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Disruptive innovation

What’s the number-one attribute Warren Buffett, arguably one of the most successful investors in the world, looks for in a company? “Sustainable competitive advantage,” he told an interviewer.

Competitive Advantage is a set of factors or capabilities that allows firms to consistently outperform their rivals. (adapted from Roberts, 2002)

If competitive advantage is so valuable, how does a business acquire it? Competitive advantage can be found at many levels. It can come from a variety of competitive differentiators. At the business model level some companies, such as Ebay, have sustainable competitive advantage from network effects. The low-cost airlines have a business-model advantage – they actively avoid the additional costs associated with serving high-demand, package travel and long-distance customers. Some very lucky businesses have monopolies. Some have a cost advantage, perhaps from scale or some technological or process advantage, which allows them to make excess profits while competing on price. Some businesses focus on having the best customer service.

For it to be a competitive advantage only one company can be best at whatever it is. For it to be a sustainable competitive advantage there must be some structural reason that another business could not emulate or beat it.

At the individual level, competitive advantage should be a key focus of every salesperson – if the salesperson can help the customer quantify how their particular solution benefits the customer, or by changing the proposition move the advantage away from a key competitor, then price becomes far less of an issue in the sales process.

What tools are available to help create competitive advantage? Michael Porter’s revolutionary approach to competitive advantage is now over 30 years old. Developed around the same time as the personal computer and before the mobile phone, the internet and worldwide web, it is an industrial-era theory. It focuses on creating competitive advantage within value chains within a business- the processes that make the product. However, the internet and globalisation has fragmented value chains into value systems.

It takes not one, but hundreds of collaborating and competing companies to manufacture a smartphone, for instance. So competitive advantage has firstly to be understood in the context of complex and dynamic value systems.

Network effects were not a consideration 30 years ago, and are not even mentioned in Michael Porters Competitive Advantage, but are a major source of competitive advantage in the modern world for companies like Ebay, Amazon, Facebook and Skype. Network effects have created businesses with the fastest growth rates ever seen.

The theory of disruptive innovation was developed in the 1990’s. It is not a new phenomenon – the huge ice transportation industry which provided ice for icehouses built for the homes of the wealthy was disrupted by the development of the refrigerator in 1844, and Schumpeter published his ideas on creative destruction in capitalism in 1942 – but Christensens’ theory was the first that analysed the circumstances in which disruption happens and why market incumbents are powerless to protect themselves despite their resources. Disruption in markets is growing and the rate at which companies enter and leave the list of Fortune 1000 companies is constantly increasing as a result. The theory of disruptive innovation has some very useful tools for understanding all types of competitive strategy.

Using Porter’s ideas, these tools and others, I’ve developed an analytical methodology for identifying and creating competitive advantage which I call The New Competitive Advantage – follow this link for a presentation of the key ideas. It updates Michael Porters approach for the information age. It introduces ideas and concepts that were not developed 30 years ago and moulds them into an approach that can take a technology, a product or a business model and create competitive advantage.

When applied to a technology (in the example I apply it to a new fundamental technology, the recently-discovered room temperature maser), the process helps understand when the technology will be good enough for particular markets. It can be used to discover early new market or potentially disruptive uses of the new technology. When applied to products it helps create differentiated propositions. I have used it to help several startups to create a business model that creates a clear competitive advantage in their market. I hope it is of similar use to you.

When a new technology comes along it is often described as ‘disruptive’. The usually unasked question is, who exactly is it disrupting and why?

I studied disruptive innovation to find out whether I could use it to develop a potentially disruptive business, rather than just recognise one ex-ante. The key ideas I took from Christensen’s disruptive innovation work and which are applicable to the analysis of all sorts of innovation, are:

  • analysing the capabilities of an innovation against substitutes (not just direct competitors) using the Good-Enough/Not Good Enough approach, and mapping these to potential uses;
  • the Jobs to be Done segmentation approach to identify new market opportunities or product improvements, including unsatisfied or over-served users that could be satisfied by a cheaper solution as in my earlier blog on the business continuity solution;
  • the Resources, Processes and Values framework to identify whether a particular industry or target business can accept an innovation, or how a business can be designed so that industry incumbents cannot respond without hurting their revenues and their stakeholders short-term interests.

