The Foundation’s Simon Caulkin on meeting the challenge of disruptive innovation
Since 1999, The Foundation has been helping businesses address growth challenges through innovation. With the help of Simon Caulkin, former Management Editor for the Observer, we wrote this piece inspired by work we have done with a number of clients in sectors that face disruptive challenges that are looking increasingly serious. The excitement of innovation has been replaced with a much more down-to-earth sense of threat.
We tend to work with big companies dealing with disruptive threats, although there is nothing to stop them becoming disruptors too. Examples include M&S with Plan A and soon with a new Energy proposition, Telefonica with Wayra and their Digital business, and Visa and Barclays in payments. We have also been involved with Just Giving’s move into the Corporates market, the establishment of Zopa, the world’s first peer-to-peer lender, and a bit further back with Egg’s ascendancy and Daewoo’s challenge to the automotive model. We are currently wrestling with live issues in media, banking, insurance, retail, the third sector, energy and more, and we can see a pattern emerging.
What we have written below describes this learning as it takes shape. We would love to discuss these ideas with others, and to apply them with people that they resonate with.
What’s the challenge?
Although the vast majority of innovations are incremental – small improvements or extensions to existing products or processes – recent times have seen a wave of disruptive innovations, sometimes coming from completely unexpected quarters, with effects so profound that they change the basis of competition and upend the existing order in the process. It’s easy to list them: iTunes and the iTunes store vs CDs, Amazon vs Borders and HMV, smartphones and tablets vs PCs and cameras, Zopa and crowdfunding vs the retail banks, social media and Google vs newspapers.
The conventional wisdom is that successful disruptive innovation is about supplanting bricks and mortar with bytes, about being first to spot an opportunity, and that small companies are better at these things than large ones. There’s some truth in these ideas. But in our experience, the picture is a bit more complicated than that.
It’s true that many of the new developments are disintermediations enabled by digitisation and the internet. But there are equally important lessons to be learned from earlier physical disruptions – as, for example, when personal computers wiped out mini- and mainframe computers, minimills dumped large integrated steel companies on the scrapheap, and when in the 1970s and 1980s small Japanese motorbikes did the same to the motorcycle industry.
With hindsight, it is possible to see that although start-ups have certainly played their part (social media, PayPal, Amazon), in many cases the big incumbent companies did see change coming, and were sometimes well prepared for it too. Thus Kodak not only foresaw the decline of film, but it had also made significant investments in digital cameras and printers. Xerox invented the Graphical User Interface (GUI) and computer mouse, but it was Steve Jobs and Apple that surfed on the disruption that they brought about, to spectacular effect. IBM could see the end of the mainframe computer as a hardware business like an oncoming train rushing down the tunnel, Woolworths and HMV in retail likewise. But none of these companies could break out of the groove set by their past, or at least not fast enough to prevent some, if not all, of their market being snaffled by others. What’s more, some of the most noteworthy examples of disruptive innovation are not the result of smaller players taking a bite out of their bigger brothers’ lunch, but big, established players making bold sideways moves into new markets. Apple in music, smartphones and tablets, Google with Android and other technologies, and Amazon with web services are recent examples. Asda into clothing, News International into satellite TV, and Whitbread into coffee shops are all others.
Why do some big companies end up as toast while others remain comfortable on the other side of the grill?
One powerful reason incumbent companies are often outflanked by new entrants is that they have a ‘wood for trees’ issue – they can’t see their markets for their own products. In the model developed by Harvard’s influential Clayton Christensen, disruptive innovations start small with cheap, accessible products or services that either open up a new market segment or address a disregarded one. Typically the reaction of incumbents is to ignore the upstart, continuing to do what they’ve always done: keep improving good, profitable products – until they are well beyond the needs and finances of already satisfied customers. The music industry thought that digital downloads would never catch on because the sound quality was so obviously poor compared to CDs or vinyl, but for consumers the utility of being able to manage their music more easily, and the value of buying the four tracks they wanted not the whole album, comprehensively trumped audiophilia. In the 1970s and 1980s, manufacturers of big bikes sniggered at Japan’s funny little putt-putt motorbikes (initially used in the US by workers scooting around within factories) but rapidly changed their tune when faced by sophisticated 250cc and 500cc models. The first personal computers were aimed at hobbyists; no one dreamed they would become a consumer product. And so the list goes on.
