When Volkswagen, Europe’s largest automaker, struck a joint-venture deal with Rivian Automotive last year, it committed to investing up to $5 billion in the US luxury truck-maker and one of Tesla’s big rivals in the electric vehicle market. It did so because it wanted “immediate access” to Rivian’s software expertise, which would complement its own manufacturing expertise.
VW’s own software developer—Cariad—had struggled to deliver the necessary products in a timely fashion, forcing the automaker to delay the rollout of new EV models. As a result, some industry observers were warning in the Financial Times that the German giant was “looking at an extinction event with low-price Chinese EVs coming into Europe.”
Cariad will refocus its efforts going forward, but VW’s partnership with Rivian—following a similar partnership with Chinese EV maker Xpeng—is a sign of things to come.
After several decades, the process of digitization is finally penetrating the slow-to-adapt parts of the global economy. Across the world, many asset-heavy industrial companies—the big traditional manufacturers that have largely, and for so long, resisted digitization—are exploring ways to do what VW is doing: in effect, to conduct a kind of heart transplant. Only, in this case, the old heart (the analog or hardware manufacturing capability with the combustion engine at its core) is not being completely replaced by the new heart (the digital or software capability with the electric powertrain at its core). On the contrary, the two hearts are expected to beat alongside each other—and thereby make the company stronger, more resilient, and better able to deal with the challenges of what we call a bifurcated world.
It is sometimes said that two heads are better than one. Now, in today’s competitive environment, it can also be said that two hearts are better than one.
Why is this?
To some extent, it is because we are all, as individuals, living in a bifurcated world that requires us to navigate through a complex and overlapping analog-and-digital environment. Go back 20 years, and there was a clear divide between analog (old, and old-fashioned) and digital (new, futuristic, and representing progress).
Now, if you take a walk through many towns and cities, you will likely encounter a street-level café (analog) located below a web-based retailer (digital). And if you work from home, as millions of people now do, then you will no doubt sit at your computer, interact with colleagues via Zoom or Teams, and have an essentially digital experience. If, the next day, you commute to an office, then you will have face-to-face conversations with your colleagues that are more of an analog experience. In much the same way, companies need to be able to navigate through this analog-and-digital environment.
What is driving them to do this?
The biggest driver is the astonishing advances in digital technology—and the smart use of software capabilities by companies in adjacent businesses. A few years ago, Apple sent shockwaves through the traditional car industry when it emerged that it had begun developing its own Apple EV. Could Apple, originally a personal computer company, do what it did to the mobile phone industry—upend it? The answer, as it turned out, was “no.” Last year, Apple formally abandoned its car ambitions. But where Apple failed, others are having some success. In China, for example, Huawei and Xiaomi, Apple’s rivals in the smartphone business, have launched subsidiary automakers and started filling showrooms with SUVs and other models.
Another driver is the private capital market, and the willingness of boldly ambitious venture capitalists to deploy their money in startups that are overturning traditional ways of doing business. The US and the world at large are in the midst of a startup boom, funded by venture capital. Already, there is talk not just of the $1 billion unicorn or the $10 billion decacorn but the “hectocorn”—a startup worth more than $100 billion. Elon Musk’s SpaceX, which is pioneering the first reusable rocket, was the first; OpenAI, which developed ChatGPT, is reputedly poised to be the second.
This surge of investment into startups is likely to lead to a shake-up in the way business is done because, as The Economist noted, “entrepreneurs tend to make use of new technologies and create novel business models, in the process keeping incumbents on their toes and propelling growth.”
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Value Creation and Valuation in a Bifurcated World
It used to be the case that variation was the enemy of profitability—and success. It may still be. But today, variation is a fact of life. The job of the CEO is no longer to solve a single problem, or even a single set of problems. Now, they must solve multiple—often contradictory—problems, make difficult tradeoffs, and still come out on top.
It could be said this is a challenge that has faced business leaders for several years—ever since the first emergence of advanced digital technology. So, why are we writing about this now?