Thinking about disruption alongside other business concepts led to some other insights. Thinking about fragmentation of the value systems that make up a market led to the understanding that, for a new innovation (disruptive or not) to be adopted, every business that remains in the new value system must be better off or it won’t be adopted. I’ve seen this happen with a number of potentially-disruptive innovations – the developer cannot get into the market because it is not in the best interest of one of the parties that would be involved in getting  the product to the customer. This is usually because the innovator is looking for a high growth route to an existing customer base.

The value system is the flow of products and services that go to make up the entirety of a product or service to the end-user, which could be an individual or a business. In the early days of the industrial revolution, and particularly before the development of the computer, companies were usually vertically integrated – they designed and built all of the parts of the products they manufactured and either sold directly to the end-user or wholesale to retailers. The computer and global communications changed that. Now a complex product like a mobile phone is the result of the combined efforts of several hundred different competing and co-operating businesses that form a market value system. If it is a fully-competitive market (ie, there is no dominant brand, natural monopoly or other factor limiting competition) then the average price will be closely related to costs.

These thoughts led to game theory and the Nash equilibrium via a little-known but very interesting book, “The slow pace of fast change” by Bhaskhar Chakravorti. I realised that competitive markets settle into a metastable equilibrium in which everyone tries to do the best they can, given what everyone else is doing. Businesses in the market system compete and co-operate to minimise two main things – input costs and risk. Lots of individual businesses fail because of poor execution or wrong resources, but on the whole the market is stable – as measured by average product price. When a new market innovation comes along that removes significant cost from the value system there is a relatively quick step change in price (once the disrupted incumbents exit) and the product settles on a new, lower average price. This seems to have happened sequentially in the PC industry, for instance, where home desktop computers were initially in the £4000 region and have dropped in steps to a price of around £300-£400 today – and are likely to disappear from most homes completely.

So who is being disrupted depends on where in the market value system the innovation is introduced and what costs are being substituted. For a new market disruption, such as the transistor radio, Honda’s Cub motorbike or Ebay auctions, a whole new value system with new customers may have to be created. The disruption is then an underperforming (by the values of the existing market products) substitute to the main markets’ products, but one that is good enough for the unserved and overserved. The tools of disruptive innovation can help us to understand whether our innovation is new market or cost-reducing, who we should be bringing along with us from the existing value system (if any), and what our proposition to them should look like.

My interest is in competitive advantage and disruptive innovation. So here’s a disruptive look at the sales profession, and a new ‘selling’ model.

Most business executives will agree that >90% of the salespeople that they meet are too incompetent to express the advantages of their product as customer benefits in the customers’ terms, which puts the onus on the customer to work out whether the product applies to them or not.

Procurement is getting more sophisticated. Many salespeople end up merely responding to tenders, with little opportunity to influence the outcome.

Companies are slimming down. Their executives don’t have the time to meet with all of the salespeople they would like to, let alone those who would like to meet them. They particularly don’t have the time to find all of the innovations from small companies that could potentially give them a competitive advantage, so they are missing out.

As globalisation, supply chain fragmentation and product complexity has increased, so the number of products and services to select from has ballooned. Executives have to kiss an ever increasing number of sales frogs to find a sales prince with the right solution for their problem. This all results in a huge amount of wasted time and resource on the part of both buyers and vendors and they might still not find the optimum solution – a M executives * N salesmen problem.

So what if we broke the problem into two – an M*1 and a N*1 problem? Create vendor-free industry forums, probably split by function along the lines of Porters’ value chain, at which executives meet to discuss industry issues. The Forums provide vendor evaluation and comparison services and provide anonymised feedback on the industry issues to the vendors in return. The Forum also looks at and reports on innovations. They could also provide best-practice procurement support services.

Our top-performing salespeople, who are really vendor-provided change agents, swap sides and work for procurement. Their skills are used to find efficiencies and competitive advantages for their employers, with a wide range of pre-assessed products and services to choose from with the assistance of the forums.

Disruption like this only works if every party that remains in the new value system is better off. The buyers will be finding better solutions faster, improving their competitive edge. The vendors can fire their under-performing sales teams and their product teams will be plugged directly into the needs of the industry. Innovators have only one place to go to to find out if there is a market for their ideas and to get advice on what they need to be accepted. The top salespeople get a more fulfilling and business-oriented role doing what they do best.

