Functional Needs and Irrational Wants

The iPhone is like a pocket Porsche -- it comes in iconic, arguably artistic designs like a Porsche. The difference is that it's affordable to a lot more people. Artistic, iconic design leads to strong brand value and purchase decisions driven not just driven by rational, functional needs but also by irrational wants (desire, lust, envy, communicating status, etc.). Some consumer products have an inherent artistic element that goes beyond purely functional needs: cars, smartphones, fashion, furniture, and so on. Conversely, some consumer products are almost entirely functional in nature -- people buy or use them because of functional needs, not because of irrational wants. Some examples of purely functional products/services might be: hard drives (Christensen's famous example from The Innovator's Dilemma), backhoes, commodities like steel or glass, Internet search engines, and artificial intelligence. 

If you're selling a purely functional product, Christensen's "good enough" concept is particularly important. That's because irrational wants don't come into play, and the buyer can easily determine what's good enough by comparing the product's functional, measurable performance attributes with the particular job the buyer needs to get done. So a buyer can look at a hard drive, for example, examine its data retrieval rate and storage capacity, and compare that to his functional needs -- how he'll be using the computer and how many photos, videos, and documents he needs to store -- to determine whether the hard drive is good enough or whether it overserves.

As noted in other posts, the best way to keep functional product elements from overserving is to make sure improvements are meaningful and actually used by buyers.

Another great way to prevent functional overserving is through technological leaps that change consumer expectations of what's good enough. This happens when a company comes up with a breakthrough product that makes consumers think that existing alternatives -- that consumers previously felt were good enough -- aren't good enough anymore. The consumer's perception of what's good enough isn't static: it's relative and changing depending on the latest breakthroughs and what's available in the marketplace.

If a sustaining technological leap or breakthrough creates a large enough performance gap between the breakthrough product and existing incumbent alternatives, it may allow the entrant to establish the beachhead needed to effectively enter an existing market. An entrant with a sustaining improvement/innovation normally doesn't do well because incumbents respond vigorously. The exception may be an entrant with a surprise breakthrough product that catches incumbents off-guard -- you could argue the original iPhone succeeded this way.

Two challenges for an entrant with a breakthrough product may be: (1) the lack of a recognized, trusted brand; and (2) ramping up manufacturing, distribution, and marketing fast enough to take full advantage of the sales opportunity. Incumbents are highly motivated to "fast follow" the entrant's breakthrough product with similar products. The key question here is whether incumbents can quickly acquire the capabilities needed to compete with the breakthrough. In the original iPhone's case, Blackberry and Nokia were unable to fast follow the iPhone with similar products because they lacked Apple's integrated hardware and software capabilities. As a result Apple had the time needed to ramp up iPhone production and distribution. Apple's strong brand also helped.

Returning to this post's original subject, a person buying a Porsche or an iPhone -- or any other product with an inherent artistic element -- considers (1) functional needs but is also influenced by (2) irrational wants like the desire/lust for something beautiful. The good enough standard is highly relevant to the functional needs part, but may not be very relevant to the irrational wants part. And irrational wants become even more of a factor when the product is distinguished by iconic, artistic design. So a product with an artistic element may overserve a buyer's functional needs but still be something the buyer wants to purchase because of irrational wants -- a Porsche or a Ferrari is a good example of this.  

You could almost look at a product on a sliding scale: as a product's artistic/iconic elements go up, the relevance of what's good enough -- and the danger of overserving -- go down. The ideal situation may be a product with improving artistic elements and improving functional elements: the key here is that functional elements must improve in a meaningful way that's valued by consumers (to prevent unused, overserving features that actually end up degrading functional performance and ease of use).

Applying another Christensen concept, when the buyer's "job-to-be-done" encompasses purely functional needs, overserving is a greater risk. When the buyer's job-to-be-done is broad, encompassing both functional needs and irrational wants, there's less danger of overserving. 

Art vs. Algorithms

Industrial design sometimes rises to the level of art, and art doesn't commoditize. Artistic design creates tremendous brand value and is very hard to copy, and close copies are never valued as highly as the original. Examples of companies producing iconic products and industrial art include Braun, Ferrari, Porsche, Apple, and Tesla. Industrial art has driven the brand value of each of these companies. 

Conversely, algorithms and machine learning methods can be copied, and the copy is valued just as highly as the original because the product's appeal is based purely on functional needs. Much of the theory behind algorithms comes from educational institutions and is in the public domain. As noted above, Christensen's good enough concept -- and the danger of overserving -- is much more relevant with purely functional products.

So if you're an investor, it seems to make sense to invest in companies that make products that aren't purely functional. The ideal situation may be a company that makes a product with artistic elements, and that is committed to iconic design. This kind of business model is (1) hard for competitors to copy and (2) reduces the danger of creating an overserving product (since buyers in this kind of market are driven by both functional needs and irrational wants).