It’s too simple to blame their unsuccessful brethren’s failure to follow suit on vested interests and resistance to change. As the novelist Upton Sinclair put it: “Never expect someone to understand change when their livelihood depends on not understanding it”. This is precisely Christensen’s ‘innovator’s dilemma’: which manager in their right mind wouldn’t choose to pursue better margins from sophisticated consumers in predictable, well-established markets over producing a product or service for a consumer that possibly exists in a new market where initial profits will be tiny if they exist at all?
It is important to start from the recognition that these barriers are non-trivial. Shareholder expectations, company reward systems, unwillingness to stand out from the crowd, psychological bias towards the ‘bird in the hand’, fear of cannibalising existing revenue streams, a skills and resource base built around current products and services – in other words, justified apprehension at self-disruption – all these things can militate powerfully against launching into the unknown. The losses appear concrete, the benefits theoretical.
How can these obstacles be overcome? Or, to put it another way, how do serial disrupters such as Apple develop the confidence and capabilities to make devastating sideways moves into entirely new sectors?
Our answer comes in the shape of six key lessons.
1. Create the conditions for long term success even if the issues are immediate
Attracting aligned investors.
There’s some evidence that as the world has become more financially driven, and shareholder value maximisation has been honed to a sharp point, the virtuous circle of enabling and sustaining innovations that has powered western economic growth for the last half-century has broken, with managers focusing single-mindedly on efficiency gains, and on liberating capital for dividends and share buybacks, at the expense of what created the value in the first place.
The result is a kind of corporate tragedy of the commons: corporate treasuries on both sides of the Atlantic are stuffed with unspent cash while the overall rate of innovation falls, impoverishing the economy as a whole (Christensen calls this the ‘capitalist’s dilemma’). But consider also the effect on the firm. The truth is that whatever they do most, large companies simply chug along at the pace of the economy. The only consistent exceptions are serial innovators such as Apple, Amazon and Google. Steve Jobs always argued that shareholder value was a by-product, not a goal, and that shareholders should keep their nose out of the business; and notwithstanding the bursting of Apple’s share-price bubble, medium- and long-term investors have done extremely well out of Apple stock. While perhaps putting it a bit more diplomatically than Jobs, there is a strong case for leadership here, as, for example, with Paul Polman at Unilever or Jeff Bezos at Amazon, in clearly spelling out to shareholders the need to invest for the long term even at the cost of a short-term hit on the share price. In so doing, they increase their chances of attracting the shareholders they deserve, re-establishing the virtuous circle.
Maintaining internal consistency.
The same consistency is needed inside the firm. It’s all too easy for companies to flip-flop between do-nothing caution and bouts of frenetic innovation activity which peters out when instant results aren’t forthcoming. Thus when the dotcom boom burst, many large companies got cold feet and pulled promising internet ventures just as the initial lessons had been absorbed and more realistic expectations had set in. To avoid such violent swings, it is important to recognise that, while the exact timing of the ‘next big thing’ is impossible to predict, being prepared for it is both possible and essential. A form of ‘horizon planning’, as practised by Shell, whereby resources are allocated to the short, medium and long term, is a helpful antidote.
2. Put the customer first
It’s not shareholders who create shareholder value; it is customers who buy a company’s products and services and thereby provide its revenues (as Peter Drucker helpfully reminds us, ‘the purpose of business is to create and keep a customer’). As we have argued repeatedly elsewhere (e.g. in ’How to Solve Growth Problems by looking at them differently‘), looking through the customer’s eyes is part of the ‘outside-in’ focus that is essential to guide innovation strategically.
