Book Summary: The Innovator’s Dilemma (when new technologies cause great firms to fail) by Clayton Christensen

The book presents Clayton’s counter-intuitive thesis on how firms with good management practices and a sound understanding of their customers’ needs eventually fail at disruptive innovations while still succeeding at sustainable innovations. The book emphasizes that its not engineering but management oversight that leads to the demise of incumbents in the face of disruptive innovations.

One-line summary: At some point, the incumbent’s product’s performance exceeds the demand of most customers. Then the “edge” which this performance metrics provided is lost, and the customers’ value proposition changes. They start valuing some other metrics, along which a disruptor’s product has better performance. The disruptor has an early mover’s advantage as well as leading to the demise of the incumbent.

The following are the salient ideas raised in the book.

The Innovator's Dilemma

Sustaining Innovation: They improve the performance of established products, along with the dimensions of product that mainstream customers in major markets have historically valued. Established firms are usually good at sustained innovations.
Disruptive Innovation: They result in worst performance, along with those established metrics, at least, in near terms; they are usually cheaper in net price, often more expensive on per performance basis; and they start by capturing emerging markets. Disruptive innovations are usually technologically straight forward. New entrants, instead of incumbents, typically make them. Sustaining innovations are typically aimed at moving upward along specific performance metrics, which the leading customers demand, that is, higher-margin products.

Impact of value networks

Competing theories

  1. Organizational hierarchy as an impediment to innovation: Since most big companies organize themselves into hierarchical subgroups, it’s challenging to make any change/innovation, which can cause conflict among multiple groups, innovation inside the group has much lower friction. That’s why these companies succeed at sustained innovation and fail at disruptive innovation, which does not fit well in the organizational chart.
  2. Capabilities and radical technologies as an impediment to innovation: Big companies have accumulated tons of prior knowledge and domain expertise. When a disruptive innovation comes, it destroys the value of that past knowledge. (ashishb: The author explicitly mentioned that this theory does not work in the cases he studied).

Value Networks: People want to work on things that they believe are valued. Most organizations value things that bring in more revenue. Revenue comes from lead customers. Therefore, these lead customers determine the direction in which an organization invests its resources. Even when established firms innovated on disruptive technologies and their marketing personnel got a negative response from lead customers, it forced the firms to focus on sustaining current innovation. This paradox creates room for a new entrant to produce disruptive innovation and capture new/small customers. From there, it moves upwards. Eventually, this threatens an established firm, who tries to fight back with a similar product. Such a product usually has a lower profit margin than their previous product. But rather than capturing the new market, that is the new entrant’s customers; the incumbent ends up selling to the same top customers leading to reduced profits and, at best, defending a portion of the prior business. Companies, or their sales/marketing personnel, are tied to lead customers since they will generate most revenues as well as the bonuses for salespeople in the short term.

Market Risk vs. Competitive Risk

There is always a market risk that a market for an emerging product might not develop. Still, by not taking that risk, incumbents push themselves into competitive threat whereas late entrants, they face the risk of entrenched competition.

Commoditization during sustaining innovation

Once the product’s differentiated specification exceeds market demand, it loses its meaning and becomes a commodity since customers no longer value that specification. (ashishb: Earlier, users saw processor clock speed as a benchmark, but that’s not the case anymore, leading to the commoditization of processors destroying the value proposition of Intel).

Principles

  1. Lead customers effectively control the patterns of resource allocation in well-run companies => align a portion of the organization working on disruptive technology with the right customer
    1. Align whole of the organization to work on new disruptive technology
      Micropolis decided to move from 8″ to 5.25″ drive, and its 8″ drive lost to competitors, sales had to refocus from mainframe customers to minicomputer manufacturers.  It was a painful move for the whole company.
    2. Align the same organization to work on sustaining as well as disruption
      Control Data Corp. (CDC) focused simultaneously on 14″ (sustained) and 8″ (disruptive). The engineers working on 8″ were regularly pulled to off to work on customer issues of 14″ drives, and the CDC failed badly at 8″ drive. To not repeat the same mistake, they assigned a new facility to the team for working on a 5.25″  drive and captured 20% market.
    3. Create a separate unit in a different facility or spin-off or acquire a new business that will run as a wholly-owned subsidiary – this is the best option. Quantum, 8″ and 5.25″ drive maker, created a spin-off Plus development Corp. with 80% ownership which focused on 3.5″. Eventually, sales of 8″ and 5.25″ died down, and Quantum took 100% ownership of its spin-off to become the largest producer of 3.5″ drives.
  2. Small markets don’t solve the growth requirements for large companies => make a new unit, a spin-off, small enough that little opportunity will be exciting for it
    Executives are focused on keeping the share price going up since that makes employees stock options more valuable. If the prices go down, companies lose the most incentivized employees, which usually are the future leaders. Therefore, there is a strong incentive to focus on increasing revenues to keep the investors happy. Directly going into small markets will not add to their bottom line. Therefore, they have three options to deal with small markets.