This post has been amended since it was first written. 

The author owns stock shares of Apple.

Sustaining Innovations Based on Different Capabilities

Clayton Christensen recently described Uber as a sustaining innovation -- rather than a new market or low end disruption -- since its service is generally better than existing taxicab options. "One More Time: What is Disruptive Innovation?", by Clayton M. Christensen, Michael Raynor, and Rory McDonald (Harvard Business Review, December, 2015). In his books Christensen counsels entrants to avoid competing with incumbents through a sustaining innovation. See Concepts page and discussion of Clayton Christensen. That's because incumbents will aggressively respond to companies that try to enter their markets with a better product. You can currently see this happening in the auto industry, with incumbent luxury car companies offering more electric vehicles to compete with entrants like Tesla.

Christensen believes Uber is an "outlier," and that its success may be due to the regulated nature of the taxi industry. "One More Time," by Clayton Christensen, et al. These regulations make it difficult for incumbent taxi companies to compete with Uber. This seems logical. I think, however, that the biggest problem facing traditional taxi companies is that they lack Uber's (1) resources (infrastructure, employees, capital access, etc.), (2) processes (manufacturing processes, logistical processes, software development processes, etc.), and (3) values (margin goals, priorities/culture, etc.), which together make up a company's capabilities.

Christensen discusses resources, processes, and values ("RPV") in The Innovator's Solution. In this book Christensen says entrants with a sustaining innovation usually lose to incumbents because incumbents have the RPV -- the capabilities -- needed to match the entrant's improvement. The Innovator’s Solution, by Clayton Christensen and Michael Raynor (Harvard Business School Publishing Corporation, 2003). He also says that incumbents normally lack the RPV needed to match a product or service that's a new market or low end disruption. Id. 

Looking at examples like the taxi industry -- and contrary to what Christensen theorizes -- incumbents may not always have the RPV/capabilities needed to match an entrant's sustaining innovation. Regional taxi companies lack the equity capital resources and the refined logistical and software processes needed to effectively compete with a global company like Uber. Uber offers a better service based on fundamentally different capabilities that are constantly refined on a massive scale. These different capabilities -- and their steady improvement -- allow Uber to effectively challenge incumbents despite the sustaining nature of Uber's service. The lesson here is that Christensen's RPV framework is relevant in both a disruption context and a sustaining innovation context.

So an entrant with a sustaining innovation can effectively compete with incumbents when the sustaining, better product/service is based on RPV/capabilities that are non-traditional relative to the pertinent industry. In this situation incumbents will be hamstrung by capabilities tailored around traditional/existing industry offerings, whether it's (1) a taxi company with employee-drivers and a cab fleet (competing with Uber's logistics/software and thousands of independent contractors driving their own cars) or (2) a hotel company with service-related employees and hotel-related infrastructure (competing with Airbnb's logistics/software and thousands of owners renting out their homes). In both these examples you have entrants -- Uber and Airbnb -- offering a different/better service and competing directly against incumbents for existing industry customers (what Christensen calls competing against consumption). Christensen would predict failure because of a vigorous and effective incumbent response, yet both Uber and Airbnb are succeeding because their RPV/capabilities are different from those of incumbents, making it difficult for incumbents to respond.

Applying these ideas to Apple, the original iPhone could be viewed as either a new market disruption (a personal computer for a new context/situation -- your hand or pocket) or a sustaining innovation relative to competing cell phone products from Nokia and Blackberry. See post titled The iPhone Conundrum and New Market Disruption. Regardless of how you class the original iPhone, it was built based on software and hardware capabilities that Nokia and Blackberry seemed to lack, which allowed it to gain a market foothold without a meaningful incumbent response.

One other point: a company that sells a mediocre service/product -- particularly a product that's become a monopoly either through market dominance and network effects or through regulatory protection -- leaves itself open to not only new market and low end disruption, but also sustaining innovations based on different capabilities. An uncompetitive industry environment leads to complacency and deteriorating products and services. 

This article has been amended since it was first posted.

The author owns stock shares of Apple.

The iPhone Conundrum and New Market Disruption

At the outset I should credit Horace Dediu at asymco.com and Ben Thompson at stratechery.com, both of whom write extensively about Apple and disruption theory. The inspiration for much of this article comes from these two great strategists. Dediu recently posted an article on asymco.com titled "Competing effectively against your most potent competitor." In the article he says that "[n]ew market disruptions take root in non-consuming contexts." In the past Dediu has referred to the iPhone as a new market disruption.

I never really grasped the idea of the iPhone as a new market disruption, because it seems like a plainly superior product -- a form of sustaining innovation -- that renders inferior feature phones obsolete. It's easier to see how the iPhone might be a new market disruption relative to functionally superior but less portable laptop PC's.

