The Innovator's Solution: Creating and Sustaining Successful Growth (Creating and Sustainability Successful Growth)

by Clayton

sustaining innovation targets demanding, high-end customers with better performance than what was previously available. Some sustaining innovations are the incremental year-by-year improvements that all good companies grind out. Other sustaining innovations are breakthrough, leapfrog-beyond-the-competition products. It doesn’t matter how technologically difficult the innovation is, however: The established competitors almost always win the battles of sustaining technology. Because this strategy entails making a better product that they can sell for higher profit margins to their best customers, the established competitors have powerful motivations to fight sustaining battles. And they have the resources to win. Disruptive innovations, in contrast, don’t attempt to bring better products to established customers in existing markets. Rather, they disrupt and redefine that trajectory by introducing products and services that are not as good as currently available products. But disruptive technologies offer other benefits—typically, they are simpler, more convenient, and less expensive products that appeal to new or less-demanding customers.

Once the disruptive product gains a foothold in new or low-end markets, the improvement cycle begins.

And because the pace of technological progress outstrips customers’ abilities to use it, the previously not-good-enough technology eventually improves enough to intersect with the needs of more demanding customers.

Whereas the current leaders of the industry almost always triumph in battles of sustaining innovation, successful disruptions have been launched most often by entrant companies.

Does this mean that incumbents should focus on entering new, adjacent markets, rather than trying to launch something disruptive in their current market?

Disruption has a paralyzing effect on industry leaders. With resource allocation processes designed and perfected to support sustaining innovations, they are constitutionally unable to respond. They are always motivated to go up-market, and almost never motivated to defend the new or low-end markets that the disruptors find attractive. We call this phenomenon asymmetric motivation. It is the core of the innovator’s dilemma, and the beginning of the innovator’s solution.

For integrated producers, gross profit margins on rebar often hovered near 7 percent, and the entire product category accounted for only 4 percent of the industry’s tonnage. It was the least attractive of any tier of the market in which they might invest to grow. So as the minimills established a foothold in the rebar market, the integrated mills reconfigured their rebar lines to make more profitable products.

1979, when the minimills finally succeeded in driving the last integrated mill out of the rebar market. Historical pricing statistics show that the price of rebar then collapsed by 20 percent. As long as the minimills could compete against higher-cost integrated mills, the game was profitable for them. But as soon as low-cost minimill was pitted against low-cost minimill in a commodity market, the reward for victory was that none of them could earn attractive profits in rebar.6 Worse, as they all sought profitability by becoming more efficient producers, they discovered that cost reductions meant survival, but not profitability, in a commodity such as rebar.

As the minimills figured out how to make bigger and better steel and attacked that tier of the market, the integrated mills were almost relieved to be rid of the bar and rod business as well. It was a dog-eat-dog commodity compared with their higher-margin products, whereas for the minimills, it was an attractive opportunity compared with their lower-margin rebar.

Look for markets your competition wants to shed because they're too small in relation

Although you could never have predicted what the technical solution would be, you could predict with perfect certainty that the minimills were powerfully motivated to figure it out. Necessity remains the mother of invention.

innovator’s dilemma: Should we invest to protect the least profitable end of our business, so that we can retain our least loyal, most price-sensitive customers? Or should we invest to strengthen our position in the most profitable tiers of our business, with customers who reward us with premium prices for better products?

as large industry incumbents, they encounter powerful and predictable forces that motivate them to flee rather than fight when attacked from below.

That is why shaping a business idea into a disruption is an effective strategy for beating an established competitor. Disruption works because it is much easier to beat competitors when they are motivated to flee rather than fight.

forces that propel well-managed companies up-market are always at work, in every c...

when we use the term technology in this book, it means the process that any company uses to convert inputs of labor, materials, capital, energy, and information into outputs of greater value.

we do not argue against the aggressive pursuit of sustaining innovation.

Almost always a host of similar companies enters an industry in its early years, and getting ahead of that crowd—moving up the sustaining-innovation trajectory more decisively than the others—is critical to the successful exploitation of the disruptive opportunity.

this is the source of the dilemma: Sustaining innovations are so important and attractive, relative to disruptive ones, that the very best sustaining companies systematically ignore disruptive threats and opportunities until the game is over.

The theory of disruption suggests, however, that once they have developed and established the viability of their superior product, entrepreneurs who have entered on a sustaining trajectory should turn around and sell out to one of the industry leaders behind them.

This is common practice in the health care industry, and was the well-chronicled mechanism by which Cisco Systems “outsourced” (and financed with equity capital, rather than expense money) much of its sustaining-product development in the 1990s.

A sustaining-technology strategy is not a viable way to build new-growth businesses, however. If you create and attempt to sell a better product into an established market to capture established competitors’ best customers, the competitors will be motivated to fight rather than to flee.9 This advice holds even when the entrant is a huge corporation with ostensibly deeper pockets than the incumbent.

For example, electronic cash registers were a radical but sustaining innovation relative to electromechanical cash registers, whose market was dominated by National Cash Register (NCR). NCR totally missed the advent of the new technology in the 1970s—so badly, in fact, that NCR’s product sales literally went to zero. Electronic registers were so superior that there was no reason to buy an electromechanical product except as an antique. Yet NCR survived on service revenues for over a year, and when it finally introduced its own electronic cash register, its extensive sales organization quickly captured the same share of the market as the company had enjoyed in the electromechanical realm.10 The attempts that IBM and Kodak made in the 1970s and 1980s to beat Xerox in the high-speed photocopier business are another example. Th...

Similarly, corporate giants RCA, General Electric, and AT&T failed to outmuscle IBM on the sustaining-technology trajectory in mainframe computers. Despite the massive resources they threw at IBM, they couldn’t make a dent in IBM’s position. In the end, it was the disruptive personal computer makers, not the major corpor...

