Disruptive Innovation1:

The theory of disruptive innovation was initially coined by Harvard prof Clayton M. Christensen in his
analysis on the disk-drive industry and later popularized by his book The Innovators Dilemma,
published in 1997. It describes a process by which a product or service takes root initially in simple
applications at the bottom of a market and then relentlessly moves up market, eventually displacing
established competitors.

The theory explains the phenomenon by which an innovation transforms an existing market or sector
by introducing simplicity, convenience, accessibility, and affordability where complication and high
cost are the status quo. Initially, a disruptive innovation is formed in a niche market that may appear
unattractive or inconsequential to industry incumbents, but eventually the new product or idea
completely redefines the industry.

A classic example is the personal computer. Prior to its introduction, mainframes and minicomputers
were the prevailing products in the computing industry. At a minimum, they were priced around
$200,000 and required engineering experience to operate. Apple, one of the pioneers in personal
computing, began selling its early computers in the late 1970s and early 1980sbut as a toy for
children. At that point, the product wasnt good enough to compete with the minicomputers, but
Apples customers didnt care because they couldnt afford or use the expensive minicomputers. The
inferior computer was much better than their alternative: nothing at all. Little by little, the innovation
improved. Within a few years, the smaller, more affordable personal computer became good enough
that it could do the work that previously required minicomputers. This created a huge new market
and ultimately eliminated the existing industry.

How Disruption Works23:

1
"Disruptive Innovation - Christensen Institute". Christensen Institute. N.p., 2017. Web. 22 Feb. 2017.
2
"What Is Disruptive Innovation?". Harvard Business Review. N.p., 2017. Web. 22 Feb. 2017.
3
"Disruptive Innovation - Christensen Institute". Christensen Institute. N.p., 2017. Web. 22 Feb. 2017.
As companies tend to innovate faster than their customers needs evolve, most organizations
eventually end up producing products or services that are actually too sophisticated, too expensive,
and too complicated for many customers in their market.

Companies pursue these sustaining innovations at the higher tiers of their markets because this is
what has historically helped them succeed: by charging the highest prices to their most demanding
and sophisticated customers at the top of the market, companies will achieve the greatest
profitability.

However, by doing so, companies unwittingly open the door to disruptive innovations at the bottom
of the market. An innovation that is disruptive allows a whole new population of consumers at the
bottom of a market access to a product or service that was historically only accessible to consumers
with a lot of money or a lot of skill.

Characteristics of disruptive businesses, at least in their initial stages, can include: lower gross
margins, smaller target markets, and simpler products and services that may not appear as attractive
as existing solutions when compared against traditional performance metrics. Because these lower
tiers of the market offer lower gross margins, they are unattractive to other firms moving upward in
the market, creating space at the bottom of the market for new disruptive competitors to emerge.

Disruption describes a process whereby a smaller company with fewer resources is able to successfully
challenge established incumbent businesses. Specifically, as incumbents focus on improving their
products and services for their most demanding (and usually most profitable) customers, they exceed
the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by
successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable
functionalityfrequently at a lower price. Incumbents, chasing higher profitability in more-
demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the
performance that incumbents mainstream customers require, while preserving the advantages that
drove their early success. When mainstream customers start adopting the entrants offerings in
volume, disruption has occurred.

The theory of disruptive innovation has proved to be a powerful way of thinking about innovation-
driven growth. Many leaders of small, entrepreneurial companies praise it as their guiding star; so do
many executives at large, well-established organizations, including Intel, Southern New Hampshire
University, and Salesforce.com.

Unfortunately, disruption theory is in danger of becoming a victim of its own success. Despite broad
dissemination, the theorys core concepts have been widely misunderstood and its basic tenets
frequently misapplied. Furthermore, essential refinements in the theory over the past 20 years appear
to have been overshadowed by the popularity of the initial formulation. As a result, the theory is
sometimes criticized for shortcomings that have already been addressed.

Two Categories of Disruption4

New-Market Disruptions

New-market disruptions compete against non-consumption because they are cheap and simpler to
use so they enable a whole new population to use them, a population who have not used the
previously generations of products. Canons desktop photocopier was a new-market disruption
because it enabled a lot of people to conveniently make photocopies close to their desk, gone were
the days where they had to go the companys photocopy centre and make a technician do it. Because
Canon made it so easy, people began to make a lot more photocopies. The challenge for new-market
disruptors is to create value network that can overcome not an incumbent but non-consumption. At
the start new-market disruptors compete against non-consumption, however gradually them improve
to be able to pull customers out of the traditional mainstream market and into the new market, when
that happens they are of course disrupting the incumbents of the old market. They start by pulling
customers in the lowest tiers and gradually move up as they improve performance. So disruptors dont
invade the mainstream market, they pull customers out of it and into the new market. Because the
disruptors start by attaining customers from the non-consumption and then by the lowest tiers of
their market, incumbents dont feel threatened. For a while they actually appreciate the disruptor
because it enables them to replace the low-end low-margin customers with high-end high-margin
customers. They of course dont realize that it signals the beginning of the end.