This structure does what good disruptive innovation always does – take a significant amount of cost out of the system.

Thoughts? And for those who think this will never happen – it’s already started. Although most of the players are still feeling their way towards the solution.

There are various innovation approaches that help create completely new high-growth opportunities. Not all of these are disruptive, but they can all be a shock to the market incumbents. Over the next few days I will publish some techniques that I have used to help create new opportunities.

1. Change the basis of competition

Changing the basis on which an industry competes is a powerful technique for taking a major share, or even control, of the industry away from the incumbents. It shifts a market from the area in which the incumbents have all of the skills needed to where the innovator has the skills and competitive advantage.

Apple has brought us great innovation again and again, from the Mac user interface through the iMac, iTunes and iPod to the iPhone, iPad and now iCloud. The common theme to all of these is that Apple has changed the basis of competition in the target market to competing through an improved user experience. These products are also designed to work well together, exploiting one of the basic principles of disruptive innovation – when there is a performance gap (in this case, the integrated user experience across all consumer devices is poor to non-existent) then an interdependent architecture developed by a single integrated company will outcompete a modular  architecture developed by many players. So Apple can be expected to maintain a competitive advantage – only Samsung, another integrated manufacturer, has a chance of competing in the near term.

As industries evolve, so the basis of competition changes. In the mobile industry the first mobile phones were very expensive and used car batteries, so the basis of competition was cost and portability. Once integrated batteries became common the basis of competition changed to coverage for the mobile operators and battery life for the handset developers. As coverage and battery life improved so the basis of competition changed to price and service bundles for the operators, with design and branding the main differentiator for the handset manufacturers. Now data coverage and throughput is becoming an issue for the mobile operators and the range of applications and user experience is the basis of competition for the handset manufacturers. What is the next basis of competition for mobile networks and handset manufacturers – maybe integrated home coverage and social collaboration?

2. Find the unserved or over-served.

Disruptive innovation is a powerful technique for creating value. Disruption is also about business models – it is quite possible to use the same technology to create both disruptive and non-disruptive businesses, as the low-cost airlines demonstrate. How can we bias our innovation efforts towards identifying more disruptive businesses?

New market disruptive innovations serve those that can’t afford to use the dominant market technology, or can’t access it. Low-end disruptive innovations target those that would be happy to have a less-featured solution at a lower price, who are usually also the less-profitable customers for the incumbent. Many innovations are a mix of both. Looking for unserved or over-served customers is a good  start in identifying new growth businesses.

For instance, many people are not served by the online travel or package holiday industry. Package holidays rely on availability data on rooms and flights, which is collected by the global distribution services like SABRE and Galileo. These run big central messaging systems for the travel industry and charge high prices to companies providing market availability information like the airlines, hotels and resorts. This means that the low-cost airlines, smaller hotels etc cannot afford to participate, which pushes up the cost of package holidays. You will not find a low-cost airline in a package holiday or on a travel website like Expedia. So is it possible to create a disruptive low-cost online travel service to put together cheaper package holidays using, for instance, social networking?

The theory of disruptive innovation contains several tools that are very useful ways of looking at the market potential of all types of innovation. I’ll use yesterday’s example to show how I used the tools to develop the idea.

Unserved/overserved. Disruptive innovations start with the unserved – those that cannot afford the existing product – and the overserved – those who do use the existing product, but would welcome a less-functional but lower cost alternative. In disaster recovery (DR) I found a sizeable group of mid-size businesses who either did not use DR centres or who found them too expensive for the service provided, and were dissatisfied with the available alternatives.

Jobs to be done. This is a market segmentation approach that identifies the causes of a purchase – what jobs the buyer is ‘hiring’ your product to do. This is a different approach to traditional attribute-based segmentation which seeks to match attributes of the product to characteristics of the buyer market but offers and gives information about correlation between features and buyer types, but offers no help with improving the product. Looking at what customers are using the product for leads to better products. For the DR service the customers I was targeting were not only interested in getting their business operating again after an incident, but also help with the recovery process and minimising their unavoidable excess costs, which they were well aware could mean the difference between the survival or failure of their business. Bigger companies have the resources to handle this themselves. The smaller businesses also wanted a scalable response which provided  a proportionate response to the nature of the emergency – flooding of the computer room was an invokable event but didn’t necessarily require evacuation of all of the staff.

