United States: Disrupting The Disruptors

Renowned as the disruptors of other industries, information technology (IT) companies are now subject to a dizzying pace of change, driven by the global pervasiveness of their own technologies.

"We've known for a while that the on-premise model has largely been supplanted by the cloud, making all technologies available as a service or everything-as-a-service," said Steve Perkins, technology leader at Grant Thornton LLP. "Reaching new markets has never been so straightforward or as low-cost. Information technology companies are aggressively blurring traditional industry boundaries.

But there are challenges."

While quickly maturing, the global everything-as-a-service (XaaS) market is still forecast to grow at a compound annual growth rate (CAGR) of 38.2% from 2016 to 2020, according to research firm Technavio.1 Storage-as-a-service will be the fastest-growing service segment in the XaaS market, delivering CAGR of more than 40% by 2020. U.S. companies will invest more than $232 billion in internet of things (IoT) hardware, software services, and connectivity in 2016, and IoT revenue is expected to skyrocket by 16.1% to $357 billion by 2019, according to research by International Data Corporation (IDC).2

Shifts of this magnitude significantly disrupt all segments of the industry's value chain. Cloud computing, for example, changes the way software applications and infrastructure are consumed and acquired. There is more elasticity and volatility in demand. IT companies must be able to scale up seamlessly in response to rapidly rising demand. They also need to be able to anticipate when a product or service is reaching maturity and scale down in response by driving efficiency and reducing costs.

Disruptive technologies like these inevitably rewrite the rules of how IT companies grow and compete. New competitors and threats are emerging. Established leaders are seeing revenues from traditional products stagnate and must pivot to new revenue sources, driving new M&A cycles.

Regulatory oversight and scrutiny are growing both domestically and internationally at the same time as IT companies are moving into nontraditional industries. International expansion tests tax and privacy policies here and abroad. As technology becomes ever more ubiquitous and essential in our daily personal and business lives, increased scrutiny is inevitable. Winning companies must redefine their business models, building platform businesses underpinned by strong operational discipline.

Today, several trends are shaping the state of play in the U.S. IT sector: hypercompetition, geopolitical volatility, regulatory and tax scrutiny, and the rise of the platform business.

Hypercompetition exposes new risks

The U.S. IT industry is not for the faint-hearted — competitive intensity is part of its DNA. Increasingly, IT companies are crossing traditional industry boundaries to take on established companies on their home turf, as they have so successfully done in media and retail.

But these moves expose IT companies to new risks. As they invest in moving into new sectors such as automotive, hospitality and transportation, they face entrenched competitors with finely honed capabilities. Suddenly, their core technical prowess isn't enough to succeed. There is a real danger they will stretch their business model and distract leadership, placing capital investments at increased risk.

In some cases, they will also step into heavily regulated markets, such as health care or financial services. This exposes them to significant risk unless they have the capabilities and experience needed to meet the compliance requirements of the sector's policymakers. Established companies in these industry sectors have powerful support bases and won't cede market share quietly.

In addition to battling on new fronts, IT companies need to protect their own borders as established firms in other industries begin to encroach on their territory. A notable example is General Electric's shift to a digital and industrial company. Today, it is a $4 billion software business that is actively working to build and deploy a dominant industrial IoT. According to the Financial Times, this 123-year-old group is investing $1 billion a year to boost its digital capabilities, hiring 1,000 software engineers and data scientists, and setting up a new data analytics center in

San Ramon, Calif.3

To prepare for the risks of expanding into new sectors, IT companies need to map and understand the current regulatory environment and potential future regulatory risks. They also need to carefully evaluate their partnership and acquisition strategy for moving into new sectors. Google, for example, managed the risk of moving into a new sector by buying the mobile wallet technologies and patents from Softcard as part of the technology giant's strategy for the booming mobile payments segment.4

Geopolitical volatility and regulatory and tax scrutiny increase

In the past, U.S. tech companies powered ahead in an environment that could be described as "regulatory lite." They didn't face the same regulatory burden as their peers in other industries, such as utilities or financial services. But this is changing — and fast — as companies grow and expand internationally. A strong signal of this geopolitical volatility was the announcement by the EU's antitrust regulator that Ireland should recoup about $14.5 billion of unpaid taxes accumulated by Apple over a decade.5

On the one hand, reaching international markets has never been so straightforward or as low-cost. Because of new technology platforms, on-demand services, global supply chains and increasing data speed, early-stage IT companies can operate globally from day one.

