Economics and Business __________________________________.docx

Economics and Business
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Influence of Dynamic Capabilities in Creating
Disruptive Innovation
Rūta Čiutienė1, Emil William Thattakath2, 1, 2 Kaunas
University of Technology
Abstract ‒ The aim of this paper is to demonstrate the
influence of Dynamic Capabilities in creating Disruptive
Innovation. For doing so the concepts of Dynamic Capabilities
and Disruptive Innovation are reviewed. The criteria of an
innovation named Disruptive Innovation are obtained by
comparative study between the various innovation types. To
demonstrate the role of Dynamic Capabilities in creating
Disruptive Innovation, the Innovation Lifecycle is demonstrated
with respect to Dynamic Capabilities. The advantages obtained

from Disruptive Innovation and its superiority in comparison
with other types of innovation are also portrayed. Suitable
examples and case studies are presented to describe certain
situations. This paper establishes the required clarification by
using comparative methodology for obtaining the results.
Keywords ‒ Dynamic Capabilities, Disruptive Innovation,
Innovation Lifecycle.
I. INTRODUCTION
In today’s world innovative companies constantly face
challenges from their respective environments. These
challenges or competitions includes hyper-competition,
governmental regulation, recession, deregulation or even
disruptive innovation [1]. In addition, these innovative
companies are forced to follow the agenda asking them to be
sustainable and environmental friendly. In the midst of all this
every innovative company wants to maintain a healthy
competitive advantage in the market. To maintain this

competitive advantage, a strong requirement is seen to develop
the dynamic capabilities – essentially those adaptive
capabilities
that enable an organisation to develop new capabilities better
fitted to the changing environment [1].
Most of the literature on technological innovation points to
established companies as victims of disruptive innovation, one
of the most influential streams in the strategy literature today
has developed the idea of dynamic capabilities which enables
established companies to thrive [2]. In the meantime, while
most of the innovative companies are thriving to create this
disruptive innovation in their market (as Christensen quotes:
“Motivation is the catalysing ingredient for every successful
innovation. The same is true for learning.”[3]), how to
maintain a competitive advantage while doing so, is quite a
difficult question to answer. As seen from the past cases, for
example, Ford’s introduction of automobile into the market
using disruptive innovation was a success while Kodak’s story

in digital photography was a failure although they were the
inventors of this. This article is mainly going to show that by
enhancing the dynamic capabilities of the innovative
company, maintaining of Disruptive Innovation to its
advantage is possible. The article will portray the literature
review of both dynamic capabilities, disruption innovation and
finally, how they could work together in particular situations
with the help of case studies. In addition to that the discussion
of a linear progression of different types of innovation with
respect to a firm and the differences between the types of
innovation in comparison with Disruptive Innovation along
with the Dynamic Capabilities applied is demonstrated. The
discussion of the main concept, features and the role of
Dynamic Capability in a company and its advantages is
demonstrated. The criteria and advantages of Disruptive
Innovation are also discussed.
II. DYNAMIC CAPABILITIES
It was primarily introduced by Gary Hamel in 1989 who

demonstrated the multinational strategic research leading to
Core Competences of the Corporation [4], although shortly
after, in 1995, it was described by Ikujiro Nonaka and
Hirotaka Takeuchi in their book on innovation strategy “The
Knowledge-Creating Company” [5]. Finally, dynamic
capability was referred to as “the capacity of an organization
to purposefully create, extend, or modify its resource base” by
Helfat [6]. Although in [7] it is explained that the capacity to
renew competences so as to achieve congruence with the
changing business environment is Dynamic Capability too.
This involves strategic management in appropriately adapting,
integrating, and reconfiguring internal and external
organizational
drawbacks, resources, and functional competences to match the
requirements of the changing environment. In line with Helfat
[6] we use the term „resource‟ in its broad sense as in [8], and
hence it includes activities, capabilities, etc., which allow the
firm to generate the rent.
So, essentially looking at resource based view (RBV) in the

company’s perspective, Daneels [9] concludes that to
understand how a firm evolves over time the dynamic RBV is
kind of essential. In this case the firm over time tries to
continuously renew and reconfigure itself to survive in the
market while deploying its available resources.
Dynamic Capabilities are built rather than being bought in
the market [10]. They mainly consist of organizational process
or routines [6], [11] which were imbibed by the firm over time
and consequently used to reconfigure the firm’s resource base
by removing decaying resources or by recombining old
resources with new ones using new methods or ways [12].
This thereby shows that Dynamic Capabilities are viewed in
accordance with the path taken [13]. This path is shaped by
the decisions the firm has made in the past and the stock of
assets it holds currently [11]. Path dependency “not only
defines what choices are open to the firm today, but also puts
doi: 10.7250/eb.2014.015

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bounds around what its internal repertoire is likely to be in the
future” [14]. Path dependency could be grounded in
knowledge, resources familiar to the firm, or influenced by the
social and collective nature of learning [14]. Learning plays an
important role in creation and development of Dynamic
Capabilities. Zollo and Winter [11] demonstrate that learning
is the base of dynamic capabilities and guides their evolution.
Learning is also considered as a dynamic capability itself,
rather than an antecedent of it. As such, learning as a dynamic
capability has been identified as “a process by which
repetition and experimentation enable tasks to be performed
better and quicker” [14]. In Zollo and Winter [11] authors
attempted to meld these two positions by explaining that
“dynamic capabilities are shaped by the co-evolution of

learning mechanisms”.
Helfat and Peteraf [15] emphasise that to qualify as a
dynamic capability, the capability not only needs to change
the resource base, but it also needs to be embedded in the firm,
and ultimately be repeatable. Dynamic capabilities are argued
to comprise four main processes: reconfiguration, leveraging,
learning and integration [14]. Reconfiguration refers to the
transformation and recombination of assets and resources, e.g.,
the consolidation of manufacturing resources that often occurs
as a result of an acquisition [25]. Leveraging refers to the
replication of a process or system that is operating in one area
of a firm into another area, or extending a resource by
deploying it into a new domain [25], for instance, applying an
existing brand to a new set of products. As a dynamic
capability, learning allows tasks to be performed more
effectively
and efficiently, often as an outcome of experimentation, and
permits reflection on failure and success. Finally, integration

refers to the ability of the firm to integrate and coordinate its
assets and resources, resulting in the emergence of a new
resource base.
In accordance with the explanation of Dynamic Capabilities
they are referred to as the ability of the firm to purposefully
create, extend, or modify its resource base in congruence with
the changing business environment. In relation to this, the
aspect that has been discovered is, that there is a change in the
business environment and to obtain this competitive advantage
in the respective market Dynamic Capabilities are deployed.
But this can also be used to create an altogether new business
environment where this company holds the advantage due to
its core competence which is difficult to be duplicated by its
competitors. One of the successful and feasible methods to do
so is introducing Disruptive Innovation which can be managed
and created with the help of Dynamic Capabilities. This will be
demonstrated shortly in this article where some of the analysed
examples show how the obtained result can be achieved.

III. DISRUPTIVE INNOVATION
A. Concept of Disruptive Innovation
Disruptive Innovation was primarily introduced by
Christensen [16] where he defines it as “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.” Disruptive
technology predates the term disruptive innovation.
Christensen changed the term to disruptive innovation so that
it would include services as well as products. Often in
literature the terms are used interchangeably. Despite the
widespread use of both terms by Christensen and other
academics, there is still some ambiguity surrounding the
definition of disruptive innovation.
One of the major flaws in Christensen’s primary model was
discovered by Tellis in [17]. He justifies that Christensen’s
definition lacks measurability and has little predictive value.
Christensen’s theory states that “Disruptive Technologies

Displace Incumbent Technologies”, but that is something
which can only be ascertained with hindsight. In today’s
market, most of the innovative companies harness
technologists and technology developers who would want to
assess the technology that they are currently working on has
the ability to become a Disruptive Innovation in the future.
Developers and marketers need to be aware of the
disruptiveness of their technologies in order to be able to tailor
their strategy around it. Market leaders also need to know
when technologies are disruptive as they pose a great threat to
their business model. Consequently, in relation to this
Danneels in [18] agrees that this lack of knowledge has to be
solved, and answers the question related to the assessing an
innovation of its disruptiveness. As a result Danneels puts
forward a complementing definition for Disruptive innovation.
He states that “a disruptive technology is a technology that
changes the bases of competition by changing the performance
metrics along which firms compete”. Although this literature

tries to solve this lapse it has not been completely done. The
most recent study was carried out by Gilbert in [19] who
defines Disruptive innovation as “a new technology that
unexpectedly displaces an established one”. The superiority of
Gilbert’s study and definition is presented as it highlights one
particular factor about what makes a technology disruptive;
the often-unexpected nature of the disruption and the fact that
established technologies are affected. But it still is missing
some key factors and it does not allow us to determine if a
new technology is likely to become a disruptive technology.
Again, it only really allows us to decide if a technology has
been disruptive after the disruption has occurred in the market
place. And it does not deal with the level of disruption.
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As the criteria for an innovation to qualify as disruptive are
not clearly demonstrated it is hard to set goals or a strategy to
create one. As in further development of this paper it will be
demonstrated how Disruptive Innovation can be advantageous
to a company and it will be done by comparing the different
kinds of innovation including Incremental Innovation, Radical
Innovation, and Breakthrough Innovation to Disruptive
Innovation.
B. Comparison between the Different Types of Innovation
and Disruptive Innovation
Innovation as a whole has a very wide view and to make it
concise and express into assessable figures has been quite a
task. When considering it, different approaches to innovation
had been applied. Normally, to demonstrate an innovation the
most efficient method was to distinguish it among the different
types of innovation. Many of the innovations are distinguished
between the two extremes, they view innovation on
dichotomous scale. For instance, Michael Porter [20] talks

