Disruption 2.0: Business Models, Not Just Products

Disruption theory, first advanced by Clayton Christensen in The Innovator’s Dilemma (HBS Press, 1997) has been taking a beating lately. Unfairly, in my opinion. 

Jill Lepore wrote a critical essay about it in the June 23, 2014 issue of The New Yorker. Ben Thompson at Stratechery has written about the demise of Christensen’s disruption theory a couple times, in September of 2013 and then again last month.  My Duke colleague Vivek Wadhwa wrote “Christensen’s disruption theory is not correct.” Christensen, Michael Raynor, and Rory McDonald responded to much of the criticism in the December 2015 issue of the Harvard Business Review.

I say “nay” to the naysayers. In fact, I think it has broader application than ever. The theory applies not just to products and companies, but to business models, markets, and technology adoption.

Define your competition correctly

 Rita McGrath, in The End of Competitive Advantage (Harvard Business Review Press, 2013), wrote:

Companies define their most important competitors as other companies within the same industry, meaning those firms offering products that are a close substitute for one another. This is a rather dangerous way to think about competition.

In more and more markets, we are seeing industries competing with other industries, business models competing with business models even in the same industry, and entirely new categories emerging out of whole cloth.

This is an important consideration. Competitive advantage is derived from offerings embedded in a business model.  Given that, we are seeing that disruption is increasingly happening in the business model rather than product offerings. Products, including services, are simply too easy to copy, so companies must design and operate a superior business model to gain the upper competitive hand. A business model, or business design, is “totality of how a company selects its customers, defines and differentiates its offerings, defines the tasks it will perform itself and those it will outsource, configures its resources, goes to market, creates utility for customers, and captures profit”, as Adrian Slywotzky wrote in Value Migration (Harvard Business School Press, 1996).

Desktop copiers disrupted the enterprise sales model

One of the examples in “The Innovator’s Solution” (Christensen and Raynor’s successor book, HBS Press, 2003) is the Canon desktop copier. They say that it created a “new market disruption”, citing use by non-consumers of the centralized reproduction department. It was not a great product when measured against the central repro products from Xerox and IBM. As Christensen and Raynor note, it was “slow, produced poor-resolution copies, and didn’t enlarge, reduce, or collate”. While the product did open up copying to previous “non-consumers”, there was a more fundamental change afoot. Through the lens of business model disruption, Canon disrupted the central repro business model. More precisely, it disrupted the traditional capital equipment sales model where Xerox account teams sold through a central procurement organization because individual department managers could authorize the purchase within their budgetary authority, bypassing the central purchasing group.

How current technologies are disrupting whole industries – and most people don’t get it

With respect to current technologies, here are giant changes disrupting existing business models OUTSIDE of “close substitutes” (like Uber and taxis):

• The iPhone disrupted PCs (not other phones). The iPhone was a low-end substitute for a computer.  Being basically a consumption device (vs. creation), it was inferior in just about every objective measure of performance, except one: convenience. (The 12/15 HBR article notes this.) Each successive version of the phone made incremental improvements along the dimensions that people expected, like larger screens.  In fact, with the iPhone 6, I found the screen to be so perfectly suitable for reading Flipboard, Facebook, and Kindle books that I sold my iPad.
  
  
• Uber is disrupting the private car ownership model (not taxis). Uber (and Lyft, etc.) is a low-end disruption to the concept of owning an expensive capital asset that sits unused 97+% of the time, requires repairs and maintenance, and must be insured. Uber started off with not enough drivers to reliably serve the market, but has since established itself as the leading intermediary between a pool of ride-seekers and a pool of ride-givers. It is the eBay of transportation. As the fleet of ride-givers gets big enough, the need to own a car goes away. And as autonomous vehicle technology improves, the need for a driver goes away, leaving the landscape with fleets of “rides in a box” roaming the streets picking up and discharging passengers at the tap of an app. It’s “Transportation-as-a-Service.”GM’s recent partnership with Lyft gives credence to this view.  From a recent article at wired.com:

“What’s key here is that this partnership shows GM is serious about moving beyond the era of the personal, human-driven automobile.

“In October, GM CEO Mary Barra said the industrial giant won’t rely on the traditional owner-driver model to keep its business going, and will ‘absolutely’ make cars for an age when human driving is defunct. ‘We are disrupting ourselves.’”

• Tesla is disrupting the petroleum industry (not cars). The $5B Gigafactory being built in the Nevada desert is designed to crank out far more batteries than Tesla will ever need for cars.  The Powerwall product is designed to store energy in your home (or business). Batteries are an inferior way to store energy when compared to gasoline – the energy density isn’t even close.  But it is good enough to do the job in a number of limited scenarios.  
  
