Digital defies a common definition. For some Digital is nothing but an upgraded IT department. For others, Digital refers to the use of online tools and technologies for daily use. For a few, it is the reason to question the why and what of the business.
Today we find that in any organisation there are multiple digital initiatives like digital marketing, sales force management, CRM initiatives, supply chain management, robotics etc.,
How should these digital initiatives be evaluated and how much value they create. Instead of getting carried away by digital labels, follow the basic principles of investment decisions. Evaluate the digital projects based on the cash flows expected. this requires some strategic analysis.
Use the base case.
Evaluate between investing in a new e-commerce site and investment in software that improves the logistics process. It can be difficult to evaluate an automation process as
- The benefits accrue over some time and may have shadow costs as it is rolled out simultaneously with the existing systems.
- It becomes difficult to compare the digital initiative with the traditional system.
- The value can be difficult to separate from its context.
- The link back to the original reasoning may be lost.
The decision making has normally been made on initiatives where the improvements are most visible or obvious or where the team managers are insistent or shout the most to catch the attention. this leads out the difficult or ambiguous initiatives where the results are not easily comparable but maybe more important to the organisation.
Ideally, all investment decisions must be evaluated with an alternative solution and for digital initiatives, it may be do nothing in many cases but at the same time in incurs costs. In many cases, digital initiatives may be undertaken to ensure that the current revenue and profits do not fall rather than to increase it.
Examine the impact of digital.
It is important to build a realistic base case to evaluate a digital initiative. At the same time, it is necessary to understand the impact that these initiatives will have. Companies digital initiatives typically fall into two categories
- use of digital tools or technologies to disrupt the existing system and create a new process.
- Use of digital tools to simplify the existing system and do it quicker or better like in customer service, cost reduction, better decision making etc.,
New business models:
In some cases, the use of new digital tools can transpose existing business or create new business. To evaluate these initiatives discounted cash flow (DCF) methods should be used. It will need to generate profits eventually and earn an attractive return on capital.
Companies in high-growth industries must start from the future and not the present as the markets envisaged may not exist today. An evaluation of the basics would help in estimating a rate of return. One should also consider the networks effects that can earn a higher return as the product becomes more valuable with an increased customer base.
Cost reduction:
Many digital initiatives help companies reduce costs. Evaluating the benefits may not be so straightforward. It is essential to estimate the present value by the standard metrics and consider the second-order benefits. You may be compelled to reduce costs due to competitive pressures irrespective of whether you start a digital initiative.
Improved customer experience:
Consumers are the focus of most digital initiatives and they benefit the most. The customer has a wide choice of ordering online or shop offline depending upon his choice. He can get it delivered to a place he wants. Using digital tools help offer a wide choice to customers and reduce transaction costs.
Evaluating these types of initiatives requires evaluating the cost of competitive effects to gain a better customer experience. Customers have come to expect a better experience and providing these services may incur additional costs for the service provider. Consider if this results in an improvement in market share or maintain market share due to competitive pressures.
New sources of revenue:
Companies may succeed in creating new revenue sources through digital initiatives. Here the evaluation may be obvious as companies may gain directly before the competition moves in. Such new sources of revenue create value as it is unique and not as a response to competition.
Better decision making.
Business analysts may use advanced techniques to make better decisions. This can lead to higher revenue or reduce costs. Focus on decisions that create the most value and apply advanced analytics to gain better insights and answers on how to operate.
As companies seek to understand the implications of digital technologies one should understand that these are dynamic and keeps changing very frequently. But the principles for evaluation should be steadfast and reliable and help leaders filter out the noise and hype and distinguish value-creating opportunities.
Why ‘digital’ is no different when it comes to valuation
by Liz Ericson and Tim Koller
McK 2020/10
R2G 