Analysis: McKinsey's guide to tackling the technological shift in retail

How prepared are today’s retailers for the changes ahead and, in particular, the pace of change that technology is driving? In our experience, too many of those who began their careers operating stores are still trying to squeeze more from their traditional business processes rather than responding to the new world in entirely new ways.

Their focus often remains on store openings, negotiations with suppliers to drive down prices, and other cost management measures. If sales are sluggish, they might have a go at more promotions or mine their loyalty card data to conduct a few one-off marketing campaigns.

Any new, digital-related opportunities they decide to explore tend to be regarded as ‘projects’, even though these are the very essence of their future identity and need to be pursued at scale.

Amazon’s growth trajectory illustrates how out-of-date this thinking is. In the past decade, Amazon’s revenues have grown by 32% a year on average, reaching $48bn in 2011. With market capitalisation in the region of $110bn, Amazon is more highly valued than Target, Walgreens and Kroger combined.

Yet how many traditional store operators have come anywhere close to capturing the potential growth that digital commerce can deliver in all manner of categories, or even carefully considered what that potential might be?

If retailers fully grasped the pace of change and how it will affect their businesses, maybe their thinking and strategies would alter. Previous chapters have spelled out the significance of the change, but the point bears reinforcing with some examples. In McKinsey’s 2011 iConsumer research, 66% of US consumers of electronics made the purchase online, up from 55% in 2010.

Even in the grocery sector, where many are still convinced that ecommerce will not work, there has been significant growth in the share of consumers who say they regularly shop online. In the UK 17% of consumers did so in 2012, up from 11% in 2008. The numbers in France (5% in 2010 versus 2% in 2007) and Spain (3% in 2010 versus 2% in 2007) are smaller but also trending upward.

Awareness of the historical pace of change also needs to be combined with an eye to the future and the realisation that the young people now on the threshold of becoming mainstream consumers are digital natives.

By 2020 about 27% of western Europe’s population will have been born after 1980, amounting to 102 million consumers. Unlike many of today’s older consumers, this cohort uses digital technology almost intuitively and will surely accelerate the speed of change in retailing.

The fact that it takes time to build the skills required of a digital-era retailer also should be a prompt to immediate action. The few store-based retailers recognised for embracing the power of technology took almost a decade to transform their businesses. Retailers that have yet to begin the process no longer have the luxury of so much time, particularly as digital-era shoppers might prove to be loyal to the first movers.

Although we argue that technology has empowered consumers by giving them more choice and transparency, loyalty still might develop in response to familiarity with a certain website, appreciation of the benefits a particular retailer offers (say, convenience or its understanding of an individual’s shopping habits and preferences), or even the building of an emotional bond through an online community.

How many of us are already loyal to certain portals simply because we are used to them?

Retailers yet to embark on a transformation will need to accept that they must move much faster and thus more boldly than those currently at the forefront of change. There is undoubtedly a great deal to be learned from the experiences of technology pioneers and from observing how they work. But the time for a me-too approach is long gone.

Leapfrogging

The good news is that technological advances can make it easier for latecomers to make huge strides. In high-tech industries, innovation is inevitably technology related: a striking new development catapults the industry ahead, creating new industry leaders.

An obvious example of leapfrogging is the Apple iPhone, which radically altered the nature of mobile phones by combining basic voice communication with internet and multimedia capabilities, touchscreen functionalities, and a platform that could feed off a vast ecosystem that included iTunes and a stunning array of apps.

Other companies have since followed Apple’s lead, but the new technology dealt a serious blow to the fortunes of some leading mobile phone manufacturers at the time of its introduction.

In retail, technology-driven innovation has been important, of course, but the pace has been slower. Now, in the digital era, we believe most retail innovation will be driven by technology, making the industry more akin to the high-tech sector and explaining why companies familiar with emerging technologies and equipped to embrace them can leapfrog ahead. As one senior executive of a global online retailer told us: “If I were forced to choose, I’d say we were a technology company rather than a retailer.”

