Clayton M. Christensen

The Innovator's Dilemma

When New Technologies Cause Great Firms to Fail

IN A NUTSHELL
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CORE CONCEPTS
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PRINCIPLES OF DISRUPTIVE INNOVATION
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IDEAS
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IN A NUTSHELL

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  • “This book is about the failure of companies to stay atop their industries when they confront certain types of market and technological change. It’s not about the failure of simply any company, but of good companies.”
  • “Simply put, when the best firms succeeded, they did so because they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. But, paradoxically, when the best firms subsequently failed, it was for the same reasons—they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs.”
  • “One theme common to all of these failures, however, is that the decisions that led to failure were made when the leaders in question were widely regarded as among the best companies in the world.”
  • “There are times at which it is right not to listen to customers, right to invest in developing lower-performance products that promise lower margins, and right to aggressively pursue small, rather than substantial, markets.”
ABOUT THE AUTHOR
Clayton M. Christensen
  • One of today’s most influential business theorists.
  • Best known for his theory of “disruptive innovation”.
  • Harvard Business School professor

CORE CONCEPTS

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Failure Framework
Why do great companies fail?
  1. Sustaining and disruptive technologies are fundamentally different.
  2. Technology oversupply —> the pace of technological progress can, and often does, outstrip what markets need.
  3. The paradox of “value networks” —> Customers and financial structures of successful companies color heavily the sorts of investments that appear to be attractive to them, relative to certain types of entering firms.
Sustaining technologies
  • Targeted at known markets in which customer needs are understood.
  • They improve the performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued.
Disrupting technologies
  • Targeted at known markets in which customer needs are understood.
  • They improve the performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued.
  • Technologies can progress faster than market demand.
  • When it happens companies “overshoot” the market —> producing better products that their customers need or are willing to pay for.
  • Established companies don’t consider disruptive technologies worth the investment.
  • Disruptive technologies are:
    • simpler and cheaper, produce lower margins and less profit
    • typically first commercialized in emerging or insignificant markets
    • initially embraced by the least profitable customers in the market
  • Established companies often don’t invest in disruptive technologies until it is too late.
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PRINCIPLES OF DISRUPTIVE INNOVATION
“These rules, which I call principles of disruptive innovation, show that when good companies fail, it often has been because their managers either ignored these principles or chose to fight them.”
Principle 1: Companies Depend on Customers and Investors for Resources
Principle 2: Small Markets Don’t Solve the Growth Needs of Large Companies
Principle 3: Markets that Don’t Exist Can’t Be Analyzed
Principle 4: An Organization’s Capabilities Define Its Disabilities
Principle 5: Technology Supply May Not Equal Market Demand
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THE PROCESS OF BEING DISRUPTED
1. The firm devotes significant resources to develop the product attributes defined by the value network (which features do customers value…)
2. Firms recognize an innovation within the same value network (innovations meant to strengthen those product attributes that the company focuses on). But it fails to recognize innovations within different value networks (innovations meant to strengthen other product attributes that mainstream customers currently care about).
3. Established firms ignore disruptive innovations because it doesn’t match it’s mainstream customers’ needs. They rather pursue sustaining innovations within the same value network.

4. Entrant firms gain an attacker’s advantage by establishing the market.

5. Established firms are “locked” into current strategies and cost structures. Switching to new disruptive products is not profitable for them.

PRINCIPLES OF DISRUPTIVE INNOVATION

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Principle 1: Companies Depend on Customers and Investors for Resources
  • Customers and investors dictate how the money will be spent.
  • WHY? Because companies that don’t satisfy customers and investors don’t survive.
  • The best-performing companies are killing ideas their customers don’t want.
  • Managers and executives often think they decide what the company can or cannot do. But customers make the ultimate decisions.
  • These companies fail to invest in disruptive technologies because their mainstream customers don’t want them.
  • Set up a new and independent organizations that develops disruptive technology and focuses on different customers than the main stream business.
  • Jeffrey Pfeffer and Gerald R. Salancik in The External Control of Organizations: A Resource Dependence Perspective
  • Chester Barnard, The Functions of the Executive

