disruption and your business

Disruptive innovation: Opportunity and Barriers

Enabling disruption within existing businesses

July, 2012

2the forum for growth and innovation

Who we are…

The Forum for Growth and InnovationThe Forum for Growth and Innovation

The Forum for Growth and Innovation is a research initiative funded by the Harvard Business School and guided by Professor Clayton Christensen, the Kim B. Clark Professor of Business Administration and one of the world’s top experts on growth and innovation. The goal of the Forum is to discover, develop and disseminate robust, accessible theory in the areas of innovation and general management. In pursuit of this goal, the Forum both hosts conferences to bring together academic experts and leading practitioners to develop current ideas and engages in extensive publishing activities.

Each year, the Forum invites a few highly qualified MBA graduates to engage in a yearlong fellowship program. The Fellows collaborate with Professor Christensen on theory development intended for publication in The Harvard Business Review and in other leading business journals.


Part 1: An Overview of Disruptive Innovation


Executive summary

Innovation is well recognized as the key ingredient to driving investor returns• A 2005 Deloitte and BCG study suggested that 73% of TSR was derived from revenue

growth and expected revenue growth• Despite its importance, innovation remains a poorly understood phenomenon within

management

In fact, innovation can be best understood when it is re-categorized• Certain innovations rely on technological change, others business model change• Certain innovations are systematically rejected by corporations, others are embraced

Today’s discussion will focus on enabling those innovations traditionally rejected by established corporation

• These ‘disruptive’ innovations share similar qualities and can drive transformational growth• Understanding why these innovations are rejected by most organizations is the key to

developing an organizational structure to enable these sorts of innovation


The Question

How, in a world where large organizations are led by the best trained managers, are equipped with the most technologically advanced resources, and maintain

relationships with industry’s most valuable customers, do startups emerge time and time again?


What is a disruptive innovation?

Disruptive innovation’s three components:

1) Introduces a product or service into an industry, competing in a fundamentally different manner than previous competitors

• Disruptive innovations reject the standard metrics of industry performance, often performing far worse than incumbent products when entering markets

2) Maintains a business model or technological advantage that scales over time• In addition to competing differently, disruptive innovations maintain scalable

business model advantages that allow them to compete in ways that could not be mimicked by incumbent competitors

3) Cannot be integrated with the existing profit model of incumbent firms• In the manner in which they are commercialized, disruptive innovations cannot

be integrated into the profit models of existing firms

The three characteristics of a disruptive innovationThe three characteristics of a disruptive innovation

1

2

3


The cycle of disruption, illustrated

Incumbents nearly always win

Disruptors nearly always win

Sustaining

Disruptive

Customer Desire

Pro

du

ct P

erfo

rma

nce

Time


Disruptive innovation BeforeDescription

Retail health clinics $5603• Over the past 2 decades, retail health clinics have emerged to offer basic healthcare services w/out expensive overhead of primary care offices

Personal computing ~$120-160K1• In the late 1970’s, companies arose to manufacture computers using existing, modular, technical components, thereby decreasing cost of production

Mobile digital learning 100M w/outaccess toeducation

• Educational platforms being developed to provide access to the more than 100M children that do not attend school across the globe

Disruptive waves tend to transform industries

After

$1103

~$1.3K2

N/A

Disruption brings services to more customers by dramatically reducing costs and increasing accessibility

1) DEC VAX 11/780 Computer Specifications. ed-thelen.org/comp-hist/vax-11-750. Accessed 6/15/20122) The Encyclopedia of Consoles, Handhelds, & Home Computers, pg. 19

3) Comparing Costs and Quality of Care at Retail Clinics… Annals of Internal Medicine, Sept 2009, pg. 324


Disruption is not equivalent to new technology

Incremental improvements to existing technologies

Integrate seamlessly with legacy formats

Example:• A traditional engine that generates 20%

more horsepower than its predecessor

Technological innovation that bypass the existing paradigm; often cited as a step-

change

Can or cannot integrate with legacy formats

Example:• An solar engine that generates 20% more

horsepower than its gasoline predecessor

Dis

co

nti

nu

ou

sC

on

tin

uo

us

Categorization of tech innovation

Dis

rup

tive

Su

stai

nin

g

Categorization of competitive innovation

Innovations that integrate with the profit models of incumbent firms

Can be derived from either continuous or discontinuous innovation

Example:• A solar engine integrated into a Ford

coupe and priced at a premium

Innovations that do not integrate with profit models of incumbent firms

Often lower quality to existing products, but cheaper and more accessible

Example:• An solar engine used to power a cheap,

around-town bicycle for city commuters


Inherent to every disruption is an “extendable core”

Disruption is not merely price competition• Disruptive innovation’s predictability is derived from an advantage that scales over time• Disruptive businesses advantage will allow them to make tradeoffs unavailable to

incumbent firms– For example, the use of standard components in the personal computer allowed

manufacturers to maintain price advantages over mini-computers even as they approached parity on processing power

An illustration –

Luxury vacation rentals Low-priced vacation rentals Disruptive vacation rentals

A lower-priced hotel chain• To compete with the Four

Seasons, the Best Western would have to adopt the competitors cost structure

A facilitated network• To compete with the four

seasons, AirBnB would only need to sign up more affluent users


Why are disruptive innovation’s interesting?