about “continuous” and “discontinuous” technological changes;
Tushman and Anderson [21] distinguish between “incremental”
and “breakthrough” innovation; Abernathy and Clark refer
[22] to “conservative” vs. “radical” innovations; and Clayton
Christensen [16] shows the difference between “sustaining”
and “disruptive” innovations. This helps to differentiate types
of innovation efforts but while viewing innovation in one
dimension [23] an effective demonstration is missing.
Fig. 1. Two-dimensional picture of innovation [23].
James Kalbach [23] has an explanation for this certain case.
He demonstrates innovation with respect to a two dimensional
scale which shows the comparison between the different kinds
of innovation.
The y-axis indicates the degree of technological progress an
innovation brings with it. Moving from low to high along this
line indicates improving existing capabilities, services and
products. The x-axis shows the impact an innovation has on
the market, also from low to high. This usually entails new

business models or reaching underserved target groups [23].
In Fig. 1, distinctly four zones of innovation can be seen.
The zones consist of Incremental Innovation, Breakthrough
Innovation, Game Changer or Radical Innovation and finally
Disruptive Innovation.
Incremental innovation involves modest changes to existing
products and services. These are enhancements that keep a
business competitive, such as new product features and service
improvements [23]. One of the most successful and recent
examples of incremental innovation is the iPhone. While
smartphones existed before Apple entered the market, it was
mostly the incremental innovation of a larger touchscreen, the
App store, ease of use and an improved overall experience,
which enabled the iPhone to be the first in making
smartphones mainstream. Apple then created a whole new
ecosystem which made the iPhone a preferred medium for
accessing the internet, sending e-mail, finding directions,
playing games, conducting online transactions and generally

becoming a central part of our daily lives. In 2013, it shipped
125 million iPhones. It is Incremental Innovation which has
brought a fundamental change in our behaviour and created a
market that will be worth $ 1.6 trillion by 2018 [27]. Although
Incremental Innovation has its inherent advantages, slowness
to reach growth targets before competitors, leading to a loss of
competitive advantage is considered to be its biggest
disadvantage. Incremental Innovation also falls under the
sphere of Sustaining Innovation. Sustainable Innovation does
not create new markets or value networks but rather only
evolves existing ones with better value, allowing the firms
within to compete against each other's sustaining improvements.
Sustaining Innovation may be also “discontinuous” [16].
Breakthrough Innovation refers to large technological
advances that propel an existing product or service ahead of
competitors. This is often the result of research and
development labs (R&D), who are striving for the next
patentable formula, device and technology [23]. These

technologies originate on the supply side of supply chain.
Conventional wisdom says ‒ listen to the market, but
breakthroughs come from labs that do not have what the
customer wants. These technologies are then pushed onto the
consumer. For example, Tim Berners-Lee, a software
engineer, created a network of interconnected computers to
share and distribute information easily and cheap in 1980.
This network developed into the Internet. Berners-Lee never
thought about what customers wanted when he created his
network. The interaction between research, marketing and
development groups can be detrimental. In general, most
marketing professionals view marketing as getting a grasp of
what customers need. They do not put emphasis on educating
customers about the usefulness of technology or creating a
new market. Therefore, R&D groups must make a marketing
group understand how useful the technology will be. R&D
groups must be visionary and lead the other groups in
productizing the technology. R&D groups should encourage

marketing groups to seek new markets for the developed
technology.
Game-changing/Radical Innovation transforms markets and
even society. This innovation has a radical impact on how
humans act, think and feel [23]. One of the most prominent
examples is Amazon's internet based approach to selling
books which enabled it to offer many more books than a
traditional bookstore, this ultimately led to a number of the
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traditional book stores going out of business. As of 2010,
Amazon was the largest online retailer in the US [28]. The
biggest disadvantage of Radical Innovation is that the cost of
introducing this innovation into the market is very high, in
addition there is always a risk of low adoption rate of the

technology which can backfire to any company [28].
In reality there is a thin line between Radical Innovation
and Disruptive Innovation. This can be explained through an
example of Disruptive Innovation. The automobile was a
revolutionary innovation but it was not disrupting the horse
drawn carts industry in the very beginning. Later on the
automobiles became a luxury commodity for elite public.
When the idea of mass production of automobiles was
introduced by Ford in 1909, the mass production of cars
disrupted the horse drawn carts industry as this car now was
affordable to a lot more people. The main difference between
Radical and Disruptive Innovation is that a Radical Innovation
might not disrupt an existing market as the innovation might
be too expensive to be approached. On the other hand
Disruptive Innovation does not need to be based on a
technological innovation, for example, Microfinance did not
involve radically new technology.
Based on the literature review, it can be concluded that the

advantages of Disruptive Innovation over the other types of
innovation are:
Innovation is at an advantage with respect to an entry
level company. Incremental Innovation mainly delivers
results to a company which has been established over
some time being an incumbent in that innovation, while
trying to modify their innovation at a certain pace. But
this technique cannot be used to attain a complete
advantage by an entrant, while it can use Disruptive
Innovation to achieve nearly the same goals as an
incumbent establishment.
Disruptive innovation was or might have been a Radical
or Breakthrough Innovation to begin with it would have
been available to an elite class of customers in the
beginning. But once that particular technology starts
getting cheaper it is able to reach majority of customers

by dispersing the existing innovation. In this case the
company yields more as it lowers its risk of low adoption
rate and ensures stable income.
IV. USING DYNAMIC CAPABILITIES TO CREATE
DISRUPTIVE INNOVATION
Here the description of how Dynamic Capabilities can be
used to create a Disruptive Innovation will be discussed. As it
was presented earlier, a firm following Disruptive Innovation
obtains higher gain as compared to using alternative
innovations. Meanwhile, there is a very small difference
between different kinds of the demonstrated innovation types
and in many cases the shift between these innovation types is
observed within a company. These shifts between the different
innovation types can be keyed together and form the
Innovation Lifecycle. Dynamic Capabilities play major role in
these shifts and overall linking of the Innovation Lifecycle. To
view how Dynamic Capabilities actually affect Disruptive
Innovation, the concept of Innovation Lifecycle will be
presented.

The description of the Innovation Lifecycle will be made
with respect to the theoretical analysis in addition to having an
evolution of a concept. Fig. 2 is a stepwise presentation of a
possible scenario that can occur to an innovative company in
the event when it created a new technology and thereby put it
to the market. Meanwhile, in accordance with the management
and innovation strategy of the company it can directly lead to
any of the steps and consequently following the Innovation
Lifecycle. In this explanation, the description of a common
example with relation to the Innovation Lifecycle will be
given. For demonstration purposes the example of
introduction of automobiles will be illustrated.
Fig. 2. Innovation Lifecycle with respect to Dynamic
Capabilities.
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In 1807, the invention of the internal combustion engine
coupled with a vehicle design by François Isaac de Rivaz was
a prominent innovation [24]. Although this was quite a
fascinating innovation, it did not directly hit the market as
people were at that time quite satisfied with the animal drawn
carts. This situation directly correlates with the first stage in
Fig. 2 which is the “Breakthrough Innovation”. The low
absorption rate of the innovation as well as the small
performance gap between the already available alternative lets
down this innovation in the market to begin with. As time
went by, application of Dynamic Capabilities occurred in the
technological perspective and by 1886 Benz Patent-
Motorwagen, by Karl Benz [24] car was regarded as the birth
of the modern automobile. The capabilities required here in
this situation were the Dynamic Capabilities to find efficient
solution and advanced product that could outrun the current
market. This, with respect to Fig. 2 represents the second stage

which is called “Radical Innovation”. The problem at this
stage is that, although the technology has an impact on the
market, because of the high price and scarcity of the product
this technology does not reach the majority of the public. In
our case the automobile was only available to an elite level of
customers who would not mind to purchase expensive
products. In 1908 the Ford T model was introduced. This time
Ford came up with the plan and criteria of the mass production
of vehicles. Through purposefully creating, extending and
modifying its resource base in accordance with the technology
and market, Ford was able to make automobiles cheaper and
more affordable to general public. In doing so the existing
market for animal driven carts were disrupted by the mass
produced automobiles. Ford was able to maintain a
competitive advantage in the market efficiently and got lot of
returns from a large population of customers purchasing their
vehicle. This represents the third stage in Fig. 2 which is
“Disruptive Innovation”. As time went by, the mass

