Chapter 1

The End of an Era

What does digital transformation look like? Well, for starters, let's acknowledge that "digital transformation" is a really vague term. It's the kind of smart-sounding phrase that gets thrown around a lot in conferences and McKinsey reports and Harvard Business Review articles. The kind of expression that lots of people instinctively nod their head at, whether they know what it means or not. It could mean everything, it could mean nothing.

Let me tell you what I think it means. You've probably seen the statistic-more than half of the companies that appeared on the Fortune 500 list in the year 2000 are now gone. Poof. Vanished off the list as a result of mergers, acquisitions, bankruptcies. The life expectancy of a Fortune 500 company in 1975 was seventy-five years-today you have fifteen years to enjoy your time on the list before it's lights out. Why is this happening? Instead of dwelling on failure and looking at all the companies that went away, let's look at the companies that have stayed.

Notice how big manufacturing companies like GE and IBM that were on the first list in 1955-and are still on it today-don't talk as much about their mainframes and refrigerators and washing machines anymore? They talk about "providing digital solutions," which is an admittedly jargony way of saying that the hardware is just a means to an end. In other words, these companies now focus  on achieving outcomes for their clients, rather than just selling them equipment.

GE was #4 on the first Fortune 500 list in 1955, and it's #13 on the list as I write this book in the fall of 2017. GE was incorporated as the Edison General Electric Company in 1889. It made and sold lightbulbs, electrical fixtures, and dynamos. Today GE generates most of its revenue from services, not products. GE ran commercials during the Oscars with the tagline "The digital company. That's also an industrial company." Notice the switch there. This transformation is what allows GE to survive and remain on the Fortune 500 list.

IBM was #61 on the Fortune 500 list in 1955, and it's #32 on the list today. IBM originally sold commercial scales and punch card tabulators. Today it sells IT and quantum computing services. It has completely transformed from a product manufacturer into a business services giant. IBM is now working on Watson-a technology platform that uses natural language processing and machine learning to reveal insights from large amounts of unstructured data. It has Bob Dylan chatting with an artificial intelligence system in its advertisements. It is now in the business of cognitive services-a pretty exciting departure from where the company started.

In fact, 12 percent of the companies on the 1955 Fortune 500 list are still on it today, and most of them have similarly transformed. Xerox has moved from manufacturing photographic paper and equipment to information services. McGraw-Hill has moved from printing textbooks and magazines with titles like American Journal of Railway Appliances to offering financial services and adaptive learning systems. NCR went from selling cash registers to saloons during the days of the Wild West to creating digital payment services that compete with companies like Square. They don't really sell stuff anymore.

Okay, what about some of the more recent entrants on the Fortune 500 list? The "new establishment" companies like Amazon, Google, Facebook, Apple, Netflix. The companies that instantly feel very familiar to us but are actually relatively new to the Fortune 500 list. They've rocketed to the top of the list and show no signs of going anywhere. They never thought of themselves as product companies-no transformation was needed. From the start, these companies were relentlessly focused on building direct digital relationships with their customers. And established enterprises are taking note.

Let's take a look at one big company we're all quite familiar with-Disney. Its CEO, Bob Iger, said recently, "It's one thing to be as fortunate as we are to have Disney, ABC, ESPN, Pixar, Marvel, Star Wars and Lucasfilm, but in today's world, it's almost not enough to have all that stuff unless you have access to your consumer." Right now, outside of its theme park attendees, Disney doesn't have much in the way of individual customer insight. Someone who buys a Spirited Away doll at a Walmart is a Walmart customer, not a Disney customer. Someone who goes to see a Star Wars movie at an AMC Theater is an AMC Theater customer, not a Disney customer. For Disney, it sounds like that's all about to change very soon.

Finally, how about the up-and-comers, the companies that may soon top the Fortune 500 list, new disrupters like Uber, Spotify, and Box? These companies came in and took everyone by storm. They haven't just gone beyond selling products, they've invented completely new markets, new services, new business models, and new technology platforms, leaving many established companies trying to play catch-up. As consumers, we love these brands, we love these services, and we love the value they provide us-a value that goes way beyond what a single product could ever offer.