All companies say they listen to customers, of course, but the critical point is to understand what they really value in relation to the problems they want to solve. These relate to markets as well as products, and often explain where a new market came from. Failure to see value to customers, as opposed to value to the business, is one of the chief reasons why so many companies miss the significance of potentially disruptive new entrants at the bottom end of the market. Conversely, understanding that significance, gives a far-sighted company at least a chance in turning a disruptive challenge to its own benefit.
One of the rare incumbents to have successfully fought off a disruptive innovation from outside is the Swiss watch industry. Faced with a classic disruptive challenge from Japanese companies such as Casio and Seiko in the 1980s, a couple of ailing Swiss manufacturers under Nicholas Hayek turned the tables by, instead of adopting the usual margin retreat, boldly launching the Swatch, a technological and marketing breakthrough of their own that retook much of the Swiss industry’s lost market share and has provided a defensive umbrella under which the rejuvenated luxury industry has prospered ever since. Swatch saw that customers appreciated accuracy and functionality, but also valued style. As a result they found a new combination of ingredients that complemented the industry’s core.
Real customer preferences aren’t always what companies think they are or wish they might be. No-frills airlines, city car clubs, online betting sites, online search, peer-to-peer banking, not to mention digital music, have all taken off by initially flying in the face of long-held assumptions about what consumers value, and therefore what they will pay for and what they will happily do without. Mike Harris, a great causer of disruption, tells of the insights that led to First Direct – everyone said that customers wouldn’t bank on the phone or online as they wanted to visit a branch…
3. Back many horses and be prepared to fail
Venture capital funds operate on the principle that out of say 10 investments, five will show zero return, three will wash their face, and two, at best, will be runaway successes that compensate for the much greater number of disappointments.
There’s no reason to think that companies will do better than seasoned venture capitalists, so they need to spread their bets. One method is to set up hotspots of innovation in separate incubators or accelerators, such as Google Labs, Unilever’s incubator for media start-ups and Telefonica’s Wayra, an accelerator that has fast-forwarded the launch of dozens of new technology ventures in record time. 3M, like Google, allows employees to use a proportion of their time on their own projects – Post-It notes famously emerged from one such individual initiative. As with lesson 1 above, consistency is all important: many media companies negated the point of having a portfolio of dotcom ventures by closing them all down at the same time when fashion turned against them.
Visa has adopted a different tack, aiming to ensure it has a stake in whatever the winning platform(s) turn out to be in mobile payments by simultaneously licensing electronic payments technology to Google, taking a strategic stake in Monetise and launching its own mobile wallet service.
4. Create a corporate culture that encourages curiosity, innovation and learning
Steve Jobs’ greatest achievement wasn’t the Macintosh, iPod or iPhone. It was an organisation capable of creating such captivating objects of desire one after the other. One part of this was structure: as a company with a single P&L and balance sheet, Apple was able to take a whole-company view of opportunities such as music downloads, whereas Sony, which had all the elements in place to do an iTunes, was paralysed by divisional infighting. Silos, conventional inside-out thinking and short-term financial targets spell death for disruptive thinking. Another clue lies in Job’s description of why the original Mac was successful: the people working on it, he said, “were musicians and poets and artists and zoologists and historians who also happened to be the best computer scientists in the world”. Such people might be ‘a pain in the butt to manage’, but the reward for harnessing that passion to ambitious goals is a creative zeal that no other company in the field has been able to replicate.
In a recent article, Dyson’s chief executive noted that “the best you can do is hire a lot of smart young people, give them a lot of responsibility and they’re going to grow on it…If you work at Dyson, you have to have fun with vacuum cleaners”. Google, which at start-up resembled a university department rather than a conventional company, operates on similar principles.
