Innovator’s Dilemma by Clayton M. Christensen

Published On: 02-Jan-2019

Innovator’s Dilemma by Clayton M. Christensen
Comments by Deepesh Agarwal
January 2019

The book explains that the incumbent firms are at disadvantage vs start-ups on disruptive technologies. The author lays a framework for the incumbents to overcome this hurdle.

There are two kinds of technologies:

a. Sustaining technologies – They improve the performance of the existing product to the existing customer. They improve the profitability of the incumbents. Shift from 3G to 4G/ 5G in telecommunication is sustaining technology.

b. Disruptive technologies – They challenge the established industry by fulfilling the needs of their customers in a new manner. Initially they target unserved/ cost conscious customers/application later with the fast pace improvement in the functionality/ fall in the cost, disruptive technologies supersede the established. Evolution of the mobile camera is a disruptive technology for camera industry.

Incumbents always have the resource to develop both technologies. However, incumbent’s failure rates are sky-high when facing disruptive technologies. Incumbents are good at sustaining technologies.

Why do incumbents fall prey to disruptive technology?

  • The future pathway of an organisation is driven by 3 factors: Resources, its processes and the values which get inculcated in its manager’s decision making. These factors work against incumbent given its focus to maximise near-term profitability.
  • Margin/ Return on Capital Employed (RoCE) dilutive projects are allotted least resources. CEO/board/mid-managers everyone are hardwired for near-term profitability. For instance, DEC entered and exited personal computer (PC) market four times over 1983-95 as its managers weren’t happy with low margin of PC business.
  • Incumbents face sizing issue as at the start, the disruptive technology market is insignificant vs incumbent’s size.
  • Good management aligns its strategy close to its customers. Feedback from customers tends to work against the disruptive technology. In US, only four earthmoving equipment makers survived the hydraulics disruption as customers gave discouraging feedback on hydraulics.
  • Incumbents over-invest in the new market on hopes of instant demand. Apple suffered set-back in 1994 by overinvesting in PDA market.

Guidelines to withstand disruptive technologies:

  • Establish distinct entity with different eco-system for the new technology. This is what IBM did when PC was yet to emerge; later its PC subsidiary contributed meaningfully to group’s fortune. Even in India, few 2-wheeler companies are investing in electric 2-wheeler start-ups.
  • When in doubt on which technology will succeed, form two distinct units and let them compete using different technology. Hewlett Packard (HP)’s laser printer division competed with its own inkjet printer business.

Learning for equity investors:

  • Technology targeted at existing customer or expected by majority to replace mainstream product is a sustainable technology. We believe shift towards Electric Vehicle (EV) in cars, fits the sustainable technology framework and not disruptive technology.
  • Products with inferior performance can replace mainstream product if the pace of improvement of former exceeds later.  For instance, falling cost/ improving efficiency imply battery equipped solar panels can replace thermal power.
  • Disruption can come from entirely different product/ market. For instance, wearable watches may disrupt preventive medical check-up industry.
  • Pioneer firm has no major advantage in sustaining innovation; however it has advantage in disruptive technology. Firms waiting for inflexion point to start investing are at major risk.

 

 

Author Bio

Deepesh Agarwal
Mr. Deepesh Agarwal is an Associate Vice President and research analyst in the domestic Equity Division of UTI Asset Management Company Ltd. He tracks the Capital Goods, Infrastructure and Textile sectors. Deepesh joined UTI AMC in its equity team in 2017, prior to that he worked with Ambit Capital as equity research analyst for 4 years. He has also worked with Hexaware Technologies in Corporate Finance for 2 years. He is a Chartered Accountant from the Institute of Chartered Accountant of India and has cleared the Level 3 exam of the CFA program conducted by the CFA Institute, USA.