The MIT Critique of Disruption Theory

I just read Andrew King and Baljir Baatartogtokh's article in the MIT Sloan Management Review (Fall, 2015) titled "How Useful is the Theory of Disruptive Innovation?" The article is a critique of Clayton Christensen's disruption theory. I thought it made a number of interesting points, including the following (with my personal comments in boldface): 

  • Based on the authors' research, incumbents often lack the capabilities needed to respond to a new entrant's product/service -- when they have the capabilities they frequently do respond. 
  • Some incumbent products/services (local meatpacking) don't show any meaningful sustaining improvement over time, so there's no opportunity for overserving. In this situation you have the opposite of overserving: the product doesn't improve at all, or doesn't improve fast enough to keep up with user needs (a perennially underserving product/service). This kind of mediocre/poor product then gets replaced by something better. The entrant's better product is often based on capabilities that the incumbent making the mediocre/poor product lacks, making it impossible for the incumbent to respond.
  • Based on the authors' research, 78% of Clayton Christensen's examples from The Innovator's Dilemma and The Innovator's Solution don't involve overserving. If accurate, this would mean the concept of low end disruption for overserved users is inapplicable to these examples. 
  • I think it's important to note that overserving isn't as relevant with new market disruption. A new market product creates an entirely new market of consumers because the entrant emphasizes different product performance attributes than those emphasized by incumbents (the vertical "P" axis). These different performance attributes either: (1) make the product affordable to people who couldn't afford prior alternatives; or (2) allow the product to be used in a new, non-traditional situation/context, creating a new market of consumers for that new context (desktop computer as mainframe for your desk, smartphone as computer for your pocket). See Concepts page and discussion of Clayton Christensen.
    • In emphasizing different performance attributes, the new market entrant creates a non-traditional "value network" with a distinctive cost structure, different suppliers, different operating processes, and different sales channels. This value network is crafted around sales to non-traditional, new market consumers.
    • Incumbents typically lack the resources, processes, and priorities -- or what you could call the desire and capabilities -- needed to transition to the new entrant's non-traditional value network. This leaves incumbents stuck in the value network they've crafted for their traditional customers, unable to compete with the entrant for non-traditional, new market consumers.
    • If the new market entrant improves its product it can eventually sell not just to new market consumers, but to the incumbents' traditional customers, taking more and more business from incumbents.
    • The point of all this is that new market disruption can occur regardless of whether incumbents are overserving their traditional customers. An incumbent could be selling widgets that don't overserve its traditional customers (e.g., corporate customers that need powerful mainframes or minicomputers) and still have an entrant launch a product that emphasizes different performance attributes and creates a new market/class of buyers (e.g., individual consumers who need desktop computers). Incumbents with a traditional value network -- and resources, processes, and priorities tailored around this network -- would have difficulty competing in this new market. The entrant could then improve its product and eventually steal traditional customers from the incumbent, even though the incumbent's widget wasn't overserving traditional customers when the entrant came into the market.
    • The big challenge for entrants trying to create a new market of consumers is creating a profitable new value network that can survive over the long term. A new market entrant needs early profits to continue improving and integrating its product around the job-to-be-done, ideally through a unique, trade-off based strategy. Otherwise the entrant ends up engaged in price-based competition with late-arriving competitors selling the same basic offering.
      • Cut-throat price competition has played out in both the Windows PC market and the Android smartphone market. Apple has survived and prospered because the new market products it introduced, the Apple II, Mac, and iPhone, improved and became more integrated/differentiated over time (largely through Apple's ecosystem approach). See Concepts page and discussion of Clayton Christensen and Michael Porter.
  • Advances and sustaining improvements in technology sometimes produce outcomes which are the opposite of those produced by overserving -- they can make the product simpler and easier to use and more accessible to less savvy consumers. They can also make the product more affordable to low end users.  
  • The authors counsel using disruption theory not for prediction, but as a warning to avoid overserving (which is typically caused by a series of meaningless sustaining improvements unconnected to the underlying job-to-be-done).

The boldfaced language discussing new market disruption has been amended since this article was first posted.

The author owns stock shares of Apple.

Ability to Partner as Competitive Advantage

When it comes to services, Apple is in a better position to partner than any other tech company. It's difficult for Facebook or Google to closely partner with other service providers because other providers steal user attention and hurt ad sales. Horizontal service companies trying to be on all devices depend on the user's choice of their services over other services. 

A vertically integrated player like Apple doesn't care if its services dominate. Apple wants its services to be attractive and promote ecosystem stickiness, but Apple doesn't need its services to dominate to drive profits. That's because Apple's profitability is driven not by services, but by a three part mix of hardware, OS, and ecosystem. No single element of this mix dominates, and Apple can have a great ecosystem with in-house services/apps like contacts, calendar, notes, maps, and iWork, and third party services/apps provided by IBM, Microsoft, Twitter, Google, Facebook, and thousands of independent developers.

