disruptive innovation

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For the last few years I have been fascinated with Clayton Christensen's theory of disruptive innovation and its application to business, politics, education, and insurgency models. What I find most interesting is that his theory, featured in both The Innovator's Dilemma and The Innovator's Solution provides a prescription for a small entrant with less resources to compete with and beat a large incumbent.

To understand his theory we begin by looking at a set of customers for a good or service. A simplified segmentation of the market is defined as non consumers, mainstream customers, and higher end customers. The incumbent starts by creating a good or service that appeals to the mainstream consumer. Upon reaching market segment saturation, the company looks up market and innovates on the product to capture the higher end more margin rich segment. Often tech companies competing in the same market play this leap frog game of matching innovation to control more of the commodity market. Clayton defines these as sustaining innovations.

In business the process is called profit maximizing resource allocation and the right competitor can use it to force an incumbent out the top end of the market. By continuing to innovate, the incumbent creates bloated products or services that have more value or performance than the consumer can utilize. The logic is that if I can please my most demanding customers then my main stream customers will be also be satisfied, but in reality it exposes the lower end of the market to the disruptive entrant who can enter in two ways:

 - By targeting non-consumers with a simple, less expensive and more convenient product - this is referred to as a new market disruption
 - By innovating on the business or manufacturing process so as to reduce costs and provide a product that over served consumers can get at a lower price.

With both the entrant and incumbent competing in the same segment, the entrant has the margin advantage as the price equilibrium is set at the marginal cost of the incumbent. The incumbent is unable to compete, and the strategy  becomes to  abandon the low end of the market which contains their least profitable, least loyal customer base and refocus the business in the higher margin tiers with more loyal customers. With the incumbent effectively pushed out of the segment, prices fall to the marginal cost of the entrant.

Now competing in a commodity market and faced with the same growth imperative as the incumbent, necessity begets innovation: The entrant must figure out how to apply the new innovation in the business, manufacturing, or product to move up market. Once this happens the incumbent abandonment, segment commoditization, and then entrant up market movement repeats itself through until the incumbent is forced out of the market.

Here is where it gets interesting: by pushing the incumbent out of the market, the entrant becomes the incumbent and is now exposed to the disruptive entrant. So how does the incumbent compete?  Clayton makes the case that the company should develop an autonomous business unit to compete at the lower end of the market. He makes a great argument that the cost structure of an organization drives its values and these cost structure based values limit an incumbent from competing directly with an entrant. 

While I think this is good solution, I see it as highly reactive. I think an organization should do as Toyota did and implement a clear and hold strategy similar to what the Marines do in their counterinsurgency operations. When competition, demanding customers, and profit mazimazation drive a company to innovate up market, a company should establish an autonomous business unit to move up market much like Toyota did with the creation of Lexus. And even though they were proactive in creating Lexus, sometimes a disruption redifines the market by turning non consumers into customers, forcing an incumbent to be reactive. Ultimately Toyota had to establish Scion to compete with disruptors like Hyundai and Kia. Thats a quick look at the Disruptive Innovation model, Thanks for watching and I look forward to your feedback. for more, Check out  Clayton's books The Innovator's Dilemma and The Innovator's Solution

Comments

[Eric Kam]

thanks again Jeff. Another very solid interpretation of a problem that innovation companies face. To lead or follow, to react or blaze trails. And in which direction to blaze.

One question: how do you break the news to the former disruptor that they are now the incumbent? Seems that nobody would ever want to admit that they are the "Empire" we all aspire to be the underdog (even google) and not the Goliath.

[Jeff Monday]

That is a very good question Eric. In the conceptual world it is easy to see that when a company innovates up market they move more towards being an incumbent, thus more exposed to disruptive entrants.

Trying to judge it in real time is far more complex. Often companies don't realize they have become the incumbent until it is too late.

My suggestion: Show them the balance sheet. If they don't get it, then show them the market share numbers.

[Linda Ireland]

Jeff, what an effective demonstration of Clayton's concept - sprinkled with your own insight.

I read it earlier, but visited again after writing this post http://bit.ly/2NODq regarding Starbuck's new 15th Ave concept store in Seattle. The debate about Starbuck's odds for success w/this new "customer experience" benefits greatly by putting it into the context of disruptive innovation. Is Starbucks doing what you advocate at the end of your presentation, although moving up vs down segment?

Always appreciate your thoughts,
LCI

[twitter.com/DenisPombriant]

jeff,

This is wonderful stuff. I am enjoying your insights.

Denis Pombriant
www.beagleresearch.com

[Jeff Monday]

Linda,

Thanks for the nice feedback. I have to agree with you that the 15th ave. store is a phenomenal proactive move by Starbucks to create a separate business unit to move up market. This allows them to protect their current market against disruptive innovation while moving into the next tier.

In the business of coffee Starbucks was the disruptive innovator when it entered the market. It innovated on the business model in such a way that it turned non-consumers into consumers by providing convenient, great tasting coffee with great customer service.

Since it's inception it has become the incumbent. The things that it used to create the disruptive innovation (convenience, great tasting coffee, and great customer service) have become abundant to the point of being a commodity. One of my favorite rules of economics is that abundances create scarcity in other areas.

Scarcity (which in this case was largely created by Starbucks success) is the ambiance and social capital that comes with purchasing coffee from a neighborhood coffee shop. What is going to distinguish a Toyota coffee from a Lexus coffee is not the coffee, (both cars go from point A to B, are easy to find and purchase, etc.) it is the experience.

15th ave.'s main goal is to provide that experience and it is an excellent example of proactive disruptive innovation by the incumbent.