Innovate or Die: How Existing Businesses Can Leverage Disruptive Innovation

Introduction

Innovation is one of the key ways that businesses can stay relevant in today's competitive market. Organisations can differentiate themselves from their competitors by developing new ideas and ways of running their business and offering customers new products or services. Innovation can also help reduce costs, increase efficiency, and improve operations.

Innovations can be self-sustaining. They could be an extension of an existing business model and build on the organisation’s existing resources, capabilities, and values of the firm. Alternatively, innovations can be disruptive. That is, they require a new business model with investments in new resources, processes, and values. Established businesses typically engage in sustaining innovation and respond to them easily.

However, rapid technological advancements, shifts in consumer behaviours, and exogenous shocks require investments in and response to disruptive innovations.

What Makes an Innovation Disruptive?

Disruptive innovation theory, as defined by Clayton Christensen in 1995, is a process by which a product or service initially takes root in simple applications at the bottom of a market and then relentlessly moves up the market, eventually displacing established competitors.

One aspect of this theory is that disruptive innovations often start by focusing on underserved or overlooked market segments. Usually, established players in an industry are often focused on serving their most demanding and profitable customers that they overlook the needs of less demanding customers at the bottom of the market.

Disruptive innovations tend to be simpler, more convenient, and less expensive than established products and services, making them appealing to these overlooked market segments. As these innovations improve and gain market share, they can also begin to compete with established players in more demanding and profitable market segments. However, it is worth noting that not all innovations are disruptive, and not all disruptive innovations have their origins in underserved markets. The theory of disruptive innovation has important implications for existing businesses, suggesting that established market leaders may be vulnerable to disruption from unexpected quarters. To stay competitive, it is crucial for organisations to be attuned to potentially disruptive innovations and to consider how they might respond to them.

The Incumbent’s Dilemma

There are many examples of organisations that have gone out of business or experienced a significant decline due to a lack of innovation. Here is a prime example:

Recording Labels

Recording companies thrived from the 1940s to the late 1990s due to the advances made to incrementally increase both the portability and quality of music consumed by consumers. The monopoly of recording companies started in the 1940s as a result of the invention of the commercial phonograph. It peaked with the invention and widespread use of compact disc (CD) technology.

By the late 1990s and early 21st century, with the rise of the internet, file sharing became a popular method of acquiring music. A single individual could purchase a CD, rip its contents and upload it to the internet. As a result, their friends and eventually anybody could obtain music without paying a penny.

This was made possible due to the rise in popularity of the MP3 file format with the release of Winamp in 1997. In Nov 1997, the website mp3.com offered downloads of thousands of MP3s for free. Napster, the files-sharing network, was launched in 1999, allowing multiple individuals to download MP3s. Sales of record labels plunged by 1/3rd between 1999 and 2003. The major record labels lodged lawsuits against Napster, and it filed for bankruptcy in 2002. Best Buy eventually merged the assets of Napster with its Rhapsody service at the end of 2011 and re-launched the service as Napster.

MP3s digitised music rendering it an information good. This allowed catering to the tail of the demand curve. Unit economics fundamentally changed. The new product was a significant and disruptive shift in terms of resources, processes, and values. Later, business models like iTunes would give the recording companies their share of the revenue. However, recording companies were relegated to benign content providers who lost ownership of the consumer and would never innovate in the industry again.

The Disruptors

Many organisations have achieved a competitive advantage by being innovative. Here is a prime example:

Apple:

In 2003, Apple introduced the iPod and iTunes, revolutionising the music industry and transforming the company. In just three years, the iPod/iTunes combination would be a nearly $10 billion product, accounting for almost 50% of Apple’s revenue.

The company’s market capitalisation too would grow exponentially from around $1 billion in early 2003 to over $150 billion by late 2007. This success story is well known. But what is not well known is the true success behind this story. Many people attribute the success of Apple to Apple’s products – the incredibly well-designed, first-to-market iPod and iTunes.

But Apple was not the first company to launch digital music players back then. Diamond Multimedia and Best Data are both examples of companies that had portable, stylish music players even before the iPod. So what did Apple do differently? Apple did create a product with great technology and a snazzy design, but it wrapped it in an incredibly clever business model that combined hardware, software, and services.

Of the 99 cents that Apple typically charges for a song, as much as 70 cents go to the music label that owns it, and about 20 cents go toward payment processing charges. That leaves Apple with only about a dime of revenue per track, from which Apple pays for its website, along with other direct and indirect costs. But that is fine since Apple was not in the business of music. Apple was in the business of devices. 

Before the launch of iTunes, Apple sold an average of 113,000 iPods per quarter. By the quarter ending 2003, that figure had shot up to 735,000 units, and the combined contribution of iTunes and iPod to Apple would be 45% of sales. The contribution of iTunes was zip. In essence, Steve Jobs had created a revenue model that was a razor-and-blade business in reverse: Apple made a loss on iTunes, the variable good, but iTunes helped to drive the profits of the iPod, the high margin earning durable good.

Until that point, consumers were unhappy because their key channel for digital music consumption was peer-to-peer platforms that provided low-quality music. The recording companies were bleeding in the new economy, and with this business model, both parties were happier. Apple’s business model, therefore, in defining value in a new way, provided game-changing convenience to the consumer and value to the recording companies and would redefine the music industry in a fundamental way.

How Can Established Companies Enable Disruptive Innovation?

