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

by Clayton

One option for department store executives was to allocate more space to even higher-margin cosmetics and high-fashion apparel, where gross margins often exceeded 50 percent. Because their business model turned inventories three times annually, this option promised 150 percent ROCII.

The alternative was to defend the branded hard goods businesses, which the discounters were attacking with prices 20 percent below those of department stores. Competing against the discounters at those levels would send margins plummeting to 20 percent, which, given the three-times inventory turns that were on average inherent in their business model, entailed a ROCII of 60 percent. It thus made perfect sense for the full-service d...

Many disruptions are hybrids, combining new-market and lowend approaches, as depicted by the continuum of the third axis in figure 2-3. Southwest Airlines is actually a hybrid disruptor, for example. It initially targeted customers who weren’t flying—people who previously had used cars and buses. But Southwest pulled customers out of the low end of the major airlines’ value network as well. Charles Schwab is a hybrid disruptor. It stole some customers from full-service brokers with its discounted trading fees, but it als...

disruption is a primary wellspring of growth.

prevalence of Japanese companies such as Sony, Nippon Steel, Toyota, Honda, and Canon in the period between 1960 and 1980 and the absence of disruptive Japanese companies in the 1990s, for example, explain a lot about why Japan’s economy has stagnated.

Japan’s economic system inhibits the creation of new waves of disruptive growth, in part because they might threaten those companies today.

The chart also shows that disruption is an ongoing force that is always at work—meaning that disruptors in one generation become disruptees later.

The Ford Model T, for example, created the first massive wave of disruptive growth in automobiles. Toyota, Nissan, and Honda then created the next wave, and Korean autom...

AT&T’s wireline long distance business, which disrupted Western Union, is being disrupted by wireless long distance. Plastics makers such as Dow, DuPont, and General Electric continue to disrupt steel, even as their low end is being eaten ...

few technologies or product ideas are inherently sustaining or disruptive when they emerge from the innovator’s mind. Instead, they go through a process of becoming fleshed out and shaped into a strategic plan in order to win funding. Many—but not all—of the initial ideas that get shaped into sustaining innovations could just as readily be shaped into disruptive business plans with far greater growth potential. The shaping process must be consciously managed, however, and not left to the dispersed and instinctive decisions of those who write business plans.

Executives must answer three sets of questions to determine whether an idea has disruptive potential.

The first set explores whether the idea can become a new-market disruption. For this to happen, at least one and generally both of two questions must be answered affirmatively: Is there a large population of people who historically have not had the money, equipment, or skill to do this thing for themselves, and as a result have gone without it altogether or have needed to pay someone with more expertise to do i...

If the technology can be developed so that a large population of less skilled or less affluent people can begin owning and using, in a more convenient context, something that historically was available only to more skilled or more affluent people in a centralized, inconvenient location...

The second set of questions explores the potential for a low-end disruption. This is possible if these two questions can be answered affirmatively: Are there customers at the low end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price? Can we create a business model that enables us to earn attractive prof...

Often, the innovations that enable low-end disruption are improvements that reduce overhead costs, enabling a company to earn attractive returns on lower gross margins, coupled with improvements in manuf...

Once an innovation passes the new-market or low-end test, there is still a third critical question, or litmus test, to answer affirmatively: Is the innovation disruptive to all of the significant incumbent firms in the industry? If it appears to be sustaining to one or more significant players in the industry, then...

If an idea fails the litmus tests, then it cannot be shaped into a disruption. It may have promise as a sustaining technology, but in that case we would expect that it could not constitute the b...

Dimension Sustaining Innovations Low-End Disruptions New-Market Disruptions Targeted performance of the product or service Performance improvement in attributes most valued by the industry’s most demanding customers. These improvements may be incremental or breakthrough in character. Performance that is good enough along the traditional metrics of perform- ance at the low end of the mainstream market. Lower performance in“traditional” attributes, but improved performance in new attributes— typically simplicity and convenience. Targeted customers or market application The most attractive (i.e., profitable) customers in the mainstream markets who are willing to pay for improved performance. Overserved customers in the low end of the mainstream market. Targets non- consumption: customers who historically lacked the money or skill to buy and use the product. Impact on the required business model (processes and cost structure) Improves or maintains profit margins by exploiting the existing processes and cost structure and making better use of current competitive advantages. Utilizes a new operating or financial operating or financial different combination of lower gross profit margins and higher asset utilization that can earn attractive returns at the discount prices required to win business at the low end of the market.

To trap Hewlett-Packard in an innovator’s dilemma, Xerox should develop a business model that’s attractive to Xerox but unattractive to the managers of HP and other leading established printer companies.

We would predict defeat if Hitachi tried to enter this market with a quieter product that offered more features and better energy efficiency.