The Resources, Processes and Values framework. Resources, processes and values are the reasons that the existing market players cannot respond to the disruption. Their current customers aren’t interested in the new product; the salesforce wouldn’t make enough commission selling it; the price is too low for their cost structure to make a profit; the company’s core skills are wrong, etc.

The incumbents in the DR market  incurred high capital costs to provide all of the IT systems that their customers required, which had to be recovered as a service rental. We created a business model with a lower capital cost and slightly higher operational costs. Our customers were going to have much lower service subscription costs but with the operational costs covered by the insurance element. The insurance company benefited from shorter recovery periods. Our model was also different in its overbooking of facilities – with standard DR services two customers in the same geographic location cannot be allocated to the same DR facility because of the risk of one disaster affecting both companies. By removing the fixed facility from the model we would have been able to share resources much more effectively.

Good enough/not good enough. A disruptive innovation is always not good enough in at least one capability required by the market incumbent’s customers. The low-cost airlines use the same planes as the incumbents, but take costs out by reducing service, using less convenient airports and charging for extras. They under-perform in customer service for the customers that are prepared to pay for better service to service the customers that want a cheaper flight.

In the DR service we were careful to ensure we were keeping our fixed costs low by, for instance, only offering a limited range of IT systems. The customers we were attracting either used only these IT systems or were prepared to work around this limitation to get a lower-price, more complete service.

Using these tools will help create a disruptive business.

Is it possible to deliberately set out to create a disruptive innovation in an existing market? I believe it is, if the tools laid out in Clayton Christensens theory are applied properly.  I’m going to describe an eight-year-old innovative idea of my own that used the tools to do just that. The idea never actually made it due to poor execution (the company I was with failed to raise the necessary finance for it), but the approach was valid. In my next blog I will cover the tools and how I use them.

I had started working with a very small IT support business with a terrible product portfolio but some strong technical skills. One of the things that the company provided was an early version of online data backup for a couple of customers. While talking to potential customers for this service I asked about their overall disaster recovery (DR) strategy, and discovered an opportunity.

Their ideal DR service was a safe alternate location that they could move their business to as soon as an emergency was declared, while they recovered from whatever problem had occurred. This also meant that their IT infrastructure had to be replicated somewhere, and that the company data had to be copied to this backup system regularly to be as up-to-date as possible when they got to the facility, because most companies ran their own IT systems at the time. This type of DR service is provided by Sungard and IBM, among others, which run huge disaster recovery facilities. Once the service was invoked the customers IT system can be quickly set up and populated with data, and Sungard also provide desks where staff can work during the recovery phase. These services proved invaluable for Manhattan’s finance businesses during, for instance, the 9/11 terrorist attacks in the USA.

The problems for smaller customers are that the service is expensive and big customers pay extra for pre-emption rights. This means that, even if the smaller company had paid for the service they could not guarantee they could use it, because if a big customer invoked at the same time the smaller customer could be pre-empted and have nowhere to go. The high price meant that many companies could not afford the service at all, or took a reduced service.

There were alternative services available. One was a truck full of computer hardware that would turn up to a site and work from the car park. The problem was that the hardware had to be installed and configured, which took many days even with expert help. Another service was DR insurance, which paid for excess costs during the recovery period. However, the insurance company refused to cover the most expensive part, the first couple of days after the disaster. The recovery period depended on the staff they had available, who may rarely or never have been trained how to deal with a disaster properly. There was no perfect solution, so could I come up with a lower cost solution that met these client’s needs?

What job were these smaller businesses trying to get done? They were trying to ensure their survival in the case of an emergency by getting their key systems and staff back up as quickly as possible, but at a reasonable cost. The longer a business is not working, the greater the chance that it will never restart.  Loss of data is increasingly damaging, with more and more supply chain integration being based on IT systems. It was more important to them to be certain of getting back up rather than having all of their systems and staff relocated.

