The Innovator's Solution
Page 30
In many ways, companies whose shares are publicly held are in a self-reinforcing vise. Their dominant shareholders are pension funds. Corporations pressure the managers of their pension fund investments to deliver strong and consistent returns—because strong investment performance reduces the amount of profits that must be diverted to fund pension obligations. Investment managers therefore turn around and pressure the corporations whose shares they own to deliver consistent earnings growth that is unexpectedly accelerating. Privately held companies are not subject to many of these pressures. The expectations that accompany their capital therefore can often be more appropriate for the building of new-growth businesses.
Use Pattern Recognition, Not Financial Results,
to Signal Potential Stall Points
Because outsiders typically measure a company’s success by its financial results, executives are tempted to rely on changes in financial results as signals that they should take comfort or take action. This is folly, however, because the financial outcomes of the most recent period actually reflect the results of investments that were made years earlier to improve processes and to create new products and businesses. Financial results measure how healthy the business was, not how healthy the business is.9 Financial results are a particularly bad tool to manage disruption, because moving up-market feels good financially, as we have noted previously.
Executives should gingerly use data of any sort when looking into the future, because reliable data are typically available only about the past and will be an accurate guide only if the future resembles the past.10 To illustrate the limitations of data in disruptive decision making, let us recount an experience that Clayton Christensen had in a recent MBA class. He had written a paper that worried that the leading business schools’ traditional two-year MBA programs are being threatened by two disruptions. The most proximate wave, a low-end disruption, is executive evening-and-weekend MBA programs that enable working managers to earn MBA degrees in as little as a year. The most significant wave is a new-market disruption: on-the-job management training that ranges from corporate educational institutions such as Motorola University and GE’s Crotonville to training seminars in Holiday Inns.
Christensen asked for a student vote at the beginning of class: “After reading the paper, how many of you think that the leading MBA programs are being disrupted?” Three of the 102 students raised their hands. The other 99 took the position that these developments weren’t relevant to the venerable institutions’ fortunes.
Christensen then asked one of the three who was worried to explain why. “There’s a real pattern here,” he responded, and he listed six elements of the pattern. These included MBA salaries overshooting what operating companies can afford; the disruptors competing against nonconsumption; people hiring on-the-job education to get a very different job done; a shift in the basis of competition to speed, convenience, and customization; and interdependent versus modular curricula. He concluded that the pattern fit: All of the things that had happened to other companies as they were disrupted were indeed under way in management education. “That’s why I’d take this seriously,” he concluded.
Christensen then turned to those who weren’t concerned, and asked why. They tended to point to the data—the numbers of students still battling to be admitted into the leading schools, the attractive starting salaries of the graduates, the brand reputations of the programs, loyal alumni and great on-campus networking opportunities, and so on. None of the disruptive programs could come even close to competing on these dimensions.
Christensen then asked one of the most vocal defenders of the invincibility of the leading business schools, “What if you were dean of one of these schools. What data would convince you that this was something that you needed to address?”
“I’d look at the school’s market share among the CEOs of the Global 1000 corporations,” he responded. “If our market share started to drop, then I’d worry.” Christensen then asked whether that data would be a signal that he should begin addressing the problem or that the game was over. “Oh, I guess the game would be over by then,” he admitted.
“Anybody else?” Christensen pressed. “Imagine that you were dean. What data would convince you that you should take action?” Several proposed evidence that they would find convincing, but in every case, the class concluded that by the time convincing data became available, the game would be over for the high-quality two-year MBA programs.
When Christensen asked, “Should these schools view this as a threat or an opportunity?” there was another interesting reaction. There was little energy in the class regarding the growth opportunity that on-the-job management education presented for the leading business schools. We suspect that the reason for the students’ indifference is related to the threat-versus-opportunity paradox highlighted in chapter 3. At the time of this writing, the leading business schools are at the top of their game, by any measure of financial, academic, and competitive performance. They don’t need growth to feel healthy. There is nothing yet in the measures of strength and organizational vitality to suggest that the world these programs have enjoyed is likely to change.11
Create Policies to Invest Good Money Before It Goes Bad
When you’re driving a car, you can wait until the fuel gauge drops toward empty before you refill the tank, and once the tank is full again you can rev the car back up to full speed. It just isn’t possible to manage growth in the same way—to wait until the growth gauge begins falling toward zero before you seek a fill-up from new-growth businesses. The growth engine is a much more delicate machine that must be kept running continuously by process and policy, rather than by reacting when the growth gauge reads empty. We suggest three particular policies for keeping the growth engine running. Taken together, the policies force the organization to start early, start small, and demand early success.
Launch new-growth businesses regularly when the core is still healthy—when it can still be patient for growth—not when financial results signal the need.
