Confronting a new-market disruption: When disrupting the disruptor is the only way to succeed

written by Thomas Bartman, Senior Researcher, Forum for Growth & Innovation

When our research team meets with executives, many of whom run some of the world’s most successful companies, one of the most common questions we are asked is “how do I spot credible threats emerging in adjacent markets, and what do I do about them?”

Managers today are aware of the risks posed by products that don’t clearly fall within their category because they’ve observed it happen many times in recent history. Mobile phones replaced landlines, the iPod/iTunes combination replaced the Walkman and hydraulic excavators replaced steam shovels. In the language of Disruption theory, we call those examples “New-Market Disruptions.”

New-Market Disruptions are particularly difficult for incumbent firms to spot because they emerge in a new plane of competition that competes on different measures of performance than the original plane. To the incumbent, this often doesn’t look like disruption at all, and that leads many incumbents to make mistakes that allow entrants to build substantial businesses or even topple the incumbent.

To explain how smart managers fall into these mistakes, I’m going to explain the phenomenon in three parts. In this first post, I’m going to present an overview of New-Market Disruption; stay tuned for future posts on the mistakes managers make and what they should do instead as well as a successful example with you, Daimler’s Car2Go car sharing business.

Part 1 — New Market Disruption

Clay Christensen, the leader of the Forum for Growth and Innovation where I research, first wrote about New-Market Disruption in his best-selling book The Innovator’s Solution. New-Market Disruption differs from Low-End Disruption by emerging in a new plane of competition — or more colloquially, a new market, whereas Low-End Disruptors emerge at the bottom of the original plane of competition.

Incumbents recognize Low-End Disruption when their least-demanding customers abandon them for the entrant but New-Market Disruptions are more subtle. They compete against “non-consumption” meaning that their customers weren’t active in the original market. This makes them more difficult to spot, but we’ve found that managers in the incumbent firms are often very aware of the emergence of the new market they just don’t acknowledge the significance of the threat because they don’t categorize the entrant as Disruptive.

Because the new-market disruption creates a new market, managers at the incumbent firm are often initially skeptical that the market exists and that the entrant’s business model is viable. This makes sense; these managers know more about the industry than anyone else and, their thinking goes, if there were an opportunity in that space, they would’ve already exploited it. Plus, they’ve seen dozens of entrants try the same approach before and fail.

When discussing the rise of a disruptive entrant in his industry, an executive from a leading firm told us “what you have to realize is that there have been dozens of other startups that have tried that approach before and failed; we even developed plans to launch that exact business and killed it when our initial tests came back negative. So it’s not like everyone sees this company coming and immediately recognizes that they will be able to make it work. It’s easy to look at them in hindsight and say ‘how did you miss that?!’ but in the beginning the successes look just like the failures.”

We’re sympathetic to how difficult it is to spot these disruptors early and our best advice is to study the theory and recognize the patterns of New-Market Disruptions. They often start small, creating new markets and drawing non-consumers into the market with lower costs or simpler, more accessible products. The key attribute to recognize is that they increase the number of consumers or consumption occasions rather than stealing share from existing consumption.

Like all Disruptive Innovations, they also possess a technological core that enables them to improve their products’ performance faster than consumers’ can utilize the improvements. Executives need to monitor the edges of their market — marginal or infrequent consumers — and look for consumers that are switching between the products or defecting the original market for the new one. This is the most obvious warning sign the managers will receive in a New-Market Disruption.

Part 2 — Managers’ ineffective responses and what they should do instead

In my first post in this 3-part series, I presented an overview of New-Market Disruption. Here, I will explain the mistakes managers make and what they should do instead.

Most managers, skeptical that the innovation will take off, adopt a wait-and-see approach to the new market. As the entrant grows and it becomes more clear that the business model is viable, incumbents begin creating contingency plans. At the core of the ineffective responses is a belief in the value of the “fast-follower” strategy.

Fast following is a strategy that many people cite as highly effective. They note that Apple is almost-always a fast-follower. It didn’t create the MP3 player but dominated the market with the iPod, didn’t create the smartphone but now dominates it with the iPhone and didn’t create the wearables market but has revolutionized it with the Apple Watch. While these examples are valid, they don’t apply in this discussion because each of those innovations was sustaining to Apple’s business model. In sustaining competition, the fast-follower strategy works because success comes from leveraging existing resource and capability advantages; in essence, it sustains the existing competition. This heavily favors incumbents but won’t help in Disruptive competition.

Fast following requires, essentially, copying the entrant but improving on their business. This is classic sustaining strategy but, again, we’re competing against a Disruptor and everything we know about Disruptive competition tells us that we are unlikely to succeed by deploying a sustaining strategy to disruptive competition. We fail because the Disruptor becomes the incumbent in their market and the original incumbent becomes the entrant in the new market.

The incumbent firm’s managers believe that its significant size, resource and experience advantages will allow it to quickly quash the entrant whenever it decides to act. These managers view their company like a coiled spring, full of energy and able to respond aggressively and quash the new competitor as soon as they decide to act. However, when competing in a new plane of competition, the resources and experiences we’ve developed in our original model are unlikely to help us and may even hurt us.

