Ashridge

Virtual Learning Resource Centre

The innovator’s dilemma

Bookcover

by Clayton M.Christensen, Harper Collins, 2003.

Abstract

This book contrasts the companies which concentrate on current profitable customers and those which are early movers into the very technologies and markets which will disrupt the current approaches. The former are concerned to sustain their profitable markets and often over-provide their customers, who may then proceed downmarket to the new providers, who from small beginnings are disrupting the traditional markets and offering what customers discover they really want. Many companies try to keep the sustaining and disruptive activities under the same umbrella, and get the worst of both worlds. Many companies have disappeared through failing to understand these dynamics. The very fact that they were often well managed led to their downfall. They listened to today’s customers instead of being ready for changed needs.

(Summarised by Edgar Wille in June 2006)

(These book summaries aim to represent some of the key aspects of what the author has written. They do not necessarily represent the views of the summariser or of Ashridge. Equally the author of the book summarised must not be held responsible for any misperceptions of the summariser. A summary does not have space for all the illustrative cases which provide the richness of a book and there is no substitute for reading the whole book. There is an element of simplification in a summary so that the message may seem more obvious than it necessarily is, though the most powerful ideas are often simple and obvious in their essence.)

Why good companies fail

This book arrests attention right from the start by the assertion that many of the best companies were sowing the seeds of ultimate failure when they were managing at their best in terms of all the normal criteria of good management. They were listening to their customers, developing growth strategies and competitive policies; their human resource policies were getting on board the best staff, they were investing in new technologies and yet they lost market dominance in the end.

The seeds of decline were being sown at the very time when their reputation was at its highest level. While they were doing all the right things to please their current customers and increasing revenues from them by improvements, yet they were working on essentially the same strategic pattern. They were in a sustaining mode; keeping the existing engine for growth running smoothly.

With this mindset, emerging new technologies which did not just improve the present offerings, but were so radical that they would destroy the present pattern, did not attract a sense of priority, or awareness that these might be the way ahead. To engage with them would take the companies’ eyes off the job in hand, which was making good and continuous profit; with high revenues from satisfied current customers. After all, these upstart technologies were in their beginning phase, which they might not get beyond. There was no knowledge of a market for them. Resources invested in them might well be wasted and divert energy. Yes! they were keeping close to customers, but to customers who showed no interest in these new ideas and technologies – customers who did not know what they might need soon.

The providing companies were making the mistake of confusing what was appropriate for sustaining policies in established markets with the requirements of developing markets for emerging technologies which could make obsolete and destroy the current line of successful offerings. So, little groups of entrepreneurs concentrated on these uncertain products with unknown markets, nurtured them, learnt how to use them and how to create a demand for them. The ones that survived, suddenly arrived on the business scene and in many cases swept all before them, leading to the decline and even demise of once prosperous companies.

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How disruptive technologies succeeded

The exceptions to such a fate were the companies who perceived the difference between sustaining and destructive technologies and the different treatment they required. These companies would spin off a small group of enthusiasts who would work on the destructive technology, unhampered by demands to keep the present bonanza going by maintenance, improvements and corrections. They could move in a different direction; they could absorb disappointments and failures on the way, as they discovered and learned what could work; they could get excited by small victories. No one was pulling them off what they were working on to stitch up problems in the mainstream.

When they had reached a stage where the technology had proved itself, they could begin to interest companies who might welcome the relative simplicity and even down market nature of the technology, because they had begun to realise that the mainstream was now offering them facilities which were beyond their needs. Once the technology took off, the writing was on the wall for the earlier technologies and the new technologies could move up market and take over the mainstream. When they did, they were then in danger of repeating the mistakes of their predecessors. They might still concentrate on what had now become conventional and normal. They would move into the sustaining mode of working and apply sustaining mode principles to destructive mode situations, instead of keeping them separate to allow small teams, as they had originally been, to incubate what would become the next generation, unencumbered by the baggage of today’s issues.

