Strategies for Digitalization in Manufacturing Firms

Understanding Digitalization

Digitalization involves the increased use of digital technologies ³ and their integration and cross-fertilization in the firm’s products and inbound and outbound activities. ⁴ This can result in fundamental changes, especially to how firms create and capture value. ⁵ In simple terms, digitalization can be seen as increased generation, analysis, and use of data in order, on one hand, to increase the firm’s internal efficiency, and on the other hand to grow the firm by adding value for customers through the change from analog to digital formats. ⁶

The challenges, opportunities, and effects of digitalization have had a major effect on both business leaders and politicians. Digitalization has come to be seen as the fourth industrial revolution (after the steam engine and mechanization, electricity and mass production, and computerization and automation). ⁷ The German government has defined the challenges, opportunities, and effect of digitalization for manufacturing firms as “Industry 4.0.” ⁸ This has inspired efforts in several other countries described as “Smart Manufacturing” in the United States, “Industrie du Futur” in France, “Fabrica Intelligente” in Italy, and “Smart Industry” in the Netherlands. However, Industry 4.0 and similar initiatives are limited mainly to manufacturing process improvements enabled by smart manufacturing, whereas digitalization has the potential to affect many other functions beyond the manufacturing process.

About the Research

This article adopts a multiple case-study approach ⁹ to analyze the specific patterns of using data generated by digital technologies in leading multinational manufacturing firms and their products. The aim is to explore how manufacturing firms create and capture value from digital technologies, the increased volumes of data involved, and related problems. While case-study research suffers from limited generalizability, the intention is not to try to extrapolate from the findings but to address the under-researched question about how manufacturing firms create and capture value by means of digitalization. The limited generalizability of case studies is, to some extent, mitigated by the use of many case firms, not focused on a specific sector or technology.

The 26 sample firms belong to a range of sectors including automotive, steel, telecommunications, pulp and paper, and defense and security. They include ABB, Volvo Trucks, Autoliv, Husqvarna, Scania, Volvo Cars, Ericsson, Atlas Copco, SKF, Assa Abloy, Saab, Sandvik, SSAB, and Stora Enso. The data are from multiple sources, including interviews, site visits, and archival records. A total of 102 in-depth semi-structured interviews were conducted with managers at different hierarchical levels and in different functional positions, including CEOs, chief technology officers (CTOs), production managers, chief digital officers (CDOs), information technology (IT) directors, business development directors, sales directors and sales staff, research managers, production operators, board members, product owners, and data analysts. The interviews focused on the constructs and perceived related challenges of value creation and value capture through digitalization efforts in relation to the different value chain activities.

What Do Manufacturing Firms Currently Do?

Observations of the manufacturing firms in this study show that obtaining advantages from new technologies and becoming digitally more mature involve several aspects. The effects of digitalization for firms can be categorized as more efficient product development, more efficient manufacturing, more sophisticated products and services, and more integrated value chains (Figure 1 exemplifies the different efforts along the value chain of leading manufacturing firms).

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Figure 1.

Examples of digitalization efforts in relation to the different manufacturing firm value chain activities.

From Efficiency to Growth

Observations show that the effects of digitalization can be traced primarily to more efficient firm operations and manufacturing processes and to better performing products with new functionality. Improved production throughput, fewer breakdowns, more efficient maintenance, more effective integration across activities in the internal value chain, and new product development methods provide many cost advantages.

However, these are not the areas that present the greatest difficulty for firms and their ability to exploit the potential offered by digitalization. It is activities and processes to grow the firms that pose the greatest challenge, while also offering opportunities that have yet to be exploited. More than half of the sample firms consider that digitalization offers equal opportunities or better possibilities to increase revenue than to lower costs. However, only a quarter of the observed firms consider that they pay more attention to increasing revenue than to lowering costs.

