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Edition:	Harvard Business Press (Hardcover)
Author:
Published:	May 1997
Pages:	225
ISBN 10:	0875845851
New:	$12.75 (65)
Used:	$1.98 (150)
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INTRODUCTION

“This book is about the failure of companies to stay atop their industries when they confront certain types of market and technological change. It’s not about the failure of simply any company, but of good companies—the kinds that many managers have admired and tried to emulate, the companies known for their abilities to innovate and execute. Companies stumble for many reasons, of course, among them bureaucracy, arrogance, tired executive blood, poor planning, short-term investment horizons, inadequate skills and resources, and just plain bad luck. But this book is not about companies with such weaknesses: It is about well-managed companies that have their competitive antennae up, listen astutely to their customers, invest aggressively in new technologies, and yet still lose market dominance.”

You could theorize that these companies were never well managed. Their success was based merely on good luck and good timing and they failed because that luck finally ran out. “An alternative explanation, however, is that these failed firms were as well-run as one could expect a firm managed by mortals to be—but there is something about the way decisions get made in successful organizations that sows the seeds of eventual failure.”

This book supports the latter theory. It is precisely because of the superior management, the investment in new technologies, the production of better goods for their customers, the intense study of market trends, and the well-invested capital that these companies lost their market dominance. “What this implies at a deeper level is that many of what are now widely accepted principles of good management are, in fact, only situationally appropriate. There are times at which it is right not to listen to customers, right to invest in developing lower-performance products that promise lower margins, and right to aggressively pursue small, rather than substantial markets.”

Why Good Management Can Lead to Failure

“The failure framework is built upon three findings. The first is that there is a strategically important distinction between sustaining technologies and those that are disruptive. These concepts are very different from the incremental-versus-radical distinction that has characterized many studies of this problem. Second, the pace of technological progress can, and often does, outstrip what markets need. This means that the relevance and competitiveness of different technological approaches can change with respect to different markets over time. And third, customers and financial structures of successful companies color heavily the sorts of investments that appear to be attractive to them, relative to certain types of entering firms.”

Sustaining versus Disruptive Technologies

Sustaining technologies are those that attempt to improve a product, either through improvements to the basic formula or through sweeping, discontinuous change. “What all sustaining technologies have in common is that they improve the performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued. Most technological advances in a given industry are sustaining in character.”

“Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

Very often, technologies are improved at a greater rate than the market really requires in order to earn higher margins. “Suppliers often “overshoot” their market: They give customers more than they need or ultimately are willing to pay for. And more importantly, it means that disruptive technologies that may underperform today, relative to what user in the market demand, may be fully performance-competitive in that same market tomorrow.”

Harnessing the Principles of Disruptive Innovation

Principle #1: Companies Depend on Customers and Investors for Resources. “It is customers and investors who dictate how money will be spent because companies with investment patterns that don’t satisfy their customers and investors don’t survive.”

Principle #2: Small Markets Don’t Solve the Growth Needs of Large Companies. Disruptive technologies are usually new markets and evidence proves that those companies who enter the new market in the beginning have advantages over those companies that jump in later in the game. Ironically, as these pioneering companies grow with market demand, they find it harder to capture the new markets that they had once capitalized on. The larger the company, the more capital is required to sustain growth. “Many large companies adopt a strategy of waiting until new markets are “large enough to be interesting.” Unfortunately, this does not often work.

Principle #3: Markets that Don’t Exist Can’t Be Analyzed. Companies thrive on sustaining technology—it can be researched, talked about, analyzed. This is not truly possible with disruptive technology. These are emerging markets and lack the data for such research. “It is in disruptive innovations where we know least about the market, that there are such strong first-mover advantages. This is the innovator’s dilemma.”

Principle #4: An Organization’s Capabilities Define Its Disabilities. Every company has liabilities when introducing innovations. The first is the processes by which it performs—how it invests time, labor, people, materials, capital, and existing technology to a new innovation. The second is in its values—how it prioritizes. Processes often need to radically change in order to incorporate an innovation into the company structure. “Similarly, values that cause employees to prioritize projects to develop high-margin products, cannot simultaneously accord priority to low-margin products. The very processes and values that constitute an organization’s capabilities in one context, define its disabilities in another context.”

