The Innovator's Solution

by Clayton Christensen

  12. This partially explains, for example, why Dell Computer has been such a successful disruptor—because it has raced up-market in order to compete against higher-cost makers of workstations and servers such as Sun Microsystems. Gateway, in contrast, has not prospered to the same extent even though it had a similar initial business model, because it has not moved up-market as aggressively and is stuck with undifferentiable costs selling un-differentiable computers. We believe that this insight represents a useful addendum to Professor Michael Porter’s initial notion that there are two viable types of strategy—differentiation and low cost (Michael Porter, Competitive Strategy [New York: Free Press, 1980]). The research of disruption adds a dynamic dimension to Porter’s work. Essentially, a low-cost strategy yields attractive profitability only until the higher-cost competitors have been driven from a tier in the market. Then, the low-cost competitor needs to move up so that it can compete once again against higher-cost opponents. Without the ability to move up, a low-cost strategy becomes an equal-cost strategy.

  13. See Clayton M. Christensen, The Innovator’s Dilemma (Boston: Harvard Business School Press, 1997), 130.

  14. The concept of value networks was introduced in Clayton M. Christensen, “Value Networks and the Impetus to Innovate,” chapter 2 in The Innovator’s Dilemma. Professor Richard S. Rosenbloom of the Harvard Business School originally identified the existence of value networks when he advised Christensen’s early research. In many ways, the situation in a value network corresponds to a “Nash equilibrium,” developed by Nobel laureate John Nash (who became even more renowned through the movie A Beautiful Mind). In a Nash equilibrium, given Company A’s understanding of the optimal, self-interested (maximum-profit) strategy of each of the other companies in the system, Company A cannot see any better strategy for itself than the one it presently is pursuing. The same holds true for all other companies in the system. Hence, none of the companies is motivated to change course, and the entire system therefore is relatively inert to change. Insofar as the companies within a value network are in a Nash equilibrium, it creates a drag that constrains how fast customers can begin utilizing new innovations. This application of Nash equilibriums to the uptake of innovations was recently introduced in Bhaskar Chakravorti, The Slow Pace of Fast Change (Boston: Harvard Business School Press, 2003). Although Chakravorti did not make the linkage himself, his concept is a good way to visualize two things about the disruptive innovation model. It explains why the pace of technological progress outstrips the abilities of customers to utilize the progress. It also explains why competing against nonconsumption, creating a completely new value network, is often in the long run an easier way to attack an established market.

  15. Some people have concluded on occasion that when the incumbent leader doesn’t instantly get killed by a disruption, the forces of disruption somehow have ceased to operate, and that the attackers are being held at bay. (See, for example, Constantinos Charitou and Constantinos Markides, “Responses to Disruptive Strategic Innovation,” MIT Sloan Management Review, Winter 2003, 55.) These conclusions reflect a shallow understanding of the phenomenon, because disruption is a process and not an event. The forces are operating all of the time in every industry. In some industries it might take decades for the forces to work their way through an industry. In other instances it might take a few years. But the forces—which really are the pursuit of the profit that is associated with competitive advantage—are always at work. Similarly, other writers on occasion have noticed that the leader in an industry actually did not get killed by a disruption, but skillfully caught the wave. They then conclude that the theory of disruption is false. This is erroneous logic as well. When we see an airplane fly, it does not disprove the law of gravity. Gravity continues to exert force on the flying plane—it’s just that engineers figured out how to deal with the force. When we see a company succeed at disruption, it is because the management team figured out how to harness the forces to facilitate success.

  16. See Clayton M. Christensen and Richard S. Tedlow, “Patterns of Disruption in Retailing,” Harvard Business Review, January–February 2000, 42– 45.

  17. Ultimately, Wal-Mart was able to create processes that turned assets faster than Kmart. This allowed it to earn higher returns at comparable gross profit margins, giving Wal-Mart a higher sustainable growth rate.

  18. The reason it is so much easier for firms in the position of the full-service department stores to flee from the disruption rather than stand to fight it is that in the near term, inventory and asset turns are hard to change. The full-service department stores offered to customers a much broader product selection (more SKUs per category), which inevitably depressed inventory turns. Discounters not only offered a narrower range of products that focused only on the fastest-turning items, but also their physical infrastructure typically put all merchandise on the sales floor. Department stores, in contrast, often had to maintain stockrooms to provide back-up for the limited quantities of any given item that could be placed on their SKU-laden shelves. Hence, when disruptive discounters invaded a tier of their merchandise mix from below, the department stores could not readily drop margins and accelerate turns. Moving up-market where margins still were adequate was always the more feasible and attractive alternative.

