Too Big to Fail? Introduction to the Concept of Disruptive Innovation

Every CEO generation has its own management buzz words. In the 1990s “re-engineering” was in fashion, then came “offshoring”, and today it is probably “disruptive innovation.” The concept was coined by Clayton M. Christensen, a Harvard Business School professor who introduced the wording in his 1995 article “Disruptive Technologies: Catching the Wave.” Two years later in his book The Innovator’s Dilemma, Christensen replaced the term disruptive technology with disruptive innovation. That was groundbreaking because he recognized that few technologies are intrinsically disruptive; rather, it is the business model behind it that disrupts and reinvents markets.

But what is disruptive innovation?

A disruptive innovation is one that creates a new market and/or consumer behavior. Often, this includes disrupting existing markets and displacing established market participants. This stands in contrast with sustaining innovation and the well-known continuous improvement model, which has a focus on the improvement of existing products. That is an interesting point because it means that even a company with a well-managed improvement and customer service ethos can be severely hurt by disruptive innovation. This happens when the companies stay “close to the customer” or “listen to the customer,” which is good, but at the same time they overhear the silent and marginal voices of future customers.

But not all innovations are disruptive, even if they are revolutionary. The automobile, for example, was not a disruptive innovation for quite a while because early automobiles were expensive luxury products that did not challenge the transportation market of horse-drawn carriages. It was Henry Ford’s Model T in 1908 that made automobility a disruptive innovation because Ford’s vision completely changed our mobility behavior.

How low-end disruption occurs

Christensen distinguishes between “low-end disruption,” which targets customers with low budgets, and “new-market disruption,” which targets new customer requests. Low-end disruption occurs when the performance of a product exceeds the needs of a certain customer segment. Then innovations enter the market with lower performance levels but also with lower prices, and this combination is fine for a certain clientele. That is how new market players gain a foothold in the market. It becomes disruptive when the new player changes the whole market in the aftermath. But again, the starting point of low-end disruption is a customer who is not willing to pay for premium products but is happy with a good enough product. For many companies, such clients are not very attractive because they are the least profitable customers.

But once the disruptors have entered this market, they seek to improve profit margins by offering additional value in small doses, so customers might be willing to pay a little more for better quality. The incumbent operators, on the other hand, do not spend too much time or thought on the least profitable customers and instead concentrate on the most profitable ones. Over time, the incumbents are squeezed into smaller markets. By the end, it is the disruptive innovator that serves the largest market segment and earns the greatest revenue, whereas the former market leaders have a niche existence or are driven out of the market. “New market disruption,” on the other hand, occurs when a product serves a new or emerging consumer desire that is not being served by existing market players.

IT sector as a place of permanent disruption

Very practical examples of both low-end as well as new-market disruptions can be seen in the IT sector. At the beginning, IT incumbents completely misinterpreted the market. “There is no reason anyone would want a computer in their home,” said Ken Olsen, founder of Digital Equipment Corporation, in 1977. Digital Equipment in those days was a major force in the computer world – four years later, the first IBM PC proved Olsen wrong. Microsoft and Dell computers are two disruptive innovators that changed the markets with their low-end innovations. Later, it was Microsoft that missed the innovation of the internet browser and the need for internet guidance, giving space to new players such as Yahoo and, most of all, Google. New market disruption also came with the rise of social media sites Facebook and Twitter. The “internet of things” surely will be the next step, a combination of low-end as well as new-market disruptions. Google promises to reinvent cars as autonomous vehicles (new market); Amazon promises to reinvent shopping (again) using drones (low-market); 3-D printing could disrupt manufacturing (sometimes low, sometimes new market). But the most surprising and promising of the disruptive innovations will come from the bottom of the market pyramid with new ways of delivering food security, education, and healthcare, etc., for millions of consumers in emerging markets.

Disruptive innovations tend to be produced by outsiders

So why is it so hard for disruptive innovators to make their way? And why are they so often outsiders with no – or only loose – ties to incumbents in the markets? There are at least three reasons why: 1) Innovations are not profitable enough at the beginning; 2) these processes can take longer to develop and results may be so new that they cannot be compared to other products; 3) it cannot be evaluated and does not fit into conventional risk schemes.

Renevue and time

Professor Joseph Bower came to the point when writing a Harvard Business Review article in 2002: “When the technology that has the potential for revolutionizing an industry emerges, established companies typically see it as unattractive: it’s not something their mainstream customers want, and its projected profit margins aren’t sufficient to cover big-company cost structure. As a result, the new technology tends to get ignored in favor of what’s currently popular with the best customers. But then another company steps in to bring the innovation to a new market. Once the disruptive technology becomes established there, smaller-scale innovation rapidly raise the technology’s performance on attributes that mainstream customers’ value.”

Comparing apples and oranges

Comparing unknown new markets with known traditional markets is a bit like comparing apples and oranges, as Milan Zeleny knows. In an article for the International Journal of Management and Decision Making, he wrote: “The effects of high technology always breaks the direct comparability by changing the system itself, therefore requiring new measures and new assessments of its productivity. High technology cannot be compared and evaluated with the existing technology purely on the basis of cost, net present value or return on investment. Only within an unchanging and relatively stable TSN [technology support net] would such direct financial comparability be meaningful. For example, you can directly compare a manual typewriter with an electric typewriter, but not a typewriter with a word processor. Therein lies the management challenge of high technology.”