production technique for automobiles was absorbed by many
other companies in relative competition with Ford and at this
stage, although Ford was still mass producing, the vehicle
competition was high. The amount of returns generated
reduced and they just started sustaining in the market. This
represents the fourth stage of Fig. 2 which is “Sustaining
Innovation”. Although Dynamic Capabilities were applied to
reach a comfortable income generating level, the competition
in the market devoid Ford to achieve as much as when its
innovation was a Dispersive Innovation. So, while it tried to
survive in the market, slight technological improvements to
the initial design were created in order to stay ahead in
competition. The engine design as well as the architecture of
the vehicle were changed. In addition to that managerial
innovation was introduced to efficiently maintain competitive
advantage. This level represents the fifth stage in Fig. 2 which
is “Incremental Innovation”. There is no assurity as to how
long the company can thrive in the market before a competitor

introduces a Dispersive Innovation and topples all gains
altogether. For example, Toyota emerged victorious in the
automobile battle when it introduced Dynamic Capabilities in
its supply chain mechanism there by introducing “just in time”
the mechanism to ensure higher quality as well as higher
production rate. The final step that happens is the creation of a
Breakthrough Innovation with the help of Dynamic
Capabilities of existing companies or borrowing an existing
Breakthrough Innovation and using it in their product design.
This example can be portrayed in introducing vehicles run by
fuel cells. Although the first modern fuel cell vehicle was a
modified Allis-Chalmers farm tractor in 1959, it was
developed and used by its inventor ‒ NASA, for powering
rockets. The first demonstration of the fuel cell car was made
by General Motors in 1966 and thereafter many vehicle
companies have tried to introduce commercial vehicles with
this technology. Currently this technology resides in the
second stage of Fig. 2 which is the Radical Innovation stage as

this technology is quite expensive for general public to utilise,
as well as the alternative fuel sources are still quite efficient
with respect to a common man use. In the near future the
expectation to build on the Dynamic Capabilities in the
organisation to create a Disruptive Innovation out of the fuel
cell technology is being aimed at.
While the whole Innovation Lifecycle proceeds, there is an
interesting relationship between Disruptive Innovation and
Incremental Innovation. Dr. Sarah E. A. Dixon [1] demonstrates
a Dynamic Capabilities Lifecycle. She demonstrated the need
for Dynamic Capabilities in adapting market by presenting the
case study of Toyota failing to adapt in accordance with their
deployment of capabilities over wide geographic regions, and
how EMI record label failed to cope with the online music
downloading trend with their audio CDs which were way
more expensive than the music downloads. By this she
explained that market turbulence affects all companies in that
market equally. She also pointed out that successful

companies combine the constant honing of their existing
capabilities to achieve operational excellence at the same time
as developing new capabilities with a better fit to a continually
evolving environment. Those new capabilities may be
associated with product innovation or management innovation;
with new market offerings or new business models [1].
As pointed out in Fig. 2, there is a Dynamic Capabilities
cycle between Incremental Innovation and Disruptive
Innovation. Dr. Sarah E A Dixon explains that this shift
between the innovations determines the firm’s failure, survival
or success. She demonstrates that to attain a Disruptive
Innovation is at an advantage in comparison to having an
Incremental Innovation strategy.
From the analysis in the Fig. 2 it can be seen that as
Disruptive Innovation is advantageous for a company, in order
to maintain it is important for Dynamic Capabilities to be
refined in the areas which direct to Disruptive Innovation. As
indicated in Fig. 2 in red, without developing and implying

Dynamic Capabilities, Disruptive Innovation cannot be
achieved. Because of this close difference between the stages
in the innovation, Dynamic Capabilities play major role in
maintaining the shift between the various innovations and
finally directing towards Disruptive Innovation. The example
of failure of Kodak when they confronted the arrival of digital
photography was analysed. Kodak did not ignore digital
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photography, it can even be said that they invented it as the
first prototype of digital camera which was finalised by a
Kodak engineer (Steven Sasson) in December 1975. This
camera weighted 3.6 kg, its picture definition was 100 x 100
pixels, and storing of the image was done on an audio tape, a
process which took 23 seconds per picture; overall a good

example of a disrupting technology with lower performance
during its initial stages. Kodak did not ignore digital
photography in the subsequent years either; it launched several
professional digital cameras in 1990 and 1991 (one of them,
the Kodak DSC-100, had a 1.3 megapixel definition and
carried a price tag of $13 000) and a consumer-level camera in
1995 (Kodak DC40, which could be connected to a PC via a
serial cable). By the mid-1990s, digital photography was
clearly gaining ground; JPEG and MPEG formats had been
created in 1988, and several companies had launched digital
cameras. But rather than going full steam for digital
photography, Kodak, along with a few other major players of
the industry (including Fujifilm, Minolta, Nikon and Canon)
chose to launch a new system based on a digital film ‒ APS
(Advanced Photo System, launched in 1996). In 1999, Nikon
introduced the Nikon D1 ‒ a 2.74 megapixel camera at a cost
of under $6,000, a price some professional photographers and
high-end consumers could afford. There were also a full range

of more affordable cameras already available for sale in Japan
(in the $500 to $1000 range). In 2000, at a time it was
becoming clearer that digital photography would prevail
thanks to improving technical performances and lower prices,
Kodak was still promoting the APS (including during the
Sidney Olympic Games). But finally Kodak had to seize the
production of APS and finally failed in the photo market.
Digital photography was a Disruptive Innovation and the lack
of modifying its management techniques and implying
Dynamic Capabilities Kodak would have been capable to
shine in the turbulent market. Had it concentrated more on the
new technology which is digital photography other than being
an incumbent in the digital film by applying Dynamic
Capabilities, it had a possibility to still conquer the market.
As a result innovative companies would be at an advantage
laying their strategies to enhance their Dynamic Capabilities
directing to Disruptive Innovation (Fig. 2, red arrows). To
have a Radical Innovation transformed into a Disruptive

Innovation certain capabilities need to be refreshed and
dynamized. The particular Radical Innovation should become
cheaper and more available to a bigger circle of customers as a
result that innovation would compete with the currently
available alternative innovation. As it was a Radical
Innovation to begin with that particular innovation would have
some inherent advantages, because of the added availability
and lowered prices this innovation disrupts the competition,
innovation thereby transforming into a Disruption Innovation.
In order to efficiently execute this transformation the firm
constituted of that Radical Innovation should purposefully
create, extend, or modify its resource base in congruence with
the changing business environment. As demonstrated earlier in
this paper the mass production of automobiles is the best
example.
To have Incremental Innovation to be converted to a
Disruptive Innovation involves exploration of ideas and new
path creation, for example the redesign of the business model

or the invention of new products. This requires a combination
of organisational slack (availability of time and resources to be
allocated to things other than the day-to-day business
operations) and absorptive capacity (the ability to
conceptualise new ways of doing things, to understand the
changing environment and to be open to new ideas to acquire
new knowledge and think in new ways) [1]. Here the focus on
creativity and exploration for new ideas and on the utilisation
of these new ideas to create new developmental paths for the
organisation is given most importance [1]. For example
Google creates an organisational climate that is conducive to
exploring new ideas, at the same time having processes for
turning those ideas into practical user propositions that help to
reinvent their business [1].
V. CONCLUSION
Before commencing conclusions a few areas for future
research will be highlighted. As noted by multiple authors, the
challenge of conceptual research is to develop empirical

measures. The next possible step for this research is to carry
out the empirical study on the demonstrated contents. The
proposal to observe the working and implication of Dynamic
Capabilities for Disruptive Innovation to arise in a company
should be carried out. The analysis of the level of difficulty of
applying Dynamic Capabilities to achieve Disruptive
Innovation should be assessed in real time. After this the
discussion should be carried out based on the results.
In conclusion the description of Dynamic Capabilities was
presented as the ability of the firm to purposefully create,
extend, or modify its resource base in congruence with the
changing business environment. It was also discussed that
Dynamic Capabilities can not only be used to cope with the
changing business environment but also to introduce change in
the particular environment.
The main concept and criteria of Disruptive Innovation
were discussed. It was concluded that the exact criteria for an
innovation to qualify as disruptive is not clearly demonstrated

in accordance with previous literature, as a result it is hard to
set goals or a strategy to create one. To counter that the
comparative study between the different innovation types is
given to obtain distinguished criteria for Disruptive
Innovation. The demonstration of innovation with respect to a
two dimensional scale which shows the comparison between
the different kinds of innovation is made in accordance with
concept portrayal and examples. The advantage of Disruptive
Innovation over the other innovation types is made.
Finally the demonstration of the Innovation Lifecycle is
carried out where the example of the evolution of the
automobile industry is given. The use of Dynamic Capabilities
to achieve each of the innovation types is demonstrated and
the Dynamic Capabilities which are used to achieve a
Disruptive Innovation have been highlighted by suitable
examples. It is thereby seen that a company implying
Disruptive Innovation in their respective market is at

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advantage and the Dynamic Capabilities are inevitable to
function in a company that wants to achieve Disruptive
Innovation.
REFERENCES
[1] Professor and Dean of Xi’an Jiaotong Liverpool University
Business
School in Suzhou, China, Dr. Sarah E. A. Dixon, “Failure,
Survival or
Success in a Turbulent Environment: The Dynamic Capabilities
Lifecycle,” Management Articles of the Year January, 2013.
[Accessed
25.05.2014].
[2] Bernard, B., “Incumbent Curse or Incumbent Capabilities?”
Solvay
Brussels School of Economics and Management, 2013.
[Accessed
27.06.2014].
[3] Christensen, C. M., Horn, M. B. and Johnson, C. W.,
“Disrupting Class:

How Disruptive Innovation Will Change the Way the World
Learns,”
New York: McGraw-Hill, 2008.
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Emil William Thattakath received the Bachelor’s degree in
Biotechnology Engineering from the SRM University, Tamil
Nadu, India.
And is pursuing the Master’s degree in Technology Management
in Kaunas
University of Technology, Kaunas, Lithuania. This paper is a
representation
of his Master Thesis. He is an Administrative Assistant with the
International
Relations Department of KUT.
E-mail: [email protected]
Rūta Čiutienė received the Doctoral degree from ISM
University of
Management and Economics, Lithuania, in 2006. The topic of

her doctoral
dissertation was „Coordination of Employees and Organizations
Interests in
Career Development”. She is a Professor with the School of
Economics and
Business, Kaunas University of Technology. Since September
2013, she has
been the coordinator of the Project Management Master
programme; since
2012 ‒ the manager of a scientific research group funded by the
Institutional
Scientific Research Programme „Challenges of Lithuanian
economy’s long-
term competitiveness”. The fields of her scientific interest are:
project
management, human resources management, human capital,
career
management problems.
E-mail: [email protected]
http://dx.doi.org/10.1177/014920639101700108
http://dx.doi.org/10.1287/orsc.13.3.339.2780
http://dx.doi.org/10.1287/mnsc.35.12.1504
0266(199708)18:7%3c509::AID-SMJ882%3e3.0.CO;2-Z

0266(199708)18:7%3c509::AID-SMJ882%3e3.0.CO;2-Z
http://dx.doi.org/10.1111/j.1540-5885.2005.00179.x
http://dx.doi.org/10.1108/eb039075
http://dx.doi.org/10.4271/R-272
http://dx.doi.org/10.1111/j.1467-8551.2010.00693.x
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Page 135
Journal of the International Academy for Case Studies, Volume
20, Number 1, 2014
THE RISE AND FALL OF NETFLIX: WHAT HAPPENED
AND WHERE WILL IT GO FROM HERE?
Grace Allen, Western Carolina University
Dorothee Feils, University of Alberta
Holly Disbrow, Western Carolina University
CASE DESCRIPTION

The primary subject matter of this case concerns company
analysis. Secondary issues
include financial statement analysis, corporate strategy and
international expansion. The case
has a difficulty level of three and should be appropriate for
undergraduate and graduate courses
in investments and financial and strategic management. The
case is designed to be taught in one
to two class hours, with three hours of outside preparation by
students.
CASE SYNOPSIS
Netflix is an innovative company that has changed the way we
rent movies and watch TV
shows. Its business model is based on a subscription service that
provides home-delivery of DVD
rentals and streaming of movies and TV shows. The company
took advantage of the rapid growth
in the DVD rental market, the internet and e-commerce by
providing a service that the
traditional brick-and-mortar retailers, such as Blockbuster,
could not compete with. In 2011,
however, a price hike, poor management decisions, changes in
technology, and increased
competition threatened Netflix, leading to a sharp decline in its
share price. In this case,
students analyze the fundamentals of Netflix including its
financials and management decisions
to help determine if Netflix’s poor stock performance in 2011
was predictable as well as what the

future might hold for this company.
INTRODUCTION
Rushing into the offices of Horizon Capital Invest (Note that
Horizon Capital Invest,
Brighton Portfolio, and the characters are fictitious) , Chris
Thompson almost knocked into the CEO,
Ms. Steinberg. “Whew” said Chris under his breath after
apologizing to the CEO. It was the last
week of April 2012 and Chris had one week left in a four month
internship for this prestigious
money management firm. He had spent his internship learning
how to research companies for
two senior analysts to whom he reported. It had been a steep
learning curve for Chris, a finance
major in his senior year at an East Coast university. He had
been lucky to land the internship and
was determined to impress the analysts at Horizon Capital
Invest, a place he dreamed of working
after graduation. He certainly didn’t want to be late for the
morning briefing. With his iPad in
one hand and his coffee in the other, he glanced at the clock as
he entered the conference room.
Chris had 30 seconds to spare and thought to himself, “another
close call. Maybe this will be my
Page 136
20, Number 1, 2014

lucky day and I finally get to show what I can do.” Chris
greeted both analysts as he took a seat
at the long table, “Good morning Ms. Hunter”, “Good morning
Mr. Richardson”. After some
pleasantries they got right to work. Ms. Hunter told Chris that
they were considering purchasing
Netflix for the Brighton Portfolio. Abruptly, Mr. Richardson
broke in and said “I don’t feel this
is a good investment. The stock has plummeted over the past
ten months and I would not
consider it a value play.” Before Chris could even begin taking
notes Ms. Hunter said pretty
forcefully “Come on Joe, this is a great company. Management
may have made some mistakes
recently but this leads to a great buying opportunity. I feel
certain we will have a double digit
return from this one.” Mr. Richardson, a very head strong
individual, wasn’t about to let Ms.
Hunter have the last say. He quickly responded “Maria, you’re
really off base with Netflix. It
would be against our fiduciary responsibility to add it to the
portfolio.” You could see that Ms.
Hunter was not going to take this lightly. Her face was red and
she raised her voice a couple of
levels and said “Joe, you have to trust me on this one. I know
management will get its act
together and we’ll see a reversal in the stock price within the
next quarter.” Chris had been
frantically taking notes but was beginning to get a bit nervous
sitting between the two arguing
analysts. Then they dropped the bomb shell. Mr. Richardson
said “alright Maria, let’s get Chris
to pull together a report covering Netflix’s background and the
factors affecting the company this
past year that could help us make a decision. I really am

doubtful but I am willing to see details
that will allow us to make a more informed decision.” “Chris”
said Ms. Hunter “can you do a
report on Netflix by 9:00 am tomorrow?” Chris eagerly agreed
to tackle the Netflix case
knowing this might be his opportunity to show both, Ms. Hunter
and Mr. Richardson, his
recently enhanced research skills. After excusing himself,
Chris left and headed to his cubicle
with butterflies in his stomach and thought “yep this is my
lucky day!”
What made this assignment even more interesting to Chris was
that Netflix was a
company he knew quite well. Many times he had watched a
movie with his family or friends
that had arrived via mail in the little red envelope. Since going
to college, instead of ordering
movies, he would just plug-in his iPod and stream a movie or a
TV show. Chris had
remembered discussing the stock in class. It was a company
that had seen very impressive
growth over the years because of its ability to provide what
many Americans want in a fast and
convenient manner: unlimited rental access to movies and TV
shows via mail or on-line
streaming for a low monthly subscription rate. Its’ price had
soared from about $180 per share
in January 2011 to over $300 per share in July (Yahoo, nd).
However, by the end of 2011 the
price per share had dropped to $69 (Yahoo, nd) and Netflix had
lost 800,000 domestic members
(Form 10-K, 2012). “Wow” thought Chris “this is going to be
interesting. My two bosses are at
odds with each other, a company that has taken an abrupt
turnaround, and less than 24 hours to

prepare the report.”
Since yesterday, Chris had been working nonstop with only a
few hours of sleep. His
cubicle was littered with pizza and donut boxes and half empty
coffee cups. He believed he had
done a thorough job researching Netflix and that Ms. Hunter
and Mr. Richardson would be
impressed with his report. He took one more look at the
document checking to make sure that
he had organized it well and there were no spelling or typo
errors. Satisfied, Chris hit the print
button and swung by the office to pick up the copies before
heading into the conference room.
Chris, a little jittery and tired from lack of sleep, took a deep
breath to get his second wind and
Page 137
20, Number 1, 2014
greeted his bosses cheerfully “Good Morning Ms. Hunter and
Mr. Richardson. I hope you both
will be pleased with my report on Netflix and that it will help
you agree on whether to add it to
the Brighton Portfolio. I made copies for both of you and
would like to go through it with you
now.”
REPORT ON NETFLIX, INC.: PREPARED BY CHRIS
THOMPSON

BACKGROUND
Netflix was founded by Reed Hastings and Marc Randolph in
1997 and is headquartered
in Los Gatos, California. Netflix originally operated as an
online movie rental store which
included per rental fees and late fees. In 1999, Netflix initiated
its subscription service which
provided unlimited DVD rentals for a monthly fee after the
company received a $30 million
investment from the Group Arnault (Netflix Inc. Company
Profile, 2011). Netflix began its
movie recommendation system in 2000 where subscribers rate
movies and Netflix used the
information to suggest selections to its members. Netflix’s
reputation was built on its unique
business model: unlimited rentals with no due date, no shipping
and handling fees and no late
fees. Netflix went public on May 22, 2002 with an IPO of
5,500,000 shares at price of $15.00
per share. It is listed on the Nasdaq under the ticker symbol
“NFLX” (Netflix Company
Timeline, nd). Reed Hastings, one of the founders of Netflix,
has stayed on as the CEO of
Netflix (Form 10-K, 2012). Netflix’s total number of suscribers,
at the time of the IPO, was
600,000 (Netflix Company Timeline, nd). The little red
envelopes that became the trademark of
the DVD subscription continued to pull large numbers of new
subscribers into the fold year after
year. In 2003, Netflix reported its first profit of $6.5 million
after years of losses (Netflix, Inc.,
2003). By the end of 2006, Netflix had 6.3 million members
(Netflix Company Timeline, nd).

