Digital Transformation Journey: Part II (Operating Model)

The current blog will discuss Part II of my series on Digital Transformation journey. Please review Part I to understand the journey in its entirety.

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Anil Inamdar

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The current blog will discuss Part II of my series on Digital Transformation journey. Please review Part I to understand the journey in its entirety. What is an Operating Model? There are several definitions but the one I prefer is – “the operating model is the bridge between an organization’s strategy and its operations.” Whether an organization comes up with a formal operating model or not, it is most definitely performing several operations to fulfill its strategy. The strategy is not constant and as the customer expectations, technologies and business boundaries change, so does the strategy. The change in strategy may render the operations out of sync. How do we ensure that the strategy and operations are always in sync? Well that is the purpose of the Operating Model. The operating model comprises of core components that could be tweaked continuously to ensure that the strategy and operations are always in sync.

The Digital Transformation must begin with reviewing the existing strategy of the business, identifying current weaknesses and new threats from the competition. Based on this knowledge the leadership can come up with a new strategy – this will be an iterative process however the leadership must identify areas of focus that must be modified. There are several ways of doing this, I have preferred using the Business Model Canvasas proposed by Alexander Osterwalder. This is a simple yet powerful way to identify both the internal and external entities that would impact the business strategy.

The Business Model Canvas has nine key components. The five components on the right focus on the external customer while the five components on the left focus on the internal organization of the business. The “value proposition” component is shared by both the external customer and internal organization. Let’s go over each of the key components briefly.

1. Customer Segments: In this component we define who the customers are. What needs are we fulfilling for each customer? How can we group these customers into meaningful segments? It may not be feasible or practical to go after every segment, so you can decide which segments are critical and which segments can be ignored. The customers could be B2B (Business to Business) or B2C (Business to Consumers). They could constitute “mass market” or “niche market.” The business model could also be a platform like Android operating system in which case one would have two sided customers – the “consumers” like the App users or the “producers” like the App builders.

2. Value Propositions: This section discusses the value proposition of the organization’s products or services. Why would customers pay for the product or service? What are some of the salient features of your offers – do they provide cost benefit, do they provide additional features, do they offer ease of use? How do the organization’s offers differentiate themselves from the competition? The different segments identified in the “Customer Segments” section may warrant a different value proposition for each.

3. Channels: This section usually connects the customer segments and the value propositions. It describes the avenues through which the products or services are sold and delivered.

4. Customer Relationship: This section defines the way in which the organization interacts with the customer before, during and after the sale. Nurturing the customer base has become the differentiator and organizations go an extra mile to maintain and cultivate that relationship. The relationships can take several forms like self-service at the company website, through a customer support person, one on one relationship with key customers or encouraging and supporting a customer community through conferences, meetups and other methods.

5. Revenue Streams: This section defines the various ways in which the organization can earn revenue from its value propositions. There could be primary source of revenue like the iPhone and secondary source of revenue like the “Apple Developer Conference.” Revenue could be one time or recurring licensing costs. Some companies like Uber also have a dynamic pricing model that charges different rates based on the demand.

6. Key Resources: This section focus on different resources that the organization consumes. These resources could range from physical resources like factories or buildings, human capital like employees, financial resources like working capital or investments to intellectual resources like new or existing patents. A keen understanding of resources and its impact on the business value chain would play a critical role in Digital Transformation.

7. Key Activities: This section focuses on unique strategic activities that the business performs to deliver its value propositions. These include factory production for product companies, service fulfillment or maintenance, marketing or research and development for cutting edge technology or pharmaceutical companies.

8. Key Partnerships: This section focuses on business partners without whom the business may not run. These include suppliers providing necessary raw materials, joint ventures or partnerships with complementary companies like storage and data mining, strategic alliances to exploit joint broader opportunities. These partnerships are necessary to extend revenue opportunities, share infrastructure, optimize cost structures and reduce risks by sharing strategy and resources.

9. Cost Structures: This section focuses on the main costs necessary to provide different value propositions. We investigate major cost drivers and determine how they might be linked to revenue. These costs could be fixed costs like rent or salaries or variable costs like electricity or cloud usage. These costs are used to acquire key resources and perform key activities.

Following is an example of Business Model Canvas completed for Uber by

Once the business strategy is established the next step is to translate it into efficient and effective operations. Here the Operating Model is critical. Like the strategy discussed above, the Operating Model also takes shape in an iterative fashion however certain key components or philosophies do not change. There are many ways to define Operating Model. The business literature is full of multiple approaches and opinions. I have summarized the following components based on my research, consulting acumen and field experience.

