The Innovator’s Dilemma

The Innovator’s Dilemma by Clayton Christiansen is is a ground-breaking business strategy book for entrepreneurs. It provides counter-intuitive insights into how and where massive markets are created by new entrants.  First published in 1997 (republished in 2003), it’s the closest thing I have found to a “treasure map” for new business leaders.

Disruptive innovations are ideal for entrepreneurs because they are typically developed with off-the-shelf technologies by small, capital-efficient businesses and, best of all, have a lower failure rate than those that compete directly with incumbents.

Clayton Christiansen offers three key lessons on disruptive innovations:  why market leaders typically don’t/won’t pursue the disruptive innovations which create new market leaders; where to look for those opportunities; and how to pursue them effectively.

It is an entertaining read:  told through interesting case studies that describe challenges faced by market leaders in multiple industries.  This is masterful storytelling, with example after example of bright, well intentioned CEOs losing their company’s market leadership position to entrepreneurial companies because they followed sound business practices.  That’s right – following good business practices and sound management decisions will eventually lead to your demise as a market leader when competitive and disruptive technologies emerge.  In this situation, if you listen to your customers, investors and employees you are doomed.   Now that’s counter-intuitive.

Why should we listen to the author?

Clay Christensen is a professor at HBS and researches and teaches this subject.   If pattern recognition is, as they say, the ultimate sign of intelligence, this man is brilliant: he has spotted a counter-intuitive pattern for commercializing disruptive technologies that few had researched/articulated.

The Big Ideas:

Market leaders often fail to capitalize on disruptive innovations and lose to new, rule-changing, entrants:  here’s why…

• The author identifies two types of innovation: Sustaining innovation and Disruptive innovation. Most are the former: they improve performance of a product or solution sought by mainstream customers (for example, for disk drives this might be megabyte capacity per disk, for mainframe computers the number of instructions per second). They are usually attained through extensive, expensive investments in technology or process improvements. Disruptive innovations, on the other hand, typically deliver solutions that focus on non-mainstream benefits; in fact they are often worse than current offerings in the key metric. The benefits of disruptive innovations often make them attractive in new or underserved markets. The innovation of PCs is a good example – they pioneered a new market: desktops. Performance improved over time eventually capturing the mainstream datacenter market.
• Disruptive innovations have characteristics that make them difficult for market leaders to pursue, leaving them available, and attractive, for entrepreneurs to exploit.
  1. Their use case is ‘unknowable’, ‘unforecastable’. A market development process is required to find new customers not served by mainstream vendors. Market research is useless, so large companies have difficulty understanding how to purse them. A great example is how Kawasaki discovered/created the dirt bike market by sheer accident which saved them from certain failure in the mainstream motorbike market
  2. Successfully pursuing them requires capital efficiency. The business has to be set up to learn and discover markets, not to scale initially. Since progress and results can’t be forecast accurately, you can’t overinvest or you are likely to fail
  3. The organization needs to be small enough for success with early market adopters to deliver meaningful wins: the first Apple only sold 600+ units, which was a big a win for the founders
  4. The technology is usually readily available and on the shelf. These opportunities, at least initially, require market development rather than technology development: Facebook, not even in the book, is a great example
  5. Over time, the performance of disruptive innovations improves, catching up with mainstream market demands. At this point the original market leaders often lose because they can’t master the new technology or business processes enabled by the innovation
  6. There is more good news for the disruptive innovators here: well managed market leaders listen to customers, investors and employees, all of which work against the process of pioneering disruptive innovations. Market leaders are driven to increase profits and deliver growth on a dependable timetable (next quarter/next year). This usually means targeting the most profitable customers with better solutions, in order to deliver more revenue. A good example is computing – vendors make higher margins on their largest servers and many companies have grown by creating ever more powerful offerings to capture more of the high end of the market. Investors in market leaders want predictable results and sizable growth. Pioneering new, small unproven markets with a disruptive innovation does not meet this objective in the short term. Finally, employees of a company will screen out and avoid working on disruptive innovations because they represent a significant career risk versus mainstream opportunities.

