The Innovator's Solution

by Clayton Christensen

  The strategy worked well for a couple of years. Then MTC’s first major development contract was completed, and the funding that had covered the salaries of three Ph.D. scientists and five engineers came to an end. Given the slow ramp to volume production inherent in MTC’s product development cycle, how could the company cover their salaries? These were some of the best materials scientists in the world, and they just couldn’t be sent packing. So the company had to sell another development contract to whomever would pay MTC enough money to cover their salaries and overhead. When the next funded project reached its end, the firm had to sell another funded program to cover the company’s high fixed costs, and so on. The company started with a strategy to be a volume product manufacturer. But very quickly and without intention, management began implementing a strategy to become a contract research house. There just wasn’t any way that the gross margins generated by initial volumes of manufactured products could cover the overheads that had to be put in place to deliver what MTC sold to its first customers.

  MTC’s long development cycle and huge funding need represent an extreme example, but every new corporate venture experiences its own version of this challenge. It is the habit of large, established companies to ramp up expenses ahead of revenues, because in a world of deliberate strategy and sustaining innovation, these are safe bets. But these outlays define a cost structure very quickly, and before you know it you’ve got yourself a business model that defines the kind of business that does or does not look attractive. Ultimately MTC did become a manufacturing company, but only through wrenching layoffs and by restructuring the nature of its costs. It was only by creating a new cost structure that a new type of customer order could appear to be attractive and could thereby be accorded priority in resource allocation.

  This example illustrates why executives need to pay careful attention to getting the initial conditions right. The only way that a new venture’s managers can compete against nonconsumption with a simple product is to put in place a cost structure that makes such customers and products financially attractive. Minimizing major cost commitments enables a venture to enthusiastically pursue the small orders that are the initial lifeblood of disruptive businesses in their emergent years.

  Accelerating the Emergent Strategy Process

  Executives whose ventures are in a discovery mode need not passively watch what evolves in the emergent strategy process. They can employ a rigorous method called discovery-driven planning to help a viable strategy emerge much more quickly and purposefully than is likely to happen through less-structured trial and error.20

  Most deliberate strategic planning processes go through four steps, as suggested in table 8-1. First, innovators make assumptions about the future and about the success that a new business idea will enjoy. These assumptions might be grounded in good predictive theory, but often they are grounded in the way things worked in the past. In the second step, the innovators make financial projections based on those assumptions, and third, senior executives approve the proposal based on the financial projections. Fourth, the team responsible for the new venture goes off to implement the strategy. There frequently is a loop from the second step back to the first in this deliberate process. Because the innovators and middle managers typically know how good the numbers have to look in order for the proposal to get funded, they often will cycle back and revise the assumptions that they are making in order to make the numbers work.

  This process does not work badly in a world of sustaining improvements and deliberate strategy. But when it is used for decision making in the emergent world of disruption, this process causes bad decisions to be made because the assumptions upon which the projections and decisions are built often prove wrong.

  Discovery-driven planning is a way to actively manage the emergent strategy process. As depicted in table 8-1, it involves reordering the four steps. The first step is to make the financial projections—the targeted or required financial performance of the venture. The logic behind this is quite compelling. If everybody knows how good the numbers must look in order to win funding, why go through the cyclical charade of making and revising assumptions in order to make the numbers look good enough? The required income statement and return on investment should just be the standard first slide in every presentation. The second step, where the real work begins, is to compile an assumptions checklist. It answers the question, “We all know how good the numbers need to be. So what assumptions need to prove true in order for us to realistically expect that these numbers will materialize?” The assumptions on this list should be rank-ordered from most to least crucial. The list must include assumptions related to each of the theories in this book: that low-end or new-market disruptions are possible, that the targeted customers will use the new product for the jobs they are trying to get done, that the new venture will lead the company to the point in the value chain where the money will be in the future, and so on.

  TABLE 8 - 1

  A Discovery-Driven Method for Managing the Emergent Strategy Process

  Sustaining Innovations:

  Deliberate Planning Disruptive Innovations:

  Discovery-Driven Planning

  (Note: decisions to initiate these projects can be grounded on numbers and rules.) (Note: decisions to initiate these projects should be based on pattern recognition.)

  1. Make assumptions about the future. 1. Make the targeted financial projections.

  2. Define a strategy based on those

  assumptions, and build financial

  projections based on that strategy. 2. What assumptions must prove true in order for these projections to materialize?

  3. Make decisions to invest based on those financial projections. 3. Implement a plan to learn—to test whether the critical assumptions are reasonable.

  4. Implement the strategy in order to achieve the projected financial results. 4. Invest to implement the strategy.

  The third and fourth steps in discovery-driven planning also reverse the order of the deliberate strategy process. The third step is to implement a plan. This is not a deliberate strategic plan, but rather a plan to test the validity of the most important assumptions. This plan needs to generate quickly, and with as little expense as possible, validating or invalidating information about the most critical assumptions. This enables innovators to revise the strategy prior to the fourth step—the decision to implement through significant investment. This can be done after the viability of various assumptions becomes more evident.