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Principle 2: Small Markets Don’t Solve the Growth Needs of Large Companies

Match the Size of the Organization to the Size of the Market

  • Disruptive technologies typically serve a small market first. This small market is not enough for a big company to satisfy its growth needs.
  • Established companies fail to enter disruptive businesses that are small today but will be large tomorrow. They wait until the market becomes large enough to be interesting. But it is often too late.
  • “While a $40 million company needs to find just $8 million in revenues to grow at 20 percent in the subsequent year, a $4 billion company needs to find $800 million in new sales. No new markets are that large.”
  • “As companies become larger and more successful, it becomes even more difficult to enter emerging markets early enough. Because growing companies need to add increasingly large chunks of new revenue each year just to maintain their desired rate of growth, it becomes less and less possible that small markets can be viable as vehicles through which to find these chunks of revenue.”
  • “Implant projects aimed at commercializing disruptive technologies in organizations small enough to get excited about small-market opportunities, and to do so on a regular basis even while the mainstream company is growing. (Similar ideas as the 3 Horizons Framework).
Let’s say the organization’s goal is to maintain a 20% growth rate.
  • A $40 million company needs an additional $8 million in revenues the first year, $9.6 million the following year, and so on.
  • A $400 million company needs an additional $80 million in revenues the first year, $96 million the following year, and so on.
  • A $4 billion company needs an additional $80 million in revenues the first year, $960 million the following year, and so on.
  • The problem is: there is no $800 million emerging market. So, large and established companies are not very interested in disruptive technologies.
  1. Try to affect the growth rate of the emerging market, so that it becomes big enough, fast enough, to make a meaningful dent on the trajectory of profit and revenue growth of a large company.
  2. Wait until the market has emerged and become better defined, and then enter after it “has become large enough to be interesting.”
  3. Place responsibility to commercialize disruptive technologies in organizations small enough that their performance will be meaningfully affected by the revenues, profits, and small orders flowing from the disruptive business in its earliest years.
What to do?
  • The first 2 scenarios are full of problems. The third is the most viable approach.
  • Give the responsibility to commercialize the disruptive technology to an organization whose size matches the size of the targeted market. Create (or acquire) a small company for a small business that gets excited about small opportunities and small wins.

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Principle 3: Markets that Don’t Exist Can’t Be Analyzed

Markets of disruptive technologies are not just “unknown”. They are “unknowable”. Suppliers and customers must discover them together.
  • Market research, planning and execution —> are hallmarks of good management WHEN applied to sustaining technological innovation.
  • New markets by definition cannot be analysed by traditional market research tools.
  • “In dealing with disruptive technologies leading to new markets (…) the only thing we may know for sure when we read experts’ forecasts about how large emerging markets will become is that they are wrong.”
  • “They demand market data when none exists and make judgments based upon financial projections when neither revenues or costs can, in fact, be known.”
  • Most managers of large established companies have learned about innovation is a sustaining context. However, this approach is not relevant when it comes to disruptive innovation.
  • The effect can be paralyzing
    • demanding quantified information when none exists
    • accurate estimates of financial returns when neither revenues nor costs can be known
    • management according to detailed plans
    • budgets that cannot be formulated
    • interviewing leading customers and industry experts
    • using tools of sustaining innovation, such as trend analysis, economic modeling
  • “Amid all the uncertainty surrounding disruptive technologies, managers can always count on one anchor: Experts’ forecasts will always be wrong.”
  • Don’t overinvest based on your guesses about the new market. Be flexible to new approaches.
  • Preserve resources. “The dominant difference between successful ventures and failed ones, generally, is not the astuteness of their original strategy. Guessing the right strategy at the outset isn’t nearly as important to success as conserving enough resources (or having the relationships with trusting backers or investors) so that new business initiatives get a second or third stab at getting it right. Those that run out of resources or credibility before they can iterate toward a viable strategy are the ones that fail.”
  • Encourage smart failures. “Discovering markets for emerging technologies inherently involves failure, and most individual decision makers find it very difficult to risk backing a project that might fail because the market is not there.”
Use a DISCOVERY-DRIVEN PLANNING approach
  • Definition: “a different approach to strategy and planning that recognizes the law that the right markets, and the right strategy for exploiting them, cannot be known in advance.”
  • Assume that forecasts are wrong, develop plans for learning what needs to be known.
  • Action should be taken before planning —> because the details of the plan cannot be known.
  • Learning is the no. 1. currency. We make plans about what do we have to learn, not about what we have to execute.
  • It is crucial to resolve important uncertainties before making expensive commitments.
  • Rita G. McGrath and Ian C. MacMillan, “Discovery-Driven Planning,” Harvard Business Review, July–August, 1995, 4–12.
  • Joseph Bower, Managing the Resource Allocation Process (Homewood, IL: Richard D. Irwin, 1970), 254.