    1. Try to make the small market grow at a faster pace – This is not possible. Small markets cannot satisfy the near-term growth requirement of big organizations. Apple tried to do that with its PDA Newton in 1993. While 43, 000 Apple II in two years was seen as a success in 1979, selling 140, 000 Newton in two years (1993-94) was as a failure.
    2. Wait for the market to become large enough and face the competitive risk
      Seagate waited for 3.5″ market to grow large enough and then was not able to get customers from Connor Peripherals, who was first getting sale orders from customers and then manufacturing those custom drives.
    3. Create a small unit focused on that small market or acquire one
      People want to work on projects which address the need of customers and hence, impact organizations’ need for profit and growth, if the project lacks this characteristic, then managers have to waste time explaining why the project should be provided resources. Best people avoid such projects, and when things get tight, companies cancel these projects first. Allen Bradley (AB) Company was a leader in electromechanical (EM) switches for HVAC. As they saw less rugged programmable motor controls emerging, they brought full stake in one company and a partial one in another. Eventually, when programmable control became standard, out of five EM manufacturers, only AB was able to maintain its lead. Johnson and Johnson follow a similar strategy of holding ~160 independent companies.
  3. The ultimate use of disruptive technology is not known in advance, first few attempts to find the right market is going to fail => iterative search for product-market fit is important
    The strategy for dealing with sustained innovation is execution, while the strategy for dealing with disruptive innovation is learning and discovery with more tolerance towards failure. Guessing the right strategy at the outset is, therefore, not essential. What’s more important is to conserve resources for the second and third iteration. HP made 1.3″ drive and targeted PDA market for it. PDA market flopped. Game makers were interested in a cheaper lower quality and lower capacity 1.3″ drive, which HP was either not interested in pursuing or was too exhausted to put more resources towards it.
    Honda launched motorbikes in the USA, which were inferior to Harley and BMW in terms of power and pickup. Out of sheer frustration of its engineers who started dirt biking to vent it out, Honda realized that their bikes were better for off-the-road conditions, and people started ordering them for the same. It became the de facto dirt bike. Regular retailers were not interested in them, and eventually, sports retailers agreed to sell the bike. Honda estimated that it would sell 0.5 million bikes annually while they sold ten times that. This estimate shows they had no idea of the market as well as market size, either. Harley tried to introduce similar bikes, but its distributors were more interested in selling regular Harley bikes with a higher profit margin and hence failed. Disruptive technologies neither fit in models of established firms nor their distributors.
  4. Organizations consist of RVP (resources, values, and processes), the latter two are pretty rigid => use resources of the main organization but do not take its processes and values. Those processes and values, after all, are aligned for sustained innovation along the current path, they are thus, sub-optimal for disruptive innovation). Managers are great at figuring out whether an employee is the right fit for a project or not. They should put the same thought into the organization as well, an organization’s values and processes are suitable for a specific type of innovation; they can fail miserably at others.
    Only companies that succeed at disruption innovation are whose organization size matches the size of the opportunity, which initially is pretty small.
    Resources are usually easy to acquire and move across an organization.
    Processes exist so that employees can do specific repetitive tasks in a predefined fashion with reduced friction and increases efficiency. Since these processes are for sustaining innovations, they are a hindrance to disruptive innovation, which would require a new set of processes.
    Values are something that an organization values. Such values are explicitly or implicitly communicated to all employees. For example, “we only focus on products whose gross margins are more than 40%” or “we only produce products with quality about certain threshold”. Values are a hinderance since employees who have internalized these values cannot value disruptive products. These disruptive products, by definition, are inferior on these metrics. Big companies implicitly value only big markets. Their size becomes a hindrance to small markets, which can later become big.
    Resources tend to be flexible and are used for a variety of situations, processes, and values, by nature, are inflexible. A startup’s capabilities reside mostly in its resources, for its initial success to continue. As it grows, it has to develop processes and values, which will ensure the continuous production of products. Therefore, for a startup addressing a new problem is about getting the resources right, for a big company, its capabilities (and disabilities) are more tied to its (rigid) processes and values. DEC, which dominated mini-computers, had resources to succeed in micro-computers. Still, its processes were more aligned towards a two-year cycle, with everything made in-house, while most companies were outsourcing the making of parts for micro-computers. Also, it valued the higher profit margin business of the mini-computer.
    IBM acquired Rolm, the PBX maker, in 1994, but rather than let it run as a standalone unit, it decided to integrate, and hence, push its processes and values onto Rolm, and it failed badly.
    Cisco acquired Stratacom, the ATM and WAN equipment maker, and let it run as an independent unit. It infused more resources for its faster growth.
    Microsoft needed to build Internet Explorer (IE) to compete with Netscape since Internet Explorer was a sustaining innovation as it strengthened its existing Windows product, but required a new process, a heavyweight internal team was needed instead of the autonomous unit.
    Compaq in 1999 tried to sell computers over the Internet, and its retailers forced it to back off. A different autonomous unit might have succeeded.
    Dell started selling computers over the telephone and later began selling them over the Internet was able to do that without any issues since for Dell, this was sustaining innovation.
  5. What makes disruptive technology unattractive for an established market constitutes their greatest strength in emerging markets => find new markets that will value the product, ignore established markets as long as the product is not up to the established market’s demand.
    Product competition has four phases, the basis of competition changes from functionality to the reliability, then convenience, and finally, price (commoditization). The real challenge for a new/disruptive product is a marketing one, and it has to find a market where product competition occurs along dimensions that favored the disruptive attributes of the product. Thus, the aim should always be to provide adequate functionality rather than superior functionality since exceeding the market’s demand is redundant.
    Quicken by Intuit was a later entrant in the small business accounting software market but captured 70% market by producing a more straightforward product, e.g., previous software required two entries per record, Quicken changed it to one.
    Genentech invested $ 1B to produce human equivalent Insulin. Earlier ones were animal-based, and a small fraction of humans built resistance against them, which were more purified. They tried to sell them at a 25% premium and failed. At the same time, Novo, the Danish Insulin maker, made Insulin pens, which made injecting Insulin more accessible. It was able to sell its product for a 30% premium. Genentech’s product was a commodity, while Novo was a premium product in the eyes of customers.
    Sony built transistor-based radios, which were of lower quality, but customers valued there portability.