What are the common threads among these three groups of companies? Whether it's GE, Amazon, or Uber, they are all succeeding because they recognized that we now live in a digital world, and in this new world, customers are different. The way people buy has changed for good. We have new expectations as consumers. We prefer outcomes over ownership. We prefer customization, not standardization. And we want constant improvement, not planned obsolescence. We want a new way to engage with business. We want services, not products. The one-size-fits-all approach isn't going to cut it anymore. And to succeed in this new digital world, companies have to transform.

The Product Era and the Tyranny of the Margin

For the past 120 or so years, we've been living in a product economy. Companies designed, built, sold, and shipped physical things under an asset transfer model. Business was about inventory, shelving, and cost-plus pricing. The relationship between seller and buyer was based on discrete, often anonymous transactions. The sign by the cash register summed it up: "All Sales Final." Early retail pioneers like Sears and Macy's changed the way mass society consumed things, but they had minimal insight into who was actually buying their products or how they were using them.

When Henry Ford's first moving assembly line went into operation in 1913, it was really just an extension of manufacturing principles first put in place during the Industrial Revolution of the 1800s. The assembly line wasn't just about maximizing efficiency through discrete repetitive tasks, it was a metaphor for how a company's product can dictate its supply chains, manufacturing processes, distribution channels, and management layer.

The product was the only governing principle-it organized everything across a perfectly straight line. The actual people involved in making, buying, and selling the product were entirely disposable. Henry Ford's customers could famously pick any Model T color they wanted, as long as it was black. The result of all this relentless efficiency was that Henry Ford's cost per unit dropped precipitously, allowing him to flood the market with cheap but durably made cars. Model Ts came only in black because with one automobile coming off the line every three minutes, that was the only color that would dry fast enough.

Then once these big companies established market share, the thinking went, they could start to gently raise their prices and make money off the difference, or margin. The margin ruled everything (and a little planned obsolescence never hurt). It's difficult to overstate the power that big postwar American corporations had. They organized themselves around strictly delineated product divisions and didn't have to answer to anyone. There were no call centers, no customer service reps, and, in many cases, no returns, period. This model didn't work particularly well when it came to customers like our grandparents, but it consistently shipped units and kept boardrooms happy.

The emergence of enterprise resource planning (ERP) systems in the latter half of the century only exacerbated this problem. These systems did a good job of measuring operational efficiency: raw materials, inventory, purchase orders, shipping, payroll. They did a lousy job of measuring actual customer experience. But as modern management guru Peter Drucker pointed out, companies tend to manage what they can measure, and so executive teams became hopelessly product-focused, both organizationally and strategically.

This period also saw the ascendance of supply chain economics. The goal was to match supply and demand with the least inventory possible. It was nirvana for engineers and management consultants, who were threatened by the new electronic products and efficiencies coming out of Japan. "Just in time inventory" meant that warehouses full of stuff just sitting around were the ultimate enemy. "Total quality initiative" meant that the work of improving processes was never over. Michael Dell built an empire based around this discipline.

Then around twenty years ago, corporate America woke up to the realization that all this relentless focus on productivity was coming at a cost-namely the relationship between the vendor and the customer. The customer was a complete unknown, a receptacle at the end of a distribution chain whose sole purpose was to "consume" the products companies made. And as it turned out, many of these new consumers were having difficulty getting their new products to work. And how did corporate America discover this? Their receptionists were getting angry phone calls.

So what did the big companies do to address this problem? They set up customer service departments! When in doubt, build another vertical silo-they launched market services, technical support lines, warranty contracts, and maintenance groups. The customer had truly arrived-they had their own department now. And that department was located way down at the far end of the supply chain, just past the loading dock.