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Examples from the disk drive industry

Clayton Christensen illustrates this by looking at industries such as those for disk drives, earth moving, fast moving consumer goods, and steel. He also considered the potential evolution of the electric powered automobile. For a reader some years after the writing of the book these may seem out of date, but in fact they are excellent illustrations of principles which ring true at any time. Later ones can be added out of the literature or out of the reader’s own reflective experience.

First he surveys the disk drive industry from 1976 to 1996. He goes through the various companies whose manufactures ranged from 14 inch disk drives down to 1.8 inch disk drives. He shows how the 14 inch drive was developed to meet the needs of large mainframe computers. Eventually they were capable of doing more than the market needed, but meanwhile 8 inch drives became the disruptive technology and was suitable for the minicomputer. It too soon exceeded the needs of the market. Meanwhile the 5.25 inch drive came in to meet demand in the desktop PC market, followed by the 3.5 drive for portable computers and the 2.5 drive for notebooks. The disk drive companies in each case exceeded the requirement of their existing markets and most of them failed to wake up to the fact that computer developments were racing ahead and changing the size of the market for more relevant disk drives.

Christensen tells the story in fascinating detail which does not lend itself to summarisation, but which bears out the principles outlined above and developed further in the last part of this summary. He mentions the companies by name and shows how some of them went right out of business and others had to struggle to make up lost ground. They remained in the sustaining arena when they should have been taking more seriously and treating more urgently the disrupting technologies that were being worked on in initially small markets.

Moreover they applied methods of development to new situations which were appropriate in their initial offering. Priam is mentioned as still working on the two year cycle honed in the minicomputer market, instead of the one year cycle required in the desktop computer world. Started in the 1970’s, it died early in the nineties.

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The computer industry

The same was happening in computers themselves; even the mighty IBM faltered through its slowness in seeing the significance of smaller high capacity personal computers. One hears little of many of the companies who missed the boat. They were concentrating on the market they had, rather than investing in the one they might soon acquire if they did not remain absorbed in their present value network. The approaches that made DEC so successful in the world of minicomputers – their values – their commercial expectations (eg on margins) – their organisation – their design processes, none of these were appropriate for the personal computer. (As Secretary of the Nationalised Industries Computer Committee during the 1970’s, I had dealings with many companies in the computer world of whom one hears little or nothing nowadays, even if they are still around.)

By technology the author means not only the actual physical items, but the ways of marketing them, distributing them and the cost containment and pricing policy involved. Dell is mentioned as developing a new distribution technology. He makes clear that most of the companies were, in conventional terms, well managed, but were staying in the familiar fields of current customers and their expressed needs, and thus they failed to achieve what might have been possible.

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The earth moving industry

Another fascinating story is told of disruptive technological change in the mechanical excavator industry. Cable actuated mechanical steam powered shovels were for years the only technology. Then came gasoline powering which changed the powering from steam, but left the basic processes much as they were (a sustaining improvement). After World War Two, hydraulically actuated systems replaced cable. By the 1950s only four of the 30 established manufacturers of cable actuated equipment were left. This minority had transformed themselves into providers of hydraulic systems.

Then some companies saw opportunities in equipment which was good at digging small trenches for residential building; the transition involved everything they did in marketing, customer relations and distribution as well as in the actual job. This smaller application was of no interest to the big earth moving companies and so a redirection happened throughout the earth moving industry, in which all the mistakes of thinking "sustaining technology" instead of being ready for "disruptive technology" occurred and put some of the companies out of business. Other companies developed attachments to existing tractors for some applications. Different value networks were established and the face of earthmoving was transformed. The prizes went to those who recognised when to work on disruptive technologies, after which nothing would ever be the same, even if they made the grade, in which case prosperity beckoned, at least for a time.

The examples given illustrate the fact that, consistently, established firms attempted to push the new technology into their established markets, while the successful entrants found a new market that valued the new technology, as the residential and small factory builders did in the case of the narrow trench earth mover. The failure of most of the cable actuated earth movers is an outstanding example of failure to see beyond present customers and markets. They should have embedded a small subsidiary organisation in the value network where there was a possibility of acceptance of the disruptive technology to meet developing needs, even if initially the market was small.

