WHY BIG COMPANIES FAIL – THE INNOVATORS DILEMMA

Companies can fail even if they invest aggressively on technology; takes constant customer feedback and listens to the competitive market. This article will tell you why.

The following article is based on the book “The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail” by Clayton M. Christensen.

51am8-0hapl-_sx320_bo1204203200__c

This book is about failure of companies when it cannot cope with changes in technology. The book talks not simply about any company but great companies that many managers have admired, companies that are known for their abilities to innovate and execute.

Companies fail due to several reasons such as arrogance, poor planning, bad management, lack of skill and resources, bad customer service and other weaknesses. But companies that are studied in this book are not such companies with weaknesses, but well-managed companies that invest aggressively on technology; takes customer feedback and listens to the competitive market.

This is because of the silent emergence of disruptive technology.

Note that the book contains several case studies and in-depth analysis of failed businesses which I cannot mention here as it will make this article too long. So if you find the following notes interesting you can dive in deeper by reading the complete book.

IN-DEPTH KNOWLEDGE

Failure of well-managed, competitive, aggressive leading firms usually will never happen due to sustaining technology. It is disruptive technology that creates almost all the failures.

To give you a better idea I will start with a few examples.

1 LETS START WITH SOME EXAMPLES

 Here are a few examples –

1) Sears Roebuck was praised as one of the best managed companies in the world, but it completely missed the emergence of discount retailing and home centers. No one praises Sears management anymore.

2) IBM dominated mainframe computer market but completely missed the emerging minicomputer market, even though minicomputers were technologically much simpler than mainframe computers.

3) Digital Equipment Corporation, Data General, Prime, HP, Nixdorf .etc soon dominated the mini computer market but completely missed the advent of personal computer market.

4) Apple Computer, Commodore, Tandy and IBM’s standalone PC division was able to create the personal computer market but lagged in bringing portable computers to market.

5) Xerox long dominated the market for high volume photocopiers but only became a small player in tabletop photocopiers.

6) Out of over 30 manufacturers of cable operated power shovels only 4 survived the industries transition to hydraulic excavation technology.

Now we will understand the meaning of sustaining technology.

2 SUSTAINING TECHNOLOGY

Most technological advances in an industry is sustaining in nature. These technologies will improve product performance in an incremental nature, although sometimes there can be radical changes as well.

What all sustaining technologies have in common is that the improvement in technology improves the performance of established products and helps the already established (mainstream) customers. Innovators already know the market and what it values.

An important finding that is established in the book is that sustaining technology, even if it’s an extremely radical improvement rarely causes failure of a well-managed leading firm.

Now let’s understand disruptive technology.

3 DISRUPTIVE TECHNOLOGY

Disruptive technology emerges occasionally. These technologies often reduce product performance in the short term.

Disruptive technologies bring new values to the market which will reduce the performance of established products. Mainstream market will not accept disruptive technologies because they don’t want to use an underperforming product.

But disruptive technology will have some new features that a smaller, emerging market might find valuable. So the innovators of disruptive technology will be forced to sell products to the new market initially and as the technology improves it will soon dominate the mainstream market as well.

Disruptive technology is the main cause of failure of well-managed leading firms.

Transistors were disruptive technology compared to vacuum tubes.

Off-road motorcycles by Honda and Yamaha were disruptive technology compared to over-the-road cycles made by Harley Davidson and BMW.

Apps may become disruptive technology to suppliers of traditional computer software developers.

4 WHY BIG BUSINESSES FAIL DUE TO DISRUPTIVE TECH

To clearly understand why big businesses fail due to disruptive tech we have to understand value networks, innovation curve and a few other key ideas. We will go through them in the following sections.

4.1 REASONS FOR FAILURE

We will go through several reasons for failure of an established company due to disruptive technology below –

4.1.1 BIG BUSINESSES DON’T LIKE SMALL MARKETS

Big businesses need big revenue for growth and hence they need big markets. A $40 billion business will need an additional $10 billion of revenue for a 25% increase in revenue and hence they will discard smaller opportunities. Small markets don’t solve the growth needs of big companies.