The Age of the Customer

Today the glory days of the soulless, all-powerful corporation are long gone. Today's customers are more informed by an order of magnitude. Most of them have researched, assessed, and categorized you before you can even say hello. And to most of them, especially younger ones, ownership just isn't that important anymore. People increasingly view the prospect of buying something as unnecessary baggage. They want media at their fingertips, not physical products to manage. That's why most of the big box retailers I grew up with are gone now: Circuit City, Tower Records, Blockbuster, Borders, Virgin Megastore. A lot of the malls are gone, too! Today people expect services to provide immediate, ongoing fulfillment, from rideshares to streaming services to subscription boxes. They want to be happily surprised on a regular basis. And if you don't meet those expectations, you get dropped, not to mention trashed on social media. It's that simple.

Forrester Research thinks we're at the beginning of a new twenty-year business cycle it calls "The Age of the Customer." Forrester sees a broad, systemic shift in capital models pivoting toward serving a newly empowered generation of customers who have the ability to price, critique, and purchase anytime, anywhere. Here's how Forrester describes the new customer mindset: "The expectation that any desired information or service is available, on any appropriate device, in context, at your moment of need." Customers have new expectations (and yes, those expectations have certainly been driven by millennials, but at this point, almost everyone shares them). They want the ride, not the car. The milk, not the cow. The new Kanye music, not the new Kanye record.

Initially, the corporate world responded to this shift in pretty typical fashion-they built more systems. They spun up customer relationship management (CRM) databases, installed customer loyalty programs, offered membership rewards and incentives, and showered people with customer satisfaction surveys. It was a truth universally acknowledged that new customers were harder to acquire than it was to retain loyal ones, and negative customer experiences traveled much further than positive ones. There was a lot of talk about customer journeys and net promoter scores.

No one knows who coined the phrase "the customer is always right," but it dates to late-nineteenth-century department-store pioneers like Harry Gordon Selfridge and Marshall Field. It was a novel concept at the time (displacing a prevailing general retail attitude of caveat emptor), but what's amazing is how all these big Fortune 500 companies still couldn't get it right. They developed a lot of prescriptive strategies built around customer focus, but they lacked a descriptive understanding of the mindset of the customer herself. Large companies were still getting blown up on social media left and right, and there were certainly no sweeping changes in public sentiment toward big enterprises. It just wasn't enough.

And then a funny thing happened-those digital disrupters like Salesforce and Amazon that I mentioned earlier took the whole customer-first concept a huge step further by actually establishing direct ongoing relationships with their customers. They didn't have customer segments anymore-they had individual subscribers. And every one of those individual subscribers had their own home page, their own activity history, their own red flags, their own algorithmically derived suggestions, their own unique experiences. And thanks to subscriber IDs, all the boring transactional point-of-sale processes disappeared. Ten years ago there was no Spotify, and Netflix was a DVD company. Today both those companies own a significant percentage of the total revenue of their respective industries! Today businesses are asking themselves a whole new set of questions: What do we need to do to build long-term relationships? What do we need to do to focus on outcomes and not ownership? To invent new business models? To grow our recurring revenue, and to deliver ongoing value?

So again-what does digital transformation look like? I think it looks a lot like a circle. Let me explain.

The New Business Model

If you remember one thing about this book, remember this diagram. It summarizes the shift under way. On the left side, you have the old model, where companies used to focus on "getting a product to market" and selling as many units of that product as possible: more cars, more pens, more razors, more laptops. They did this by getting their products into as many sales and distribution channels as possible. Of course there must be a customer on the other end buying all this stuff, but often you didn't really care who they were, as long as more units flew off the shelves.

That's not how the modern company thinks. Today successful companies start with the customer. They recognize that customers spend their time across many channels, and wherever those customers are, that's where they should be meeting their customers' needs. And the more information you can learn about the customer, the better you can serve their needs, and the more valuable the relationship becomes. That's digital transformation: from linear transactional channels to a circular, dynamic relationship with your subscriber.