The Innovators Dilemma

by Jörgen Eriksson on September 11, 2012

It is not the strongest of the species that survive nor the most intelligent but the one most responsive to change.

– Clarence Darrow

Now in the 21st century we live in hyper competitive markets. This means that whatever product or service your company can come up with and bring to the market, someone else can very quickly bring out something similar at a lower price.

In Bearing we see three main drivers of hyper competition, which are illustrated below.

image

The second bullet point, the speed of hyper connected communication, is perhaps the strongest force at the moment, as my friend and former colleague Matteo Pacca pointed out to me recently. By the immediate connections we can get through the internet, we can instantly gain knowledge on new products and services launched in another market, region or country and use this business intelligence for competitive purposes.

To deal with hyper competition, it is important for businesses to continuously and incrementally innovate, to get and stay ahead of competitors and to differentiate themselves in their offerings. Such innovation must be pro-active and it is not good enough anymore to be reactive.

Innovation Management

Innovation Management is the discipline of managing processes in innovation. It can be used to develop both product and organizational innovation. In Bearing, we believe in and advice clients on innovation work in twelve different dimensions.

Innovation Navigator footprint

Without proper processes, it is not possible for business development or R&D or innovation in any of these dimensions to be efficient. Innovation management includes a set of tools that allows people to cooperate with a common understanding of goals and processes. The focus of innovation management is to allow the organization to respond to external and internal opportunities, and use its creative efforts to introduce new ideas, processes or products.

Importantly, innovation management is not only about R&D. When implemented properly, it involves employees at every level in contributing creatively to a company’s development, manufacturing, and marketing.

ToolsBy utilizing appropriate innovation management tools, management can trigger and deploy the creative energy of the whole work force towards the continuous incremental development of a company.

The process can be viewed as an evolutionary integration of organization, technology and market by iterating a series of activities: search, select, implement and capture.

To implement Innovation Management in a company, we recommend undertaking the following steps.

The ten steps

1. Adopt a disciplined method for innovation management including project management, focus on customer needs and alignment of research and development to marketing plans.

2. Use advisers, experienced consultants and collaborators to obtain resources which are non-core, vital or of superior quality to resources and experience available in-house.

3. Identify customer needs in market segments.

4. Identify a differentiating edge in your innovative offering (goods, services, branding, customer engagement, linkages and partnerships, systems or a combination of them) to meet those customer needs.

5. Develop the offering for the identified differentiation.

6. Ensure you secure your intellectual property.

7. Use the differentiation as a component to create competitive advantages.

8. Refine the positioning of the offering at either the offerings, operations or organizational structure level.

9. Monitor, anticipate and respond to your competitors, to make sure you keep your offering unique and avoid direct competition .

10. Monitor and respond to the market performance and feedback for the offering.

This may seem simple, but in fact it can be difficult to implement as it is often a matter of changing corporate culture and encouraging and capturing creativity from individuals and teams.

Clayton M. Christensen

The Innovators DilemmaOne of the first business books about innovation was Harvard Business School Professor Clayton M. Christensen´s  revolutionary bestseller The Innovator´s Dilemma, which was originally published in 1997. It remains a very good read.

In the book, Christensen claims that outstanding companies can do everything right and still lose their market leadership—or worse, disappear altogether. And not only does he prove what he says, but he provides tools that can allows others how to avoid a similar fate.

Focusing on disruptive technology, Christensen shows why most companies miss out on new waves of innovation. Whether in electronics or retailing, a successful company with established products will get pushed aside unless managers know when to abandon traditional business practices. Using the lessons of successes and failures from leading companies, The Innovator’s Dilemma presents a set of rules for capitalizing on the phenomenon of disruptive innovation.

Initially, Christensen examines why firms fail despite being leaders in their market, willing and able to compete with the best, and capable of continuous innovations within their industry.

“Sustaining technological changes” are not the problem for leaders in an industry. Time and time again, they showed their ability to compete in the high end of their market, innovating and at times dealing with radical technological changes. Yet, because these are sustaining innovations, they are almost always best utilized by the firms that already have the best position in an industry.

These are changes that follow an “s-curve”, increasing performance as their customers come to expect. New market entrants attempting to compete by means of these sorts of innovations often fail, because the established firms nearly always have more money, more established relationships with clients, a better reputation, and more technological prowess in the market. “The leaders … did not fail because they became passive, arrogant, or risk-averse or because they couldn’t keep up with the stunning rate of technological change.”

The S-curve says that with successive groups of consumers adopting new technology (shown in blue), its market share (yellow) will eventually reach the saturation level.

File:Diffusionofideas.PNG

However, the story changes radically when it comes to what are called disruptive innovations – these are the “changes that toppled the industry leaders”. These are not radical improvements – quite the contrary, disruptive innovations are usually an innovation that are either so much cheaper that they open a new market, or start in a niche that the industry doesn’t care about because it’s too small. However, often the performance of the disruptive technology grows faster than users’ needs, with time catching up to, and surpassing the more high-end or mainstream technologies that are the domain of industry leaders.