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The steel industry

The steel industry provides further illustrations of missed opportunities. Minimills came in, which produced cost competitive steel from scrap at less that one tenth of the scale, and a quarter of the labour costs, required for a normal integrated mill to produce cost competitive steel from iron ore in basic oxygen furnaces. Even by 1995 minimills were producing 40% of American steel. Major integrated steel facilities were closing on a large scale, yet by that date not a single one of the world’s major traditional steel companies had built a minimill. Their response was ferocious downsizing of their processes and staff to get their costs down and improve performance in the traditional activity. They operated in sustaining mode, to try to maintain their traditional current market.

Of course there was a rationale for this attitude. The minimills initially produced steel of marginal quality. It was fine for products such as steel reinforcing bars, right at the bottom of the market in terms of quality, cost and margins. But these companies at the bottom of the steel pyramid had low operating costs, low managerial overhead, little depreciation, low research and development costs, low selling costs (most of this was by phone). The minimill people found markets which were being provided by the traditionalists with products beyond their needs. Cars, cans and appliances needed consistent sheet steel with defect free surfaces and the integrated mills continued to do well out of these. Meanwhile the minimills moved upward into other higher quality products as they refined their processes to get better surfaces, for example for structural beams.

Then in Germany the thin-slab casting method was developed, which could cast steel from its molten state into long, thin slabs that could be transported directly, without cooling, into a rolling mill. This was a much simpler process than the traditional. The integrated mills looked at it, discussed it, but concentrated on their normal processes and markets, which were prospering wonderfully. So why bother?

Minimills did. Nucor was the first, and they took over all the parts of market where final smoothness was not required, in most of the activities where the steel was not on display, hidden in culverts, pipe lines and site huts where slight blemishes did not matter. The story was not complete when Christensen was writing, but even by 1995 Nucor had 7% of the American steel industry and were already achieving an ever larger reduction in surface blemishes, enabling them to challenge the traditional firms still further, from an initial base which had been considered merely a commoditised one.

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Other stories

Other stories include the success of Hewlett Packard with their downmarket ink jet printers, which were quite adequate for millions of users, especially individual computer owners in the home or in very small businesses. It was one of many examples of the old motto not being true every time: "If a thing’s worth doing it’s worth doing well". "Well" has been interpreted as perfection. This summariser draws from the discussion, in the light of so many examples, that the slogan could be replaced with: "A thing is worth doing as well as it’s worth doing".

Johnson and Johnson is cited as an example of a company which leaves development of disruptive technology to small autonomous operating companies acquired for the purpose. Many of their 160 companies fall into this bracket. Allen Bradley in the electro-mechanical motor control business set up a separate plant, far from the main plant, to focus on electronic motor controls. This separation enables the growth of a viable and promising business.

The idea, propounded by Jack Welch that you should get out of a business where you are not first or second does not necessarily apply to sustaining businesses. The unrelenting search to be first may lead to the overprovision in performance to existing customers. This, in turn, may predispose some customers to prefer something less ambitious and turn to the disrupters.

The story is also told of how the major retail chains in America did not see the threat posed by the emerging discounters in time and suffered by assuming that their higher quality provision was what was needed. Often they fell between two stools, trying to do both in the same sustaining organisation.

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Separate running of disruptive start ups

From these examples it is evident that destructive technologies, with their emerging, but initially unknown markets, require different capabilities, cultures and practices from sustaining markets. As we have seen, established firms successfully planted themselves in a market for the disruptive technologies only where they had spun off from the mainstream small, independent, autonomously run organisations. Such were dedicated to being embedded in the new emerging value network as it grew to the commercialisation stage.

