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Howard Dresner recently spoke with Dr. Clayton Christensen, a Harvard Business School professor and the preeminent expert in the area of disruptive innovation and business strategy. Their discussion covered a broad range of topics from identifying and creating a disruptive strategy to protecting oneself from disruptive competitors. The resulting interview was so content-rich, we found it necessary to divide it into two parts. In this first installment, Dr. Christensen and Howard begin by defining what is meant by "disruptive" and "sustaining" innovation. Interview conducted 26 April 2004
Howard Dresner: Please explain the concepts of disruptive innovation and sustaining innovation. Clayton M. Christensen: Well, the reason I'm asking the question that led to this model of sustaining and disruptive innovation is to understand what kind of strategy could an entrant firm pursue, that would make it the easiest to kill a larger giant incumbent? Sustaining innovation is an innovation that brings to market a product or service that a company in the market could sell for higher margins to its best customers. In other words, sustaining innovation brings a better product into the market. Some sustaining innovations are simple, incremental, year-to-year improvements. Others are dramatic, breakthrough technologies the transition, in telecommunications, from analog to digital, and digital to optical. They were a real technological tour de force, but their affect on the service was to bring a better product into the existing market that could be sold for higher margins to the best customers of the leaders. The odds overwhelmingly favor the incumbent leaders of the industry in battles of sustaining innovation — whether they are simple, incremental innovations or breakthroughs.
I call that a disruptive innovation not because it's a breakthrough from a technological sense, but instead of sustaining the trajectory of improvement that has been established in a market, it disrupts it and redefines it by bringing to the market something that is simpler. Dresner: What are some good and relevant examples of each? Christensen: Well, in the computer hardware industry, the mini-computer disrupted the mainframe. Then when the personal computer came along, it disrupted the mini-computer. And so Digital Equipment and all those guys got blown out of the water. Today, wireless handheld devices like Blackberries and iPAQs and Palm Pilots are disruptive relative to notebook computers. So those are good examples.
Dresner: Wal-Mart's been a disruptive innovator for a very long time. I suspect there are some that follow a relatively short cycle and those that have a very much longer cycle. Is there any way to predict that? Christensen: I bet you there is, but I just haven't thought about it. You should do that [laughs]. But some, in fact, are very long. Merrill Lynch is a great example. We associate the name Merrill Lynch with high net-worth clients, but Merrill Lynch actually came into the brokerage market in about 1912, and Charles Merrill was bringing Wall Street to Main Street. He made it so simple and cheap for middle-income people to own stock, that he created a big new market. And from 1912 to today, they've cleaned out a lot of brokerage firms whose names you can't remember anymore. And they're still a healthy company. They haven't yet been decimated by the online people. Dresner: What are your views on General Electric and IBM? IBM has reinvented itself more than once and we could argue they disrupted themselves. And General Electric, which is a holding company, but interesting in the sense that they have very different businesses they manage quite differently. Some arguably are disruptive in nature, and others are more sustaining. Christensen:
So IBM, when the mini-computer disrupted the mainframe, were very late. But they then set up a separate business unit in Rochester, Minnesota, and when the personal computer — as it disrupted the mini — IBM set up a separate business unit in Florida.And they're the only one of the major computer companies of the 1960s and '70s that did that, and they are the only ones that survived. What you say is really wise, because if you look at any company that you would say has transformed itself over the last 30 years or so, it is GE. In every case, they achieved the transformation by setting up or acquiring new disruptive business units and selling off or shutting down ones that had reached the end of their lives. In no case did they transform the business model of an existing business unit to cause it to catch the disruptive wave. So it's like in biological evolution, you and I as individuals will just die, and the mutants will take over. A corporation can evolve, really quite effectively if you know how to do it. It's just the individual business units have a hard time. Dresner: In The Innovator's Solution you suggest, if I understand correctly, focusing on profit versus growth will prevent or impede innovation, thereby preventing future growth. And if we assume companies must innovate to grow, does that mean all public companies are incapable of innovation and will ultimately fail? Christensen: The evidence is just overwhelming that is true. We can't use the word innovation here, because if a market is known and a company has a good foothold in that market already, they should be very impatient for growth: invest aggressively and get ahead of the competition is the only way to succeed. But this particular type of innovation we call disruption needs a longer runway for it to take off, and part of the reason is that many of the strategy details are just unknowable in advance. You've got to get into the market, try a few things, fail a few times and iterate towards a viable strategy. Then, once the strategy is known and tested, it's very important to invest aggressively to grow.
