Managing Disruptive Innovation

ISM 6026
Mgmt. of Information Systems
& Technology
Presentation #2
- Staying Ahead of Disruptive
Innovation -
October 13, 2002

© William J. Brown
Copyright WILLIAM J. BROWN
All Rights Reserved.

Don't hesitate to embrace
technology!
• Established companies find it hard to
cope with emerging technologies. It
need not be so, say George Day and
Paul Schoemaker (Wharton School of
Business distinguished faculty)
– “Wharton on Managing Emerging
Technologies”
– Required course text (not yet arrived – I
have the first few chapters for you tonight)

Objectives of this Discussion
• Understanding emerging & discontinuous
technologies
• Discuss disruptive innovation
• Typical strategies for incumbents
• The 4 traps
• How to avoid the pitfalls
• Lots of “mini-cases” to emphasize
principles

What Are Emerging
Technologies
• What was the definition given by Day?
• Defined: Emerging technologies are
science-based innovations that have the
potential to create a new industry or
transform an existing one.


Discontinuous Technologies
• Emerging technologies include
“discontinuous technologies”
• Defined: These are derived from radical
innovations
– Examples include:
• Biotherapeutics
• Digital photography
• High-temperature superconductors
• Microrobotics
• Portable computers


Evolutionary Technologies
• Emerging technologies are also inclusive of
“evolutionary technologies”
• Defined: These are formed by the
convergence of previously separate research
streams
– Examples of these include:
• MRI imaging
• Faxing
• Electronic banking
• HDTV
• the Internet itself

Defining Technology
• Defined: Used broadly in business and
science to refer to the process of
transforming basic knowledge into useful
application.
• Day challenges one to consider science
as a know-what, and technology as
know-how.
– Similarly, he views markets and businesses
focusing on know-where and know-who

• Thus, as business people we define
technology as a set of discipline-based
skills that are applied to a particular
product or market
– Technology can focus on a component,
an entire product or an industry.


• Emerging technologies are those where:
– the knowledge base is expanding,
– the application to existing markets is undergoing
innovation, or
– new markets are being tapped to existing markets
• It is also useful to distinguish technologies
that are new to the firm or unit of the firm from
those that are new to the world


• Many managers struggle with how to scan,
experiment and integrate externally available
technologies into their existing products as
well as to create new products
• The focus of the first text is on how to
transform technologies that are still emerging
into value creation within existing or newly
emerging markets


• Disruptive innovations, spawned by
developments in emerging technologies
such as the Internet, intelligent sensors,
genomics, nanotechnology, digital ink,
mutant materials and file sharing
software, have the potential to consume
industries and make existing strategies
obsolete.


But how do you spot the winners?

• Which of the flashy new technologies in
the labs or on drawing boards today will
become the hot new products of
tomorrow?
• Which ones will be embraced by the
market and which ones ignored?


• New technologies often produce a major
disruption on the established trajectory of
technical advances
– They draw upon new or different science bases
– Thus require the arduous development of new
competencies
• But, in their earliest stages of development, it
is not evident they will achieve a decisive
relative advantage

How is this different from
“business as usual”?
• Uncertainty in a stable environment is
manageable because there are usually only a
few discrete outcomes that define the future
– Robust strategies can be devised to adapt to
those possibilities
• Uncertainty created by an emerging
technology is very different:
– Risks are not just external but also internal
– i.e., there is a risk of not knowing what we do not
know


Management Still Critical
• Too many managers throw up their hands
and fail to analyze situations
• A huge mistake is made if a coherent strategy
for maneuvering through the uncertainty isn’t
attempted
• Choices must be made about initiatives to
support the emerging technology, alliances to
pursue and human resources to develop
– The strategy must also include a learning
component and acknowledge multiple futures

“Internet Time” isn’t the only
thing passing by fast
• Adoption rates of various communication technologies
100
90
80

2
70
60

4
50

5
40

1
30

3
20

6
7
10

8
0

1920 1930 1940 1950 1960 1970 1980 1990 2000
Source: The Wall Street Journal, 1998

• As a result of breakthroughs and
relentless capitalistic pressures, an
increasing compression of technology
adoption curves is clearly happening
• The Internet is not the only example:
– Similar forces are at work with other
technologies, reflecting the overall rate of
technological progress and the desire to
gain a first-mover advantage

Capitalistic Pressures?

