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InfoQ Homepage Articles Guide to Digital Transformation - Part 2

Guide to Digital Transformation - Part 2

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Key Takeaways

  • Business transformations, whether digital or not, are complex. Leveraging a frame of reference to model, comprehend, and price their economic, risk and financial impacts is critical.
  • To be effective, a digital transformation must be disruptive. The framework proposed in this article helps assess the nature and extent of the disruption, so that the selection of a digital evolution is the result of a conscious decision.
  • The assembly, sharing, and integration of business and technology blocks to form a ”composable” enterprise is the essence of becoming digital.
  • The nature of work and its organization has evolved from being hierarchical and top-down, to multidirectional and collaborative. As a result, companies must reinvent their culture and engagement model with their workforce if they want to successfully harvest the benefits associated with their digital transformation.

The first part of this article defined the term “digital” and introduced a frame of reference labeled the Digital Transformation Framework (DTF) to help organizations better apprehend and model digital strategies.  The intrinsic elements of the framework were also introduced in detail in order to understand that any digital transformation requires the confluence of finance, economic, risk, and technology dimensions.  The figure below visually illustrates the key themes covered in Part 1.

The second and final installment of the article starts by explaining how to use the Digital Transformation Framework (DTF) to craft a digital strategy to reinvent the Middle Office of a generic asset management firm.  It then proposes a possible target state architecture to realize the digital strategy created in the prior step.  The future state architecture relies on the concept of “the composable enterprise”, a key notion for any organization that strives to be digital.  The “composable enterprise” is subsequently explained in detail.

It is superficially easy to understand the importance of human resources to successfully execute a traditional, or non-digital, corporate restructuring.  However, digital transformations are different because their essence is to enable frequent and constant change.  Indeed, one of the main business motivations to digitally transform is to put organizational, operational and technological foundations in place to foster constant evolution and cross-functional collaboration.  In other words, companies are purposefully organizing themselves to be able to execute any transformation at any time in order to stay competitive and relevant in the future.  As a result, the article briefly addresses the importance of altering a firm’s culture to successfully enable a digital change.  Finally, a few closing thoughts are articulated to, I trust, successfully guide your own digital journey.

The Digital Transformation Framework in Action

This section exercises the Digital Transformation Framework for a financial services company (an Asset Management firm in particular). At a high level, an asset manager is logically broken down in three distinct business capabilities labeled Front, Middle and Back Office, as shown in Figure 23.

The Front Office is responsible for the sale of financial services and products, and is usually regarded as information intensive and customer critical. Its performance and contribution to the business is less about operational efficiency, and more about tasks that deliver a superior and sticky customer experience to clients.

Conversely, the Back Office is very structured, and relies on a set of exhaustive procedures and processes to deliver administrative and support services. As a cost center that must operate with a high level of reliability, this business capability is typically well automated, because its performance is measured in terms of operational efficiency.

Figure 23: Simplified Business Capability Model of an Asset Management Organization

The Middle Office, however, is different from both the Front and Back Offices because its execution requires complex knowledge that only a skilled workforce can provide. A number of its business functions are critical because the decisions they produce and the actions they determine typically shape a company’s direction, risk appetite and cost structure. As a result, this business capability has proven challenging to measure and improve.

Under the current model, Middle Office functions are still mostly performed in-house. However, with the advent of the digital themes referenced by the Digital Transformation Framework, financial services organizations, and investment managers in particular, have an opportunity to turn this business capability into a source of competitiveness that could potentially generate income. For this transformation to succeed, asset managers must go beyond the traditional one dimensional cost reduction initiative (labor force cuts), as recently reported by the Financial Times on April 28, 2016, in an article labeled “UBS to revamp Wealth management business to cut cost”. A new shift in responsibilities for the Middle Office is necessary.

The next section examines a possible vision and subsequent (not-so-distant) future state of an asset management’s Middle Office, where decentralization and modularity of both business and technology functions, along with automation are central elements to the proposed evolution.

One conceivable vision for the Middle Office is to evolve from primarily bridging the Front and Back Offices by performing transaction processing, to becoming a near-real time analytic hub that consumes and meshes risk, investment and regulatory raw data points to generate both strategic and tactical information, and contribute to a firm’s decision making process, at every rung of the hierarchy. Figure 24 graphically models this proposed evolution.

Figure 24: Envisioned evolution of the Middle Office function.

This transformation requires focus on the Middle Office business functions that generate the most economic value, while assessing their level of complexity, labor specialization, capacity for industrialization, and the amount of resources necessary to realize and execute them in a secure environment. Figure 25 offers a possible ranking of a select number of Middle Office business functions based on their economic value and their potential for strategic differentiation and brand strengthening.