Dresner: Obviously, that's the problem public companies face every day: trying to balance pleasing Wall Street with long-term strategy and — survival, even. And one could make a case for staying private — or perhaps returning to private ownership — as a way to insure long-term viability. Christensen: I think you're right. Look at Kodak today. They were very prescient, saw digital photography coming, invested in it. They have a business now that's nearly $1.5 billion; it's profitable. But the digital business just won't get big enough, fast enough to satisfy Wall Street and they don't have a long enough time horizon. If Kodak could go private for a couple of years and then come back out, I bet you they'd do better. Dresner: So what advice would you give a company that's not currently public? Don't go public? Never go public? Obviously, it's extremely enticing to management to go public. Christensen: It's very enticing. There are lots of advantages to the sorts of capital you can raise in that environment, but I guess you just have to say, if you do it, just go in with both eyes open. You're walking on the razor's edge, and as long as you keep growing, you have the privilege of investing to grow. But if growth stops, then life gets very hard. Dresner: Would you say a company's install base of customers is another inhibitor of innovation? Christensen: That's right. A customer will never lead you to develop a product which that customer cannot use. Dresner: So sustaining innovation of course can keep a company viable for many, many years, but listening only to the customer base, for the long term, could in fact be quite damaging. Christensen: That's right. In fact, if you're looking to start a new-growth business, very often, the most important customers to understand, are non-customers. Because if you figure out why it is they're not customers, and then bring an innovation that allows them now to become customers, that's what growth comes from. Dresner: For an existing company with an installed base, how would you suggest they simultaneously serve the installed base, while trying to invest in future growth businesses? How do you do that? What's the right structure? Christensen: If the organization or the business unit charged with serving the installed base is also asked to go after non-customers with the more affordable, simpler product, they can't do it. Because the business models are so different, and small customers with the lower priced product — it's not an attractive financial — it doesn't solve the financial goals of an established business unit. Almost always, this new game begins before the old game ends. If you somehow create a strong economic incentive for the management of the existing business unit to go after the new disruptive opportunity, you take your eye off the main profit and cash engine of the company, and you stumble very quickly. And yet, while that is still going, you've got to get your foothold in the new market. And that's why it's just really important to set up a separate unit. Dresner: In Innovator's Solution there were some examples of companies that went after new disruptive businesses, disruptive growth businesses, and were hammered by Wall Street. They brought in somebody to turn the company around, shed the new disruptive business, and were rewarded by Wall Street simply be returning to the status quo. Christensen: [Laughs]... That's right. Not a very complimentary book about Wall Street. Dresner: Perhaps you could spend a few moments talking about your model for segmentation. You talk about how most companies focus on product segmentation, or various demographics. And you talk about what I would call purpose-specific segmentation; based on what people are actually buying, or problems they're trying to solve with a particular product. Christensen: Well, you think about your own — the sequence of thought you go through when you ultimately end up deciding to buy a product. Somehow, you become aware you need to get something done for yourself. And then the next thought is, "What can I buy or what can I hire, to get this job done for me?" And then you start the search. But what comes to your mind, after you're aware that you have a job that you need to get done for yourself, is that you then start to think, "Who can I hire to do this job?" And so in many ways, we hire products to do jobs for us. We hire services to do jobs for us. If an innovating company focuses on the job, then when you go through that sequence, and you become aware you've got to get that job done, there'll be a product sitting there designed to do that job. You don't think in terms of demographics. You don't say, "I'm in the 40 to 50 year old Caucasian male bracket, and therefore, there's a 35% probability that I'd prefer this product over that one." You don't think that way. But when people do consumer research on 40 to 50 year old Caucasian males, the results of it will be that X percent of the demographic segment, prefer this product over that one. And so they develop a product when they target the demographic segment — that may nor may not connect with what you're trying to do for yourself — because you actually are a very unpredictable person. Over the course of a day, or a week, or a month, there are a lot of things that you're trying to get done for yourself.
