Book Summary: “The Innovator’s Dilemma” by Clayton Christensen

Title: The Innovator’s Dilemma; When New Technologies Cause Great Firms to Fail
Author: Clayton Christensen
Scope: 3 stars
Readability: 4 stars
My personal rating: 5 stars
See more on my book rating system.

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Topic of Book

Christensen seeks to explains why good companies fail to adapt to disruptive technologies.

My Comments

This is a classic book in Innovation theory. Innovation theory straddles the line between the history of technology and business management practices. Christensen includes very interesting case studies of technology innovation with the hard drive disk and construction industries.

While I believe that Christensen is incorrect in assuming the disruptive technologies always come the bottom of the market, I agree with his overall perspective.

Key Take-aways

  • Established companies  optimize existing technologies for a specific set of customers. They do so with a long series of innovations of sustaining technologies that meet their needs of those customers. A close relationship with their customers is critical to knowing which sustaining technologies are most profitable.
  • Disruptive technologies are typically invented by engineers within establish companies. Initially, these technologies are of no interest to established customers because they do have characteristics that appeal to their current customer base. Without a clear market the established company loses interest in the new technology.
  • New, small companies formed around those disruptive technologies. These companies are forced to seek new niche markets that are neglected by bigger companies. These markets often have much lower profit margins. They can then gradually ratchet up the performance of the technology until they appeal to larger and more profitable markets.
  • At the same time, established companies are making far higher profits by selling current technology to their current customers. The smaller companies do not appear to be a threat.
  • At some point in time, the disruptive technology becomes performant enough to appeal to a broader and more profitable markets. By this time, it is too late for established companies to deliver the new technology, so they lose market share and perhaps go bankrupt.
  • Ironically, the good business practice of listening to customers actually hurts established companies when disruptive technologies emerge.

Important Quotes from Book

This book is about the failure of companies to stay atop their industries when they confront certain types of market and technological change. It’s not about the failure of simply any company, but of good companies—the kinds that many managers have admired and tried to emulate, the companies known for their abilities to innovate and execute.

As we will see, the list of leading companies that failed when confronted with disruptive changes in technology and market structure is a long one… One theme common to all of these failures, however, is that the decisions that led to failure were made when the leaders in question were widely regarded as among the best companies in the world.

The research reported in this book supports this latter view: It shows that in the cases of well-managed firms such as those cited above, good management was the most powerful reason they failed to stay atop their industries. Precisely because these firms listened to their customers, invested aggressively in new technologies that would provide their customers more and better products of the sort they wanted, and because they carefully studied market trends and systematically allocated investment capital to innovations that promised the best returns, they lost their positions of leadership.

What this implies at a deeper level is that many of what are now widely accepted principles of good management are, in fact, only situationally appropriate. There are times at which it is right not to listen to customers, right to invest in developing lower-performance products that promise lower margins, and right to aggressively pursue small, rather than substantial, markets. This book derives a set of rules, from carefully designed research and analysis of innovative successes and failures in the disk drive and other industries, that managers can use to judge when the widely accepted principles of good management should be followed and when alternative principles are appropriate.

The failure framework is built upon three findings from this study. The first is that there is a strategically important distinction between what I call sustaining technologies and those that are disruptive. These concepts are very different from the incremental-versus-radical distinction that has characterized many studies of this problem. Second, the pace of technological progress can, and often does, outstrip what markets need. This means that the relevance and competitiveness of different technological approaches can change with respect to different markets over time. And third, customers and financial structures of successful companies color heavily the sorts of investments that appear to be attractive to them, relative to certain types of entering firms.

Most new technologies foster improved product performance. I call these sustaining technologies. Some sustaining technologies can be discontinuous or radical in character, while others are of an incremental nature. What all sustaining technologies have in common is that they improve the performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued. Most technological advances in a given industry are sustaining in character. An important finding revealed in this book is that rarely have even the most radically difficult sustaining technologies precipitated the failure of leading firms.

Occasionally, however, disruptive technologies emerge: innovations that result in worse product performance, at least in the near-term. Ironically, in each of the instances studied in this book, it was disruptive technology that precipitated the leading firms’ failure.

Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller, and, frequently, more convenient to use.

The second element of the failure framework, the observation that technologies can progress faster than market demand, means that in their efforts to provide better products than their competitors and earn higher prices and margins, suppliers often ‘‘overshoot’’ their market: They give customers more than they need or ultimately are willing to pay for. And more importantly, it means that disruptive technologies that may underperform today, relative to what users in the market demand, may be fully performance-competitive in that same market tomorrow.

The last element of the failure framework, the conclusion by established companies that investing aggressively in disruptive technologies is not a rational financial decision for them to make, has three bases. First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits. Second, disruptive technologies typically are first commercialized in emerging or insignificant markets. And third, leading firms’ most profitable customers generally don’t want, and indeed initially can’t use, products based on disruptive technologies. By and large, a disruptive technology is initially embraced by the least profitable customers in a market. Hence, most companies with a practiced discipline of listening to their best customers and identifying new products that promise greater profitability and growth are rarely able to build a case for investing in disruptive technologies until it is too late.

