Companies stumble for many reasons, among them bureaucracy, arrogance, tired executive blood, poor planning, short-term investment horizons, inadequate skills and resources, and just plain bad luck. But this book is not about companies with such weaknesses: It is about well-managed companies that have their competitive antennae up, listen astutely to their customers, invest aggressively in new technologies, and yet still lose market dominance.
But Apple and IBM lagged 5 years behind the leaders in bringing portable computers to market. Similarly, the firms that built the engineering workstation market — Apollo, Sun, and Silicon Graphics — were all newcomers to the industry.
As in retailing, many of these leading computer manufacturers were at one time regarded as among the best-managed companies in the world and were held up by journalists and scholars of management as examples for all to follow.
In some, the new technologies were complex and expensive to develop. In others, the deadly technologies were simple extensions of what the leading companies already did better than anyone else. One theme common to all of these failures, however, is that the decisions that led to failure were made when the leaders in question were widely regarded as among the best companies in the world.
Good management was the most powerful reason they failed to stay atop their industries. Precisely because these firms listened to their customers, invest aggressively in new technologies that would provide their customers more and better products of the sort they wanted, and because they carefully studied market trends and systematically allocated investment capital to innovations that promised the best returns, they lost their positions of leadership.
Technology means the processes by which an organization transforms labor, capital, materials, and information into products and services of greater value. All firms have technologies. A retailer like Sears employs a particular technology to procure, present, sell, and deliver products to its customers.
In their efforts to provide better products than their competitors and earn higher prices and margins, suppliers often “overshoot” their market: They give customers more than they need or ultimately are willing to pay for.
Mainframe performance has surpassed the requirements of many original customers, who today find that much of what they need to do can be done on desktop machines liked to file servers.
First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits. Second, disruptive technologies typically are first commercialized in emerging or insignificant markets. And third, leading firms’ most profitable customer generally don’t want, and indeed initially can’t use, products based on disruptive technologies. By and large, a disruptive technology is initially embraced by the least profitable customers in a market.
Companies depend on customers and investors for resources.
While managers may think they control the flow of resources in their firms, in the end it is really customers and investors who dictate how money will be spent because companies with investment patterns that don’t satisfy their customers and investors don’t survive. The highest-performing companies, in fact, are those that are best at this, that is, they have well-developed systems for killing ideas that their customers don’t want.
Small markets don’t solve the growth needs of large companies.
To maintain their share prices and create internal opportunities for employees to extend the scope of their responsibilities, successful companies need to continue to grow. A $4B company needs to find $800M in new sales to grow at 20%. No new markets are that large.
Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies. They demand market data when none exists and make judgments based upon financial projections when neither revenues or costs can be known.
The pace of technological progress in products frequently exceeds the rate of performance improvement that mainstream customers demand or can absorb. As a consequence, products whose features and functionally closely match market needs today often follow a trajectory of improvement by which they overshoot mainstream market needs tomorrow.
In their efforts to stay ahead by developing competitively superior products, many companies don’t realize the speed at which they are moving up-market, over-satisfying the needs of their original customers as they race the competition toward higher-performance, higher-margin markets. In doing so, they create a vacuum at lower price points into which competitors employing disruptive technologies can enter.
Simply put, when the best firms succeeded, they did so because they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers’ next-generation needs. But, paradoxically, when the best firms subsequently failed, it was for the same reasons.
When faced with sustaining technology change that gave existing customers something more and better in what they wanted, the leading practitioners of the prior technology led the industry in the development and adoption of the new.
Clearly, they were technologically capable of producing these drives. Their failures resulted from delay in making the strategic commitment to enter the emerging market in which the 8-inch drives could be sold. They were held captive by customers. Mainframe computer manufacturers did not need an 8-inch drive. In fact, they explicitly did not want it: they wanted drives with increased capacity at a lower cost per megabyte.
Seagate’s marketers tested the 3.5-inch prototypes with customers in the desktop computing market it already served. Not surprisingly, they indicated little interest in the smaller drive.
The established firms were, in fact, aggressive, innovative, and customer-sensitive in their approaches to sustaining innovations of every sort. But the problem established firms seem unable to confront successfully is that of downward vision and mobility, in terms of the trajectory map. Finding new applications and markets for these new products seems to be a capability that each of these firms exhibited once, upon entry, and then apparently lost.
When he removed the cover of the DEC minicomputer and examined its structure, he saw “DEC’s organizational chart in the design of the product.”
The concept of the value network — the context within which a firm identifies and responds to customers’ needs, solve problems, procures input, reacts to competitors, and strives for profit — is central to this synthesis.