Nobel Laureate Oliver Williamson argues that strategy starts at home, and that in the long run, the best strategy is to operate and organize efficiently, ¹⁴ which he describes as economizing. ¹⁵ This might suggest that firms should start with upstream digitalization activities, which is the strategy adopted by most of the observed firms, at the expense of focusing on activities to create new income streams and to reinvent the business model, or with strategizing activities to create defensible positions against competitive forces. ¹⁶ Economizing is an important source of profitability because it affects relative cost positions and underpins competitive advantage. ¹⁷ Digitalization is defining a new standard for operational efficiency in upstream activities for the observed firms and has raised the best practice bar even for the most advanced firms. ¹⁸

However, the current rapid digital advances not only provide greater efficiency for manufacturing firms but also promote a growth agenda from new combinations (innovation). ¹⁹ They are not mutually exclusive, and both are essential for long-run superior performance. Few firms can compete successfully over the long term on the basis of operational efficiency alone. ²⁰ Many of the firms in this study are very ambitious and are attempting to build growth and transform their business models to create and capture more value from the use of digital technology and data. ²¹ However, with few exceptions, the effects on firm performance have been small. There is a trend among the firms in this study toward becoming more service-oriented to realize value from digitalization. Several are selling operational and complementary services based on the new functionality of their products, but the effects, scope, and scale of these efforts are limited. The resulting firm revenue has been negligible, and most firms are disappointed that the results do not match expectations. At the same time, several manufacturing firms are trying to change their business model from selling products to selling services. However, the results of most of these changes have yet to materialize. For example, some automotive firms have ambitions to switch from selling vehicles to selling vehicles as a service and have been working on this for some time, but so far without much implementation. In sum, business leaders have focused mainly on cutting costs based on greater efficiency, and these initiatives have proven more successful than the few initiatives aimed at growth. ²² Business leaders believe that major competitive and market effects will not emerge without changes to their business offers to customers. ²³ However, a growth agenda will require these manufacturing firms to shift from greater efficiency in established ways of working to working differently.

Driving growth is a different game than using digitalization to achieve greater efficiency and is also experienced as more difficult (see Table 1 for a summary). For the firms in this study, operational efficiency based on digitalization has been confined primarily to achieving excellence in individual functions. Compared to achieving growth, elimination of waste, for instance, has been relatively straightforward and generic across firms and sectors. ²⁴ It is relatively easy also to evaluate returns on investments aimed at cost-cutting via operational efficiency. However, digitalization aimed at driving growth involves combining functions that require a good fit among internal activities across functions. Firms also need to create customer value in a more uncertain external environment. This is a challenge in the earliest stages of development. As described by Day and Schoemaker in the case of emerging technologies, customer usage patterns and behaviors are exploratory and formative and are accompanied by scarcity of market knowledge and embryonic competition among new solutions. ²⁵ Hence, investment in digitalization is considered uncertain for innovation and growth. According to the case firms, processes are inadequate, governance is weak, and there is no relevant and appropriate growth strategy that explains the asymmetric gains between cost-cutting and growth efforts.

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Table 1.

Factors Explaining the Differences between Digitalization Aimed at Cost-Cutting versus Growth.

	Cost-Cutting/Operational Efficiency	Growth/Innovation
Asset redeployment	Well-established mechanisms (e.g., taxes from the business divisions) for money-saving alternatives, to improve lead times, quality, and throughput.	No established mechanisms to allocate capital needed by several functions to build a growth agenda.
Culture	Well-established culture to reduce waste through better methods.	Collective ability across functions to transform output markets. There is no established culture to develop and sell services or to use data to build new businesses.
Coordination between functions	Dependent on excellence in individual functions.	Dependent on several functions.
Data management	Data are generated internally and usually fewer variables need to be considered to identify efficiency improvements.	Data are generated from customer applications and many variables need to be considered to identify growth options.
Demand	Internal demand and firm’s responsibility to decide if it would be productive.	Uncertain market demand.
External cooperation	Well-established partners and suppliers for implementing efficiency improvements.	Partnerships are context dependent and there is strong dependence on the complementors in the ecosystem to create value.
Investments	Relatively easy to estimate.	Difficult to estimate.
Managerial processes	Established managerial processes are working.	Dependent on new managerial processes to become flexible.
Return on investments	Easy to estimate.	Very uncertain.
Strategy	Well-established procedures to invest in solutions that are critical for competitiveness and that have high rates of return on investment.	No established strategy. Need to make trade-offs among many uncertain alternatives.
Time to implementation	Relatively easy to estimate.	Difficult to estimate.
Transferability	High between firms.	Low between firms.

