Many Venture Capital (VC) firms invest in start-ups that are bringing a disruptive innovation to market, including my own firm Sure Valley Ventures (SVV). But what is a disruptive innovation? How is it different to regular innovation and why do some VCs look to invest in it? This article will give a personal view on these topics as well as highlighting it in the context of SVV’s disruptive innovation investment strategy and its value-add strategy, which its delivered through SVV’s value-add Platform.
Several theories and related frameworks have been proposed for different types of innovation and Clayton Christensen developed the theory of disruptive innovation with a number of collaborators beginning in a 1995 article in the Harvard Business Review. This led to the new field of disruptive innovation that has been called the most influential business idea of the early 21st century and much work continues to advance the field today.
The theoretical development of disruptive innovation by Christensen came to focus on the process by which a new product or service creates a new market, i.e. is designed for a new set of customers, and which over time displaces established competitors, who are most often large companies. Disruptive innovation is often enabled by disruptive technology, but according to this theory not all inventions are disruptive innovations, as it is creation of the new market with a related business model that makes a disruptive innovation. Christensen also theorized that such disruptive innovations are more likely to come from start-ups and whilst large companies may be aware of the innovation their value-network may not support its pursuit by the firm.
Many theorists today argue that the creation of a new market is the defining feature of disruptive innovation, particularly in the way it tends to improve products or services differently in comparison to normal market drivers. Specifically this “new market disruption” creates opportunities for start-ups to bring their innovation to the market through a new market niche (i.e. market segment) with a new and different set of customers and correspondingly different value-network from existing incumbents in the industry. Over time the start-up will seek to build out from the initial market segment to adjacent market segments and then proceed to define the industry over time, once it is able to penetrate the market or induce consumers to defect from the existing market into the new market it created.
So SVV is focused on investing in companies that are creating new disruptive innovations from our chosen disruptive technology areas (Metaverse, Artificial Intelligence (AI) and Security technologies) and companies that have developed significant intellectual property (IP) in a product / platform, which are in particular seeking to create new product markets — initially niche but with very large growth potential.
These product/markets exhibit an S-Curve of growth over time and Figure 1 below shows the last three S-curves of innovation along with next big curve, often called the “fourth wave”:
Figure 1 S-Curves of Innovation
As the Figure shows the last three S-curves of innovation started with the PC; then the Internet and Web; and more recently Mobile, and in particular the eco-systems that support and have been developed around smart phones such as the iPhone. The Figure also shows the next S-Curve of innovation, the “Fourth Wave”, which is generally seen as being driven by Metaverse Technologies such as the convergence of AR/AR, Web 3.0 Decentralized systems, computer game technology such as game engines, open worlds and AI.
Also in the Figure, we have mapped some of the SVV metaverse companies to the Fourth Wave S-curve. We also see Security e.g. InfoSec or Cybersecurity as a related and essential technology for all current and future waves of technology due to the underlying vulnerability of the internet (i.e. it was never designed or architected with security in mind) and the rise, and growth during Covid-19, of malicious actors that seek to “hack” systems including individuals, criminal gangs and nation states.
The S-curve models the adoption of innovations over time — starting initially slowly but then growing very rapidly — exponentially at its peak — and then levelling off. This is called the technology adoption lifecycle and has been studied extensively since the 1950s, initially at the land grant universities in the USA as they were commercializing Agri-tech innovations. A great modern example of recent S-curve growth is the iPhone, which has had incredible growth but where the growth rates are now tailing off as it reaches the top of its S-curve. Based on the early research in the 1950s, Everett Rodgers and other researchers developed the field of the Diffusion of Innovation, which studies how innovation is adopted over time by customers, markets and society.
As Figure 2 below highlights, Rodgers identified a number of categories of customers, that adopt innovations sequentially: starting with Innovators, Early Adopters, then the Early Majority, the Late Majority and then finally the Laggards. The significance of this model is that Innovators will be the first to adopt new innovations, and as a result, companies launching an innovation for a new market should start with them first, followed then by the other categories.