• Disruptive technologies usually develop in markets that are unattractive to market leaders. They often involve new product designs that can’t compete for the “best”, high margin customers. Instead, they address the need of a different group of customers that are ignored or poorly supported by market leaders. These customers are the least profitable for market leaders. Also, they often have different needs – be it price, ease of use, safety, energy consumption. A good example is the launch of discount retailers – US brands Target & Kmart and TK Max/Primark. Their low margin and high inventory turns represented a disruptive innovation in retailing once dominated by department stores with high margins, low turns and expensive sales professionals. Discounters addressed a large market that could not afford the department stores. As more nationally-branded products emerged, stores required less sales support and the discount market grew to absorb customers that previously would have gone to department stores.

Where are the opportunities for disruptive innovations?  The author offer some clues to look for:

1. Customers not well addressed by mainstream vendors
2. Markets in overshoot mode – where the technology improvement by mainstream vendors has or will overshoot the needs of mainstream customers
3. Solutions enabled by off the shelf components benefiting from continued cost reductions ( e.g. Robotics is being enabled by rapidly falling component costs – cameras, chips, sensors)
4. New product architectures that use proven, available technology (read: low investment)
5. Products where the weakness in the mainstream market is a strength in the new emerging markets ( i.e. disk drive size)
6. The benefits of the new offering are usually simpler, cheaper, more reliable and convenient

As a case study, the author predicts disruptive innovation in the electric vehicle (ev) market.  It has a lot of the characteristics of a market in overshoot mode: the driving range and acceleration speed requirements of car consumers are not likely to change dramatically over the next 15 years so while gasoline cars might get more and more powerful, electric cars may be able to catch up with market needs. Assuming continued battery and electric motor productivity improvements, it’s easy to see how this will happen.   Using his advice, we would not chase this market by trying to build a car to compete with the major vendors.   Instead we would build an electric vehicle to compete in markets ignored by the major car manufacturers because they are too small.  We would also pick markets that would value the benefits associated with the vehicle’s current shortcomings – range and acceleration.   One market might be taxi or delivery vehicles in less developed countries. A market where driving range is low, congested traffic would benefit from electric engines which consume no power when idling, and fuel cost and pollution is an issue. This is a large market for a startup, and a terrible market for a major vendor.  Over time, the startup would build better and better vehicles and eventually have a solution for the mainstream market, leveraging everything it has learned along the way.

How I Have Applied This

This is a great model to help identify growth markets.  As a fund we focus on capital-efficient businesses that can succeed as they look for large markets with disruptive innovations and there are a number of markets undergoing change from disruptive innovations, including:

• Education – a move from classrooms to computer-based education. Look at the for-profit university market and the home school offerings for early innovators.

• Cloud Computing – Datacenters are undergoing a classic disruptive innovation with cloud computing where outsourced servers are available on-demand. Where are these innovators succeeding? Small markets: Casual games and social application startups that need to be able to dial up and dial down capacity quickly. These vendors will eventually reach the mainstream customers but they need a new value chain.

• Web data – The availability of data is turning the current data information industry on its head with more information available from the web than they can offer on their own

• Video Advertising – TV viewing habits are shifting to the computer and with it will be the way video ads get distributed, shown and tracked.

Not all disruptive innovations succeed on the timetable we are looking for, but that’s the nature of the beast.   The data in Clay Christiansen’s’ book shows that disruptive innovations, pursued correctly, are actually less risky than sustaining innovations, yet most people believe the opposite.

Author: Clayton Christiansen

Who should read this book: Entrepreneurs, Company Owners, CEOs, Product Marketers

An abridged version of this review first appeared on Vitesse Media’s Growth Business

Javier Rojas

Javier Rojas is a managing director at Kennet Partners, a private equity firm that invests in growth companies in Europe and North America. He has been reviewing the best business books for awhile, posting summaries of the authors’ big ideas on his blog and also monthly on Entrepreneur Corner at VentureBeat.