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2016-02-25 11:03:41
Joshua Gans
From the March 2016 Issue
Since Clayton Christensen published The Innovator s Dilemma, in 1997,
management scholars have focused on innovations that disrupt customer demand
patterns. The story usually plays out like this. A new entrant develops an
innovative product that is initially attractive only to a niche segment of
customers and may underperform mainstream products on traditional measures. At
first, customers reject the innovation, but as it improves rapidly along
performance dimensions that they care about, they begin to embrace it, and the
new entrant becomes a real threat to incumbents.
Over the past two decades, managers have developed a defensive playbook for
confronting this kind of demand side disruptive innovation. Most commonly,
they ll either acquire new entrants or disrupt themselves by setting up
autonomous units charged with exploring potentially disruptive innovations. The
idea is that once the disruptive innovation begins to dominate the industry,
the firm will be ready to roll its new technology into its principal
operations, transforming itself in the process.
But pulling that off turns out to be more difficult in practice than it sounds
in theory: In many cases, disrupted incumbents find themselves unable to
transfer the new technologies into their mainstream operations because doing so
requires them to fundamentally change the way they manufacture and distribute
their products. In essence, the basic architecture of the product how it is put
together changes along with customer expectations and preferences, creating
supply side disruption.
Consider the challenge the iPhone posed to the BlackBerry in 2007. By all
accounts, the iPhone initially was a poor performer in terms of call quality,
battery life, and network usage compared with the BlackBerry, and it did not
include the keyboard that BlackBerry users loved. But the iPhone s
fundamentally new product design, as we know with hindsight, represented the
future, and customers began to embrace it. BlackBerry and its peers moved
quickly to include iPhone-like features such as a touch screen and a better web
browser but they were unable to compete effectively because the innovation
required them to redesign the process for making phones from the ground up.
Only newer entrants like Samsung, who were not locked into an existing
production model and could more easily orient the organization around the new
product architecture, were able to really challenge the iPhone.
Though less commonly understood, supply-side disruption is arguably more
dangerous than the kind Christensen describes; indeed, disruption of a product
s architecture threatens a company s very survival in a way that changes in
customer demands do not. The good news is that demise is not necessarily
inevitable when product architectures and, therefore, organizational structures
are upended. Incumbent firms can survive, and some even thrive on, repeated
architectural disruptions. On the basis of research by Rebecca Henderson, Mary
Tripsas, and others and my own study of companies facing disruption, I have
identified three prescriptions for long-term survival: an integrated
organizational model, ownership of a feature important to the end customer, and
a strong sense of corporate identity. Let s look at each of these in turn.
The Virtue of Integration
The first rule of surviving architectural disruption developing an integrated
organizational model has its roots in the work of management scholar Rebecca
Henderson. From 1987 to 1988, she collected data and conducted interviews on
the impact of innovation on the photolithographic alignment industry.
Photolithography is the standard method of fabricating printed circuit boards
(PCB) and microprocessors. Henderson found that while the industry experienced
continual incremental innovation in aligner technology, it also underwent four
separate waves of disruptive innovation. The four waves didn t affect prices,
which remained stable a pattern that differs from Christensen s examples, in
which disruptors enter at the low end of the market and apply downward pressure
across the industry. Rather, they changed the way the aligners were put
together and manufactured, representing a relatively pure example of
architectural, or supply-side, disruption.
With each wave of disruption, market share shifted dramatically in favor of new
entrants. On average, they captured more than half the market in their first
year. When an incumbent was first with a new architecture, it gained only 7% of
the market, on average. Incumbents also fared worse in terms of market share
gained per dollar of R&D spent on the architectural innovations.
Yet one incumbent company, Canon, bucked the trend and maintained its market
share throughout the waves of disruption. Henderson found that what chiefly
distinguished Canon from its competitors was its more integrated organization,
which supported investments in different generations of technology at the same
time. Canon cultivated tightly knit teams that had a wide range of capabilities
and experience across all the technology generations. This organizational
structure meant that it was able to imagine and respond to new product
architectures. By contrast, Canon s competitors were largely organized around
the traditional product architecture. Their teams focused on building
specialized knowledge of components and generating rapid but incremental
innovation, with consequent improvements in efficiency and performance.