But the value of understanding this history is that out of its complexity emerge a few stunningly simple and consistent factors that have repeatedly determined the success and failure of the industry’s best firms. Simply put, when the best firms succeeded, they did so because they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. But, paradoxically, when the best firms subsequently failed, it was for the same reasons—they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. This is one of the innovator’s dilemmas: Blindly following the maxim that good managers should keep close to their customers can sometimes be a fatal mistake.

A team of researchers at IBM’s San Jose research laboratories developed the first disk drive between 1952 and 1956. Named RAMAC(for Random Access Method for Accounting and Control), this drive was the size of a large refrigerator, incorporated fifty twenty-four-inch disks, and could store 5 megabytes (MB) of information (see Figure 1.2). Most of the fundamental architectural concepts and component technologies that defined today’s dominant disk drive design were also developed at IBM. These include its removable packs of rigid disks (introduced in 1961); the floppy disk drive (1971); and the Winchester architecture (1973). All had a powerful, defining influence on the way engineers in the rest of the industry defined what disk drives were and what they could do.

In literally every case of sustaining technology change in the disk drive industry, established firms led in development and commercialization.

Why were the leading drive makers unable to launch 8-inch drives until it was too late? Clearly, they were technologically capable of producing these drives. Their failure resulted from delay in making the strategic commitment to enter the emerging market in which the 8-inch drives initially could be sold. Interviews with marketing and engineering executives close to these companies suggest that the established 14-inch drive manufacturers were held captive by customers. Mainframe computer manufacturers did not need an 8-inch drive. In fact, they explicitly did not want it: they wanted drives with increased capacity at a lower cost per megabyte. The 14-inch drive manufacturers were listening and responding to their established customers. And their customers—in a way that was not apparent to either the disk drive manufacturers or their computermaking customers—were pulling them along a trajectory of 22 percent capacity growth in a 14-inch platform that would ultimately prove fatal.

There are several patterns in the history of innovation in the disk drive industry. The first is that the disruptive innovations were technologically straightforward. They generally packaged known technologies in a unique architecture and enabled the use of these products in applications where magneticdata storage and retrieval previously had not been technologically or economically feasible.

The second pattern is that the purpose of advanced technology development in the industry was always to sustain established trajectories of performance improvement: to reach the higher-performance, highermargin domain of the upper right of the trajectory map. Many of these technologies were radically new and difficult, but they were not disruptive. The customers of the leading disk drive suppliers led them toward these achievements. Sustaining technologies, as a result, did not precipitate failure.

The third pattern shows that, despite the established firms’ technological prowess in leading sustaining innovations, from the simplest to the most radical, the firms that led the industry in every instance of developing and adopting disruptive technologies were entrants to the industry, not its incumbent leaders.

Sustaining projects addressing the needs of the firms’ most powerful customers (the new waves of technology within the value network almost always preempted resources from disruptive technologies with small markets and poorly defined customer needs.

Step 1: Disruptive Technologies Were First Developed within Established Firms

Although entrants led in commercializing disruptive technologies, their development was often the work of engineers at established firms, using bootlegged resources. Rarely initiated by senior management, these architecturally innovative designs almost always employed off-the-shelf components.

Step 2: Marketing Personnel Then Sought Reactions from Their Lead Customers

The engineers then showed their prototypes to marketing personnel, asking whether a market for the smaller, less expensive (and lower performance) drives existed. The marketing organization, using its habitual procedure for testing the market appeal of new drives, showed the prototypes to lead customers of the existing product line, asking them for an evaluation.

Step 3: Established Firms Step Up the Pace of Sustaining Technological Development

In response to the needs of current customers, the marketing managers threw impetus behind alternative sustaining projects.

Step 4: New Companies Were Formed, and Markets for the Disruptive Technologies Were Found by Trial and Error

New companies, usually including frustrated engineers from established firms, were formed to exploit the disruptive product architecture. The start-ups, however, were as unsuccessful as their former employers in attracting established computer makers to the disruptive architecture. Consequently, they had to find new customers.

Step 5: The Entrants Moved Upmarket

Once the start-ups had discovered an operating base in new markets, they realized that, by adopting sustaining improvements in new component technologies,20 they could increase the capacity of their drives at a faster rate than their new market required. They blazed trajectories of 50 percent annual improvement, fixing their sights on the large, established computer markets immediately above them on the performance scale.

Customers in these established markets eventually embraced the new architectures they had rejected earlier, because once their needs for capacity and speed were met, the new drives’ smaller size and architectural simplicity made them cheaper, faster, and more reliable than the older architectures.

