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A quick deck I threw together on Disruption for a Fortune 500. Creating a shared language around disruption.
Citation preview
Disruptive innovation: Opportunity and Barriers
Enabling disruption within existing businesses
July, 2012
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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.
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Part 1: An Overview of Disruptive Innovation
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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
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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?
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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
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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
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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
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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
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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
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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
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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?
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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
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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
&
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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”
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Part 2: Overcoming the organizational challenge
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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Part 3: Key questions to guide discussion
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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?