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Disruptive Innovation

The theory of disruptive innovation was first coined by Harvard professor Clayton M. Christensen in his research on the disk-drive industry and later popularized by his book The Innovator’s Dilemma, published in 1997. The theory explains the phenomenon by which an innovation transforms an existing market or sector by introducing simplicity, convenience, accessibility, and affordability where complication and high cost are the status quo. Initially, a disruptive innovation is formed in a niche market that may appear unattractive or inconsequential to industry incumbents, but eventually the new product or idea completely redefines the industry.[1]


What makes a technology or innovation “disruptive” is a point of contention, and the term may be used to describe technologies that are not truly disruptive. The Internet was disruptive because it was not an iteration of a previous technology, while the Model T car is not considered disruptive because it was an improvement on an existing technology. Investing in a disruptive innovation can be complicated. It requires an investor to focus on how companies will adopt to a new disruptive technology, instead of focusing on the development of the technology itself. Companies such as Amazon, Google, and Facebook are examples of companies that have heavily focused on the Internet as a disruptive technology, which has become so ingrained in the modern world that the companies that have failed to integrate the disruptive innovation into their business models have been pushed aside.[2]


Four Key Elements of the Theory of Disruptive Innovation[3]

  • Incumbents are improving along a trajectory of innovation. ...
  • The pace of sustaining innovation overshoots customer needs. ...
  • Incumbents have the capability to respond but fail to exploit it. ...
  • Incumbents flounder as a result of the disruption.


Disruptive Innovation
source: MITSloan


The Disruptive Innovation Theory[4]
Christensen argues that disruptive innovations can hurt successful, well-managed companies that are responsive to their customers and have excellent research and development. These companies tend to ignore the markets most susceptible to disruptive innovations, because the markets have very tight profit margins and are too small to provide a good growth rate to an established (sizable) firm. Thus, disruptive technology provides an example of an instance when the common business-world advice to "focus on the customer" (or "stay close to the customer", or "listen to the customer") can be strategically counterproductive. While Christensen argued that disruptive innovations can hurt successful, well-managed companies, O'Ryan countered that "constructive" integration of existing, new, and forward-thinking innovation could improve the economic benefits of these same well-managed companies, once decision-making management understood the systemic benefits as a whole. Christensen distinguishes between "low-end disruption", which targets customers who do not need the full performance valued by customers at the high end of the market, and "new-market disruption", which targets customers who have needs that were previously unserved by existing incumbents.
"Low-end disruption" occurs when the rate at which products improve exceeds the rate at which customers can adopt the new performance. Therefore, at some point the performance of the product overshoots the needs of certain customer segments. At this point, a disruptive technology may enter the market and provide a product that has lower performance than the incumbent but that exceeds the requirements of certain segments, thereby gaining a foothold in the market. In low-end disruption, the disruptor is focused initially on serving the least profitable customer, who is happy with a good enough product. This type of customer is not willing to pay premium for enhancements in product functionality. Once the disruptor has gained a foothold in this customer segment, it seeks to improve its profit margin. To get higher profit margins, the disruptor needs to enter the segment where the customer is willing to pay a little more for higher quality. To ensure this quality in its product, the disruptor needs to innovate. The incumbent will not do much to retain its share in a not-so-profitable segment, and will move up-market and focus on its more attractive customers. After a number of such encounters, the incumbent is squeezed into smaller markets than it was previously serving. And then, finally, the disruptive technology meets the demands of the most profitable segment and drives the established company out of the market.
"New market disruption" occurs when a product fits a new or emerging market segment that is not being served by existing incumbents in the industry. The extrapolation of the theory to all aspects of life has been challenged, as has the methodology of relying on selected case studies as the principal form of evidence. Jill Lepore points out that some companies identified by the theory as victims of disruption a decade or more ago, rather than being defunct, remain dominant in their industries today (including Seagate Technology, U.S. Steel, and Bucyrus). Lepore questions whether the theory has been oversold and misapplied, as if it were able to explain everything in every sphere of life, including not just business but education and public institutions.


Examples of Disruptive Innovation[5]
Examples of Disruptive Innovation
source: ClaytonChristensen.com


Is Uber a Disruptive Innovation?[6]
Let’s consider Uber, the much-feted transportation company whose mobile application connects consumers who need rides with drivers who are willing to provide them. Founded in 2009, the company has enjoyed fantastic growth (it operates in hundreds of cities in 60 countries and is still expanding). It has reported tremendous financial success (the most recent funding round implies an enterprise value in the vicinity of $50 billion). And it has spawned a slew of imitators (other start-ups are trying to emulate its “market-making” business model). Uber is clearly transforming the taxi business in the United States. But is it disrupting the taxi business?