Instead, these managers need to take a different approach. First, they need to be pioneers, exploring market adjacencies and creating new businesses that could disrupt themselves. Most managers avoid this because they’re afraid of cannibalizing their existing business but we’ve found that it’s better to disrupt yourself than wait for someone else to do it. Because the disruption creates a new market, it will always increase consumption meaning that there is often more absolute profit available, even if the market offers lower profitability.

If they don’t succeed in first disrupting themselves, they need to create a business that disrupts the disruptor. Creating a new disruptive business allows the original incumbent to regain the advantage and develop another new market. Creating disruptive businesses is the subject of significant parts of Clay’s work so I’m not going to go into detail here but I encourage all readers to regularly consult The Innovator’s Solution.

Part 3 — Car2Go

In my first post in this 3-part series, I presented an overview of New-Market Disruption. In my second post, I explained the mistakes managers make and what they should do instead. In this post, I’m going to share a successful example with you, Daimler’s Car2Go car sharing business.

Most of you are familiar with Zipcar, the industry leader in car sharing that was founded in 2000 to offer an alternative to car ownership for urban residents. Zipcar didn’t directly compete with either car manufacturers or traditional car rental companies but it grew quickly thanks to its convenience and affordability.

Zipcar offers hourly rentals that are reserved in advance on the company’s website or mobile app. Zipcars are parked at fixed locations throughout urban areas, and at high population density locations like corporate offices and college campus. Users drive the vehicle for as long as they have reserved and return it to its assigned parking space for the next user. Users pay an annual membership fee and an hourly rental fee that includes all potential costs including gas and insurance.

Witnessing Zipcar’s expansion, the traditional car rental companies all launched competing offerings. In 2008, Hertz launched Hertz Connect and Enterprise launched WeCar. Both companies took very similar approaches to Zipcar, essentially copying its model and leveraging their existing brands, fleets and technology systems. The results have been disappointing. According to market research firm IBIS, as of March 2015, Zipcar controlled almost 30% of the US market while Hertz controlled 9.5% and Enterprise just 5.4%. Similarly indicative, both Hertz and Enterprise have re-branded and re-launched their car sharing businesses at least once. Avis may have taken the best approach, acquiring Zipcar in 2013 for $500 million in cash.

While the traditional companies copied Zipcar without seeing many positive results, German automotive giant Daimler witnessed the rise of car sharing and the threat it poses to traditional car ownership and developed a truly unique response. In 2008, Daimler began developing a unique car sharing alternative called Car2Go, in Ulm, Germany.

Car2Go operates a very different model than Zipcar. It initially offered only Smart Fortwo vehicles (although it added Mercedes B Class cars to its fleet as part of a new, premium service called Car2Go Black in 2014). Daimler owns Smart, so it’s unsurprising that they would select vehicles from the corporate parent but Smart cars also offer unique benefits themselves. They are developed for urban environments with small formats that are easy to park and offer good fuel economy.

Easy parking is important because Car2Go operates a “roving” model where its cars have no fixed spaces but can be parked anywhere in their home territory at the end of a trip.

This means that every rental is one-way and users don’t book in advance but instead locate available vehicles on their smartphones and have no claim to a vehicle until they drive off in it. Also unlike Zipcar, Car2Go charges users by the minute (although it allows for hourly or daily rentals, too).

Car2Go didn’t attempt to fight Zipcar head-to-head. Geographically, it focused on Europe, where Zipcar is not strong, first and in expanding to the US and markets where Zipcar is present, initially targeted smaller cities with lower population densities that were less attractive to Zipcar because of its need for high densities. Car2Go was also unapologetic about its model; it purposely chose not to offer services for consumers that require advance registration or more than 2 seats per vehicle. Doing this meant that Car2Go avoided direct competition with Zipcar and the traditional rental car companies and created a completely new market.

So, what’s become of Car2Go? It’s still small in the United States (less than 5% market share according to IBIS) but it’s growing rapidly and its strength in Europe has made it the world’s largest car sharing company.

Conclusion

The most important thing to take away from the example of Car2Go is the importance of creating a new, disruptive business to disrupt the disruptor. Daimler recognized that car sharing could have significant negative impacts for its business and its used that understanding to create a business that leveraged corporate strengths where appropriate but created a fundamentally new business model that is disruptive to all competitors in addition to itself.

If you face competition from a Disruptive entrant in a new market, remember that they are the incumbent in their market and you will be the entrant if you choose to enter their market. Attempting to copy their model and outcompete them with your larger size, greater experience and significant resources will predictably lead to failure.

Buying the entrant is one option, if it’s available, but will be very expensive, if you can afford it all. The best option is to develop your own disruptive business.

Now I ask for your help: have you seen other examples of this?

Do you know if examples where this isn’t the case?

If so, please leave them in the comments so we can study them to learn more!