Disruption: To disrupt? or be disrupted?
It was a 1995 HBR article by Clayton Christensen and Joseph L. Bower that coined the concept of Disruptive Innovation — the process by which a smaller company with limited resources is able to launch a product or service that displaces established competitors — that has been so extensively used in the startup jargon and often loses its value.
One thing to note is that in the realms of the startup world there are two distinct types of people and hence two types of startups— those who value breaking vs. building — and each have its different and respective consequences. Disrupters’ flashy ideas may energize and inspire others, they may also move on to the next disruptive idea once the first product or idea reaches a point of stability given they display a higher incidence of serial entrepreneurship than builders. Conversely, those who value building something may experience more difficulty in attracting capital (both financial and human), but these startups tend to stick for the longer term.
The most important thing to note is that in disruptive innovation, the product takes root in the bottom of a market — and in many cases, develops a bad or low-class reputation because of it. However, due to low costs, higher accessibility, or other advantages, the product eventually becomes more appealing than its competitors within the industry. Eventually, these startups come up with “sustaining innovations,” i.e new inventions and modifications in an attempt to stay relevant with customers. These innovations can be valuable too, but in most cases, products and services developed along these lines become too sophisticated, inaccessible, or expensive to have any real lasting power. Accordingly, customers look to less expensive, sometimes radical alternatives to meet their needs and the cycle of disruptive incumbents continues as the ‘original’ disruptors become irrelevant.
Rules for Disruption
Rule #1: Be number one in the market. The nature of a true disruptor is to have the vision to be the number one player in the market. When a self-described ‘disruptor’ startup makes a pitch to an investor with the aim at being a ‘competitor’ it has set itself for failure, at least in terms of getting funded; as much as an investor may like the ‘idea’ or the team, investors or VCs make money is if the startup has the potential to be the undisputed, number 1 company in the market. The key is to attack a huge potential market, with an emphasis on “potential.” The defining traits of disruptive innovators are lower gross margins, smaller target markets, and products and services that are often simpler than their contemporaries in their industry.
Rule #2: Have a sustainable business model. This is how you create sustainable value. Reality is, a startup business model is as important as its innovative product and a sound business model is needed to be able to raise capital, scale and achieve the vision to be number 1 in the market (the defining trait of a disruptor). In addition, finding a business model that is sustainable also means that the startup has a product-market fit and is ready to make a transition into becoming a scalable company.
Rule #3: Have an enticing valuation.
Rule #4: Pivot and test (fundamental tactics). These are important to find the best business model for the startup. Pivoting often is used as a strategic tool to test not only products but business models.
This may be an overused example but take a look at Uber, they came out of nowhere to become a major player in their industry and a threat to their competitors and that is why they attracted large amounts of investment.
Examples of ‘True Disruptors”
- Chegg started out as craigslist for students. A short time after they launched, Facebook started offering a very similar service with ecommerce. When Chegg only had 4 months of money left they knew they had to do something substantial in order to achieve their goals. So they decided to become Textbookflix (the later changed their names back to Chegg.) They were now “Netflix for textbooks” and allowed students to easily rent textbooks. Once they decided to do this, their business started to do really well. They had discovered a great business model because they could buy a textbook for a wholesale rate, rent the book for almost as much as it costs, and then get it back and rent it over and over again. In the end they went public, and are worth around $640M today.
- Odeo Podcasting company: Odeo started out as a company that allowed users to easily start a podcast. They were able to spark Maples interest, and he wired them money for an early investment. A week later, apple launched podcasts in iTunes. Odeo tried to hold out for a while, but eventually realized that their whole business had just been released as a feature of a tech giant’s product. The founders decided to do something strange and “refund” the investors. When the founders wanted to return his money, Maples asked “What are you guys going to work on now?.” They answered “Twitter.” Maples urged them to keep his investment to work on Twitter. They made the pivot from audio blogging, to micro blogging. The rest is history. Twitter is worth over $25B today.
Examples of Innovators (Builders)
- Uber is often cited as an example of disruption, but is in fact an innovator. Now climbing north of a $72 billion valuation, Uber is undoubtedly a pinnacle of modern tech success. And on the surface, it has a few hallmarks of disruptive businesses; it did, after all, replace the taxi industry for many travelers globally, after a start as a small, scrappy company. Uber isn’t disruptive because it didn’t open up a new market or capitalize on low gross margins. It just took the typical taxi service model, and upgraded it with tech to make it more convenient and a little less expensive.
- Google is an innovator from the perspective of its emergence as the dominant search engine. Google was the first online company to prove the value of online search, and the first to make ridiculous amounts of money from online advertising — it did, therefore, help to spawn a new industry (if not several). But Google isn’t a disruptor because it wasn’t the first search engine — not by a long shot. All it did was take an existing model and make it better. This is an impressive feat, but doesn’t qualify as disruption.