Netflix began to offer streaming as an added feature with its
DVD subscriptions in 2007.
Streaming, which allows movies or TV shows to be watched
instantly over the internet, became
increasingly popular as Netflix teamed up with electronic
companies to broaden the scope of
devices that could stream. At that time, streaming was
available only for personal computers,
but by 2008 devices such as the Xbox 360, Blu-ray disc players,
TV set-top boxes and the
Macintosh computer could stream. By 2009, PS3 and internet
connected TVs were among the
devices able to stream (Netflix Company Timeline, nd). At the
end of 2009, Netflix had 12.3
million members (Form 10-K, 2012). In 2010, streaming
Netflix content became available “on
Apple’s iPad, iPhone, iPod Touch, the Nintendo Wii and other
internet connected devices”
(Netflix Company Timeline, nd). In 2010 Netflix took its
streaming content international by
expanding into Canada. By the end of 2010, Netflix reported
almost 20 million members up
from 12.3 million in 2009 (Form 10-K, 2012).
Page 138
20, Number 1, 2014
source: Form 10-K (2012). *Note that there is a considerable
overlap between streaming and DVD subscribers.

Therefore, the number of total unique subscribers is less than
the sum of domestic streaming and domestic DVD
subscribers. Prior to 2011, Netflix provided only a combined
streaming and DVD service.
FACTORS AFFECTING NETFLIX, INC. IN 2011
INCREASED COMPETITION AND CONTENT COSTS
By 2011, Netflix began to see competitors aggressively
competing for market share (Q1
Publishing, 2011). Companies such as Hulu.com, Google TV,
Apple TV, various cable
companies and others were getting in on the rivalry by offering
streaming. For instance,
Comcast offered Streampix to its Xfinity subscribers with a
base price of $4.99 per month
(Gorman, 2012). Dish network and Blockbuster joined in, as
did Verizon and Redbox, to offer
movies and TV shows on the internet. Hulu Plus cost $7.99 per
month, the same as Netflix, but
also offered a limited selection of free previously run TV shows
(Gadget Review, 2012). Since
there are more alternatives for consumers, Netflix no longer has
as large a hold on the market as
it once had.
The cost of acquiring content differs for the streaming and the
DVD segment. To acquire
content for streaming, Netflix typically acquires and licenses
content on a fixed cost basis (Form
10-K, 2012). Movie studios have been benefitting from more

competitors entering the market
since they have been able to charge more for the rights to
stream movies and shows and thus for
Netflix, the fixed cost of acquiring content for streaming is
likely going to increase. Netflix
likely will have to deal with rival companies as its content
contracts come up for renewal and as
it looks to expand its limited libraries. “Netflix’s content costs
have jumped to $3.5 billion over
the past several years, up from the $2.4 billion reported
previously…” (Lang, 2011). The
0
5000
10000
15000
20000
25000
30000
Total Unique
Subscribers
Domestic
Streaming
Domestic DVD International
Streaming
Subscribers by Segment and Location (in thousands)*

2009
2010
2011
Page 139
20, Number 1, 2014
potentially severe increase in the cost of content could have a
major impact on Netflix’s ability to
generate profits in the future.
However, the cost structure differs for the DVD segment. In the
DVD segment, Netflix
has many revenue sharing arrangements (Netflix, Inc. Company
Profile, 2011), resulting in a
variable cost model (Form 10-K, 2012). Due to the "mature
state of the business" (Form 10-K,
2012), Netflix does expect healthy contribution margins from
the DVD business, but also not
much growth. The company expects that growth will come
mainly from streaming (Wingfield,
2011b).
MANAGERIAL DECISIONS
Netflix’s loyal and growing customer base was upset in July
2011 when Netflix decided

to change its subscription plans and rates to better match them
to the company’s business
segments: streaming and DVD rentals (Form 10-K, 2012). The
existing subscription plans
included a $7.99 per month plan for unlimited streaming and a
$9.99 per month for unlimited
streaming and unlimited DVDs sent one at a time. Starting July
2011, subscribers could
subscribe separately to a streaming only or a DVD only plan for
$7.99 each. If subscribers
wanted to subscribe to both, streaming and DVDs, the
subscription price increased to $15.98 per
month, starting immediately for new subscribers and in
September for existing subscribers
(Netflix Company Website, 2011a). This change implied a 60
percent price hike for those
subscribers that wanted to maintain the same level of service
provided by the $9.99 plan
previously upsetting many members (Wingfield, 2011a). Since
many current and potential
subscribers felt that the online library wasn’t up to par as it
lacked a wide array of new content,
subscribers who preferred to stream still tended to order DVDs
when they could not get a
specific movie or show from the online library. Many
subscribers felt that Netflix was being
greedy although the price increase was a way to raise cash to
increase the online library for
streaming (Barnes and Stelter, 2011).
In addition, Netflix faces problems securing content for its
streaming services.
Negotiations with Starz failed in September, 2011 (Hollister,
2011), which meant that as of
February 28, 2012 “Netflix’s three-and-a-half-year-old deal
with Starz …[came] to an end, and

Starz’s roster of classic and newer films …[disappeared] from
the Netflix portfolio”(NYTBits,
2012). These films include movies from Walt Disney Studios
and Sony Pictures Entertainment
and were taken out of the library by the end of February 2012.
The loss was a blow but Netflix
has made a deal with Dreamworks for its films and television
specials beginning in 2013 when
Dreamworks’ contract with HBO is due to expire. “The Netflix
accord, which analysts estimate
is worth $30 million per picture to Dreamworks over an
unspecified period of years, is billed by
the companies as the first time a major Hollywood supplier has
chosen Web streaming over pay
television” (Barnes and Stelter, 2011). The company has also
been increasing its television
content; however, it is not clear how well these changes will be
accepted by consumers.
On September 18th 2011 Reed Hastings, CEO and Cofounder,
posted a blog apologizing
for not communicating the reasons behind the price hike but
also announcing the splitting of
Netflix into two companies. The DVD by mail service would be
renamed Qwickster and would
offer video games for an additional charge and the streaming
component of the company would
Page 140
20, Number 1, 2014
take the Netflix name. The two companies would have separate

websites that would not be
integrated. Reed stated, “Some members will likely feel that
we shouldn’t split the businesses,
and that we shouldn’t rename our DVD by mail service. Our
view is with this split of the
businesses, we will be better at streaming, and we will be better
at DVD by mail. It is possible
we are moving too fast – it is hard to say” (Netflix Company
Website, 2011b). On October 10th,
after a severe backlash, including a loss of 800,000 subscribers
in the third quarter, Mr. Hasting
reversed his decision to split the company. “The now aborted
plan by the Netflix co-founder
and chief executive to distance the Netflix brand from its DVD
rental business has gone down as
one of the year’s biggest business blunders”(Wingfield and
Stelter, 2011).
Finally, the United States Postal Service announced in
December that it hopes to get rid
of next day delivery for first class mail. This might cause
issues for Netflix as it could slow
down deliveries of its DVDs. Management will have to think
about a way to deal with this
potential problem, since customers might decide to go
elsewhere if the DVD service were to
become less convenient. Consumers are already upset about the
price hike and it seems as if
Netflix’s focus for the future is on streaming at any cost
(Wingfield, 2011b).
INTERNATIONAL EXPANSION
In 2010, Netflix decided to go international by offering

streaming services in Canada.
International expansion continued in 2011 as Netflix moved into
42 countries in Latin America
and the Caribbean including Brazil, Chile, Columbia, Ecuador,
Peru, Venezuela, Mexico, and
Central America (Team, 2011). Netflix is looking for new
subscribers outside the borders of the
U.S. as competition is heating up in the U.S. but this move
faces challenges of its own.
First, Netflix has to create an international library that would
have enough content to be
appealing in each country. As streaming content needs to be
licensed separately for each market,
Netflix faces difficulty in providing foreign subscribers access
to comparable content available to
US subscribers (Warren, 2011). For example, Netflix Canada
has only about one third of the
titles offered by Netflix USA (Huffington Post, 2011). In
addition, Netflix will have to make
some country specific content available. For example, Netflix
would have to increase its French
language content to be able to attract the francophone market in
Canada.
Second, the existing digital infrastructure varies greatly from
country to country but is of
critical importance as a minimum of 800 kbps were required to
stream movies (Team, 2011).
“A MSNBC article sourcing Ibope Nielsen’s report says that
only 20% of Brazil’s 42 million
Internet users have a connection speed above 500 kbps…Latin
America is also plagued by
rampant video piracy…”(Team, 2011) Netflix might have
issues being able to reach its full
potential in these countries as its services might not be