In the future, the most profitable growth in the airframe industry will probably come from firms with disruptive strategies, such as Embraer and Bombardier’s Canadair, whose regional jets are aggressively stretching up-market from below.11

An idea that is disruptive to one business may be sustaining to another.

recommend a strict rule: If your idea for a product or business appears disruptive to some established companies but might represent a sustaining improvement for others, then you should go back to the drawing board.

You need to define an opportunity that is disruptive relative to all the established players in the targeted market, or you should not invest in the idea.

For Dell, the Internet was a sustaining technology. It made Dell’s core business processes work better, and it helped Dell make more money in the way it was structured to make money. But the identical strategy of selling directly to customers over the Internet was very disruptive relative to Compaq’s business model, because that company’s cost structure and business processes were targeted at in-store retail distribution.

The theory of disruption would conclude that if Dell (and Gateway) had not existed, then start-up Internet-based computer retailers might have succeeded in disrupting competitors such as Compaq. But because the Internet was sustaining to powerful incumbents, entrant Internet computer retailers have not prospered.

A disruptive business model that can generate attractive profits at the discount prices required to win business at the low end is an extraordinarily valuable growth asset.

When a company tries to take a higher-cost business model down-market to sell products at lower price points, almost none of the incremental revenue will fall to its bottom line. It gets absorbed into overheads. This is why, as we discuss in chapter 7, established firms that hope to capture the growth created by disruption need to do so from within an autonomous business with a cost structure that offers as much headroom as possible for subsequent profitable migration up-market.

in doing what they must do, every company prepares the way for its own disruption. This is the innovator’s dilemma.

Innovator’s Dilemma showed that following a strategy of disruption increased the odds of creating a successful growth business from 6 percent to 37 percent.

Because the established company’s course of action is mandated so clearly, it is also clear what executives who seek to create new-growth businesses should do: Target products and markets that the established companies are motivated to ignore or run away from. Many of the most profitable growth trajectories in history have been initiated by disruptive innovations.

Our original dimensions—time and performance—define a particular market application in which customers purchase and use a product or service.

value network. A value network is the context within which a firm establishes a cost structure and operating processes and works with suppliers and channel partners in order to respond profitably to the common needs of a class of customers.

Within a value network, each firm’s competitive strategy, and particularly its cost structure and its choices of markets and customers to serve, determines its perceptions of the economic value of an innovation. These perceptions, in turn, shape the rewards and threats that firms expect to experience through disruptive versus sustaining innovations.14

The third dimension that extends toward us in the diagram represents new contexts of consumption and competition, which are new value networks. These constitute either new customers who previously lacked the money or skills to buy and use the product, or different situations in which a product can be used—enabled by improvements in simplicity, portability, and product cost. For each of these new value networks, a vertical axis can be drawn representing a product’s performance as it is defined in that context

refer to disruptions that create a new value network on the third axis as new-market disruptions

low-end disruptions are those that attack the least-profitable and most overserved customers at the low end of the original value network.

We say that new-market disruptions compete with “nonconsumption” because new-market disruptive products are so much more affordable to own and simpler to use that they enable a whole new population of people to begin owning and using the product, and to do so in a more convenient setting.

The personal computer and Sony’s first battery-powered transistor pocket radio were new-market disruptions, in that their initial customers were new consumers—they had not owned or used the prior generation of products and services. Canon’s desktop photocopiers were also a new-market disruption, in that they enabled people to begin conveniently making their own photocopies around the corner from their offices, rather than taking their originals to the corporate high-speed photocopy center where a technician had to run the job for them. When Canon made photocopying so convenient, people ended up making a lot more copies. New-market disruptors’ challenge is to create a new value network, where it is nonconsumption, not the incumbent, that must be overcome.

Although new-market disruptions initially compete against non-consumption in their unique value network, as their performance improves they ultimately become good enough to pull customers out of the original value network into the new one, starting with the least-demanding tier. The disruptive innovation doesn’t invade the mainstream market; rather, it pulls customers out of the mainstream ...

Because new-market disruptions compete against nonconsumption, the incumbent leaders feel no pain and little threat until the disruption is in its final stages. In fact, when the disruptors begin pulling customers out of the low end of the original value network, it actually feels good to the leading firms, because as they move up-market in their own world, for a time they are replacing t...

We call disruptions that take root at the low end of the original or mainstream value network low-end disruptions.

Disruptions such as steel minimills, discount retailing, and the Korean automakers’ entry into the North American market have been pure low-end disruptions in that they did not create new markets—they were simply low-cost business models that grew by picking off the least attractive of the established firms’ customers.

new-market and low-end disruptions both create the same vexing dilemma for incumbents. New-market disruptions induce incumbents to ignore the attackers, and lowend disrupti...

Low-end disruption has occurred several times in retailing.16 For example, full-service department stores had a business model that enabled them to turn inventories three times per year. They needed to earn 40 percent gross margins to make money within their cost structure. They therefore earned 40 percent three times each year, for a 120 percent annual return on capital invested in inventory (ROCII). In the 1960s, discount retailers such as Wal-Mart and Kmart attacked the low end of the department stores’ market—nationally branded hard goods such as paint, hardware, kitchen utensils, toys, and sporting goods—that were so familiar in use that they could sell themselves. Customers in this tier of the market were overserved by department stores, in that they did not need well-trained floor sales-people to help them get what they needed. The discounters’ business model enabled them to make money at gross margins of about 23 percent, on average. Their stocking policies and operating processes enable...

It is very hard for established firms not to flee from a ...

Retailers’ critical resource allocation decision is the use of floor or shelf space.