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Disruption according to the Cambridge dictionary is ‘an interruption in the usual way that a system, process or event works’. In the context of technology, startups and Venture Capital, disruption has become a buzzword that is overused and very often misused. You can constantly read about Product X being ‘disruptive’, or companies and whole industries being ‘disrupted’ on a daily basis. Everyone though has their own understanding and definition of disruption.
What many people do not actually know is that there is an entire academic theory, defined and analysed by Clayton Christensen, a Harvard Business School Professor. During the past 2 months I took an online course from HBS on Disruption, called ‘Disruptive Strategy with Clayton Christensen’. It is a very interesting course for anyone who wants to dive deeper in this exciting topic. One of the things that became evident quite quickly during this course is that most of the people are using the term ‘disruption’ incorrectly.
‘Disruptive innovation ‘describes a process by which a product or service takes root initially in simple applications at the bottom of a market and then moves up market, eventually displacing established competitors’
The main outcome of the theory is that ‘outstanding companies can do everything right and still lose their market leadership, or even fail, as unexpected competitors rise and take over the market’. There is a very interesting, counter-rational, mechanic in the market that leads companies with great management, who listen to their customers, spend heavily in R&D and relentlessly pursue profits to fail.
Simply put, disruptive innovation ‘describes a process by which a product or service takes root initially in simple applications at the bottom of a market and then moves up market, eventually displacing established competitors’. The main idea states that ‘Disruption describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. As incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more suitable functionality. Incumbents chasing higher profitability tend not to respond vigorously. Entrants then move upmarket, delivering the performance that mainstream customers require, while preserving the advantages that drove their early success. Then mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred’.
3 types of innovation
According to Christensen, there are 3 types of innovation. Sustaining innovations, low-end disruption and new market disruption.
- Sustaining innovations are represented by better products that companies can sell for better profits to their best customers. They provide performance improvements in attributes that are most valued by the industry’s most demanding customers. These improvements may be incremental or breakthrough in character. A company that is creating a better / faster / more beautiful computer is not disrupting apple’s macbook business, it has simply created a sustaining innovation.
- Low end disruptions target over-served customers at the low end of the mainstream market. As incumbent companies introduce higher quality products to satisfy their most profitable customers (usually at the high end of market), they overshoot the needs of low end and mainstream customers. This leaves an opening for entrants to find footholds in the less profitable segments. These offer ‘good enough’ performance, and target the ‘over served’ customers. Salesforce was initially a low-end disruption, targeting the lower end of the market that other legacy, on premise CRMs could not serve.
- New-market disruptions are opening new markets, by focusing on customers who historically lacked the money or skills to buy and use the product. Betterment and Wealthfront (and other robo-advisors) are offering wealth management services to the masses, who are not (and can not) be served by the traditional Wealth Managers and Asset Managers.
Main implications of the theory
The mechanic that happens in the market at low end and new market disruptions is that incumbents, following rational business principles are motivated to flee away from the low end of the market, and strengthen their offering towards their most profitable customers, at the high end of the market. It is very hard for companies to pursue opportunities where there is no profitability. If on the other hand a new company is trying to make better products to sell for higher price to the industry’s most lucrative customers, the large incumbents will fight hard to maintain their position.
Both entrepreneurs, but also VCs should be cautious on how they use the word disruption. After all, you can always be challenged or give a different impression than the one initially in your mind.
Overall, I believe disruption theory is very interesting, providing useful insights as well as a nice framework to assess new opportunities and potential threats. It provides a valuable toolset to entrepreneurs, investors, managers and strategists.
My strong belief is that the most exciting investing opportunities will come from new technologies and market trends that are creating disruptions.
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