They didn’t have to take notice of what the mainstream customers said they wanted, with limited knowledge of what was possible. They didn’t have to worry about contributing to the mainstream current growth. Their focus was on tomorrow, even though it was not yet clear what tomorrow’s market would be like. It wasn’t there to start with, so they couldn’t do the traditional market analyses that are taught on MBA courses. They moved forward in confidence in their technological prowess and their intuition about the value of what they were doing, without being constantly measured by the efficiency criteria of the mainstream; they could absorb small failures on the way as part of the learning process; they would be active in searching for markets, driven by the fact that the money available was not limitless.

Companies who kept this operation in with the mainstream didn’t get the spirit and understanding needed for disruptive innovation; the latter couldn’t coexist with the sustaining philosophy and in the end companies got the worst of both worlds. They would fail to realise that products that seem useless to our customers today may be vital to them tomorrow. Even if they encouraged a group to work on future disruption, they would tend to starve the disruptive innovators of resources or at least informally fail to accord them priority. As mainstreamers, their mindset had been developed in a different value network – a sustaining one. Historically the mainstream will have had its mindset shaped in a different context in relation to size, acceptable margins, customer volumes, product cycles and similar criteria.

Those working on disruptive technologies would know that success came to the first movers and thus would be under self exerted pressure to get there first. On the other hand many companies, even though they were aware of ultimate value in the disruptive technologies, decided to wait until the market demand clarified, only to discover that then it was too late The disruptive innovator will have worked on a different range of customers in a small way, long before the mainstream customers became aware of the same needs. By then the mainstream providers had fallen behind in development time.

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Four principles of disruptive technology

Christensen offers a framework of four principles for disruptive technology to explain why management practices which are the most productive for exploiting existing technologies are anti-productive when developing disruptive technology:

  1. Ultimately companies depend on customers and investors for the resources they need and must therefore provide them with the products, services and profits they expect. The providing companies have therefore developed systems which kill ideas that customers don’t currently want. Such companies won’t invest resources in low margin opportunities which meet no known customer demand.
  2. Small markets being created by the developers of destructive technologies don’t contribute to current shareholder value; they don’t help maintain, let alone increase growth rates in the mainstream. So the mainstream company will focus on large existing markets.
  3. Market analysis to "prove" the viability of what the innovators are working on cannot be carried out, because as yet the markets don’t exist.
  4. The rate of progress in the mainstream technology often exceeds what customers actually want and when these customers realise this and begin to get interested in these developers of technology, which by mainstream standards, underperforms, the mainstream will have missed the boat. The innovators will win customers on the grounds of criteria such as reliability, convenience and price, rather than paying more for something which is in excess of their real needs. The new market will have been established and the former mainstream is not part of it.

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Success factors for disruptive technology

The author presents the characteristics of a disruptive technology as generally being simpler, cheaper and lower performing, promising lower margins, rather than higher profits. Initially, leading companies don’t want them and they are commercialised in emerging or insignificant markets.

In all markets, companies tend to move upmarket toward more complicated products with higher prices. Eventually they may upscale themselves out of business. Emerging markets based on disruptive technology eventually follow the same process and become mainstream. On the way to that, they may discover that what they developed with one market in view, was actually attractive to another. The almost accidental success of the Honda Super Cub motorcycle in America as a sporting item illustrates this.

The disrupters have to start with a different range of customers from those wooed by the mainstream. They have to find customers who value the very attributes considered as shortcomings by others

The author also makes much of the point that power to provide resources to destructive innovators in a mainstream company does not necessarily lie with the top managers. Such innovations can be killed by lack of priority accorded by middle managers and other staff on a day to day basis. Many of these experiences mount up, whereas they are absent in a dedicated small separated company. Career considerations also affect willing exploitation of disruptive technologies. Why should someone risk their career in a vague and unproven technology?

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How the irrational becomes rational

The whole challenge of this book is highlighted at the end in some discussion notes:

"The primary thesis is that the management practices that allow companies to be leaders in mainstream markets are the same practices which cause them to miss the opportunities offered by disruptive technologies. In other words, well managed companies fail because they are well managed. Do you think that the definition of what constitutes "good management" is changing? In the future will listening to customers, investing aggressively in what those customers SAY they want, and carefully analysing markets become "bad management"? What kind of system might combine the best of both worlds?"

