How can your digital investment strategy reach higher returns?

Companies are accelerating their digital spending in 2022. This is in response to mounting pressure to quickly bring technology-enabled products and services to market and achieve efficiencies.

Executives plan to allocate 5.8% of their revenues to digital as compared with 3.5% in the 2020 survey. To understand the significance of this increase, consider that for a company with $10b in revenues, 5.8% spending on digital would mean a bounce from $350m to $580m — an increase in spending of 65%.

For companies seeking to accelerate digital transformation efforts, it is critical to be transparent on digital use cases. To do this, companies can:

• Develop a systematic approach to their digital capital allocation with the right governance in place
• Focus on high-value use cases where companies have successfully validated how a digital business case has positively impacted a key aspect of the business
• Set clear guiding principles to drive the digital capital allocation strategy, while simultaneously considering corporate strategy goals, the company’s tech portfolio, return on investment and potential impact to the business

How companies can use inorganic investments to accelerate innovation and increase value

Most survey respondents (55%) are choosing inorganic investments, such as corporate venture capital (CVC), M&A and partnerships, over building capabilities in-house to accelerate their digital journey.

Inorganic investments are attractive due to easier access to capital, increased quantity and improved quality of technology targets. They also provide an accelerated pathway to access new technologies and fill key capabilities and skills gaps. Today there are more tech partners and targets than ever: in Q4 2021, the number of new global unicorns reached a record high of 959, representing a 68% increase from Q4 2020.³

When deciding on inorganic investment vehicles, companies say they prefer partnerships to gain financial returns with lower capital investment (34%). They also prefer M&A to gain faster access to new technology and products (32%) and favor CVC (45%) to support new market expansion and have early access to forward-looking technology or assets.

Companies say they are using the entire suite of investment vehicles to drive their innovation strategy. This is critical, as different types of investments offer different risk and return profiles. While most executives (87%) indicate that their most recent inorganic investments met or exceeded expectations, many are unsure of how to optimize their inorganic mix of investment vehicles.

To achieve an optimal mix, it is important for companies to break down silos and become more purposeful in synchronizing these investment types with each other. Build, buy and partner decisions should not be made in isolation; rather, they should align with overarching corporate and business unit-specific objectives.

Leading practices for inorganic investments

Companies can lose value by choosing the wrong investment vehicle and not fully weighing the benefits and drawbacks of each option. Likewise, setting up the right incubation structure and building an operating model that links each investment vehicle will improve transparency, efficiency and effectiveness of investments across various stages of maturity.

These considerations can guide decisions:

Partnerships

This investment vehicle is used to support new market expansion, strengthen customer relationships, close capability gaps and leverage startup solutions.

Benefits

Partnerships typically represent less financial burden compared to other inorganic vehicles.

Considerations

• Companies should consider partnership constructs that require commitment from both parties, such as equity joint partnerships.
• It is important to choose the right partnership vehicle (e.g., equity partnership or joint venture, commercial agreement) based on a company’s unique situation and goals.
• In some cases, certain partnership options (e.g., licensing, research and development) may yield greater returns in a shorter time frame.

Potential risks

While partnerships can help drive value by leveraging the other companies’ capabilities, drawbacks may include the sharing of business decisions, culture mismatch, misaligned commercial or go-to-market aspirations, splitting profits, and losing full rights to intellectual property.

CVC

Companies often structure corporate venture funds as a separate entity or “branded CVC” fund to operate with autonomy and keep off-balance sheet investments to capitalize swiftly on venture opportunities.

Benefits

Companies can use CVCs to learn from startups, identify future M&A opportunities and build an ecosystem of incubators.

