The Innovator's Solution

by Clayton Christensen

  18. Historically, some venture capital–backed start-ups, particularly in telecommunications and health care, have followed a strategy of developing a breakthrough sustaining innovation—leapfrogging ahead of the leader on the sustaining curve—and then quickly selling out to the larger established company that is moving up the trajectory behind them. This strategy works—not because the established companies’ values constrain them from targeting the same innovation, but because their processes aren’t as fast as those of the start-ups. This is a proven way to turn a profit, but it is not a route by which a new-growth business can be created. Either by acquiring the product or by outmuscling the entrant, the established company will in the end be offering the improved product as part of its product line, and the venture that developed it first will not exist. The start-ups essentially comprise heavyweight project teams, which develop products autonomously and then get disbanded when the products are ready for commercialization. It is a mechanism by which established companies with attractively priced equity can pay for research and development with equity, rather than expense.

  19. Dow Corning Corporation’s establishment of its Xiameter subsidiary is an example of exactly this situation. Xiameter is a high-dependability, low-overhead sales and distribution business model that allows the company to make attractive profits on commodity-level pricing of standard silicone products. Customers who need higher-cost services to guide their purchasing decisions can purchase their silicones through Dow Corning’s mainstream sales and distribution structure.

  20. We make this statement for illustrative purposes only. At the time of this writing, catalog and online retailing are so well established as a disruptive wave in retailing that if a department store were to attempt to create a major new online growth business, it would be following a sustaining strategy as an entrant, relative to the firms that created online retailing. Even a giant like Macy’s would likely lose to the firms that are already on a sustaining march up the disruptive trajectory. Acquiring a firm that has a strong position on that disruptive trajectory—as Sears did when it bought Lands’ End—is about the only way that department stores could now catch that wave.

  21. Like Merrill Lynch, Goldman Sachs has also implemented Internet-based trading systems for their existing customers within their mainstream, full-service brokerage businesses. The technology was, as a consequence, implemented in a manner that sustained the values, or cost structure, of those business units. In fact, the implementation of Internet-based trading capabilities probably added cost to the companies’ structures, because it was an additional option and did not displace the traditional broker-based trading channel. See Dennis Campbell and Frances Frei, “The Cost Structure and Customer Profitability Implications of Electronic Distribution Channels: Evidence from Online Banking,” working paper, Harvard Business School, Boston, 2002.

  22. An interesting stream of research is coming to this same conclusion. See, for example, Rakesh Khurana, Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs (Princeton, NJ: Princeton University Press, 2003). Khurana has found that bringing into a company high-profile “superstar” managers—those who in our parlance have many of the most coveted right-stuff attributes in abundance—meets with failure far more frequently than many have supposed.

  23. See Kim B. Clark and Steven C. Wheelwright, “Organizing and Leading Heavyweight Development Teams,” California Management Review 34 (Spring 1992): 9–28. The concepts described in this article are extremely important. We highly recommend that managers interested in these problems study it thoughtfully. Clark and Wheelwright define a heavyweight team as one in which team members typically are dedicated and co-located. The charge of each team member is not to represent his or her functional group on the team, but to act as a general manager—to assume responsibility for the success of the entire project, and to be actively involved in the decisions and work of members who come from each functional area. As they work together to complete their project, they will work out new ways of interacting, coordinating, and decision making that will come to compose the new processes, or new capabilities, that will be needed to succeed in the new enterprise on an ongoing basis. These ways of getting work done then get institutionalized as the new business or product line grows.

  24. The fundamental conceptual breakthrough that leads to the conclusions in this paragraph comes from the seminal study by Rebecca M. Henderson and Kim B. Clark, “Architectural Innovation: The Reconfiguration of Existing Systems and the Failure of Established Firms,” Administrative Science Quarterly 35 (1990): 9–30. This is the research that, in our view, elevated the state of theory building in process research from attribute-based categories to circumstance-based categories. Their essential idea is that over a period of time, the patterns of interaction, communication, and coordination among those responsible for designing a new product (the product development process that a company follows) will come to mirror the pattern in which the components of the product interact within the architecture of the product. In the circumstance in which the architecture is unchanged from one generation to the next, this habitual process will facilitate the kinds of interactions that are necessary for success. But in the circumstance in which the development organization needs to change the architecture significantly, so that different people need to interact with different people about different topics and with different timing, the same habitual process will impede success.

  In many ways, the diagnosis and recommendations about process change that are on the vertical axes of figure 7-1 derive from Henderson and Clark’s work. The diagnoses and recommendations on the horizontal axes that relate to the values of the organization derive from The Innovator’s Dilemma, which in turn built on the work of Professors Bower and Burgelman that we have cited elsewhere. This body of research also seems to have lifted the state of theory from attribute-based categorizations to circumstance-based theory.