If you don't need your services to dominate or even be profitable to prosper, then you're free to partner with any service company you want. And that's what Apple does, partnering with IBM for enterprise software, Microsoft for its Office suite, and even Google for maps. These kinds of partnerships are difficult if you have a horizontal business model and you need your services to dominate to drive subscriptions or ad sales (e.g., Google search, Facebook, Evernote, etc.).

In a 2007, D5 interview Steve Jobs said he admired Microsoft's ability to partner with other companies. Apple now seems to address this issue by partnering as convenient on services while still owning the key hardware, manufacturing, and OS technologies and IP. See post titled Why Apple "Outsources" Applications and Services.

The author owns stock shares of Apple.

Prioritize Great Products

Marketing and even strategy are irrelevant without great product design and a great product. As noted in Becoming Steve Jobs, Apple was nearly bankrupted when Windows 95 was released and was better than the Macintosh OS -- a better competing product caused Macintosh sales to tank. Becoming Steve Jobs, by Brent Schlender and Rick Tetzeli (Random House, 2015). Pixar overcame early troubles through a great product -- "Toy Story" -- that led to a successful IPO. Id. NeXT succeeded because the company's great OS made it an attractive acquisition target (NeXT was acquired by Apple). Id. Conversely, NeXT struggled early on because it failed to create a great computer for its target market. Id. Google's success flows from a great search engine. Great products are core to a company's success.

Without a well-designed, well-engineered product, the best sales, marketing, and strategy have a muted or immaterial impact. You need a compelling product first. I think this is why Tim Cook is always emphasizing how Apple is focused on making "great products." Compelling products are the priority and drive a company's long term success or failure -- not marketing, sales, strategy, or financial measures of capital efficiency. A company that focuses too much on sales or marketing or capital efficiency has lost sight of what made it successful in the first place -- a compelling product.

So How Do You Make a Compelling Product?

Great products are designed around jobs-to-be-done. See Concepts page and discussion of Clayton Christensen. As noted in Horace Dediu's podcast with Bob Moesta, Critical Path #146, a company can think about jobs-to-be-done by looking at the functional, emotional, and social "energies" that surround a consumer's purchase decision. Functional energy refers to the physical effort expended in making the purchase. Emotional energy refers to any anxiety, fear, uncertainty, pleasure, security, or ease involved in the purchase. Social energy refers to concerns about what other people will think about the purchase.

In the podcast Dediu and Moesta also discuss the Kano Model of Quality, which says that products consist of the following attributes:

  1. Basic attributes: Attributes that must be present for the consumer to buy, like an affordable price, enough computer memory to store all the consumer's media, basic customer service, etc.
  2. Performance attributes: Measurable feeds and speeds like horsepower, engine size, zero to 60 acceleration time, battery life, number of pixels, etc.
  3. Excitement attributes: Subtle details that are often hard to quantify but that create delight or excitement, like the tactile qualities of sports car controls, the sound or smell of a car engine, the way a product is packaged, etc.

Looking at functional, emotional, and social energy, it's easy to see why the Google Glass hasn't sold well. It's expensive and has been difficult to try out, which raises the functional energy needed to purchase in addition to increasing negative emotional energies like buyer anxiety and uncertainty. And the social energy of the Google Glass seems tremendously negative -- potential buyers are obviously concerned about how people will react to someone who may be surreptitiously recording them.

With the Apple Watch, Apple's online and retail stores reduce the functional energy needed to make the purchase. Apple's retail stores reduce negative emotional energies like anxiety and uncertainty while increasing positive emotional energies like pleasure, security, comfort, and ease. Apple's brand strength conveys status, making the social energy of the Watch a positive. Excitement attributes -- subtle details -- also seem to work in favor of the Watch, whether it's product packaging or haptic feedback or clasps on the Watch bands.

In looking at products like the Google Glass and Apple Watch, the first order question is not whether the product is a logical part of a grand strategy, but whether the product itself is a great product. Is the Apple Watch a great product? Is Google Glass a great product? Is Google still coming up with innovative, great new products, or are its products more market/sales driven? Do recent European Commission filings -- regarding possible search engine bias in favor of Google sites -- suggest Google is too focused on sales and is losing its focus on a great search engine/product? Is Amazon coming up with great, innovative new products? Is the Fire Phone a great product? These are important questions in assessing a company's long term success or failure.

The Importance of People and Collaboration; Investing Issues 

Great products require lots of good ideas. These ideas come from teams of great people collaborating well together, not from just one person. With complex, cutting edge products, one person can't do it all. Hence the critical importance of: (1) hiring the best people; and (2) creating an environment that fosters candid, free-flowing communication/collaboration among these people. See post titled The Rational Management Checklist.

From an investing perspective, it's also worth noting that the typical retail investor probably can't assess whether an industrial/b2b product is "great" and well-targeted on a job-to-be-done. That's because a retail investor normally lacks hands-on experience or deep knowledge of b2b products. With b2b companies a retail investor has to rely more on portfolio diversification and financial ratios/metrics.

Conversely, retail investors can use and directly experience consumer products, allowing them to subjectively assess whether a company is making great products and/or whether a company's products are improving or deteriorating.