Considerations

• Define governance and operating models that link to the parent company with a dotted line to the chief executive officer (CEO) or chief financial officer (CFO) to empower future-think investment decisions
• Determine investment strategy in terms of fields of play, technology gaps and strategic goals that tie into larger outcomes.
• Build off-balance sheet investment structure to avoid impacting financial reporting
• Develop an attractive compensation package to secure high-quality venture capital and startup talent and maintain a differentiated incentive plan to foster innovation
• Build strong industry relationships to be able to tap into the startup ecosystem

In a sign of digital transformation maturity, the DII reveals that more companies are moving from the initial stage of “building” digital capabilities to “running” or scaling technology solutions and are beginning to see benefits. In 2022, 31% of digital spending is being dedicated to “building” capabilities, while 69% of spending has shifted to “running,” in comparison to 36% and 64%, respectively, in 2020. This suggests that companies are pivoting from core internal operational efficiencies to new digital products and services that enable them to get closer to their customers and generate revenue.

Another indication of companies’ digital journey progression can be seen in the scaling of existing technology investments. For example, many companies have been building data platforms through investments in cloud and IoT. The number of companies reporting that they are now realizing full benefits of their investments in cloud, IoT and AI increased 54% in 2022 compared to 2020. This means they have moved from a proof-of-concept and build phase for key digital technologies to a launch phase.

Overall, companies are setting the foundational elements of digital transformation while moving toward full benefit realization.

Strategy is critical to securing funding for digital projects

A clear strategy, business case and proven agile capabilities are prerequisites to secure the right level of funding. The survey indicates that more companies are connecting their digital strategies with successful implementation, e.g., culture, agility, clear accountabilities, measurement and execution pathways. But many companies still show room for improvement when it comes to defining an actual digital strategy with clear implementation plans and executive accountabilities.

Only 16% of respondents strongly agree that they have a clearly defined strategy for digital — an essential factor in the success of digital investments. However, the numbers do suggest progress compared to the last survey (see Figure 2).

Although companies say they expect to have easier access to capital during the next two years, more than half of executives still face budget and funding issues for their digital programs. For example, a life sciences company had a portfolio of 89 digital product and market-facing applications. Less than 25% of these projects resulted in additional revenues. It was important for the company to focus on the most valuable digital products and services, then to establish a clear business case based on technology platform, capability requirements and addressable market. Based on this new scope with a clearly defined path to implementation, the chief financial officer was able to establish a funding plan over the next three years.

Companies continue to focus on customer experience in 2022

Customers remain at the heart of most companies’ digital priorities, with respondents noting that improving customers experience is a leading goal. Specifically, 42% of executives say customer acquisition, retention and experience will be one of the top priorities during the next two years.

Customer experience (CX) also ranked highest in positive outcomes from important digital investments. More than half (55%) of executives indicate “improved CX” as an area where they have seen a positive impact from their digital investments. But to accelerate improvements and move to more predictive models and personalization in this area, companies will need to harness essential customer data.

A select group of executives — called digital performance leaders — is building momentum and separating itself from the pack in terms of digital investment success.

This group (126 companies, representing 8% of the survey sample) is defined as those companies that (1) estimate their RODI to be more than 8% in 2022 and (2) strongly agree that their organization leads others in the success of their digital initiatives. Leaders are equally distributed across major regions including Asia-Pacific; Europe, Middle East, and Africa (EMEA); and the Americas. Industries represented range from telecommunications, media and technology (TMT) to infrastructure and health care.

What a digital performance leader looks like

Our survey suggests that leaders are more likely to track performance on digital investments, generate greater financial impact than others and mature their digital investments faster:

• Leaders report an average RODI of 10.8% as compared to all others who reported an average RODI of 5%.
• And almost one in five expect their digital investments to contribute to revenue growth during the next two years, as compared to 11% of all other survey respondents (Figure 4).

How digital leaders differentiate themselves

Leaders are achieving nonlinear or outsized value creation by investing heavily in foundational capabilities and building their teams, technology and data platforms. Leaders are now moving on to the next stage of their digital transformation journey, with the vast majority (87%) taking a centralized governance and oversight approach to benefits and associated cost outlays. Finally, 79% of them have a formal program to identify, measure and report digital investment outcomes.