Low-End Disruptions

Disruptions that take their starting point in the low-end of the original or mainstream value network
are low-end disruptions. Even though they are different from new-market disruptions they create the
same painful dilemma for the incumbents. The new-market disruptions make incumbents ignore the
attackers the low-end disruptions motivate them to flee rather than attack. A good example of low-
end disruptions is the retailing market, where several discount retailers have disrupted established
retailers. Many products that before was sold in specialty shops are now being sold in much larger
stores with much less educated staff than before. It is because the discount retailers realized that the
customers didnt need highly educated staff to help them purchase many products such as paint,
hardware, kitchen utensils, toys, and sporting goods. Customers in these tiers of the markets were
over served by the incumbents and new discount retailers business model enabled them to make
money at a much lower gross margin.

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Bo Hansen, Mikkel. "Disruptive Innovations And Business Models". Print.
Its easy to see why many traditional retailers chose to flee instead of fight. They had the choice of
either attacking the discount retailers by matching their low prices, which would make their own gross
margin plummet something which would be unsustainable with their profit margin, or they could
choose to devote their shelf space to high-end products which usually had a higher gross margin that
the products that the discount retailers were selling, thereby increasing their profits. It made perfect
sense for the retail incumbents to flee rather than fight, to get out of the tiers the discount retailers
were motivated to enter.

Many disruptive technologies are hybrids, in the meaning that they combine both new-market and
low-end approaches. Discount Airliners targeted both the low-end of the market and the non-
consumption (people who drove or took the train). Figure 6 shows that many of the most famous
disruptive technologies or companies are positioned in between the pure new-market and low-end
approaches.

The Market vs. the Company5

The research behind Foster and Kaplans Creative Destruction shows that there has never existed a
company that continually performs better than the market in fact in the long run the market always
wins. This is a very interesting fact. Despite the market dont have any highly educated vastly
experienced managers, any meticulous crafted organizational structures, advanced management
methods and so on, it still outperforms every company.

The answer for how the market be always wiser than the manager is that the capital markets motivate
the creation of companies, allow their efficient operations however when the companies loses its
ability to compete, the market rapidly and remorselessly removes them. Most corporations operate
with management philosophies based on continuity, as a result they are not able to change at the
pace and scale of the market. Consequently, they are not able to create value in the long term at the
pace and scale of the markets. It is typically among the relatively new entrants that the highest growth
rates are found at least for a time. The structure and the mechanisms of the market enable these
companies to deliver better returns than even the best surviving companies. Low performing
companies are removed by the market in favour of the new high performing companies in a process
Joseph Alois Schumpeter called the gales of creative destruction. The challenge of keeping up with the
market is a huge one, one that few managers have the time and energy to take on, however this is
exactly what is needed if a company wants to sustain market levels of long-term performance

The most significant difference between companies and the market is in the way they enable, manage,
and control the processes of creative destruction. Companies are built on the assumption of continuity
with a focus on operations, while markets are built on the assumption of discontinuity with a focus on
creation and destruction. Because rapid creation and extensive destruction creates more wealth the
market encourages this. It is far less tolerant of long-term underperformance that companies are.
Excellent companies do win the right to survive, but not the ability to earn above-average or even
average shareholder return in the long-term. This is the result of the companys own control
processes, prevents the companies from seeing the need for change.

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Bo Hansen, Mikkel. "Disruptive Innovations And Business Models". Print.
6
How to Develop the Ability to Innovate and Change According to the Market?

Many companies are not able to change the corporate culture or their actions even in the face of clear
market threats. This is due to a phenomenon called cultural lock-in and is the reason why companies
find it very difficult to respond to market signals. It results from their habits of managing, from their
processes. This basically means that the company has of a defined and/or undefined way of doing
things by which it has typically built up the company and achieved success, nevertheless when the
market shifts these habits and processes makes the company unable to change accordingly because
they are stuck in the past. This cultural lock-in reduces the companys ability to innovate and to phase
out operations with a less exciting future. When cultural lock-in occurs it signals the start of an
inexorable decline to inferior performance. The lock-in often shows itself by three general fears; the
fear of channel conflict with important customers, the fear of cannibalization of an important product
line, and the fear of earnings dilution that might result from a strategic acquisition. These fears are
typical and fair however they are not felt by the market so it moves wherever it wants and often where
the company dares not.

The essence of the cultural lock-in problem is the habits as described, also known as mental models.
Once these are formed they can be extremely hard to change as they are the core concepts of the
company. In successfully companies they are well crafted and have allowed the management to
anticipate the future and act accordingly, but by doing this they also become self-reinforcing, self-
sustaining, and self-limiting. When the market or the environment change they are therefore
extremely hard to change. In that scenario they cause the management to make consistently bad
decisions, when the company starts to underperform while being threaten by new high-performing
companies the mental models have created a set of defensive routines, as the failure to challenge
status quo and superiors, which makes change impossible. These habits and processes also obstruct
the ability of the organization to innovate at the scale and pace of the market. If a company is based
on continuity a new business proposal can be turned down because its probable success cannot be
proven in advance. Instead the company will launch incremental growth ideas that are based on
current capabilities and mental models.