Keep dividing business units so that as the corporation becomes increasingly large, decisions to launch growth ventures continue to be made within organizational units that can be patient for growth because they are small enough to benefit from investing in small opportunities.
Minimize the use of profit from established businesses to subsidize losses in new-growth businesses. Be impatient for profit: There is nothing like profitability to ensure that a high-potential business can continue to garner the funding it needs, even when the corporation’s core businesses turn sour.
Start Early: Launch New-Growth Businesses Regularly While the Core Is Still Healthy
Establishing a policy that mandates the launch of new disruptive growth businesses in a predetermined rhythm is the only way that executives actually can avoid reacting after the growth engine has stalled. They must regularly launch or acquire new-growth businesses while their core businesses are still growing healthily, because when growth slows, the dramatic change in the company’s values that ensues makes growth impossible. If executives do this, and continue to shape the strategies of those businesses to be disruptive, soon a new business or two will punch into the realm of major revenue every year, ready to sustain the total corporation’s growth. If executives use their corporations’ investment capital when they can be patient for growth, the money will not spoil. It remains fresh, able to fund new-growth businesses.
Acquire New-Growth Businesses in a Predetermined Rhythm
Some executives of large, successful companies fear that even if they develop high-potential ideas and business plans for disruptive growth businesses, they just won’t be able to create the processes and values required to nurture them. They therefore are inclined to buy disruptive growth businesses, rather than to make them internally. Acquisition can be a very successful strategy if it is guided by good theory.
Many corporate acquisitions are triggered by the arrival of an investment banker with a business t
o sell. Decisions to acquire or not are often driven by discounted cash flow projections and an assessment of whether the business is undervalued or fixable or can yield cost savings through synergies with an existing business. Some of the theories that are used to justify these acquisitions prove to be accurate, and the acquisitions create great value. But most of them don’t.12
Corporate business development teams can just as readily acquire disruptive businesses. If they wait until the growth trajectories of these companies are obvious to everyone, of course, the disruptive companies may be too expensive to acquire. But if a business development team identifies candidates through the lenses of the theories in chapters 2 through 6 rather than waiting for conclusive historical evidence, then acquiring early-stage disruptive growth businesses in a regular rhythm can be a great strategy for creating and sustaining a corporation’s growth. In contrast to the acquisition of mature businesses that put a company on a higher but still flat revenue trajectory, acquiring early-stage disruptive companies can change the slope of the revenue trajectory.
One company whose fortunes have been heavily shaped by acquiring disruptive businesses has been Johnson & Johnson. For most of the 1990s, J&J was organized in three major operating groups—ethical pharmaceuticals, medical devices and diagnostics (MDD), and consumer products. Figure 9-1 shows that in 1993 the consumer and MDD groups were comparably sized, each generating just under $5 billion in sales. They subsequently grew at very different rates. The consumer business’s intrinsic growth trajectory was essentially flat, and it grew by acquiring big new revenue platforms, such as Neutrogena and Aveeno, whose growth trajectories were similarly flat. Although these acquisitions put the revenue line of the consumer group on a higher platform, they did not change the slope of the platform—and remember that it is changes in the slope of the platform, not the level of the platform, that create shareholder value at an above-average rate. Even with the acquisitions, the consumer group’s total revenues only grew at about a 4 percent annual rate over the decade.
In contrast, the MDD group of businesses grew at over 11 percent annually over the same period. This was driven by four disruptive businesses, each of which the company had acquired. J&J’s Ethicon Endo-Surgery company makes instruments for endoscopic surgery, a disruption relative to conventional invasive surgery. Its Cordis division makes instruments for angioplasty, which is disruptive relative to open-heart cardiac bypass surgery. The company’s Lifescan division makes portable blood glucose meters that enable patients with diabetes to test their own blood sugar levels instead of needing to go to hospital laboratories. And J&J’s Vistakon disposable contact lenses were disruptive relative to traditional lenses made by companies such as Bausch & Lomb. The strategies of each of these businesses fit precisely the litmus tests for new-market disruption described in chapter 2. Together, they have grown at a 43 percent annual rate since 1993, and now account for about $10 billion in revenue. The group’s overall growth rate was 11 percent because the other MDD group companies—those not on disruptive trajectories—grew in aggregate at a 3 percent annual rate. Both the consumer and MDD groups grew through acquisition. The growth rates of the two groups differed because MDD acquired businesses with disruptive potential, whereas the consumer group acquired premium businesses that were not disruptive.13
FIGURE 9 - 1
Johnson & Johnson Consumer Products (CP) Versus Medical Devices & Diagnostics (MDD) Revenue and Operating Profit, 1992–2001
Hewlett-Packard also sustained its growth for nearly two decades after its core lines of business matured, using a hybrid strategy for finding disruptions. Its acquisition of Apollo Computer, a leading workstation maker, was the platform upon which HP built its microprocessor-based computer businesses, which disrupted minicomputer makers such as Digital Equipment. HP’s ink-jet printer business, which today provides a significant portion of the corporation’s total profit, was a disruption that was conceived and launched internally, but within an organizationally autonomous business unit.