Leaders do not radically differ from the total survey population when it comes to their industry, share of revenue devoted to digital investments or investment-vehicle mix. Where they do distinguish themselves is in their company culture. Forty-six percent consider necessary culture changes when mapping digital strategies.

Digital leaders note that they:

• Develop strategies that can be adjusted in the event of unforeseen disruptions, and 40% say they maintain a fail-fast culture that encourages employees to be unafraid of experimentation and allows for increased agility and speed. Leaders are also much less likely than others to cite talent and skills gaps and lack of alignment among organizational units as obstacles to achieving a high RODI.
• Empower team leads or change agents to socialize and champion digital projects requiring more scrutiny. A vast majority of leaders have also taken to heart lessons of the pandemic: ensuring flexibility in their workplace, developing new strategies to attract talent and formalizing approaches to measure digital investment outcomes.
• Decouple their innovation operating models, incentive structure and measures of success from the mother ship to encourage “futureproofing.”
• Focus their digital investments on innovation and new products and services, succeeding by being judicious about investing and scaling the foundational technologies so they can quickly focus on advanced initiatives aimed at bringing greater integration and agility to the operating model. They are successful at bringing together corporate, business units and functions to collectively focus on specific customer needs. More than half of leaders (55%) say they have seen a positive impact from their 2021 digital investments in terms of improved customer experiences and successfully launching new digital products and services (58%). Going forward, 48% say launching new products and services is a top goal for their investments.
• Take a lean portfolio approach, carefully prioritizing use cases and establishing a formal funding process with milestones tied to the investment and corporate objectives. Leaders create an outcome management office-style governance program with an agile operating model to provide rigor, speed and meaning to investment decisions. This office can also track user and customer feedback using formalized, real-time dashboards to provide direct input into current and future strategies. 

The next frontier for digital leaders

While others choose inorganic investment vehicles in search of market expansion or for near-term financial gains, leaders use inorganic investments to learn and experiment, strengthen existing relationships, and support cultural transformation.

Leaders are also distinguished by the progress of their investments in more sophisticated technologies. Leaders are specifically reporting full benefit realization of physical robotics and automation (72% vs. 36% of non-leaders) and AI (39% compared to 19% of non-leaders). While most companies plan to focus their investments on cloud and IoT as they continue to build foundational data and analytics capabilities, leaders are more likely than others to invest in even further advanced technologies such as blockchain (30% vs. 20% of non-leaders) during the next two years. This suggests that while many companies are progressing in their digital journeys, leaders remain a step ahead.

Conclusion

With record levels of digital investments on the horizon, driven by a need for speed, CEOs and other C-level executives are under more pressure than ever to select the right mix of investment vehicles and demonstrate measurable returns on digital investment. Making wise investment decisions and generating a high RODI remain challenging since the last iteration of the Digital Investment Index. Capital allocation has become even more critical to success, as well as having flexible strategies and a company culture to integrate digital investments with greater agility.

Strengthen your digital investment strategy with these five steps:

1. Capitalize on your digital spend: Set up clear guiding principles to drive your digital capital allocation strategy, considering your corporate strategy goals, tech portfolio, ROI and potential impact on the business.
2. Develop an integrated inorganic growth strategy: Deciding whether to build internal capabilities or use inorganic investments (e.g., buying or partnering) to meet innovation goals will determine how quickly a company can bring new products and services to market and deliver RODI.
3. Establish a strong digital foundation first: Invest in foundational technologies first, putting the right building blocks in place before looking into more advanced digital initiatives.
4. Create a playbook to scale your digital initiatives: Establish a formal process for prioritizing, developing and scaling your digital initiatives.
5. Establish a strong governance model to measure your success: Set metrics, review key performance indicators, assess impact on portfolio value realization and adjust accordingly.

EY-Parthenon contributors to this article include Isaac Branaum, Shai Eilat, Ankur Sharma, Daniel Weil, Andy Youn and Richard Yang.