I realised that businesses have a range of needs. Their most important systems have to be back up immediately, but other systems can wait for an hour or two, a day or two, or even a few weeks. They can send most of their staff to work from home and only need the DR facility for critical workers. Most importantly, they needed additional skilled people to help with the invocation and the recovery.

I worked with a datacentre-based managed services company to come up with an alternative model. We would provide a range of recovery options, ranging from complete synchronisation of critical servers, guaranteed 1 hour recovery using an early virtualisation approach, through 2 hour guaranteed recovery using disk swapping and 1 day guaranteed recovery to ordering and delivery of replacement hardware within 7 days. We would provide an online data backup service to ensure their data was current. Besides the most expensive live datacentre services, we would maintain a stock of standard servers which could be installed and brought up quickly. Most importantly we would have a team of IT/DR specialists who would be trained constantly to respond quickly to a customer invocation, a bit like the emergency services. For staff accommodation we maintained a small number of desks in the datacentre for emergency IT workers, we did a deal with a managed office business to reserve some space as an emergency facility, and we would provide a VPN for the majority of the staff to work from home. We would assist with expertise throughout the recovery, which opened another opportunity – we agreed with a big insurer that they would cover the first few days as well, because we could reduce the excess cost of working and the recovery time. So the customer’s needs were met while, with the range of options available, their costs were greatly reduced.

I had several customers ready to sign LoIs, including one with 200 servers, by the time the CEO announced that he had failed to raise the finance necessary and was going to liquidate the company.

Why was this potentially disruptive? The big DR facilities rely on a number of customers paying for the facility on the assumption that no more than one or two would invoke a disaster at the same time. If I took the smaller customers away then their costs would have to be shared among fewer big customers – but they could not close these DR facilities without losing their big customers that paid most of their costs. We would also be sharing facilities, but on a different basis, so  with careful planning we could ensure that our customers could be guaranteed service in the event of a disaster that affected a larger area. We were not good enough to attract the DR facilities’ bigger customers because we would only cover the basic Linux and Windows operating systems, not mainframes or specialist systems – to do otherwise would have increased the size of our IT support teams and our cost base. We may also have been able to attract the least-important part of the bigger company’s systems, reducing the services that the bigger companies would require from the big DR facilities.

Naveen Jain, who is the founder of the World Innovation Institute, Moon Express, iNome and Infospace, takes on Malcolm Gladwell’s “Outliers” in this article on Forbes. Outliers proposes that expertise is a key requirement for success. Naveen, who is also a trustee of Singularity University, believes that the people who will come up with the creative solutions that will change our planet will NOT be the experts in their fields. He believes that experts are best at incremental improvements, not disruption. His reasons are:

  • myopic thinking – those who are down in the detail can’t easily see the big picture
  • increasing pace of obsolescence of expertise and the increasing availability of information to non-experts

I agree with Naveen. When your expertise is in widgets, the solution to every problem will look like a widget. Most experts have spent years building up their knowledge and have developed shortcuts – rules of thumb and implicit assumptions that they judge everything by. They are not often inclined to re-think these and come up with a different answer.

I love to identify and challenge implicit assumptions, and it’s a great way of encouraging innovative thinking.

Experts are also not going to be able to bring expertise from other fields into new thinking about solving problems. One thing I learned very early on was to keep a very wide watching brief on what others are doing in other fields. I like spotting links between how one field works and another – it helps in understanding, and it often leads to new ways of thinking about a problem. For instance, thinking about IT architectures as a response to the costs of the component parts, and how that changes as the performance of the component parts improves, has generated some useful insights.

Finally, experts don’t tend to go back to basics and rethink things from the ground up. I’ve found several useful techniques for generating new ideas. One is to extrapolate growth curves, like Moore’s law, data storage growth and storage costs, to see what happens as these diverge – eventually, things break and the opportunity for a disruptive innovation appears. Moores’ law has generated several generations of disruptive technology on its own. Another is to take things to extremes –  for instance, the most efficient waste-to-energy system will generate more electricity and more money – what happens if we try and maximise efficiency and how might we do this?

Finally we have to run these innovative ideas through the innovation filter – who will want it and why, what does it compete with (do nothing and substitutes included), how do we take it to market, etc. Which is the subject of this blog.