DisruptiveInnovation.Org - Defining Disruption

How disruption theory has evolved and where it is headed


Theory of Disruptive Innovation: A Summary

Disruption occurs at the intersection of two trajectories of improvement in most markets. One of these trajectories measures the rate of improvement that customers are able to utilize in their lives. The second is a different trajectory of improvement that innovating companies provide as they strive to make better and better products. Usually, but not always, the trajectory of performance improvement by the company exceeds their customers’ abilities to utilize the improvement. This means that a product’s performance that is not good enough for what customers need at one point, is likely to offer more than what those customers are able to use at another point in time.

Innovations – whether incremental or breakthrough – that help companies make better products that they can sell for greater profits to their best customers we call sustaining innovations. These innovations make good products better. These innovations are the engines that drive companies up-market, along the second of the trajectories described in the preceding paragraph.

There is another type of innovation that we call disruptive. These are not as good as the sustaining innovations described above. But because of their simplicity and affordability, disruptive innovations give entrée to a larger population of customers that historically had not been able to buy and use a product or service.

Disruptive innovators do not try to sell their products to customers who are using sustaining innovations – because the products can’t compete. They sell to customers at the bottom of the market, often whose alternatives are nothing at all.

In this diagram we have described these two trajectories and the innovation needs that drive them along these trajectories. Note that sustaining innovators are continuously at their work. Disruptive innovations are more akin to a discrete event, in which innovators create new markets and new customers at the bottom. Then from that foothold, they seek to improve their simple and affordable products using sustaining innovations of their own. Whether an innovation is sustaining or disruptive can only be expressed relative to other products and competitors, or relative to what was available in the past.

Trajectories

What defines the steepness of these trajectories? The first trajectory is determined by how quickly our lives can change so that we can use better products. My ability to use a faster laptop computer in typing documents for example, is limited by how fast my brain can compose sentences and how fast my fingers can move accurately. On the other hand, occasionally have needed to create a model of an industry. In the diagram, that application would be represented by a parallel trajectory to the word processing trajectory, but at a higher level of need. This requires a much more capable computer. But in that application, too, my ability to use more computing power is limited by my understanding of statistical tools, and so on.

In a similar way, Tesla’s best electric cars in 2015 go from zero to 60 miles per hour in 3.2 seconds. That excites us. But our ability to utilize Tesla’s improvement is limited by congestion, traffic laws, and the laws of inertia and deceleration, and so on.

When these trajectories are essentially flat and do not intersect, then the disruption does not occur in a market. As we describe in Figure 2, the trajectory of improvement that innovating companies in this situation can offer is flat. Indeed, the trajectory of performance improvement can vary by industry. When its trajectory is steep, disruption can happen very fast, as was the case in disk drives. When the slope is more shallow, disruption occurs at slower rates – as happened in steel and in retail stores. And when the slope of the trajectory approaches flatness, disruption does not occur.

Technology and business models can steepen the slope of this trajectory – as has recently happened in the hotel and higher education industries. So, for example, for centuries the trajectory of improvement in higher education was flat. There was no technological core that could propel a community college into competition with CalTech. There was no disruption in that industry – they competed by emulation better universities, on the sustaining trajectory, needing to beat the incumbents at their own game. Universities could reposition themselves higher in the market, but it has been a very costly game.  Now, however, online learning has brought a technological driver to higher education. And as depicted in Figure 2.2 disruption has now begun.

At the beginning of this industry the leaders could only position their colleges only at the positions where they competed against other colleges in a similar situation of market and prestige. If they wanted to compete against higher-end colleges, they had to emulate the programs, opportunities and even physical plants of the competitors that they chose to compete against. Now, through online learning, students can learn from universities to which they have never been admitted.

The Business Model

The impact that the disruption has on established and entrant companies can best be explained using a simple model of a business. A business model has four elements, as shown on the right: a customer Value Proposition; Resources; Values; and a Profit Formula. Most often the creation of a new a business begins with a customer value proposition – a job-to-be-done that arises in people’s lives. This launches people on a search for something that they can buy, borrow or use in order to address the job to be done.