It is true that some industries—for example, retail and media—have been among the pioneers in the business of operating with two hearts. But the biggest industries—including automobile manufacturers and the oil and gas behemoths—have been slower to adapt because the digital revolution has not impacted them in the same dramatic way. Until now.
In the automotive industry, Tesla, the Chinese automaker BYD, and other EV manufacturers are disrupting what remains one of the most valuable business sectors. It is an oft-quoted fact—but no less astonishing for all that—that Tesla is worth more than all the other carmakers in the world’s top 10: Toyota, BYD, Ferrari, Mercedes-Benz, Porsche, General Motors, Volkswagen, BMW, and Ford. Its elevated valuation is attributable not to its manufacturing prowess but rather to its software (digital) prowess and its focus on design. Meanwhile, as we have noted, telecom companies such as Huawei and Xiaomi are moving into the automaking business, building their own separate auto units with hardware and software capabilities.
This dual approach is modeled on the approach adopted by retailers and media businesses. For instance, the Financial Times created a separate digital operation when it first launched ft.com in the mid-1990s. Only later did it merge the two. Initially operating a “digital-first” strategy, the media group worked on bringing the two hearts together, and today they form a fully converged entity.
Likewise, in the automobile industry, the internal combustion engine is likely to remain an important part of the product mix for many years to come. Back in 2017, The Economist reported that “the first death rattles of the internal combustion engine are already reverberating around the world,” explaining that “the end is in sight for the machine that changed the world.” But eight years on, vehicles powered by electric batteries are facing a backlash from some consumers.
Other industries, including the
energy production industry,
also face the two hearts challenge. Many
oil and gas companies
are torn between continuing to focus on oil and gas production and related industries and investing in alternative energies such as wind, solar and biofuels. Similarly, the power utilities have to operate the traditional coal, gas and oil power plants while at the same time engaging in wind craft, solar plants, and biomass plants.
Future Success: Building a Business for Tomorrow
So how should leaders—typically rewarded by investors for the performance of their companies in the “here and now”—prepare their company for a time long after their tenure has come to an end?
In this regard, the story of Kodak—whose top executives ignored the firm’s own engineers who had developed a prototype digital camera—is a favorite case study of business schools. But the fact is that the people who ignored this innovation (because it would have disrupted Kodak’s then-lucrative film business) were not penalized for their failure to see into the future. It was left to their successors to deal with the fall-out of decisions made (or not made).
Our answer to this thorny question is to go back to the first principles of portfolio theory articulated by Bruce Henderson, BCG’s founder, in the 1970s. His famous 2x2 has one quadrant with a question mark. It signifies the fact that some portion of today’s profits must always be set aside for investment in projects that may not see the light of day for several years—and, in some cases, may not come to fruition at all.
Microsoft’s experience is instructive. The company’s leaders have certainly made mistakes—or missed opportunities. After dominating the software industry, Bill Gates was initially an internet-skeptic, doubting its commercial value. Later, his successor as CEO, Steve Ballmer, took a wrong turn when he acquired Nokia as part of an ultimately failed move into mobile telephony. But more recently, this experimental approach—which the current CEO Satya Nadella calls “high-ambition North Stars”—has paid off in the early move into generative AI through the inspired investment in OpenAI and ChatGPT.
For this to work—for business leaders to forgo, or rather defer, some of their personal gain in the long-term interests of the company—there must be a pact between the CEO and the Board. In the language of game theory, a Board should incorporate the “shadow of the future” in a CEO’s compensation scheme to ensure that CEOs act in the best long-term interests of the company.
A Call to Action for CEOs—What You Should Do Next
A two-heart company presents you with a set of complex challenges—each of which, on their own, would be difficult to deal with but which, together, could overwhelm an unprepared business leader. What are these challenges and what action steps should you take to overcome them?
Strategy. The first challenge is strategy. How do you combine the traditional hardware-oriented business model and the newer software-oriented business model? Companies are experimenting with a variety of different approaches—and the jury is out as to which works best.
