To save their companies from destruction, Clayton Christensen tells managers to look at the low end of the market.
Christensen ranks as one of the world’s foremost business thinkers on technological innovation and renewal. He is the Robert and Jane Cizik professor of business administration at the Harvard Business School and his book, The Innovator’s Dilemma, received the Global Business Book Award for the best business publication of 1997.
It shows how ‘disruptive innovation’ like the personal computer and the internet can kill major companies. Frozen in place by success at the high-end of the market, these companies often fail to adapt to the challenge of down-market innovation or competitor. The innovator’s dilemma is whether to continue on the trajectory of proven success or court high growth which inherently means risking failure.
Christensen talks with James Nelson about how companies can look to the low end of the market to see the future.
In an era of disruptive innovation, your work has raised the disquieting possibility that the publicly traded corporation as we know it may be doomed. Do you really believe this?
It is doomed unless managers can be taught to think of innovation in new ways – ways they have not been schooled in before. In the capital markets in the United States, Europe and increasingly in Japan for example, 10 percent of equity is held in hedge funds. The hedge fund time horizon is about 60 days. An additional 35 percent of the trading volume in these financial markets is short-term, meaning that prices are driven by investors who have no interest beyond 60 days. Most of the remaining equities in corporations are held by mutual funds whose average holding is about 10 months.
This crucially affects innovation. An executive in publicly traded corporation who wants to make investments that will pay off even in the short-term can’t do so and at the same time address the needs of the people who own the company’s securities. So, an executive whose objective is to maximise shareholder value is forced to shut down innovations that do not pay off in the very short term.
You’ve used the metaphor of an aircraft runway, saying that the runway needed to launch an innovation is too long for the corporation’s financial leash.
The problem is even worse than that. Most private money is equally impatient. There are two kinds of privately held companies: family-owned firms can have very long time-horizon but those held by venture capitalists or private equity investors are on shorter leash than publicly held companies. In short, the efficiency of capital markets works against the capacity of companies to introduce long-range innovation.
You’ve said that because of their culture, large corporations with mainstream business tend to be intolerant of the trial-and-error that often accompanies innovation. Would you elaborate on that?
I don’t want to give the impression that trial-and-error is always critical for innovation. That’s because the methods and processes appropriate to some kinds of situations won’t work in others. This is the core dilemma faced by most managers. All good companies must engage in what I call ‘sustaining innovation’, the introduction of products they can sell for even more attractive profits to their best customers. Sustaining innovation is predictable and needs to be thoroughly planned. By contrast, in creating new growth businesses, in making what I call ‘disruptive’ innovation, it is almost impossible to know in advance what the right strategy is. All the manager can do is dive into the market and through trial-and-error figure out how best to go about it.
You argue that these disruptive innovations often cannot be made within the existing corporate walls.
That’s because the old game is still very healthy while the new business needs to be incubated. If you try to change the model and current successful processes of the traditional business in order to adapt them to the new innovative opportunities, you may end up dismantling something that – while perhaps no longer leading edge – is still very valuable. To catch the new wave you must begin while you are still at the top of your old game. It’s hard to do that within the stadium where the old game is still being played.
Given this institutional resistance, how can executives best communicate the necessity for change and innovation to the rest of the organisation?
By presenting the innovation first and foremost as threat instead of an opportunity. Threats elicit more intense response. New opportunities only elicit response when the core of the business is in crisis, and even then pursuing new opportunities rarely seems as attractive as fixing the old product. So an executive needs to frame the opportunity as threat to mobilise the organisation to respond to it. Then, quickly, they need to get the new business outside the core. Once outside, away from the sceptical culture of the established business, the opportunity becomes very clear – just as clear as it would be for start-up corporation. Start-ups can be innovative because for them there is no threat. There’s only opportunity.
Can you give an example of how disruptive innovation has destroyed previously successful business model?
Probably the most visible types of failure and success have come in the computer business. I live in the Boston area, where Digital Equipment was hugely successful corporation through the ’70s and ’80s. In the business press Digital’s success was invariably attributed to its brilliant management team. And then, about 1988, Digital just fell off the cliff and unravelled very rapidly.
The business press invariably attributed its failure to the ineptitude of the same, formerly brilliant, management team. At first, I wondered, how could good managers get that bad overnight? The standard explanation was that they suddenly found themselves in new league, one they just couldn’t play in. But that explanation never felt right because every small-mainframe computer manufacturer in the world – Digital, Data General, Prime, Wang, Nixdorf, Hewlett-Packard – collapsed in unison. Something more fundamental than bad management was involved. That something was the advent of the personal computer, classic disruptive technology.
The small-mainframe manufacturers had cost structure intrinsic to succeeding in that business. They had to sell their machines direct to their customers. That involved lot of training, support and service. To cover that overhead, they had to sell their machines at approximately $200,000, and at gross profit margin of roughly 45 percent. Now people were walking into these companies in the ’80s with proposals to make better computers than they had made before, to reach up into the top of the market where, historically, customers had to buy ever more expensive computers. Those business plans promised gross margins of 60 percent and you could sell the machines for $500,000.
At the same time other people were coming in and saying, no, the future is in the personal computer. Those business plans, in the best of years, promised margins of just 40 percent that quickly headed down to 20 percent. You could sell the PCs for only $2000. Worse, in those early years of the PC, their performance was so poor they could only be sold as toys for children. None of the customers of the small-mainframe manufacturers would think of using PC, given the way computers were used at that time.
So the small-mainframe computer manufacturers were prisoners of their own customers?
Yes, and the more carefully the manufacturers listened to them, the more their customers told them: the PC is not important to us. And it wasn’t. Meanwhile, the message being sent by the financial community was, go where the mark-ups are most attractive. The small-mainframe manufacturers had to choose: should they develop products that the
