On our Luna MBA booklist you’ll find The Innovator’s Dilemma by Clayton Christensen. Written in 1997, you shouldn’t be bragging about just discovering it now, though many people are. Better late than never I suppose. I love Clay’s thinking and the way he writes – he crystallised some frightening trends in the shrinking lifespan of business models that became evident in the 1980s, in language that everyone could understand.
Thus, when the opportunity to see him in person came up this week, I was compelled to go. Sure, it was $800 a ticket. Sure, you can read the books (we have). Watching and listening to this giant of a man (in all senses, he is 203cm tall!) is like seeing Leonard Cohen in person, rather than downloading his greatest hits on iTunes. Or perhaps trekking to town and buying vinyl in James’ case.
With his entire oeuvre of change and business teaching available (8 books!), what did this towering figure from management literature choose to talk about?
1. Disruptive Change
First Clay reminded us how disruptive change is defined in his work – that disruptive innovations create new customers and markets, rather than fighting in the home ground of existing products or services. This makes them very different to changes that you invent to sustain your current business model.
His personal example was transistor radios adoption by teenagers in the 1950s. At the time, the core consumer market for radio and TV was wealthy middle class families – spawning a massive industry supplying valve based products to US consumers that were large and costly.
Realising that the transistor was going to be part of the future of the technology, the main industry players invested $3b on R&D to develop transistors that would produce high fidelity sound and pictures. None of which delivered a new product in the short term for consumers.
The industry disruption occurred because of a change in the metric of performance from quality of sound to portability of sound. Teenagers were perfectly happy with static-filled rock and roll music if they could listen to it away from the prying and censoring ears of their mothers!
The key question around this kind of disruption becomes “is it better than nothing?” rather than “is it better?” The disruption is occurring away from the core market, in a place that likely seems unattractive to the incumbent players.
He used the Peapod electric car (later seemingly a victim of the downturn in the US car industry) as another example – are there possibly customers for a car that won’t go far or fast? Yes – parents of teenagers. Compare that to manufacturers chasing the easier to understand mid-range and higher end electric car segments – Toyota producing the Prius, and Tesla the $100,000 Model S.
He talked about the emerging trend of corporate universities eg Purdue Chicken’s university (as opposed to the prestigious Purdue University!); and how in the 1960s a Toyota Corona was so much better than walking to a college student. In his books he details the disruption of the floppy and hard disk industries in the same way.
Now – were stupid managers to blame for missing these opportunities and driving 9 out of 10 of the main American consumer TV and Radio manufacturers into bankruptcy? No! Turns out that the rational pursuit of increased profit drives managers to focus on products and segments with bigger margins, often in luxury or higher end market segments, and allow low cost disrupters to get a footing (steel mills, cars, disks).
Those bottom-end disruptive entrants that went on to disrupt the established, high margin players started out by chasing markets the big players never wanted. Astonishingly, after adjusting for inflation, the first Toyota in the USA cost 1/4 the price of a Model T! How did they do this? The clue is in the supply chain, which for a Ford was 60 days in the 1960s (including how long components took to order, build, deliver and store for the production line). Toyota made that a 2 day process – just in time personified.
A ‘technological core’ is what enables disruptive innovation in his parlance. In the US steel industry example, the mini-mill, which improved dramatically over time (through measurement of the ingredients making the output of steel products from rebar to finished sheets predictable) was exactly such a core. You could take that technology and move your way up the market to the top, eventually displacing the old industry players.
Hotels don’t have such a core – to move up-market you must emulate the higher priced options down to the uniforms of the staff and the chocolates on the pillow. In that market the disruption comes from outsiders like AirBnB. Higher education had no such technological core, until the internet came along!
So now you don’t really need to read The Innovator’s Dilemma.
2. The Church of New Finance
The way new, disruptive market entrants are born and grow up can be described as a cycle, beginning with ‘market-creating‘ innovation; followed by sustaining innovation (which increases the capability of your existing product or service, often beyond the useful requirements of the consumer by the way); then finally efficiency innovations. The latter eliminate jobs and free up capital.
How is that capital then used?
By the 2000s, the Church of New Finance, a less than holy alliance of business school professors, accountants and financiers began to advocate ratios as the new measure of business’s success/ profitability (as opposed to weighing ‘tons of cash’). Managers now fiddled with whichever was the easier number (between denominator and numerator) to manipulate the fraction – eg improve ROC by getting assets off the books through outsourcing.
One result was companies reinvesting savings made from efficiency innovations back into further efficiency innovations with a 2 year payback vs 10; thus avoiding the need for capital and risk associated with market-creating innovations. This breaks the cycle in Clay’s view.
As an example, the steel industry got obsessed with gross margin percentage. If they had thought about net margin per tonne instead, and they would have likely stayed in the low end of the market, and defended their industry against the smaller electric powered steel-making plants called mini-mills.
