Tuesday, May 30, 2006

Disruptive Innovation- I

By: Clayton M. Christensen

1. When you are wildly successful you are doomed.

2. Companies often fail because of the very management practices that have allowed them to become industry leaders. Because these practices make it extremely difficult for them to develop the disruptive technologies that ultimately steal away their markets. (Technology means the processes by which an organization transforms labor, capital, materials, and information into products and services of greater value. This concept of technology therefore extends beyond engineering and manufacturing to encompass a range of marketing, investment, and managerial processes. Innovation refers to a change in one of these technologies).

3. Well-managed companies are excellent at developing the sustaining technologies that improve the performance of their products in the ways that matter to their customers. This is because their management practices are biased toward : Listening to customers, Investing aggressively in technologies that give those customers what they say they want, Seeking higher margins, Targetting larger markets rather than smaller ones.

4. Disruptive technologies, however, are distinctly different from sustaining technologies. Disruptive technologies change the value proposition in a market. When they first appear, they almost always offer lower performance in terms of the attributes that mainstream customers care about. But disruptive technologies have other attributes that a few fringe (generally new) customers value. They are typically cheaper, smaller, simpler, and frequently more convenient to use. Therefore they open up new markets. Further because with experience and sufficient investment, the developers of disruptive technologies will always improve their products’ performance, they are eventually able to take over the older markets. This is because they are able to deliver sufficient performance on the old attributes, and they add some new ones.

5. Good theories are statements of what causes what and why. Most managers are not aware of good theories. Their analysis is based on data. And data refers to the past. And therefore to guide their actions in the future, with or without data, they have to rely on randomness. Because they do not have recourse to a good theory. This is the case with innovation.

6. Flight became possible only after people came to understand the relevant natural laws and principles that defined how the world worked : the law of gravity, Bernoulli’s principle, and the concepts of lift, drag, and resistance. When people then designed flying systems that recognized or harnessed the power of these laws and principles, rather than fighting them, they were able to fly to heights and distances that were previously unimaginable.

7. Another aspect of ‘Innovation’ is that it changes according to the various needs of constituencies. Just like a piece of legislation being passed through Parliament. The innovation may be different from the original idea because it has been shaped and morphed in order to mirror the economic model of the company.

8. There are 10 questions which we need to get right for creating new businesses.

  • How can we beat the competition ? (Business Model)
  • Which customers should we target ? (Resource)
  • What products will our customers want to buy ? (Resource)
  • How should we distribute to and communicate with our customers ? (Process)
  • Which things should our company do, and which should our partners and suppliers do ? (Process)
  • How can we avoid commoditization ? (Business Model)
  • Who should be on our management team ? (Resource)
  • What is the best organizational structure for this business ? (Process)
  • How can we know when to change course ? (Business Model)
  • Whose investment capital will help, and whose will hurt ? (Resource)

9. The Disruptive Innovation Theory states that there are 2 trajectories. One trajectory represents the pace of technological progress or how products and services are getting better over time. The other trajectory relates to how much of improvement can the customer utilize or absorb.

10. In the initial phase any new product or service is not good enough for anything but gradually as it improves it gets too good for everything. Intel when it introduced its first chip it was not found good enough but through gradual improvement it became too good at everything.

11. In stable business incumbent companies nearly always win because they play catch-up with the progress of technology and use it to increase their profits.

12. Innovations that disrupt usually emerge at the low cost end of the business. In the 70s and 80s Digital was the most admired company having gone from zero to $16 ban. In 16 years. However, in 1988 it collapsed and with it every mini-computer company collapsed. Why? The mini-computer companies were making around a 45% margin and with innovations in mini-computers they were predicting a 60 % margin. So DEC had to adopt a set of values that essentially dictated, “If it generates 50 per cent gross margins or more, it’s good business. If it generates less than 40 per cent margins, it’s not worth doing.” At the same time one found that the PC, which was a disruptive technology, was earning a margin of 40%, which would move down towards 20%. Digital entered the PC market 4 times and each time found that it could not achieve the profitability it had in the mini-computer business. Good companies find it easy to move up but difficult to move down.

13. When one looks at the Steel industry one finds that Integrated Steel Mills dominated all segments of the market. The lowest segment of this market was the steel used for concrete reinforcement, which was termed as the ‘Rebar’ segment. When the Mini-steel Mill entered this segment, the ‘Rebar’ steel, which they made was much below quality but as they improved they had the cost advantage that the large integrated steel plants could not match. The Integrated Steel Mills gave up this segment to the Mini-Steel plants and concentrated on the higher quality and more profitable segments of ‘Angle iron’ steel. The same story was repeated by the Mini-Steel Mills also moving up the chain, at first creating a below quality product and then improving and getting the large Integrated Steel Mills to relinquish this segment and concentrate on the next more profitable segment which was ‘Structural Steel’. Again the same story was repeated and the Integrated Steel Mills relinquished the ‘Structural Steel’ segment to the Mini-Steel Mills and concentrated on the most profitable segment, which was ‘Sheet Steel’. The same story was played out and ultimately all but one Integrated Steel Mill closed down.

14. The lesson from this is that one needs to define the fight in such a way that the existing giant wants to run away from you rather than fight you. Disrupt them by taking a piece of the market they are motivated to run away from. Enter from the low cost end of the market and target non-customers.

15. One sees the same game played out in the automobile industry. GM and Ford never entered the small low cost car market. It didn’t make sense to enter. Just like it didn’t make sense for the Integrated Steel Mills to remain in the low end of the market. Toyota came in and disrupted them and moved up the value chain. Today Toyota has a Lexus at the premium end.


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