• The overall trends toward free markets,
globalization, and deregulation are only
adding fuel to the accelerating rate of
technological change.
• Also, advances in one domain are
feeding and reinforcing progress in
other domains.


The “Fast Follower” Strategy

• It used to be possible for companies to
sit-by and watch for an occassional
discontinuity or wait for other firms to
take the development risks.
• This has become a risky bet in “winner-
take-all” markets
– Where there is a widening gap between
leaders and followers

• Example:
– By 1998 (ancient history now), one study
found that the top 5% of all Web sites
garnered more than 74% of all traffic


Developing New
Competencies
• We’ll see that a discontinuous innovation can
either enhance or destroy the existing
competencies of incumbent leader.
• Too often, emerging technologies do not fit
the competencies of incumbents and
undermine the slowly acquired skills,
knowledge and assets that were needed to
master the original technology now being
replaced.

The Case of Western Union


Western Union
• A “Fortune 100” company 50 years ago
• It’s telegram transmission competencies
were by-passed in turn by:
– Couriers
– Fax
– Overnight delivery services
– Email
• Today, where is Western Union?

“Creative Destruction” Not New
Attackers dislodged incumbents when:
• Diesel-electric locomotives prevailed over
steam locomotives
• Ball points replaced fountain pens
• Vacuum tubes gave way to transistors
• Battle between Edison & Westinghouse over
DC versus AC electricity distribution

Can you think of any others?

Not a “New Game”
– Just Different
• We’ll examine in-depth the cumulative
different challenges
• The manager’s role is to control and manage
the uncertainty
– Characterized by disequilibrium, ambiguity, and a
rate of change that defies standard analysis
• Some of the most successful players in
emerging technologies have not managed
uncertainty as much as navigated and
exploited it

Best Practices:
The PDA Industry
• 1992, Apple introduces the Newton
“personal digital assistant”
– Heralded as a new “$3.5 trillion digital
information industry”
• That same year, Palm Computing, Inc.
was founded


Looking @ Newton


The history of the Newton:
Click on the link
• Apple Newton prototypes


• By 1998, the PalmPilot had become
the fastest selling consumer electronics
product in history, shipping more than
1 million units in the first 18 months.
• That same year, after spending $500
million on the Newton, Apple pulled the
plug on its failing product.


Lots of Companies Join the Party

• Besides Apple, Compaq, Motorola, AT&T,
Bell South, IBM, Hewlett-Packard, Novell,
Casio, Sony, and Microsoft all announced
plans to build or invest in these products.
– Most were casualties
– Go Corporation (back by Kleiner Perkins)
burned through $75 million before Chapter 11
– Palm claimed to have spent just $3 million to
develop the first prototype of the Pilot

How did Palm do it?

• Palm Computing shaped and has lead
this emerging technology since its
inception
• How were they able to turn a technology
that many others also recognized into a
commercial blockbuster?
• Why did Apple Newton fail?


Lessons from PDAs

• Incumbents can be at a disadvantage
• Knowledge assets outweigh physical
assets
• Understand how customers use the
technology
• Learn from experiments
• Don’t go for the big market all at once

A Valuable Disclaimer
• Stories of successes and failures are told with
the benefit of hindsight – and they’re perhaps
somewhat misleading.
• In reality, as managers we must make
decisions about pursuing new technologies
with highly imperfect information.
• The reality is also that we some technologies
succeed, and some fail, and managers can
never know for sure beforehand if a
technology will be a dud or the next killer
application. Copyright WILLIAM J. BROWN

• Conventional wisdom holds that large
established companies are likely to lose out
to smaller attackers when they try exploiting
these breakthroughs.
• Yet why should incumbents encounter so
much difficulty?
• Can they overcome their handicaps?
– Companies such as GE, Intel, Schwab and
Microsoft have embraced disruptive innovations.
– What can we learn from their examples?