  19. Low-end disruptions are a direct example of what economist Joseph Schum-peter termed “creative destruction.” Low-end disruptions create a step-change cost reduction within an industry—but it is achieved by entrant firms destroying the incumbents. New-market disruption, in contrast, entails a period of substantial creative creation—new consumption—before the destruction of the old occurs

  20. For a deeper exploration of the macroeconomic impact of disruption, see Clayton M. Christensen, Stuart L. Hart, and Thomas Craig, “The Great Disruption,” Foreign Affairs 80, no. 2 (March–April 2001): 80–95; and Stuart L. Hart and Clayton M. Christensen, “The Great Leap: Driving Innovation from the Base of the Pyramid,” MIT Sloan Management Review, Fall 2002, 51–56. The Foreign Affairs paper asserts that disruption was the fundamental engine of Japan’s economic miracle of the 1960s, 1970s, and 1980s. Like other companies, these disruptors—Sony, Toyota, Nippon Steel, Canon, Seiko, Honda, and others—have soared to the high end, now producing some of the world’s highest-quality products in their respective markets. Like the American and European companies that they disrupted, Japan’s giants are now stuck at the high end of their markets, where there is no growth. The reason America’s economy did not stagnate for an extended period after its leading companies got pinned to the high end was that people could leave those companies, pick up venture capital on the way down, and start new waves of disruptive growth. Japan’s economy, in contrast, lacks the labor market mobility and the venture capital infrastructure to enable this. Hence, Japan played the disruptive game once and profited handsomely. But it is stuck. There truly seem to be microeconomic roots to the country’s macroeconomic malaise. The Sloan paper builds upon the Foreign Affairs piece, asserting that today’s developing nations are an ideal initial market for many disruptive innovations, and that disruption is a viable economic development policy.

  21. Our choice of wording in this paragraph is important. When customers cannot differentiate products from each other on any dimension that they can value, then price is often the customer’s basis of choice. We would not say, however, that when a consumer buys the lowest-priced alternative, the axis of competition is cost based. The right question to ask is whether customers will be willing to pay higher prices for further improvements in functionality, reliability, or convenience. As long as customers reward improvements with commensurately higher prices, we take it as evidence that the pace of performance improvement has not yet overshot what customers can use. When the marginal utility that customers receive from additional improvements on any of these dimensions approaches zero, then cost is truly the basis of competition.

  22. We emphasize the term product strategy in this sentence bec
ause there certainly seems to be scope for two other low-end disruptive plays in this market. One would be a private-label strategy to disrupt the Hewlett-Packard brand. The other would be a low-cost distribution strategy through an online retailer such as Dell Computer.

  23. There actually is a fourth strategy to be evaluated here—making components for sale to Hewlett-Packard and its subsystem suppliers. We will discuss this strategy at greater length in chapters 4 and 5.

  24. Matsushita, in fact, attempted entry with a sustaining strategy of exactly this sort in the 1990s. Despite its strong Panasonic brand and its world-class capabilities in assembling electromechanical products, the company has been bloodied and has captured minimal market share.

  CHAPTER THREE

  WHAT PRODUCTS WILL

  CUSTOMERS WANT TO BUY?

  What products should we develop as we execute our disruptive strategy? Which market segments should we focus upon? How can we know for sure, in advance, what product features and functions the customers in those segments will and will not value? How should we communicate the benefits of our products to our customers, and what brand-building strategy can best create enduring value?

  All companies face the continual challenge of defining and developing products that customers will scramble to buy. But despite the best efforts of remarkably talented people, most attempts to create successful new products fail. Over 60 percent of all new-product development efforts are scuttled before they ever reach the market. Of the 40 percent that do see the light of day, 40 percent fail to become profitable and are withdrawn from the market. By the time you add it all up, three-quarters of the money spent in product development investments results in products that do not succeed commercially.1 These development efforts are all launched with the expectation of success, but they seem to flourish or flop in unexpected ways. Once again, we argue that the failures are really not random at all: They are predictable—and avoidable—if managers get the categorization stage of theory right. Of the many dimensions of business building, the challenge of creating products that large numbers of customers will buy at profitable prices screams out for accurately predictive theory.

  The process that marketers call market segmentation is, in our parlance, the categorization stage of theory building. Only if managers define market segments that correspond to the circumstances in which customers find themselves when making purchasing decisions can they accurately theorize which products will connect with their customers. When managers segment markets in ways that are mis-aligned with those circumstances, market segmentation can actually cause them to fail—essentially because it leads managers to aim their new products at phantom targets.

  We begin this chapter by describing a way to think about market segmentation that might differ from what you’ve seen before. We believe that this approach, based on the notion that customers “hire” products to do specific “jobs,” can help managers segment their markets to mirror the way their customers experience life. In so doing, this approach can also uncover opportunities for disruptive innovation.

