Many disruptions are hybrids, combining new-market and lowend approaches, as depicted by the continuum of the third axis in figure 2-3. Southwest Airlines is actually a hybrid disruptor, for example. It initially targeted customers who weren’t flying—people who previously had used cars and buses. But Southwest pulled customers out of the low end of the major airlines’ value network as well. Charles Schwab is a hybrid disruptor. It stole some customers from full-service brokers with its discounted trading fees, but it also created new markets by enabling people who historically were not equity investors—such as students—to begin owning and trading stocks.19
Figure 2-4 shows where some of history’s more successful disruptors were positioned along the continuum of new-market to low-end disruption at their inception. The appendix to this chapter offers a brief historical explanation of each of the disruptive products or companies listed on the chart. This is not a complete census of disruptive companies, of course, and their position on the chart is only approximate. However, the array does convey our sense that disruption is a primary wellspring of growth. The prevalence of Japanese companies such as Sony, Nippon Steel, Toyota, Honda, and Canon in the period between 1960 and 1980 and the absence of disruptive Japanese companies in the 1990s, for example, explain a lot about why Japan’s economy has stagnated. Many of its most influential companies grew dramatically by disrupting others; but the structure of Japan’s economic system inhibits the creation of new waves of disruptive growth, in part because they might threaten those companies today.20
The chart also shows that disruption is an ongoing force that is always at work—meaning that disruptors in one generation become disruptees later. The Ford Model T, for example, created the first massive wave of disruptive growth in automobiles. Toyota, Nissan, and Honda then created the next wave, and Korean automakers Hyundai and Kia have now begun the third. AT&T’s wireline long distance business, which disrupted Western Union, is being disrupted by wireless long distance. Plastics makers such as Dow, DuPont, and General Electric continue to disrupt steel, even as their low end is being eaten away by suppliers of blended polyolefin plastics such as Himont.
FIGURE 2 - 4
Examples of Companies and Products Whose Roots Were in Disruption
Shaping Ideas to Become Disruptive: Three Litmus Tests
At the beginning of this chapter, we mentioned that few technologies or product ideas are inherently sustaining or disruptive when they emerge from the innovator’s mind. Instead, they go through a process of becoming fleshed out and shaped into a strategic plan in order to win funding. Many—but not all—of the initial ideas that get shaped into sustaining innovations could just as readily be shaped into disruptive business plans with far greater growth potential. The shaping process must be consciously managed, however, and not left to the dispersed and instinctive decisions of those who write business plans.
Executives must answer three sets of questions to determine whether an idea has disruptive potential. The first set explores whether the idea can become a new-market disruption. For this to happen, at least one and generally both of two questions must be answered affirmatively:
Is there a large population of people who historically have not had the money, equipment, or skill to do this thing for themselves, and as a result have gone without it altogether or have needed to pay someone with more expertise to do it for them?
To use the product or service, do customers need to go to an inconvenient, centralized location?
If the technology can be developed so that a large population of less skilled or less affluent people can begin owning and using, in a more convenient context, something that historically was available only to more skilled or more affluent people in a centralized, inconvenient location, then there is potential for shaping the idea into a new-market disruption.
The second set of questions explores the potential for a low-end disruption. This is possible if these two questions can be answered affirmatively:
Are there customers at the low end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price?
Can we create a business model that enables us to earn attractive profits at the discount prices required to win the business of these overserved customers at the low end?
Often, the innovations that enable low-end disruption are improvements that reduce overhead costs, enabling a company to earn attractive returns on lower gross margins, coupled with improvements in manufacturing or business processes that turn assets faster.
Once an innovation passes the new-market or low-end test, there is still a third critical question, or litmus test, to answer affirmatively:
Is the innovation disruptive to all of the significant incumbent firms in the industry? If it appears to be sustaining to one or more significant players in the industry, then the odds will be stacked in that firm’s favor, and the entrant is unlikely to win.
If an idea fails the litmus tests, then it cannot be shaped into a disruption. It may have promise as a sustaining technology, but in that case we would expect that it could not constitute the basis of a new-growth business for an entrant company.
For summary, table 2-1 summarizes and contrasts the characteristics of the three strategies that firms might pursue in creating new-growth businesses: sustaining innovations, low-end disruptions, and new-market disruptions. It compares the targeted product performance or features, the targeted customers or markets, and the business model implications that each route entails. We hope that managers can use this as a template so that they can categorize and see the implications of different plans that might be presented to them for approval.
