Despite a common ambition, only a small number of emerging companies succeed in disrupting
The ambition to disrupt industry segments, or large incumbent competitors, is a common catchcry of many emerging companies pursuing high growth rates and even higher valuations. However, with over 483,000 new businesses entered the market last year in Australia, they are a long way from being alone in their aspirations.
In a world characterised by unprecedented competition, abundant optionality, and high rates of change, real success comes to only a few of these new entrants. Over 90% of new business creation ends in tears with many others struggling to return their cost of capital. These statistics rightfully raise the question of whether disruption is just harder than it looks, or whether it is the most misunderstood and misused descriptor used in strategy. Equally, it begs the question for investors in emerging businesses, are there identifiable characteristics that make real disruption easier to identify?
Disruptive is just one of three types of innovation
‘Disruptive innovation’ is just one of three different types of innovations exploited by new businesses and tends to sit alongside the two other categories of innovations including sustaining and efficiency innovations.
‘Sustaining innovations’ are generally focused on making existing good products and services better. With the tendency to replace/cannibalise old capabilities with new ones, sustaining innovations don’t necessarily add to market growth, but rather influence the competitive battle for market share. Sustaining innovations generally target existing consumers, and most frequently, the best customers in the pursuit of better margins. With sustaining innovations, home ground advantage matters and rests with the market incumbents – eventually; because even if they are slow to initiate the innovation, they can generally catch up quickly and replicate the moves of new entrants.
‘Efficiency innovations’ are those improvements aiming to do more with less, such as driving higher productivity, automating processes, improving design, improving materials, or more targeted selling. With efficiency innovation it is not the absolute level of improvement that is important, but rather the relative movement. Competitors are rarely standing still, so relative advantage can only be achieved if competitors can be outpaced in efficiency improvements.
The distinguishing feature of ‘disruptive innovation’ is that it more likely to growth the size of markets. It does this primarily by improving accessibility that enables existing non-consumers to become consumers. The real competitors to disruptive innovators are non-consumers rather than existing established market incumbents. Technology is the most overt driver of disruptive innovation, but it is not the only driver nor, on its own, a sufficient driver of disruption. Disruptive technology, without a disruptive delivery business model, is a contribution to science, and on its own, will not disrupt or grow markets.
Importantly, it is disruptive business models, not disruptive technology that incumbents find harder to replicate. The secret to disruptive innovation is often found in simplifying the current complex market offering to consumers. This can unleash a causality chain whereby simpler offerings increase accessibility, improved accessibility increases consumption, increase consumption grows the market, and market growth provides the space for new entrants to prosper. It is therefore not surprising that unicorns are found feeding more frequently in the disruptive paddock than the sustaining or efficiency ones.
Disruption invariably comes from the bottom end of existing markets
Disruptive innovation invariably comes from the bottom end of well-established existing markets. This is not surprising as early market development for a product or service generally starts with customers with money. Over time, companies tend to prosecute a range of sustaining innovations that improve the quality and features of the offering to those customers. If the rate of sustaining innovation is not matched by the rate of efficiency innovation, the market offer becomes more expensive over time. The more expensive the offering, the more niche the customers become, leaving the market wide open for disruption.
When the disruption arrives, it is generally dressed up in a simpler and less sophisticated offering, leading market incumbents to discount the competitive threat of the new entrant. While the simpler, but more accessible, product drives increased consumption, the target consumers are generally different to those buying from the market incumbents – at least initially. As the disruptive new entrant increases scale and scale improves the quality of its offering, it starts to peel away at the core consumers of the incumbent – by which time it can often be too late for incumbents to respond.
Why incumbents find it hard to fight real disruption
As companies get bigger and more successful, it becomes more difficult to exploit lower value market segments (that may exhibit lower margins) and smaller emerging markets (that hold less portfolio materiality). The pursuit of profit makes it easy for companies to go up the quality and capability curve, and just about impossible to go down it. Equally, incumbents are frequently founded on an organisational architecture that is interdependent and closed, making innovation complex and slow to execute. In contrast, the operating model of new disruptive entrants is increasingly modular and open, thereby facilitating both rapid innovation and scaling.
Disruption is frequently misunderstood and overused
It appears that many companies espousing disruption are not actually working with ideas and business models that are disruptive in their nature, but rather are focused on sustaining and or efficiency innovation. The consequence is often intense and direct competition with marketplace incumbents where the probability of business success is shown empirically to be low. In these circumstances, disruption is misunderstood and misused.
There is a much smaller population of new entrants that succeed in wrapping a disruptive business model around a disruptive capability (most often enabled by technology) to attack existing markets with simpler and lower cost solutions who tend to compete more vigorously with non-consumers than with the market incumbents. Not only do they succeed in growing the overall market, they tend to encounter far less early competitive resistance, and in many cases, ultimately end up overwhelming the incumbents in a much-altered marketplace.