies, IT employees can lower their costs, boost performance, and
will need to become business managers, while turn software into a competitive advantage. •
product-development and business unit leaders
will need to become software savvy. A base level For additional thinking, please
see the following articles:
of software fluency will be a requirement for all
levels, including upper management, in order David Kirkpatrick, “Now every company is a software
to understand not only the core technologies company,” forbes.com, November 30, 2011.

but also the dynamics of working in a quick-turn, Marc Andreessen, “Why software is eating the world,”
massively more connected, and digitized market- Wall Street Journal, August 20, 2011.

Hugo Sarrazin is a director in McKinsey’s Silicon Valley office and Johnson Sikes is a consultant in the New York
office. Copyright © 2013 McKinsey & Company. All rights reserved.