Although Canon was routinely a few years behind competitors with
next-generation products, ceding first-mover advantage, its organizational
structure enabled it to seize other kinds of advantage. In particular, Canon s
engineers had the benefit of learning from their competitors innovations and
used those insights to reinvent not just its components but also its product
architecture. Indeed, two of the waves of disruption the proximity printer and
scanning projection were based on technology and processes that Canon had
developed internally.
Although other incumbents also recognized the value of emerging technologies,
their organizational models appeared to resist the innovations. Here s a
typical example. In 1965, Kasper Instruments, a component supplier in the
photolithography industry, introduced a contact aligner; just five years later,
it had captured half the market. But when it realized, in 1973, that proximity
capability could further improve its product and launched the new technology,
microprocessor manufacturers rejected the innovation. The new technology took
off only after Canon introduced an improved proximity aligner in the late
1970s. Kasper s inability to profit from its early insight stemmed from its
failure to understand that introducing the capability required changing the
relationship between the aligner s components.
The Importance of Unique Assets
The big risk in taking an approach like Canon s is forfeiting first mover
advantage. This risk, however, is eliminated if the company owns a core element
of the product whose architecture is being disrupted something that the
customer values. Nowhere is this more clearly illustrated than in the print
typesetting industry.
Typesetting dates back to the 1400s and Gutenberg s invention of movable type.
Not until 1886 was the modern approach of using a keyboard as the primary input
device invented by Ottmar Mergenthaler. His Linotype machine, which used liquid
metal to create the type, reigned for about 60 years as the only method of
typesetting. Mergenthaler Linotype, along with two other firms Intertype and
Monotype dominated the industry.
In 1949 the technology changed, and hot metal pouring gave way to a
photographic process using a xenon flash. A decade later, the process went
digital and the xenon flash was replaced by a cathode ray tube. Finally, in
1976, today s laser typesetting technology became the standard. You might
expect, on the basis of Henderson s research, that with each wave of innovation
a new entrant would have become the market leader. Yet Mergenthaler long
remained a dominant player in the industry.
When the xenon-flash phototypesetting technology emerged, the three incumbents
had time to work out their strategies, and it was the choices they made at this
point that decided their futures. All three developed machines that
incorporated the new technology. Intertype was the first to market. Allying
itself with external partners such as Kodak, it sought to graft the
technologies onto its existing machines, leaving its component interfaces and
production processes unchanged in any fundamental way.
Mergenthaler took a very different approach, as research by Mary Tripsas, of
Boston College s Carroll School of Management, shows. After an initial failed
attempt to build a new machine, it went back to the drawing board, recruited
people with expertise in the new technology, and integrated them closely with
an existing team in order to design not just a new machine but a completely new
model for producing it. As was the case with Canon, this process slowed
Mergenthaler down: It took 10 years to come out with its first phototypesetting
machine. How, then, did Mergenthaler survive the delay to reap the benefits
from its superior architecture?
The answer is simple. It owned fonts. The primary customers of typesetters were
newspapers and publishers. Each had a look and feel to its products that
depended crucially on the font it used. And as it turned out, those fonts were
proprietary and owned by the incumbent hot metal typesetters. So if a customer
wanted Helvetica (perhaps the most popular font of all time), it would have to
purchase the font from Mergenthaler. The company did not own any specific
intellectual property other than the trademark on the name, but that proved
enough to give the company an advantage. Although the dominant technology of
the machines may have changed over the years, customer demand for the fonts
never waned.
Of course, all three companies owned fonts. So why did Mergenthaler benefit
more than the others? Because it exploited the breathing space provided by its
ownership of fonts to explore the architectural disruption that the new
technology entailed and eventually offered a demonstrably better typesetter. It
could have opted to unbundle its fonts and abandon typesetting altogether, but
until digital typesetting appeared, it was not easy to separate the price of a
font from the cost of typesetting with it, so supplying the machine remained an
integral part of the business. It is only since the advent of full digital
typesetting that Mergenthaler has exited the physical part of the business to
focus on marketing and licensing its fonts.