Employing low-cost labor constitutes a low-cost business model only until competitors avail themselves of the same option.

new-market disruption, however? There are hundreds of millions of nonconsumers of residential air conditioning in China, who have been blocked from that market because the power-hungry, expensive machines that historically have been available don’t fit in the average family’s pocketbook or apartment. If Hitachi could design a $49.95 product that would easily slip into the window of a cramped Shanghai apartment and reduce the temperature and humidity in a ten-foot by ten-foot room with ten amps of current, things might get interesting—because once Hitachi had a business model that could make money at that price point, taking on the rest of the up-market world would be easy. Parenthetically, while Western executives are understandably concerned about the threat that low-cost manufacturing in China poses to them, our guess is that China’s greatest competitive asset is the unfathomable amount of nonconsumption in its markets, which makes them fertile ground for new-market disruptive companies of many sorts.

Because the idea likely does not satisfy the conditions for either a new-market or a low-end disruption, Internet banking is likely to be implemented as a sustaining innovation by established banks. As for the third test, there already are many banks and credit unions, with only a limited number of office locations, that transact much of their business by mail. Internet banking would have a sustaining impact on their business models.

Disruption is a theory: a conceptual model of cause and effect that makes it possible to better predict the outcomes of competitive battles in different circumstances. The asymmetries of motivation chronicled in this chapter are natural economic forces that act on all businesspeople, all the time. Historically, these forces almost always have toppled the industry leaders when an attacker has harnessed them, because disruptive strategies are predicated upon competitors doing what is in their best and most urgent interest: satisfying their most important customers and investing where profits are most attractive. In a profit-seeking world, this is a pretty good bet. Not all innovative ideas can be shaped into disruptive strategies, however, because the necessary preconditions do not exist; in such situations, the opportunity is best licensed or left to the firms that are already established in the market. On occasion, entrant companies have simply caught the leaders asleep at the switch and have succeeded with a strategy of sustaining innovation. But this is rare. Disruption does not guarantee success: It just helps with an important element in the total formula. Those who create new-growth businesses need to get on the right side of a number of other challenges, to which we will now turn.

Amazon.com A low-end disruption relative to traditional bookstores.

Bell Telephone Bell’s original telephone could only carry a signal for three miles and therefore was rejected by Western Union, whose business was long-distance telegraphy, because Western Union couldn’t use it. Bell started a new-market disruption, offering local communication, and as the technology improved, it pulled customers from telegraphy’s long-distance value network into telephony.

Bloomberg began by providing basic financial data to investment analysts and brokers. It has gradually improved its data offerings and analysis and subsequently moved into the financial news business. It has substantially disrupted Dow Jones and Reuters as a result. More recently it has created its own elecronic clearing network to disrupt stock exchanges. Issuers of government securities can auction their initial offerings over the Bloomberg system, disrupting investment banks.

Until the early 1980s, when people needed photocopies, they had to take their originals to the corporate photocopy center, where a technician ran the job for them. He had to be a technician, because the high-speed Xerox machine there was very complicated and needed servicing frequently. When Canon and Ricoh introduced their countertop photocopiers, they were slow, produced poor-resolution copies, and didn’t enlarge or reduce or collate. But they were so inexpensive and simple to use that people could afford to put one right around the corner from their office. At the beginning people still took their high-volume jobs to the copy center. But little by little Canon improved its machines to the point that immediate, convenient access to high-quality, full-featured copying is almost a constitutional right in most workplaces today.

Sears, Roebuck and Montgomery Ward took root as catalog retailers—enabling people in rural America to buy things that historically had not been accessible. Their business model, entailing annual inventory turns of four times and gross margins of 30 percent, was disruptive relative to the model of full-service department stores, which required 40 percent gross margins because they turned inventories only three times annually. Sears and Montgomery Ward later moved up-market, building retail stores.

Started in 1975 as one of the first discount brokers. In the late 1990s Schwab created a separate organization to build an online trading business. It was so successful that the company folde...

Disrupted the consumer electronics departments of full-service and discount department stores, which has sent them up-m...

Founded by Kaplan, a unit of the Washington Post Company, this online law school has attracted a host of (primarily) nontraditional students. The school’s accreditation allows its graduates to take the California Bar exam, and its graduates’ success rate is comparable to those of many other law schools. Many of its students don’t enroll to become lawyers, however. They want to understand law to help them succeed in other careers.

Dell’s direct-to-customer retailing model and its fast-throughput, high asset-turns manufacturing model allowed it to come underneath Compaq, IBM, and Hewlett-Packard as a low-end disruptor in personal computers. Clayton Christensen, the quintessential low-end consumer, wrote his doctoral thesis on a Dell notebook computer purchased in 1991 because it was the cheapest portable computer on the market. Because of Dell’s reputation for marginal quality, students needed special permission from Harvard to use doctoral stipend money to buy a Dell rather than a computer with a more reputable brand. Today Dell supplies most of the Harvard Business School’s computers.

