Is your company's business model: Sustaining or Disruptive?

Update! First came the the steam engine. It disrupted the old mode of production. Then came the combustion engine. It disrupted the old mode of production. And now comes the battery. It will disrupt the old mode of production.

Some CEOs and managers of large and resource-rich businesses have long tried to find ways that could predict the outcome of competitive fights by looking at the attributes of the strengths of the companies involved: Larger companies with more resources to throw at a problem will beat the smaller competitors. But they forget despite repeated evidence that the level of resources allocated often bears little relationship to the outcome.

Others look at the attributes of the change: When innovations are incremental, the established and leading companies in an industry are likely to reinforce their dominance. However, compared with entrants, they will be conservative and ineffective in exploiting breakthrough innovation.

Disruptive Technologies: Catching the Wave

Clayton M. Christensen has since his article from 1995 "Disruptive Technologies: Catching the Wave" written together with Joseph Bower in his ongoing study of innovation found another and more profitable way to understand when incumbents will win, and when the entrants are likely to beat them.

In the article they developed the concepts sustaining and disruptive to understand when incumbents will win, and when the entrants are likely to beat them. Christensen elaborated the concepts in "The Innovator’s Dilemma" from 1997 where he identified two distinct categories disruptive innovation and sustaining innovation to better understand and explain the outcome of competitive fights.

Disruptive innovation and sustaining innovation

He defined the two categories in this way:

• A disruptive technology or disruptive innovation is an innovation that helps create a new market and value network, and eventually goes on to disrupt an existing market and value network. The concept disruptive technology is widely used but disruptive innovation seems a more useful concept in many contexts since few technologies are intrinsically disruptive. It is rather the business model than the technology that enables and creates the disruptive effect
• In contrast to disruptive innovation, a sustaining innovation does not create new markets or value networks but only develops existing ones with better value, allowing the companies to compete against each other's sustaining improvements

As you can see Christensen's understanding of disruptive innovation is different from what might be expected by default, and he called this naive realism hypothesis the "technology mudslide hypothesis".

Technology mudslide hypothesis

According to the "technology mudslide hypothesis" an established business fails because it doesn't keep up technologically with other businesses. In this hypothesis, businesses are like climbers crawling upward on wobbly legs, where it takes constant upward-climbing effort just to stay still, and any break from the effort such as complacency causes a rapid downhill slide.

Christensen and others have shown that this naive realism hypothesis is wrong; it doesn't reflect reality. Instead they have shown that good companies are aware of the innovations, but their business environment does not allow them to pursue them when they first arise, because they are not profitable enough at first and because their development can take scarce resources away from sustaining innovations. Therefore they are not in a position where they can take advantage of the new disruptive innovations and create a new business model:

Apple's new business model

Christensen has used Apple to explain his idea about a new business model based on disruptive innovations versus the "technology mudslide hypothesis":

When Apple introduced the iPod, it did something far smarter than wrap a good technology in a stylish design. It wrapped a good technology in a groundbreaking business model.

Integrating hardware, software, and service, the business model provided game-changing attraction for consumers and record-breaking profits for Apple.

This success story is well known. But it's less well known that Apple was not the first to bring digital music players to market. A company called Diamond Multimedia introduced the Rio in 1998. Another firm, Best Data introduced the Cabo 64 in 2000. Both products worked well and were portable and attractive.

Apple’s real innovation was to make downloading of digital music easy and convenient. To do that, Apple developed a groundbreaking business model that integrated hardware, software, and service. This approach worked like Gillette’s famous blades-and-razor model in reverse: Apple more or less gave away the “blades” (low-profit iTunes music) to lock in purchase of the “razor” (the high-profit iPod).

Before I will explain more about Christensen's business model and its elements I want to mention two types of disruptive innovations because it will make it easier to understand Christensen's business model.

Two types of disruptive innovations

The two types of disruptive Innovations are:

1. Low-End Disruptions

Companies utilizes a new operating and / or financial approach—a different combination of lower gross profit margins and higher asset utilization that can earn attractive returns at the discount prices required to win business at the low end of the market. They don't create new markets. They are simply low-cost business models that grew by picking off the least attractive of the established companies’ customers.

An example is the Korean automakers’ entry into the European and North American market. They did not create new markets. They grew by picking off the least attractive of the established automakers’ customers.

Another example is Amazon.com in their early days. Amazon was a low-end disruption relative to traditional bookstores.

2. The New-market Disruptions

The new-market disruptions compete with “nonconsumption” because new-market disruptive products are so much more affordable to own and simpler to use that they enable a whole new population of people to begin owning and using the product, and to do so in a more effective setting.

An example is the smartwatch. The Swiss watch industry's users are not the smartwatch's target market. The real target here is the 60% of 18-34 year olds that get the time from their phones.

Another example is the PC. The PC's were real new-market disruptions because for years they were sold and used in their unique value network before they began to capture sales from higher-end professional computers.

Another example is Canon’s desktop photocopiers. They enabled people to make their own photocopies right in their offices or homes, rather than taking their originals to the corporate high-speed photocopy center. When Canon made photocopying so convenient, people ended up making a lot more copies.

Hybrids disruptions

Of course there hybrid disruptions. Hybrids disruptions combines new-market and low-end approaches, as depicted by the continuum of the third axis in the figure "Two Types of Disruptive Innovations" below.

Southwest Airlines, Virgin and other discount airlines are actually hybrid disruptors. They initially targeted customers who weren’t flying-people who previously had used cars, trains and buses. But Southwest and Virgin pulled customers out of the low end of the major airlines’ value network as well.