Usually disruptive technology will decrease the product performance in an established market and will only satisfy the needs of a smaller emerging market.

And hence big companies will wait until the emerging market becomes big. This is often a bad move.

4.1.2 MARKET THAT DON’T EXIST CANT BE ANALYZED

Big firms will usually make moves based on analysis and forecasts. The problem is that they will forecast and create strategies based on the mainstream market.

But disruptive technology usually will not satisfy an existing market and sometimes the only way to find a new market is by trial and error. When you don’t even know the market that a new technology will cater to how is it possible to analyze it?

Big firms have to assume that forecasts and strategies they chose to pursue may be wrong.

4.1.3 GETTING FEEDBACK FROM EXISTING CUSTOMERS WILL KILL YOU

Companies depend on customers and investors for resources. Highest performing companies will kill ideas that their customers don’t want.

It is important to get feedback from existing customers when you are developing a sustaining technology.

But when you are dealing with a disruptive technology you cannot depend on your existing customers because it’s going to be first embraced by a new (many times unknown) smaller emerging market. Disruptive technology is going to decrease performance of products for the mainstream market and will only satisfy a new smaller market.

4.1.4 TECHNOLOGY SUPPLY MAY NOT EQUAL MARKET DEMAND

Sustaining technology will usually overshoot market demand over the long run.  In other words, needs of many existing users will grow slowly than the improvement in technology. Soon, sustaining technology might overshoot market demands and disruptive technology might match market demands. 

For example, when desktop computers first came to market it did not satisfy the existing mainframe computer market. But soon, mainframe computer performance surpassed the needs of existing customers and desktop computer performance improved enough to satisfy them. Much of what needs to be done could be done on a desktop computer and hence the existing market switched. Mainframe computer manufacturers were soon out of business.

Look at the picture below to understand this concept more clearly.

untitled-1_c

In the picture above,

1 is the performance demanded at the high end of the market.

2 is the improvement in product performance due to sustaining technology.

3 is the improvement in product performance due to disruptive technology.

4 is the performance demanded at the low end of the market.

As you can see the product performance due to sustaining technology (2) overshot the performance demanded at the high end of the market (1) while the product performance due to disruptive technology (3) entered the performance demanded at the low end of the market (4). By this time, usually it will be too late for a big business to win the competition against the new disruptive business.

When companies develop over-satisfying products and create high performance and high margin markets they create a vacuum where competitors with disruptive tech can enter. 

4.1.5 ORGANIZATIONS CAPABILITIES CAN BE A DISABILITY

Big businesses have processes and values that are not flexible. That is how they are able to function smoothly and harmoniously with thousands of employees and billions of revenue. But this is also their biggest disability when they are faced against a disruptive startup.

For a new startup, one of its greatest powers is its speed of execution and flexibility. They will be able to handle things on the fly and work hands on in the beginning. Also they have smaller revenue goals to grow their business. Most big businesses are managed by fat-cats who are usually great managers but are not very hands on. All of these capabilities of a startup makes it a great place for disruptive technology to thrive and grow.

Now, we will understand value network.

4.2 UNDERSTANDING VALUE NETWORK

What is a value network?

A value network is a set of nested markets with similar value systems. If that sounds confusing check out the image below –

untitled-2_c

The main buyers of disk manufacturers are drive manufacturers. And the main buyers of drive manufacturers are computer manufacturers. Computers are bought in bulk by MIS (Management Information System) departments in a company. So in the above case disk manufacturers, drive manufacturers .etc belong to the same value network and have similar value systems.

Every nested commercial system is a value system. A big company will buy and assemble from other companies.

Every market has its own value system. Different value systems have specific requirements.

Example –

1) Laptop Market needs devices with small size, less weight and rugged quality.

2) Desktop Market does not care about size and ruggedness that much.

Even profit % of value network is usually the same. For example, both disk manufacturers and drive manufacturers might take 30% profit.