It is however preferable to embark on this transformation if lower-value business functions are already digitized and are reliability and predictability executed. Otherwise, the proposed evolution of the Middle Office is unlikely to produce the anticipated business outcomes.

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Once an asset management firm has identified its business functions that either generate or have the potential to generate the most economic value, we recommend, at a minimum, to assess them against both value creation and cost models, as illustrated in Figure 26, because finding new structural ways to unlock value is difficult, expensive and prone to failure. So modeling the transformation is an imperative. Also, an Operational Execution framework could be added, for instance to appreciate the efficiency, robustness, and predictability of the underlying business processes. Similarly, organizational schemes could be leveraged to better infer a future staffing model. This evaluation step has two main objectives. The first objective is to establish benchmarks that can be used to quantitatively measure the effectiveness of the transformation.

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The second objective is to understand the pricing and cost structure shift associated with the digital transformation of high-value business functions, and whether their new re-composition significantly modifies the asset manager’s value chains to achieve sustainable industrialization, competitiveness, and productivity gains within the risk limits of the organization. Next, the DTF is leveraged to formulate a possible digital strategy to reify the Middle Office vision.

Figure 27 models a possible digital strategy to achieve the business vision of the Middle Office expressed in the above section and modeled in Figure 24. The first goal of the proposed digital strategy is to leverage the Automation theme to structurally alter the way high business value functions are designed, integrated and executed. It is important to note that the strategy demands a level of automation that is above the industry to create the sought after strategic differentiation. The digital strategy also focuses on the asset manager’s internal customers, or the internal roles that participate to the execution of the high-value business function. This entry in the DTF suggests that the organization will investigate new organizational models to match a targeted level of automation as a means to improve labor productivity. This contributes to the second goal of the digital strategy, which is to increase operational efficiency as a sustained mechanism to, first reduce, and then control operational costs. Finally, advanced analytics is incorporated to continuously generate information to better understand and manage the new digital model.

Figure 27: Possible Digital Strategy to Support the New Vision of the Middle Office

The reification of this digital strategy must start by reshaping the old business operating model, where all business functions and processes are solely executed by their owner. This is accomplished by first, rationalizing, and then delegating or distributing the execution of specific Middle Office business functions to external partners that can execute them better and cheaper. In our example, the new business operating model leverages the concept of Business Process as a Service (BPaaS), as a means of recomposing the Middle Office from a business perspective, while shifting cost curves downward, and hopefully improving the automation, robustness and efficiently of the overall business capability.

Figure 28 conceptually illustrates the new business operating model for the Middle Office, where a number of business processes that make up one or many business functions are delegated to external partners because they can be executed more reliably, faster and cheaper by outside vendors than the actual owner of these business processes. The diagram also shows that a set of business processes are kept in-house. However, the ability to re-design business value streams through composition of best-of-breed business processes is critical to embrace the digital world. And BPaaS inherently facilitates the transformation toward business process modularity and composability.

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Figure 28

Continuing with the asset manager example, the result of the prior analysis may generate the following redistribution of a select number of high-value business functions when mapped to a sourcing framework, as illustrated in Figure 29.

Figure 29

However, it is important to recognize that the new business operating model and its explicit division of labor are likely to introduce some amount of operational risk, as well as security challenges. So it is important to understand the tactical and operational advantages and disadvantages of such a decentralized functional structure before designing a BPaaS-based business operating model. Figure 30 provides a non-exhaustive list of pros and cons to evaluate before adopting this new way of executing business capabilities.

Figure 30: Benefits and Drawbacks of BPaaS

From a technology implementation perspective, an Application Programming Interface (API) strategy has been selected to reify the new business operating model and fulfill the Automation theme of the digital strategy. Indeed, APIs provide a means for building distributed software systems, whose components are loosely coupled and that may be owned by different parties, as depicted in Figure 31. They connect, extend and integrate software, while blurring code and execution ownership. They can connect businesses, products and services seamlessly, regardless of geographical location. More importantly, APIs are used for machine to machine communication (Automation theme) and for the integration and collaboration of two or more software systems.

Figure 31

Figure 32 shows how multiple API gateways could be leveraged to facilitate architecting the “composable” enterprise. It is an architecture that strives to decompose both business and technology elements in reusable module so that they can be assembled and reassembled to match business opportunities with unprecedented speed and agility, along with minimal and controlled disruption to a firm’s business operations.