• Established companies control substantial
resources:
– established infrastructure and processes
– scale and scope
– valuable brand names
– entrenched relationships and deep pockets
• They can and do spend heavily on
technology development and market
research, although most of this money is
devoted to evolutionary innovations that
make their current offerings perform better in
ways their customers already value.


• For all their advantages, incumbents are often
impotent when it comes to disruptive innovations.
• Their size slows them down, and past commitments
restrict their flexibility.
• Equity markets expect continued growth in earnings
while start-ups are valued for their prospects and
rewarded with large market capitalizations they can
use to fund innovation.
• Incumbents are disadvantaged by their structures,
capabilities and outlook.
– Their finely honed instincts, established ways of thinking and
embedded skills make it tough to deal with a disruptive
innovation that requires a different approach.


• Many of the problems that befuddle
incumbents are rooted in the
technological uncertainties, ambiguous
customer signals and immature
competitive structures of markets for
disruptive innovations.


• As recently as 1995, interactive television dominated
corporate radar screens as the hottest new electronic
marketplace.
– This technology soon faded as the internet revealed the
power of networks.
• Which of the technologies now reaching critical mass
in the laboratories will become the hot innovations of
the future?
• Few companies can avoid asking themselves how
well they will capitalize on these future disruptions.


Pitfalls for Incumbents
• Disruptive innovations, posing the threat to
their existing capabilities, make established
companies prone to stick with what is familiar
for too long.
• Even if this is avoided, incumbents are often
unwilling to make a strong commitment and
find it difficult to persist in the face of
uncertainty and adversity.
• Although these dangers are related, they
occur at different points in the decision
process and require different remedies.

Trap 1: Delay
• When faced with uncertainty, it is tempting to
wait.
– A watching brief may be assigned to an internal
team that monitors families of technologies.
• Whether there is any value in these moves
depends on whether there is a credible
champion who can see beyond the
imperfections of the first costly version:
– early electronic watches were bulky and personal
digital appliances were devalued by the limitations
of the Apple Newton.

• It is natural to underestimate developing
technologies or new approaches because
they don't measure up to the familiar
alternative, or appear suitable only for narrow
applications.
• Other developments may be easy to dismiss
on the grounds that their small markets will
not meet the growth needs of large
companies.
• Yet all large markets were once in an
embryonic state with their origins in limited
applications.


Trap 2: Sticking with the Familiar
• Choice of technology is often clouded by
uncertainty about whether technical hurdles
can be overcome and which standard or
architecture will prevail.
• When there are competing choices,
companies are likely to base their decision on
the technology path that feels most familiar.
• For example, various US newspapers
merged their classified recruitment
advertising into a common database
(Careerpath.com), without much change in
approach, (unlike Monster.com).

• Established companies typically search in
areas close to their current expertise, and
may not have the capability to appraise the
options properly.
• Their instincts may be to seek a proprietary
position to lock in customers, because that
worked in their core market.
• Such a move makes customers suspicious,
especially in today's open systems
environment.


Trap 3: Reluctance to Commit
• Established companies seldom commit
wholeheartedly to a disruptive innovation.
• Instead, they are more likely to enter in stages.
• Many plausible reasons explain their
hesitation.


• First, managers are concerned about
cannibalizing profitable products or
encountering resistance from channel
partners.
– Even if this is not an issue, prospects may appear
less attractive than current business, making it
difficult to justify investments.
– Encyclopedia Britannica was slow to move to CD-
Rom and lost 70 per cent of its revenue between
1990 and 1997.


• As one classic study showed, of 27
companies confronted with a threatening
technology, only four entered aggressively
and three never participated at all.
• One reason is that managers are focused on
existing customers and new technologies
may seem applicable only to small market
segments they don't serve or understand.
• This makes them vulnerable to attacks by
outsiders who use the disruptive innovation
as their platform.