GE Capital, which was the primary engine of value creation for GE shareholders in the 1990s, has been a massive disruptor in the financial services industry. It has grown through a hybrid strategy of incubating disruptive businesses in some segments of the industry and acquiring others.
Start Small: Divide Business Units to Maintain Patience for Growth
The second policy imperative is to keep operating units relatively small. A decentralized company can maintain the values required to see and enthusiastically pursue disruptive innovations far longer than can a monolithic, centralized one, because the size that a new disruptive venture must reach to make a difference to a small business unit is more consistent with the revenue ramp of a new disruptive business.
Compare the perspective in a monolithic $20 billion company that needs to grow 15 percent annually with the perspective in a $20 billion corporation that is composed of twenty business units. The managers of the monolithic company will have to look at every proposed innovation from the perspective of needing to find $3 billion in new revenues beyond what was done in the prior year. The average perspective of the twenty business unit managers in the decentralized company, in contrast, is that they need to bring in $150 million of new business in the next year. In the multiple-business-unit firm there are more managers seeking disruptive growth opportunities, and more opportunities will look attractive to them.
In fact, most of the companies that appear to have transformed themselves over the past thirty years or so—companies such as Hewlett-Packard, Johnson & Johnson, and General Electric, for example—have been composed of a large number of smaller, relatively autonomous business units. These corporations have not transformed themselves by transforming the business models of their existing business units into disruptive growth businesses. The transformation was achieved by creating new disruptive business units and by shutting down or selling off mature ones that had reached the feasible end of their sustaining-technology trajectories.14
One reason the mortality rate of independent disk drive companies measured in The Innovator’s Dilemma was so high was that they all were single-business companies. As monolithic organizations—even relatively small ones—they had never learned how to manage nascent disruptive growth businesses alongside larger, maturing businesses. There were no processes for doing this.
In following the policy we are recommending, managers again need to be guided by theory, not by the numbers. Accountants will argue that redundant overhead expenses can be eliminated when business units are consolidated into much larger entities. Such analysts rarely assess the impact that consolidation has on the consequent demands in those mega-units that any new businesses that are launched must get very big very fast.15
Demand Early Success: Minimize Subsidization of New-Growth Ventures
The third policy, which is to expect new-growth businesses to generate profit relatively quickly, does two important things. First, it helps accelerate the emergent strategy process by forcing the venture to test as quickly as possible the assumption that there are customers who will pay attractive prices for the firm’s products. The fledgling business can then press on or change course based on this feedback. Second, forcing a venture to become profitable as soon as feasible helps protect it from being shut down when the core business turns sour.16
Honda: An Example of Forced Floundering
Not having much money proved to be a great blessing for Honda, for example, as it attacked the U.S. motorcycle market.17 Founded in postwar Japan by motorcycle racing enthusiast Suchiro Honda, by the mid-1950s the company had become best known for its 50cc Super Cub, designed as a more powerful but easy-to-handle moped that could wind its way through crowded Japanese streets for use as a delivery vehicle.
When Honda targeted the U.S. motorcycle market in 1958, its management set a seat-of-the-pants sales target of 6,000 units a year, representing 1 percent of the U.S. market. Securing support for the U.S. venture was not merely a matter of co
nvincing Mr. Honda. The Japanese Ministry of Finance also had to approve the release of the foreign currency needed to set up operations in America. Hard on the heels of Toyota’s failed introduction of the Toyopet car, the Ministry was loathe to give up scarce foreign exchange. Only $250,000 was released, of which only $110,000 was cash; the rest had to be in inventory.
Honda launched its U.S. operations with inventory in each of its 50cc, 125cc, 250cc, and 305cc models. The biggest bets were placed on the largest motorcycles, however, because the U.S. market was composed exclusively of large bikes. In our parlance, Honda set out to achieve a low-end disruption, hoping to pick off the most price-sensitive customers in the existing market with a low-price, full-sized motorcycle.
In 1960 Honda sold a few models of its larger machines, which promptly began to leak oil and blow their clutches. It turned out that Honda’s best engineers, whose skills had been honed through developing products that performed well in short stop-and-go bursts in congested streets, didn’t know what they didn’t know about the demands of the constant, high-speed, over-the-road travel that was common among motorcyclists in the United States. Honda had little choice but to invest its precious currency in sending the defective bikes via air freight back to Japan. The problem almost broke Honda.