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.
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