  25. We have observed a frustrating tendency among managers to seek one-size-fits-all solutions to the challenges they face, rather than to develop a way of applying solutions that are appropriate to the problem. On this particular issue, some managers seem to have concluded in the 1990s that heavyweight teams were the “answer,” and flipped their entire development organizations into using heavyweight development teams for all projects. After a few years, most of them decided that heavyweight teams, while they offered benefits in terms of speed and integration, were too expensive—and they then flipped their entire organizations back into the lightweight mode. Some of the companies cited in the text have suffered these problems, and have not learned how to employ the appropriate types of team in the appropriate circumstance.

  26. See Charles A. Holloway, Steven C. Wheelwright, and Nicole Tempest, “Cisco Systems, Inc.: Acquisition Integration for Manufacturing,” Case OIT26 (Palo Alto and Boston: Stanford University Graduate School of Business and Harvard Business School, 1998).

  27. We recognize that this is a dangerous statement to make; probably a more accurate statement is that at the time of this writing, nobody seems to have been able to devise a viable disruptive strategy for online banking. It is possible, for example, that E*Trade Bank is successfully building a low-end disruptive bank. We cited in note 21 one of an ongoing series of papers that Professor Frances Frei of the Harvard Business School has been writing with various coauthors about the impact of providing new service channels to customers. When established banks have added ATM, telephone, and online services to customers, they have not been able to discontinue the old channels of service, such as live tellers and loan officers. As a consequence, Frei has have shown that the provision of lower-cost channels of service actually adds cost, because they are additive and not substitutive. It is possible that E*Trade Bank, without the legacy infrastructure and costs of in-person service, can actually create a business model whose costs are low enough that it can earn attractive returns at the discount prices required to win the business of overserved custome
rs.

  28. A retailer’s inventory turns are not simple to ratchet up (see chapter 2, note 18). When heading up, retailers carry a relatively rigid structure of inventory turns into higher margin products, resulting in an immediate improvement in ROI. Heading down-market entails carrying the same rigid turnover structure into lower-margin products, resulting in an immediate hit to ROI. This is a very asymmetric part of the world.

  CHAPTER EIGHT

  MANAGING THE STRATEGY

  DEVELOPMENT PROCESS

  Don’t just tell me that the right strategy is crucial for success. How do I come up with a strategy that works? What process for formulating strategy is most likely to generate a strategy that will lead to success? Is it better to be the pioneer in an emerging market, or to be a follower once the market’s topography is clearer? When should we let innovations bubble up from within the company? When and why should we drive things from the top? Which aspects of strategy formulation do senior executives need to manage most closely?

  Most questions about strategy that arise in building a new business concern the substance of the strategy. Managers are anxious that their strategy be the right one. There is an even more important strategy question, however, that most managers forget to ask—and it is the reason many ventures end up with flawed strategies. This crucial question relates to the process of strategy formulation that the venture’s management team will use to develop and implement a winning plan. Although executives are understandably obsessed with finding the right strategy, they can actually wield greater leverage by managing the process used to develop the strategy—by making sure that the right process is used in the right circumstances.

  Innovative ideas always emerge in a half-baked, partially formed condition, as we have noted. They subsequently go through a shaping process that transforms them into the fully fleshed-out business plan, complete with strategy, that is required to win funding. This chapter describes two simultaneous but fundamentally different processes of strategy development, and presents a circumstance-based theory that indicates which of these processes management should rely on as the most reliable source of strategic insight at different stages of business development. It then describes the workings of the resource allocation process, which is the filter through which all strategic actions must flow in order to affect the company’s course. The chapter ends by describing some tools and concepts that executives can use to manage the ongoing processes of strategy formulation more effectively.

  Two Processes of Strategy Formulation

  In every company there are two simultaneous processes through which strategy comes to be defined. Figure 8-1 suggests that both of these strategy-making processes—deliberate and emergent—are always operating in every company.1 The deliberate strategy-making process is conscious and analytical. It is often based on rigorous analysis of data on market growth, segment size, customer needs, competitors’ strengths and weaknesses, and technology trajectories. Strategy in this process typically is formulated in a project with a discrete beginning and end, and then implemented “top down.” We hope that the theories discussed in this book can help executives and their advisers devise even better deliberate strategies for creating and sustaining growth than have been possible through traditional methods of data analysis.