Customer Value Business Interest

Maximize personal utility

• Inherently a balancing act – budget constrained

• Incentivized to spend less on solutions to free capital

Unconcerned with how a problem is solved

• Parity between products and services that solve identical problems

Maximize return to existing assets

• Leverage customers

• Leverage existing resources

• Leverage talent• Secure marginal

price increases

Maximize investments in additional assets

• Devote investment dollars to areas that will generate largest returns to shareholders

Normally these interests are aligned, in instances of disruption, they are not necessarily

aligned


Despite opportunity, disruptions don’t appear appealing to incumbents

Cannibalization• The fear of revenue cannibalization often deters managers from pursuing disruptive

opportunities• Xerox PARC saw the opportunity for smaller, cheaper, copiers, but avoided

development to avoid revenue cannibalization – Ultimately Ricoh and Cannon entered to capture share from Xerox

Reduced Marginal Profitability• Many disruptive products capture lower profitability due to their reduced performance levels

• In developing the Alto, Xerox management saw a failure in a product that would not garner the 60% margins of computing competitors such as DEC and Data General

Initially, Small in Market Scope• Disruptive innovations tend to follow the standard adoption curve – investors must be

patient for revenue and profit growth

A key question: Disruptive to who?


Nor do they appear appealing to existing buyers

“If I had asked people what they wanted, they would have said a faster horse”

Lo

w-e

nd

dis

rup

tio

nN

ew-m

ark

et

dis

rup

tio

n

Low-end disruptions apply new business models or technologies to aid in the delivery of products in existing markets

• E.g., Mini-mill steel producers sold commodity steel, for use in existing markets, with a novel process to allow their entry into the low-end of the market

• Demanding customers with high willingness to pay for products are not interested in low-end disruptions

New market disruption introduces products and services that make products and services available to those without existing access

• E.g., Smart phones, introduced to provide computing power on the go, initially appealed to those looking for connectivity where existing solutions didn’t exist

• These products and services tend to underperform existing industry offerings in such a way that they are not viewed as competitive threats at all


But disruption is predictable…

For Incumbent FirmsFor Incumbent Firms Disruptive FirmsDisruptive Firms

Retreat will look more appealing than direct competition

• When opportunity exists to spread fixed costs across higher margin customers, retreat will look more profitable on the margin

Over time, improvements in disruptive technologies will force competition or acquisition

• De-risked businesses will be expensive on acquisition

• Rose Park Advisors studies suggest disruptive businesses consistently command P/E multiples between 20-30

Entrants will consider lower margin customers appealing

• Lowest-end of existing markets will look appealing and profitable to start-ups with no existing revenue and flexible business models

Once growth becomes limited, profit incentive will lead entrants to invest in product improvement

• If technology can be improved to satisfy additional players, it will be

Scalable advantages will allow disruptive entrants to steal share by offering by offering

&


If you do everything right, everything goes wrong

“The principles of good management – like the principles we teach here at Harvard Business School – are exactly what lead to

success being so hard to sustain”


Part 2: Overcoming the organizational challenge


Developing disruptive businesses is unnatural, but possible

Key to developing an organization capable of disruptive innovation is acknowledging the inherent limitations of legacy businesses

• Good business practices will restrict disruptive opportunity

Leveraging disruption to achieve transformative growth requires…• Long time horizons• Willingness to fail• Desire to serve new customers• Recognition that the best ways of completing a task today will not be the best ways of

completing that task in the future

“The customer rarely buys what the company thinks it’s selling” – Peter Drucker


As firms mature, they naturally shift focus from discovery to operational excellence

Groupfocus Discovery Growth Operations

Maturity

Rev

enu

e

Goal of developingan appealing

value proposition

Goal of developingamassing resources

and deliveringvalue to customers

Goal of creating processesand corporate culturethat allow the firm to

maximize profit over time

A simplified product lifecycle


The business model framework

PROCESSES:

Ways of working together to address recurrent tasks in a

consistent way: training, development, manufacturing,

budgeting, planning, etc.