VW’s struggle to answer the critical question illustrates just how hard it is. Initially, it tried building an in-house software capability—but plainly this hasn’t worked. Now, it is trying out a joint-venture partnership with two software-oriented newcomers: Rivian and Xpeng. This is an approach that some traditional or “legacy” Chinese automakers are also taking (to compete with local rivals that were “born” with two hearts, such as BYD, the world’s largest producer of EVs). For instance, Seres, which was founded in the mid-1980s as (among other things) a car parts manufacturer, has teamed up with Huawei.
Meanwhile, VW’s US rival General Motors has pushed forward with plans to build an in-house software capability, ignoring VW’s painful experience of doing this. Originally, it relied on Apple’s “CarPlay” technology. Now, it has disconnected from Apple’s technology and announced plans to, as The Wall Street Journal reported, launch “new GM-specific software [that] will offer a more personalized experience for its drivers.” Its new interface will, however, continue to rely on foundational technology provided by Google.
This is an approach taken by Ford. It has started to leverage Google’s technology to enhance its product offerings, improve its operational efficiencies, and ultimately provide a better experience for its customers. Indeed, Ford’s partnership with Google is extensive. As Ford’s preferred cloud provider, Google offers expertise in data, artificial intelligence, and machine learning. It has also joined a dedicated collaboration team, known as “Team Upshift,” tasked with creating personalized experiences—including the “connected vehicle” experience allowing drivers to access a variety of Google apps and services. Beyond this, Ford is looking to Google’s data analytics expertise to help improve decision-making and operational efficiency, modernize its manufacturing and supply chain processes, and push the boundaries of self-driving technologies.
And, as we’ve explained, Xiaomi has opted to build its own separate auto unit with hardware and software capabilities. Already a digital software specialist, it initially partnered with a conventional automaker, BAIC Motor, to get a second, analog manufacturing heart. But since July 2024, when it received an independent car-making qualification from the Chinese government, it has been operating with its own two hearts.
It remains to be seen if any of these strategies is successful, and if other ways of solving the strategic problems associated with competing in a bifurcated world will be found. But you should consider starting with one of them.
Talent Management. A second challenge is talent management. How do you recruit for each capability? Today, the workforce in countries such as Germany and the United States spans an unprecedented five generations. To what extent do you need to manage this multigenerational workforce, with younger Gen Z employees (those born between 2000 and 2020) more likely to supply the company with software engineers? As a first step, we recommend that you recruit and retain people for your analog and your digital businesses who have plenty of tech expertise and experience, a deep understanding of changing customer needs and behavior, and the skills to work in different countries. Also, they should be stationed close to customers and empowered to customize products and services in a way that meets the needs of customers wherever they are in the world.
Capital Allocation. The third challenge is capital allocation. How do you decide how much investment each capability gets—and when? In our view, you should be prepared to make bold and very deliberate shifts in capital allocation: in effect, multiyear funding commitments that, by implication, mean taking operating and project capital away from some existing businesses. As a first step, we recommend that you assemble a portfolio of bets and then, as these develop, double down on the emerging winners. This is an approach favored by some of the big pharmaceutical companies. In 2023, they spent more than $300 billion on R&D—up from $137 billion in 2012—as they raced to develop innovative medicines before the patents on their existing drugs expired. A significant proportion of this expenditure was directed toward clinical and contract research companies. A big factor in Pfizer’s success during the global pandemic was its partnership with an external business—BioNTech, a little-known biotech business before its pioneering work on the first COVID-19 vaccine.