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Principle 4: An Organization’s Capabilities Define Its Disabilities

  • “Organizations have capabilities that exist independently of the people who work within them”
  • “One could take two sets of identically capable people and put them to work in two different organizations, and what they accomplish would likely be significantly different.”
  • Frequently, managers “assume that if the people working on a project individually have the requisite capabilities to get the job done well, then the organization in which they work will also have the same capability to succeed. This often is not the case.”
Three classes of factors affect what an organization can and cannot do: its resources, its processes, and its values.
1. Resources
  • Things, or assets—they can be hired and fired, bought and sold, depreciated or enhanced. People, equipment, technology, product designs, brands, information, cash, and relationships with suppliers, distributors, and customers.
  • Access to abundant and high-quality resources enhances an organization’s chances of coping with change.
  • HOWEVER, resources cannot fully determine what an organization is capable of. We also have to consider the organization’s processes and values.
  • “we could deal identical sets of resources to two different organizations, and what they created from those resources would likely be very different”
2. Processes
  • Transform inputs of resources— people, equipment, technology, product designs, brands, information, energy, and cash— into products and services of greater worth.
  • Manufacturing processes, product development, procurement, market research, budgeting, planning, employee development and compensation, and resource allocation.
  • Formal processes: explicitly defined, visibly documented, and consciously followed.
  • Informal processes: habitual routines, “That’s the way we do things around here.” Further reading on this: Schein: Organizational Culture
  • Most serious disabilities of companies that are unable to change typically can be found in their inflexible processes.
3. Values
  • “The values of an organization are the criteria by which decisions about priorities are made.”
  • Example: ethical values: Johnson & Johnson —> ensure patient well-being
  • Values are prioritization decisions: “An organization’s values are the standards by which employees make prioritization decisions—by which they judge whether an order is attractive or unattractive; whether a customer is more important or less important; whether an idea for a new product is attractive or marginal; and so on.”
  • “The larger and more complex a company becomes, the more important it is for senior managers to train employees at every level to make independent decisions about priorities that are consistent with the strategic direction and the business model of the company.”
  • Disruptive products promised lower profit margins per unit sold and could not be used by their best customers. —> these innovations were inconsistent with the leading companies’ values (make a profit by serving customers).
  • “Disruptive project cannot be forced to compete with projects in the mainstream organization for resources. Because values are the criteria by which prioritization decisions are made, projects that are inconsistent with a company’s mainstream values will naturally be accorded lowest priority.”
  • The most important factors that determine an organization’s capabilities (what they can or cannot do) lies in its processes and value, and NOT in its resources.
  • Processes and values are inflexible by nature. “To ensure consistency, they are meant not to change.”
  • That’s the reason why most organizations fail to manage sustaining and disruptive innovations at the same time. “Because of its task-specific nature, it is impossible to ask one process to do two fundamentally different things.”
  • David Garvin: “The Processes of Organization and Management,” Sloan Management Review, Summer, 1998.
  • Thomas Peters and Robert Waterman, In Search of Excellence
    (New York: Harper & Row Publishers, 1982).
  • Dorothy Leonard-Barton, “Core Capabilities and Core Rigidities: A Paradox in Managing New Product Development,” Strategic Management Journal (13), 1992, 111–12