available to all interested consumers. Not
only does the infrastructure vary, but also the design of the
internet plans. For example, some
Canadian internet providers introduced usage-based billing, or
data caps. These are imposed to
limit the amount that subscribers can download per month.
Netflix's response to this has been to
reduce the quality of videos it streams to Canadians, meaning
that on average content will use up
two-thirds less data to stream. (El Akkad, Krashinsky and
Marlow, 2011).
Third, Netflix has to deal with regulatory uncertainty in foreign
markets. For example,
at the end of 2011, Canadian regulators did not require Netflix,
or other internet-based movie
Page 141
20, Number 1, 2014
distributors, to fund Canadian broadcast content or to adhere to
other regulations required by
cable and satellite companies. Not surprisingly, the competitors
argued that Netflix had a
competitive advantage that needed to be addressed (Argitis,
2011). The cost of operating in
Canada could increase significantly, should the Canadian Radio-
television and
Telecommunications Commission change the regulations for
internet-based movie distributors.
Finally, the international expansion has been costly, in no

insignificant part due to the
fact that streaming content licenses has to be paid for on a
national basis. Thus, Netflix expects
to run losses in the foreign markets in the short-term until a
sufficiently large foreign subscriber
base can be established (Form 10-K, 2012). The capital used to
finance the international
expansion could have been used to increase Netflix’s library in
the U.S. “Wedbush analyst
Michael Pachter, a well-known digital-entertainment analyst,
criticized what he saw as Netflix’s
“growth at all costs business model, ”….adding that its desire to
expand internationally will only
cause it to incur losses for years” (Reisinger, 2012). The
company’s extensive “push to go
international” is a risky move for Netflix. Only the future will
tell whether the international
expansion strategy will pay off in the long-run.
FOLLOW-UP MEETING
After going through his report, Chris sensed that Ms. Hunter
and Mr. Richardson were
still not on the same page. Ms. Hunter had a smile on her face
and Mr. Richardson was
frowning. Immediately, Ms. Hunter said “so Joe, Chris’s
research shows, as I have been telling
you all along, that Netflix is a great company and we should add
it to the Brighton Portfolio.
Netflix is facing some challenges but the company is well
positioned for the future.” Mr.
Richardson responded emphatically with “hold on a minute
Maria, I am still leaning towards the

opposite. In fact, I cannot even consider the purchase without a
more in depth analysis. Chris,
you have done an outstanding job but you need to take it a step
further. Are you up to spending
another day on Netflix? By the way, we don’t have a lot of
time to make this decision. We are
meeting with the Brighton representatives next week and we
want to make sure that we can
justify our holdings and the portfolio is positioned to
outperform our benchmark in the forward
twelve months. Please summarize your analysis with your own
prognosis of Netflix and be sure
to back-up your opinion with facts.” Chris was delighted to
get such positive feedback from
Mr. Richardson, someone who gave praise sparingly, but was
also a bit nervous about his new
assignment. He knew he could dig deeper and had the skills to
synthesize the data but a lot
hinged on the outcome. An exceptional job would set him up
for a potential job offer from
Horizon Capital Invest, a dream come true.
REFERENCES
Argitis, Theophilos (September 30, 2011). Netflix Said not To
Face Broadcast Regulations in Canada, Bloomberg,
Retrieved July 15, 2013 from
http://www.bloomberg.com/news/2011-09-30/netflix-said-not-
to-face-
broadcast-regulation-as-sought-by-bce-in-canada.html
Barnes, Brooks and Stelter, Brian (September 25, 2011). Netflix
Secures Streaming Deal With DreamWorks.,The
New York Times Reprints. Retrieved July 3, 2012 from

20, Number 1, 2014
http://www.nytimes.com/2011/09/26/business/media/netflix-
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Disruptive Innovation . . . in Reverse:
Adding a Geographical Dimension to
Disruptive Innovation Theory
Simone Corsi and Alberto Di Minin
Based on a literature review on disruptive innovation and
innovation from emerging econo-
mies, we offer an interpretation of a subset of reverse
innovation within the disruptive
innovation theory. We argue that the combination of these two
theories provides a useful
framework to look at emerging economies as sources of new
products and technological
solutions. Finally, we provide a new categorization of
disruptive innovation considering a
geographical dimension and future research directions.
Introduction
In a fast-changing world, where emergingeconomies are
constantly increasing their
importance in the global economy and where
innovation assumes an international dimen-

sion, an increasing number of scholars have
looked at the phenomenon of innovation in
emerging economies. Several authors are
investigating in what way these countries are
not only recipients (Vernon, 1966) but also
sources of innovation (Hart & Christensen,
2002; Immelt, Govindarajan & Trimble,
2009; Kenney, Massini & Murtha, 2009;
Govindarajan & Trimble, 2012).
Scholars refer to this trend in different ways,
depending on the aspect they focus on, such as
‘disruptive innovation from emerging econo-
mies’ (Hart & Christensen, 2002), ‘innovation
at the bottom of the pyramid’ (Prahalad, 2004),
‘cost-innovation’ (Zeng & Williamson, 2007) or
‘reverse innovation’ (Immelt, Govindarajan &
Trimble, 2009). However, the managerial lit-
erature is still lacking both a clear and solid
theoretical position and a strong theoretical
framework within which a new innovation
trend from emerging economies can be read
and interpreted (Govindarajan & Ramamurti,
2011). Hence, the aim of this paper is firstly to
critically review the literature concerning
innovation from emerging economies, and sec-
ondly to contribute a rationalization of the
related concepts, attempting a reinterpretation
of the concept of ‘reverse innovation’ (Immelt,
Govindarajan & Trimble, 2009; Govindarajan
& Trimble, 2012), defined as a type of ‘disrup-
tive innovation’ (Christensen, 1997).
Building on our review of the existing work
(see Appendix A and Table 1), we suggest that

the combination of these two frameworks pro-
vides a useful scheme to look at emerging
economies as sources of new products and
technological solutions.
In the last ten years, scholars have started to
look at companies that serve those markets in a
different way. Glocalization – adapting to
emerging markets products developed for
advanced ones – is in fact assumed to be par-
tially ‘blind’ or ineffective for the purpose of
serving emerging market needs, given its
ability to reach only the wealthier part of the
population. The new challenge of the twenty-
first century has been identified in the profit-
able development and sale of new products for
the mass markets of less affluent populations
of emerging economies that are currently not,
or only partially, served by multinational cor-
porations (MNCs). The innovation manage-
ment literature has produced a limited
number of studies (Hart & Christensen, 2002;
Prahalad, 2004; Immelt, Govindarajan &
Trimble, 2009; Hang, Chen & Subramanian,
2010; Govindarajan & Trimble, 2012), largely
based on anecdotal evidence, trying to identify
new ways of pursuing innovation in emerging
economies. Most of these studies build their
76 CREATIVITY AND INNOVATION MANAGEMENT
Volume 23 Number 1 2014
10.1111/caim.12043
© 2013 John Wiley & Sons Ltd

argument, more or less implicitly, on the well-
known ‘disruptive innovation’ paradigm as
defined by Christensen (1997) and Christensen
and Raynor (2003), further derived as disrup-
tive innovation in emerging economies in
Prahalad’s seminal work on innovation for the
‘bottom of the pyramid’ (BOP) (Prahalad,
2004).
Given the specificity of the context for and
in which these innovations need to be devel-
Table 1. Main Innovation Concepts Related to Emerging
Economies (Literature and Examples)
Concept Literature Examples
Disruptive
Innovation
Acee (2001); Anthony et al. (2006); Bower &
Christensen (1995); Cefis & Marsili (2006);
Charitou & Markides (2003); Christensen
(1997, 2006); Christensen & Overdorf
(2000); Christensen & Raynor (2003);
Christensen et al. (2000, 2006); Chesbrough
(2002); Corso & Pellegrini (2007); Danneels
(2004); Gilbert (2003); Gilbert & Bower
(2002); Glazer (2007); Govindarajan (2012);
Govindarajan & Kopalle (2006a, 2006b);
Govindarajan et al. (2011); Henderson
(2006); Johnson et al. (2008); Johnson
(2012); Kanter (2010); Kassicieh et al.