TABLE 2 - 1
Three Approaches to Creating New-Growth Businesses
Dimension Sustaining
Innovations Low-End
Disruptions New-Market
Disruptions
Targeted
performance
of the product
or service Performance improvement
in attributes most valued
by the industry’s most
demanding customers.
These improvements
may be incremental
or breakthrough in
character. Performance that
is good enough
along the traditional
metrics of perform-
ance at the low end
of the mainstream
market. Lower performance
in“traditional”
attributes, but
improved performance
in new attributes—
typically simplicity and
convenience.
Targeted
customers
or market
application The most attractive (i.e.,
profitable) customers
in the mainstream
markets who are willing
to pay for improved
performance. Overserved customers
in the low end of the
mainstream market. Targets non-
consumption:
customers who
historically lacked the
money or skill to buy
and use the product.
Impact on
the required
business model
(processes and
cost structure) Improves or maintains
profit margins by
exploiting the existing
processes and cost
structure and making
better use of current
competitive advantages. Utilizes a new
operating or financial
operating or financial
different combination
of lower gross profit
margins and higher
asset utilization that
can earn attractive
returns at the discount
prices re
quired to win
business at the low
end of the market. Business model must
make money at lower
price per unit sold,
and at unit production
volumes that initially
will be small. Gross
margin dollars per unit
sold will be signifi
cantly lower.
Executives can use this categorization and the litmus tests to foresee the competitive consequences of alternative strategies as they shape an idea. To illustrate, we’ll examine three questions: whether Xerox could disrupt Hewlett-Packard’s ink-jet printing business, how to create growth in air conditioning, and whether online banking had (or has) the potential to create a disruptive new-growth business.
Could Xerox Disrupt Hewlett-Packard?
We don’t actually know if Xerox has considered the possibility of creating a new business of the sort we will examine here, and we use the companies’ names only to make the example more vivid. We’ve based this scenario solely on information from public sources. Xerox reportedly has developed outstanding ink-jet printing technology. What can it do with it? It could attempt to leapfrog Hewlett-Packard by making the best ink-jet printer on the market. Even if it could make a better printer, however, Xerox would be fighting a battle of sustaining technology against a company with superior resources and more at stake. HP would win that fight. But could Xerox craft a disruptive strategy for this technology? We’ll test the conditions for a low-end strategy first.
To determine whether this strategy is viable, Xerox’s managers should test whether customers in the lowest market tiers might be willing to buy a “good enough” printer that is cheaper than prevailing products.21 At the highest tier of the market, customers seem willing to pay significantly more for a faster printer that produces sharper images. However, consumers in the less-demanding tiers are becoming increasingly indifferent to improvements. It is likely they would be interested in lower-cost alternatives. So the first question gets an affirmative answer.
The next question is whether Xerox could define a business model that could generate attractive returns at the discounted prices required to win business at the low end. The possibilities here don’t look good. HP and other printer companies already outsource the fabrication and assembly of components to the lowest-cost sources in the world. HP makes its money selling ink cartridges—whose fabrication also is outsourced to low-cost suppliers. Xerox could enter the market by selling ink cartridges at lower prices, but unless it could define an overhead cost structure and business processes that would allow it to turn assets faster, Xerox could not sustain a product strategy of low-end disruption.22
This means we’ll need to evaluate the potential for a new-market disruption—competing against nonconsumption. Is there a large, untapped population of computer owners who don’t have the money or skill to buy and use a printer? Probably not. Hewlett-Packard already competed successfully against nonconsumption when it launched its easy-to-use, inexpensive ink-jet printers.
What about enticing existing printer owners to buy more printers, by enabling consumption in a new, more convenient context? Now, this might be achievable. Documents created on notebook computers are not easy to print. Notebook users have to find a stationary printer and connect to it either over a network or a printer cable, or they must transfer the file via removable media to a computer that is connected to a printer. If Xerox incorporated a lightweight, inexpensive printer into the base or spine of a notebook computer so that people on the go could get hard copies when and where they needed them, the company could probably win customers even if the printer wasn’t as good as a stationary ink-jet printer. Only Xerox’s engineers could determine whether the idea is technologically feasible. But as a strategy, this would pass the litmus tests.23
If Xerox attempted this, we would expect HP to ignore this new-market disruption at the outset because the market would be much smaller than the stationary printer market. HP’s printer business is huge, and the company needs large sources of new revenue to sustain its growth. To trap Hewlett-Packard in an innovator’s dilemma, Xerox should develop a business model that’s attractive to Xerox but unattractive to the managers of HP and other leading established printer companies. This might entail pricing ink cartridges for embedded notebook printers low enough that the executives of HP’s ink jet printer business would find the market unattractive relative to investments they might make to move up-market in search of the higher profits they could find by competing against higher-cost stationary laser printers.