Selling directly to end users involves significant sales force costs, and the field service network to support the complicated machines represents a substantial ongoing expense. All these costs must be incurred in order to provide the types of products and services customers in this value network require. For these reasons, these firms needed gross profit margins of 50-60% to cover the overhead cost structure inherent to the value network in which they competed.
Many scholars have asserted that the essence of strategic technology management is to identify when the point of inflection on the present technology’s S-curve has been passed, and to identify and develop whatever successor technology rising from below will eventually supplant the present approach.
Disruptive technologies emerge and progress on their own, uniquely defined trajectories, in a home value network.
Competition and customer demands in the value network in many ways shape the firms’ cost structure, the firm size required to remain competitive, and the necessary rate of growth. Thus, managerial decisions that make sense for companies outside a value network may make no sense at all for those within it, and vice versa.
Established firms confronted with disruptive technology change did not have trouble developing the requisite technology: Prototypes of the new drives had often been developed before management was asked to make a decision. Rather, disruptive projects stalled when it came to allocating scarce resources among competing product and technology development proposals. Sustaining projects addressing the needs of the firms’ most powerful customers almost always preempted resources from disruptive technologies with small markets and poorly defined customer needs.
In other cases, managers did approve resources for pursuing a disruptive product — but, in the day-to-day decisions about how time and money would actually be allocated, engineers and marketers, acting in the best interests of the company, consciously and unconsciously starved the disruptive project of resources necessary for a timely launch.
Seagate’s decision to shelve the 3.5-inch drive seems starkly rational. It simply did not make sense for Seagate to put its resources behind the 3.5-inch drive.
The startups, however, were as unsuccessful as their former employers in attracting established computer makers to the disruptive architecture. Consequently, they had to find new customers.
Once the startups had discovered an operating base in new markets, they realized that, by adopting sustaining improvements in new component technologies, they could increase the capacity for their drives at a faster rate than their new market required.
Customers in these established markets eventually embraced the new architectures they had rejected earlier, because once their needs for capacity and speed were met, the new drives’ smaller size and architectural simplicity made them cheaper, faster, and more reliable than the older architectures.
Many found that the entrant firms had developed insurmountable advantages in manufacturing cost and design experience, and they eventually withdrew from the market. The firms attacking from value networks below brought with them cost structures to achieve profitability at lower gross margins. The attackers were able to price their products profitably, while the defending, established firms experienced a severe price war.
For established manufacturers that did succeed in introducing the new architectures, survival was the only reward. None ever won a significant share of the new market; the new drives simply cannibalized sales of older products to existing customers.
As hard drive manufacturers move up to the gigabyte range, they ware unable to be cost competitive at the lower capacities. As a result, disk drive makers are pulling out of markets in the 10-40MB range and creating a vacuum into which flash can move.
Incumbent firms are likely to lead their industries in innovations of all sorts — architecture and components — that address needs within their value network, regardless of intrinsic technological character or difficulty. These are straightforward innovations; their value and application are clear. Conversely, incumbent firms are likely to lag in the development of technologies — even those in which the technology involved is intrinsically simple — that only address customers’ needs in emerging value networks.
The most formidable barrier the established firms faced is that they did not want to do this.
The essence of the attacker’s’ advantage is in the ease with which entrants, relative to incumbents, can identify and make strategic commitments to attack and develop emerging market applications, or value networks. At its core, therefore, the issue may be the relative flexibility of successful established firms versus entrant firms to change strategies and cost structures, not technologies.
These companies logged record profits until 1966 — the point at which the disruptive hydraulics technology had squarely intersected with customers’ needs in the sewer and piping segment.
Although some had employed hydraulics to a modest degree as a bucket-curling mechanism, they lacked the design expertise and volume-based manufacturing cost position to compete as hydraulics invaded the mainstream.
Clearly, with the benefit of hindsight, they should have invested in hydraulics machines and embedded that piece of their organizations charged with making hydraulic products in the value network that needed them. But the dilemma in managing the disruptive technology in the heat of the battle is that nothing went wrong inside these companies. Hydraulics was a technology that their customers didn’t need — indeed, couldn’t use. Each cable shovel manufacturer was one of at least 20 manufacturers doing everything they could do to steal each other’s customers.
Rational managers can rarely build a cogent case for entering small, poorly defined low-end markets that offer only lower profitability. In fact, the prospects for growth and improved profitability in the upmarket value networks often appear to be so much more attractive than the prospect of staying within the current value network, that it is not unusual to see well-managed companies leaving (or becoming uncompetitive with) their original customers as they search for customers at higher price points.
As companies leave their disruptive roots in search of greater profitability in the market tiers above them, they gradually come to acquire the cost structures required to compete in those upper market tiers. This exacerbates their problem of downward immobility.