Digital technologies combined with the manufacturing firm’s inherited resources and capabilities can produce fundamental changes to how the firm creates and captures value, ²⁶ which makes the nature of future competition difficult to predict. ²⁷ In turn, this adds to the importance of innovation and growth to achieve long-run competitive advantage. Work in the area of dynamic capabilities has taught us that such circumstances demand the honing of internal technological, organizational, and managerial processes to sense and seize opportunities. ²⁸

If manufacturing firms do not seize opportunities and do not transform themselves to embrace the growth opportunities offered by digitalization, they are likely to be outcompeted by firms able to solve customer problems in more creative ways. In the present climate of Schumpeterian competition, this threat comes from both incumbent firms and firms outside the industry ²⁹ because on many occasions, new technologies can produce disruptions to an established technical advancement trajectory. ³⁰ Digitalization has changed the game for incumbents in many industries by introducing competition from firms outside the industry and competition with more asset-light business models. ³¹

Teece, Peteraf, and Leih note that in environments characterized by uncertainty, firms must grasp opportunities for growth before their logic becomes apparent to all market players. ³² However, this does not assume first-mover advantages (or disadvantages) and we have to be very careful with such assumptions. ³³ Digital transformation is equally important for the ability to follow, to have options related to growth, and to achieve learning advantages over firms that have yet to undergo digital transformation. Moreover, the digital transformation of manufacturing firms does not necessarily involve a radical business model, a new product category, or response to a competing technology; it can take many shapes. In the context of the firms in the sample, until markets stabilize, it is too early to claim that digital transformation pioneers have achieved first-mover advantages or disadvantages. ³⁴ What can be said is that many firms’ attempts to achieve growth and to obtain economic returns from innovation have failed, but this cannot be attributed only to second-mover advantages. Nevertheless, business leaders from the observed firms believe that without some transformation, their companies’ prospects are poor, and they do not consider it to be a waiting game. ³⁵ Some of the case firms would be suffering had they not sensed and seized opportunities and embarked on a digital transformation. ³⁶ One of the most successful examples of a digital transformation among the case firms is Assa Abloy. The firm dominated the world market in mechanical door locks. Assa Abloy had no experience of using digital technologies or working with data but recognized that it needed to transform itself to exploit the opportunities related to various types of digital door locks. The market emerged in Southeast Asia with contributions from several firms from other sectors (e.g., Samsung). After a major transformation, Assa Abloy has become the market leader in digital door locks and is collaborating successfully with complementors such as Apple and Google to drive the market forward. Assa Abloy appears in the Forbes list of the world’s 100 most innovative companies, and 57% of its top line comes from electromechanical products and digital solutions. It now also enjoys recurring revenue based on subscriptions and upgrade services.

Unresolved Strategic Challenges to Growth

Firms have several issues that require resolution for investments in growth to bear fruit. The challenges related to increasing the top line through implementation of digital technologies and exploitation of data generated internally and by customers are that firms generally do not have in place appropriate processes to develop and test new customer offerings. Most firms apply the same processes to develop new business and to achieve incremental development. They include the waterfall model, which is suited to incremental development when both the customer and offering are known. However, manufacturing firms typically do not have previous experience with the concepts and solutions they want to develop, and they involve product features and customer segments that are uncertain. Most firms believe that they need to change their processes and become more agile. ³⁷ This will be increasingly important to allow utilization of the data generated by digital technologies and identification of viable business. Some firms argued that their service developments had failed because of their ad-hoc nature and lack of strategy and their being based on ideas the firm considered feasible with no consultation with customers.