Data Utilization. The fourth challenge is data utilization. How do you collect, interpret, and ultimately tap the hidden value of all the new data to create new forms of revenue? Your customer and other data really does have the potential to transform the fortunes of your company, although we find that business leaders so often fail to understand this. But many of those leaders that do understand this have a rule of thumb: the value of the data collected from the consumer’s use of a physical product is worth half the value of the physical product itself. This may seem like an overestimate, but it has even been suggested that for some companies, customer data may be worth more than the company itself. During the COVID-19 pandemic, United Airlines secured a multibillion-dollar loan by collateralizing its customer loyalty program, indicating that the data was worth more than twice the market value of the company. If you, too, are to extract value from your data, we recommend that you ensure your business has a well-attuned data analytics capability that can help you not only enhance a particular product but also identify new product opportunities, new markets, new ways to attract and retain customers, and new ways to reduce waste.
Leadership. A fifth, and all-encompassing, challenge is leadership. How do you lead a company with two hearts? It is not easy. It requires truly visionary leadership. For the time being, you cannot simply shut down your analog business because it will likely remain—in Bruce Henderson’s words—your company’s cash cow for the foreseeable future. At the Financial Times, for example, full-page and half-page advertising in the print newspaper continue to supply a significant source of revenue, even though the bulk of readers have migrated to the digital edition. This means that the experience curve will continue to be a critical metric for assessing corporate performance, driving your company to produce more products that are better and cheaper for customers.
But there is no question that your company’s future success rests on its digital capabilities, and as a first step, you should pay attention to the imagination curve that is a vital metric in a bifurcated world. How well does your company deploy imagination to convert ever increasing amounts of data into products and services of astonishing value? Tesla and SpaceX’s success lies in their ability to imagine a different future. Likewise, for Amazon, its continued success rests as much as anything on the design of its “next best purchase” algorithm. This cross-selling tool, which allows Amazon to make product recommendations to customers with a friendly “people who bought this book also bought…”, reportedly accounts for $48 billion of Amazon’s retail sales.
One way to deploy the imagination in a practical way is to reimagine the idea of “value”: What is it? What does it mean in your business? Beyond this, you should be seeking to foster a corporate culture that embraces change—and the idea of change. You can do this by encouraging cross-functional collaboration: breaking down silos between different business units through the creation of shared focus areas; and implementing targeted improvements in specific business domains such as supply chain management or customer service. Also, you can promote the development of agility and adaptability by investing in continuing learning training programs to upskill employees and by establishing systems for capturing real-time feedback that can be used to refine products and processes.
The Pathway to Convergence: Making the Hearts Beat Together
There can be no doubt that all kinds of companies will be seeking ways to bring together their differing hardware-software, analog-digital capabilities. Ultimately, this may lead to some kind of convergence. The Financial Times has brought its print and digital businesses together, as have some other media companies. Similarly, Apple, which started out as a hardware computer business before becoming a company that outsources manufacturing and creates value through software engineering and smart design, has found a way to operate with two hearts.
Amazon’s pathway to convergence has been in the opposite direction: it began as an online bookshop, later becoming “the everything store.” At the same time, it moved into the analog world, creating massive warehouses from which to distribute the products on its online shelves; buying Whole Foods, with its physical high street presence; and establishing vast cloud data centers filled with banks of giant computers.
It remains to be seen if companies with a software technology heritage, or those with an industrial manufacturing heritage, will make the strategic leap to succeed in a two-heart world.
It won’t be easy.
For a start, the companies now embarking on their transformation are the hardest to change. That’s because they have managed to survive and thrive without having to change, even though the digitization process began decades ago. Now, however, they can no longer resist. As VW is finding, the commercial pressure to change is just too great. Their leaders will need to make tough decisions about stranding big and still-valuable assets and about partnering with companies that think and operate in a very different way. Moreover, the process of transformation is necessarily experimental, and it will almost certainly be messy. There will be mistakes, setbacks, unexpected events—all of which will require leaders to make course corrections (even if the destination remains clear).
Many companies will be busy operating with two hearts in the coming years. It remains to be seen how long they will have to continue doing so—or whether, at some point in the future, they will reach a stage when the hardware-software, analog-digital capabilities are perfectly entwined: in effect, two hearts beating as one.
