When Creative Destruction is the Right (or Wrong) Foundation for Innovation

The term “creative destruction” was coined by famed economist Joseph Schumpeter in the 1940s. In defining the term, Schumpeter described the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Translating that to today’s business environment, we’re seeing corporate evolution happen at a faster pace than ever before. New technologies and new business models are fundamentally redefining entire industries. And the companies that fail to adapt don’t survive.

Take, for example, Toys “R” Us. In 1994, more toys were sold at Toys “R” Us than anywhere else in retail. As of 2017, roughly one out of every five toys in the U.S. was purchased from Toys “R” Us — still an impressive volume. And in 2018, the retailer announced that it would be closing for good. This story isn’t all that unique. According to one study, the average tenure of companies on the S&P 500 is shrinking rapidly; roughly half of the current S&P 500 will be replaced over the next ten years.

But rather than lamenting the loss of the old, we should be celebrating. The constant cycles of destruction and replacement of what exists today are what allow for productivity improvements and new growth. And it’s the knowledge of when to focus on addition and when to focus on replacement that gives companies a competitive edge and a roadmap for growth.

The right times to grow through destruction

While the right innovation strategy depends on a number of factors — industry, company dynamics, competitive advantages, and so on — there are several contexts in which a plan based on the premise of creative destruction is usually worthy of consideration.

The market is mature and over-satisfied. Customers buy products because they are trying to get certain jobs done in their lives. They may buy toys, for instance, to entertain their children. The choice of what toys to buy and where to buy them will be influenced by a number of factors, or they may decide that there’s an alternative to toys that’s a better option for entertaining their children. But by and large, customers will make purchasing decisions that allow them to easily satisfy the jobs they are trying to get done.

As markets mature, customers find it very easy to satisfy the jobs that are most important to them. And that makes sense. Companies have directed their innovation efforts at developing better and better products that best meet the needs of their customers. Toys become more fun. They hold a child’s attention for a longer period of time. They allow children to develop skills and learn. The companies that sell toys boast a wider selection or an easier ability to get the toys. At some point, there’s little more that a toy — or a toy retailer — can do. Ultimately, the focus shifts to competing on price. When markets mature to this point, companies need to shift quickly.

In the case of Toys “R” Us, its vast inventory and selection and its broad footprint of stores quickly went from being major assets to a major liability. While it’s hard to improve the product in mature markets, Toys “R” Us could have innovated around the customer experience or its profit model to better serve its customers. By challenging conventional wisdom around its most important assets, the company could have decreased its costs while simultaneously focusing on the things that were starting to matter more to its customers; we call this Costovation. Instead, it sold toys that could be purchased more cheaply elsewhere — from online retailers with more favorable cost structures and from broader retailers that could afford to sell cheaper toys as loss leaders. While Toys “R” Us was destined to face a tough journey in today’s harsh retail climate, its reluctance to destroy its infrastructure-heavy model helped ensure its fall.

Startups and low-cost competitors are threatening the business. Even before industries reach peak maturity, competitive threats may start to pop up. Perhaps a foreign competitor has cheaper labor and materials costs. Or maybe a small competitor with a leaner workforce is stealing away market share. Companies often respond by ceding some lower ground and pushing further up-market, adding new features that they think will differentiate their offering. That can be a dangerous plan for the long-term. It adds costs that can be hard to cut later, generally without adding significant barriers for competitors or new entrants. Rather, companies need to take stock of what customers actually value. At that point, they can eliminate features and offerings that customers value less — creating a chance for cost savings — while simultaneously focusing on the things that really do matter.

The wrong times to grow through destruction

While carefully executed destruction frees up resources to focus on the things that matter most, there are times when it isn’t the right strategy.

Your tiered brand strategy requires differentiated offerings. In many categories, companies use a good-better-best model to avoid tarnishing premium brands, appeal to a broader range of customers, or optimize revenue potential. In the airline industry, for example, airlines may offer an array of options that includes Economy, Premium Economy, and First Class, among others.

By eliminating higher-end options to focus on the broader “bottom of the pyramid,” companies risk losing valuable sources of revenue. Airlines getting rid of First Class or Business Class tickets, for example, could alienate valuable business travelers who tend not to balk at higher price tags. Even Southwest Airlines — famously known for its industry-leading performance despite its single-cabin open seating policies — has taken steps to attract business travelers as its growth has slowed. In 2007, the company rolled out its Business Select tickets with priority seating, and in 2015 it began targeting routes between larger airports that are frequented by business travelers.

The market is nascent and there are under-satisfied customer jobs. In nascent markets — think connected homes or augmented reality — customers generally have jobs to be done that are still under-satisfied. While customer jobs tend to be stable over time, shifts in trends or advances in technology can quickly make jobs rise in importance, and their jolt into the spotlight often means that companies have not been working to help customers get those jobs done. In these markets, it may be too early to fully understand the tradeoffs customers are willing to make or how they will react to particular propositions. The focus — at least initially — should be on finding the optimal balance of helping customers satisfy both traditional jobs and newly important ones. While it may be time to start re-imagining the future, core product lines will provide important stability while new (less certain) opportunities are explored.

Resources aren’t without limits. Companies have limits on how high their costs can grow. Customers have limits on how much money they’re willing to spend on a product. Finding ways to deliver less can ultimately be a win for both groups. They key is understanding where customers are willing to accept less and which customers you might be alienating when you deliver less. This requires creating a market segmentation that clearly identifies the jobs customers are trying to get done, the importance of each job, the current ability of customers to get those jobs done, and the factors that cause certain jobs to be more or less important for particular segments. With that information, you’re set to develop offerings that give customers exactly what they want at a price that pleases.

Dave Farber is a strategy and innovation consultant at New Markets Advisors. He helps companies understand customer needs, build innovation capabilities, and develop plans for growth. He is a co-author of the award-winning book Jobs to be Done: A Roadmap for Customer-Centered Innovation.