Given at Pakira we are building the digital fabric of the supply chain in wood, this is a very timely article by McKinsey & Company
As software transforms every industry, leaders must turn to a new playbook.
Marc Andreessen’s observation from more than ten years ago that “software is eating the world”[1](javascript:void(0)
needs an update: software is the world. The software industry continues to grow at a massive clip. More and more traditional companies are realizing that to compete and grow in a digital world, they must look, think, and act like software companies themselves.
Per McKinsey research from June 2022, nearly 70 percent of the top economic performers, compared with just half of their peers, are using their own software to differentiate themselves from their competitors.[2](javascript:void(0) Fully one-third of those top performers monetize software directly.
The pressure to evolve is building thanks to three fundamental shifts. First, the accelerated adoption of digital products is driving an effort to embed software in the product and purchase experience through everything from personalization to seamless omnichannel delivery. Second, more of the value in more products and services from more industries is coming from software. For example, the average industrial company expects its share of revenue from software to double over the next three years. Finally, the growth of cloud computing, platform as a service, low- and no-code tools, and AI-based programming assistance are putting unprecedented power into the hands of billions of workers.
Yet while companies might already accept the importance of software (research shows that nearly two-thirds of companies have invested in software as a service or modern commercial software), they still tend to look at software as a capability that they can bolt onto their existing business. That just doesn’t work. Becoming a software business requires foundational change with different skill sets, practices, leadership, and organizational structures.
Share
Sidebar
Three ‘switch to software’ models
It is hard to become a software company—less than 7 percent of all software revenue in the world accrues to nontech companies.[3](javascript:void(0) But models for successful transformation do exist (see sidebar, “Three ‘switch to software’ models”). To understand what works, we analyzed more than 20 software transformations and spoke with a dozen senior executives who have led successful software transitions. The result: six principles that are at the core of any successful effort to become a software company.
Commit to a software culture
Every leader we spoke with underlined the fact that building a software-centric business means building a software culture. This goes way beyond adding a few software veterans and implementing DevOps (software development and IT operations). It requires building a culture that deeply values the creativity and artisanship of great engineering, elevates product leadership and a customer-first focus, and empowers a leadership team with a strong understanding of software business models and tech. Building that culture is challenging, but the CEOs and business leaders we spoke with highlighted three keys to success: leadership, communication, and investment.
Leadership
In our experience, one-third to one-half of a leadership team should be deep software experts. This might require radical steps depending on the makeup of the leadership team currently in place.
The board should have at least two directors with software experience and should also keep the pressure on management by monitoring progress against specific software KPIs. The CEO of one company felt compelled to light a fire under its emerging progress in software when one influential board member added a review of the software business to the top of the agenda at every board meeting.
At many leading software companies, CEOs’ direct reports include tech visionaries and AI scientists to stimulate thinking and push the organizations. Marc Andreessen urges companies to be even bolder: “Find the smartest technologist in the company and make them CEO,” he told McKinsey Quarterly in 2022.[4](javascript:void(0)
Besides hiring software leaders, most companies must educate their existing senior team. This means getting past basic training sessions and visiting start-ups. Real learning comes from building relationships and interacting closely with software companies. Some CEOs told us that they gain expertise both by inviting software leaders to join their boards and by joining the boards of software companies.
For example, Latin American bank Itaú Unibanco established a space for an informal incubator of 120 start-ups. Chief information officer Ricardo Guerra credits the informal networks that have sprung up between the bank and these start-ups as being instrumental in raising the bank’s software IQ. “The best way to understand what’s happening is to spend real time with software businesses,” says Guerra.
Communication
The strategy, value proposition, and progress of a software business need to be communicated consistently. One challenge is to do so in a way that prioritizes the software business while keeping the core business and its people performing and feeling valued.
Some companies we spoke with address this issue by reinforcing the idea that all employees, whether in the software business or not, are part of a single culture. For example, all employees at Keysight Technologies, a leader in electronic testing and measurement, have a certain portion of their pay tied to overall performance of the company. Some CEOs we spoke with also emphasize being intentional about spending time with business leaders in the legacy business and ensuring that those leaders’ priorities continue to have a place at the top of the corporate agenda.
External communications about the software effort are equally important, especially given the impact of software initiatives on valuations. The CEO of a large industrial company told us that half of all the questions it had faced on a recent investor call were about the company’s new software business.
Investment
Software-centric businesses can be highly valuable franchises, but they require sustained investment. Most of these new businesses need to invest an average of 25 to 35 percent of revenues over three to five years before they start to generate profits.
Given the significant operating-expenditure requirement to maintain this level of investment, many companies turn to acquisitions to accelerate the process. The IT company Hexagon, for example, acquired more than 25 software companies over ten years. In many cases, a single major acquisition is the key to accelerating the development of a software-centric business. McKinsey experience suggests that a big software acquisition is often a key indicator of success.