This is what Clayton calls ‘the capitalist dilemma’. One result is too much money is released that isn’t applied to disruptive innovation, and with this flush of cash, when the cost of capital tends towards zero, measures like NPV become useless. The time value of money in the future is worth the same as today – zero. Traditional economic analysis busted!
Trillions are now languishing in investment funds globally, with nobody daring or bothering to invest in the riskier disruptive innovations.
He talked about ‘royalty capital‘ – a new model of funding startups and post-startups (those likely to be beyond the venture capital stage, and more likely to be taking private money than listing publicly with all the management overhead).
With royalty capital you bring cash into a company as licensed ‘IP’ with an annual royalty of say 3%, payable when revenue starts to come in. The royalty builds up until it pays off the capital sum, and the license to use the money as pseudo-intellectual property is taken off the books.
This apparently aligns the investor and the entrepreneur for growth, longer term. There is less obsession with liquidity – much better than venture capital, which wants in and out quickly.
Another economics ‘bust’ is how traditional assumptions that the ‘do nothing’ scenario that your boss made you prepare for the economic analysis of your business case is value neutral, whereas it is more likely to now be destructive to revenue, and of negative value to your business. The net present value (NPV) calculation thus has to include the avoidance of the negative outcome. Good point, though never built into any business case I have ever seen. Way easier to just do nothing it seems, as you can’t be blamed for waiting and seeing what happens next.
With an industry example close to my heart, Dell got out of the motherboard business by devolving production to Asian supplier Asustek, who originally only made simple circuit boards. They then chipped away at assembly, then logistics, until all Dell had left was the brand. With no assets, ROC was better for Dell every year! Genius right? Nope, because they had just funded a vicious competitor in the US PC market.
Thus, in business, the right metric of profitability might just be good, old-fashioned money.
With an increasing level of interest in education, Clay also pointed out that measuring kids this way is distorting their education, and leaves us not caring for 10 year outcomes.
3. PROBLEM: marketers analyse customers, not the job to be done.
This is a useful insight from his work in The Innovator’s Toolkit. Imagine your product or service is not a thing, but a person. That person can be hired, or not hired. What job are you hiring them to do?
It’s a good way to jolt yourself out of traditional thinking for a minute. In a nutshell, marketers and product people don’t spend enough time thinking about for what purpose (or a job that needs doing) a consumer would ‘hire’ this imaginary person.
In my day job context – why would a person hire our REA Commercial iPhone app? What job were they hoping it would do for them? When you understand this (as I believe we do), you’re in a much better place to innovate.
Clay gives us this framework for thinking about the architecture of a job to be done:
1. What is the job to be done? (Functional, emotional and social dimensions).
2. What experiences (in purchase and use) do we need to provide so the job is done perfectly?
3. What and how to integrate within that experience?
4. Purpose brand: a snapshot or glimpse of a brand that represents all of the above.
Turns out the hard bit to copy is the link between #2 the experience, and #3 the integration steps, with a good example being Ikea (good people to hire when the job to be done is to furnish an entire apartment). Why has nobody followed Ikea?
Obsessing about the job to be done is the Clayton Christensen secret, as opposed to obsessing about consumer behaviour, products and services, which are easily mimicked. He went on to talk about retailers, and their spectacular miss with this point. Are you listening Australia?
4. Final thoughts.
During the final panel session, I enjoyed a great quote from Alan Kohler, founder of the Business Spectator in Australia, who was famously fired from Fairfax for predicting that the end of newsprint in its traditional form was nigh – way back in 1993:
“When it comes to predicting the future, being early, and being wrong, amount to pretty much the same thing.”
On surviving disruptive innovation, there were too few cases that are easily drawn on for organisations that have successfully adapted over time. Clay offered an unlikely metaphor (being a deeply Christian person that as individual humans, we don’t evolve in our lifetime (like products, we are engineered for a fixed duration), but populations do. In parallel, business models don’t evolve, but corporations can over generations.
His example given was IBM moving from $2m mainframes, the size of a building, to $200,000 mid-range computers (the IBM 36 features in my career) to $2,000 PCs, then consulting, and finally to software. It’s a radical example, where the centres of innovation had to be geographically at opposite ends of the USA to survive. Today’s obituary of IBM’s own inventor of the PC, William Lowe, tells a bittersweet story of that organisation’s treatment of its disruptive innovators.
In the closing panel, Clay also made the observation that data is heavier than water in most companies. It stays at the bottom while managers try desperately to find the solution and float that upwards toward the boss, making themselves look good. Thus the chances of a CEO knowing the truth are low, the Chairman even less so, explaining why so many smart executives and directors miss opportunities to see disruptive change coming.