Disruptive Innovation

By Dr. Amit Bhadra, Dean-WSB

Disruptive innovation is any situation in which new entrants using a different business model win over customers of previously successful incumbents. Right? Not necessarily.Disruptive innovation is a process where a smaller company successfully challenges a bigger incumbent but not by targeting the most attractive customers of the incumbent. The entrant targets less attractive foothold markets. These are of two types. i) Under served customers who have lower expectations and lower willingness to pay a high price. Like the market for small cars in the US in the 1970s. ii) Non-users of a category. Like non users of personal computers in the 1980s and non users of radio in the 1960s. These segments proved to be the major markets for desktop computers and transistor radios.

The incumbent disregards the new entrant and continues to focus on the mainstream profitable upmarket customers, whom it over serves, and under serves smaller and less profitable customers. The entrant targets the underserved customers; delivers a functionality more suited to the small customer at a lower price. The entrant eventually moves upmarket, delivering the functionality the mainstream upmarket customers require, while preserving it’s strengths arising out of it’s new business model. As upmarket customers adopt the entrant’s offerings in volume, disruption occurs.

In the beginning the mainstream upmarket and most profitable customers view the entrant’s offering as inferior.But that changes over time as the disrupter rapidly improves the offering. Canon’s strategy in copiers vis-a-vis Xerox is a classic disruptive innovation strategy. Xerox served only the central copying facilities of big corporate customers. Smaller opportunities such as school libraries, small offices and offices of departments of large corporations were not targeted by Xerox. Cannon changed all that with their $ 1000 copiers. Canon sold through distributors and office product stores while Xerox used its direct sales force. It gained a foothold in the underserved and unserved markets and later moved up the value chain to target the large corporates.

Another example of disruptive innovation is Netflix which entered the movie distribution market for retail customers when the incumbent was Blockbuster which had a chain of Video rental stores in every neighbourhood. Netflix sent DVDs by mail. The movies were not the latest ones and there was a one or two day wait period. Netflix appealed to those who were willing to wait, see older releases and wanted to pay less. But Netflix improved distribution using video streaming and eventually emerged as a superior product even for Blockbuster’s valuable customers.

On the other hand Uber’s strategy does not qualify as a disruptive innovation. It did take market share from taxi operators but it was not a disruptive innovation because it targeted the mainstream customers served by incumbents and was viewed as a superior service right from the start, not one that compromised on quality or features. Sustaining Innovation: The other type of innovation is called sustaining innovation. Here the entrant offers products which are superior to the incumbent’s products in the eyes of the incumbent’s most valuable customers at the outset. The iPhone is an example of sustaining innovation in the cell phone market. It took incumbents head on even in the incumbent’s core customer constituencies. Another example is Tesla which is targeting mainstream upmarket customers of the incumbents taking on Ferrari, BMW and Toyota head on.This business model makes it more difficult for sustaining innovations to succeed than disruptive innovations. The incumbents feel threatened at the outset and are likely to improve their products or drop prices while the entrant is still weak. Only if the entrant is very sure of its product should this strategy be tried.

The mistake incumbents make: On the face of disruptive innovation incumbents often find themselves helpless. If they introduce the entrant’s business model, their own mainstream business could be affected. Xerox didn’t introduce $1000 copiers to protect its own $7000 copiers. When they see a disruptor serving the underserved “foothold market” they allow them to do so, and concentrate on protecting their own customer turf with superior offerings. Some of the entrants fail not because of actions of incumbents but because of their own underdeveloped business practices. The incumbents see it as a sign of a failed business model. Consider the online retail businesses of the 90s. Most of them failed. The brick and mortar businesses remained complacent. But failure at present is not a predictor of failure in future. If the new business model adopted by entrants has a technology dimension, they will be able to rapidly improve and eventually succeed. In the next round many e-commerce companies succeeded. Today the incumbents are under threat.The phenomenon of disruptive innovation has been seen in many industries. Automobiles, bikes, computers, retail, entertainment, telecom and education. It has the potential to disrupt all established business models.

What should incumbents do? In the Indian air travel market when Air Deccan launched it’s low cost air travel services targeting the foothold market comprising of non-users of the category, Jet Airways was quick to launch Jet Lite in order to contain it. Incumbents must learn to defend markets where they are not even present, though it may be counter intuitive to do so when the entrants themselves seem to be failing in the foothold markets. When an entrant using a new business model starts targeting foot hold markets, observe it closely. Launch a frontal attack at the first sign of success for the entrant instead of waiting for the disruptors to gain strength and move upmarket. The defensive strategy may include adopting the business model of the disrupter even if it leads to cannibalizing one’s own market.