Geoffrey Moore built on this work later by highlighting that there is a large gap between the needs of the Innovator and Early Adopters categories, who will often accept “bleeding edge” products and Early Majority who will want a more developed product and service offering. Moore theorized that start-up companies very often failed to make the transition from selling to Innovators and Early Adopters to the Early Majority. This he called this “the Chasm”, which technology start-ups often fell into and died, as they failed to make the transition quickly enough before running out of cash.
Figure 2 Diffusion of Innovation (a) and the Chasm (b)
This “Chasm” transition (at least for enterprise software companies) is one every disruptive innovation company needs to make and it typically needs to be made after Seed investment and before Series A, as the company needs to get from initial revenues, to £1m+ annual recurring revenue (ARR), which will normally come from the Early Majority. We believe this phenomenon is a key reason why Dealroom recently found that 81% of European Seed companies fail to make the transition from Seed to Series A within 36 months and CBInsights found in a study across the USA, UK and EU that 48% of seed companies fail entirely.
SVV has developed its origination, evaluation and investment management processes with this in mind and has also developed a comprehensive start-up Platform that is designed and focused on providing our portfolio companies with a customized set of supports, advice and a network to help them make this transition and to support our portfolio companies get to £1m ARR within 24 months. In doing so we increase the chances of success for our companies on this journey (more on SVV and VC Platforms in general in another post).
SVV is an early stage investor and it invests in disruptive innovation for the following reasons:
· Firstly, early stage does come with some risk but it also comes with a corresponding reward for VCs such as SVV, as investment is typically made at attractive valuations.
· SVV invests in sectors that have massive growth potential ahead of them which creates a tail-wind behind the companies that are creating these new markets as part of their disruptive innovation .
· These companies will as they move up the S-curve and get to exponential growth, have the potential of becoming the next big tech unicorns or achieving an IPO (the reward for SVV).
· SVV’s Platform and network can help fast-track the development of these companies across the Chasm to the Series A investment round, which in turn increases the potential for rapid growth to the upside and also reduces the risk of the failure of the start-up on its journey. Indeed I would argue that Platform is most essential at the early stages of the development of a start-up and that the most successful early stage VCs will have strong value-add systems delivered through Platform.
So in conclusion, SVV is very focused on disruptive innovations emerging out of a well-defined set of disruptive technology areas. The core focus is on the creation of a new market as opposed to a technology innovation alone. The creation of this new market may come from new deep intellectual property (IP), and SVV favours this where possible, or it may be existing technology being reconfigured for a new customer problem / market or it may be a combination of technology, business model, value proposition and customer engagement that creates the new market. The key thing for SVV is the creation of the new market and product-market fit. SVV invests in disruptive innovations as it believes that companies that harness them have significant growth potential, as the market develops through its S-Curve of innovation diffusion. There is always the risk, for early stage companies, of “the Chasm”, but well designed Platforms can help companies jump over the chasm to rapid growth and ultimately have a shot at becoming a unicorn.
 Bagehot (15 June 2017). “Jeremy Corbyn, Entrepreneur”. The Economist. p. 53. Retrieved 23 June 2017. The most influential business idea of recent years is Clayton Christensen’s theory of disruptive innovation.”
 Ab Rahman, Airini; et al. (2017). “Emerging Technologies with Disruptive Effects: A Review”. PERINTIS eJournal. 7 (2). Retrieved 21 December 2017.
 Christensen, Clayton M. (1997). The innovator’s dilemma: when new technologies cause great firms to fail. Boston, Massachusetts, USA: Harvard Business School Press.
 Christensen, Clayton M. (2003). The innovator’s solution : creating and sustaining successful growth. Harvard Business Press.
 Rajagopal (2015). The Butterfly Effect in Competitive Markets: Driving Small Changes for Large Differences. Basingstoke, Hampshire: Palgrave Macmillan. p. 108.
 Rogers, E. M. (2003). Diffusion of innovations (5th ed.). New York, NY: Free Press