Applying Systems Thinking to decode Disruptive Innovations

In his seminal book "The Innovator’s Dilemma", Clayton Christensen lays out a conceptual model to predict whether innovative ideas eventually lead to disruptive business outcomes. It describes the interplay between economic forces and human behaviors that influence one another in a causal relationship over and over again. This blog is an attempt to understand the interplay of such cause and effect acting at the micro and macro levels of an organisation using systems thinking.

“There is something about the way decisions get made in successful organisations that sows the seeds of eventual failure” 

Christensen’s work identifies three critical elements for a product or service disruption:

1. Consumption rate of improvements or the performance delivered - how much of it do customers utilise or actually need in the first place?
2. Continuous increase in performance owing to technological progress - innovations that fuel more performance over time
3. Target audience or market segments - the high end customers who always demand better performance vs new or less demanding ones who prefer convenience and simplicity at a lower cost

As can be observed, the pace of technological progress outstrips the rate at which consumers can adopt the new and improved performance that gets enabled by it. For instance, online shopping experience has improved leaps and bounds over the past decade. Many traditional brick and mortar companies had to include an omnichannel strategy to stay relevant in the digital age.

Christensen classifies innovation under two distinct types - sustaining and disruptive. 

Sustaining innovations are critical to stay ahead of the competition. It focuses on high end customers to improve an organisation’s profitability. Such customers demand more performance and are also willing to pay for them. Hence, there is no dearth of motivation or willingness for an organisation to go down this path.

"In doing what they must do, every company prepares the way for its own disruption"

These innovations could be path breaking or incremental in nature and they move the product or service into a higher profit margin territory, almost in a virtuous cycle. For example, back in the late 90's the origin of the Internet disrupted industries far and wide. But for Dell Computers who were already selling their products directly to customers, it was a sustaining innovation that enabled them to sell online and grow at a prolific pace.

Disruptive innovations on the other hand, shifts focus to the over-served customers in existing markets and newer markets altogether.

In the first category, over-served customers are those who tend to prefer simpler, convenient and low cost solutions compared to the ones they already use. They feel they are charged more and hence motivated to switch to an alternate solution when feasible. For example, Deskjet Inkjet printers when introduced by Hewlett-Packard became an instant hit and disrupted the laser jet printer market.

With a foothold in the market, further technological progress improves the performance of the product or service. Gradually, the originally considered "inferior" technology evolves to become more capable to meet the demands of a growing customer base.

"A disruptive business model that can generate attractive profits at discount prices is an extraordinarily valuable growth asset"

Such disruptors remain profitable though they offer lower prices and discounts because of an existing over priced market created by established firms. Hence, the number of active incumbents who offer a similar product or service is a key enabler for their competitive pricing strategy.

And not surprisingly, established organisations feel much relieved when competitors line up with products and services at the lower-end margin. They aren't seen as a threat as this is a low profit margin territory. Hence, it’s rather convenient to reallocate resources and focus on work that can generate higher margins.

Nokia owned about 50% market share when smartphones were first introduced. However, it failed to recognise the disruptive potential in them and instead focused on hardware upgrades and product diversification. "Nokia's longer term strategy remains valid and intact" was their press statement even when the disruption had begun.

Now let's combine both the causal loops of sustaining and disruptive innovations to understand the interplay between them.

Christensen calls this phenomenon as asymmetric motivation where in the established firms are motivated to go up-market compared to the low-end markets. This creates an opportunity for the disruptors to enter the game and eventually, they go on to disrupt the entire market.

The disruptors make profits at the lower end as long as they are competing against the incumbents. However, when the last of the remaining incumbents decides to move up-market a price crash is imminent. Now, they are only left with other similar disruptors operating at low margins. They can no long remain profitable by making improvements in efficiency and selling at lower costs. They need to move up-market. There is no other choice.

"Disruptors in one generation become disruptees in the other "

The other category of disruptive innovation is one that targets new markets. Or perhaps, a customer segment that has until now never utilised the product or service. It could be owing to lack of money or skills or simply, the difficulty or inconvenience that it entails.

New market disruptions compete more against non-consumption of a product or service than an incumbent per se. However, as they improve (similar to low-end disruptions) they tend to attract customers from existing markets as well. Air Deccan became India's first low cost airline with connectivity to tier-1 and tier-2 cities. Within a few years of their launch they went up to 380 flights a day covering 67 airports across the country.

In the case of such disruptions, incumbents tend to ignore them. They aren't a threat in the early stages as they seem to operate in a different market offering a different product or service. And even when the low end customers get pulled out, it feels good for the incumbents as they have more reasons to go up-market now. Over time, the existing market gets disrupted too.

"For incumbents, it feels like replacing their low-margin revenues with higher-margin revenues"

To summarise, sustaining innovations are important for growth. A technology breakthrough could still be a sustainable innovation to keep the incumbent ahead of the race. However, it is not a viable way to build new growth business.

Disruptive innovations start with profits at the lower end or new markets and eventually go on to disrupt the entire market. Established firms need to leverage this opportunity by spinning of a new business unit with freedom to define its own cost structure and operating model. This opens up possibilities for growth through successive migrations up-market with lower overheads.