Strategy literature, particularly work by Clayton Christensen, suggests that it is challenging for established companies/incumbents to do disruptive innovation. They tend to do more sustaining innovation that perpetuates what they are currently doing. It's incremental, but it's hard to disrupt yourselves. There is a way, but it requires a phased approach. There is a four-step approach that an incumbent business can adopt for disruptive innovation.

These four steps are:

• Insulate
• Nurture
• Partner
• Assimilate

Insulate

When starting with a disruptive innovation, you should insulate it from the rest of the company. Otherwise, the corporate antibodies (Individuals or teams who do not support new ideas for one reason or another) in the company may snuff it out. The reasons why this step is vital are 

a) Resource allocation processes tend to be biased towards existing products in large incumbent organisations.

and

b) Organisations get caught in a competency trap since their prior experience with existing practices makes them resistant to change or adapt to alternatives.

Nurture

When you build the capability, you begin to enhance it, or if it's a new venture, you start to nurture it till you can establish a proof of concept.

Partner

After establishing the proof of concept, the next steps are to hit scale, have production, create investments and capacity, and access distribution channels and sales organisations. In this phase, you start bringing some of the innovative capabilities back into the core business.

Assimilate

In this stage, you bring that disruptive capability, integrate the innovation, and assimilate it with the rest of your core business.

Let's examine some case studies on how established companies achieved disruptive innovation. There are two types of case studies we’ll consider:

a) Companies that created their own internal unit for disruptive innovation: Companies that set up independent business units like what IBM did with EBO (Emerging Business Organisation) or AT&T did with EDO (Emerging Devices Organisation). These business units were set up on the side, reported straight to the CEO, and could do disruptive ventures. These disruptive ventures were then eventually brought back into the mainstream business.

IBM's Enterprise Business Operations (EBO) system was created under Lou Gerstner in the 2000-2006 time frame. About 25 of these ventures were started and they ended up contributing around $ 15 billion to IBM's revenues by 2006. The same thing happened with EDO organisations run by Glenn Lowry of AT&T that did the iPhone deal with Apple, which was transformative.

b) Companies that acquired a disruptor.

In this case, there are two prime examples to consider - Walmart acquiring Jet.com in 2016 and Allstate acquiring Esurance in 2011.

In both these cases, what the companies were buying were capabilities. Walmart was not primarily interested in the Jet.com business. They were interested in Mark Lore, the founder, who was a very creative entrepreneur in e-commerce. Within a year, they made Mark Lore the head of e-commerce of Walmart, and he led the transformation of Walmart's e-commerce operation to the point that when he left in 2021, Walmart became a significant player. Their e-commerce business grew exponentially, especially during the pandemic. Jet.com was shut down quietly in 2019.

Similarly, Esurance was acquired by Allstate in 2011, which had problems going directly to customers. They learned from Esurance, built out the e-commerce channel, and closed down Esurance.

Some observations - If you don't do the insulate and nurture stages, the corporate antibodies will kill the disruptive venture. But if you don't do the next two stages, you'll just be building an innovation silo that will never have the scale that the parent organisation provides.

The most tricky of these four stages is the assimilate stage when you start bringing disruptive ventures back into the parent organisation. First, you need to decide what tether points you need. What capabilities do you need from the parent organisation, and what capabilities are you bringing in? You also need good buy-in from the business leaders of the core business to accept this change.

Challenges to overcome while implementing disruptive innovation

There are several challenges that established businesses may face when implementing disruptive innovation. Some of these are:

1) Resistance to Change: 

Disruptive innovations often require significant changes to established processes and business models, which might be met with resistance from employees and other stakeholders.

2) Limited Resources: 

Implementing disruptive innovation can require significant resources, including financial investment, time, and expertise. This can be a challenge for businesses that are already stretched thin.

3)Tackling Uncertainty: 

Disruptive innovations often involve a degree of uncertainty, as it can be challenging to predict how the market will receive them. As a result, businesses may find it difficult to justify the resources required to implement them.

4) Lack of Focus: 

Businesses may struggle to balance focusing on their core business with pursuing disruptive innovation. This can lead to a lack of focus and ultimately hinder progress.

5) Legal and Regulatory Challenges:    

Disruptive innovations may face legal and regulatory challenges, especially if they involve new technologies or business models that are poorly understood.

To overcome these challenges, businesses may need to adopt strategies such as building a culture of innovation, investing in research and development, and seeking partners to help them navigate legal and regulatory challenges. It is also necessary to be patient and persistent, as the process of implementing disruptive innovation can be long and difficult.

Relationship Between Disruptive Technology and Disruptive Innovation    

Disruptive technology refers to a new technology that has the potential to change an industry or market significantly. Disruptive innovation, on the other hand, refers to a process by which a new entrant in a market introduces a product or service that initially may perform worse than existing offerings but eventually becomes much more effective and disruptive to the existing market.

In many cases, disruptive innovation is fueled by disruptive technology. For example, the rise of the internet and the development of e-commerce were enabled by disruptive technologies that allowed businesses to reach customers online and revolutionised how products and services were bought and sold. Similarly, the rise of ride-sharing services such as Uber and Lyft was made possible by the widespread adoption of smartphones and the development of GPS technology.

Overall, disruptive technology and disruptive innovation are closely related, as disruptive technology can enable disruptive innovation and drive significant changes in an industry or market.

Summary

In today's business environment, companies that can innovate effectively are more likely to succeed in the long term. By embracing disruptive innovation, businesses can position themselves to take advantage of new opportunities and stay ahead of the competition. This can be especially important in industries that are prone to disruption, as businesses that can anticipate and adapt to change are more likely to survive and thrive in the long term.