Good managers do what makes sense for them. And what makes sense is primarily shaped by their value network.

This is a very good approach when you are going through a sustaining technology but it is destructive when you are up against a disruptive technology. Because disruptive technology comes with a very different value system which will not be embraced by your existing value network.

4.3 UNDERSTANDING S-CURVE OR INNOVATION CURVE

S-Curve, also known as the innovation curve is how new ideas and technologies spread.

The S-curve is formed from Moore’s Idea Diffusion Curve as you can see in the picture below.800px-diffusion_of_ideas-svg_c

S-curve will start with a low market share because initially a new technology is adopted only by a small group of innovators and early adopters. Then the market share will increase rapidly as the technology will diffuse to the majority of the market. And then the market growth will reach saturation as the technology is bought only by the laggards.

As market reach saturation for current technology, another competing technology will enter majority market share.

In case of sustaining technology improvement in Market A from Technology 1 to Technology 2 this is how the S-Curve will look like –

untitled-3_c

As you can see in the curve above, a well-managed company will switch technology from technology 1 to technology 2 when technology 1 reaches diminishing returns. This is shown by the red-curve. Also note that the whole innovation happens in Market A.

But in case of disruptive technology the innovation happens in two different markets (Market A and Market B).

untitled-4_c

Two graphs are shown above, first graph is the growth of market share over time in Market A and second graph shows the growth in Market B solely due to disruptive tech.

The competing technology will start building market share in a completely different market (Market B). And when the product quality reaches good enough to satisfy Market A, the new technology will invade the market in lightning speed. And businesses which dominate Market A will instantly lose all their business. This is how disruptive technology kills established businesses.

4.4 PATTERNS OF WRONG DECISIONS BY ESTABLISHED FIRM

Now that you understand Value Networks, Innovation Curve and the common reasons for failure of an established firm due to disruptive tech, we will dive into something more interesting.

Disruptive technology is usually created initially in an established firm. And it will destroy the same firm due to a number of wrong decisions taken by the management. We will go through the pattern of wrong decisions taken by an established firm below

1) Disruptive technology is first developed within an established firm but it is rarely initiated by senior management.

2) Engineering team will show prototype to marketing tem. Marketing will test the prototype with lead customers so that they can get their reactions. The reactions from the lead customers are usually negative because disruptive technology will lack in performance for the existing market.

3) Established firm will increase the speed of development of sustaining technology by reacting to competition and the company’s big goals. Big firm will move upmarket and will neglect downmarket in search of more profit margin. Senior managers will try to remain consistent with firm strategy and will aim higher ROI when starting new projects.

4) Everyone has their best interests. Top management and engineers will discuss about going upmarket (sustaining technology) versus going downmarket (disruptive technology). Managers want good career and they do not want to risk failure by going disruptive.

5) Disruptive technology development plan is cancelled by top management due to low profit margins, no market, more ambitious and important goals .etc. Note that good management like this is the reason why a large firm prospers when faced with sustaining technology and crumple as well when faced with disruptive technology.

6) Soon new companies are formed and usually the founders are people/engineers from the established firm. Market for disruptive technology is found by trial and error.

7) Entrants will move upmarket and will soon reach the market of established firms.

8) Established firms will belatedly jump into the bandwagon to defend customer base.  But by then the entrants might have refined their process so much that the established firms will find it hard to compete. Soon they can be out of business.

5 HOW TO HANDLE DISRUPTIVE TECHNOLOGY ?

There are several things that an established firm can do in order to keep market share when it is faced by a disruptive technology.

But we will go into that detail in another article.

WHAT ELSE ?   

I hope you found this article useful. If you are a manager, employee or a founding team member of an established firm you might want to go in deeper to figure out if your business needs to be aware of any crisis due to disruptive technology.

Buy The Innovator’s Dilemma By Clayton M. Christensen if you like the notes and you want to dive in deeper.

If you have any doubts feel free to ask me in the comments below.

Shares
Share This
Startup Strong