Salesforce.com is another example. Before Salesforce was introduced to the market CRM like Siebel was expensive software and it was only offered to enterprise businesses that ran it on big servers in house. But Salesforce's cloud solution disrupted the market and Salesforce learned many new customers in medium and small business to use CRM. Now Salesforce is used in enterprise businesses too.

The Danish CRM OnBRM is also a cloud solution. For about 10 years ago the first version of OnBRM (then called Jyfi) was offered free to all Danish car dealers by a Danish bank and that version combined with the bank's business model disrupted the market for car financing and car sales in Denmark.

As we saw above there are two different types of disruptive innovations, and it can best be visualized by adding a third axis to the original disruption figure:

Copyright © Clayton Christensen. All Rights Reserved.Figure: Two Types of Disruptive Innovations

The axes are: The performance of the product on the vertical axis, with time plotted on the horizontal dimension. The third axis represents new customers and new contexts for consumption.

In geometric terms, this application and set of customers reside in a plane of competition and consumption, which Christensen in "The Innovator’s Dilemma" called a value network.

Value network

A value network is the context within which a business establishes a cost structure and operating processes and works with suppliers and channel partners in order to respond profitably to the common needs of a class of customers.

Within the value network, each business' competitive strategy, and particularly its cost structure and its choices of markets and customers to serve, determines its perceptions of the economic value of an innovation. These perceptions create which rewards and threats that a business expect to experience through disruptive versus sustaining innovations.

The third dimension in the figure represents new contexts of consumption and competition, which are new value networks. These constitute either new customers who previously lacked the money or skills to buy and use the product, or different situations in which a product can be used enabled by improvements in simplicity, portability, and product cost. There can be drawn new vertical axis for each new value network.

Business model

Today as we saw above Christensen talks about business models and he has enhanced his model with new terms / elements because CEOs and managers can get a more successful business if they operate their company based on an effective business model.

A business model, from Christensen's point of view, consists of four intergrated elements that together create and deliver value.

The elements are Customer value proposition (CVP), Profit formula, Key resources and Key processes. The most important element is CVP:

1. CVP

A successful business is one that has found a way to create value for customers—that is, a way to help customers get an important job done. A job that gives a solution to a fundamental problem in a given situation. Once you understand the job and all its dimensions, including the full process for how to get it done, you can design the offering.

The CVP will grow:

• The more important the job is to the customer
• The lower the level of customer satisfaction with current options for getting the job done
• The better your solution is compared to existing alternatives at getting the job done

Opportunities for creating a CVP are best when alternative products and services have not been designed with the real job in mind and your business can design an offering that gets that job and only that job done perfectly.

2. Profit formula

Another element is the profit formula. The profit formula is the blueprint that defines how your business creates value for itself while providing value to the customer. It consists of the following:

• Revenue model: Price x volume
• Cost structure: Direct costs, indirect costs economies of scale. Cost structure will be predominantly driven by the cost of the key resources required by the business model
• Margin model: Given the expected volume and cost structure, the contribution needed from each transaction to achieve desired profits
• Resource velocity: How fast you need to turn over inventory, fixed assets, and other assets ie how well you need to utilize your resources to achieve your anticipated goals

People often think the terms “profit formulas” and “business models” are interchangeable. But how you make your profit is only one element of the model. It is more useful to start by setting the price required to deliver the CVP and then based on this decision to determine what the variable costs and gross margins must be.

3. Key resources

The key resources are assets such as the people, technology, products, facilities, equipment, sales channels, and brand required to deliver the value proposition to the targeted customer. The focus must be on the key elements that create value for the customers and the way those elements interact.

4. Key processes

Successful companies have operational and managerial processes that allow them to deliver value in a way they can successfully repeat and scale. These processes may include tasks such as development, manufacturing, budgeting, planning, sales, training, and customer service. Key processes also include a company’s rules, metrics, and norms.

These four elements form the building blocks of a business. The CVP and the profit formula define value for the customer and the company.

Key resources and key processes describe how that value will be delivered to both the customer and the company.

The power of this simple business model lies in the complex interdependencies of its parts.

Major changes to any of these four elements affect the others and the whole.

Successful CEOs and managers devise a more or less stable system in which these elements are related to one another in consistent and complementary ways.

You can in the figure "The Elements of a Successful Business Model" below see how the elements interacts.

Intuit and MinuteClinic are examples of how to generate a succesful CVP by overcoming some of most common barriers keeping people from getting particular jobs done.

The Accounting software company Intuit developed QuickBooks to fulfill small business owners’ need to avoid running out of cash. By fulfilling that job with greatly simplified accounting software, Intuit broke the skills barrier that kept untrained small business owners from using more-complicated accounting packages.

MinuteClinic, the drugstore-based basic health care provider, broke the time barrier that kept people from visiting a doctor’s office with minor health problems.

Have you ever heard Clayton M. Christensen live?

Finally, have you ever heard Clayton M. Christensen live? If you saw the episode of the HBO sitcom “Silicon Valley” in which the characters attend TechCrunch Disrupt 2014, and you saw a guy from the stage, a Paul Rudd look-alike, shouts, “Let me hear it, DISSS-RUPPTTT!,” you have heard the voice of Clayton M. Christensen.

You can also hear Clayton M. Christensen if you check out the interview in Reinventing Your Business Model by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann.

References

Disruptive Technologies: Catching the Wave by Joseph L. Bower and Clayton M. Christensen

The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail by Clayton M. Christensen

Disruptive Innovation by Clayton M. Christensen

Reinventing Your Business Model by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann. This reference includes an interview with Clayton M. Christensen

The Disruption Machine by Jill Lepore

Picture Credit Brian Stauffer and The New Yorker.

Figure: The Elements of a Successful Business Model (from Reinventing Your Business Model by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann)