Beyond Old Economy: how to thrive in the Phygital World

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Dietmar C. Schlößer

TÜV NORD GROUP, Germany
Beyond Old Economy: how to thrive in the Phygital World
From the Edited Volume
Edited By:
Professor John Metselaar
Content

Introduction

For decades, we have heard and experienced that the world is changing. That the pace of change is accelerating. The fourth industrial revolution brought digital technologies, which have penetrated every aspect of private and business life. Hence, the why of innovation is very clear: we need to be faster than the change. At the same time, innovation as we know it does not exist anymore. It became open and collaborative to adapt to the economics of change (Chesbrough, 2006), and it became digital to embrace emerging technologies. We started talking about digital transformation, digitalisation and even digitisation as synonyms or rather as prerequisites for innovation (Jarrett, 2019).

As a 150-years old business, which was thriving on experience, stability and routines, while staying an expert in the latest technology, TÜV NORD found itself in the situation where pure expertise and quality were not enough to compete for customers. The markets have changed; the regulations are changing with them. We arrived at the point where digital transformation seemed inevitable, and innovation was the only way to compete in the global markets. Digital technologies have already changed the customers, competition, data, innovation, and value (Rogers, 2016).

Digital transformation is more about change than it is about digital technologies (Stackpole, 2021). It requires a new way of working, digital-era skills for employees, digitalisation of business models, and analogue processes. What is more, it needs an innovation strategy to become future proof and an adequate measurement system to evaluate the progress and change the course if necessary.

In this chapter, we will look at the case of TÜV NORD in adapting and driving change. We will first look at the background and company history of TÜV NORD. We then introduce the innovation strategy process and look at how we distinguish between innovation and digitalisation, the innovation governance and measurement (via the Balanced Scorecard), followed by our approach to transforming our employees’ skills and mindset of our employees via the Digital Academy. We then conclude our case by reviewing how the recent COVID-19 pandemic has influenced our digital transformation journey.

Company Background

It is no exaggeration to say that the TÜV brand is a German institution. Founded as a decentral “bottom-up” initiative more than 150 years ago, the TÜV brand stands for trust in the industrialised world. The purpose has always been to protect human lives from the risks and potential adversity of technology. The time of its foundation was in the middle of the First World Industrial Revolution (Schwertner, 2021). What started with traditional steam boiler inspection evolved to a worldwide TIC[1] business covering a broad range from functional safety in mining to the reliability of spacecraft components for Mars missions. In addition, TÜViT stands for top-notch cybersecurity in the digital world. The first 150 years of TÜV NORD’s history have been a fascinating journey (Paetrow et al., 2019).

TIC stands for functional safety in the physical world. As a consumer, you only want to use products that are safe and pose no risk to your life and health, whether this product is a car, a lift or a toy for children. Our brand promise is trust – trust in the safe and secure use of technology. This trust also forms the basis for the acceptance of new technology. The TIC business has successfully mastered the challenges of three world industrial revolutions. TIC emerged from the first industrial revolution when the world was mechanised. In the second revolution, the physical world became electromechanical, and the third one was the beginning of the digital world, and cyber security came with it.

However, the intelligent automation of the fourth industrial revolution will change the TIC business in an unprecedented way (Ritsema et al., 2018). Figure 6.1 illustrates that we are dealing with a convergence of the physical and digital worlds – the phygital world. On the one hand, digitalisation changes the fundamental nature of products. Take cars, for example. Over-the-air software updates can change the essential characteristics of a car. It is in fact, a different car after such updates. This undermines the effectiveness of traditional homologation and the concept of periodic inspections.

On the other hand, many technical components and products interact and form intelligent networked systems, such as autonomous driving or industry 4.0. The “intelligence” of these networked systems comes from AI algorithms. Thus, networks of physical components and AI algorithms form the new phygital world (Iansiti, 2020).