New Market Disruption

In The Innovator's Solution Christensen talks about new market disruption in the context of non-consumers who can't afford or use existing products. Existing incumbent products typically emphasize traditional performance measures/attributes like speed, quality, and reliability, and have an entire "value network," or market and operating context, tailored to the common needs of customers who prioritize traditional performance attributes. This value network is comprised of suppliers, distributors, cost structures, and internal processes.

A market entrant then introduces a new product that solves a job-to-be-done that incumbents have ignored, and that emphasizes different performance measures/attributes, like simplicity, convenience, portability, and accessibility. New performance attributes, and a new solution to an unmet job, lead to a "new market" of consumption -- or new market of consumers -- where none previously existed. New market consumers buy the entrant's product because it's more affordable and easier to use than incumbent offerings, or because it can be used in previously non-consuming situations (or on previously non-consuming occasions). The entrant's product has a value network tailored to the common needs of customers who prioritize non-traditional performance attributes/measures. Because incumbents have a value network tailored to customers who prioritize traditional performance attributes, it's difficult for incumbents to compete with the disruptive new entrant. See Concepts page and discussion of Clayton Christensen and list of sources.

The iPhone

The iPhone was a new market disruption because it emphasized the performance attribute/measure of simple, convenient, highly portable computing that could be accessed anywhere, anytime, in almost any situation (in bed, at dinner, walking, standing in line, sitting with friends, etc.). By emphasizing a new performance attribute (highly portable computing), the iPhone generated consumer demand in a previously non-consuming situation (in bed, at dinner, etc.). The iPhone satisfied a job-to-be-done for these new market users: the need for simple, anywhere/anytime computing (a job that laptops failed to address). And the iPhone created this market without drawing a meaningful competitive response from laptop manufacturers. That's because the iPhone was functionally inferior to laptops (on the traditional performance measures of speed and computing power) and had a radically different form factor. So laptop manufacturers didn't consider it a threat. Without meaningful competition the iPhone was able to gain a market foothold, and has since improved to the point where, for at least some people, it replaces a laptop.

As a phone and email/texting device the original iPhone was also, at least arguably, functionally inferior to feature phones from companies like Blackberry, but because it emphasized a different performance attribute/measure -- simple, convenient, highly portable computing -- it created a new market of users who valued anywhere/anytime computing (the new situation) more than reliable phone reception and enterprise-class email and texting. This new market of users gave the iPhone a market foothold. And while feature phone manufacturers like Blackberry and Nokia may have wanted to compete in this new market, they lacked the value network and computer making capabilities/processes needed to do so (at least early on). So the iPhone could compete as a simple portable computer without a meaningful competitive response from incumbent feature phone manufacturers. The iPhone's more traditional, feature phone-like attributes -- calling, email, and texting -- then improved over time, disrupting more and more of the feature phone business.

The iPhone is disrupting the camera business for the same reasons. Compact cameras have traditionally emphasized the performance attributes/measures of picture quality and small size. The iPhone can function as a compact camera, but it has always emphasized the performance attribute/measure of simple, convenient, highly portable computing. Early iPhone users valued highly portable computing (the new performance attribute) that's available anywhere/anytime (the new situation) more than call quality, email/texting quality, or the quality of the iPhone's built-in camera. This new market of users allowed Apple to sell enough iPhones -- with iPhone cameras -- to gain a market foothold. Camera makers lacked the value network and computer making capabilities/processes needed to competitively respond, and probably didn't consider the original iPhone camera a serious threat (since it was functionally inferior on the traditional performance measure of picture quality). The iPhone's camera has since improved, disrupting more and more of the traditional camera business.

So a different performance attribute/measure that focuses on satisfying a job-to-be-done in a new situation -- like simple, convenient, highly portable computing available anywhere, anytime -- can lead to the creation of a new market of users who value the different performance attribute/measure (portable computing) more than the traditional performance attribute/measure (high end laptop computing or call/email/texting quality or photo quality). Once the entrant gains a new market foothold based on the different performance attribute/measure (portable computing), it can then improve its product relative to traditional performance attributes/measures (whether it's computing power or call/email/texting quality or photo quality) to the point where incumbents start losing business.

When you consider the inherent difficulty of satisfying a job-to-be-done in a new situation, based on a performance attribute/measure far different than what has traditionally mattered, you can really see the advantages of being an integrated company. When it comes to new market disruption, integrated manufacturers like Apple have a big advantage over modular final assemblers. That's because integrated companies have in-house capabilities and processes that modular companies lack, giving them the ability to create an entirely new product/service that satisfies a job-to-be-done in a new situation.

The author owns stock shares of Apple.