According to the theory, the answer is no. Uber’s financial and strategic achievements do not qualify the company as genuinely disruptive—although the company is almost always described that way. Here are two reasons why the label doesn’t fit:

  • Disruptive innovations originate in low-end or new-market footholds: Disruptive innovations are made possible because they get started in two types of markets that incumbents overlook. Low-end footholds exist because incumbents typically try to provide their most profitable and demanding customers with ever-improving products and services, and they pay less attention to less-demanding customers. In fact, incumbents’ offerings often overshoot the performance requirements of the latter. This opens the door to a disrupter focused (at first) on providing those low-end customers with a “good enough” product. In the case of new-market footholds, disrupters create a market where none existed. Put simply, they find a way to turn nonconsumers into consumers. For example, in the early days of photocopying technology, Xerox targeted large corporations and charged high prices in order to provide the performance that those customers required. School librarians, bowling-league operators, and other small customers, priced out of the market, made do with carbon paper or mimeograph machines. Then in the late 1970s, new challengers introduced personal copiers, offering an affordable solution to individuals and small organizations—and a new market was created. From this relatively modest beginning, personal photocopier makers gradually built a major position in the mainstream photocopier market that Xerox valued. A disruptive innovation, by definition, starts from one of those two footholds. But Uber did not originate in either one. It is difficult to claim that the company found a low-end opportunity: That would have meant taxi service providers had overshot the needs of a material number of customers by making cabs too plentiful, too easy to use, and too clean. Neither did Uber primarily target nonconsumers—people who found the existing alternatives so expensive or inconvenient that they took public transit or drove themselves instead: Uber was launched in San Francisco (a well-served taxi market), and Uber’s customers were generally people already in the habit of hiring rides. Uber has quite arguably been increasing total demand—that’s what happens when you develop a better, less-expensive solution to a widespread customer need. But disrupters start by appealing to low-end or unserved consumers and then migrate to the mainstream market. Uber has gone in exactly the opposite direction: building a position in the mainstream market first and subsequently appealing to historically overlooked segments.
  • Disruptive innovations don’t catch on with mainstream customers until quality catches up to their standards: Disruption theory differentiates disruptive innovations from what are called “sustaining innovations.” The latter make good products better in the eyes of an incumbent’s existing customers: the fifth blade in a razor, the clearer TV picture, better mobile phone reception. These improvements can be incremental advances or major breakthroughs, but they all enable firms to sell more products to their most profitable customers. Disruptive innovations, on the other hand, are initially considered inferior by most of an incumbent’s customers. Typically, customers are not willing to switch to the new offering merely because it is less expensive. Instead, they wait until its quality rises enough to satisfy them. Once that’s happened, they adopt the new product and happily accept its lower price. (This is how disruption drives prices down in a market.)Most of the elements of Uber’s strategy seem to be sustaining innovations. Uber’s service has rarely been described as inferior to existing taxis; in fact, many would say it is better. Booking a ride requires just a few taps on a smartphone; payment is cashless and convenient; and passengers can rate their rides afterward, which helps ensure high standards. Furthermore, Uber delivers service reliably and punctually, and its pricing is usually competitive with (or lower than) that of established taxi services. And as is typical when incumbents face threats from sustaining innovations, many of the taxi companies are motivated to respond. They are deploying competitive technologies, such as hailing apps, and contesting the legality of some of Uber’s services.


How can companies survive disruption?[7]
Google is developing self-driving cars, Amazon is experimenting with drones to deliver shopping, and there’s a chance that in future we could 3D print medication in our own homes. With these potentially disruptive innovations on the horizon, how should existing companies respond? While the mantra “disrupt or be disrupted” may strike fear into the heart of many a large firm, true disruptive innovation is surprisingly rare. Companies need to react to disruption, but they should not overreact, say Christensen, Raynor and McDonald, for example, by dismantling a still-profitable business. The answer is instead to bolster relationships with key customers by investing in "sustaining innovations". In addition, companies can create a new division tasked with going after the growth opportunities resulting from disruption. “Our research suggests that the success of this new enterprise depends in large part on keeping it separate from the core business. That means that for some time, incumbents will find themselves managing two very different operations,” they write. “Of course, as the disruptive stand-alone business grows, it may eventually steal customers from the core. But corporate leaders should not try to solve this problem before it is a problem.”


References

  1. Definition- Disruptive Innovation ChristensenInstitute.Org
  2. Breaking Down Disruptive Innovation Investopedia
  3. How Useful Is the Theory of Disruptive Innovation? MIT Sloan
  4. Disruption Innovation - Theory on Wikipedia
  5. Some Examples of Disruptive Innovation ClaytonChristensen.com
  6. What is Disruptive Innovation?HBR
  7. Disruptive Innovation - How Can Companies Survive Disruption? World Economic Forum


External References

  • The Five Most Disruptive Innovations At CES 2015 Forbes
  • Clayton M. Christensen’s theory of disruptive innovation. But how well does the theory describe what actually happens in business?MITSloan
  • Why Uber isn’t Disruptive but Netflix Is Fortune
  • Clayton Christensen On What He Got Wrong About Disruptive Innovation Forbes