Book: Innovator’s Dilemma
Author: Clay Christensen
Christensen says upfront that this book is about failure of good companies, about how the decisions that got made in successful organizations sowed the seeds of their eventual failure.
PART I – Framework of the Dilemma: Why Great Companies Can Fail
There are three findings as part of the study of the failure framework:
(a) There is a distinction between sustaining technologies and disruptive technologies
Sustaining technologies improve the performance of established products along the dimensions of performance that are valued by mainstream customers in major markets. Most technological advances are sustaining in nature, and rarely do leading firms stumble because of mistakes made in advancing even the most challenging sustaining technology.
Disruptive technologies are often cheaper, simpler, smaller and frequently more convenient to use. There is also this prejudice that may be in people’s heads that disruptive technologies have to tough or advanced; this is not necessarily the case. A disruptive technology can be pretty easy on a technological basis–just not packaged in the same way before (and/or customers were not targeted in this fashion before).
Technology (and thus industry) leaders often slip when the next leg of the product innovation is driven by disruptive technologies (vs. sustaining technologies).
(b) Pace of the technological progress often times outstrip what the markets need
So as to make better products than competitors (and earn higher margins), suppliers often “overshoot” the market by giving customers more than they need, or are ultimately willing to pay for.
(c) Customers and financial structures of successful companies color the sort of investments that they find attractive. Disruptive products typically have –
- Lower margins: a disruptive product is often embraced by the least profitable customers in the market
- First commercialized in emerging/insignificant markets
- Most profitable customers don’t want (/can’t use) the new disruptive product
Thus, if you’re listening to your best customers, you will likely not invest in the new disruptive technology
Organizations and Managerial Explanation of Failure:
Henderson and Clark found that companies’ organizational structure typically facilitate component-level innovations, because most that’s how a company is organized. Companies fail where architectural change is required for success. Christensen seems to agree with this somewhat but still says that since the organization structure is after all designed so as to deliver the product that the customers want, this “direction of causality may ultimately reverse”.
Radical New Technology as as Explanation of Failure:
Again, Christensen says that this does seem like a factor on the face of it, evidence (at least in the disk drive industry that’s heavily profiled in the book) shows that if customers wanted a product, the companies somehow found a way to deliver it. There’s something called the “Technology S-Curve Framework” which predicts that if the current technology’s curve has passed the point of inflection, with the technology improving at a decreasing rate, when a new technology can emerge to supplant the established one, and if it does, it is disruptive for the previous leaders.
My personal thought on the two sets of explanations for the dilemma is that the these are likely more valid and plausible explanations if the speed of customer adoption is high, and the incumbents may be able to fight this if they have the luxury of time (due to adoption, contract terms etc.)
Value Networks as a Driver of Failure – Book’s Preferred Methodology:
Value network is the context within which the firm identifies and responds to customers’ needs. Within a value network, a company sets strategy to deliver on its perception of economic value. Each value network exhibits a very different rank-ordering of the various product attributes, even for the same product (e.g. disk drive performance is measured in terms of capacity and speed vs. ruggedness and low power consumption by the portable computing value network). As firms gain experience within a given network, they develop capabilities, organizational structures and cultures tailored to their value networks’ distinctive requirements. And over time, these decisions dictate the profit margins and to firms are loathe to move to different value network if a different cost structure is required, which is often a low-margin one (e.g. makers of 14-inch disk drives needed 50-60% gross margins but competing in the portable computer value network required a very different cost structure with gross margins in 15-20% range). Reasonable resource allocation processes are at the root of companies’ upward mobility and downward immobility across the boundaries of value networks.
The example cited in the book to depict how disruptive technology is not used by the large company is as follows:
- Disruptive technology is developed at established firms (rarely initiated by senior management)
- Marketing personnel sought reactions from lead customers, who will often show no interest. On top of this, these being low margin products, the firm’s analysts join the sales-people in shooting down the idea. (In a way, this makes sense. If you’re competing with a number of players in the existing technology, if you take your eyes off the current needs of the customers, you’re putting your existing business at risk, esp. if you’re pitching the new products to you existing customers. When looked at this way, it is easier to appreciate why people would be more focused on stealing share from the existing competitors for the existing primary business, as opposed to spending time and energy on a small developing, if at all, market.)
- Firms continues to funnel money into sustaining technology, even if it’s expensive because variables and needs are known
- New companies are formed and markets discovered by trial and error
- The entrants slowly move upmarket, challenging the established firms
- Established firms belatedly jump on the bandwagon to defend their base, often unsuccessfully, and then again, often while experiencing a severe price war.