To make fast progress, retailers can choose from three different kinds of opportunity. Just by deploying the most recent innovations on the market today, such as cloud computing, retailers that have so far occupied the
rearguard will be able to leap forward.

In addition, given the pace of innovation and the potential of the new technologies, IT-backed solutions to retailing’s challenges will quickly emerge and be way ahead of what even today’s most digitally astute retailers have yet discovered.

Finally, leapfrogging opportunities will arise from consumers’ growing receptiveness to new ways of shopping.

Developments in areas such as mobile, augmented reality, and social media will be used to target the next generation of digitally savvy consumers in entirely new, though as yet unknown, ways that many of today’s consumers simply would not have an appetite for. The aspiration must be to avoid merely emulating today’s digital leaders in retail, but rather to move ahead of them.

The way forward

If store-based retailers are determined to transform their business and succeed in the digital era, what then do they need to do? There are three preliminary steps:
1) Shift the mental model
2) Set a new aspiration for the business
3) Adapt the organisation

Shift the mental model

Before the digital era, retailers enjoyed a privileged position as intermediaries between suppliers and consumers, controlling the physical flow of goods between them as well as the information flows required to match supply with demand. Their power as intermediaries was reinforced as they learned how to manage more complex operations and thus how to grow through territorial expansion, at home or abroad.

But that business model has been threatened as the emergence of new competitors and consumers’ growing use of technology to take more control over purchasing decisions has blurred retail’s boundaries. In addition, technology has supercharged information as a competitive weapon in retail. In consequence, we believe that store-based retailers wanting to make their mark in the digital era need to refocus the mental model that has guided retailers’ business thinking for centuries. This will require that retail organisations become customer-centric, digitally fluent, and super agile.

Set a new aspiration for the business

A successful transformation begins with clarity about what a company aspires to be. To this end, a retailer must understand how the paradigm shifts we describe are changing customers’ behaviour in its sector, segment, and geography; the competitive dynamics; and the potential impact on the economics of the current business model. A retailer also needs to understand the opportunities - the new ways to engage customers and capture cost efficiencies, for example, and the capabilities and skills required to do so.

With this contextual understanding, different archetypes might prove helpful in starting to shape the new aspiration and, from there, the business strategy. Their clarity and simplicity can help a company to consider whether its current value proposition is sound in the digital era, or whether it will be forced to formulate a new one.

Bear in mind that it is always easier to build distinctive propositions on current strengths than to try to build new strengths, but structural change may still be required. For example, a retailer that prides itself on knowing what customers want, based on their interaction with sales associates in its stores, might be hard-pressed to
replicate that strength online. New skills and capabilities are likely to be required, as well as significant investment.

Each company’s value proposition will be largely defined by a single archetype, perhaps with others to reinforce it.

For example, a store-based retailer could decide to take advantage of its understanding of customers’ needs and opt for the preselection archetype, knowing it can offer distinct value in the selection of goods. But it could also add an experience component to bolster the value proposition.

Multi-format retailers will have to think through which archetype best suits different parts of their business.

They might choose a different reference archetype for each one but, as has always been the case, they will have to ensure that the overall brand strategy remains coherent.

Adapt the organisation

With the broad direction of travel clear, retailers will have to adapt their organisations for the journey. We have already touched on the need to change the company’s mindset, which will have implications for the kinds of
staff and skills required. Processes and organisational structures also must be adapted.

Digital fluency demands that technology be integrated into the thinking and capabilities of every part of management. All persons concerned with building the company’s talent, from the chief executive to operating leaders and human resources, have to accept the requirement to transform the way in which their teams talk, think, and work.

They might have to face the fact that some of the best-qualified teams are likely to be younger than many of their existing staff. Like it or not, young people are more familiar with the various technology platforms and more comfortable using them than older people, which means they are better placed to understand the coming generation of digital consumers. Leveraging their talents will be important for retailers wanting to build a digitally fluent organisation, and recruitment, training, and development processes might have to change to put younger people in more senior positions more quickly.

• Chapter co-authored with James Naylor