The fixed cost and skill required to make a full-length animated movie historically was so high that almost nobody could do it except Disney. Digital animation technology now enables far more companies (such as Pixar) to compete against Disney.

Department stores such as Korvette’s in New York, and later Kmart, Wal-Mart, and Target, disrupted full-service department stores. The discount stores made money by accelerating inventory turns to five times per year, which enabled them to earn attractive profit with 23 percent gross margins. Because their salespeople were much less knowledgeable about products, at the outset the discount department stores had to start at the simplest end of the merchandise mix, with branded hard goods that were so familiar in use that they sold themselves. They subsequently have moved up-market into soft goods such as clothing.

eBay was a notable exception because it pursued a new-market disruptive strategy—enabling owners of collectibles that could never turn the heads of auction house executives to sell off things that they no longer needed.

E-mail is disrupting postal services. The volume of personal communication that is done by letter is dropping precipitously, leaving postal services with magazines, bills, and junk mail.

We normally think of disruptive technologies as being inexpensive, and many people are puzzled at how we could call flat-panel displays disruptive. Haven’t they come from the high end? Actually, no. Flat-panel LCD displays took root in digital watches and then moved to calculators, notebook computers, and small portable televisions. These were applications that historically had no electronic displays at all, and LCD displays were much cheaper than alternative means of bringing imaging to those applications. Flat screens have now begun invading the mainstream market of computer monitors and in-home television screens, disrupting the cathode ray tube. They are able to sustain substantial premium prices because of their two-dimensional character.

Google and its competing Internet search engines are disrupting directories of many sorts, including the Yellow Pages.

Whereas the established industry leaders in accounting software enabled small-business managers to run all sorts of sophisticated reports for analytical purposes, QuickBooks, which was a derivative of Intuit’s personal finance software product Quicken, basically helped them keep track of their cash. It created a huge new market among very small business owners (most with fewer than five employees) who historically did not keep their books on computer. Within two years of launch, Intuit had seized 85 percent of the small-business accounting software market—mainly by creating new growth. The stealing of the established companies’ customers came later, as QuickBooks’ functionality improved.

PC-based accounting software is disrupting personal tax preparation services such as H&R Block.

Whereas Southwest Airlines initially followed a strategy of new-market disruption, JetBlue’s approach is low-end disruption. Its long-range viability depends on the major airlines’ motivation to run away from the attack, as integrated steel mills and full-service department stores did.

Until the late 1800s, photography was extremely complicated. Only professionals could own and operate the expensive equipment. George Eastman’s simple “point and shoot” Brownie camera allowed consumers to take their own pictures. They could then mail the roll of film to Kodak, which would develop it and return the photos by mail.

Kodak’s Funsaver brand single-use camera was born after painful labor within Kodak, because its profit model and gross margins were lower than Kodak could earn by selling roll film, and the quality of the images was not as good as those taken in high-quality 35mm cameras. But Kodak commercialized it through a different division, and it sold almost exclusively to people who would not have bought film anyway because they didn’t have a camera. Although it has potential to move up-market and tak...

The fast food industry has been a hybrid disruptor, making it so inexpensive and convenient to eat out that they created a massive wave of growth in the “eating out” industry. Their earliest victims were mom-and-pop diners. In the last decade the advent of food courts has taken fast food up-market. Expensive, romantic restaurants still thrive at the high end, of course.

Enabled by electronic ticketing, online travel agencies such as Expedia and Travelocity have so badly disrupted full-service, bricks-and-mortar agencies such as American Express that many airlines have dramatically cut the substantial commissions that historically they had paid to travel agencies.

This company, with its inexpensive, simple, Internet-based system, is disrupting the leading providers of customer relationship management software, such as Siebel Systems.

Sony pioneered the use of transistors in consumer electronics. Its portable radios and portable televisions disrupted firms such as RCA that made large TVs and radios using vacuum tube technology. During the 1960s and 1970s, Sony launched a series of new-market disruptions, with products such as videotape players, handheld consumer video recorders, cassette tape players, the Walkman, and the 3.5-inch floppy disk drive.

It was a hybrid disruptor because its original strategy was to compete against driving and buses and to fly in and out of nonmainstream airports. In addition, because its prices were so low, it also took business from established airlines. Just as Wal-Mart enjoys profit protection from being in small towns whose market can support only one discount store, many of Southwest’s routes offer the same protection.

Cellular and digital wireless phones have been on a disruptive path against wireline phones for twenty-five years. Initially they were large, power-hungry car phones with spotty efficacy, but gradually they have improved to the point where, by some estimates, nearly one-fifth of mobile telephone users have chosen to “cut the cord” and do without wireline telephone service. The viability of the wireline long-distance business is now in jeopardy.