So it's a different way of thinking about market segmentation, but I think that reason why — like P&G, their new product failure rate is over 85%. Of the products they launch into the market, 85% fail. And this is allegedly one of the most sophisticated market research organizations in the world. But if you look at how they segment markets, they divide markets by product category, and then they divide markets by demographics. And that's why they fail. Dresner: I would say that's probably the classical approach to segmentation. I know a lot of our clients struggle with segmentation, and spend a great deal of time. And of course, you know we focus a lot on analyzing data, going through it trying to figure out exactly why did their customers buy, and when did they buy. What drives that behavior, and when they do buy, what does that transaction look like? What are the sorts of associative properties between the different things they actually purchase — and they struggle with this — and in some cases, they bring in consultants and use all sorts of technology to try and sort through it. Using your model, what approach would you take? Is there a best practice, if you will, for learning the true segmentation? Christensen: Yeah. There are two approaches that really work, and I recommend you do them in sequence. The first one is the management of the company trying to understand the structure of its markets — just get 'em all in a room, and give them 20 Post-it notes. Get them to think, "What are the activities, or the reasons why customers buy products?" And then go through — there's a technique called KJ diagramming, where you get everybody to rank order their Post-it notes as the most important activity for which customers buy the product. You ask one person to put their most important note on a flip-chart and read it, and explain why he thinks it's the most important reason why people buy this product.
Then just get all the others in the room to interview, write a similar thing on your Post-it note, and you stick it on the chart — and then you get someone who had a different purpose or activity, and stick that on the chart. So you kind of aggregate these collections of Post-it notes. And then you look at the collection of Post-it notes, and try to abstract at a level, that, when people engage in these activities, what's their motivation? What's the broader purpose they're really trying to accomplish? Dresner: That's got to be the difficult leap to take. Christensen: Yes, but you can do it. The next thing to do is whip those as hypotheses. Out of that kind of an exercise most companies will come up with four or five jobs or purposes out there for which people might hire a product like ours. Then go interview customers who bought one of your products, or used one of your products yesterday, and ask them what was the situation you were in yesterday that caused you to pick up this product and use it. And write a case study about it. And don't necessarily ask the customer to articulate their reasons, but just to describe the situation they were in. If you write eight or ten case studies from customers who recently used a product, and the cases about the situation they were in, you start to see things line up pretty well — between your internal brainstorming and this survey of customers — of what are the reasons why, what motivates them to pick up a product? And then the third is, as you understand the situation, then you ask them, "Now think back when you were in a similar situation, but you weren't in a position to hire that product to do the job for you. What did you do? What alternative did you hire?" As you ask those questions, you get a sense for, who do you really compete against in that job? And that really allows you to put some substance around a job. Dresner: In your estimation, who's done a good job of that? What companies that we would know? Christensen: I know of none. Seriously. I was talking to Scott Cook about this, who is the founder and Chairman of Intuit. And Intuit has done it occasionally, with their QuickBooks product and Turbo Tax. Scott said, "Looking back on it, whenever we failed with a new product, we followed a conventional marketing paradigm, of segmenting by a product attribute, or customer demographic." And assuming I've got it right, I asked Scott, "Why does everybody get it wrong?" And one of the puzzles is that, at the Harvard Business School, the god of marketing 30 years ago, was a guy named Ted Leavitt, who wrote this article called Marketing Myopia and so on. He taught this in his classes. He said, "People don't buy a quarter-inch drill. They buy a quarter-inch hole. You've got to study the hole, not the drill. The drill is just a solution for it." It's the very same concept, but why is it that the concept, although everybody knows it's right, never gets traction? Scott said maybe one reason why is that many of today's leading edge marketing techniques were perfected by companies like P&G, where Scott used to work. In many of their markets, there's almost a 1:1 correspondence between the demographic group and the job to be done. Feminine hygiene products, for example, if you understand the customer, you understand the job, in many ways. But then when you move outside of that realm, where there's not a 1:1 correspondence between job and demographic segment, then you end up misapplying the technique. Dresner: Interesting. What about looking at it from the other perspective. If I want to create a product or a service, what technique would I use to identify jobs that need to be done, that perhaps are not being done today? Christensen: You have to start somewhere, but for example, Federal Express was a business that was positioned on a job to be done. Get the stuff from here to there overnight, with perfect certainty. And before Federal Express, there just wasn't anybody that had a business model really positioned on getting that job done. But if you have an interest, and maybe this thing exists, then go to the postal service, and interview people who use the postal service. Ask them about the circumstances in which they found themselves in when they found that service. And as soon as you begin to interact with people who are thinking, "Boy, I wish I could have gotten there," you know. That's the best example I can offer.
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