From a TIC perspective, the decisive question is how to ensure that intelligent networked systems are safe and secure. It is no longer enough to test the physical brakes of a car, once they are controlled by algorithms based on the input of a myriad of different sensors and smart-city infrastructure components. Moreover, the necessary norms and standards for this do not exist yet. In fact, we are still far from knowing all the relevant answers. For TIC organisations, this poses nothing less than an existential threat. Not finding an adequate answer to this question will mean the end of our brand promise. If someone else finds it, we will eventually be out of business. In a way, this situation is comparable to TÜV NORD’s period of formation. We will possibly need a new founding period, a second Gründerzeit.

Figure 6.1. Convergence of the physical and digital worlds

Innovation vs. Digitalisation

Many people struggled in the beginning to understand these two terms. They would ask if a project was an innovation or digitalisation project and how to tell the difference. We positioned innovation as the commercially successful application of something new as opposed to R&D activities that might lead to new business in the long term. In simple terms, R&D turns money into knowledge, and innovations turn knowledge into money.

For digitalisation, we rely on the Gartner definition as the use of digital technologies to change a business model and provide new revenue and value-producing opportunities; it is the process of moving to a digital business. According to this definition, digitalisation is an integral component of the innovation strategy. Every digitalisation project is an innovation project, but not necessarily the other way around.

It is important to note that we make a clear distinction between digitalisation and digitisation (according to Gartner, “the process of changing from analogue to digital form, also known as digital enablement”). This means that changing internal processes to digital form has nothing to do with innovation. This does not imply a general order of precedence, though. Our company requires both digital enablement and moving to a digital business.

The Innovation Journey

TÜV NORD GROUP Innovation Strategy

Given the existential threat to TIC business, developing the first dedicated group innovation strategy in the company’s history was pivotal. Its main purpose is to secure our long-term future viability.

Some business units had already started significant innovation activities and established innovation teams, but an overall structured approach and framework were still required in 2018.

The TÜV NORD GROUP’s Innovation Strategy defines three key objectives:

1)To Increase Customer Benefit

Increasing the customer benefit would appear to be an obvious and relevant objective for most organisations. In the case of TÜV NORD, it has a deeper significance, though.

Considering periodic car inspection as one of our most emblematic services, the notion of a “customer” did not exist before the deregulation of the German TIC market in the early 1990s.

With a legal obligation for car holders to present their cars for general inspection at their local monopolist station, there was simply no need to act like a service provider (Paetrow et al., 2019). Car holders often had to put up with long waiting times and felt like petitioners of a public authority. Although those times are long gone, they left perceptible traces in the organisational culture. Today, we will certainly do our best to treat customers with respect, but that does not necessarily mean we really know their needs.

We need to work closely with customers to co-create solutions and services that will solve our customer’s problems. This requires an entirely different perspective, as we have to think from the customer’s point of view. An organisation of engineers defined by profound technical expertise will need to transform from searching for technical answers to asking the right questions.

At the same time, these new solutions need to be scalable to allow for a profitable business. In the phygital age, this translates to platform-based digital business models. The need for the TIC industry to accelerate its digital transformation might be evident (Raghavan et al., 2021). Still, in our view, it is important to link digital technologies to customer benefit.

A good example is the IoT platform DMT Safeguard, which was developed by the Business Unit Engineering & Natural Resources team. It is a data platform offering a comprehensive and project-specific selection of sensors with a wide range of performance characteristics. It enables both internal and external customers to control and analyse sensor data holistically and build their own analytics solutions on top.

2)To Increase the Innovation Rate

Increasing the innovation rate will require structured and standardised innovation processes, which often seems counter-intuitive given the creative nature of innovation itself. Yet, the only way to prevent innovation theatre is by measuring outputs in a systematic way. You cannot plan successful innovation, but you can change the odds by ensuring less promising initiatives will fail as early as possible. There is an abundance of relevant literature on this topic. For more inspiration, please see (Viki et al., 2017).

Eventually, the approach is to allow as many “bets” as possible with limited (financial) resources. It is in line with the concept of antifragility (Taleb, 2012).