  Deliberate strategies are the appropriate tool for organizing action if three conditions are met. First, the strategy must encompass and address correctly all of the important details required to succeed, and those responsible for implementation must understand each important detail in management’s deliberate strategy. Second, if the organization is to take collective action, the strategy needs to make as much sense to all employees as they view the world from their own context as it does to top management, so that they will all act appropriately and consistently. Finally, the collective intentions must be realized with little unanticipated influence from outside political, technological, or market forces. Because it is difficult to find a situation in which all three of these conditions apply, the emergent strategy-making process almost always alters the strategy that the company actually implements.2

  FIGURE 8 - 1

  The Process by Which Strategy Is Defined and Implemented

  Emergent strategy, which as depicted in figure 8-1 bubbles up from within the organization, is the cumulative effect of day-to-day prioritization and investment decisions made by middle managers, engineers, salespeople, and financial staff. These tend to be tactical, day-to-day operating decisions that are made by people who are not in a visionary, futuristic, or strategic state of mind. For example, Sam Walton’s decision to build his second store in another small town near his first one in Arkansas for purposes of logistical and managerial efficiency, rather than building it in a large city, led to what became Wal-Mart’s brilliant strategy of building in small towns discount stores that were large enough to preempt competitors’ ability to enter. Emergent strategies result from managers’ responses to problems or opportunities that were unforeseen in the analysis and planning stages of the deliberate strategy-making process. When the efficacy of a strategy that was developed through an emergent process is recognized, it is possible to formalize it, improve it, and exploit it, thus transforming an emergent strategy into a deliberate one.

  Emergent processes should dominate in circumstances in which the future is hard to read and in which it is not clear what the right strategy should be. This is almost always the case during the early phases of a company’s life. However, the need for emergent strategy arises whenever a change in circumstances portends that the formula that worked in the past may not be as effective in the future. On the other hand, the deliberate strategy process should be dominant once a winning strategy has become clear, because in those circumstances effective execution often spells the difference between success and failure.3

  The Crucial Role of Resource Allocation

  in the Strategy Development Process

  Figure 8-1 charts the confluence of these deliberate and emergent decision-making processes in defining actual strategy. Ideas and initiatives, whether of deliberate or emergent origin, are filtered through the resource allocation process, as represented by the center-left box in the figure. The resource allocation process determines which of the deliberate and emergent initiatives get funded and implemented, and which are denied resources. Actual strategy is manifest only through the stream of new products, processes, services, and acquisitions to which resources are allocated.

  The resource allocation process is typically complex and diffused, operating at every level and all the time. If the values that guide prioritization decisions in resource allocation are not carefully tied to the company’s deliberate strategy (and often they are not), then significant disparities can develop between a company’s deliberate strategy and its actual strategy. Actively monitoring, understanding, and controlling the criteria by which day-to-day resource allocation decisions are made at all levels of the organization are among the highest-impact challenges a manager can tackle in the strategy development process.

  Initiatives that receive funding and other resources from the resource allocation process can be called strategic actions, as opposed to strategic intentions. Intel chairman Andrew Grove has counseled, “To understand companies’ actual strategies, pay attention to what they do, rather than what they say.” 4 In our parlance, this means that a company’s strategy is what comes out of the resource allocation process, not what goes into it.

  As the company does these things, managers then confront and respond to unexpected crises and opportunities, and their experiences cycle back into the emergent process. As managers learn what works and what doesn’t in the competitive marketplace, their improved understanding flows back into the deliberate strategy process. Each resource allocation decision, no matter how slight, shapes what the company actually does. This creates a new set of opportunities and problems and generates new deliberate and emergent inputs into the process.

  How does this crit
ical resource allocation process work? It is powerfully driven by the values of the organization, which, as noted in chapter 7, are the criteria by which managers and employees make prioritization decisions. Most of the ideas for developing new products, services, and businesses bubble up from employees within the organization. Middle managers cannot carry all of these ideas up to senior management for approval and funding, however. The values or criteria that middle managers use to decide which ideas they will promote and which they will allow to languish play a crucial role in determining what comes out of the resource allocation process. We noted in chapter 1 that once middle managers decide an idea has merit, they engage with the innovators in a process of shaping the idea into a fully fleshed-out business plan that can win funding. The values that senior management employ in these funding decisions therefore exert an equally powerful influence on the types of ideas that can and cannot emerge from the resource allocation process.5

  Two factors exert a particularly important influence on the values that guide resource allocation decisions. The first is the company’s cost structure, which determines the gross profit margins that it must earn to cover overhead costs and make a profit. Good managers have a very difficult time according priority in the resource allocation process to innovative proposals that will not maintain or improve the organization’s profit margins.6 The second factor is the size threshold that new opportunities must meet in order to get through the resource allocation filter. This threshold grows higher as a company becomes larger. Opportunities that were seen as energizing in a company’s resource allocation process when the company was small get filtered out as “not big enough to be interesting” in the larger company.