The Theory of Disruptive Innovation
What makes a promising new idea? How do we distinguish between the ideas that will blossom into success stories, versus those that will inevitably fail? If you asked these questions to a room full of students, VC’s, or entrepreneurs, how do you think they would respond?
My answer would be simple: “Well… I don’t know exactly.”
And I’m not sure anybody truly knows the answer to this question. There is no calculation, no logic, no process that can say, for certain, whether a new idea will fail or succeed. People’s preferences and desires are simply too opaque, and there are far too many variables to form a reliable conclusion.
Or, at least, that is what I had thought.
After my sophomore year at Duke, I spent the first half of my summer taking a class at Apple University in Cupertino, Ca. The class was titled “How to Build and Sustain a Successful Enterprise.” It was instructed by one of the foremost pioneers in the business world, HBS professor Clay Christensen, accompanied by his son Matt, a successful venture capitalist. The topic of the class was Clay’s world-renowned Theory of Disruptive Innovation, and I had the unique opportunity of learning from the master himself.
Clay’s theory provides a framework to help identify promising business ideas, particularly in the realm of technology. His theory is fairly straightforward: As time progresses, companies over-index on the complexity and performance of their products, thus overshooting user expectations. In turn, new entrants will enter the market, and provide performance-inferior alternatives that emphasize other aspects of the user experience: affordability, user-friendliness, convenience, etc.
Due to their inferior product, the new entrant will only be attractive to customers with the least demanding expectations for performance. In many cases, these users are the least lucrative customers for the incumbent company. For this reason, their opting out may be inconsequential for, or even welcomed by, the incumbent company, which can then focus their attention on more profitable customers. However, as the new entrant strips away a small slice of the incumbent’s customer base, it will gain the fuel necessary to improve its products.
As their products improve, the new entrant slowly eats away at more and more of the incumbent’s market share. What happens next? You guessed it: a snowball effect ensues, whereby incumbents are incentivized to cater to their most-demanding, and most loyal, customers, while the new company slowly moves “up-market,” absorbing higher and higher tiers of the customer base. Eventually, even the most demanding customers find the new entrant satisfactory, and they opt out for the new entrant as well. This is truly what it means for an industry to be “disrupted”.
Alright, that was a lot of theory condensed into just a few paragraphs. Let’s look at a few examples, and then you can decide for yourself whether you find the theory compelling.
As time passes, people’s expectations for technology slowly rise.
[Note: The brackets represent the range of customer expectations for product performance.]
However, technological improvements vastly outpace the rise in user expectations.
This paves the way for new entrants to enter the market, gaining a foothold by indexing on a deficient aspect of the user experience. At the beginning, shown here as X1, the entrant will only appeal to the lowest tier (i.e. least demanding) customers in the market.
As time passes, designated here as X2, the entrant is able to improve its product. As the product matures, it appeals to a larger percent of the market, thus stripping away more market share from the incumbent.
Eventually, the theory predicts, the new entrant’s product will improve to the point where it appeals to the entire market, and beats the incumbent.
Let’s consider a few concrete examples concerning some of the biggest tech success stories from the past few years.
Airbnb begins with a small following of college students and low-cost travelers. Now, just a few years later, it operates across the world and competes with the best hotels in the market.
The disruption in higher education is still in its infancy. However, considering the skyrocketing costs of higher education and the new age of free and readily available information, it appears as though new business models like Coursera and Minerva will thrive in the next decade. I’ll talk about this subject more in-depth in my next post.
The final example considers the rise of Uber and Lyft through the lens of the Theory of Disruptive Innovation. Lyft, initially, was a disruptor to Uber by providing a less luxurious, but more affordable alternative. (This is when Uber still only had black cars.) In response, Uber did exactly what Clay Christensen would have suggested: they took part in their own disruption by mimicking the new entrant, and soon released UberX as a cheaper alternative. This, according to the theory, is the only way, aside from legal barriers, to save a company from being disrupted.
This ends my synopsis of the Theory of Disruptive Innovation. Though a blog may seem like an odd place so summarize someone else’s thoughts, it seemed appropriate in this case because I will be referring to his ideas heavily in my next blog post on the future of higher education. I hope you found this article compelling and interesting, and I would love to hear from you regardless! Leave a comment below- all feedback is welcome!
Thanks for reading!