Step 6: Established Firms Belatedly Jumped on the Bandwagon to Defend Their Customer Base

When the smaller models began to invade established market segments, the drive makers that had initially controlled those markets took their prototypes off the shelf (where they had been put in Step 3) and introduced them in order to defend their customer base in their own market. By this time, of course, the new architecture had shed its disruptive character and become fully performance-competitive with the larger drives in the established markets. Although some established manufacturers were able to defend their market positions through belated introduction of the new architecture, many found that the entrant firms had developed insurmountable advantages in manufacturing cost and design experience, and they eventually withdrew from the market. The firms attacking from value networks below brought with them cost structures set to achieve profitability at lower gross margins. The attackers therefore were able to price their products profitably, while the defending, established firms experienced a severe price war.

For established manufacturers that did succeed in introducing the new architectures, survival was the only reward. None ever won a significant share of the new market. It is clear from the histories of the disk drive and excavator industries that the boundaries of value networks do not completely imprison the companies within them: There is considerable upward mobility into other networks. It is in restraining downward mobility into the markets enabled by disruptive technologies that the value networks exercise such unusual power…  Rational managers, as we shall see, can rarely build a cogent case for entering small, poorly defined low-end markets that offer only lower profitability. In fact, the prospects for growth and improved profitability in upmarket value networks often appear to be so much more attractive than the prospect of staying within the current value network, that it is not unusual to see well-managed companies leaving (or becoming uncompetitive with) their original customers as they search for customers at higher price points. In good companies, resources and energy coalesce most readily behind proposals to attack upmarket into higher-performance products that can earn higher margins.

In the tug-of-war for development resources, projects targeted at the explicit needs of current customers or at the needs of existing users that a supplier has not yet been able to reach will always win over proposals to develop products for markets that do not exist. This is because, in fact, the best resource allocation systems are designed precisely to weed out ideas that are unlikely to find large, profitable, receptive markets. Any company that doesn’t have a systematic way of targeting its development resources toward customers’ needs, in fact, will fail.

The most vexing managerial aspect of this problem of asymmetry, where the easiest path to growth and profit is up, and the most deadly attacks come from below, is that ‘‘good’’ management—working harder and smarter and being more visionary—doesn’t solve the problem.

Three factors—the promise of upmarket margins, the simultaneous upmarket movement of many of a company’s customers, and the difficulty of cutting costs to move downmarket profitably—together create powerful barriers to downward mobility. In the internal debates about resource allocation for new product development, therefore, proposals to pursue disruptive technologies generally lose out to proposals to move upmarket. In fact, cultivating a systematic approach to weeding out new product development initiatives that would likely lower profits is one of the most important achievements of any well-managed company.

The reason is that good management itself was the root cause. Managers played the game the way it was supposed to be played. The very decisionmaking and resource-allocation processes that are key to the success of established companies are the very processes that reject disruptive technologies: listening carefully to customers; tracking competitors’ actions carefully; and investing resources to design and build higher-performance, higher-quality products that will yield greater profit.

Successful companies want their resources to be focused on activities that address customers’ needs, that promise higher profits, that are technologically feasible, and that help them play in substantial markets.

In practice, it is a company’s customers who effectively control what it can and cannot do

Yet companies must not throw out the capabilities, organizational structures, and decision-making processes that have made them successful in their mainstream markets just because they don’t work in the face of disruptive technological change. The vast majority of the innovation challenges they will face are sustaining in character, and these are just the sorts of innovations that these capabilities are designed to tackle. Managers of these companies simply need to recognize that these capabilities, cultures, and practices are valuable only in certain conditions.

First, the pace of progress that markets demand or can absorb may be different from the progress offered by technology. This means that products that do not appear to be useful to our customers today (that is, disruptive technologies) may squarely address their needs tomorrow.

Second, managing innovation mirrors the resource allocation process: Innovation proposals that get the funding and manpower they require may succeed; those given lower priority, whether formally or de facto, will starve for lack of resources and have little chance of success. One major reason for the difficulty of managing innovation is the complexity of managing the resource allocation process.

Third, just as there is a resource allocation side to every innovation problem, matching the market to the technology is another. Successful companies have a practiced capability in taking sustaining technologies to market, routinely giving their customers more and better versions of what they say they want. This is a valued capability for handling sustaining innovation, but it will not serve the purpose when handling disruptive technologies.

Fourth, the capabilities of most organizations are far more specialized and context-specific than most managers are inclined to believe. This is because capabilities are forged within value networks. Hence, organizations have capabilities to take certain new technologies into certain markets. They have disabilities in taking technology to market in other ways.

Fifth, in many instances, the information required to make large and decisive investments in the face of disruptive technology simply does not exist. It needs to be created through fast, inexpensive, and flexible forays into the market and the product. The risk is very high that any particular idea about the product attributes or market applications of a disruptive technology may not prove to be viable.

Sixth, it is not wise to adopt a blanket technology strategy to be always a leader or always a follower. Companies need to take distinctly different postures depending on whether they are addressing a disruptive or a sustaining technology. Disruptive innovations entail significant first mover advantages: Leadership is important. Sustaining situations, however, very often do not.

If you would like to learn more about innovation in history read my book From Poverty to Progress.

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