  Innovators who are using the discovery-driven process frequently learn quite early that there just isn’t a reasonable set of assumptions to support a plan that will achieve the numbers the organization requires. This might imply that the idea simply can’t be shaped into a viable strategy at all. Or it might mean that the idea needs to be placed within a smaller business unit, whose values might not demand that it get prohibitively big prohibitively fast.

  Managing the Mix of Emergent and Deliberate Strategies

  Many processes in an organization can become so refined and effective that they simply keep chugging along with little top-management attention, freeing managers to worry about more nonstandard dimensions of the business. It is dangerous, however, to allow the strategy development process to operate on autopilot. At any given point in time, some businesses under a manager’s care may need to be managed through aggressive, deliberate strategy processes, while others need emergent processes.

  Executives cannot twist an on/off valve to start and stop the flow of opportunities and problems from deliberate and emergent directions. These are always flowing in, and the CEO’s job is to manage constantly which direction should predominantly influence strategic thinking. The valve, which is the resource allocation process, can get really sticky—which is why CEOs need to keep their hands on the control constantly and consciously. When a viable strategy has emerged and it is time for execution, the CEO needs aggressively to switch to a deliberate strategy mode and stop funding emerg
ent opportunities that might divert the company from its focus on the winning plan.

  Once this has been done, however, executives often suffer amnesia and selectively remember only their success in deliberately implementing the successful strategy. They lose memory of the emergent process through which the successful strategy was discovered, and therefore forget to reset the strategy process to an emergent mode in those new organizations that are attempting to build the next growth businesses. Nearly all companies, as a result, employ one-size-fits-all deliberate strategy systems. This is a very common reason why new ventures launched by corporations and by many venture capital firms fail.21 Managing the strategy process in ways that are appropriate to the circumstance can greatly improve the odds that a venture can succeed.

  Simply seeking to have the right strategy doesn’t go deep enough. The key is to manage the process by which strategy is developed. Strategic initiatives enter the resource allocation process from two sources—deliberate and emergent. In circumstances of sustaining innovation and certain low-end disruptions, the competitive landscape is clear enough that strategy can be deliberately conceived and implemented. In the nascent stages of a new-market disruption, however, it is almost impossible to get the details of strategy right. Rather than executing a strategy, managers in this circumstance need to implement a process through which a viable strategy can emerge.

  There are three points of executive leverage in strategy making. The first is to manage the cost structure, or values of the organization, so that orders of disruptive products from ideal customers can be prioritized. The second is discovery-driven planning—a disciplined process that accelerates learning what will and won’t work. The third is to vigilantly ensure that deliberate and emergent strategy processes are being followed in the appropriate circumstances for each business in the corporation. This is a challenge that few executives have mastered, and is one of the most important contributors to innovative failure in established companies.

  Notes

  1. The notion that these two different processes coexist was articulated by Henry Mintzberg and James Waters in their classic paper “Of Strategies, Deliberate and Emergent,” Strategic Management Journal 6 (1985): 257. Stanford Professor Robert Burgelman is probably the preeminent scholar in this field, and many of his papers are cited in this chapter. Two important papers of his are “Intraorganizational Ecology of Strategy Making and Organizational Adaptation: Theory and Field Research,” Organization Science 2, no. 3 (August 1991): 239–262; and “Strategy as Vector and the Inertia of Coevolutionary Lock-in,” Administrative Science Quarterly 47 (2002): 325–357. Burgelman’s recent book, Strategy Is Destiny (New York: Free Press, 2002), summarizes many of his findings. Professors Rita McGrath and Ian MacMillan of the Columbia and Wharton Business Schools, respectively, have also studied these issues. We have found their article “Discovery-Driven Planning” (Harvard Business Review, July–August 1995) to be particularly helpful in understanding what processes of strategy development are appropriate in what circumstances. Finally, we have also drawn heavily on the work of Professor Amar Bhide, The Origin and Evolution of New Business (Oxford and New York: Oxford University Press, 2000).

  2. Mintzberg and Waters, “Of Strategies,” 258.

  3. This, too, is a departure from the traditional approach to thinking about the “right” way to set strategy. Typically, business scholars have adopted an “either-or” approach to the process of strategy formulation, as (in)famously demonstrated in the highly visible arm wrestle between Henry Mintzberg (“bottom-up”) and Igor Ansoff (“top-down”) in the pages of the Strategic Management Journal (vol. 11, 1990, and vol. 12, 1991).

  4. Andrew Grove, Only the Paranoid Survive (New York: Doubleday, 1996), 146.

  5. Professors Joseph L. Bower of the Harvard Business School and Robert Burgelman of Stanford are the leading scholars who have described how resources get allocated across competing alternative investments at all levels of the organization. See Joseph L. Bower, Managing the Resource Allocation Process (Boston: Harvard Business School Press, 1970); and Robert A. Burgelman and Leonard Sayles, Inside Corporate Innovation (New York: Free Press, 1986).