As customers realize that that this product might satisfy a job they need to get done, the company needs to buy or invest in Resources that can get the job done. These include people, facilities, equipment, technologies, distributors, and other things, in order to get the job done. Little by little as people in the company use the resources to do the job, Processes emerge that define how the resources need to work together. As the needed processes become clear, the company learns how to make money – the costs, prices, asset turnover, and so on – so that the company can structure itself to make money in a specific way. This is its Profit Formula that, in turn, defines the value propositions that the company can and cannot offer in their markets.

The most important of the four elements of the business model is its profit formula. An innovation that will help a company make more money in the way it is already structured to make money--and in a way that drives up the metrics that present and  prospective investors use to measure success--always attract the primary capital in the company. It drives the company up-market. If an innovation promises to earn lower profits by these metrics, then a well-run company will find it very difficult to drive down-market and invest in less-attractive projects. Disruption occurs when the pursuit of profit drives companies to walk away from competitors coming at them from below, rather than fight them.

When and why innovators go up-market?

Low-end and new-market footholds typically are populated not by one firm, but several comparable entrant firms whose products are all simpler, more convenient and less costly, compared to the performance of products sold by incumbent firms. Although they are rarely unmolested from the incumbents at the high end, price-competition amongst the group of entrants can still become severe. This compels these entrants to improve their products as aggressively as they can. As long as these entrants drive up-market and compete at the margin against higher-cost established competitors who are in retreat, their profits can be attractive. But if they stop driving up-market and simply compete against comparably low-cost entrants, the entrants’ profits disappear. The disruption drives every competitor – incumbent and entrant – to drive up-market. Pricing power only exists in relation to a company’s competitors.

Some companies whose executives understand disruption are able to resist these forces that drive their companies up, and stay at the bottom of their markets.  But even then, these forces are at work, 24-7.

Metrics are choices, not demanded by deity

The metrics that companies use in pursuit of disruptive innovations profoundly affects how managers think about these trajectories. For example, many of them have accepted the metric of gross margin percentages as a metric of their company’s success in the market. As they strive to improve their results on this metric, it causes them to drop products from the low end of their product line and replace them with products whose margins are higher. If instead they would measure their success not by gross margin percentage, but rather net dollars per ton or per product, it could cause managers to defend their market share at the low end.

The metric that should be applied to the vertical axis of the disruptive diagram should be whatever helps the company make more money in the way that they are organized to make money. Route length (airlines); airplanes (seats); billable hours per project (consulting); net profit per ton (steel); and size of deal or size of loan (venture capital, private equity, banks) – all are examples of what we should measure on the vertical axis. This should be done carefully.

 “Disruption lies in the process by which the ideas get shaped …. Managers will be inclined to promote only those new growth ideas that will pay off within the time that they reside in that particular job.”[1] My friend, Ron Adner at Insead (now at Tuck), built a model grounded in rigorous mathematics[2] that simplified the statement of causality to its essence: What causes successful companies to fail is the pursuit of profitability.[3] It is not the pursuit of profit (as in whole dollars). It is the pursuit of profitability (as in percentages).  Disruption is not simply something that occurs “to” a company or its managers. Rather,  disruption occurs at the intersection of management decision, the resource allocation process, competitive behavior, and technological progress. And it is a process, not an event.

It took me and those that I worked with and around me ten years to articulate the causal mechanism in this theory that we call disruption – and in the end it was Adner, and not me, that pulled it all together in his mathematically grounded model. I suspect that smarter people than me could have arrived at this destination faster than 10 years. I take some solace, however, in Oliver Wendell Holmes’ statement in 1911, “I would not give a fig for the simplicity this side of complexity, but I would give my life for the simplicity on the other side of complexity.”


Footnotes

[1] Christensen and Raynor, The Innovator’s Solution: Creating and Sustaining Successful Growth, Harvard Business School Publishing, 2003, p. 10.

[2] Adner, Ron. 2002.  “When are technologies disruptive: A demand-based view of the emergence of competition” Strategic Management Journal. 23: 667-688.

[3] There is an important difference between the pursuit of profits and the pursuit of profitability. Profits are simply the gains a firm realizes. Profitability, however, is about the capacity to achieve gains, based on a standard set of ratios—such as operating margin and return on assets. Pursuit of profitability is not just pursuing profits, but pursuing a configuration of ratios that are regarded as favorable for a firm, where actual profits are just one input.