An example from the excavator industry

mechanical excavatorAn example in the book that has nothing to do with high tech comes from the mechanical excavator industry. This industry was dominated by steam shovels until the 1920’s, when gasoline powered engines began to replace them. This was, however, not a disruptive innovation, but a sustaining one, even though the design of the machines changed radically from that of a steam-powered system of cables, to that of a gasoline engine driving a system to extend and retract the cable connected to the bucket.

The new engines were more capable than the old ones, and were better at doing more work more reliably, and cheaper than the old system. Despite the radical change in the industry, the same firms that were strongest in steam shovels stayed on top. The disruptive change came with the introduction of hydraulic-actuated systems after World War II – a change that eliminated nearly all of the established players by about 1970, in favor of companies that entered the market with hydraulics.

hydraulicsThe first hydraulic-based excavators were less capable than the cable systems that were in existence, and certainly couldn’t compete with them. However, they were small enough that they could be deployed for jobs previously done by hand, opening up a new market, in which the desired attributes were quite different from the big jobs that the cable actuated excavators were used for. The technology involved in hydraulics continued to improve, however, and with time eventually equaled and then surpassed the needs formerly filled by cable-based systems.

In the meantime, however, the established firms were still going strong, and didn’t do much, if anything, to deal with the new competitor (because it wasn’t really seen as a competitor, not being sufficient for their existing clients’ demands) until the new arrivals were “in the midst of their mainstream market”.

By the time the established companies introduced their own hydraulics, however, it was too late, and the later entrants were by then better positioned with the new technology.

The theory

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 and sizable firm.

Thus disruptive technology provides an example of when the common business-world advice to "focus on the customer" can sometimes be strategically counterproductive.

How low-end disruption occurs over time

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 suppliers in the market.

Low-end disruption occurs when the rate at which products improve exceeds the rate at which customers can adopt the new enhancements. 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 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.

Business implications

changeWhen we think of the term “disruption”, the image in our mind is often something immediate or involving fast change. However Christensen says disruptive technologies are not always disruptive to customers, and often takes a long time before they are significantly disruptive to established companies.

Whilst they are occurring, market disruptions are often difficult to recognize. This is why market leaders can go from domination to close-to-bankruptcy in a matter of a few years, as we have described elsewhere on this blog in the cases of Motorola, Nokia and Lego.

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. One very clear example of this was Kodak, which we also have described in a previous blog.

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 (Kodak) and internet telephony (Skype), where the replacement technology does not, and sometimes cannot practically replace all of the non-obvious attributes of the older system.

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 companies.

Often established firms will escape upmarket, by for example repositioning their brand,  and thus try to make up the revenues and margins lost to the disruption rising from competition in the lower entry segments. They often eventually fail (Telefunken, Sony).

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.

To give an example, one of the mobile phone handsets I currently use is branded “Telefunken”, which was a great German electronic consumer product manufacturer in the 1970s and 1980s, but today is only a brand name for an unknown Chinese technology manufacturer.

My handset is a great product, allowing for using four simultaneously active SIM-cards, but it caught my attention not because of this, but because of the familiarity of the brand name, remembering my grandparents television set where we watched the lunar landing on 20 July 1969. Thus showing that innovative development of brand names can just as well be about re-use as it is about invention.

To learn more about Clayton M. Christensen, here is a link to an interview published in March 2011. 

About Jörgen Eriksson :

Jörgen Eriksson is the founder of Bearing and is the Chairman of the firm since it was created. He has successfully expanded Bearing into covering projects on four continents. He is also Adjunct Professor of Innovation Management at the International University of Monaco and at Universitat Politècnica de Catalunya in Barcelona and he is an active member of the Founders Alliance organisation.

Working with consulting engagements across Bearings practices, he has over the past fifteen years participated in and supervised a large number of client projects, from innovation system development and place development and branding, to merger and acquisition assignments and leading edge research and business development activities for key clients.

His new book, Branding for Hooligans, will be published in 2015. It is about how innovation and branding are key survival factors in our modern times of hyper competitive markets.

Prior to Bearing, he was Director of Europe, Middle East, and Africa for Trema Treasury Management, a technology and consulting services provider, supplying financial software solutions for the global financial industry, Clients included The European Central Bank, Citibank, SEB, South African reserve Bank, Deutsche Bank, Abu Dhabi Investment Authority (ADIA), as well as many other large financial institutions and Fortune 500 companies.

Early in his career Eriksson was educated at the Stockholm School of Economics, where he studied economics, financial economics and philosophy. He then worked in Scandinavian investment banks and also for the Swedish Institute of National Defense Research.

You can contact Jörgen on e-mail jorgen.eriksson@bearing-consulting.com, connect on LinkedIn on http://fr.linkedin.com/pub/jörgen-eriksson/0/38/8a0/ and follow him on twitter on joreri508.

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