The Innovator's Dilemma

The Innovator's Dilemma by Clayton Christensen explains how successful companies fail by sticking to their established business models, overlooking disruptive innovations. It offers a framework to help managers anticipate and respond to market changes.

The innovator's dilemma is a management book about innovation written by Clayton M. Christensen, a Harvard Business School professor with a fantastic haircut, in 1997. Its findings are widely considered to be extremely insightful and in contrast to common wisdom at the time of publishing. Due to the importance of innovation in the technology sector, it has since become the quintessential management book in those circles.

Here is an excerpt from the book to hopefully explain disruptive innovation:

"Most new technologies foster improved product performance. I call these sustaining technologies. Some sustaining technologies can be discontinuous or radical in character, while others are of an incremental nature.

What all sustaining technologies have in common is that they improve the performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued.

Most technological advances in a given industry are sustaining in character. An important finding revealed in this book is that rarely have even the most radically difficult sustaining technologies precipitated the failure of leading firms.

Occasionally, however, disruptive technologies emerge: technologies that result in worse product performance, at least in the near-term. Ironically, in each of the instances studied in this book, it was disruptive technology that precipitated the leading firms’ failure.

Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use. There are many examples in addition to the personal desktop computer and discount retailing examples cited above. Small off-road motorcycles introduced in North America and Europe by Honda, Kawasaki, and Yamaha were disruptive technologies relative to the powerful, over-the-road cycles made by Harley-Davidson and BMW. Transistors were disruptive technologies relative to vacuum tubes. Health maintenance organizations were disruptive technologies to conventional health insurers. In the near future, “internet appliances” may become disruptive technologies to suppliers of personal computer hardware and software."

It's especially important to understand the difference between radical sustained innovation and disruptive innovation as explained above. 

The Dilemma:

The innovator’s dilemma is that in every company there is a disincentive to go after new markets. Competent managers in established companies are faced with the question: "Should we make better products to make better profits or make worse profits for people that are not our customers that eat into our own margins?". Paradoxically, this will doom companies in the long run.

5 Key Takeaways

1. Disruptive technology is usually built around proven technologies put together into a novel product architecture that offers the customer a new set of attributes never before available.
2. A technology has the potential to be disruptive if the trajectory of improvement is steep enough to intersect the demand of the mainstream market.
3. Disruptive technology is not attractive to the mainstream customer because it is not an incremental improvement. It will only be successful in the beginning with a niche market that values the new technology.
4. Big companies fail to adapt, not because of a lack of resources, but because their processes and values get in the way of developing small margin opportunities.
5. Managers must align resources and incentives to encourage small scale innovation, tolerate failure, and go after new markets.

Argument 1:

The organisational strategy of firms operating in established, mature, markets is not effective for disruptive technologies.

Successful companies want their resources to be focused on activities that address customers’ needs, that promise higher profits, that are technologically feasible, and that help them play in substantial markets. Yet, this is not nurturing disruptive technologies 

Argument 2:

Creating a new market is less risky and more rewarding than entering established markets:

Argument 3:

Being a first mover is an advantage when developing disruptive innovation, and indifferent when acting in an established market.

There is no evidence that any of the leaders in developing and adopting sustaining technologies developed a discernible competitive advantage over the followers.

The result is quite stunning. The firms that led in launching disruptive products together logged a cumulative total of $62 billion dollars in revenues between 1976 and 1994. Those that followed into the markets later, after those markets had become established, logged only $3.3 billion in total revenue. It is, indeed, an innovator’s dilemma. Firms that sought growth by entering small, emerging markets logged twenty times the revenues of the firms pursuing growth in larger markets

 

Argument 4:

Emerging markets are not attractive for established firms because they do not provide significant short term gains. It is at this stage, however, that firms should enter them in order to become market leaders in the future.

“The last element of the failure framework, the conclusion by established companies that investing aggressively in disruptive technologies is not a rational financial decision for them to make, has three bases. First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits. Second, disruptive technologies typically are first commercialized in emerging or insignificant markets. And third, leading firms’ most profitable customers generally don’t want, and indeed initially can’t use, products based on disruptive technologies. By and large, a disruptive technology is initially embraced by the least profitable customers in a market.

 

Argument 5:

In order for firms to maintain longevity, they should establish smaller sub-organisations that act independently. These organisations are not to be pressured into making a short term profit, but should instead be given a unique identity and allowed to create their market.

"Woolworth’s organizational strategy for succeeding in disruptive discount retailing was the same as Digital Equipment’s strategy for launching its personal computer business. Both founded new ventures within the mainstream organization that had to earn money by mainstream rules, and neither could achieve the cost structure and profit model required to succeed in the mainstream value network."

 

Argument 6:

These unique firms shouldn't be pressured into being right the first time. In fact, they should be considered to be taking bets, and the most important factor should be reducing sunk costs in case of a failed bet, in order to make pivoting cheap. "Business plans" should instead be "learning plans".

"Careful planning, followed by aggressive execution, is the right formula for success in sustaining technology. But in disruptive situations, action must be taken before careful plans are made. Because much less can be known about what markets need or how large they can become, plans must serve a very different purpose: They must be plans for learning rather than plans for implementation."

 

Argument 7:

Customers follow the "Buying Hierarchy" depending on the maturity of the market. The phases, in order, are: functionality, reliability, convenience, and price.

When two or more vendors improve to the point that they more than satisfy the reliability demanded by the market, the basis of competition shifts to convenience. Customers will prefer those products that are the most convenient to use and those vendors that are most convenient to deal with. Again, as long as the market demand for convenience exceeds what vendors are able to provide, customers choose products on this basis and reward vendors with premium prices for the convenience they offer.

 

Argument 8:

Aside from excelling in all aspects of the Buying Hierarchy, the characteristics that make disruptive products valuable in emerging markets are the same ones that make them worthless in mainstream markets.

"O'Conner Peripherals created a market for small drives in portable computers, where smallness was valued; J. C. Bamford and J. I. Case built a market for excavators among residential contractors, where small buckets and tractor mobility actually created value.

Argument 9:

The best way to identify disruptive technologies is by creating a graph with performance improvement demanded in the market vs. performance improvement supplied by the technology:

"Does it constitute an opportunity for profitable growth? To answer these questions, I would graph the trajectories of performance improvement demanded in the market versus the performance improvement supplied by the technology; … Such charts are the best method I know for identifying disruptive technologies.

If these trajectories are parallel, then (electric vehicles) are unlikely to become factors in the mainstream market; but if the technology will progress faster than the pace of improvement demanded in the market, then the threat of disruption is real."