The key is to understand and control the key factors which affect success, and to employ well-tested theories. Successful disruptive innovations and business models do not require breakthrough technologies. Disruptive innovations are either based on having a lower cost structure or simple, low cost products targeted at non-consumers that gain acceptance through undemanding applications. Through rapid innovation, product quality improves and products move up market into larger more mainstream markets. Among the keys to launching disruptive innovations are targeting the right customers (non-consumers who are more easily satisfied than existing customers), and employing more effective techniques to segment the market based on the job to be performed, leading to products that are “hired” to do these specific jobs.

Key Learnings to help managers to create disruptive innovations:

• Disciplined use of theory can decrease risk and improve results. Use of theory gets scoffed at because it sounds like “theoretical”, which is interpreted as “impractical.” However, managers are voracious consumers of theory, even if they do not know it. A theory is a statement of cause and effect: what causes what, and why. Managers have theories (even if unstated) based on experience and observation. The challenge is to distinguish between useful and non-useful theories. Useful theories are those that have been tested and refined to consistently and accurately predict the results that a specific action will yield. Using explicit, well-researched theories can have tremendous value to managers and significantly decrease risk in pursuing new growth businesses.

• Innovation need not be as random or risky as thought. Maintaining growth at a consistent rate in a way that allows companies to deliver above-average shareholder returns is widely desired, but rarely achieved. And, for companies that had achieved such results but then stalled, it is very difficult to regenerate above-average rates of growth. Also, historically managers and investors have not been very good at predicting which new innovations will succeed and which will not. While venture capitalists believe that every investment will be successful, they know that only about 20% are. Likewise, when established companies launch new products believing they have the right product for the right customer, confirmed by the right research, the success rate is only about 25%. As a result, conventional wisdom has been: innovation is risky and random. However, by understanding the key factors that affect innovation success and using sound theories to guide decisions, launching innovations and new growth businesses need not be as risky or random as has been thought. Ten key questions to be answered in building new growth businesses are:

1. How can we beat the competition?
2. Which customers should we target?
3. What products will our customers want to buy?
4. How should we distribute to and communicate with our customers5. Which things should our company do, and which should our partners and suppliers do?
6. How can we avoid commoditization?
7. Who should be on our management team?
8. What is the best organizational structure for this business?
9. How can we know when to change course?
10. Whose investment capital will help, and whose might hurt?

• Disruptive innovations and business models create a higher probability of success for beating competition.

There are two types of innovations: sustaining and disruptive.

– Sustaining innovations: The purpose is to make a good product better. Sustaining innovations deliver better products, at higher margins, to existing customers. Sustaining innovations rarely alter a market’s competitive landscape; the incumbents nearly always win and sustaining innovations help them insulate their position. Most innovations are sustaining, and most organizations are organized to deliver sustaining innovations.

– Disruptive innovations: Truly disruptive innovations redefine the competitive landscape and change the basis for competition. Disruptive innovations are not necessarily tremendous technological breakthroughs. In fact, most begin as simple, affordable products that mainstream customers cannot initially use because the product does not perform well enough. The innovation initially takes root through new customers using an undemanding application. Because the trajectory of product improvement is so rapid, the performance of the innovation improves quickly, allowing the product to perform more demanding applications in more mainstream markets. Through this process, new entrants can shake up markets and assume leadership positions.

Dominating Your Markets Through Disruptive Innovation

• It is understandable why companies pursue sustaining innovations. When companies experience success, it is often attributed to good management; when they are unsuccessful, management is blamed. This doesn’t tell the whole story. The decision to invest in sustaining innovations usually makes sense, while potentially disruptive investments can be difficult to justify. The markets for sustaining innovations are easily quantifiable, targets are known because they are current customers, product ideas are easy to research by listening to current customers, financial models are known, and the likelihood of success is good. In contrast, the markets for disruptive innovations do not exist, margins may be lower, targeting and research is more difficult, and the failure rate has historically been high. It is understandable that companies would deploy resources against sustaining innovations. “Managers have to choose: do we invest to make better products at higher margins that our best customers can use, or make worse products at worse margins for non-existent customers?”

• Disruptive business models create an “asymmetry of motivation” where the established leader chooses to flee, not fight, benefiting the new entrant. While existing players have advantages when competing based on sustaining innovations, new entrants can win when the competition is based on a disruptive innovation. There are two types of disruptive strategies: low-cost and new-market disruptions.

- Low-cost disruptions: This does not create a new market, but can create a new business. Low-cost disruptions target existing customers who are over served by current products and who would prefer a lower-performing product at a lower price. A low-cost disruption requires a business model and/or cost structure that allows a company to succeed with lower prices. This only works if a market has a high-cost competitor to disrupt. However, once disrupted, the higher-cost competitor will usually choose to exit the market to pursue better margins elsewhere, leaving only the low-cost disrupters to compete. This results in deterioration of pricing, and causes the low-cost entrants to look “up market” for better margins, with the pattern repeating itself. Steel mini-mills are a good example. Mini-mills had a 20% cost advantage over integrated mills, but produced inferior product. At their outset, the only segment mini-mills could target was low-end rebar, which was small volume at low margins. Because it was so unimportant, the integrated mills chose to exit the rebar business for higher margin opportunities. Over time, mini-mill quality improved, while competitive pressures drove rebar margins down. In pursuit of better margins, the mini-mills went “up market” into new segments, with the rebar pattern repeating itself. Over time, the mini-mills killed the integrated mills.

- New-market disruptions: These create entirely new markets by targeting consumers who are trying to get a job done, but lack the money, skill, or products to do so. A new growth market starts with a simple, low-cost, unsophisticated product targeted at non-consumers who have no alternatives. They are easily satisfied with an inferior product, because previously they had nothing. Over time, the product becomes better, moves up market, and attracts mainstream consumers with more demanding applications. The initial product is not perceived as a threat by the market leader because its business was not affected; no customers were lost since the initial sales were to non-consumers. The existing player has a difficult time allocating resources to such opportunities because existing companies target big existing markets, not small markets of non-consumers. By the time the existing leader sees the threat, it is too late. “When you compete against non-consumption, you just have to be better than nothing in order to delight the customer.”

• Deciding which products to market to which customers should be based on the job the customer wants to get done. Companies often introduce products that fail because the segmentation and market research is irrelevant. Markets are commonly segmented based on customer demographics, product features, and price points because this is how data is most easily available. However, consumers do not think in demographic terms. They think about the “jobs” they need to get done, and they “hire products” that can do the job. Thus, research should focus on “what job is the customer trying to get done?” Too often, companies define their market in demographic terms or in product terms and introduce products that fail. By focusing on the job, companies will become better at determining the products and features that get the job done, and new products will be more successful.

About Christensen
Clayton Christensen, a Harvard Business School professor and sought-after business consultant, is renowned for his work on innovation and disruption.

Christensen will lead the Special Management Program Strategic & Disruptive Innovation on June 17-18, 2008 in New York City. More information: www.hsmglobal.com/us/christensen