Wednesday, June 25, 2014
Is Your Firm Vulnerable to Disruptive Innovations?
If your company is a market leader it is potentially vulnerable to attacks from disruptive innovations. Clayton Christensen defines disruptive innovations as new market entrants that develop “good enough” products to serve a market leader’s least profitable customer. These least profitable customers are the result of the market leaders efforts to continually improve its products to better serve its most profitable customer.
Every time a market leader develops a product enhancement to serve its very best customers, it also creates a pool of customers that no longer want or need the new enhancements. These customers that are “left behind” have a value, in that they use the product but are less profitable than those customers who adopt and pay premium prices for the new product attributes.
Christensen gives as one example, the displacement of vertically integrated steel mills by mini mills in several product categories. In the beginning, mini mills discovered they could produce rebar at significantly lower costs than the vertical steel mills and make an acceptable profit. The vertical mills were losing money on rebar and treated it as a loss leader.
When mini mills began selling their rebar they didn’t encounter resistance from the vertical mills. The vertical mills viewed the mini mills as capable of only creating rebar and therefore weren’t much of a threat to the other, more profitable, products made by the vertical mills. The mini mills, in effect helped the vertical mills improve their financial performance.
Of course the mini mills didn’t just produce rebar but found ways to produce the same products produced by the vertical mills. Over time mini mills became a real threat to the very existence of vertical steel mills.
Christensen give examples of disruptive innovations from all business sectors in his books The Innovator’s Dilemma and The Innovator’s Solution. It seems that all industries are vulnerable and are in need of strategies to protect their turf. It also seems that if an entrepreneur could determine markets ripe for disruption new companies could be created.
A study of value created and value forfeited may provide a means for identifying markets that are ready for disruption. If markets can be identified where new innovations are being introduced to satisfy the wants and needs of very profitable customers (these are referred to as sustaining innovations and are used by market leaders to protect their most profitable customers) then customers can be segregated by purchase patterns. For example, all customers that adopt a product enhancement can be identified and the value (profit) created by that group’s purchases could be quantified (number of customers times the incremental profit per purchase).
Similarly, customers who bought prior models of the product but did not buy the most recent enhancement can be identified. The value forfeited (profits foregone) is the profit that would have been made if these customers had adopted the new product enhancements (number of customers not purchasing upgrade times the incremental profit on the new enhancement).
Knowing the size of the value forfeited provides an indication of the ability of a market leader to maintain its leadership. For example, if the incremental value gained is less than the value forfeited then there is evidence that the ability to improve long-term profitability through continued sustaining innovations has reached a point of diminishing returns.
This doesn’t mean that the sustaining innovation strategies should be scrapped but it may mean that additional strategies need to be developed to protect a customer base that may be loyal but is being left exposed to “good enough” product substitute strategies that could be developed by new market entrants.
The value of a forfeited value over time can be determined by quantifying revenues and potential profits represented by those customers, over time that have not adopted the market leaders new innovations. This may be a more difficult task since some customers may skip a product generation and come back to adopt a later version of the market leader’s product. Even so, an estimate of the cumulative number of customers “left behind” and the potential revenue available based on the price of a previous generation of product would give an indication of the potential market size available to a new market entrant. As the size of the customer base represented by the value-forfeited increases, the viable customer base for a market disruptor is increased.
Both the market entrant and the market leader must decide upon strategies to address market created by the markets leader’s forfeited value customers.
For market leaders the options include:
· Starting a separate entity to provide “good enough “ products for the customers “left behind”,
· Developing pricing strategies to provide low cost options,
· Developing strategies to allow customers to replace or repair current products as the customers needs dictate.
For market entrants, the options include:
· Developing a “good enough” product that is attractive and profitable,
· Introducing programs to trade in the market leader’s products as a portion of the payment for the entrant's new product,
· Developing warranty and bundling programs to create a stable customer base.
Clearly, knowing the point at which a market is large enough to support a new market entrant is important when developing marketing strategies for both new market entrants and market leaders. Developing metrics to monitor the value of customers’ value forfeited can be a useful tool.