Investors Reward Companies That Highlight Digital Initiatives

Investors Reward Companies That Highlight Digital Initiatives

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Digital technologies have the potential to transform a wide range of businesses, especially in traditionally non technological sectors. Motivated by the breadth of these digital transformations, we’ve done research  exploring how frequently they are occurring, what benefits they are creating and what impact they are having on financial performance. We’ve tried to answer three specific questions:

First, how extensive is the adoption of digital technologies by non-tech firms? We find that firms that are larger and younger, and that hold more cash and spend less on capital expenditures, are also more likely to go digital. Companies with weaker performance are going digital sooner, perhaps as a possible response to competitive pressures.

Second, what are the benefits of going digital? For one, investors seem to love it. Valuations of firms that go digital are 7% to 21% higher than those of peers. Moreover, firms that go digital also receive higher valuations on their earnings. Their price-earnings ratio is 3% to 9% higher, and they receive 30% to 90% higher returns per dollar of incremental earnings than firms that don’t disclose digital activities.

Third, how are companies faring as they adopt digital technologies? Surprisingly, we find little evidence of immediate improvement in financial performance. We find positive performance benefits only in terms of asset turnover (a measure of efficiency of use of assets), which increases by 3% to 9% over three years relative to peers, following the disclosure of digital activities.

However, we find no change in overall financial performance (measured by return on assets) and significant declines in operating margins and sales growth (lower by 14% to 42% and 10% to 30% respectively) when digital activities are disclosed. These limited benefits could be due to several factors.

One, the gains from digital activity take a long time to bear fruit and firms have to bear the costs in the interim. Many successful tech firms that undertook large digital investments, like Amazon.com, waited many years to become profitable. Two, competitive forces may quickly erode the benefits of going digital. For instance, customers may benefit from better products but companies cannot sustain higher prices because of competition. Three, firms may not have the right management team to go digital. It’s imperative to pay attention to having senior managers with the right tech acumen.

Investors are rewarding the early movers even if immediate financial-performance benefits remain elusive. The risky nature of the digital investments highlights the need for companies to keep capital markets better informed, and provide assurance that they have the right managers to execute the digital transformation.

(Suraj Srinivasan is a professor at Harvard Business School, where Wilbur Chen is a doctoral student.)



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