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.

Chance Favors the Prepared Mind (Company)

Steve Jobs had a prepared mind which allowed him to see and take advantage of opportunities. Jobs also prepared Apple and its executive team to see and take advantage of opportunities. Apple's vertical integration is a form of preparation which allows the company to opportunistically follow the river. Following the river refers to a company's ability to intuitively adapt to the natural evolution/flow of products and technologies, such as the way music went from CD's to downloads to streaming, or the way television is moving away from cable toward over-the-top broadband options like Apple TV, Netflix, and HBO Now. Vertical integration gives Apple the flexibility and in-house capabilities needed to follow the river. Integration, intuition, and jobs-to-be-done thinking allow Apple to create new product categories and meaningful product improvements in response to the natural evolution of products and technologiesSee post titled Focus, Functional Toys, Tradeoffs, and Following the River.

Apple prepares for new product categories and meaningful product improvements by hiring the best people and by developing/acquiring and integrating the key product technologies (fingerprint technology resources/processes, mobile chip technology resources/processes, and so on). Apple also applies follow the river learning from prior products to help it develop new product categories. iTunes learning leads to the iPod, iPod learning and Apple's computing capability lead to the iPhone, and iPhone learning leads to the Apple Watch.

When an integrated company like Apple follows the river, relying on capabilities and learning from prior products to develop a new product category, it can be difficult for companies that haven't followed the same river to compete. Feature phone makers couldn't compete with the original iPhone because they didn't follow Apple's river -- companies like Nokia and Motorola never developed products like iTunes, the iPod, and the PC, so they lacked the capabilities and learning needed to develop a small, handheld computer that also functioned as a phone and music player. Traditional luxury watch makers are facing the same problem in trying to compete with the Apple Watch.

The author owns stock shares of Apple.