- Tesla is known for ground-level innovations in everything from the design of its vehicles to its organizational structure, it can’t be considered a disruptor. Its vehicles are exactly that — vehicles — and while they rely on a unique power source, they don’t enable transportation in any truly market-changing way. Plus, even the cheapest models started at $35,000, making it too overpriced to appeal to the low-level market.
If having a solid core of capabilities is so effective, why are companies so ready to believe that agility, or even no reaction at all, is a better response to disruption? Often, it’s because of natural cognitive biases: People tend to overestimate the power of a threat and underestimate the time they have to respond.
This apprehension leads some companies to a state of strategic paralysis, holding cautiously to business as usual and avoiding risk. Their lack of confidence appears to be linked to a lack of self-awareness; they don’t appreciate their own strengths enough to double down on them and make them viable. And so, it hold true that if you don’t do it, your competitor will. Two well-known stories of once-successful companies that failed to disrupt their own businesses and were essentially driven out of business by innovative competitors are: Research in Motion vs. Apple /Samsung and Blockbuster vs. Netflix
When should successful businesses change? All the time. However, other companies react to the perceived threat by doing too much. Companies that see the threat of disruptors start placing bets on many new ventures, and launching digital ventures in new places (pirate ships), even when it’s not clear that they have the capabilities needed to succeed in most of them. Unfortunately, because these moves are disassociated from the company’s core strengths, they are also less likely to be effective. They become distractions, exhausting the company’s resources and taking time and effort away from more productive strategies.
Ultimately, the best defense is to not fight disruption with disruption, at least, if your startup has not been a disruptor in the first place. It is far better to be or continue being a ‘builder’ i. e create advantage through a few distinctive, deeply ingrained capabilities that allow the company to deliver on its value proposition better than anyone else. Although it may take years to fully build them out, significant results will begin to appear much more rapidly in most companies. Apple proved that when it began developing its digital hub strategy in the late 1990s, which was based on the idea that the computer would be a central connecting point for all sorts of other devices. Therefore, when I say pivot often, it means pivot playing on your strengths and keep in mind that everyone is looking at industries with established companies and wondering how they can topple them.
When is an industry ready to be disrupted? the first sign is that the companies within the industry form an ‘oligopoly’ — where a few companies have consolidated vast amounts of the market share either on the supply or demand side.
The second sign is when in an industry there are big companies that have incredibly complex systems, and that makes it difficult for them to implement new technology quickly. For example, creating a smartphone app seems pretty simple, until you realize you have to deal with your complicated backend system and business model. A mobile platform requires simplicity, not complexity.
The third sign is when business practices don’t change or haven’t changed for a while despite negative consumer feedback. Look up for industries with a very low ‘Net Promoter Score — NPS’. Often times, companies who are in an oligarchy (have little or no competition)or are massive in their operations do very little to improve the overall customer experience — either because they didn’t want to, or simply couldn’t due to the complexity of their systems and operating models.
Lastly, metrics — research breeds confidence. From an competitive standpoint, research is needed to decide whether or not there is opportunity on an industry and a startup needs to figure out who their competitors are and what they have.
Examples of industries ready to be disrupted:
- The Insurance Industry: everybody needs insurance, however, the insurance industry consistently lands near the bottom of the Customer Satisfaction Index, and this is driven in part by difficult-to-understand policies and low levels of customer trust. Insurance is heavily regulated and requires a lot of capital, so the barriers to entry are high — but there are opportunities to be had.
- The Wedding Industry: The U.S. wedding industry grew to $76 billion in 2017, according to market research firm IBIS World. But an interesting trend is growing: people are spending less on wedding planners than they did five years ago, instead opting to customize their events and choose caterers, bartenders, DJs, and other vendors themselves. ‘Wedding-as-a-service’ could be a thing!
- Education: As schools transition away from paper, textbooks, and projectors, there’s a growing opportunity for startups to create new tools geared toward educators. Perhaps not surprisingly, VC funding for ed-tech startups was estimated to approach $3 billion last year, according to CB Insights. (*Pro tip — you need AI to break ground)
- The Health Industry: It is true that products created on this space will not replace doctors but rather supplement their practice and artificial intelligence might soon be able to do it even better. Last year, a machine vision program developed by Stanford researchers was able to distinguish between cancerous and non-cancerous moles with more than 90 percent accuracy, beating out its human dermatologist counterparts — possibly a sign of what’s to come in the field of AI.
It is important to distinguish that disruptive innovation is only one type of innovation — and “true” disruptors are NOT the only ones making a difference in industries. It is equally true that being a “true” disruptor does not equate to having an invention or being innovative. Even with a good idea in place, there’s no guarantee that a new technology or potentially disruptive idea will take hold. Some inventions require multiple phases of evolution before they reach their final form — and that means lots of inventions get lost in the shuffle before they get there, losing out to unsustainable practices, market shifts, or stagnation.