Principle #5: Technology Supply May Not Equal Market Demand. Disruptive technologies, in the beginning, supply small, niche markets. As they grow, however, they invariably move into the mainstream because, although technology progresses faster than demand, eventually customers will demand this technology.

PART ONE: WHY GREAT COMPANIES CAN FAIL

The history of the disk drive industry is one of the most revealing examples of well-managed companies failing. IBM developed the first disk drive between 1952 and 1956. It was “the size of a large refrigerator, incorporated fifty twenty-four-inch disks, and could store 5 megabytes (MB) of information.” IBM, at the time, developed and produced mainframe computers. From this development, fringe companies arose to compete with this market. For the next three decades, the development of faster, more durable disk drives that had increased storage capacity increased at a furious rate. Disk size went from 14 inches to 8 inches to 5.25 inches to 3.5 inches to 2.5 inches and finally to 1.8 inches.

It is important to note that most of the research and innovation, usually years of intense effort, was done by the leading companies as sustaining technologies. IBM actually developed the 8-inch drive but shelved it and it became a disruptive technology. Why? Because, at the time, the majority of their customers had no interest in it. Small, entrant companies took the technology, found markets for it—being small, their profit margin did not need to be as high as the larger, more established companies. By the time the market became “interesting” enough for IBM to pay attention, they had lost their advantage in garnering a large enough market share. This cycle continued. The larger companies stuck to their proven technologies to satisfy their existing customers and their necessary profit margins and, as technology changed, smaller, entrant companies found success in found markets. These markets eventually grew and the entrant companies became the leaders in the industry—only to fall into the same problems they caused the established companies they originally took on.

Value Networks and The Impetus to Innovate

Why do companies, who have actually developed new technologies, fail to market them and thus ride the wave of success that small, entrant firms take advantage of? Most of the problem is in how these companies actually operate—they follow good management. “Companies are embedded in value networks because their products generally are embedded, or nested hierarchically, as components within other products and eventually within end systems of use.” Depending upon the company, the value network changes. For example, in the computer industry, a Corporate Management Information System will have a different priority architecture than a Portable Personal Computer System. The former has less interest in durability, size, and power consumption than the latter.

These differences in value networks actually define the boundaries of a particular company. “As firms gain experience within a given network, they are likely to develop capabilities, organizational structures, and cultures tailored to their value network’s distinctive requirements.”

An organization’s value network is also defined by its cost structure. “For example, competing within the mainframe computer network entails a particular cost structure. Research, engineering, and development costs are substantial. Manufacturing overheads are high relative to direct costs because of low unit volumes and customized product configurations. Selling directly to end users involves significant sales force costs, and the field service network to support the complicated machines represents a substantial ongoing expense. All these costs must be incurred in order to provide the types of products and services customers in this value network require.” The portable computer value network is quite different. The companies rarely develop the technology; they utilize proven component technology. They do not manufacture these components; merely assemble them into a finished product—usually in low-labor-cost regions. Sales are indirect, through distributors, retail chains, or mail order. Due to lower overhead, these companies can find success with much lower profit margins.

“The cost structures characteristic of each value network can have a powerful effect on the sorts of innovations firms deem profitable. Essentially, innovations that are valued within a firms’ value network, or in a network where characteristic gross margins are higher, will be perceived as profitable. Those technologies whose attributes make them valuable only in networks with lower gross margins, on the other hand, will not be viewed as profitable, and are unlikely to attract resources or managerial interest.” In brief, the higher the necessity for high-margin profit in order to keep a company viable, the lower the interest in low-margin profit. Resources are finite and expenditure of resources for minimal profit is not good management.

“Entrant firms have an attacker’s advantage over established firms in innovations—generally new product architectures involving little new technology per se—that disrupt or redefine the level, rate, and direction of progress in an established technological trajectory. This is so because such technologies generate no value within the established network. The only way established firms can lead in commercializing such technologies is to enter the value network in which they create value.”