  6. The effect that such a filtering mechanism can have on a company’s strategy possibilities can be profound. 3M Corporation, for example, is one of the most innovative companies in modern history, in terms of its abilities to apply its core technological platforms to an array of market applications. Its insistence that all new products meet relatively high gross margin targets, however, has focused the company on a vast array of small, premium product niches and has prevented all but a few of its new products from becoming large mass-market businesses.

  7. This history has been chronicled in Robert A. Burgelman, “Fading Memories: A Process Study of Strategic Business Exit in Dynamic Environments,” Administrative Science Quarterly 29 (1994): 24–56; and in Grove, Only the Paranoid Survive.

  8. EPROMs are erasable, programmable, read-only memory circuits. Like its microprocessors, Intel’s EPROM product line also resulted from the emergent, rather than deliberate, process. See Burgelman, “Fading Memories.”

  9. There were strong reasons why senior management continued to invest in DRAMs. For example, management believed that DRAMs were the “technology driver” and that remaining competitive in DRAMs was essential in order to be competitive in other product lines.

  10. Grove, Only the Paranoid Survive.

  11. Microprocessors were a new-market disruptive technology in that they brought logic to applications where it previously had not been feasible, given the size and cost of the large printed wiring board logic circuitry that was used in the mainframe computers and minicomputers of the day. Relative to Intel’s business model, however, microprocessors were a sustaining innovation. The product helped Intel make more money in the way that it was structured to make money, and therefore resources were readily allocated to it. This illustrates a very important principle—that disruptiveness can only be expressed relative to the business model of a company and its competitors.

  12. Strong evidence for this is discussed in Amar Bhide, The Origin and Evolution of New Businesses (New York: Oxford University Press, 2000).

  13. Mintzberg and Waters, “Of Strategies,” 271.

  14. In a number of speeches and articles, Dr. John Seeley Brown has made this point—that it is very hard to predict in advance how people will end up using the disruptive technologies that change the way we live and work. We recommend all of Dr. Brown’s writings to our readers. He has influenced our own thinking in profound ways. See, for example, J. S. Brown, ed., Seeing Differently: Insights on Innovation (Boston: Harvard Business School Publishing, 1997); J. S. Brown, “Changing the Game of Corporate Research: Learning to Thrive in the Fog of Reality,” in Technological Innovation: Oversights and Foresights, eds. Raghu Garud, Praveen Rattan Nayyar, and Zur Baruch Shapira (New York: Cambridge University Press, 1997), 95–110; and J. S. Brown and Paul Duguid, The Social Life of Information (Boston: Harvard Business School Press, 2000).

  15. In the parlance of chapter 4, most of these firms were trying to cram the disruptive innovation—handheld devices—into the large, obvious mainstream market, notebook computers. True to form, this strategy proved to be very expensive, and they all failed.

  16. An important theoretical perspective called “resource dependence” asserts that it is the entities external to the organization that control what the organization can and cannot do. These entities—customers and investors—provide to the organization the resources that it needs to thrive. Managers cannot do things that are not in the interests of these external providers of resources, or they will withhold their resources and the company will die. See Jeffrey Pfeffer and Gerald R. Salancik, The External Control of Organizations: A Resource Dependence Perspective (New York: Harper & Row, 1978). The Innovator’s Dilemma devoted significant space to this issue, noting that the mechanism for managing change in the face of resource dependence is to create
independent organizations that can be dependent on other providers of resources, who value the disruptive products.

  17. The distinguished sociologist Arthur Stinchcombe has written extensively on the importance of initial conditions in determining the subsequent chain of decisions and events.

  18. Clayton Christensen, “Materials Technology Corp.,” Case 9-694-075 (Boston: Harvard Business School, 1994); and Clayton Christensen, “Linking Strategy and Innovation: Materials Technology Corp.,” Case 9-696-082 (Boston: Harvard Business School, 1996).

  19. For Christensen, studying these problems as an academic has made it clear that MTC’s technology was a breakthrough sustaining innovation: The company was trying to bring better products into established markets, and the breakthrough technology entailed extensive interdependencies in development and design. MTC made many of the choices described in this book incorrectly—and as a result, although the company has survived and is profitable, the path was absolutely tortuous.

  20. See Rita Gunther McGrath and Ian C. MacMillan, “Discovery-Driven Planning,” Harvard Business Review, July–August 1995, 44–56. Professors McGrath and MacMillan have written a number of very useful things about managing the creation of new businesses, of which this article is representative. We encourage you to badger them in their offices at Columbia and Wharton, respectively, for more good ideas. In their article, they use the term “platform-based planning.” We have instead called this process “deliberate strategic planning” to be consistent with the language used elsewhere in this chapter.