1. Design Principles: The Design Principles translate the business strategy into specific, concise and clear statements that could be interpreted objectively. Some of such statements could be – “What matters most to our customers,” “What are some of our distinct capabilities,” “What are some of our strengths,” “What are some of our weaknesses,” “What can facilitate future acquisitions.”

2. Business Structure or Organization (including location): This involves creating precincts across departments, lines of business and geographic locations. These precincts must encourage improved decision making and corresponding accountability. Digitally transformed companies encourage cross-functional teams to own products and services.

Digital Transformations often create new precincts to support improved value chains. An insurance company that I worked for had grown organically by introducing one insurance product at a time. They started with Auto Insurance, then ventured into home insurance, then into motorcycle, life and other types of insurance. The different types of insurance products were independent business units. There was no way to have a customer centric view – the sales folks did not know what types of insurance John Doe had. If he had three types of insurance, he was a unique entity in three different systems. This created a serious challenge for servicing the customer or cross-sell / upsell opportunities. The improved web-based offers from competitive insurance companies had forced the business to rethink its business model. They decided to be customer centric not product centric. They wanted to have a market P & L not a product P & L. The new precincts at the insurance company were customer and market based not product based. So, the transformation at this insurance company began with changing the business organization before embarking on the technology implementation.

A similar example is at Nike’s. Nike’s business units were structured around products like footwear or apparel. The customers were demanding head-to-toe gear, personalized to their choice of sport. Nike responded to the customer’s demands and redesigned its organization around sport categories. Products related to a particular sport were shipped together like shoes, shirts and shorts.

3. Accountability Matrix (Roles and Responsibilities): This component of the Operating Model is closely linked to the structure or organization that we discussed above. This component describes the roles and responsibilities of the structural entities – these include decisions making abilities, P & L responsibilities and incentive structures.

Digitally transformed organizations are decisively customer-centric. They succeed in becoming customer focused by changing the accountability matrix in such a way that rewards customer value over anything else. This may involve switching from centralized accountability to local or vice-versa or a combination of both central and local flavors.

A multinational bank realized that its Net Promoter Score (NPS) customer surveys had a separate approach for each country that added complexity, cost and diminished its value at the central level. The bank standardized the process at the central level with limited local flexibility. This resulted in improved NPS.

On the other hand, Ritz-Carlton hotel chain has been giving its front-desk staff $2000 of discretionary funds to resolve any customer complaints without any input from the central authority.

4. Governance & Management Principles: This component of the Operating model emphasizes the establishment of principles and policies with respect to the organization and accountability as discussed in #2 and #3 above. It also includes monitoring and implementation of the principles and policies by a governing body.

Leaders in Digital Transformations incorporate performance management into the fabric of the organization. They convert business priorities and value propositions into corresponding metrics and Key Performance Indicators (KPIs). They focus on creating feedback mechanism between frontline and back-office operations, between organizational levels and between different geographies.

The companies have to be careful as not to convert metrics / KPIs into rigid rules and frameworks. It is critical for the leadership to define clear governance and management principles that the employees could follow instead of complex rules and regulations. Principles promote agility while rules encourage bureaucracy.

The reputed semiconductor company Intel had a long-established principle referred to as “disagree and commit.” The leadership encouraged employees to escalate the decisions they disagreed with openly. They can debate vehemently and passionately but once the decision is made they must back that decision up with total commitment irrespective of their initial stance.

5. Business Capabilities (People, Process & Technology): This critical component of Operating Model focuses on the company’s ability to effectively combine people, processes and technology in an iterative fashion to deliver established value propositions.

A company doesn’t have to be good at every capability. In fact, a key function of the leadership attempting Digital Transformation is to prioritize capabilities essential for supporting the strategy. Once capabilities are prioritized they can be reinforced by the right people, processes and technologies.

A key challenge with traditional organizations is the existence of legacy processes and corresponding technology. Implementing new processes and technologies alongside legacy systems or attempting to replace the legacy system with a big bang approach are too risky and time-consuming.

A viable and secure approach is to implement modular architecture in an iterative manner. There is of course immense benefit in envisioning the overall architecture for the new system however this idealism must be followed by a pragmatic step of implementing the architecture in iterative, consumable, value-added chunks. The leaders are investing in Agile methodology, DevOps and cloud technologies to make this happen. We will be discussing this in more detail when I talk specifically about the technologies in the next blog.

These were some of the key components of the Operating Model that the leadership trying to pursue Digital Transformation may consider. In my following blog I will address the succeeding critical step necessary for Digital Transformation – Technology.

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