The Innovator's Solution

by Clayton Christensen

  22. Clayton M. Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Boston: Harvard Business School Press, 1997).

  23. Managers need to know if a theory applies in their situation, if they are to trust it. A very useful book on this topic is Robert K. Yin’s Case Study Research: Design and Methods (Beverly Hills, CA: Sage Publications, 1984). Building on Yin’s concept, we would say that the breadth of applicability of a theory, which Yin calls its external validity, is established by the soundness of its categorization scheme. There is no other way to gauge where theory applies and where it does not. To see why, consider the disruptive innovation model that emerged from the study of the disk drive industry in the early chapters of The Innovator’s Dilemma. The concern that readers of the disk drive study raised, of course, was whether the theory applied to other industries as well. The Innovator’s Dilemma tried to address these concerns by showing how the same theory that explained who succeeded and failed in disk drives also explained what happened in mechanical excavators, steel, retailing, motorcycles, accounting software, motor controls, diabetes care, and computers. The variety was chosen to establish the breadth of the theory’s applicability. But this didn’t put concerns to rest. Readers continued to ask whether the theory applied to chemicals, to database software, and so on.

  Applying any theory to industry after industry cannot prove its applicability because it will always leave managers wondering if there is something different about their current circumstances that renders the theory untrust-worthy. A theory can confidently be employed in prediction only when the categories that define its contingencies are clear. Some academic researchers, in a well-intentioned effort not to overstep the validity of what they can defensibly claim and not claim, go to great pains to articulate the “boundary conditions” within which their findings can be trusted. This is all well and good. But unless they concern themselves with defining what the other circumstances are that lie beyond the “boundary conditions” of their own study, they circumscribe what they can contribute to a body of useful theory.

  24. An illustration of how important it is to get the categories right can be seen in the fascinating juxtaposition of two recent, solidly researched books by very smart students of management and competition that make compelling cases for diametrically opposite solutions to a problem. Each team of researchers addresses the same underlying problem—the challenge of delivering persistent, profitable growth. In Creative Destruction (New York: Currency/Doubleday, 2001), Richard Foster and Sarah Kaplan argue that if firms hope to create wealth sustainably and at a rate comparable to the broader market, they must be willing to explore radically new business models and visit upon themselves the tumult that characterizes the capital markets. At the same time, another well-executed study, Profit from the Core (Boston: Harvard Business School Press, 2001), by Bain consultants Chris Zook and James Allen, drew upon the same phenomenological evidence—that only a tiny minority of companies are able to sustain above-market returns for a significant time. But their book encourages companies to focus on and improve their established businesses rather than attempt to anticipate or even respond to the vagaries of equity investors by seeking to create new growth in less-related markets. Whereas Foster and Kaplan motivate their findings in terms of the historical suitability of incrementalism in a context of competitive continuity and argue for more radical change in light of today’s exigencies, Zook and Allen hold that focus is timeless and remains the key to success. Their prescriptions are mutually exclusive. Whose advice should we follow? At present, managers grappling with their own growth problems have no choice but to pick a camp based on the reputations of the authors and the endorsements on the dust jacket. The answer is that there is a great opportunity for circumstance-focused researchers to build on the valuable groundwork that both sets of authors have established. The question that now needs answering is: What are the circumstances in which focusing on or near the core will yield sustained profit and growth, and what are the circumstances in which broader, Fosteresque creative destruction is the approach that will succeed?

  CHAPTER TWO

  HOW CAN WE BEAT OUR

  MOST POWERFUL COMPETITORS?

  How can we know in advance of the battle whether we’re going to be able to beat the competition? Why has disruption proven to be such a consistently effective strategy for causing strong incumbent competitors to flee from their entrant attackers, rather than fight them? How can we shape our business idea into one of these disruptive strategies? Can we really predict the winners in a race for innovative growth? What if we could choose our competitive battles knowing we could win nearly every time? What if we knew in advance which growth strategies would succeed, and which would fail?

  Managers have long sought ways to predict the outcome of competitive fights. Some have looked at the attributes of the companies involved, predicting that larger companies with more resources to throw at a problem will beat the smaller competitors. It’s interesting how often the CEOs of large, resource-rich companies base their strategies upon this theory, despite repeated evidence that the level of resources committed often bears little relationship to the outcome.

  Others have considered the attributes of the change: When innovations are incremental, the established, leading firms in an industry are likely to reinforce their dominance; however, compared with entrants, they will be conservative and ineffective in exploiting breakthrough innovation.1 We noted in the introduction that predictions based on attribute-based categories, as these are, prove frustratingly undependable.

  Our ongoing study of innovation suggests another way to understand when incumbents will win, and when the entrants are likely to beat them. The Innovator’s Dilemma identified two distinct categories—sustaining and disruptive—based on the circumstances of innovation. In sustaining circumstances—when the race entails making better products that can be sold for more money to attractive customers—we found that incumbents almost always prevail. In disruptive circumstances—when the challenge is to commercialize a simpler, more convenient product that sells for less money and appeals to a new or unattractive customer set—the entrants are likely to beat the incumbents. This is the phenomenon that so frequently defeats successful companies. It implies, of course, that the best way for upstarts to attack established competitors is to disrupt them.

