Disruptive Innovation and Your Web Business

I am a sucker for business books -- take it as evidence of my basic optimism. Disappointing book after unfinished book, I keep buying them. Because, every once in a while, there's a good one in the bunch.

The Innovator's Dilemma by Clayton Christensen is one of the good ones.

This is not a gee-whiz book about how the Internet is changing the world. Neither "Internet" nor "e-commerce" appear in the index. Instead, Christensen has focused his research on industries where there are already long, well established histories of growth and failure due to market disruptions brought on by innovation. Starting his research in the mid 1980's, he set out to understand why strong, well managed companies, companies that lead markets and pay attention to customers, suddenly stumble and fail. The answer is not simply "The Internet."

He focused first on the disk drive industry. Disk drive companies, like fruit flies, have had very short life cycles, and so make a great research base for someone wanting to understand how new technology and market developments make some companies thrive while killing off others. Beginning with the simple, popular assumption that the rate of technological change and innovation was simply too fast for some companies, particularly larger ones, to sustain, Christensen soon discovered that it was typically the larger, more well established companies that benefited from innovation -- even when the innovation was risky and difficult. But he also found that there was a particular kind of innovation that did consistently cause widespread failures in leading firms. These "disruptive" innovations were consistently different in character than the "sustaining" innovations that help leading firms consolidate their hold on a market. Expanding his research to other markets, he found that disruptive innovation did not just operate among disk drive manufacturers, but also in markets as different as retail sales and the manufacture of mechanical excavators.

The Internet and e-commerce are the basis for a great deal of disruptive innovation. Christensen's research contains important insights for any business trying to adapt itself to the network economy.

Sustaining and Disruptive Innovations

The important difference between sustaining and disruptive innovation is that sustaining innovations are demanded by a company's current customers. Disruptive innovations, on the other hand, are of little use or interest to current customers. They typically offer lower functionality in terms of the customer's requirements -- but typically offer something else -- to someone else.

In the early 1980's, for example, what customers buying mini-computers wanted was more powerful minicomputers. Personal computers, a disruptive technology, did not offer the speed or power that minicomputer customers needed. Any minicomputer company that was listening carefully to its customers focused on building bigger minicomputers, and stayed away from "microcomputers," which could not meet customer needs. But PCs offered low price -- for lower computing power -- which was of great value to a new kind of customer -- customers that the minicomputer companies were not trying to serve.

New technologies can become disruptive if the rate of growth in new capability is steeper than the rate of increase in customer requirements -- the kind of situation illustrated in the figure below.

Figure 1. Changes in capability increasing faster than demand, allowing disruptive technologies to enter higher value markets.

This should be a familiar picture to anyone who has been in technology driven markets for awhile. The rate of improvement and increased functionality of the products in the original market outstrips the ability of the average customer to use the new functions and power. This happens because the company is responding to its most important, and typically most demanding, customers. The new technology, on the other hand, initially has inadequate functionality for the original market (e.g., enterprise users), but meets the needs of some other, new market (e.g., small business users). But the new technology, too, is adding capability faster than its initial market can use it. This means that it can eventually offer functionality sufficient to meet the needs of users in the original, higher end market. At this point the disruptive technology can invade the higher end market. Typically, the companies developing the new, disruptive technology have also developed cost structures and distribution capabilities that make it very difficult for the incumbent companies to defend successfully against the new entrants.

This is, of course, what happened with PCs. Eventually, they became fast and powerful enough that they could meet the needs of what had been minicomputer buyers, which put the minicomputer makers into serious trouble. Their market had been invaded from below.

High Stakes

The key trick for a company dealing with innovation and change is the ability to know when an innovation is disruptive and when it is sustaining. The distinction is critical because sustaining innovations favor companies that already have established positions in a market -- Christensen's research shows that new entrants typically fail when trying to introduce a new technology or business model when the innovation is of the sustaining variety. On the other hand, when the innovation is disruptive, the odds of success shift dramatically in favor of the new entrant.

Christensen's research suggests that there are a handful of key factors that determine whether innovation is disruptive or sustaining. In general, an innovation is disruptive when:

the innovation is not of interest to a company's current customers because it does not meet their requirements.
the innovation is of interest to new, different markets that are hard for the established companies to service (due to the market's cost structure, sales channels, or other fundamental business concerns)
functionality of the innovation is increasing faster than the change in customer demand, so that the functionality can eventually meet the needs of current, high end customers, as illustrated in Figure 1.

The first factor is the one that causes trouble. Because the current customers can't use and don't (initially) want the innovation, virtually any company that is doing a good job of meeting the needs of these customers will either overlook or disregard the innovation. Christensen does an excellent job of showing how, even when executive management knows that the innovation will ultimately be important, the internal processes of the company will still make it nearly impossible for the company to succeed with the innovation. Further, since the disruptive innovation is initially of interest only to early markets, it simply will not bring in the kind of money, during the early stages of market development, needed to meet the growth targets of the established companies. Unfortunately, by the time the innovation is well enough established to be of financial interest, the barbarian is already at the gate, and the established vendor is in trouble.

Disruptive Innovation and the Web

The problem of separating sustaining and disruptive innovation is no simpler on the web than anywhere else. It is certainly not the case that all web innovations are disruptive. National Semiconductor, for example, is doing a great job of using the Internet to increase its ability to sell to its current customer base (see Fastwater's National Semiconductor case study.) For National, the web provides an opportunity to develop sustaining innovations that strengthen National's position against new companies as well as existing competitors.

One the other hand, when we look at innovations such as those supporting data interchange on the web, the situation looks much more like a potentially disruptive innovation. Currently the web based approaches do not have the security, robustness, and capacity of dedicated, closed system EDI -- but they are appealing to a new class of EDI customer, at dramatically decreased price points.

Real Assistance

As we consult with companies regarding their approach to developing new business around the Internet, one of the most frequent issues that comes up is how to organize the approach to the business. Should the Internet initiative be an extension of the current business? Or should it be managed as something different and separate? In short, what is the best way to handle the relationship between the Internet business and the existing products and existing channels? Answering this question wrong can result in an ineffective Internet business that cannot compete with the newer, "pure Internet play" startups, or it can result in real damage to the primary business, confusing existing customers. Or both.

The Innovator's Dilemma provides the best framework I have yet encountered for thinking through, analyzing, and making that critical decision.