• Finally, successful organizations are not
naturally ambidextrous, so they cannot
balance the demands of familiar
markets with the alien requirements of a
disruptive innovation.


• These four explanations reinforce each
other to impair decision-making, erode
enthusiasm and cause managers to
hesitate.
• Such afflictions do not inhibit new
entrants.


Trap 4: Lack of Persistence
• Established companies being held to
earnings forecasts have little patience with
adverse results.
• US newspaper giant Knight-Ridder, owner of
more than 30 titles, is a case in point.
– When its early forays into television in 1978 and
cable in 1983 met setbacks, the company sold the
business.
– Success may require patience. It took Gannett a
decade of losses to make USA Today a winner.


• Yet missed forecasts and dashed hopes are
inevitable with disruptive innovation:
– demand may not materialize as expected,
– competitors may crowd into the market,
– or the technology may veer in an unexpected
direction.
• Initial enthusiasm may be replaced with
skepticism about the innovation becoming
profitable.
• The result is that companies often withdraw
from early probes and don't come back until the
innovation is proven by others.
• At this point it is too late to achieve leadership.

Avoiding the Pitfalls
• While awareness of the pitfalls described can help
avoid them, the best defense is a good offence.
• Here, there are four proven approaches:
– widening peripheral vision,
– creating a learning culture,
– staying flexible in strategic ways,
– providing organizational autonomy.
• These solutions do not correspond one-to-one
with each trap, but rather address several of them
at a time.
• Think of them as ingredients from which an
approach can be fashioned that fits your needs.

Signals from the Edge
• Disruptive innovations signal their arrival long
before they bloom.
• Some signs may be clear to those who look;
others can only be seen by the prepared
mind.
• As the philosopher Kant noted, “we can only
see what we are prepared to see.”
• Weak signals usually come from the
periphery, where previously unknown
competitors are making inroads, unfamiliar
customers are early adopters and different
standards are emerging.

• But the periphery is noisy, with numerous
tangential technologies that may or may not
be relevant.
• Background noise surrounds the converging
entertainment, telecommunications,
information, cable, and computer sectors.
• Here, a myriad of technologies such as
interactive TV, web TV, DVD, desktop video,
and satellite transmission combine to create
new products.
• Background noise to one company may be a
strong signal to another.

• The first step in deciding which signals and
trends to scan is to define the significant
technologies.
• This requires shifting the focus from the
characteristics of products to features that
provide benefits.
• For example, customers did not want X-rays
as such, but they did need more accurate
images of tissues and bones to help spot
problems.


• Companies also can study users who
are ahead of the curve to see the
promise of a new technology, or work
jointly with lead users (in say, industrial
markets) on the next generation of
products.


• Once features are defined, the next question is
how well the innovation can deliver features
that meet customer needs and budgets,
relative to competing technologies.
• This entails more than a linear extrapolation into
the future.
• First, remember the typical S-shaped curve
plotting the relationship between performance and
development expenditure: initially, there is little
sign of progress, but then performance rises
steeply for relatively little effort before leveling off.


• Once a technology trajectory has been
projected, the challenge is to estimate the
rate of adoption and potential market size.
• When it is not yet apparent who customers
will be and even early users have yet to
experience the product, such estimates are
difficult.
• Traditional market research is seldom
applicable to embryonic markets. Sample
surveys, concept tests, and conjoint analysis
were designed for well-defined problems in
existing markets.

• A different approach is needed when the
concept is ill-formed, the technology is barely
ready and questions of cost, availability, and
performance are unresolved.
• People may not know whether they want
holographic TV, but they can assess how
much more they value its benefits relative to
present offerings.


• Xerox's strategy for estimating the potential
market for fax machines in the 1970s illustrates
how customer benefits and functionality can be
used to estimate markets.
• Managers measured the extent and frequency of
urgent written messages, their time sensitivity,
and the form and size of the message.
• Then they contrasted the promise of fax with
mail, telephone, express delivery and so on.
• With this approach, Xerox foresaw a business
market of a million units. In hindsight, this
number proved too low, but was then larger than
people expected.

