Disruptive Innovation

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A disruptive innovation creates a new market and value network, and eventually goes on to disrupt an existing market and value network (over a few years or decades), displacing an earlier technology. The term is used in business and technology literature to describe innovations that improve a product or service in ways that the market does not expect, typically first by designing for a different set of consumers in the new market and later by lowering prices in the existing market.

By contrast, a ‘sustaining innovation’ does not create new markets or value networks but rather only evolves existing ones with better value, allowing the firms within to compete against each other’s sustaining improvements; they may be either ‘discontinuous’ (i.e. ‘transformational’ or ‘revolutionary’) or ‘continuous’ (i.e. ‘evolutionary’).

The term ‘disruptive technology’ has been widely used as a synonym of ‘disruptive innovation,’ but the latter is now preferred, because market disruption has been found to be a function usually not of technology itself but rather of its changing application. Sustaining innovations are typically innovations in technology, whereas disruptive innovations change entire markets. For example, the automobile was a revolutionary technological innovation, but it was not a disruptive innovation, because early automobiles were expensive luxury items that did not disrupt the market for horse-drawn vehicles. The market for transportation essentially remained intact until the debut of the lower priced Ford Model T in 1908. The mass-produced automobile was a disruptive innovation, because it changed the transportation market. The automobile, by itself, was not.

The current theoretical understanding of disruptive innovation is different from what might be expected by default, an idea that Harvard Business School professor Clayton M. Christensen called the ‘technology mudslide hypothesis.’ This is the simplistic idea that an established firm fails because it doesn’t ‘keep up technologically’ with other firms. In this hypothesis, firms are like climbers scrambling upward on crumbling footing, where it takes constant upward-climbing effort just to stay still, and any break from the effort (such as complacency born of profitability) causes a rapid downhill slide. Christensen and colleagues have shown that this simplistic hypothesis is wrong; it doesn’t model reality. Good firms are usually aware of the innovations, but their business environment does not allow them to pursue them when they arise, because they are not profitable enough at first, and because their development takes scarce resources away from sustaining innovations (which are needed to compete against current competition). In Christensen’s terms, a firm’s existing value networks place insufficient value on the disruptive innovation to allow its pursuit by that firm. Meanwhile, start-up firms inhabit different value networks, at least until the day that their disruptive innovation is able to invade the older value network. At that time, the established firm in that network can at best only fend off the market share attack with a me-too entry, for which survival (not thriving) is the only reward.

The term ‘disruptive technologies’ was coined by Christensen and introduced in his 1995 article ‘Disruptive Technologies: Catching the Wave.’ The article is aimed at managing executives who make the funding/purchasing decisions in companies rather than the research community. He describes the term further in his book ‘The Innovator’s Dilemma,’ which explored the cases of the disk drive industry (which, with its rapid generational change, is to the study of business what fruit flies are to the study of genetics) and the excavating equipment industry (where hydraulic actuation slowly displaced cable-actuated movement). In his sequel, ‘The Innovator’s Solution,’ Christensen replaced the term ‘disruptive technology’ with ‘disruptive innovation’ because he recognized that few technologies are intrinsically disruptive or sustaining in character; rather, it is the business model that the technology enables that creates the disruptive impact. The concept of disruptive technology continues a long tradition of the identification of radical technical change in the study of innovation by economists, and the development of tools for its management at a firm or policy level. However, Christensen’s evolution from a technological focus to a business modelling focus is central to understanding the evolution of business at the market or industry level. For example, Christensen’s contemporary emphasis on the applied business model rather than the technology itself was developed by Henry Chesbrough’s pioneering notion of ‘Open Innovation.’

In keeping with the insight that what matters economically is the business model, not the technological sophistication itself, Christensen’s theory explains why many disruptive innovations are not ‘advanced technologies,’ which the technology mudslide hypothesis would lead one to expect. Rather, they are often novel combinations of existing off-the-shelf components, applied cleverly to a small, fledgling value network. Christensen defines a disruptive innovation as a product or service designed for a new set of customers: ‘Generally, disruptive innovations were technologically straightforward, consisting of off-the-shelf components put together in a product architecture that was often simpler than prior approaches. They offered less of what customers in established markets wanted and so could rarely be initially employed there. They offered a different package of attributes valued only in emerging markets remote from, and unimportant to, the mainstream.’

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 when the common business-world advice to ‘focus on the customer’ (‘stay close to the customer,’ ‘listen to the customer’) can sometimes be strategically counterproductive.

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 which has lower performance than the incumbent but which 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 foot hold 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.

Disruptive technologies are not always disruptive to customers, and often take a long time before they are significantly disruptive to established companies. They are often difficult to recognize. Indeed, as Christensen points out and studies have shown, it is often entirely rational for incumbent companies to ignore disruptive innovations, since they compare so badly with existing technologies or products, and the deceptively small market available for a disruptive innovation is often meager in comparison to the market for the established technology. Even if a disruptive innovation is recognized, existing businesses are often reluctant to take advantage of it, since it would involve competing with their existing (and more profitable) technological approach. Christensen recommends that existing firms watch for these innovations, invest in small firms that might adopt these innovations, and continue to push technological demands in their core market so that performance stays above what disruptive technologies can achieve.

Disruptive technologies, too, can be subtly disruptive, rather than prominently so. Examples include digital photography (the sharp decline in consumer demand for common 35 mm print film has had a deleterious effect on free-riders such as slide and infrared film stocks, which are now more expensive to produce) and IP/Internet telephony, where the replacement technology does not, and sometimes cannot practically replace all of the non-obvious attributes of the older system (sustained operation through municipal power outages, national security priority access, the higher degree of obviousness that the service may be life-safety critical or deserving of higher restoration priority in catastrophes, etc.).

Disruptive technologies rarely wipe older technologies off the face of the earth, or out of the business world altogether. But they do often wipe out particular firms. Often established firms will flee upmarket trying to make up the revenues and margins lost to the disruption rising from below. They often eventually fail. Many decades later, their original technologies may still find suitable applications in human life and commerce. But they will no longer be manufactured by those original firms of the earliest generations, and the value networks around them will be substantially different from the original ones. For example, bias-ply tires for passenger-car use still exist, and they are still manufactured and bought and sold. However, today they occupy smaller, hobbyist-oriented automotive restoration value networks, whereas 40 years ago they were what most average car-tire buyers were buying, occupying a larger, lower-margin, more utilitarian value network. Today radial tires occupy that larger network. Bias-ply tires’ commercial existence has shrunk to a small upmarket niche, and in the eyes of a wholesale discount mass-market tire dealer, they have very little value.

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