Resource Allocation and Upward Migration
As we saw above, resources allocation ends up making the not ideal decision even though it is very reasonable. A big reason how this happens is the difference in models for resource allocation. The first model is is a rational top-down decision making process in which senior managers weigh alternative proposals for investments in innovation and puts $s in those projects, with the other proposals killed. In reality, the other model often wins out. In the second model, proposals to innovate are generated from deep within the organization, not from the top. As the ideas bubble up from the bottom, the middle-managers play a very important role but invisible role in screening the projects. These managers can’t throw their weight behind every project and they need to decide what’s best–what’s best for their careers. Their careers can get a big boost if they sponsor an important project but can be permanently derailed if they have the misfortune to backing project(s) that fail. Furthermore, if the project failed because the technologists couldn’t deliver is okay because at least the firm learned some new technologies. But, if the project failed because there was no market for it, it reflect extremely poorly on the middle manager. Hence, these managers back projects for which market demand is most assured. Thus, while senior managers may think that they make resource allocation decisions, many critical decisions are being made by the middle-managers.
We also need to remember that best resource allocation systems are designed to weed out ideas that are unlikely to find (a) large (b) profitable, (c) receptive markets. A company that doesn’t have this, will fail to begin with. In fact, such a set of processes is one of the most important achievements of a well-managed company.
On the flip side, this rational pattern of upmarket movement is that it can create vacuum in the low-end value networks that draw in entrants with technologies and cost structures better suited to competition. For example, in the steel industry in the ’80s, the large mills were happy to cede the bar and beam business to mini-mills and cut their own costs (mini-mills couldn’t compete in a sheet metal rolling mill business because it cost $2 bn to put up a cost competitive factory).
PART 2 – How to Resolve the Dilemma
To resolve the dilemma, companies must understand the following principles –
1. Companies Depend on Customers and Investors for Resources: Companies with investment patterns that don’t satisfy the needs of their customers and investors will not survive (at least in the current form). Thus, companies often find it difficult to invest in disruptive technologies. Companies that have been successful in doing this typically have an autonomous organization within, charged with building a new and independent business around the disruptive technology.
This way the new small organization can get excited small opportunities and small wins. If not, it would take enormous amounts of energy and time to secure adequate resources to focus on the new technology. IBM was successful in personal computing because it created an autonomous organization in FL, away from its NY headquarters to work on the market, and allowed to be free to succeed along metrics of success that are relevant in the personal computing market. Two models for how to make money cannot peacefully co-exists within a single organization.
Customers also impact the resource allocation decisions of the non-executive participants. Their decisions on which projects to propose to senior management, tied with the idea of what these could do their individual career trajectories exert a powerful influence on the process of resource allocation, and thus innovation.
Disruptive products re-define the dominant distribution channels because dealers’ economics are powerfully shaped by the mainstream value network, and often it is impossible to introduce disruptive products through existing dealer networks.
2. Small Markets Don’t Solve the Growth Needs of Large Companies: This is why large companies often end up waiting for the markets to become big enough, but this is often not a successful strategy. Growing companies need to add increasingly large chunks of new revenue to maintain their desired growth rate, and it becomes less and less possible for them to find these chunks of revenue with small markets as the vehicle. But, we need to remember that leadership in disruptive technologies is very important. Given that, organizations competing in these small niche markets must be profitable at a small scale, which is why it is critical to have a small autonomous entity doing this work (vs. the mothership).
3. Markets that Don’t Exist Can’t Be Analyzed: A lot of variables related to sustaining technologies are known and thus can be analyzed and planned for. This is impossible to do for disruptive technologies, but this is often where first-mover advantages lie (personally, not sure how much of this last statement is true).
4. An Organization’s Capabilities Define its Disabilities: It’s often not the people, but processes and values that define an organization’s capabilities. Three class of factors affect what an organization can and cannot do–(a) resources–things, including people, that can be hired and fired, (b) processes and (c) values.
Processes are both formal and informal, defined or evolved, and can exist for manufacturing, product development, market research, budgeting, planning, employee development and compensation, and resource allocation. Now, by their very nature, they are established so that employees can perform recurrent tasks in a consistent way, time after time. Thus, they are by definition, inimical to change. Furthermore, the processes that are not very visible (how market research is done, how plans and budgets are negotiated etc.) are where many organizations’ most serious abilities/disabilities lie. Processes are very hard to change (organization boundaries are drawn to help operate the processes, and if there are new cross-functional processes, it’s difficult to make that work). Plus, the reason that the processes presumably exist is because they work fine as is–they’re not meant to change.
Values of an organization are the criteria by which decisions about priorities are made. 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/business model of the company. In fact, this is one of the defining metrics of good management.
In the start-up stages of an organization, much of what gets done is attributable to its resources–its people, and over time, this shifts to the organization’s processes and values. Thus, for the new independent org, it is useful to employ some of the resources of the parent org but not its processes or values.
5. Technology Supply May Not Equal Market Demand: When performance of competing products improve beyond what the market demands, customers no longer base their choice upon what’s the higher performing product–it evolves from functionality to reliability to convenience and then ultimately to price. Often the new orgs have to find new markets to commercialize their products. And when there are no new markets, companies migrate unconsciously to the north-east, setting themselves up for a change in the basis of competition and an attack from below by disruptive technology.