Assessing Disruptive Innovation
• In summary, choosing how to assess the
market for a disruptive innovation should be
guided by three principles.
– First, paint the big picture: this is not the time to
ask for carefully calibrated results.
• The issue is simply whether the market is big enough to
support development.
– Next, use multiple methods.
• While any one market research method will be limited or
flawed in some respect, a combination may yield
conclusions that are directionally sound.
– Finally, focus on needs not products: prospective
customers may not be able to visualize radical
products, but they can be eloquent about their
problems andCopyright WILLIAM J. BROWN
changing needs.

Building a Learning Capacity
• A second way to avoid the pitfalls of
disruptive innovations is to keep learning.
• The challenge here is collective, not just
individual.
• Without learning, noisy information flowing
from the periphery will create confusion, not
insight. Information must be absorbed,
communicated, and intensively discussed so
its implications are understood.

The organization must possess or
acquire several attributes:
• openness to diverse views, within and
across departments;
• willingness to challenge deep-seated
assumptions;
• a climate that encourages experimentation
and rewards "well-intentioned" failure.


• Entrenched attitudes may impede thinking
needed to grasp discontinuities and
surprises.
• Changing is not easy because attitudes are
grounded in experience, reinforced by
commitments and protected by inertia.
• Before prevailing thinking can be challenged,
it should be described by making the views
and assumptions of managers clear.
• Scenario planning can help challenge deep-
rooted mentalities.

• Adapting to the vagaries of disruptive
innovations requires experiment and an
openness to learning from failures.
• Sometimes experiment requires a willingness
to create diverse solutions, by endorsing
parallel development activities.
• For example, Intel was researching Risc
chips even as complex microprocessors were
being emphasized; and Shell is developing
renewable energy sources, from solar to wind
to geothermal.


• It may also mean introducing prototypes into
a market segment.
• Learning from this quickly is vital, followed by
modifying the product, and trying again in a
process of successive approximation.
• This is how Motorola entered the cellular
phone market, and GE tackled the scanning
business.


Maintain Strategic Flexibility
• A paradox of disruptive innovation is that although it
is prudent to make limited investments, sometimes a
strong commitment leads to success.
• One way to reduce this dilemma is to increase
organizational flexibility, so lowering the cost of
making a commitment and the cost of reversing
direction.
• This is similar to using flexible rather than fixed
manufacturing systems.
• Commitment might seem to be the opposite of
flexibility and you may not be able to have it both
ways. However, only if the commitment is irreversible
does it destroy flexibility.

Microsoft is a prime example of a
company maintaining flexibility
• Its much-celebrated "turn on a dime"
response when confronted with
Netscape's web browser is just one
instance.


• Microsoft was placing many bets as early as
1988.
– At that time, Apple was at its peak with its superior
graphical interface for the Macintosh making
Microsoft's DOS look like a distant second.
– However, Microsoft was operating on several
fronts. On the one hand, it was developing
Windows; on another, it was pushing OS/2, which
it developed with IBM.
– At the same time, Microsoft was introducing
application software, including Excel and Word, for
both Windows and Macintosh. Lastly, Microsoft
was in partnership with SCO, the largest provider
of Unix for the PC.


Lessons from Microsoft
• In essence, Microsoft had developed a strong
hand of cards to play in a variety of worlds
that might emerge.
• In hindsight, its portfolio of options was
commensurate with the uncertainties then
surrounding hardware and software
development.
• Questions of standards, features, channels
and delivery modes (PCs versus servers)
were still to be settled.
• In addition to developing a robust hand,
Microsoft developed a culture that could
quickly change strategy. J. BROWN
Copyright WILLIAM

Organizational Separation
• The fourth strategy to avoid the pitfalls of
large incumbents is to hive off the disruptive
business into a separate unit.
• The more the initiative can operate from a
smaller, entrepreneurial mindset, the less it
will be held back by the inertia, controls, risk-
avoidance and big-company thinking that
leads to the pitfalls discussed above.
• By creating an isolated nursery, the company
protects the new venture from infection by
microbes that, while not dangerous to the
large company, can be deadly to the new.