The Power of Identity
Both Mergenthaler and Canon demonstrate that firms can ride out architectural
disruptions in cases in which the final products (newspapers and printers)
remain functionally the same even though the underlying technology of producing
them has changed radically. But some architectural disruptions trigger
fundamental changes in the value proposition as well, necessitating a
reinvention of corporate strategy along with a reconfiguration of the way
companies develop and manufacture their products. A good example of disruption
on this scale is the photography industry.
We all know the story of how the leading incumbents, Polaroid and Kodak, failed
to make the transition from film to digital photography. Although both had
anticipated the shift, organizational priorities and internal conflicts made it
difficult to embrace a radically new business model that did not include high
margins from film as a revenue source. One company, however, was able to make
the shift: Fujifilm. Mary Tripsas offers an explanation one that takes a leaf
out of Ted Levitt s seminal HBR article Marketing Myopia : When a firm
establishes an externally oriented identity built around the needs and desires
of customers and the emerging technologies and markets that support them, it
can manage the inevitable conflicts over capital and resources without having
to sacrifice the strengths.
How It s Made Matters
Early in the evolution of a complex, technology-based product, engineers
experiment with different ways of putting the components together. Eventually,
a dominant product architecture emerges one that sets standards for components
and how they relate to one another. At this stage, engineers working on the
products are consciously aware of the rationale behind the dominant design.
They have the architectural knowledge to understand how a change in one
component affects the performance of others and to manage trade-offs as
components evolve.
From that point on, most firms begin to organize themselves around the product
components. Specialized teams on a smartphone, for example, work on the
battery, the casing, the input screen, and so on. It makes sense to have these
component teams working furiously on improving their parts of the product: It
is wonderfully efficient and leads to a smoothly operating firm. The downside
is that engineers and designers become less aware of the overall product
architecture and the trade-offs and relationships embedded within it;
architectural knowledge becomes tacit and part of the wallpaper.
When technological advances lead to a new product architecture, companies with
modular organizations often falter. Because of their specialization, component
teams lose sight of technological advances outside their area of focus as well
as the larger picture of how components are put together. (At this point, it s
very possible that nobody in the firm is focused on overall architectural
design.) When a new architecture emerges, managers tend to undervalue it,
because it usually doesn t initially deliver as good a performance as the
continually improving established architecture does.
By contrast, firms whose operations remain more closely integrated across task
and function boundaries adapt better to architectural change (at least in
principle). Their architectural knowledge is conscious and widely distributed;
they are more alert to the potential of a new architecture to deliver very
rapid performance improvement in production and to give rise to products that
displace those of incumbents.
Fujifilm, like its competitors, realized the potential for digital photography
early on. It began researching new technologies in 1975 and produced prototype
products in the early 1980s. At the time, the bulk of its sales came from film,
photographic paper, and photographic chemicals, but the company also had
businesses in x-ray film and processors, microfilm, graphic arts films,
magnetic tape, and carbonless copying paper. This breadth of capabilities and
scope allowed Fujifilm to define itself as something more than a film
manufacturer or photography company like Kodak and other competitors. In 1978
it began describing itself instead as an audio-visual information recording
company. This was the first step in a longer strategic process that moved the
company s identity away from the rather specific domain of photography to the
broader domains of image and information.
This orientation had clear strategic implications for Fujifilm. For instance,
it could consider launching a high-priced hardware product for electronic
radiography without worrying about violating the traditional razor and blades
business model whereby photography companies sold their hardware cheap in order
to get customers hooked on film. The more inclusive identity of Fujifilm made
it easier for managers to envision and implement new business models suited to
the digital world. Fujifilm also took a path very different from competitors
in how it approached research and development. For example, its digital imaging
units were integrated with the main R&D division, whereas Polaroid s were
distinct. This gave Fujifilm s digital units legitimacy and minimized internal
conflicts during the transition away from film. The company was also able to
find new imaging applications for the existing chemistry capabilities it had
built up through the film business, notably applying chemicals in display
screens for digitally generated images.
By becoming an information and imaging company, therefore, Fujifilm was able
to thrive in the digital realm in ways its competitors failed to do.
The Real Dilemma
Facing down the threat of architectural disruption does come at a cost.