A structured and standardised innovation management process requires effective governance involving all relevant players; in the case of TÜV NORD, this means both business units and central functions.

We use a classic stage-gate approach for the innovation management process consisting of 3 phases and 5 stages:

  • Ideation phase which comprises the stages of Idea generation, Idea refinement and Concept
  • Implementation phase for innovation projects
  • Scaling phase which is about Go-to-market & Growth

The main purpose of a standardised innovation management process is to establish a common understanding across all business units. The people involved in innovation need to “speak the same language” regarding innovation activities. It is a prerequisite for creating a high degree of group-wide visibility and a foundation for cross-functional collaboration.

In the TÜV NORD innovation strategy, we defined process standardisation as conformity with the ISO 56000 family of standards for two reasons. First, ISO standards are close to the heart of a TIC company – remembering that the “C” stands for certification. The term “ISO” in itself enjoys a high level of credibility in the internal organisation, making it easier for people to accept the process. Second, there might be a business opportunity to offer our expertise to external customers, true to the motto of “drinking your own champagne”. We are also actively involved in the international ISO working group that further develops the ISO 56000 family of standards.

The results after two years are very encouraging: the innovation rate (which we define as the percentage of revenue generated by new services/innovations within the first three years after launch) has more than doubled, and we expect further growth by 2025. Of course, a part of this effect is simply caused by the significant attention increase regarding innovation. In other words, we managed to create much more visibility of things that might have existed already. At first glance, this might bear a similarity with a phenomenon called the “observer effect” in physics [Dirac, 1930]. In contrast to experimental physics, though, our interest is to consciously use and even maximise this effect!

Making time for innovation would appear to be the ever-present challenge, though. You need to safeguard an intentional slot protecting against tyranny of the urgent. To this end, we offer different learning formats and workshops as part of HR development programs for middle management. We believe that our innovation journey rather requires a middle-out transformation as opposed to top-down or bottom-up approaches. In our experience, top managers and employees are in general both supportive of more innovation. In contrast, middle managers are responsible for the actual heavy-weight lifting of turning innovation into reality while meeting operational goals at the same time [March, 1991].

3)To Increase Innovation Breadth

The phygital world relies on intelligent networked systems consisting of individual technical components interacting with each other. When you have experts with deep knowledge of those individual components, what could be more obvious than having the experts interact with each other to co-create expertise on intelligent networked systems?

In the history of the company, we have always tried to solve business problems in the respective organisational silo. We simply had no practice in doing this any other way. In the phygital world, no organisational silo can be big enough to continue this way of working. We have to apply the full breadth of experience and expertise, hence the term innovation breadth. Changing the organisational structure will not solve this issue effectively. Instead, the experts from six BUs need to form effective knowledge networks. Communities of Practice (Lave, 1991; Schlößer, 2014; Garfield, 2021) are tailored to serve this purpose.

The challenges and the complexity involved are so significant that no single player will be able to master them successfully on their own. We also need to work much more closely with customers, suppliers, R&D partners, universities and even competitors (Chesbrough, 2003). In our view, innovation in the phygital world will happen mostly within innovation eco-systems. The need for building an innovation eco-system might seem obvious, but getting there is primarily a cultural challenge for an organisation with a 150-year-history of self-sufficiency.

In practice, measuring cultural change would appear to be a rather sophisticated endeavour. We started by looking at the number and percentage of innovation projects involving two or more business units. The number of projects in co-creation with customers is another useful indicator. We also integrated cross-functional collaboration and customer co-creation as criteria for the annual TÜV NORD GROUP Innovation Award, which we established in 2019.

Depending on the relevant aspects of innovation culture, you can think of different types of KPIs [Toma, 2021]. We are currently working on defining adequate composite KPIs to provide a more holistic picture of cultural change.

The Governance Model

The first deliverable of the innovation strategy was the implementation of an effective governance model. The starting point was an existing financial innovation controlling process for innovation activities of each business unit. It was a bilateral process between the individual business unit and the group controlling team. The next step was to form a TNG Innovation Council consisting of one innovation representative from each business unit and representatives of central functions.