Expansion is also growing more complex. To succeed with their international ambitions, IT businesses must overcome increasingly complex and diverse legal and regulatory obstacles that differ regionally. Their cloud offerings, for example, rely on the free flow of data across international and other jurisdictional borders. But governments around the world are impeding the free flow of data in the name of protecting privacy. A notable example was the decision of the European Court of Justice to strike out the safe harbor framework in October 2015, which had allowed the likes of Facebook and Google to move data from the EU to the U.S.

As more IT companies become global enterprises, taxation authorities are taking an increasingly critical view of their tax strategies. Where an IT company physically supports, sells and innovates its products often has very little connection with where the products are consumed. IT companies are increasingly at odds with taxing authorities about this fundamental aspect of their business. The Organisation for Economic Co-operation and Development's base erosion and profit shifting initiative, aimed at closing international tax loopholes and establishing where taxes should be paid, is adding complexity. Within U.S. borders, the Supreme Court's reversal of Quill v. North Dakota has increased complexity as local state taxing authorities lay jurisdictional claims to out-of-state transactions.

IT companies need to understand how these regulatory and tax risks affect how they structure their global operations, define their product and service offerings, and manage value chains that span borders. These risks affect multiple aspects of the business — from the partnerships they forge, to how they manage risk, to their brand reputation. Joel Waterfield, Grant Thornton's national managing director for Technology, said, "Information technology companies need to build a detailed view of the tax landscape in all their target markets — understanding where the inconsistencies are, where changes are pending, and what the implications are for compliance and tax reporting."

The rise of the platform business redefines value creation

Fortune favors the brave in the IT industry. In many cases, the winning tech companies are those that can develop the platforms that redefine an existing industry rather than seek incremental improvements. The network effects of aggregator platforms like eBay or social platforms like Facebook have delivered significant value to their creators.

Tomorrow's IT winners will build and orchestrate pervasive and compelling platforms that connect producers and consumers. IT companies that "own" successful platform communities will be able to tap into and monetize user-generated content, creativity and data — the currency of the future for tech companies.

Creating long-term sustainable value requires strong operational discipline and constant vigilance to defend the platform from competitors. It can be easy for a platform business to be commoditized or imitated in different geographic markets. Orchestrators have to have the structures and processes in place to offer a compelling end-to-end customer experience. Given that platform operators learn and evolve based on data, they also need robust approaches to data governance.

IT companies also need to re-evaluate their acquisition strategy in light of their platform ambitions. Perkins said, "Constant prioritization of investments must be made to favor those features most apt to build and sustain customer participation in the platform. Should usability be enhanced? Should throughput be accelerated? Should an end-to-end process be optimized? Should they go deep into a subindustry or functional specialization? IT must address all these questions, with constant customer feedback, an agile approach to development and an obsession with client service."

Success based on clear purpose

U.S. IT companies are justifiably seen as world leaders. However, IT is also an unforgiving segment, where the leaderboard is constantly changing. It's difficult to predict which companies will provide the winning services and products in a cloud-based, open-source era.

What is clear, though, is that success will entail a significant transition into how companies manage competitive risk, growing regulatory and tax scrutiny, and engagement with communities of consumers. By building executive understanding and alignment behind the key strategic themes facing the industry, U.S. IT companies can gain the clarity of purpose required to succeed.

Footnotes

1 Technavio. "Global Anything as a Service Market 2016–2020," May 17, 2016.

2 Shirer, Michael and Torchia, Marcus. "IDC Spending Guide Finds U.S. Organizations Accelerating Their Investment in the Internet of Things as Meaningful Use Cases Find Their Way to Fruition," IDC, June 22, 2016.

3 Crooks, Ed. "General Electric: Post-industrial revolution," Financial Times, Jan. 12, 2016.

4 Mishkin, Sarah. "Google in deal to boost mobile payments; Search group buys technology from Softcard as it takes on Apple Pay," Financial Times, Feb. 23, 2015.

5 Drozdiak, Natalia and Schechner, Sam. "Apple Ordered by EU to Repay $14.5 Billion in Irish Tax Breaks," The Wall Street Journal, Aug. 30, 2016.

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