PROFIT FORMULA:

Assets & fixed cost structure, and the margins & velocity

required to cover them

THE VALUE PROPOSITION:

A product that helps customers do more effectively, conveniently

& affordably fulfill a need

RESOURCES:

People, technology, products, facilities, equipment, brands, and cash that are required to

deliver this value proposition to the targeted customers


With unknown value proposition, business model must be in flux

Build

MeasureLearn

Cycle of entrepreneurial iteration…Cycle of entrepreneurial iteration……must occur prior to process codification

…must occur prior to process codification

Goal

Discovery

Growth

Pro

ce

ss

Co

dific

atio

nV

alu

e

Entrepreneurial endeavor requires aprocess of learning to identify value

proposition and de-risk scalable product

Once understanding of value proposition issolidified, resources can be scaled and processes

and priorities developed effectively


As firms shift to operational excellence, resources, processes, and priorities solidify

Reduction in operational risk comes from codifying processes• Decrease individual control in product creation, leading to product predictability• Standardization of reporting and accounting systems allows control despite growth• Adoption of uniform production techniques leads to economies of scale

This shift is perfectly sensible at the level of the business unit• Maximize profit given an existing product base• Leverage existing resources most efficiently• Listen and respond to valuable customers

However, failures to innovate arise when firms allocate resources in the same way at the corporate level as they would otherwise allocate resources at the business unit level

• Instead, there must be a switch to enable simultaneous disruptive discovery and sustaining operations


Unfortunately, discovery is vital to renewal & growth

Group 1

Group 2

Discovery Growth Operations

Discovery Growth Operations

Maturity

Rev

enu

e

Conflicting focus demandsdistinct organizational

structure

A simplified corporate lifecycle

Requires ever-increasing product development to

achieve continuedgrowth


Resources, processes, and priorities interfere with the ability to capture disruptive opportunity

Example Description

Blockbuster • Blockbuster’s existing resource base – primarily stores – made the cannibalization available through online distribution unacceptable

Problem with…

Resources

Xerox PARC Priorities

Sonosite Processes

• Xerox’s role out of its front office products was ultimately abandoned, in accordance with the prioroties of the executive team

• After inventing the personal computer, the mouse, the graphic user interface, the laser printer, and ethernet ports

• Sonosite almost failed under legacy leadership• The sales processes favored high commission

products, the antithesis of the cheap handheld sonogram

Any misalignment can cause disruptive businesses to fail


Examples of everyday RPP in the way of disruptive growth

Resources

Processes

Priorities

Existing manufacturing facilities• Existing facilities often change consideration on the marginal value of investment in disruptive

opportunities – decisions tend to inaccurately forecast the pace of technological change

Existing talent• People familiar with process or technology will systematically overvalue its need in a system

Customer surveys and other feedback mechanisms• People always want more for equivalent prices – surveys, interviews, call lines, etc. will always

point out opportunities for improvement within service delivery

Scripted sales and marketing interactions • Often these processes encourage up-selling and draw focus from disruptive products

Poorly structured corporate values systems• Value systems often direct managers and line employees to define corporate identity based on

industry or expertise instead of


Developing an organization capable of disruptive growth requires a solution to this paradox

The Goal: Take advantage of existing strengths without falling victim to their weaknesses

Create RPP agnostic disruptive business units• Business units must have the freedom to

experiment, fail, pursue new customers, and compete with existing units

Assume high growth of disruptive entrants within financial models

• Conservative assumptions often impair predictions surrounding cannibalization and value of legacy assets

Create a market for resources• Legacy business units and internal “start-ups” must

have different evaluation metrics within the market to reflect their differing payoff natures

Utilize independent sales forces• Once disruptive products have been developed, it is

vital to create independent sales forces with interests aligned with disruptive

Base product design off of more than customer requests

• Look to both non-consumption and lowest value customers as sources of information

• Distill job-to-be-done wherever possible

Implement Activity-Based-Costing• Ensure that all relevant costs are embedded in

financial analysis and that depreciation schedules are accurate

Best practices in satisfying this goalBest practices in satisfying this goal


It’s an uphill battle, but strategic renewal is possible

Recognizing the commoditization of silicon products, Dow Corning engaged in business model innovation

• Simplifying product line and automating sales of standard products

While exploring sustaining innovations to their floor cleaners, Proctor & Gamble realized that soap was the wrong product

• Improved upon the ‘wet paper towel’ to disrupt floor cleaners

After a decade of subsidizing book sales to build a distribution network and achieve cost leadership, Amazon turned to digital

• Lower margin dollars, higher volume and market share

In 2010, Apple released the iPad in a direct attempt to cannibalize market share from the laptop category

• “If someone is going to cannibalize the market, it should be us”

With leadership support and patience, disruptive innovation can lead to amazing growth businesses


Part 3: Key questions to guide discussion


Key Questions

Disruptive to who?• How do we define white space?• How do we define boundaries?

How do we create R.P.P. independence?• Who needs to be bought in?

• Leadership? Public investors? Board?• Where do the disruptive organizations sit?• What resources should they draw upon, what should they avoid?

How can we effectively allocate resources?• What are the appropriate • What human capital needs must we satisfy?

• Do we have to go outside of the organization?

disruption and your business

Technology