(2002); Mangelsdorf (2009); Markides
(2006); O’Reilly & Tushman (2004); Rafii &
Kampas (2002); Sandström, Magnusson &
Jörnmark (2009); Schmidt & Druehl (2008);
Simanis & Hart (2009); Suzuki & Kodama
(2004); Utterback & Acee (2005); Yu &
Hang (2010, 2011)
Hard disk drive; digital
photography; mobile
phone
Disruptive
Innovation
from Emerging
Economies
Hang et al. (2010); London & Hart (2004);
Markides (2012); Ray & Ray (2011); Schanz
et al. (2011)
Galanz’s microwave;
Suzlon’s windmills;
Haier’s washing
machine
Innovation for
the Bottom of
the Pyramid
Akula (2008); Anderson et al. (2010); Ansari
et al. (2012); Garrette & Karnani (2010);
Gino & Staats (2012); Hart & Christensen
(2002); Karamchandani et al. (2011);
Karnani (2007); Olsen & Boxembaum
(2009); Prahalad (2004, 2012); Prahalad &

Hammond (2002); Prahalad & Hart (2002);
Rangan et al. (2011); Simanis (2012); Wood
& Hamel (2002)
Aravind Eye Care’s
hospitals; ICICI Bank’s
microcredit; Casas
Bahia’s retailers
Cost Innovation Williamson (2010); Williamson & Zeng (2004,
2009); Zeng & Williamson (2007)
China International
Marine Containers
Group’s shipping
service; Dawning’s high
performance computers
Reverse
Innovation
Govindarajan and Trimble (2012); Immelt,
Govindarajan & Trimble (2009)
GE Healthcare’s ECG
machine; P&G’s
honey-based cold
remedy; P&G’s
feminine hygiene
product; Tata Nano
DISRUPTIVE INNOVATION . . . IN REVERSE 77

oped, domestic companies seem to be best
placed to pursue them. By virtue of their
embeddedness, local market knowledge and
low cost approach, domestic companies
develop new product solutions for emerging
markets that challenge the activities of foreign
MNCs. This phenomenon has mostly been
referred to as ‘cost innovation’ (Zeng &
Williamson, 2007). Indeed, growing attention
has been paid to companies from emerging
economies and how in going global they
threaten western MNCs in the home markets
that they have dominated for decades.
Responding to this threat is a new challenge
for incumbent MNCs and, in our opinion, ‘dis-
ruptive innovation’ is a useful way to describe
the new trend that has recently been defined
as ‘reverse innovation’ (Immelt, Govindarajan
& Trimble, 2009). According to Immelt,
Govindarajan and Trimble (2009) and
Govindarajan and Trimble (2012), since most
current and future global economic growth is
likely to take place in emerging economies,
innovation specifically aimed at responding to
these markets is crucial. Indeed, new products
developed entirely in emerging markets for
emerging markets are likely to disrupt devel-
oped markets and open new business oppor-
tunities, as shown, for example, by Zeng and
Williamson (2007). This phenomenon thus
configures a process of innovation that no
longer sees developed economies as the locus
where new products are conceived, designed
and commercialized, but instead takes on the

role of the last recipient of innovations devel-
oped in and for emerging economies.
This paper builds on the disruptive innova-
tion literature and contrasts its analysis with
the concept of reverse innovation. We believe
we bring two theoretical contributions:
1. Adding a geographical dimension to disruptive
innovation. The original specification of
disruptive innovation is a theory that seeks
to explain dynamics within established
markets. However, a geographical dimen-
sion needs to be considered to make disrup-
tive innovation useful for interpreting
situations where the disruptors originate
from emerging markets.
2. A new look at disruptive and reverse innovation
side by side. Consistent with Govindarajan
and Trimble (2012), we emphasize that the
concepts of disruptive and reverse innova-
tion have an overlapping, though not a one-
to-one, relationship. By looking at these two
theories side by side, we are able to better
clarify similarities and differences. We dis-
tance ourselves from the claim that disrup-
tive innovation in reverse stems only from
an income gap. On the contrary, disruptive
in reverse rests not only on cost advantage
in the market segment but also on new
characteristics and features of the disrup-
tive product originated and tested in a
developing country and appreciated in
advanced countries.

This paper is organized as follows. In the
next section, we lay the foundations of our
analysis by reviewing disruptive innovation
theory. This will be used as our framework to
interpret the other sections that take into
account disruptive innovation as considered in
the different streams of literature related to
innovation in emerging economies. The third
section explores the dynamics of innovation at
the Bottom of the Pyramid (BOP), while the
fourth section investigates the conceptuali-
zation of disruptive innovation from emerging
economies. The concept of reverse innovation
is introduced in the fifth section and inter-
preted within the Disruptive Innovation
framework in the sixth section. The seventh
section provides a new categorization of Dis-
ruptive Innovation, considering a geographi-
cal dimension. Finally, conclusions and future
research directions are presented together
with selected research propositions.
Disruptive Innovation
Introduced in 1995 by Bower and Christensen,
the concept of disruptive innovation was
refined by Christensen in 1997 with his ‘Inn-
ovator’s Dilemma’, asking why great compa-
nies pursuing innovation in mainstream
markets suffer from market myopia and are
overtaken by entrant firms introducing prod-
ucts based on new, disruptive technologies.
To explain this phenomenon, Christensen
distinguishes between sustaining and disrup-

tive technologies. The former are technologies
that respond to an improvement, radical or
incremental, of ‘established products, along
the dimensions of performance that main-
stream customers in major markets have his-
torically valued’ (Christensen, 1997, p. xv).
Disruptive technologies, on the other hand,
are innovations for existing products but on
attributes that differ from those that are mainly
valued by mainstream customers. These inno-
vations, which initially underperform with
respect to the main attributes of sustaining
technologies, become disruptive when they
reach the same performance as the sustaining
innovations on the attributes valued by main-
stream customers. At this point, they displace
existing technologies and cause, in most cases,
the failure of incumbent firms. Christensen
describes as an example the evolution of the
hard disk drive industry between 1976 and
1992. In this market, mainstream customers
constantly required improvements in two
attributes, total capacity and recording density.
The industry and incumbent firms were led by
this trend until an emerging segment asked for
improvements on different attributes, in par-
ticular, the size of drivers. At the beginning,
this segment remained marginal and was

mainly covered by small entrant firms that
could afford to do so by virtue of their rela-
tively limited cost structure, but while the
products offered gained improved perfor-
mance, including the mainstream segment
attributes, the market based on sustaining
technologies was progressively displaced,
causing the failure of incumbents.
In earlier works, Christensen (Bower &
Christensen, 1995; Christensen, 1997) refers to
disruptive technology only as an ‘innovation
that results in worse product performance in
mainstream markets’. It is also described as a
‘typically cheaper, simpler, smaller and fre-
quently more convenient to use’ version of an
existing product.
In an updated version of the concept,
Christensen and Raynor (2003) distinguish
between ‘low-end disruptions’ and ‘(new-
market) high-end disruptions’. The former are
those offering lower performance at a cheaper
price but no other performance improve-
ments, while the latter are described as prod-
ucts and services that offer better performance
on attributes that differ from those valued by
mainstream customers (e.g., the mobile phone,
initially low performing in reception, which
disrupted the market for home phones).
Christensen also asserts that disruptive
technologies should be framed as a marke-
ting, and not a technological, challenge
(Christensen, 2006; Glazer, 2007). Firms suc-
ceeding in disruptive innovations have a

strong attitude in interpreting and addressing
needs expressed by a market niche or a new
market segment. Thus, the challenge that
incumbent firms should overcome in develop-
ing and responding to disruptive innovations
relates to the development of capabilities to
forecast market trends and attitudes as well as
‘riding’ new technological trajectories (Rafii &
Kampas, 2002; Charitou & Markides, 2003;
Suzuki & Kodama, 2004; Corso & Pellegrini,
2007).
Disruptive innovation has been used from
the very beginning to discuss innovation
dynamics taking place with the entry of new
companies in established and developed
markets (Chesbrough, 2002). One of the most
convincing responses provided by research-
ers, albeit widely discussed and doubted
(Danneels, 2004), is that these companies
should promote the creation of spin-off enter-
prises in order to better serve and interpret
emerging markets (O’Reilly & Tushman, 2004;
Kanter, 2010; Johnson, 2012). The creation of a
separate organization of a smaller dimension
with large autonomy allows the problem of
resource allocation that is too mainstream cus-
tomer oriented to be overcome. Matching the
initially small market size to the size of
the investment potentially enables the new
company to be profitable (Kassicieh et al.,
2002; Anthony, Eyring & Gibson, 2006; Cefis &
Marsili, 2006; Sandström, Magnusson &
Jörnmark, 2009).

Since its coinage, the concept of disruptive
innovation has been widely discussed from
different perspectives (Christensen, Bohmer &
Kenagy, 2000; Christensen, Johnson & Rigby,
2002; Gilbert & Bower, 2002; Gilbert, 2003;
Danneels, 2004; Christensen et al., 2006;
Henderson, 2006; Johnson, Christensen &
Kagermann, 2008; Schmidt & Druehl, 2008;
Yu & Hang, 2010, 2011). In particular,
Govindarajan and Kopalle (2006a, 2006b)
make a clear distinction between low-end and
high-end disruptions based on the level of
radicalness of disruptive innovations (techno-
logically more radical in high-end disruptions,
technologically less radical in low-end disrup-
tions). The authors also make a clear distinc-
tion between innovations that are radical and
disruptive and merely radical, stating that
radicalness is a technology-based concept
while disruptiveness is a market-based
concept. Analogously, Markides (2006) draws a
clear distinction between different kinds of
disruptive innovations: technological, business
model and new-to-the-world product innova-
tions. From this distinction and from the work
of Utterback (2004), Acee (2001) and Utterback
and Acee (2005), who recognized the impor-
tance of disruptive technologies not in the fact
that they displace existing products but in
their ability to enlarge existing markets and
provide new functionalities, Govindarajan and
Kopalle add rigour to an expanded view of
disruptive innovation, including both high-
end and low-end disruptions and define the
concept as follow (2006a, p. 190):

A disruptive innovation introduces a differ-
ent set of features, performance and price
attributes relative to the existing product, an
unattractive combination for mainstream
customers at the time of product introduc-
tion because of inferior performance on the
attributes these customers value and/or a
high price – although a different customer
segment may value the new attributes. Sub-
sequent developments over time, however,
raise the new product’s attributes to a level
sufficient to satisfy mainstream customers,
thus attracting more of the mainstream
market.
In the examples of disruptive technologies
provided by Christensen (1997) and
Christensen and Raynor (2003), the new
market segment that adopts the disruptive
solution belongs to the same market where
incumbent companies operate. The emergence
of new technologies triggers interest within
the mainstream segment where these incum-
bents operate, hence rendering access to the
disruptive offering (initially not desired)
also possible to mainstream customers
(Govindarajan, Kopalle & Danneels, 2011).