From a technology perspective, this new approach may combine commercial off the shelf (COTS) packages, SaaS platforms, and custom development to promptly address market conditions. And this ability to compose technology elements to create a best-of-breed operational foundation is spreading across all technology domains. For instance, the notion of “composable” infrastructure refers to a system formed by disintegrating the various components (compute, storage, and networking) of the data center IT infrastructure and integrating them in different ways, in order to satisfy the needs of specific workloads. “Composable” infrastructure enables a completely integrated data center architecture, with highly abstracted resources, software-defined functionality controlled by platforms and in which APIs enable disparate environments to function as a single, fluid pool of resources.

Figure 32

Consequently, modern businesses must and will evolve from a hierarchical and hardwired model to one that is flexible, architected for change, designed to be agile, scale globally, and provide new avenues for cost efficiency and revenue generation.

Figure 33 depicts a possible future technology operating model for an asset manager based on the digital strategy formulated in Figure 27. A select number of high-value Middle Office business functions are executed by external partners, and APIs are leveraged to reify business and technical value streams. In this example, the  Investment Book of Record (IBOR) and Client Reporting business functions are kept in-house. This decision to specifically retain IBOR within the remit of the firm is not random. The original vision for the Middle Office was that this business capability becomes a near-real time analytic hub that consumes and meshes risk, investment and regulatory raw data points to facilitate the decision making-process, as depicted in Figure 24. And IBOR might just help deliver this vision.

Indeed, IBOR’s functional responsibility is to centralize intraday positions (current investment activities, cash balances, existing positions, cash & stock forecasting) across all asset classes by providing a single, enterprise-wide, trusted source of consolidated financial truth, real-time investment data, exposures and risks. As a result, it is one of the cornerstone business functions to transform the Middle Office from transaction processing to strategic and tactical supplier of meaningful analytics.

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Figure 33

This proposed vision of the Middle Office introduces profound business and technology changes for the Asset Management industry. However, future industry leaders and laggards are likely to be defined by whom will take advantage of such cutting-edge approaches to operate their business.

Digital Culture

Lastly, as effective of a tool the Digital Transformation Framework can be, any business transformation, whether digital or not, requires a culture shift in order to hold.

An organization’s culture could be described as a set of formal or informal beliefs and rituals that act as a rallying point for how individuals behave and interact with one another. Led by accepted group norms, a culture unites individuals in a sense of belonging and common purpose. People identify with a culture not because they have been told to, but because of shared values and attitudes that motivate and inspire them.

Unfortunately, many organizations view digital transformation as primarily a set of investments in technology. Two independent surveys recently conducted by McKinsey and Altimeter echoed that companies underestimate the impact of the human element on their digital evolution.

More importantly, the McKinsey survey also shows that organizations that underinvest in their human capital while attempting a transformation are less likely to reap the economic benefits associated with the evolution.

Figure 34 proposes a frame of reference to incorporate the human factor into a business transformation, whether digital or not. And organizations should anticipate to perform a delicate balancing act when allocating finite resources to complete their digital journey. The right mix of resource distribution is unique to each company, and is likely to impact the economic outcome of a firm’s next business evolution.

Figure 34

Conclusion

Leveraging digital technologies is more than just good business. It is crucial to staying relevant and profitable. However, digital transformations are not only about implementing new technologies. To deliver on their promise, they must mesh economic and capital performances, changes in risk propagation across operations, automation, operational efficiency, customer experience, and organizational culture to name a few dimensions, as illustrated in Figure 35.

Furthermore, digital transformations must be driven by clear business intents. For instance, they may stem from a desire to reinvent a business model or an entire industry by addressing consumer needs in completely new ways. As a result, an organization should challenge itself and not be afraid to disrupt its own business model if it wants to become a leader. Core business functions and processes must be digitized and optimized for reliability and efficiency in parallel, in order to create a robust foundation for digital execution.

In addition, to match the speed and scale of the digital world, organizations must design their business and technology operating models with interconnectedness and interoperability in mind. Conversely, they must participate to the broader digital ecosystem by enabling third party vendors to develop composable models that incorporate their products and services at will. Finally, to become digital, internal and external data must be collected to compete on analytics and generate business value, as explained by Thomas H. Davenport in his seminal paper titled “Competing on Analytics”.

Figure 35

To conclude, a business-led digital strategy must be crafted before embarking into any digital transformation. The Digital Transformation Framework is a perfect tool to help prototype a variety of digital strategies until a proper one is identified.

About the Author

Philippe Assouline is a seasoned expert in enterprise architecture, specializing in engineering economic performance, operational efficiency, and enterprise competitiveness by conjoining the risk management, cybersecurity and enterprise architecture disciplines.

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