Strategic Analysis

Disruption, servitization and the value of winning (Part 1)

In numerous articles in this blog and elsewhere we discuss the importance of servitization for manufacturers and how digitization, data and the Industrial Internet of Things are changing offerings and disrupting business models and the nature of competition. We then urge managers to understand and come to terms with the new environment and find ways for their companies to succeed. But what do we really mean by disruption and should all companies threatened by it really try to fight back by radically changing what they do and how they go about it?

The “theory of disruption” has been a central tenet in strategic management thinking since Clayton Christensen, a professor at Harvard Business School, published the first groundbreaking article (Disruptive Technologies: Catching the Wave) in the Harvard Business Review in 1995.

In a nutshell the theory predicts that incumbents can (and eventually will be) be disrupted from below. As Christensen and co-authors note in another HBR article (What is disruptive innovation?) 20 years later:

“Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services [Note SI2: through incremental, sustaining innovation] for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price. Incumbents, chasing higher profitability in more- demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred”.

Examples of disrupted industries are many and diverse and famously include disk drives, steel making, book publishing and retailing, travel agents and airlines. Since publication of the idea though, the phenomenal (and accelerating) pace of technological innovation has caused a wholesale transformation of consumption patterns, markets, economics and competitive dynamics and therefore disarray (disruption?) in many industries. Consequently the word disruption has lost its meaning as intended by Christensen and is now used to describe almost any of the radical, technology driven, changes that are taking place. Christensen’s disruption theory is in danger of becoming a victim of its own success:

Despite broad dissemination, the theory’s core concepts have been widely misunderstood and its basic tenets frequently misapplied. This creates problems because, of course, misunderstanding causes leads to wrong remedies: As Christensen and co-authors note when reviewing the theory’s strengths and shortcomings and trying to put the concept in context:

“The problem with conflating a disruptive innovation with any breakthrough that changes an industry’s competitive patterns is that different types of innovation require different strategic approaches. To put it another way, the lessons we’ve learned about succeeding as a disruptive innovator (or defending against a disruptive challenger) will not apply to every company in a shifting market. If we get sloppy with our labels or fail to integrate insights from subsequent research and experience into the original theory, then managers may end up using the wrong tools for their context, reducing their chances of success. Over time, the theory’s usefulness will be undermined”.

Recently, perhaps coinciding with the theory’s 20-year anniversary, there has been a lot of debate about the theory’s explanatory and predictive power and the context within which it is applied.  For example, two of the innovations, whose “disruptiveness” has been challenged by Christensen himself are Apple’s iPhone and Uber. According to Christensen neither is a disruption (in his sense), because, in Apple’s case, rather than coming from below the iPhone targeted the high end of the mobile phone market, while Uber challenged the taxi/mobility market by offering a superior (rather than inferior) service. However, is this the right way to view these innovations? Context and boundaries in business (and social science) are fluid. If one thinks of the iPhone as challenging the personal computer market (rather than the mobile phone market) and Uber challenging car ownership, at least among the young, (rather than taxis) then completely different conclusions emerge.

But also in a broader sense it is becoming increasingly clear that Christensen’s disruption theory, while powerful, is a special case. It is able to explain some, but not all, upheavals that have been driving change in many industries over the past decade. Most threats faced by companies are complex, deeply challenging and cannot be understood from a single viewpoint.

A case in point is how companies (should) respond to disruptive threats. Christensen argues that incumbent leaders often have the resources and abilities needed to succeed in competing against a disruptive innovation, but lack the values, modes of interaction, and decision making to do so. Sometimes they are myopic and underestimate the threat’s potential or they cannot bring themselves to move away from accepted wisdom such as the “most profitable customers” paradigm. In other cases they lack the incentives or cannot accept the risk of cannibalizing their own business -few can emulate Jack Welch’s “destroyyourbusiness.com” outside of an academic exercise.

However there is also evidence that many managers do, in fact, develop the correct competitive responses to disruptive threats. And, as Andrew King and Baljir Baatartogtokh argue in a recent article (How useful is the theory of disruptive innovation) in MIT’s Sloan Management Review, formulating and implementing counter-strategies is often a very difficult undertaking: Companies have to navigate fundamental transitions in technology which can be treacherous, because they involve different engineering skills, new product designs and production facilities. And the authors conclude that it is therefore often the right or rational choice to avoid competing with a disruptive innovation. For example switching from a full service hub-and-spoke to a low cost point-to-point airline business model requires a dramatically different fleet of airplanes, new workers, radically different labor contracts, new airports, and new gates.

Whether a company can or, more importantly, should stem such a task is a crucial, indeed fundamental,strategic question – “should, in fact, a company choose to compete (fight) in a market where the rules of the game have completely changed and incur the costs of doing so? Or should it exit the market and see those revenues vanish? Should a company invest in a profitable but declining business, or should it turn away? Is the best course to maximize returns by letting the business slowly die?” Many, including top managers, assume that companies must always choose to compete and fight, however:

“Choosing to fight without studying the options violates a basic principle of strategy: The first step in responding to any major innovation is assessing whether the industry continues to be an attractive place to compete. When industries become structurally unattractive, it may be time to plan an organized retreat”.

What, in other words, is the value of winning?

Sometimes technology transitions shift paradigms. As Willy Shih, another professor at HBS, noted on analog to digital transitions:  “Such transitions are competency-destroying because the capabilities, tacit knowledge, and experience base of the incumbent firms are rendered irrelevant… While the firms may still possess valuable complements like brands or sales and distribution channels, such transitions are immensely challenging because of the exposure to commoditization… Digital technologies often cause barriers to entry to fall and competition to become cutthroat”.

So where does this leave manufacturers and servitization?  As we have argued in other posts manufacturers are indeed confronted with difficult challenges in a digitizing, servitizing world. What is the value of winning to them? Which companies are more likely to succeed? And are there companies for whom the price to win is probably too high, who should, as it were, accept to irreversibly decline?

We’ll discuss these questions in the next post.

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