Understanding Digital Transformation — Part 1: What is DX anyway?

I was speaking with an executive in a large Japanese company recently who confided that many companies are uncertain or confused about what digital transformation or “DX” as it’s called in Japan, actually means. I’m not surprised as the term by itself has become a popular but somewhat meaningless catch-phrase in recent years. This is a three-part series of articles covering: 1) The four types of DX; 2) Developing a Digital Mindset; and 3) Using Digital to build an innovation engine.

There are four basic levels of DX:

Level 1 — Improving Operations This is the most basic form of DX. The focus is on digitising existing analogue data and automating manual processes. For example the Japanese government’s push for the adoption of the “My Number” unique identifier for all residents, or the recent decision to no longer require physical seals (hanko) for signing legal documents. The primary benefits at Level 1 are gaining operational efficiencies; that is, reducing cost and increasing speed. For example, a publisher posting information about their authors and new releases online and enabling people to purchase books through the website.

Level 2 — Improving Experiences. Organisations reach this level when they start innovating by using digitisation to improve experiences and/or to gain new insights. Generally, they are focused on existing processes and products. This is what John Naisbitt referred to as “high tech, high touch’, way back in 1983. At this level, the previously mentioned publisher would not only digitally replicate the experience of browsing and buying books but adds experiences only possible in the digital domain. For example, Amazon leveraging crowd-sourcing by enabling customers to review and rate books and for others to rate the quality of these reviews.

Level 3 — Creating New Value. This is an extension of level 2, where existing technology is used not only to improve experience but to create new value within existing markets. For example, taxis and hotels have been around a long time but Uber and Airbnb were able to leverage existing digital tools to build new business models that both improved customer experiences and created new markets (private car drivers and spare rooms).

Continuing with the previously mentioned publisher, this is the equivalent of Amazon creating their merchant platform which enables other companies to sell books using the Amazon platform. By giving competitors access to their platform, Amazon encourages price competition and still makes money regardless of who the customer purchases from. They also gain access to valuable data. Today, merchant sales account for more than half of all revenue from the Amazon.com platform.

Another company to successfully follow this approach for opening up its internal tools to the competition as a paid platform is Chinese financial giant Ping An. In 2015 it bundled its proprietary AI, blockchain and biometric identity technologies into a cloud platform called OneConnect, which is now used by more than 3,000 other financial institutions.

In the course of its journey to transform itself from a financial institution to a technology company, Ping An has risen from #383 on the Fortune Global 500 list in 2010 to #16 in 2021.

Level 4 — Create New Markets and Arenas. The pinnacle of DX is reached when organisations use technology to create entirely new markets and arenas. This is using computer technology to enable what we refer to as Transformational Innovation. For example, Amazon created a new market for computing as a utility with Amazon Web Services (AWS). This service now accounts for 10% of Amazon’s revenue, but over 50% of its operating income.  It make access to high-end computer processing power, storage and networking affordable, fast and easy. It is what has fuelled the rapid rise of many new companies and business models over the past 10 years. For example, Uber, Airbnb and Netflix all run on AWS.

Each of these levels is a significant step up from the prior level in terms of the technical and organisational capabilities required. So being aware of what level you are currently at is key to being able to advance. See Part 2 of this series to learn about the “Digital mindset” and how it is critical for effectively innovating and progress to higher levels of DX.