Conditions for Growth in Air Conditioners
The window-mounted air conditioner market is widely known to be mature, dominated by giants such as Carrier and Whirlpool. Could a company like Hitachi wallop them? We would predict defeat if Hitachi tried to enter this market with a quieter product that offered more features and better energy efficiency.24 Is a low-end disruption viable? Our sense is that there are overserved customers at the low end of the existing market. They signal their overservedness by opting for the least-expensive models they can find, unwilling to pay premium prices for the alternative products that are available to them. Hitachi might expand its already substantial manufacturing operations in China, making air conditioners for export to developed economies. This might bring modest but temporary success, because after the established companies respond by setting up their own manufacturing operations in China, Hitachi would find itself locked in a battle with competitors whose costs are comparable and whose distribution and service infrastructure are strong, and where the targeted customers already have manifested an unwillingness to pay premium prices for better products. Employing low-cost labor constitutes a low-cost business model only until competitors avail themselves of the same option.
How about a new-market disruption, however? There are hundreds of millions of nonconsumers of residential air conditioning in China, who have been blocked from that market because the power-hungry, expensive machines that historically have been available don’t fit in the average family’s pocketbook or apartment. If Hitachi could design a $49.95 product that would easily slip into the window of a cramped Shanghai apartment and reduce the temperature and humidity in a ten-foot by ten-foot room with ten amps of current, things might get interesting—because once Hitachi had a business model that could make money at that price point, taking on the rest of the up-market world would be easy. Parenthetically, while Western executives are understandably concerned about the threat that low-cost manufacturing in China poses to them, our guess is that China’s greatest competitive asset is the unfathomable amount of nonconsumption in its markets, which makes them fertile ground for new-market disruptive companies of many sorts.
The Potential for Internet Banking
When we ask the test questions about Internet banking, we conclude that disruption using this technology is not possible. In the first place, there is not a large population of people who have been unable to open and maintain a bank account because they have lacked the money or skill. Existing banks’ penetration of this market is high. This rules out a new-market disruption for Internet banking.
Second, are there current bank customers at the low end who would be happy to accept a bank account with fewer privileges and features in order to get the service at a lower price? The prevalence of advertisements featuring no-fee accounts is a testament that such customers exist. But is it possible to design a business model that would afford a disruptive online bank attractive profits at the discount prices required to win business at the low end? This is problematic. The cost of money is similar for all banks. E*Trade Bank and Sony Bank are seeking answers to the low-cost business model question.
Because the idea likely does not satisfy the conditions for either a new-market or a low-end disruption, Internet banking is likely to be implemented as a sustaining innovation by established banks. As for the third test, there already are many banks and credit unions, with only a limited number of
office locations, that transact much of their business by mail. Internet banking would have a sustaining impact on their business models.
Disruption is a theory: a conceptual model of cause and effect that makes it possible to better predict the outcomes of competitive battles in different circumstances. The asymmetries of motivation chronicled in this chapter are natural economic forces that act on all businesspeople, all the time. Historically, these forces almost always have toppled the industry leaders when an attacker has harnessed them, because disruptive strategies are predicated upon competitors doing what is in their best and most urgent interest: satisfying their most important customers and investing where profits are most attractive. In a profit-seeking world, this is a pretty good bet.
Not all innovative ideas can be shaped into disruptive strategies, however, because the necessary preconditions do not exist; in such situations, the opportunity is best licensed or left to the firms that are already established in the market. On occasion, entrant companies have simply caught the leaders asleep at the switch and have succeeded with a strategy of sustaining innovation. But this is rare. Disruption does not guarantee success: It just helps with an important element in the total formula. Those who create new-growth businesses need to get on the right side of a number of other challenges, to which we will now turn.
Appendix: A Brief Description of the
Disruptive Strategies of the Firms in Figure 2-4
Table 2-2 briefly summarizes our understanding of the disruptive roots of the success of the companies that are arrayed in figure 2-4. Because of space limitations, much important detail has been omitted. The companies are listed in alphabetical, rather than chronological, order. We do not pretend to be strong business historians, and as a consequence can only present here a partial listing of disruptive companies. Furthermore, it is often difficult to identify a specific year in which each firm’s disruptive strategy was launched. Some firms existed for a considerable period, often in other lines of business, before the disruptive strategy that led to their ultimate success was implemented. In some cases it seems easier to visualize the disruption in terms of a product category, rather than by listing the name of one company. Hence, we ask our readers to regard this information as only suggestive, rather than definitive.
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