In addition, very few firms have central control of data, which tends to be spread throughout the organization (across different functions and market segments, and geographically). If these different firm functions do not routinely cooperate and share data, it can be difficult for the firm to organize digitalization efforts. ³⁸ This lack of control over the data also means that in most cases, firms are unable to share data outside the firm boundaries. ³⁹ Many firms also lack the capabilities for rigorous analysis of available data to decide how they should be exploited. A potential solution to facilitate the better use of data is setting up data science groups. Volvo Cars and Scania have established such groups to work on data-driven innovations. For Scania, data science is viewed as necessary for firm survival and provides a way to adapt to the new reality. Volvo Cars and Scania believe that data science has the potential to identify previously unrecognized patterns that would allow the firm to leverage its new knowledge to improve existing or create new business. These firms have created so-called data lakes that allow their firm members to access and analyze data. A data lake is a single storage for all the firm’s data (structured, semi-structured, unstructured, and binary data). ⁴⁰

As firms find better processes for working with data and as their businesses develop, more problems arise. They need to establish governance structures and mechanisms to allow good coordination of their internal organizational and managerial processes. The observations conducted as part of this study show that firms find the organization of and responsibility for digitalization extremely difficult. The importance of digitalization is exemplified by the fact that most of the firms analyzed have created the post of CDO, although responsibilities and the position in the hierarchy vary among firms. For example, in Atlas Copco, Saab, Volvo Cars, and most steel manufacturing firms, promoting digitalization is the responsibility of the IT department. However, many IT department members lack experience in building new business and are more appropriately cast in the support function. At the same time, if they have the required experience, they may not have budgetary authority and may be dependent on another firm function. For example, in Husqvarna, Autoliv, and Inwido, this responsibility belongs to the R&D department. Although this can result in digitalization efforts organized to develop new customer solutions, problems arise in relation to coordination with sales and marketing functions to launch new products and services. Thus, problems can arise in the hand over and coordination of digitalization efforts across firm functions. Appointing a CDO but retaining the existing organizational structure may not solve organizational problems related to promotion of growth by means of digitalization. Many functions and firms are stuck in old ways of organizing, which results in silos. Not all firms have a CDO to promote growth. Several firms (e.g., Bombardier, SKF, Volvo Penta) consider that digitalization should not be driven by one specific function but rather is an organization-wide responsibility. However, they may risk a lack of focus in their digitalization efforts and are trapped in an old way of organizing. Moreover, the lack of an appropriate culture to support digital transformation and strategy can result in stagnation. It seems clear that digitalization will entail ongoing complex organizational and managerial challenges. Its design is important because it has been shown to be a crucial enabler of dynamic capabilities and the capacity to sense changes, seize opportunities, and to transform the firm. ⁴¹

Many business leaders want their firms to become more agile and see the need for more flexible working as a result of digitalization. However, most have not come to grips with working with data, organizing for digitalization, or achieving better cooperation among different functions. Development and maintenance of agility is costly, but trying to exploit the opportunities and benefits from digitalization without an agile organization may be even more costly. ⁴² Looking forward, many large firms will need to coordinate their functions in new ways and find easier, faster, and more efficient ways of working to achieve full digitalization and drive a growth agenda. However, there is no “one-size-fits-all solution,” and firms need to have dynamic capabilities to achieve agility and address the business environment changes caused by digitalization. ⁴³

Scania, one of the case firms, has reorganized more appropriately and changed its organizational dynamics, which allows it to benefit from the new growth opportunities brought by digitalization. Scania established “Digital” as a new business function responsible for coordinating, developing, and driving the firm’s digital transformation. It has undertaken other efforts to improve organizational dynamics and to better govern how it integrates, builds, and reconfigures competences to address digitalization. It has reallocated the IT department’s responsibilities among various firm functions, and every department in the firm includes data scientists. The result of these changes to the organizational structure is that all the firm functions are involved in the digital transformation and are less dependent on input from software developers and data scientists from other functions in their efforts to explore and develop new customer solutions. A data lake allows all firm functions easy access to internally generated and customer data. Each firm function includes digitalization champions who are responsible for driving the digital transformation and keep digitalization high on the firm’s agenda. The different functions focus on sharing information to achieve greater coordination and unity. All these efforts are supported by the CEO who believes and communicates clearly that digital transformation is necessary for the firm’s survival.