Organizational integration requires managers to move fluidly across teams or
develop cross-functional teams responsible for multiple technologies old and
new simultaneously so that embedded architectural knowledge is brought to the
top. This model is diametrically opposed to traditional prescriptions for high
performance, which call for modular structures and stand-alone next generation
product development teams.
Therefore, companies face a dilemma: Organizing around a modular structure is
extremely efficient in developing component innovation; however, the separate
divisions create organizational barriers, closing off paths by which new
architectural knowledge can be integrated into the primary business.
A New Narrative
Most managers are very familiar with the disruptive innovation narrative
described by Clay Christensen: Disruptors enter a market and compete fiercely
with incumbents, gobbling up market share as their innovations gain traction.
So it may come as a surprise to learn that more often competition between
disruptive innovators and incumbents morphs into cooperation.
In a recent study of more than 50 years of start-up strategies in the automatic
speech recognition industry, Matt Marx, David Hsu, and I examined innovations
in the industry that fit Christensen s definition of disruptive: technologies
that entered at the low end of the market and improved steadily over time on
traditional metrics. New entrants introduced most such innovations, but they
typically ended up being acquired by or cooperating with incumbents.
A case in point is Vlingo, which in 2010 developed a mobile speech recognition
app. Unlike existing software, the new technology did not confine users to a
predefined set of recognizable phrases but rather allowed them to speak
naturally. Not surprisingly, it was initially less accurate than previous
technologies.
Vlingo s long-term goal was to embed its technology in mobile devices and other
companies apps under license, but because of its poor performance early on, it
needed to prove to mobile providers that consumers would take to the
technology. So it went to market with its own app, competing directly with
companies it hoped to eventually secure licensing deals with. This strategy
worked: Customers began to embrace the technology, and Vlingo was able to
switch from competing against incumbent firms to cooperating with them.
Vlingo was not alone: We found (controlling for other factors) that among new
entrants who started out competing with incumbents, those with disruptive
technologies were four times as likely to switch to cooperation as those with
nondisruptive innovations. This suggests that for incumbents, waiting until a
disruptive technology has been proven and then cooperating with the most
promising entrant is a successful strategy for dealing with demand-side
disruption.
So what s the most coherent strategy for survival? Demand-side disruptions can
often be managed reactively through acquisition or even cooperation with the
emerging disruptors. In many industries, my research shows, disruptors and
incumbents do in fact cooperate very successfully, suggesting that the
conventional disruption narrative whereby the plucky disruptor displaces the
incumbent is not the standard plot. Much more often incumbents acquire the
disruptor or license from it. This is not to say that managers facing
demand-side disruption should sit idle. Even reactive management requires the
development of internal capabilities, and, as empirical evidence emphatically
shows, few companies are good at acquiring or integrating other companies or at
managing relationships with entrepreneurial firms.
That said, companies should put most of their focus on managing proactively for
architectural disruptions, because they are more likely to be firm-ending
events. Managers should organize the firm toward deeper integration and build a
more inclusive identity so that architectural innovations can be absorbed and
exploited, while ensuring that they retain control or ownership of key aspects
of the end customer experience that will remain relatively constant through
disruption. This will represent a substantial shift in managerial focus and
best-practice assumptions which is hardly surprising considering the general
lack of attention paid to architectural disruption.
When it comes to disruption, companies that survive best generally don t
perform best. They may be solid competitors, but they are unlikely to be the
leading player. By the same token, companies that perform best may ultimately
be doomed sooner or later they ll encounter a disruption that will render them
obsolete. To some extent, this is also nature s model. Large, specialized
animals like pandas and polar bears struggle to survive the depredations of
humanity. By contrast, adaptable, usually smaller mammals think foxes and
monkeys seem to be carving out a successful niche for themselves in towns and
cities. The difference is that animals can t choose whether to be adaptable or
not. Companies and their managers can.
A version of this article appeared in the March 2016 issue (pp.78 84) of
Harvard Business Review.
Joshua Gans is a professor at the University of Toronto s Rotman School of
Management, where he holds the Jeffrey S. Skoll Chair of Technical Innovation
and Entrepreneurship. He is also the chief economist of the University of
Toronto s Creative Destruction Lab and the author of The Disruption Dilemma
(MIT Press, 2016).