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Principle 5: Technology Supply May Not Equal Market Demand

  • The phase of technological improvement often exceeds the level customers demand.
  • Disruptive technologies can become the future mainstream and today’s mainstream technologies can “overshoot” market demand.
  • “Technologists were able to provide rates of performance improvement that have exceeded the rates of performance improvement that the market has needed
  • “Performance oversupply occurs, it creates an opportunity for a disruptive technology to emerge and subsequently to invade established markets from below”
  • When performance oversupply occurs the basis of the competition change (The rank-ordering of the criteria by which customers choose one product or service over another).
  • “The criteria used by customers to choose one product over another changes to attributes for which market demands are not yet satisfied.”
  • Changes in the basis of competition indicate the next phase of the product lifecycle.
  • It happens when customers are no longer willing to pay a premium price for continued improvement in a particular attribute.
  • Other attributes become more important to them (than the attributes in the established value network) —> the basis of the competition changes.
Figure 9.3 Changes in the Basis of Competition in the Disk Drive Industry
  • Creators: Windermere Associates of San Francisco, California
  • The 4-phase hierarchy represents the basis of competition.
1. Functionality
  • When there is no competition that can satisfy the demand of the market for a particular product the basis of competition tends to be functionality.
2. Reliability
  • As competitors enter the market and more and more products are capable to offer the same functionality the criteria by which product choice is made changes. The most important buying criteria becomes reliability.
3. Convenience
  • When more and more products can offer the same functionality in the same reliable way the basis of competition changes again. The most important attribute tends to be convenience.
  • “Customers will prefer those products that are the most convenient to use and those vendors that are most convenient to deal with.”
4. Price
  • When multiple vendors offer a package of convenient products and services that fully satisfies market demand, the basis of competition shifts to price.
  • Similar underlying logic: but stages are determined in terms of the user rather than the product.
  1. First wave of customers: EARLY ADOPTERS —> customers who initially embrace the product, who base their choice on functionality.
  2. Second wave of customers: EARLY MAJORITY ––>as the demand of the mainstream market have been met, after the product has become reliable enough —> markets expand dramatically
  3. Third wave of customers: LATE MAJORITY —> when reliability issues have been resolved, the basis of competition shifts to convenience.