Another consideration is what firms should do themselves and how much they need to cooperate with or acquire other firms. Many of the observed firms cooperate outside the firms’ traditional boundaries for the development of technological solutions, and several firms have made acquisitions to obtain access to technological competencies for immediate use or that they view as real options. The present manufacturing firm value system is based largely on the ecosystem, ⁴⁴ and because digitalization increases system dependence among technologies, products, and services to form a system of systems, firms need to be better prepared to work according to an open paradigm to create and capture value. ⁴⁵ Crafting an ecosystem strategy in which a firm approaches the alignment of partners can be a way to seize new growth opportunities. ⁴⁶ However, this means that firms increasingly need to be involved in more dynamic value constellations where different actors from multiple industries contribute to firms’ value creation, and where parts of the firms’ value chain activities shift to new actors. ⁴⁷ Hence, it can be a clever strategy (as the example of Assa Abloy demonstrates) to partner with firms that possess critical complementary assets, reducing the need to build them in-house, or to be outcompeted by these partner firms. ⁴⁸ Business leaders consider that orchestration of ecosystems and cooperation is paramount, but most have yet to begin work on this. It will be difficult, especially since several of the case firms have ambitions to become “leading firms” by catalyzing ecosystem developments to enhance their competitive advantage. ⁴⁹

All the firms in the study stated that they would be giving more importance to digitalization in the coming years. Undoubtedly, digitalization is changing the competition conditions for manufacturing firms and presents both challenges and opportunities.

Implications

How can business leaders develop management practices, capabilities, and strategies that will allow better creation and capture of value from digitalization? The implications of this study are as follows. ⁵⁰

Supporting Long-Term Digital Transformation

Digital transformation should be triggered by an awareness that existing internal processes depend on a stable market environment. These processes may have been important for past success, but may not allow the firm to be competitive in the future. ⁵⁴ In that case, parallel to the existing near-term strategy, firms must undertake a wider digital transformation in order to continue in business over the long term. To identify the right path and achieve successful digital transformation, business leaders must address the questions of why, where, what, and how (see Table 2). If they do not, then the chances of remaining competitive will reduce dramatically.

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Table 2.

Questions That Need to Be Addressed for Digital Transformation.

	Digital Transformation
Why	Why could digital technologies and data help the firm to resolve its problems and promote value for the firm and its customers?
Where	Where do digitalization efforts create the most value, and how feasible and urgent are they?
What	What enablers and capabilities are needed to support digitalization efforts?
How	How is the firm approaching identification of an operating model, including culture, and organizational and managerial processes, to drive the transformation?

Why?

The first question to be addressed is why digitalization is important for the firm, that is, why digitalization might allow the firm to create and capture more value. Successful firms are starting by asking why digital technologies and data will help them to solve their main challenges in obtaining value for the firm and its customers (e.g., customer experience, employee experience, and business decisions).

Where?

Having established why (or if) digitalization is important, business leaders need to explore where digitalization would create most value, and its feasibility and urgency. A digital transformation needs a focus, and because it requires capital, resources, and commitment, there must also be trade-offs. Business leaders must formulate possible acceleration initiatives based on whether the digital transformation evolution is related to operational efficiency and/or growth along the vectors of product development, manufacturing, supply chain, product innovation, service innovation, and business model transformation (e.g., selling their products as services or catalyzing the development of ecosystems). Business leaders then have to decide what they should and should not do, based on the value creation and capture potential, effort (cost, speed, resources) and feasibility, and prioritization of the initiatives. Porter emphasized that strategy renders choices about what not to do, which are as important as what to do. ⁵⁵ Therefore, business leaders play a critical role in deciding where resources should be allocated to realize the most valuable opportunities. If they make the wrong decisions, the firm will fail.

Successful firms are selective about what they do, try not to do too many things at the same time, and have a clear view of what they want to achieve. Many unsuccessful firms suffered from false starts and misguided efforts, especially in relation to their growth agendas. Many business leaders do not understand the need to make choices. They sometimes believe they can work on several value dimensions simultaneously, leading to piecemeal initiatives with poor results because there is no clear understanding of objectives.