It probably goes against the grain to see the future in terms of disruptive innovations which offer products and services that initially are not as good as those that historically have been used by customers in mainstream markets and that, therefore, can take root only in new or less demanding applications among less demanding customers. Examples include such ultimate successes as transistor radios, small cars, personal computers and on-line investing.

Some of the above ideas are expanded in an article in the Fall 2002 MIT Sloan Management Review written by Clayton Christensen with Stuart L Hart entitled The Great Leap: Driving Innovation from the Base of the Pyramid. This is adapted in Stuart Hart’s book Capitalism at the Crossroads, already summarised on VLRC. The theme of Christensen’s book is put in a nutshell:

"Well managed companies are pressured to invest in innovations that target markets, large enough to sustain corporate growth rates and enhance overall profit margins. To them pursuing disruptive innovations seems irrational. This allows disruptive innovators to incubate their businesses in the safety of markets that resource rich competitors are motivated to ignore and then to grow upmarket by attacking a sequence of market tiers that are the least attractive investment options facing the leaders."

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Radical change

The aspect particularly addressed in the additional material referred to above, is that business and industry face a challenge to make faster progress in developing policies and processes which will pursue their strategies in a way which is sustainable, given the limited nature of earth’s resources and problems such as global warming. Most large corporations were created in a period when raw materials and cheap energy seemed limitless, along with "sinks" for waste disposal. They now face a different situation, though many are reluctant to adopt a radical change in their apparently successful ways of doing business. However doing something serious about it is on most agendas and the principle of disruptive technology developed in less sophisticated environments could be the key to a solution.

Continuous or incremental improvement will not suffice; it continues trying to grow through better ways of providing goods and services in existing markets and, as we have seen, it courts failure by not spotting the opportunity in disruptive technologies and markets beginning to develop in an initially small way. Material and energy intensive industries will find the elusive nature of global sustainability compels radical repositioning and the development of new competencies.

This will mean the "clean sheet approach" of looking at situations, without assuming that progress lies along the route of doing what we have been doing so far, only doing it better, providing a wider range of facilities. The escape route lies in applying modern technology in a way that provides those who cannot afford to be consumers in the global economy with simple, downmarket, affordable products, which may seem unattractive by Western standards, but which could transform life in the least developed parts of the world, where two thirds of the world’s population live in dire poverty. New materials, wire-less IT, distributed energy sources, instead of unaffordable grid systems, coupled with microfinance, would open up a new market of four billion people.

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"The great leap downward"

As well as beginning the move from poverty this would provide a vast "laboratory" in which simple, cheaper methods could be honed to the point where more sophisticated customers would begin to be attracted and the traditional products and markets would decline in the face of a business revolution. The MNCs would feel obliged to take note as new products and markets were incubated in areas which were previously thought of as primitive.

All the principles we have seen above would come into play on a worldwide scale as large corporations brought their economic and technological strength to bear upon the opportunities in emerging markets. Growth is increasingly eluding the large Western corporations – an annual average growth rate of 3/4 per cent needs to become more than 10 percent growth in sales and earnings in the near future and the spectre of saturated markets looms.

But the approach which might appear to be going downmarket, which is the constant theme of Christensen’s book, would have found a market in which to grow, even though the modus operandi would be totally new – true innovation. Forcing clean technologies into established markets at the top of the economic pyramid is unlikely to succeed. Forming initially small subsidiaries to learn from the larger indigenous companies who are already at work in this market, as well as from rural and shantytown entrepreneurs, can be the way ahead. Sophisticated and modern technology would be applied to relatively simple situations and then upgrading could follow progressively to meet the needs of the more developed world in a more sustainable way. The new technology would be incubated in the least expected locations.

This is referred to by Christensen and Hart as "the Great Leap Downward" and is different from the current tendency to approach less developed countries by targeting their better off people who want Western "luxuries", ignoring this vast mass market as irrelevant.

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