As the governance body of the innovation management process, the purpose of the Innovation Council is to create and continuously develop the TÜV NORD GROUP innovation portfolio. It supports the goals of innovation management and ensures group-wide communication. The council is also responsible for exchanging suitable methods and procedures, selecting group-wide reference projects, and the joint development of supporting documentation for innovation management.

The intention is to involve the BUs as much as possible in the innovation management process. BUs are responsible for innovation, and the BU leaders are measured by output. Given that BUs eventually carry all burden involved with innovation projects, it is natural to expect resistance against any form of central innovation policing. We consider shared responsibility for the governance of the innovation management process an effective way to overcome this resistance. It helps catalyzing innovation where it occurs.

Furthermore, effective governance requires setting a very clear focus. The Innovation Council only deals with digitalisation (business models) as opposed to the digitisation of internal processes. The governance of the latter is owned and executed by a different body called Business Process Management Council (BPMC). In this respect, it turned out to be not sufficient to simply define the “out of scope” but to establish proper governance around digitisation, too. Otherwise, you might end up explaining over and over again why you defined digitisation as out of scope in the first place. People will turn to you with their digitisation issues as long as there is no one else they can go to. Therefore, it is appropriate to state that the success of the Innovation Council also relies on the existence of a well-functioning BPMC. You don’t get to digitalise your business if you get constantly side-tracked by digitisation issues.

Balanced Scorecard

The Balanced Scorecard (BSC) was introduced by Robert Kaplan and David Norton (Kaplan, 1992). The BSC is a strategic planning and management system that organisations use to:

  • Communicate what they are trying to accomplish
  • Align the day-to-day work that everyone is doing with strategy
  • Prioritise projects, products, and services
  • Measure and monitor progress towards strategic targets

We developed an Innovation BSC to manage the implementation of our innovation strategy (Malinoski and Perry, 2011). The first step was to create clear strategic goals for each of the four BSC categories (Financial, Customer, Internal Process, and Organizational Capacity). The outcome is also known as strategy map (Kaplan and Norton 1996) and can be seen in Figure 6.2. Each category has its own Key Performance Indicators (KPI). For each KPI, we determine a strategic initiative to support reaching the respective goal.

Figure 6.2. Innovation Balanced Scorecard (Strategy Map)

For instance, increasing the innovation rate is the major strategic goal in the financial category. In the customer category, we measure e.g. the number of collaborative market launches with customers (co-creation). Regarding internal processes, we intend to shorten the time from idea to market. An interesting KPI in organisational culture is the number of innovation projects involving more than one business unit.

The Innovation BSC was a new concept for business units when we introduced it in 2019, and we will probably need to adjust the KPIs. The effort for measuring some KPI might be too high due to underestimated complexity of acquiring the data or an initial overestimation of its usefulness. We want to ensure that business units see the value in this as opposed to BUs perceiving the BSC as a time-consuming controlling exercise with little added value.

Digital Academy

Strategy, governance, and a systematic way of measuring output are necessary cornerstones of our innovation journey by providing structure and creating focus. The indispensable underpinning for innovation is organisational culture though. Being in the TIC business does not make things easier. The TNG practitioners are typically engineers who are well trained to identify risks and why things could potentially go wrong. This is what customers expect, as they want to be and feel safe when using a product that we have tested, inspected or certified. The pursuit of zero defect is part of the organisational DNA. A zero-defect culture is not only obstructive to innovation but, in fact, to all kinds of change.

In 2017, we established the TÜV NORD Digital Academy to drive digital transformation from within. The objective was to enable our employees to drive this transformation as opposed to relying on expensive external consultants and creating digital silos. In a 6-week program, employees seconded from operational units throughout the whole company would spend half of their time on new project ideas and the other half on learning new methods like design thinking. At the end of the so-called Digital Expert program, they would pitch their projects to the Group Executive Committee in a Shark Tank format. This program and later extensions became so successful that it is a commercial offer for external customers today.