A mistake commonly made by business leaders is investing in searching for growth in adjacent areas that have little overlap with the current business, rather than using digitalization to improve existing business to achieve growth. Successful firms start from customers’ needs and what will provide customer advantage. A sound digital transformation strengthens the core business, making it costly and difficult for other firms to compete. However, many business leaders focus on easy growth based on the provision of additional products and services, often based on completely new activities and customer segments that are not connected to the core business. For example, Volvo Cars’ strategy is based on identifying time-saving services for customers (one week a year), such as delivery of online purchases directly to customers’ cars, refueling owners’ cars, and collecting them for servicing. These activities have little in common with Volvo Cars’ core business and require the establishment of local partnerships (which are difficult to scale into new geographical markets). The services it currently offers and wants to offer in the future are easily imitated and offer little uniqueness. Some firms have established new divisions with their independent management and tailored activities. Ericsson established a “Digital Services” division to serve many new customer segments with weak connections to its core business. ⁵⁶ The losses suffered by Digital Services have been substantial ($3.4 billion in 2017 and $1.5 billion in 2018) and have had a major negative effect on Ericsson’s results for several years. In 2017, none of its product areas in Digital Services were profitable, forcing the firm to terminate many of its product and service offerings as part of a turnaround plan.

What?

Successful manufacturing firms use enablers, which allows them to develop capabilities to support their digitalization accelerator initiatives. These have been shown to be critical for the transformation of manufacturing firms. For example, Scania uses data management (e.g., structuring and pooling of data to make it easily accessible across the organization and outside the firm boundary when relevant), new working methods (e.g., design thinking and agile processes to develop new services and internal processes), business automation (e.g., replacing manual processes with software robots), and advanced analytics and business intelligence to work with data to identify what is possible and to develop new solutions. Hence, business leaders need to define the enablers they need to successfully drive their digital transformation. This will allow identification of competence gaps and the need for new talent, but will also show the extent to which firms need complementary assets from other firms to succeed with their digital transformation (because they are too costly or difficult to acquire or develop in-house).

How?

Based on why digitalization is important, where digitalization efforts should be directed, what enablers and competencies are needed, firms need an operating model with organizational and managerial processes to make things happen and achieve successful digital transformation.

It is important that digital transformation is supported by business leaders who foster a culture of consistent, coherent, and comprehensive presence of values and norms that promote the implementation and use of digital technologies and data to facilitate long-term firm success. Business leaders must promote the need for digital transformation and ensure that everyone works toward this common goal. Firm organization is aimed at facilitating coordination and collective effort from firm members. ⁵⁷ However, digitalization makes additional demands on business leaders to act entrepreneurially and professionally and to think strategically in a more uncertain market environment. ⁵⁸

The most successful firms have decentralized their digital transformation, have flexible internal processes, and learn from their mistakes. Although firms should have the long-run objective of line businesses being responsible for their own activities, successful firms have coordinated cross-organization teams with a clear agenda on where the firm is heading. They motivate organizational members by communicating examples of what can be done and demonstrating successful and unsuccessful investments in other parts of the organization to promote institutional learning. ⁵⁹ The teams highlight where investments are necessary, communicate goals, and follow-up on whether investments have been made and how implementation is progressing. The teams challenge organizational members about their assumptions related to their chosen implementation methods. In the early stages of digital transformation, it is important that firms do not underestimate the value of “simple things” that give fast results. To promote institutional learning, it is also critical that individuals in similar functional positions, and different functions, exchange information and knowledge. Hence, digital transformation for firms is about collective ability, and the implementation of more complex processes and tasks throughout the transformation. These are critical aspects for large multinational manufacturing firms with thousands of employees.

What do less successful firms do? Many firms remain isolated, implement only cross-functional programs with no identifiable ownership, and lack support from senior management in line businesses in the form of allocating money and resources. Others work on the basis that a digital transformation can be managed by one function (often coordinated by a CDO), which generally creates friction among functions.

Clarity about why digitalization is important, where it is important, what enablers are needed, and how the organizational and managerial processes should be governed is fundamental. In addition, the firm should be clear about what it wants to achieve, have flexible internal processes, and be open to continuous learning. This will accelerate its digital transformation and result in a more competitive firm.