The Innovator's Dilemma

The Innovator’s Dilemma, by Clayton M. Christensen, breaks down how disruptive innovation causes great firms to fail. Christensen looks at patterns seen when dynamic changes occurred and incumbent firms were unable to compete with or underperformed compared to entrant companies in the hard drive, steel production, mechanical shovel, retailing, and other industries.

The Innovator’s Dilemma is that the reasons firms succeed in their industry are eventually the reasons they fail. Listening to consumers, focusing on sustained developments within a value network, and targeting higher-margin markets all cause firms to perform very well until disruptive technologies emerge.

The hard drive market was the perfect industry to look at why firms fail as the industry developed very quickly and had many companies enter and exit in a short amount of time due to dynamic change. Significant data on the industry was also available to analyze through the Disk/Trend Report, a yearly report that detailed the current state of the market and future projections. The hard drive market in the mid-70s was composed of vendors selling 14-inch hard drives to mainframe companies. 14-inch manufacturers focused on increasing the capacity of their drives as that’s what their consumers said they wanted. They did such a good job of this that they well exceeded market demand for capacity per dollar in the mainframe market. Starting in 1978, companies started producing 8-inch drives. These companies were not 14-inch manufacturers but were new companies that were catering to the minicomputer market. 14-inch manufacturers consciously did not pursue 8-inch technology because the margins for 8-inch drives in the minicomputer market were less substantial than those gained with 14-inch drives and therefore didn’t satisfy growth needs for their companies. However, as 8-inch drive technology progressed, it was able to meet the hard disk capacity demanded in the mainframe market in terms of cost per megabyte. Since the pricing needs of the mainframe industry was met by both drives, the buyers looked at other factors like mechanical vibration where the 8-inch drives had less variance. The mainframe market eventually chose to switch over to 8-inch drives. This became a pattern in the hard drive market, with companies focusing on sustained innovation and disregarding emerging technologies and the markets that came with them. It was not poor management or an inability to produce the new technology that caused firms to fail, but a lack of understanding of how to manage disruptive innovations.

Companies sell within a value network. Value networks desire certain attributes from products that are essential to that value network. The value network of mainframe computers desired an efficient price per megabyte. 14-inch drive companies pursued sustained innovations for price per megabyte performance with their drives as that was what was asked for by their customers. Initially, 8-inch drives were only able to cater to companies outside 14-inch drive manufacturers' value networks, so it did not make sense for 14-inch drive manufacturers to pursue the technology. It also meant a potential cannibalization of 14-inch drive sales, which had a higher margin, if mainframe companies bought the 8-inch drives. Many times, disruptive innovations come from people inside an existing company, but the ideas are passed by middle management because of their low and uncertain returns. This causes innovators to create new companies that eventually encroach on the value network of the company that refused to pursue the new technology.

Development of technology typically follows an S-curve like the one below. A new technology’s development is usually slow to take off, then experiences faster-sustained innovation for some time before plateauing.

The above curve could be used to represent the 14-inch hard drive market. It could also be used to represent the 8-inch drive market. These two technologies, being developed separately from each other, eventually reach a point where they intersect as the first industry plateaus, shown below.

The incumbent industry doesn’t realize that the entrant will overtake their market because of the perceived market differentiation when the disruptive technology enters the market. By the time the disruptive tech is dominating the industry, it is often too late to enter the market. A company late to the game can also have trouble adapting to emerging markets’ processes if it enters after the market is developed enough to have them. Being present while firms develop these processes creates a first-mover advantage. It “[doesn't] make sense-until it was too late.”

So there’s a simple solution, right? Companies just have to invest in disruptive technologies even if it means accepting a lower margin at first. It’s not that simple. Disruptive technologies don’t initially suit a company's existing value network and finding a market where a new technology fits can be challenging. Even if a market is found, a company’s structure can prevent them from succeeding in the emerging market.

Christensen looks at two examples of this. Before the PDA market emerged, Apple and HP tried to get a first-mover advantage with the Newton and Kittyhawk respectively. With the Newton, Apple sought to dominate the PDA market as it emerged by offering a product that was capable of meeting the needs of consumers that didn’t exist yet. They invested such a substantial amount of capital into the creation of the Newton that a return from the emerging market wasn’t feasible. In the case of HP developing Kittyhawk, a 1.3-inch drive, a similar mistake was made. Attempting to capture the emerging PDA market, HP developed the small drive. Similarly, HP invested so much time and money into the product that when the market did not emerge the way HP had hoped, it failed to make a return. When a market emerged that could take advantage of the drive, it was not substantial enough for HP to enter. Both firms operated on the idea that the information they had on the markets, that didn’t exist yet, was correct. Their plans had no flexibility built into them and did not account for failures.

What an organization can and can’t do is decided by its resources, processes, and values (RPV). Together, these three factors make up a company's culture. A company culture is a double-edged sword, causing it to excel or fail. Resources are the tangibles of a company including its staff, equipment, cash, and brand. It also includes the firm's knowledge and relationships it has accrued over the years. Resources are the easiest thing to replace in RPV. Processes are how a company turns its resources into worth. Processes are created for and evolve over time to cater to specific organizational tasks which makes it difficult to adapt to new tasks. Values are what the company uses to determine what it does. Values typically hold back a firm by not allowing it to pursue disruptive technology because it doesn’t meet the decision criteria. Values prevent companies from developing something irrelevant to their value network and with a lower margin.

For companies to not let their culture prevent them from succeeding, they might have to create a new company proportional to the new market. Something that is leaner and can grow as the market does. Leadership in this area should be separated from the established culture. The chart below explains how an organization should approach creating spinout organizations.  

The Innovator’s Dilemma was an insightful read on how firms should approach disruptive technologies outside their value network. Maybe the reason why companies like Microsoft, Amazon, and other tech giants have persisted so long is because of their consistent investing and acquiring of disruptive startups.