When Being Rational Kills Your Business – Clayton Christensen

Last week, I attended the World Innovation Forum on behalf of my company, Spigit. One of the speakers was Clayton Christensen, Harvard professor most famous for his book The Innovator’s Dilemma. His talk was one I really looked forward to, and he didn’t disappoint.

The theme of his talk was Disruptive Innovation as a Platform for Growth. A good all-purpose title, but one that really didn’t do justice to the range of topics. Clayton delivered a lot of good knowledge and analysis. I tweeted most of his talk, and I wanted to pull it together in a blog post here. So let’s get to it.

Big Steel vs. Mini Mills

He opened with a discussion that one can find in The Innovator’s Dilemma. It’s the tale of how big traditional integrated steel mills lost market share to upstart mini mills over the course of several decades. To the point where the integrated steel mills have for the most part been shuttered.

Key to the story is this: The steel market could be segmented into different segments, from low-grade to high-grade steel. And profit margins improved as you sold into the higher grade markets. The big integrated mills produced all grades of steel, which meant the profit margins for the different segments averaged out.

Cue the disruptive technology, mini mills in this case. The mini mills initially were too small to utilize the then-current technology to produce high grade steel. But they could produce low-grade quite well, and at a much lower cost. This meant they could easily underprice the big integrated steel mills, and they gained market share in the lower end of the steel market.

Ultimately ceding the low-end seemed OK to the big mills. It meant dropping the lowest profit business, which made margins look better, as the graphic below demonstrates:

In the short term, this strategy was quite beneficial to the integrated mills. The next part of the story is where the disruption really kicks in. The low grade mini mills’ technology got better, so that they could produce increasingly higher grade steel at lower costs. This forced the big integrated mills to retreat to ever higher margin segments, until there was no place left to hide.

Disruptive technology. Steel in this case, but it happens everywhere.

Why Do Companies Allow this to Happen? They’re Being Rational

This is a wide open question, and it’s one that cannot be answered completely here. But Christensen provided some valuable points.

In pursuing the higher margin business and jettisoning the lower segments, companies are being eminently rational. Fighting it out over low-margin business is generally not considered a good application of corporate capital. Why? Here’s my personal take on Christensen’s disruption model:

• Existing customers are not clamoring for your low-margin business
• Current manufacturing and installed base do not support lower cost production or delivery
• Return on capital for protecting the low-margin business is poor
• Low-margin business is not strategic to customers, and does not fit long term company goals

Indeed, all of the above are rational and generally the right approach to the problem. Spending large dollars pursuing low-margin commodity businesses is something most of us would view as folly. Christensen, in describing the big integrated steel mills’ management, noted that he never uses the word “stupid”. They’re actually being rational.

In being rational, companies encounter a significant problem when it comes to innovation:

A business model hijacks an idea and forces it to change to conform.

The existing business model rides on a set of processes and principles. Anything new must work with that “innovation infrastructure” to get anywhere internally. But often, this requires changing an idea so fundamentally that it no longer works like it’s originator thought it would. Innovation takes a hit.

Who’s Next for Disruption? Oracle and Toyota

Christensen mentioned some specific companies at risk for disruption.

Oracle, the ever growing enterprise software behemoth, is at risk for disruption from Salesforce.com. I get that. Salesforce clearly has lower cost applications that can target Oracle. In databases, Oracle seems to have prevented disruption by MySQL by acquiring it.

Toyota was a surprise pick for disruption…by the likes of Kia and Hyundai. As Christensen explained it, Toyota has been putting resources into higher margin luxury cars and pick-up trucks. Meaning they’re vulnerable at the lower end.

That’s one thing with these disruptive technologies. It’s really hard to believe it before it happens.

Key Strategies for Addressing Market Insurgents

Christensen offered three pieces of advice to companies in dealing with market disruption:

1. Create separate units to deal with insurgents
2. Frame the problem correctly
3. Understand the job your product was hired to do

Separate business units. This advice is in his book, but it still makes sense. Essentially, the best way to handle disruptive technologies is to tackle them in a separate division outside the main corporate focus. Keys to this division:

• Separate sales force
• Leverage new technologies for cost-advantage, performance benefits
• Be willing to cannibalize existing sales

Most companies do not do this. In the computer industry, Christensen cited IBM as the only company to successfully navigate disruptive technologies: Mainframe -> Mini computers -> PCs. Of course, they’ve jettisoned the PC business. I wonder if the next wave will be the mobile platforms emerging, like the iPhone.

Frame the problem correctly. Christensen believes the root cause for the inability to innovate is not framing the problem correctly. Companies do not understand what is happening with their customers as they use new technologies:

Expensive failure always results when disruption is framed as technological rather than business model terms.

There’s a tendency to view market competition through a technology lens, not a business one. A company will see a new technology, and note its obvious inferiority to what current leaders offer. It then becomes easy to dismiss it.

That’s the mistake.

Companies should think in terms of the business context for changes in their industry.Best way to do this?

Customers hire your product for a job. This was an intriguing way to put things. Christensen advises thinking in terms of “the job your product has been hired to do”. I heard this, and my initial instinct was…huh? But it really is a powerful way to understand how your customers use your products and services.

The crux of his point is that segmenting the market on demographics – e.g. urban hipsters, suburban soccer moms, etc. – is a way of performing marketing. But it’s not useful as context for product roadmaps or assessing new competition for your customers’ wallets.

Christensen referenced a Peter Drucker quote to bring this home:

The customer rarely buys what the company thinks it is selling him.

There’s an enormous amount to be learned when you consider your company’s product in the hands of a customer. In understanding the uses of the product, the  job of the product, you increase the likelihood of framing diruptioon in business terms, not technology. One example he gave is Ikea. Ikea’s not a low-priced furniture store. It’s integrated to get a job done – to get your place furnished fast.

The Disruptive Potential of Green Tech

Green technology has emerged as an important driver of our future economy. There’s a lot of investment in the sector. Here’s where Christensen put forth an interesting observation.

He traveled to Mongolia to see his kid who was on a mission there. While walking through a market, he came across some cheap solar-powered TVs. They were miniature, and the solar panels were low-cost materials. The quality wasn’t great, but they functioned well enough for that part of the world.

He compared these little cheap solar devices to the larger green initiatives underway today. And in his view, disruption of the traditional power industry is more likely to come from things like cheap solar TVs than from big heavy investments.

Those TVs are closer to the job people are hiring for.

Electric cars are often in the news today. The biggest challenge for them is that currently technology requires a heavy battery onboard. This causes them to be slow, and they don’t go very far on a charge. So who might be interested in “hiring” heavy, slow cars that can’t go too far? Parents of teenagers.

The Power of Employee Ideas

I’ll close out this post with this note. Christensen was engaged by Intel to talk to its employees about disruptive innovation, and framing the problem correctly. Led by then-CEO Andy Grove, the company held a series of employee meetings to discuss new ideas for their markets.

Last year, ideas coming from those employee ideas amounted to $18 billion for Intel. Not bad, not bad at all.