  Few technologies or business ideas are intrinsically sustaining or disruptive in character. Rather, their disruptive impact must be molded into strategy as managers shape the idea into a plan and then implement it. Successful new-growth builders know—either intuitively or explicitly—that disruptive strategies greatly increase the odds of competitive success.

  This chapter’s purpose is to review the disruptive innovation model from the perspective of both the disruptee and the disruptor in order to help growth builders shape their strategies so that they pick disruptive fights they can win. Because disruption happens whether we want it or not, this chapter will also help managers of established companies capture disruptive growth, instead of seeing their companies get killed by it.

  The Disruptive Innovation Model

  The Innovator’s Dilemma identified three critical elements of disruption, as depicted in figure 2-1. First, in every market there is a rate of improvement that customers can utilize or absorb, represented by the dotted line sloping gently upward across the chart. For example, the automobile companies keep giving us new and improved engines, but we can’t utilize all the performance that they make available under the hood. Factors such as traffic jams, speed limits, and safety concerns constrain how much performance we can use.

  FIGURE 2 - 1

  The Disruptive Innovation Model

  To simplify the chart, we depict customers’ ability to utilize improvement as a single line. In reality, there is a distribution of customers around this median: There are many such lines, or tiers, in a market—a range indicated by the distribution curve at the right. Customers in the h
ighest or most demanding tiers may never be satisfied with the best that is available, and those in the lowest or least demanding tiers can be oversatisfied with very little.2 This dotted line represents technology that is “good enough” to serve customers’ needs.

  Second, in every market there is a distinctly different trajectory of improvement that innovating companies provide as they introduce new and improved products. This pace of technological progress almost always outstrips the ability of customers in any given tier of the market to use it, as the more steeply sloping solid lines in figure 2-1 suggest. Thus, a company whose products are squarely positioned on mainstream customers’ current needs today will probably overshoot what those same customers are able to utilize in the future. This happens because companies keep striving to make better products that they can sell for higher profit margins to not-yet-satisfied customers in more demanding tiers of the market.

  To visualize this, think back to 1983 when people first started using personal computers for word processing. Typists often had to stop their fingers to let the Intel 286 chip inside catch up. As depicted at the left side of figure 2-1, the technology was not good enough. But today’s processors offer much more speed than mainstream customers can use—although there are still a few unsatisfied customers in the most demanding tiers of the market who need even faster chips.

  The third critical element of the model is the distinction between sustaining and disruptive innovation. A sustaining innovation targets demanding, high-end customers with better performance than what was previously available. Some sustaining innovations are the incremental year-by-year improvements that all good companies grind out. Other sustaining innovations are breakthrough, leapfrog-beyond-the-competition products. It doesn’t matter how technologically difficult the innovation is, however: The established competitors almost always win the battles of sustaining technology. Because this strategy entails making a better product that they can sell for higher profit margins to their best customers, the established competitors have powerful motivations to fight sustaining battles. And they have the resources to win.

  Disruptive innovations, in contrast, don’t attempt to bring better products to established customers in existing markets. Rather, they disrupt and redefine that trajectory by introducing products and services that are not as good as currently available products. But disruptive technologies offer other benefits—typically, they are simpler, more convenient, and less expensive products that appeal to new or less-demanding customers.3

  Once the disruptive product gains a foothold in new or low-end markets, the improvement cycle begins. And because the pace of technological progress outstrips customers’ abilities to use it, the previously not-good-enough technology eventually improves enough to intersect with the needs of more demanding customers. When that happens, the disruptors are on a path that will ultimately crush the incumbents. This distinction is important for innovators seeking to create new-growth businesses. Whereas the current leaders of the industry almost always triumph in battles of sustaining innovation, successful disruptions have been launched most often by entrant companies.4

  Disruption has a paralyzing effect on industry leaders. With resource allocation processes designed and perfected to support sustaining innovations, they are constitutionally unable to respond. They are always motivated to go up-market, and almost never motivated to defend the new or low-end markets that the disruptors find attractive. We call this phenomenon asymmetric motivation. It is the core of the innovator’s dilemma, and the beginning of the innovator’s solution.

  Disruption at Work: How Minimills

  Upended Integrated Steel Companies

  The disruption of integrated steel mills by minimills, whose history was partially reviewed in The Innovator’s Dilemma, offers a classic example of why established leaders are so much easier to beat if the idea for a new product or business is shaped into a disruption.

  Historically, most of the world’s steel has come from massive integrated mills that do everything from reacting iron ore, coke, and limestone in blast furnaces to rolling finished products at the other end. It costs about $8 billion to build a huge new integrated mill today. Minimills, in contrast, melt scrap steel in electric arc furnaces—cylinders that are approximately twenty meters in diameter and ten meters tall. Because they can produce molten steel cost-effectively in such a small chamber, minimills don’t need the massive-scale rolling and finishing operations that are required to handle the output of efficient blast furnaces—which is why they are called minimills. Most important, though, minimills’ straightforward technology can make steel of any given quality for 20 percent lower cost than an integrated mill.

