1. New pressure on prices and margins

Digital technologies create near-perfect transparency, making it easy to compare prices, service levels, and product performance: consumers can switch among digital retailers, brands, and services with just a few clicks or finger swipes. This dynamic can commoditize products and services as consumers demand comparable features and simple interactions. Some banks, for instance, now find that simplifying products for easy purchase on mobile phones inadvertently contributes to a convergence between their offerings and those of competitors that are also pursuing mobile-friendly simplicity.

Third parties have jumped into this fray, disintermediating relationships between companies and their customers. The rise of price-comparison sites that aggregate information across vendors and allow consumers to compare prices and service offerings easily is a testament to this trend. In Europe, chain retailers, which traditionally dominate fast-moving consumer goods, have seen their revenues fall as customers flock to discounters after comparing prices even for staples like milk and bread. In South Korea, online aggregator OK Cashbag has inserted itself into the consumer’s shopping behavior through a mobile app that pools product promotions and loyalty points for easy use across more than 50,000 merchants.

These dynamics create downward pressure on returns across consumer-facing industries, and the disruptive currents are now rippling out to B2B businesses.

2. Competitors emerge from unexpected places

Digital dynamics often undermine barriers to entry and long-standing sources of product differentiation. Web-based service providers in telecommunications or insurance, for example, can now tap markets without having to build distribution networks of offices and local agents. They can compete effectively by mining data on risks and on the incomes and preferences of customers.

At the same time, the expense of building brands online and the degree of consumer attention focused on a relatively small number of brands are redrawing battle lines in many markets. Singapore Post is investing in an e-commerce business that benefits from the company’s logistics and warehousing backbone. Japanese web retailer Rakuten is using its network to offer financial services. Web powerhouses like Google and Twitter eagerly test industry boundaries through products such as Google Wallet and Twitter’s retail offerings.

New competitors can often be smaller companies that will never reach scale but still do a lot of damage to incumbents. In the retailing industry, for instance, entrepreneurs are cherry-picking subcategories of products and severely undercutting pricing on small volumes, forcing bigger companies to do the same.

3. Winner-takes-all dynamics

Digital businesses reduce transaction and labor costs, increase returns to scale from aggregated data, and enjoy increases in the quality of digital talent and intellectual property as network effects kick in. The cost advantages can be significant: online retailers may generate three times the level of revenue per employee as even the top-performing discounters. Comparative advantage can materialize rapidly in these information-intensive models—not over the multiyear spans most companies expect.

Scale economies in data and talent often are decisive. In insurance, digital “natives” with large stores of consumer information may navigate risks better than traditional insurers do. Successful start-ups known for digital expertise and engineer-friendly cultures become magnets for the best digital talent, creating a virtuous cycle. These effects will accelerate consolidation in the industries where digital scale weighs most heavily, challenging more capital- and labor-intensive models. In our experience, banking, insurance, media, telecommunications, and travel are particularly vulnerable to these winner-takes-all market dynamics.

In France, for instance, the start-up Free has begun offering mobile service supported by a large and active digital community of “brand fans” and advocates. The company nurtures opinion-leader “alpha fans,” who interact with the rest of the base on the Internet via blogs, social networks, and other channels, building a wave of buzz that quickly spreads across the digital world. Spending only modestly on traditional marketing, Free nonetheless has achieved high levels of customer satisfaction through its social-media efforts—and has gained substantial market share.²

4. Plug-and-play business models

As digital forces reduce transaction costs, value chains disaggregate. Third-party products and services—digital Lego blocks, in effect—can be quickly integrated into the gaps. Amazon, for instance, offers businesses logistics, online retail “storefronts,” and IT services. For many businesses, it may not pay to build out those functions at competitive levels of performance, so they simply plug an existing offering into their value chains. In the United States, registered investment advisers have been the fastest-growing segment³ of the investment-advisory business, for example. They are expanding so fast largely because they “insource” turnkey systems (including record keeping and operating infrastructure) purchased from Charles Schwab, Fidelity, and others that give them all the capabilities they need. With a license, individuals or small groups can be up and running their own firms.

In the travel industry, new portals are assembling entire trips: flights, hotels, and car rentals. The stand-alone offerings of third parties, sometimes from small companies or even individuals, plug into such portals. These packages are put together in real time, with dynamic pricing that depends on supply and demand. As more niche providers gain access to the new platforms, competition is intensifying.

5. Growing talent mismatches

Software replaces labor in digital businesses. We estimate, for instance, that of the 700 end-to-end processes in banks (opening an account or getting a car loan, for example), about half can be fully automated. Computers increasingly are performing complex tasks as well. “Brilliant machines,” like IBM’s Watson, are poised to take on the work of many call-center workers. Even knowledge-intensive areas, such as oncology diagnostics, are susceptible to challenge by machines: thanks to the ability to scan and store massive amounts of medical research and patients’ MRI results, Watson diagnoses cancers with much higher levels of speed and accuracy than skilled physicians do. Digitization will encroach on a growing number of knowledge roles within companies as they automate many frontline and middle-management jobs based upon synthesizing information for C-level executives.

At the same time, companies are struggling to find the right talent in areas that can’t be automated. Such areas include digital skills like those of artificial-intelligence programmers or data scientists and of people who lead digital strategies and think creatively about new business designs. A key challenge for senior managers will be sensitively reallocating the savings from automation to the talent needed to forge digital businesses. One global company, for example, is simultaneously planning to cut more than 10,000 employees (some through digital economies) while adding 3,000 to its digital business. Moves like these, writ large, could have significant social repercussions, elevating the opportunities and challenges associated with digital advances to a public-policy issue, not just a strategic-business one.