  We will then crawl beneath this concept of segmentation and explore the forces that cause even the best managers to segment their markets erroneously. A lot of marketers actually know how to do what we urge in this chapter. The problem is that predictable forces in operating companies cause companies to segment markets in counterproductive ways. Finally, we show how segmenting markets according to the jobs that customers are trying to get done addresses other important marketing challenges—such as brand management and product positioning—to help disruptive businesses grow. Taken together, this set of insights constitutes a theory of how to connect disruptive innovations with the right customers in order first to create a foothold in a market and then to grow profitably along the sustaining trajectory into market-dominating products and services.

  Pomp and Circumstances in Segmenting Markets

  Much of the art of marketing focuses on segmentation: identifying groups of customers that are similar enough that the same product or service will appeal to all of them.2 Marketers often segment markets by product type, by price point, or by the demographics and psychographics of the individuals or companies who are their customers. With all the effort expended on segmentation, why do the innovation strategies based on these categorization or segmentation schemes fail so frequently? The reason, in our view, is that these delineations are defined by the attributes of products and customers. As we see over and over in this book, theories based on attribute-based categorizations can reveal correlations between attributes and outcomes. But it is only when marketing theory offers a plausible statement of causality and is built upon circumstance-based categorization (segmentation) schemes that managers can confidently assert what features, functions, and positioning will cause customers to buy a product.

  Predictable marketing requires an understanding of the circumstances in which customers buy or use things. Specifically, customers—people and companies—have “jobs” that arise regularly and need to get done. When customers become aware of a job that they need to get done in their lives, they look around for a product or service that they can “hire” to get the job done. This is how customers experience life. Their thought processes originate with an awareness of needing to get something done, and then they set out to hire something or someone to do the job as effectively, conveniently, and inexpensively as possible. The functional, emotional, and social dimensions of the jobs that customers need to get done constitute the circumstances in which they buy. In other words, the jobs that customers are trying to get done or the outcomes that they are trying to achieve constitute a circumstance-based categorization of markets.3 Companies that target their products at the circumstances in which customers find themselves, rather than at the customers themselves, are those that can launch predictably successful products. Put another way, the critical unit of analysis is the circumstance and not the customer.

  To see why this is so, consider a quick-service restaurant chain’s effort to improve its milkshake sales and profits.4 This chain’s marketers segmented its customers along a variety of psychobehavioral dimensions in order to define a profile of the customer most likely to buy milkshakes. In other words, it first structured its market by product— milkshakes—and then segmented it by the characteristics of existing milkshake customers. These are both attribute-based categorization schemes. It then assembled panels of people with these attributes, and explored whether making the shakes thicker, chocolatier, cheaper, or chunkier would satisfy them better. The chain got clear inputs on what the customers wanted, but none of the improvements to the product significantly altered sales or profits.

  A new set of researchers then came in to understand what customers were trying to get done for themselves when they “hired” a milkshake, and this approach helped the chain’s managers see things that traditional market research had missed. To learn what customers sought when they hired a milkshake, the researchers spent an eighteen-hour day in a restaurant carefully chronicling who bought milkshakes. They recorded the time of each milkshake purchase, what other products the customer purchased, whether the customer was alone or with a group, whether he or she consumed it on the premises or drove off with it, and so on. The most surprising insight from this work was that nearly half of all milkshakes were bought in the early morning. Most often, the milkshake was the only item these customers purchased, and it was rarely consumed in the restaurant.

  The researchers returned to interview customers who purchased a morning milkshake to understand what they were trying to get done when they bought it, and they asked what other products they hired instead of a milkshake on other days when they had to get the same job done. Most of these morning milkshake customers had hired it to achieve a similar set of outcomes. They faced a long, boring commute and needed something to make the commute more interesting! They were “multitasking”—they weren’t yet hungry, but knew that if they did not eat something now, they would be hungry by 10:00. T
hey also faced constraints. They were in a hurry, were often wearing their work clothes, and at most had only one free hand.

  When these customers looked around for something to hire to get this job done, sometimes they bought bagels. But bagels got crumbs all over their clothes and the car. If the bagels were topped with cream cheese or jam, their fingers and the steering wheel got sticky. Sometimes they hired a banana to do the job, but it got eaten too fast and did not solve the boring commute problem. The sorts of sausage, ham, or egg sandwiches that the restaurant also sold for breakfast made their hands and the steering wheel greasy, and if customers tried to drag out the time they took to eat the sandwich, it got cold. Doughnuts didn’t last through the 10:00 hunger attack. It turned out that the milkshake did the job better than almost any available alternative. If managed competently, it could take as long as twenty minutes to suck the viscous milkshake through the thin straw, addressing the boring commute problem. It could be eaten cleanly with one hand with little risk of spillage, and the customers felt less hungry after consuming the shake than after using most of the alternatives. Customers were not satisfied that the shake was healthy food, but it didn’t matter because becoming healthy wasn’t the job for which they were hiring the product.5