  Steel is a commodity. You would think that every integrated steel company in the world would have aggressively adopted the straightforward, lower-cost minimill technology. Yet as of 2000 not a single integrated steel company had successfully invested in a minimill, even as the minimills had grown to account for nearly half of North America’s steel production and a significant share of other markets as well.5

  We can explain why something that makes so much sense has been so difficult for the integrated mills. Minimills first became technologically viable in the mid-1960s. Because they melt scrap of uncertain and varying chemistry in their electric arc furnaces, the quality of the steel that minimills initially could produce was poor. In fact, the only market that would accept the output of minimills was the concrete reinforcing bar (rebar) market. The specifications for rebar are loose, so this was an ideal market for products of low and variable quality.

  As the minimills attacked the rebar market, the integrated mills were happy to be rid of that dog-eat-dog commodity business. Because of the differences in their cost structures and the opportunities for investment that they each faced, the rebar market looked very different to the disruptee and the disruptor. For integrated producers, gross profit margins on rebar often hovered near 7 percent, and the entire product category accounted for only 4 percent of the industry’s tonnage. It was the least attractive of any tier of the market in which they might invest to grow. So as the minimills established a foothold in the rebar market, the integrated mills reconfigured their rebar lines to make more profitable products.

  In contrast, with a 20 percent cost advantage, the minimills enjoyed attractive profits in competition against the integrated mills for rebar—until 1979, when the minimills finally succeeded in driving the last integrated mill out of the rebar market. Historical pricing statistics show that the price of rebar then collapsed by 20 percent. As long as the minimills could compete against higher-cost integrated mills, the game was profitable for them. But as soon as low-cost minimill was pitted against low-cost minimill in a commodity market, the reward for victory was that none of them could earn attractive profits in rebar.6 Worse, as they all sought profitability by becoming more efficient producers, they discovered that cost reductions meant survival, but not profitability, in a commodity such as rebar.7

  Soon, however, the minimills looked up-market, and what they saw there spelled relief. If they could just figure out how to make bigger and better steel—shapes like angle iron and thicker bars and rods—they could roll tons of money, because in that tier of the market, as suggested in figure 2-2, the integrated mills were earning gross margins of about 12 percent—nearly double the margins that they had been able to earn in rebar. That market was also twice as big as the rebar segment, accounting for about 8 percent of industry tonnage. As the minimills figured out how to make bigger and better steel and attacked that tier of the market, the integrated mills were almost relieved to be rid of the bar and rod business as well. It was a dog-eat-dog commodity compared with their higher-margin products, whereas for the minimills, it was an attractive opportunity compared with their lower-margin rebar. So as the minimills expanded their capacity to make angle iron and thicker bars and rods, the integrated mills shut their lines down or reconfigured them to make more profitable products. With a 20 percent co
st advantage, the minimills enjoyed significant profits in competition against the integrated mills until 1984, when they finally succeeded in driving the last integrated mill out of the bar and rod market. Once again, the minimills reaped their reward: With low-cost minimill pitted against low-cost minimill, the price of bar and rod collapsed by 20 percent, and they could no longer earn attractive profits. What could they do?

  FIGURE 2 - 2

  The Up-Market Migration of Steel Minimills

  Continued up-market movement into structural beams appeared to be the next obvious answer. Gross margins in that sector were a whopping 18 percent, and the market was three times as large as the bar and rod business. Most industry technologists thought minimills would be unable to roll structural beams. Many of the properties required to meet the specifications for steel used in building and bridge construction were imparted to the steel in the rolling processes of big integrated mills, and you just couldn’t get those properties in minimills’ abbreviated facilities. What the technical experts didn’t count on, however, was how desperately motivated the minimills would be to solve that problem, because it was the only way they could make attractive money. Minimills achieved extraordinarily clever innovations as they stretched from angle iron to I-beams—things such as Chaparral Steel’s dog-bone mold in its continuous caster, which no one had imagined could be done. Although you could never have predicted what the technical solution would be, you could predict with perfect certainty that the minimills were powerfully motivated to figure it out. Necessity remains the mother of invention.

  At the beginning of their invasion into structural beams, the biggest that the minimills could roll were little six-inch beams of the sort that undergird mobile homes. They attacked the low end of the structural beam market, and again the integrated mills were almost relieved to be rid of it. It was a dog-eat-dog commodity compared with their other higher-margin products where focused investment might bring more attractive volume. To the minimills, in contrast, it was an attractive product compared with the margins they were earning on rebar and angle iron. So as the minimills expanded their capacity to roll structural beams, the integrated mills shut their structural beam mills down in order to focus on more profitable sheet steel products. With a 20 percent cost advantage, the minimills enjoyed significant profits as long as they could compete against the integrated mills. Then in the mid-1990s, when they finally succeeded in driving the last integrated mill out of the structural beam market, pricing again collapsed. Once again, the reward for victory was the end of profit.