For established, well-grooved incumbents, loosening up is easier said than done, since encouraging creativity inevitably involves giving up a measure of control. Expecting ‘culture change’ to inspire a hotbed of innovation is the wrong way round: as Marks & Spencer showed with its Plan A for long-term sustainability (see ’What we can learn about innovation from Marks and Spencer’s Plan A‘), it’s easier to act your way to a new way of thinking than think your way to a new way of acting. Plan A is indeed causing a culture change, but that is the result of setting out clear goals for innovation, making them public, showing they are taken extremely seriously from top to bottom of the business and liberating people to carry it out: it is a result, not an abstract end. Tolerance for failure (provided it is learned from) has to become more than an empty phrase, and reward systems have to be modified accordingly.
5. Develop the ability to master entirely new capabilities or recognise when you can’t
It is essential that a company is honest about what it is good at and what it is not. For example, Unilever recognises that while it has a chequered record of invention on its own account, it is second-to-none in scaling ideas from one market to many. So it reasons that it makes more sense to acquire and commercialise innovations from others than pursue them itself.
In its high-growth phase, Cisco turned acquisition into a potent innovation weapon, acquiring literally hundreds of small technology start-ups and integrating their products in a very short space of time. In other words, the tool needs to be fitted to the task. Underlining the message, a recent article in Harvard Business Review warned companies against launching large-scale transformation efforts to head off disruptive challenge before they had carefully mapped their resources, processes and values against what they were trying to achieve. Without such a systematic review, ‘in trying to transform an enterprise, managers can destroy the very capabilities that sustain it.’
It is a delicate balance, since seasoned innovators understand that to do something new, they generally have to give up doing something old. Nokia had started out making wellington boots among many other things, all of which it ditched to focus on mastering market segmentation and design, at least for a period, in mobile phones. Jobs prided himself on being able to say ‘no’ to projects that failed to meet Apple’s exacting standards, but conversely had no qualms about developing entirely new platforms even at the price of cannibalising existing ones (e.g. tablets vs standard computers). The cost of not developing the ability to adopt new processes and technologies in a timely fashion is high: like many incumbents, Kodak correctly foresaw what was coming in digital imaging and printing but not its speed. In the face of unexpectedly rapid change, its foresight was of little practical use.
6. Play at being the outsider in new markets not just the insider in your own
Acquisition isn’t always the right answer. Sometimes being an outsider enables an innovator to reframe customer needs without the preconceptions that invisibly constrain thinking in industry incumbents. Such was the case with Apple, which revolutionised two, possibly three, sectors (music, phones and retail) by bringing its distinctive outsider’s values to bear on sectors that it could see were ripe for reinvention; likewise for Amazon in retail. As already noted, given Sony’s history (it invented the successful Walkman), technological skills and distribution knowhow, it should have developed the iPod and iTunes store. But it couldn’t bring itself to make the final step and was rapidly leapfrogged by the quicker- and freer-thinking – Silicon Valley upstart.
Disruptive innovation doesn’t happen every day, and its timing, especially whether and when it takes hold at scale, is unpredictable. But it rarely strikes as a bolt from the blue – in most cases companies have ample warning of the coming shift, and indeed the impending changing of the guard soon comes to seem inevitable. Yet the cases where firms have failed to react, or react sufficiently or fast enough, are legion. It is a matter of record that much disruptive innovation is carried out by new entrants to the industry; despite the apparent odds in their favour – established market share and distribution networks, dedicated resources and experience – even large industry incumbents rarely emerge unscathed.
Despite this apparently unpromising history, however, our work with companies coping with or conducting disruptive innovation has convinced us that the challenges, although difficult, can be managed.
The most important step in solving a problem is understanding it. That means managers taking account of their company’s resources and ambitions and the needs of the market. We can’t guarantee a success like the iPod.
But if, at the same time, you work systematically to set long-term ambitions to complement short-term urgency; really put measures and mind-set in place to understand what customers value; build a portfolio of experiments in the knowledge that some will fail but all will generate learning; infuse the company with a culture of curiosity, optimism and learning; develop the art of mastering or acquiring new capabilities to complement those that remain valuable (recognising realistically when you can’t); and practise studying your market like a visitor from Mars, looking from the outside in – then you’ll have done a great deal more than most to prevent yourselves becoming someone else’s breakfast.
Originally posted on www.the-foundation.com