As these ideas bubble up from the bottom, the organization’s middle managers play a critical but invisible role in screening these projects. These managers can’t package and throw their weight behind every idea that passes by; they need to decide which are the best, which are the most likely to succeed, and which are most likely to be approved, given the corporate financial, competitive, and strategic climate.
In most organizations, managers’ careers receive a big boost when they play a key sponsorship role in very successful projects — and their careers can be permanently derailed if the have the bad judgment or misfortune to back projects that fail. Middle managers aren’t penalized for all failures, of course. Projects that fail because the technologists couldn’t deliver often are not regarded as failures at all, because a lot is learned from the effort and because technology development is generally regarded as an unpredictable, probabilistic endeavor. But projects that fail because the market wasn’t there have far more serious implications for managers’ careers. These tend to be much more expensive and public failures. They generally occur after the company has made full investments in product design, manufacturing, engineering, marketing, and distribution.
While senior managers may think they’re making the resource allocation decisions, many of the really critical resource allocation decisions have actually been made long before senior management gets involved.
The minimills, however, saw the rebar market quite differently. They had very different cost structures than those of the integrated mills: little depreciation and no R&D costs, low sales expenses (mostly telephone bills), and minimal general managerial overhead. They could sell by telephone virtually all the steel they could make — and sell it profitably.
Managers played the game the way it was supposed to be played. The very decision-making and resource-allocation processes that are key to the success of established companies are the very processes that reject disruptive technologies: listening carefully to customers; tracking competitors’ actions carefully; and investing resources to design and build higher-performance, higher-quality products that will yield greater profit.
Resource dependence: Customers effectively control the patterns of resource allocation in well-run companies.
How did IBM do it? It created an autonomous organization in Florida, far away from its NY state HQ, that was free to procure components from any source, to sell through its own channels, and to forge a cost structure appropriate to the technological and competitive requirements of the PC market. The organization was free to succeed along metrics of success that were relevant to the PC market.
The most straightforward way of confronting this difficulty is to implant projects aimed at commercializing disruptive technologies in organizations small enough to get excited about small-market opportunities.
If a company’s current share price is predicated on a consensus growth forecast of 20%, and the market’s consensus for growth is subsequently revised downward to 15%, then the company’s share price will likely fall — even though its revenue and earnings will still be growing at a healthy rate. A strong and increasing stock price, of course, gives a company access to capital on favorable terms; happy investors are a great access to a company.
Rising share prices make stock option plans an inexpensive way to provide incentive to and to reward valuable employees. When share prices stagnate or fall, options lose their value. In addition, company growth creates room at the top for high-performing employees to expand the scope of their responsibilities. When companies stop growing, they begin losing many of their most promising future leaders, who see less opportunity for advancement.
Every innovation is difficult. That difficulty is compounded immeasurably, however, when a project is embedded in an organization in which most people are continually questioning why the project is being done at all.
Not only are the market application for disruptive technologies unknown at the time of their development, they are unknowable. The strategies and plans that managers formulate for confronting disruptive technological change, therefore, should be plans for learning and discovery rather than plans for execution.
The HP project managers concede in retrospect that their most serious mistake in managing the Kittyhawk initiative was to act as if their forecasts about the market were right, rather than as if they were wrong. They had invested aggressively in manufacturing capacity for producing the volumes forecast for the PDA market and had incorporated design features that were crucial to acceptance in the PDA market they had so carefully researched.
Gordon Moore recalled that IBM’s choice of the Intel 8088 microprocessor as the “brain” of its new PC was viewed within Intel as a “small design win.” Even after IBM’s stunning success with its PCs, Intel’s internal forecast of the potential applications for the next-gen 286 chip did not include PCs in its list of the 50 highest-volume applications.
The reaction of some managers to the difficulty of correctly planning the markets for disruptive technologies is to work harder and plan smarter.
Many of the ideas prevailing at Intel about where the disruptive microprocessor could be used were wrong; fortunately, Intel had not expended all of its resources implementing wrong-headed marketing plans while the right market direction was still unknowable.
Guessing the right strategy at the outset isn’t nearly as important to success as conserving enough resources so that new business initiatives get a second or third stab at getting it right.
In most companies, however, individual managers don’t have the luxury of surviving a string of trials and errors in pursuit of the strategy that works. Rightly or wrongly, individual managers believe that they cannot fail.
The inability or unwillingness of individual managers to put their careers at risk acts as a powerful deterrent to the movement of established firms into the value networks created by those technologies.
The hallmark of a great manager is the ability to identify the right person for the right job, and to train his or her employees so that they have the capabilities to succeed at the jobs they are given.