In conclusion, we can argue that disruptive
innovation is a theory that seeks to explain
changes and new entries into established
markets. The result of disruptive innovation is
visible when mainstream customers switch to
the new disruptive product that is gaining
market share on established markets.
What if the new disruptive solution has
been brought to maturity and has triggered
interest in markets that are geographically
distant and disconnected from established
markets? Disruptive innovation theory was
not developed, and is as yet too unrefined, to
explain this phenomenon.
Innovation at the Bottom of the
Pyramid (BOP)
While the disruptive innovation paradigm
explores the dynamics originating within the
hub of an industry, a new approach was devel-
oped to understand what was taking place in
emerging economies and their markets
(Karnani, 2007; Akula, 2008; Gino & Staats,
2012). This orientation brought scholars to
thinking of emerging economies as focal
markets to which companies should pay
increasing attention and develop a new R&D
orientation (Prahalad & Hart, 2002).
Traditionally, MNCs delocalized their R&D-
oriented foreign direct investment (FDI) in
emerging economies for two main reasons
(Gassmann & Han, 2004; Von Zedtwitz, 2004):

• access to local markets,
• access to high-skilled research personnel at
a lower cost.
Following these two drivers, most R&D
carried out by foreign MNCs in emerging
countries consisted in the adaptation of global
products to the specific needs of the local
market. R&D, crucial for the development of
new products, has traditionally been undis-
closed by headquarters (Patel & Pavitt, 1991; Di
Minin & Bianchi, 2011), and this is particularly
true of R&D internationalization in emerging
economies.
The new perspective in the early 2000s was
that emerging market potential was not
exploited with the previous approach and that
a new type of innovation management had to
be developed. Companies noted that respond-
ing to local market needs with a simple local
adaptation of global products developed in
their (mainly) western headquarters (glocali-
zation) was ineffective in exploiting the entire
potential of these growing markets (London &
Hart, 2004; Rangan, Chu & Petkoski, 2011).
Prahalad and Hart (2002), and later on
Prahalad (2004), introduced the new approach
to emerging economies as a source of signifi-
cant profit generation through the develop-
ment and commercialization of ad hoc products
and services for the markets of the poor
(Garrette & Karnani, 2010; Simanis, 2012).

Prahalad’s approach is expressed in the title of
his 2004 book The Fortune at the Bottom of the
Pyramid: Eradicating Poverty through Profits. The
author identifies a large opportunity both for
local and MNCs operating in emerging econo-
mies and provides examples such as ICICI
Bank, which provides Indian rural populations
with bank credit for small projects (which in
turn become profitable and make them able to
return the loan with low interest), or Voxiva,
which developed a text message-based plat-
form for favouring communication between
urban and health centres in Peru. Both projects,
based on low cost and pricing strategies, faced
an experimental stage for the purpose of vali-
dating their economic feasibility and soon
moved forward, replicating their model in
other emerging countries and contexts.
According to Prahalad’s perspective, MNCs
serving only the top of the pyramid (the
wealthier part of the population) in emerging
economies suffer from business myopia in a
way that closely recalls the marketing chal-
lenge that Christensen’s incumbent firms
faced in developing disruptive innovation for
new or emerging market niches.
What is of great interest to us is that,
although there is no direct and explicit link
between these theories, the BOP concept
shares some similarities with the disruptive
innovation theory (Hart & Christensen, 2002;
Prahalad & Hammond, 2002; Prahalad, 2012).
It suggests developing products and services
for a market segment requesting different

attributes than those of mainstream customers
(Wood & Hamel 2002; Seelos & Mair, 2007;
Anderson, Markides & Kupp, 2010) and, in
particular, access to the same technology at a
much lower price. In reality, it addresses a
market that does not yet exist, seemingly con-
figuring what Govindarajan and Kopalle
(2006a, 2006b) identify as disruptive innova-
tion that creates a new market. In our opinion,
innovation at the BOP cannot be easily, or
entirely, assimilated with disruptive innova-
tion theory. We will explain why in the next
section, explicitly linking the BOP to the dis-
ruptive innovation paradigm.
Disruptive Innovations from
Emerging Economies
Parallel to the work on ‘Serving the Bottom of
the Pyramid’, a further wave of exploration
was initiated by scholars linking the disruptive
innovation theory and Prahalad’s non-served
markets of the poorest in emerging economies
(Hart & Christensen, 2002; London & Hart,
2004).
The argument of scholars applying disrup-
tive innovation to explain the success of new

products originating from emerging econo-
mies is as follows: foreign MNCs develop
products for emerging markets and later use
them to penetrate the low-end segment of
developed markets in the US and Europe, and
domestic firms leverage on their cost structure
and knowledge of the domestic context to
serve local, and later developed, markets (Ray
& Ray, 2011; Schanz et al., 2011; Markides,
2012).
To the best of our knowledge, Hart and
Christensen (2002) for the first time introduced
the link between disruptive innovation theory
and emerging economies. Their argument is
clearly in line with Prahalad’s work referring
to ‘innovation from the base of the pyramid’.
The authors propose examples of Asian com-
panies that succeeded in introducing disrup-
tive innovations in low-income countries,
enabling poor people to afford certain types of
technological products and generating profits
for themselves.
Recently, Hang, Chen and Subramanian
(2010) demonstrated four cases of Asian com-
panies that, starting from their low-income
markets (China and India), developed disrup-
tive products. Galanz and Haier, for example,
developed ad hoc products for penetrating the
Chinese domestic market and responding to
specific local needs (a microwave for Galanz
and a washing machine for Haier). Once they
succeeded in China, they were able to export
their product to developed countries serving a
market segment that was ignored by incum-

bents due to its size, a market segment that
was eager for low-cost products with strong
energy and room-saving attributes and that
did not care about traditional attributes for
those items such as capacity. After a few years
of internal and external R&D investment, both
companies were able to penetrate also the
high-end of advanced economies’ markets,
disrupting local incumbents. The success
pursued in these markets brought them per-
formance improvements on attributes that had
at first been neglected and valued by main-
stream customers in developed economies.
This pushed them to invest globally and to
steadily grow in developed economies.
We believe that in both works cited above,
the disruptive innovation concept is used in a
way that differs from the traditional applica-
tion of the concept within established markets
in developed economies. The traditionally
defined disruptive innovation paradigm
(Bower & Christensen, 1995; Christensen,
1997) claims that new products (or services)
are considered disruptive when they respond
to an ignored and new market segment that is
usually small, unprofitable for incumbents and
has differentiated needs in terms of product
attributes. Could we say that the idea of inno-
vation originating in emerging markets pre-
sented by Hart and Christensen (2002) is
indeed a disruptive innovation? We think this
is true only in part, and that three limitations
need to be considered in relation to the char-
acteristics of disruptiveness mentioned above.

In particular, we need to consider (1) the
categorization of mainstream and non-
mainstream customers, (2) market size, and (3)
disruptive innovators (see Table 2):
1. Companies operating in emerging econo-
mies have traditionally served those
markets adopting a glocalization approach
to market segmentation, thus serving cus-
tomers that correspond and share similar
characteristics to those segments served
back in their country of origin or in devel-
oped markets. These are their mainstream
customers, who might represent the great
majority at home but in emerging econo-
mies represent only the top of the pyramid.
Adopting a marketing perspective instead,
as the disruptive challenge requires us to
(Christensen, 1997; Danneels, 2004), main-
stream customers in emerging markets
should be defined as the large part of the
population (be it individuals or companies)
that cannot afford expensive state-of-the-art
technology and that are partly served by
local companies that can interpret their
needs and respond to them thanks to their
cost structure.
2. One of the main challenges that incumbent
firms face when developing or responding
to disruptive innovations in their markets is
that the size of the emerging market with

different requirements is too small to cover
the development costs of new products
(Christensen, 1997; Christensen & Raynor,
2003). Indeed, the size of the market does
not match the size of the company and its
related cost structure as it does in the case
of small entrants or spin-off companies.
This is not true in emerging economies,
where the market served by innovations, as
in the cases presented in Hart and
Christensen (2002) and Hang, Chen and
Subramanian (2010), is much bigger than
that served by glocal products, so that the
market size is potentially huge, assuming
that access to these market segments is
feasible.
3. Disruptive innovations in developed econo-
mies generally come from a small entrant
firm (e.g., a start-up company) that is gen-
erated by either a new entrepreneurial
activity or a spin-off company from an
incumbent firm (Bower & Christensen,
1995; Christensen, 1997; Walsh, Kirchhoff &
Newbert, 2002; Christensen & Raynor,
2003). The generation of disruptive innova-
tions in emerging economies could be
developed by domestic companies that
naturally have a cost structure and a market
orientation that fits the local environment
and by subsidiaries of MNCs that have
evolved and gained enough autonomy to

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