The Digital Experts can only become effective in their organisations when they get the necessary leadership support. Leadership events have been pivotal in creating awareness and getting buy-in from leaders. The Digital Leadership Convention is a yearly (now digital) event for more than 200 participants in which projects involving strategic future-oriented topics like quantum computing and artificial intelligence are featured. Furthermore, the target leadership group has changed. In the beginning, people were invited based on job level. In the meantime, people need to apply for tickets based on their active contribution to digitalisation.

Although it had originally been designed for digital transformation, the Digital Academy’s focus has shifted gradually toward innovation over time. We have integrated the Digital Expert Training into the innovation management process and let the Innovation Council decide what innovation project ideas the next round of to-be Digital Experts will work on.

This way we ensure a direct contribution to the three key objectives of the innovation strategy. The Vitual Lab solution, for instance, was developed by a multidisciplinary team of Digital Experts from different business units as their Digital Academy project. Vitual Lab gives customers online real-time access to all data when testing their devices and components. It was originally designed for testing of satellite components. These components undergo complex and very time-consuming tests. Before Virtual Lab, this often required the presence of all parties on site.

The Impact of COVID-19

The Corona pandemic has shown society the true meaning of the term “exponential”. Authorities were quickly overwhelmed because our ways of doing things rely on the assumption of linear processes and predictability. The key insight is that time is of the essence. The longer you wait, the more draconic measures are required to get the situation back under control.

When the first lockdown began, audits could no longer take place on-site. We were able to switch to remote audit almost immediately: in Germany, from almost none in 2019 to several thousand in March and April 2020. This was only possible because the innovation team of Industrial Services had identified and tested the required technology and procedures in the two years before the pandemic. Of course, they did not have a pandemic in mind. They were looking for alternative ways to provide one of the core TIC services. This example illustrates the vital importance of innovation in uncertain, exponential times. If we had started to make up our mind about innovation during the lockdown, we would have suffered a severe drop in revenue.

What we often tend to ignore is that we live in a non-linear world full of exponential developments. We do not realise it while we are still in the early stage of the exponential curve. However, the early stage is by far the best time to take measures and to invest in innovation though. This is, in my opinion, what we must learn from COVID-19.

Consequently, we need to question our business assumptions on a continuous basis. In the previous example, the assumption had always been that audits must be on-site, but do customers insist on this? The pandemic has indeed offered the opportunity to challenge many longstanding assumptions whose validity we previously took for granted (Stackpole, 2021).

Conclusion

Like many other industries, the TIC industry is facing an existential threat. This creates an unprecedented need for innovation. TÜV NORD has been implementing an innovation strategy with three key objectives: digitalisation, an effectively governed innovation management process and building an innovation eco-system. At the same time, this requires cultural development from a fundamentally risk-averse approach toward a more entrepreneurial way of thinking on all levels of the organisation.

A few things which might help along this way:

  • It is important to move away from a unilateral focus on standard financial controlling. A Balanced Scorecard can help your organisation look at a more holistic way of innovation. This requires different KPIs for each stage in the innovation process.
  • Although it would appear to be a platitude, innovation requires a high degree of perseverance. Many fancy innovation labs closed after a few years because they could not demonstrate a positive ROI. An incremental approach (step-by-step) might seem much less attractive from a marketing perspective, but it will probably turn out to be more sustainable in the long term.
  • Do not panic! Embracing the concept of exponentiality might lead to the troublesome impression that your organisation is excessively slow, no matter what you do. Instead, see every crisis as an opportunity to drive and accelerate change.
  • Do not forget to build a solid foundation while improving your innovation culture. If you do not have defined processes, governance, measurement model or KPIs, you will never be able to evaluate the success of your innovation culture initiatives. To transform a 150-year-old company into a digital powerhouse, you need to address both culture and structure at the same time.

Last but not least, don’t forget to practice what you preach. If you intend to build an open innovation eco-system, be open for embracing other people’s perspectives and experiences. Standing on the shoulders of a giant is often the most effective way of making progress.

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