Unfortunately, some manager don’t think as rigorously about whether their organizations have the capability to successfully execute jobs that may be given to them.
Organizations create value as employees transform inputs of resources — people, equipment, technology, product designs, brands, information, energy, and cash — into products and services of greater worth. This pattern of interaction, coordination, communication, and decision-making through which they accomplish these transformations are processes. Processes include not just manufacturing processes, but those by which product development, procurement, market research, budgeting, planning, employee development and compensation, and resource allocation are accomplished.
Processes differ not only in their purpose, but also in their visibility. Some are “formal,” in the sense that they are explicitly defined, visibly documented, and consciously followed. Others are “informal,” in that they are habitual routines or ways of working that have evolved over time, which people follow simply because they work — or because “That’s the way we do things around here.” Still other methods of working and interactive have proven so effective for so long that people unconsciously follow them — they constitute the culture of the organization.
The larger and more complex a company becomes, the more important it is for senior managers to train employees at every level to make independent decisions about priorities that are consistent with the strategic direction and the business model of the company. A key metric of good management, in fact, is whether such clear and consistent values have permeated the organization.
One of the bittersweet rewards of success is, in fact, that as companies become large, they literally lose the capability to enter small emerging markets.
Although their merged organizations might have more resources to throw at innovation problems, their commercial organizations tend to lose their appetites for all but the biggest blockbuster opportunities. Huge size constitutes a very real disability in managing innovation.
The disruptive innovations occurred so intermittently that no company had a routinized process for handling them. Furthermore, because the disruptive products promised lower profit margins per unit sold and could not be used by their best customers, these innovations were inconsistent with the leading companies’ values. The leading disk drive companies had the resources required to succeed at both sustaining and disruptive technologies. But their processes and values constituted disabilities in their effort to succeed at disruptive technologies.
Large companies often surrender emerging growth markets because smaller, disruptive companies are actually more capable of pursuing them. Though startups lack resources, it doesn’t matter. Their values can embrace small markets, and their costs structures can accommodate lower margins. Their market research and resource allocation processes allow managers to proceed intuitively rather than having to be backed up by careful research and analysis, presented in Powerpoint.
In the startup stages of an organization, much of what gets done is attributable to its resources — its people. The addition or departure of a few key people can have a profound influence on its success. Over time, however, the locus of the organization’s capabilities shifts toward its processes and values.
In contrast, at highly successful firms such as McKinsey, the processes and values have become so powerful that it almost doesn’t matter which people get assigned to which project teams. Hundreds of new MBAs join the firm every year, and almost as many leave.
Once members of the organization begin to adopt ways of working and criteria for making decisions by assumption, rather than by conscious decision, then those processes and values come to constitute the organization’s culture. Culture enables employees to act autonomously and causes them to act consistently.
When the organization’s capabilities reside primarily in its people, changing to address new problems is relatively simple. But when the capabilities have come to reside in processes and values and especially when they have become embedded in culture, change can become extraordinarily difficult.
If the acquired company’s processes and values are the real driver of its success, then the last thing the acquiring manager wants to do is to integrate the company into the new parent organization.
Wall Street exerted nearly inexorable pressure on management to consolidate the 2 organizations in order to cut costs. However, integrating the 2 companies would likely vaporize the key processes that made Chrysler such an attractive acquisition in the first place.
4 phases: functionality, reliability, convenience, and price.
They took it for granted that the market needed the highest-possible quality of surface finish and invested more capital in a conventional caster. They applied to a disruptive innovation a way of thinking appropriate to a sustaining technology.
Because established companies are so prone to push for high-performance, high-profit products and markets, they find it very difficult not to overload their first disruptive products with features and functionality.
The 3rd strategic option for dealing with these dynamics is to use marketing initiatives to steepen the slopes of the market trajectories so that customers demand the performance improvements that the technologists provide.
Microsoft, Intel, and the disk drive companies have pursued this last strategy very effectively. Microsoft create and market software packages that consume massive amounts of disk memory and require ever-faster micro-processors to execute.
I don’t want my organization to have pockets that are too deep. While I don’t want my people to feel pressure to generate significant profit for the mainstream company, I want them to feel constant pressure to find some way — some set of customers somewhere — to make our small organization cash-positive as fast as possible.
The capabilities of most organizations are far more specialized and context-specific than most managers are inclined to believe. This is because capabilities are forged within value networks.
Economists have extensively described barriers to entry and mobility and how they work. A characteristic of almost all of these formulations, however, is that they relate to things, such as assets or resources, that are difficult to obtain or replicate. Perhaps the most powerful protection that small entrant firms enjoy as they build the emerging markets for disruptive technologies is that they are doing something that is simply does not make sense for the established leaders to do.