The phrase "digital transformation" has been casually tossed around the business world for a few years but has recently become quite the buzz term. Its use is on the rise, and some TV ads have started to feature it, so chances are even the most casual followers of business and investing have heard of it at this point.

Though the phrase has been cheapened, digital transformation is an important movement that investors need to understand. Various researchers expect spending on digital tools to grow at near a 20%-a-year rate for the foreseeable future. Going about it the right way can in fact mean transformative results, but the wrong way leads to just the opposite.

A man in a suit holding a tablet. A picture of a brain made of electrical connections hovers above it, illustrating artificial intelligence.

Image source: Getty Images.

Wait, digital what?

When executive teams talk about digital transformation at their companies, they fall into three basic camps: those enabling digital transformation (like salesforce.com (NYSE:CRM) and co-CEO Marc Benioff, who I remember as the first person using the term); those trying to use digital transformation to disrupt an industry; and those trying to adapt to the digital age we now live in.

But what is it exactly? In a recent conversation, Dan Neiweem, co-founder and principal at digital strategy consultant Avionos, defined digital transformation as a business thinking about what kind of outcomes it wants to create through the use of technology. "It's not just about changing the business, but how we do business," he explained.

Digital transformation gone wrong

Tech has become an inseparable part of our lives, and more organizations around the globe are feeling the pressure to change with the times. New technology start-ups have been popping up like weeds, and as Neiweem pointed out, many incumbent companies have been pressured into becoming "tech companies" themselves.

Tech can be a powerful driver of growth, but it isn't the end-all and be-all in the conversation. There have been some real horror stories in the last few years. Neiweem pointed out the WeWork tragedy in 2019, in which the company marketed itself as a totally new way of managing real estate rather than as a landlord intermediary optimized with tech. General Electric (NYSE:GE), Ford (NYSE:F), and Procter & Gamble (NYSE:PG) are other examples of companies that threw money at tech but to little avail. I also thought of various food delivery and meal kit businesses like Grubhub (NYSE:GRUB) and Blue Apron (NYSE:APRN) that advertised brand new ways of doing things rather than more properly framing themselves as a fresh take on an old model. After all, my dad has been sending me gifts of food through the mail for years through companies like Omaha Steaks.

The good news is that every failure for firms that embark on digital transformation means they are one step closer to success. But where did they go wrong? Neiweem says of companies that have had success:

Digital transformation isn't about spending money [on tech], it's about spending money right. And so when you're looking at that, you go in you say, How can I improve my sales team's effectiveness by implementing a digital solution like Salesforce CRM to do sales and service enablement? How do I do e-commerce to be able to take mundane reordering off [customers'] plate? [How do I help my business] focus on giving the right information to the customer and being a partner that makes recommendations and focuses on keeping the customer here? The technology is an enabler, it isn't what drives true return on investment.

Ignore the buzz and look for details

All sorts of investment gems arise from making this switch in thinking, such as "tech as an enabler of investment returns rather than the reason for investment returns." As conversation around digital transformation heats up, investors will need to improve their game when it comes to due diligence.

That's because some real success stories have emerged. The world of retail is an example, with Walmart (NYSE:WMT), Target (NYSE:TGT), Best Buy (NYSE:BBY), and Home Depot (NYSE:HD) effectively using tech to stave off the likes of Amazon (NASDAQ:AMZN) and return to growth. Domino's Pizza (NYSE:DPZ) also drove massive shareholder returns in the last decade by getting ahead of the curve on digital ordering and food delivery capabilities. The promise of similar success can be intoxicating.

As I have discussed with Avionos in the past, though, Neiweem sees all the retailer transformation of the last 10 years beginning to shift to the much larger business-to-business (B2B) world. As previously mentioned, Salesforce talks a lot about capitalizing on this opportunity, but not to be forgotten are the industrialists themselves beginning to implement changes. Neiweem pointed to water heater manufacturer A.O. Smith (NYSE:AOS) and Frymaster commercial kitchen equipment maker Welbilt (NYSE:WBT) as having some early success as they have found ways to create value-added services for customers.

As for investing tips, Neiweem says to do some digging and look for a company's detailed plan on digital transformation. Do they outline specifics on how they're doing it and how it will make business more efficient? Or is it more of the "here's my shiny new toy" talk? Remember, tech works best when properly applied to a problem with measurable results.

This exercise can be applied to fast-growing tech and software companies as well. Many start-ups are dumping lots of cash into expanding their sales teams, sometimes so much so that operating expenses have begun to grow at a faster rate than actual revenue for an extended period of time. There must be a plan to dial back this kind of behavior if the results aren't there and to put more focus on what drove booming growth in the first place -- like developing new solutions that bring customers to the table. (More on that in a later article.)

So investors beware as the digital transformation wave picks up momentum. Digital updates to legacy operations can mean big returns, but growth isn't a given. Well-developed plans and processes for implementation are essential, and investors should focus on those companies that are looking to improve upon existing business methods and results -- not simply applying tech on its own as the sole solution.