• Many large companies set up separate unit dedicated
to new ideas.
• Examples include GM's Saturn division, IBM's PC
unit, or Roche's Genentech investment.
• The objective of putting the new business in a cocoon
is to enable the new group to do things differently
while still permitting the transfer of resources and
ideas from the parent.
• This also permits separate objectives, recognition of
long development cycles and continuing cash drains,
as well as different criteria so the performance of
managers in the rest of the organization is not
jeopardized.
• Above all, it creates flexibility.

Many Degrees of Separation
• Some companies take the approach as far as to
create spin-offs.
• These may be complete companies with their
own stock, board and management teams, in
which the parent retains some ownership.
• Such equity carve-outs have been pursued by
Thermo Electron, Safeguard Scientifics, Enron,
Genzyme, and The Limited.
• This approach offers access to capital (via a
public stock offering), strategic value from the
corporate center, operating independence,
development of executive talent in smaller units
and greater motivation for key personnel through
stock options and operatingBROWN
Copyright WILLIAM J. freedom.

Lessons from Kodak
• Kodak's experience with electronic imaging
highlights the strategic importance of
separation (in whatever form).
• Originally, electronic imaging activities were
dispersed among Kodak's chemical imaging
facilities.
• This had a number of bad consequences.
Managers of the film business continually
interfered with electronic imaging projects,
which were perceived as threatening the
existing customer base.

• The company policy that all engineers
be paid the same meant Kodak could
not compete for highly paid electronic
engineers.
• Because digital imaging projects were
scattered throughout the company,
there was no cohesive vision and
limited accountability for performance.


• When George Fisher moved from
Motorola to become chief executive, he
put all digital imaging projects in one
autonomous division and told managers
to launch products.
• In a departure from a traditional "go it
alone" strategy, he also initiated
alliances to jointly develop projects.

Threaten the Establishment

• Separation also implies willingness
to cannibalize core business.
• Indeed, a new venture may absorb
the parent.
– This happened when Charles E.
Schwab entered online brokerage.


Lessons from Charles Schwab
• The Schwab website let investors trade securities for $30.
• By 1998, it was the dominant online broker.
• Meanwhile, customers of Schwab's discount brokerage
were paying an average of $65 a trade, but getting
personal service.
• As online trading boomed, the tensions from forcing
customers to choose between service and price mounted.
• The decision was made that all trades would be made at
$30, despite the damage to revenue.
• OUTCOMES: Not only did this help Schwab compete with
online rivals, but its ability to deliver personalized
information to customers at low cost made Schwab a
bigger threat to full-service brokers.

Conclusions

How can established companies
compete, survive and succeed in
industries that are being created or
transformed by disruptive innovations?

• Success requires support from senior
management, separation of the new, flexibility
and a willingness to take risks and learn from
experiments.
• There should be a diversity of opinion to
challenge dominant attitudes and misleading
precedents, so avoiding myopic views of new
ventures.
• The best innovators think broadly and will
entertain a wide range of possibilities before
they converge on a solution.


• These prescriptions need considerable
tailoring to match each disruptive innovation
and the organization involved.
• Indeed, the purpose of a template for a high-
commitment organization is to enable it to
cope with the tension of uncertainty while
achieving commitment to the choices made.
• The main point is that managing disruptive
innovations constitutes a different game for
established companies, with its own traps
and solutions.


• We have identified the major pitfalls and
remedies from empirical experience and
academic studies of the underlying causes.
• We are a long way from understanding the
intricacies of these pitfalls and ways to avoid
them, but the broad outlines of common
mistakes and practical solutions are
becoming apparent.


Managing Disruptive Innovation

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