Because a disruptive business model enables the company to achieve attractive profits at low prices
which is required to conquer the low end of a market makes it a very valuable corporate asset.
Furthermore, when the executives move the business up market to levels where the products are of
a higher quality but also where the gross margins are higher, much of the price increase will fall to the
bottom line. This will continue as long as the disruptor competes against the higher cost incumbents
of the industry. It can be done the other way around. When a company tries to take a higher cost
business model down the market, almost none of the additional revenue will fall on the bottom line
because it will all be absorbed by overheads. This is also why that established companies who want to
exploit disruptive technologies have to do it with a business model which is designed for disruption.
This often means that it needs to be very different from the current business model of the mother
company. All good managers aim to move up the market in an effort to keep their margins strong and
their stock price healthy, thereby also dumping less profitable products in the lower end of the market.
If they stand still they end up in the unwanted position of fighting it out with similar companies with
similar products which inevitable will drive the prices down. This actually means that every company
is paving the way to be disrupted, because they are willing to move away from the low-end of the
market and allow new companies to enter. Disruption does not guarantee success but it increases the
odds of creating a new growth business from 6 to 37 percent.

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Bo Hansen, Mikkel. "Disruptive Innovations And Business Models". Print.
Examples of disruptive innovation:

Netflix7

Take a look at the entertainment and retail disruptor Netflix. Netflix has brought streaming movies
and television shows to an entirely new level. Netflix disrupted in store DVD rentals so much that it
pushed Blockbuster out of business after filing for bankruptcy in the fall of 2010. Netflix is a major
disruptor because its services are extremely convenient. Netflix can be accessed from any device with
internet capability at any given time. You cant get any better than that.

As millions of people become savvier with technology, the conventional way of doing things is
becoming more obsolete. Companies have been developing disruptive innovations for years;
however, now those innovations are becoming more mainstream which places a lot of older
traditional companies out of business.

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"A Disruptive Innovation That Is Netflix | Altitude". Altitude. N.p., 2017. Web. 22 Feb. 2017.
iTunes8

Apple, Inc is considered iconic when it comes to product development. This example explains the way
in which iTunes can be considered a disruptive innovation. The iPod was launched in 2001, a year in
which Apples global market share of personal computers was around three per cent. The iPod is a
device where customers load digital songs for subsequent listening. It is important to point out here
that at the time there were other digital music players, such as MP3 players, available in the market
which could serve similar utility for customers. However, Apple had the foresight to encourage iPod
customers to use the Internet. Along with the launch of the iPod, Apple also launched iPod Lounge, a
website owned by Apple wherein iPod users could design customised covers and accessories for their
music device and send suggestions to the organisation. Simultaneously, Apple launched iTunes. iTunes
is software used to play and organise digital music. Apple ensured that iTunes was bundled with each
iPod. iTunes ensured that songs available in common formats such as MP3 could not be played on the
iPod. These songs had to be converted to an iPod-specific format using the iTunes interface to be
played.

Two years on, in 2003, Apple launched the iTunes Music Store. This was an Internet-based interface
through which iPod users could load songs onto their music player. Songs were available in the iTunes
Music Store for a nominal cost of $0.99.

If we look at the sequencing of product introduction by Apple, it is clear that the iPod was not a
disruptive innovation. Products with similar output features existed in the market, as discussed earlier.
It is the bundling with iTunes that gave Apple the disruptive edge. It changed the very business model
of the industry. Because of iTunes, iPod users were locked-in and had to purchase songs from the
iTunes store. By previously encouraging customers to use iPod Lounge, a perception in the market had
already been built that iPod users had to be educated in Internet use. It was not a very daunting task
for Apple to lead iPod users to the iTunes Music Store to purchase music.

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"10 Years Of Itunes: An Era Of Disruptive Innovation". Techzone360.com. N.p., 2017. Web. 22 Feb. 2017.
Some other examples of disruptive innovations:

Disruptor Disruptee
Personal computers Mainframe and mini computers
Mini mills Integrated steel mills
Cellular phones Fixed line telephony
Community colleges Four-year colleges
Discount retailers Full-service department stores
Retail medical clinics Traditional doctors offices

References

"Disruptive Innovation - Christensen Institute". Christensen Institute. N.p., 2017. Web. 22 Feb. 2017.

"What Is Disruptive Innovation?". Harvard Business Review. N.p., 2017. Web. 22 Feb. 2017.

"Disruptive Innovation - Christensen Institute". Christensen Institute. N.p., 2017. Web. 22 Feb. 2017.

Bo Hansen, Mikkel. "Disruptive Innovations And Business Models". Print.

"A Disruptive Innovation That Is Netflix | Altitude". Altitude. N.p., 2017. Web. 22 Feb. 2017.

"A Disruptive Innovation That Is Netflix | Altitude". Altitude. N.p., 2017. Web. 22 Feb. 2017.

10 Years Of Itunes: An Era Of Disruptive Innovation". Techzone360.com. N.p., 2017. Web. 22 Feb.
2017.