  Electric cars are the most demanding use case for batteries.  Cars are heavy. They start and stop – accelerating is particularly draining on a battery. They go fast, meaning that air resistance must be overcome. Their range is limited. I see the Tesla automotive line as a series of products – test beds for batteries – to refine the battery technology to where it can ultimately replace the generation of energy based on fossil fuels. As I’ve pointed out before, in 1960, Theodore Levitt wrote this about the petroleum industry:

Would not chemical fuel cells, batteries, or solar energy kill the present product lines? The answer is that they would indeed, and that is precisely the reason for the oil firms’ having to develop these power units before their competitors do, so they will not be companies without an industry.

Management might be more likely to do what is needed for its own preservation if it thought of itself as being in the energy business. But even that will not be enough if it insists on imprisoning itself in the narrow grip of its tight product orientation. It has to think of itself as taking care of customer needs, not finding, refining, or even selling oil. Once it genuinely thinks of its business as taking care of people’s transportation needs, nothing can stop it from creating its own extravagantly profitable growth.

Let us start at the beginning: the customer. It can be shown that motorists strongly dislike the bother, delay, and experience of buying gasoline. People actually do not buy gasoline.  They cannot see it, taste it, feel it, appreciate it, or really test it. What they buy is the right to continue driving their cars. The gas station is like a tax collector to whom people are compelled to pay a periodic toll as the price of using their cars. [Emphasis mine.]

A few solar panels and some batteries is, indeed, a low-end disruption to building a power plant.

• Facebook is disrupting publishing and postal services (not in-person social interactions). More and more people are using Facebook as a personal or corporate publishing platform and a substitute for email.  As a publishing platform, it is clearly inferior to even blogging – you can’t even use bold or italics.  (I don’t think that emojis are a full substitute, although they do allow for some creative means of expression!) Facebook is easy to use, and their messaging platforms look like they will become dominant ways to communicate, as a recent announcement from WhatsApp indicates.

• Oculus Rift will disrupt DisneyWorld and travel (not gaming systems). Virtual reality headsets are inferior to actual experience, but are much more convenient and much cheaper than actually going places and doing things. A simple experiment with Google Cardboard is all that you need to see how explosively transformational this technology is – even in its crudest manifestation.

In each of these scenarios, critics of disruption theory fall into the trap of comparing “firms offering products that are a close substitute for one another”. Applied that way, the theory does fall short.  Tesla is more expensive than gas powered cars, the iPhone is more expensive than other smartphones, and an Oculus Rift headset is more expensive than a PS/4. But that is the wrong standard of comparison.

Customers adopt disruptive technologies in the lowest risk use cases: the “cloud”

A different way of looking at disruption theory is that customers will often adopt, or try out, new business models in ways that expose them to the lowest possible risk. Let’s examine the adoption of cloud-based data storage (and, by extension, cloud computing in general).

The evolution of this industry followed Christensen’s model perfectly.  Cloud storage vendors went after the very low end of the storage market – backup and archival. This is a “job” that companies don’t really want to do – store old data that they hope they never need to access. Outsourcing this was a low-risk proposition – it allowed them to adopt a low-end disruption.

Box, Dropbox, Carbonite, and others all offered ways to back up cold data. Backblaze offered unlimited backup for $5 a month. Amazon offered its S3 (Simple Storage Service) for pennies per gigabyte per month. NetApp and EMC, the leading makers of enterprise data storage systems sold to large companies, did not view these low-end companies as competition. (Think of them in the same way as the integrated steel mills in “The Innovator’s Dilemma”.)

NetApp reported its “market share” every quarter in employee “all-hands” meetings. Execs showed charts plotting NetApp’s share against five competitors: EMC, HP, IBM, Dell, and Hitachi Data Services. 

Amazon (and the others) were not on the chart.

Should they have been? Let’s listen to Rita McGrath describe the drivers of proper categorization of competition:

• The customer’s desired outcome – the “job to be done” for which the customer is “hiring” a solution (product, service or combination)
• The customer will evaluate all the alternative ways to get that job done, whether or not a particular vendor feels that the alternatives are “competitors” [Emphasis mine.]

  

  
  

• “The most substantial threat to a given advantage are likely to arise from a peripheral or non-obvious location.”

When people get up in the morning and say to themselves, “let’s go store some data!”- the “job-to-be-done” – they evaluate all the different ways to get that “job” done, including solutions that NetApp and EMC didn’t think of as competitors. (Nobody actually says, “let’s go store some data!”. They actually want to use data to achieve some goal.)

As companies got comfortable with the low-risk use case, they moved more and more important tasks to the cloud, following the disruption model. Just like the integrated steel mills, the vendors of expensive, comprehensive enterprise data storage systems were disrupted by low-end competitors who started off with offerings that were only “good enough” at the low end, and progressed along their own trajectory of sustaining innovations to take on more and more important “jobs”.

Disruption theory is alive and kicking

Far from being itself disrupted, the theory of disruptive innovation is still sound, and can be extended to disrupting business models and industry structures as well as substitute products. The theory still supplies guidance to both insurgents and incumbents, and to treat it as no longer relevant would be dangerous to your business health.

Call it Disruption 2.0.