The author owns stock shares of Apple.

Nobody Goes Back to Something Less Convenient

Just a quick speculation on why I think the Apple Watch will succeed. I think it will succeed because it will make important information easier and more convenient to access, and buyers who get used to it won't want to go back to a less convenient way of doing things (i.e., accessing the same information through your smartphone). Speaking anecdotally, I never wanted to go back to MS-DOS and command lines after I discovered the convenience of Windows and a mouse. Similarly, I never wanted to go back to Windows and Internet Explorer after using a Mac and the Safari browser (and I used MS-DOS and Windows for 20 plus years before switching to a Mac).

People don't willingly return to less convenient ways of doing things. If I get used to having certain important information readily available on my wrist, then I'm not going to want to give it up -- I'm not going to return to something less convenient and more intrusive (pulling a smartphone out of my pocket).

The author owns stock shares of Apple.

How Outsourcing Can Destroy a Company

In making outsourcing decisions, Clayton Christensen recommends that companies focus on: (1) what capabilities (resources, processes, and priorities) they need to keep in-house in order to succeed in the future; and (2) the type of work subcontracting suppliers will try to do later on. See "How Will You Measure Your Life?" and list of Christensen sources on Concepts page. Subcontractors making cheap, outsourced components don't want to stay at the low end of the market -- they want more sophisticated, profitable product work as they move upstream in search of better margins. As a low end subcontractor moves upstream and acquires new capabilities, it often displaces the company it formerly worked for. The original outsourcing company creates its own demise at the hands of a more cost efficient low end competitor (that formerly served as a subcontracting supplier).

Christensen notes that Dell outsourced its way to mediocrity by subcontracting more and more work to component suppliers like Asus. As a result Dell gradually lost its capabilities, while Asus gained new capabilities and eventually started making Asus-branded computers. Dell ended up just stamping its brand name on computers designed and made by its subcontractors, losing its ability to create innovative new products. Outsourcing: (1) retarded Dell’s ability to create compelling new products; and (2) hampered meaningful sustaining improvements to Dell’s existing products.

Consistent with Christensen's recommendations, Apple seems aware of the need to protect its future by keeping key technologies and capabilities in-house. The following quote from Steve Jobs is revealing: "One of our biggest insights [years ago] was that we didn't want to get into any business where we didn't own or control the primary technology because you'll get your head handed to you." Tim Cook has said the same thing. And Cook's expertise in supply chain management gives him the ability to create a unique supply chain where Apple avoids outsourcing too much. Apple keeps the following key technologies or capabilities in-house: industrial design, hardware and software engineering, mobile chip design and engineering, fingerprint authentication, Siri, and retail sales and service. Apple also maintains ownership or exclusive control of certain key manufacturing equipment/processes (through agreements with companies like GT Advanced, which is producing sapphire for Apple). 

Outsourcing is great for a company’s return on net assets, since it reduces the net assets denominator, but it can destroy the capabilities needed to make: (1) meaningful product improvements; and (2) innovative new products. The outsourcing company gives up control of its destiny: lacking in-house capabilities, an outsourcing final assembler is at the mercy of the supplier's ability to continue making meaningful innovations at the component level. 

If component suppliers can't continue making meaningful improvements, the outsourcing company’s business is vulnerable to more integrated companies with strong in-house capabilities. These integrated companies are better positioned to improve existing products and come up with new products. And that's exactly what’s happening right now with Apple taking more and more business from traditional PC makers. Intel and Microsoft are no longer making meaningful improvements to key PC components, leaving PC makers like HP and Dell vulnerable to integrated companies like Apple. 

Integrated companies are well-positioned to create innovative, affordable new products that disrupt overserving modular products. The conventional wisdom is that modular companies sell more affordable products. Dell, HP, and Asus sell standardized, modular PC's at very affordable prices. Outsourcing has caused a modular, price-focused "race to the bottom" in the PC market. Yet an integrated company — Apple — created the iPad. And the simpler, more affordable iPad has disrupted modular PC's, which overserve many users. 

Somewhat ironically, integrated companies may be best at creating disruptive, affordable products for new and low end markets, since outsourcing causes modular manufacturers to lose the capabilities needed to create this type of offering. When a modular, snap-together product starts to overserve, the final assembler/manufacturer lacks the capabilities needed to do anything about it. In this situation, an integrated company can swoop in and design, engineer, and manufacture an affordable alternative that isn’t overserving, and that squarely addresses the job that needs done.

And this is a big, long term problem for modular assemblers/manufacturers. At some point meaningful innovation at the outsourced component level dries up. Component suppliers start making improvements that aren’t meaningful, resulting in a final product with overserving product attributes. This leaves the modular final assembler vulnerable to integrated competitors with strong in-house capabilities. These integrated competitors are well-positioned to create affordable new products that: (1) don’t overserve; (2) squarely address a job that needs done; and (3) appeal to new and low end markets, thereby disrupting modular, overserving alternatives.

The author owns stock shares of Apple.