IDEAS

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THE CONCEPT OF VALUE NETWORK
  • Which attributes of the product are we focusing on —> what is the basis of competition (“the criteria by which customers choose one product over another”)
  • Value in this context is the rank-ordering of important product attributes. In other words: what makes the product valuable for customers.
  • The context within which a firm identifies and responds to customers’ needs, solves problems, procures input, reacts to competitors, and strives for profit. It’s a pattern of solutions developed throughout the years.
An example:
  • The value network of the laptop market consists of product attributes like a smaller size, energy efficiency, low weight, portability.
  • The value network of the desktop market consists of product attributes like performance, reliability, capacity.
  • Companies focus on these attributes, perfecting the products according to these criteria.
In case of a sustaining innovation
  • Engineers of companies try to solve the customer’s problems using the same architecture as the previous solution. For example, mainframe computers were using the same structures as their ancestors.
  • Inventing “new” solutions by improving the components of the system. BUT the the framework, the architecture and design of the system remains in place. It is using the same components.
Disruptive technology
  • Using the same components and putting them into a very different framework, ultimately re-designing the system itself.
Sustaining innovation
  • Today’s desktop computers have basically the same functional components as the mainframe computers of the 1960s. having the same parts: cooling system, RAM memory, disks, cache, processors etc.
Disruptive innovation
  • In contrast: hand-held mobile devices (smartphone, etc…) using the same components but putting them into an entirely different architecture. Today 70% of the websites are opened on hand-held devices.
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How to identify disruptive innovation?
Consistent characteristics of disruptive technolgies
  • Disruptive innovators take a product and optimize an attribute that is valued by a small number of customers BUT not by the mainstream market.
  • Companies that failed “did not attempt to market the technology until they felt it was good enough to be valued in the mainstream market”.
  • “Established firms confronted with disruptive technology typically viewed their primary development challenge as a technological one: to improve the disruptive technology enough that it suits known markets. In contrast, the firms that were most successful in commercializing a disruptive technology were those framing their primary development challenge as a marketing one: to build or find a market where product competition occurred along dimensions that favored the disruptive attributes of the product.”
  • “When performance oversupply has occurred and a disruptive technology attacks the underbelly of a mainstream market.”
  • “In terms of the buying hierarchy, and because it is simpler, cheaper, and more reliable and convenient than mainstream products”
  • Established companies tend to push for high-performance, high-profit products and markets. They tend to overload their products with functionality and selling them to higher and higher tier customers.
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MANAGING DISRUPTIVE TECHNOLOGICAL CHANGE
How did the successful managers harness these principles to their advantage?
  • They embedded projects to develop and commercialize disruptive technologies within an organization whose customers needed them. 
  • They placed projects to develop disruptive technologies in organizations small enough to get excited about small opportunities and small wins.
  • They planned to fail early and inexpensively in the search for the market for a disruptive technology – an iterative process of trial, learning, and trial again.
  • They utilized some of the resources of the mainstream organization to address the disruption, but they were careful not to leverage its processes and values. In other words, they worked fairly independently from the mainstream organization.
  • When commercializing disruptive technologies, they found or developed new markets that valued the attributes of the disruptive products, rather than search for a technological breakthrough so that the disruptive product could compete as a sustaining technology in mainstream markets.
  • Theory of resource dependence: not executives of companies who control what they can and cannot do. CUSTOMERS control ultimately the resources, they can control what a firm can do.
  • Firms that succeed will be those who give their customers what they want.
The question: What can managers of companies do when they are facing a disruptive technology that the company’s customers explicitly do not want?
1. First approach: convince everyone in the firm that the company should pursue it anyway despite lower profitability than the upmarket alternatives because it has long-term strategic importance.
2. Second approach: create an independent organization and embed it among emerging customers that do need the technology.
  • First approach: going against the grain, fighting with the laws of the market.
  • Second approach: harnessing the power by giving everyone what they want.
  • “Resource allocation and innovation are two sides of the same coin.”
  • It determines which projects will get founded and which will not.
  • “(…) the findings reported in this book provide rather stunning support for the theory of resource dependence—especially for the notion that the customer-focused resource allocation and decision-making processes of successful companies are far more powerful in directing investments than are executives’ decisions.”
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STRATEGIES FOR TECHNOLOGY OVERSUPPLY
Figure 9.4 Managing Changes in the Basis of Competition
  • Refers to sustaining innovation.
  • Developing better technologies and products with increasingly higher performance.
  • Targeting customers of ever-higher tiers of the market, ultimately abandoning lower-tier customers when simpler, more convenient, or less costly disruptive approaches emerg
  • Staying with the same customer segment, answering to their needs.
  • Responding to the waves of change on the basis of competition.
  • It is a sustainable strategy. However, it is very difficult to do because higher-tier markets promise ever-higher short-term profits.
  • It is a marketing-based strategy.
  • Using marketing initiatives —> making customers demand the performance improvements that the technologists provide.
  • Examples: Microsoft, Intel, and the disk drive companies successfully applied this strategy. “Microsoft has used its industry dominance to create and successfully market software packages that consume massive amounts of disk memory and require ever-faster microprocessors to execute.”
  • “This study finds clear evidence that there is no one best strategy. Any of the three, consciously pursued, can be successful.”

The end!