Some more examples

  1. Sears dominated departmental stores era but lost to discount stores, once the quality of products sold by discount stores improved beyond customer’s requirements.
  2. IBM dominated the mainframe but failed to capture minicomputer. DEC dominated minicomputer but lost the microcomputer market. Interestingly, IBM returned to dominated PC market for a while with its stand-alone PC division.
  3. As hard drives became smaller, at each stage, new entrants found new customers to sell their products. The new markets, initially, were too small to be lucrative for incumbents, 8″ (customer – mini frame), 5.25″ (customer – mini), 3.5″ (customer – micro), 2.5″ (customer – portable computers), 1.8″ (customer – heart monitor and automobiles).
    Interestingly, 1.8″ drive was developed at a big company first, which failed to market it to automobiles, who were buying them from a small startup instead.
  4. Mechanical excavators were more powerful than hydraulic ones and hence, more preferred for mining. So, the maker of hydraulic ones initially found a market in home construction, e.g., for sewer lines. Eventually, the “power” metric of hydraulic exceeded market’s demand though remained less powerful than mechanical excavators, and people started using them in mining since they ranked better on metrics of “safety”. Mechanical excavators were hazardous when a cable snapped.
  5. US integrated mill makers focused on the higher end of the market like cans. At the same time, mini-mills, which initially produced lower quality steel and focused on low margin reinforcement bars, later, as they improved the quality, they moved to the higher end of the market.
  6. HP created a separate unit to focus on ink-jet printers, while the leading organization focused on laser printers. They ended up targeting distinct markets giving HP edge over Cannon.
  7. Intel focused on the DRAM market in the 1970s. Its resource allocation formula allocated capacity proportional to the gross margins of product lines. So, more resources were shifted towards the microprocessor automatically. Eventually, without a specific strategy, Intel became the market leader of the microprocessor market, which Gordon Moore himself underestimated.

2 Replies to “Book Summary: The Innovator’s Dilemma (when new technologies cause great firms to fail) by Clayton Christensen”

  1. Great summary, thanks for writing.

    Another recap of Innovator’s Dilemma (in video format) that I recently found is here:

  2. Thanks for your effort and good mind.

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