What is disruptive innovation?

I’m currently researching disruptive innovation and how managers can understand and use this approach to decode potential futures of their business within ever-changing and competitive industries.

The reason I’m posting this, in addition to trying to get my thoughts straight, is that the idea of disruption is widespread in industries now, and many companies claim to be disruptive.

I’d like to discuss how you can tell dangerously disruptive innovation, from normal positive innovation and how you can insulate yourself against being disrupted.  I believe it will take about 5 posts to explain this theory and its applications.

Clayton Christensen
Clayton Christensen, creator of Disruption Theory

Disruptive innovation – a process where often very successful companies seemingly lose their competitive advantage against low cost challengers – was created by Harvard Professor Clayton Christensen, and publicised The Innovator’s Dilemma (1997) (video summary). He identified a process by which a new product or service takes root initially in simple applications at the bottom of a market, is ignored by competitors at the top of the market, and then relentlessly moves up market, eventually displacing established competitors.  Here’s a diagram about how Disruption comes into play.

ANDREW A. KING AND BALJIR BAATARTOGTOKH How useful is the theory of innovation? Sloan Mgmt Review fall 2015
ANDREW A. KING AND BALJIR BAATARTOGTOKH How useful is the theory of innovation? Sloan Mgmt Review fall 2015

Lets take the example of the mobile phone market as an example of disruption.

Please excuse the simplifications, in the past 5 years there have been two main players- high priced Apple and lower priced Samsung.

Samsung, in response to customer demands have been trying to mirror Apple ideas. They have built their own operating system to mirror Apples OS, they have added better cameras, wider screens, curved screens.  It seems Samsung has a mobile phone variant for every customer.  This i believe is described in point (1) and point (2) above.

Samsung-2014-All-Phoes

Fantastic, but still Apple has a strong core of supporters and a significantly high price.

What has happened in the last couple of years is the advent of Xiaomi, a Chinese phone manufacturer making low grade phones just for the Chinese market. With support of patient shareholders Xiaomi set to work building from a strong Chinese base to expand overseas, selling low cost phones that started to mirror Samsung but at a much lower price. They even used Android OS enabling the usage experience of Samsung to be mirrored on their phones (point (3) above). And through 2014 and 2015 Xiaomi products became better and better offering many of the features Samsung offered.

In 2014 and 2015  Samsung reported a significant drop in profit as it struggled to ward off the disruption of Xiaomi (point (4) above). See below the profit shares of major phone manufacturers.

mobile phone share of profits 2010-2015

Innovation that is disruptive allows a whole new population of consumers or buyers at the bottom of a market access to a product or service that was historically only accessible to consumers with a lot of money or a lot of skill.  Xiaomi’s entry into internet feature phones, followed by other super low cost manufacturers, have really opened mobile phones to a wide range of new consumers.  Samsung, following a trading-up strategy, from its initial cost-leadership strategy, has been hurt badly by low cost manufacturers.  It will be interesting to see how they can cope with this.

Reviewing this innovation process, characteristics of these disruptive opportunities – at least in their initial stages – typically include:  lower margins, smaller target markets, and simpler products and services.  These are not attractive opportunities to industry incumbents using backward looking measures of performance. Industry leaders are loath to “go backwards” to offer a cheap feature-less or feature-light versions of their products just to meet the needs of price conscious consumers. Shareholders and Industry press laud and reward companies whose strategy is move upmarket, and equally denigrate any move to introduce “retrograde” products.  This creates space at the bottom of a market (demand with limited supply)  for new disruptive competitors to emerge. Again, Samsung’s response to Xiaomi mirrored this, ignoring the upstart as the market for low-feature phones at low-cost was considered both unprofitable and a retrograde step to the Korean manufacturer.

Disruptive innovations, according to Christensen, don’t attempt to focus on better products to established high-value customers in existing markets. Rather, they disrupt and redefine industry trajectory by introducing products and services that are initially not as good as currently available products but which take customers in different directions.  Apple introduced the computer-like phone, Samsung offered this at low price, Xiaomi offered the same at a super low price.

Can YOU tell the difference?
Can YOU tell the difference between a Xiaomi and a Samsung?

Back to Samsung, Xiaomi was able to produce good-enough phones that drew a market, and provided  Xiaomi investors with sufficient reasons to keep supporting them as they gradually copied more and more features of Samsung, at lower cost, until they were producing pretty much the same phone as Samsung for a significantly lower cost (see picture above). Samsung’s profitability was destroyed as they were forced to compete using price against the upstart innovators who exactly copied their offerings but at a distinctive discount.  Anyway that’s a common story that we’ll discuss later.

Disruption, such as this, has a paralyzing effect on managers within these industry leaders.  A managers traditional training and standard experience leaves them unable to respond when disruptive innovation hits. We managers are incentivised and motivated to go up-market and “add-value” and respond to high value customer needs, and almost never motivated to defend against new or low-end markets that the disruptors find attractive.

When faced with the prospect of these lose-lose decisions;  against a disruptive innovator a manager must choose between losing margin by competing at a lower price or losing volume, market share and customers if they don’t compete.  Either way a response means you don’t meet your targets and your Boss doesn’t get his bonus. You get fired.

And now Xiaomi, is being disrupted by even newer upstarts replicating their business model at even lower costs.

So looking back, it can be said that many industries have been “disrupted” in this way and many leading companies turned to dust- phones vs mobile phones, radios vs tape players vs walkman vs iPod, US cars vs Japanese cars vs Korean cars, retailers vs discount retailers vs online retailers… the list can go on and on. Christensen surveyed 77 industries where he saw disruptive innovation in developing this theory.

In succeeding weeks I’d like to explore this theory further, to look at why disruptive innovation is so dangerous, whether there are other factors to explain disruption, why hasn’t Apple been disrupted in phones as Christensen predicted they would be and finally how you can pre-empt becoming disrupted. See you next week.