The Innovator's Dilemma Summary

The Innovator's Dilemma Summary

Why Good Companies Go Bad

This book is about the failure of good companies. It is not about firms that suffer stifling bureaucracy, can’t plan, make lousy investments, neglect quality, ignore customers or commit other well-known managerial sins. On the contrary, this book is about companies that do everything right, have excellent management, stay close to customers and continuously improve the quality of their products - yet fail.

For many decades, Sears Roebuck was the preeminent name in retailing. Sears managed an existing business, and pioneered many innovations, such as the department store credit card, the catalog, supply chain management, store brands and more. Yet Sears failed. It did not notice or counter the threat from the discount retailers and box stores that eventually supplanted it. It failed to exploit its advantage as a first mover in store credit cards, allowing upstarts Visa and MasterCard to eat its lunch. Sears has plenty of company in the list of great companies that struggled to innovate successfully. Consider IBM, which let the minicomputer market go to disruptive innovator Digital Equipment Corporation (DEC). Consider DEC, which excelled in minicomputers only to founder in personal computers. Consider U.S. Steel and Bethlehem Steel, which could not counter the threat from mini-mills.

Paradoxically, great companies do not fail because they do bad things. They fail because they keep doing better at the things that made them great. They fail because they listen to their crucial customers; invest in the highest return opportunities; improve product quality; study market trends and strive to surpass the competition. The paradox of failure, the innovator’s dilemma, is that there is a point at which the right things are dead wrong. Sometimes, a company has to ignore its best customers, invest in lower return opportunities, take a poor quality product to market and fly blind, without market research. Sometimes, the right thing to do makes no sense in the context of the past and present, and only the wrong things can work. Great companies have understandable difficulty making that adjustment. So they fail.

Sustaining vs. Disruptive Innovations

Innovation comes in two forms. Sustaining innovations improve on existing, established products. They deliver higher performance in the dimensions that existing customers value. Sustaining innovations include, for example, bigger, more powerful mainframe computers. Disruptive innovations, such as personal computers, under-perform existing products. They disrupt the value proposition. They are less sophisticated, less powerful and of lower quality - but often they are also less expensive, simpler, more convenient, adequate and easier to use.

Sustaining innovations are a strong suit for established companies that continuously improve their products. But they almost inevitably hit a point at which they offer more quality than customers need, want or can afford. In pursuing higher margin business from more demanding customers, established firms sacrifice the low end. This creates openings for disruptive innovations, which usually debut at the market’s bottom among new consumers.

Driving Disk

This pattern is particularly evident in the disk drive industry’s history. Disk drives became progressively smaller, dropping from 14-inches to eight, five and then 3.5 inches. The established market leaders in 14-inch drives failed in eight-inch drives; the eight-inch drive leaders failed in five-inch drives; and the five-inch drive leaders failed in 3.5-inch drives. While established market leaders in each generation of disk drives focused on improving their products for existing up-market customers, the disruptive innovators found a low-end opening. It did not make sense for established companies to invest early in the disruptive technologies, because the margins tended to be much lower and the market was unproven.

Engineers at established companies often discover and develop disruptive innovations, but their firms’ customers generally have no need for the changed products. Typically, the least profitable customers are first to embrace a disruptive technology. Thus, established firms that heed their key customers probably cannot make a case for investing in disruptive technologies. These firms do not do the wrong thing; they do the right thing - and go the wrong way.

Why Is the Right Action Sometimes Wrong?

Managers do not really decide where they will allocate investments. Their customers and investors decide. Investing in disruptive technology does not serve existing customers and does not promise the initial return that investors demand. So the best-performing companies kill great ideas and do not invest in disruptive technologies until existing customers demand them - by which time a disruptive innovator leads the market.
Big companies look for big growth opportunities, which the small or uncertain markets for disruptive innovations do not promise. Disruptive innovations typically appeal to the least desirable customers. Steel mini-mills, for example, started out making such poor steel that it was only suitable for reinforcing rods. This end of the market was low in quality, price and margins. Because of their higher cost structure, the established steel companies couldn’t make much money in this market and were glad to abandon it to the upstart mini-mills.

Mini-mills had cost advantages that let them make money in this market. Once they established a base, they improved quality and moved up the market chain. They added products such as bars and iron angles from the bottom of the established companies’ market, lower in price and margin than the more desirable segments. The established companies again gladly abandoned those products. The mini-mills continued to improve, moving on to structural steel. The established companies closed their structural steel mills and focused on higher quality, more demanding, more profitable products. Investors and the most demanding customers were pleased. But the established companies had sacrificed industry leadership and the lion’s share of the market. They never mastered mini-mill technology, and their burdensome high cost structures made it impossible for them to compete with the upstarts.

Organizational capabilities are an outgrowth of the organization’s processes and values, the considerations that determine which customer to emphasize. Individuals can change the way they work, but that is very difficult for organizations. Because established organizations listen to their most profitable customers, they typically improve quality to the point that their products offer more than most of the market can use. When established competitors improve their quality beyond what the market demands, relative quality differences no longer affect customer decisions. Customers begin to focus on reliability, convenience and price. Over and over, in industry after industry, established companies focused on the top of the market and created opportunity at the bottom. Disruptive innovators stepped in.

The Value Network

An organization’s structure and way of working determine what it can do. But organizations do not operate in a vacuum. The value network - which is central to the concept of disruptive innovation - is the context in which the firm operates, assesses customer needs, responds to customer demands, gets resources and deals with competitors. A company’s product is typically a component in another firm’s product, which may be a component in another network member’s product. Value networks measure value with their own metrics, which tend to be consistent across the network. Value networks have characteristic cost and margin structures. Manufacturers of 14-inch disk drives usually obtained 60% margins, as did their drive’s primary users, the mainframe computer makers. Similarly, suppliers of 8-inch disk drives obtained 40% margins, similar to those of the minicomputer firms that used those drives. Small disk drive suppliers earned 25% margins, comparable to those of the personal computer makers who bought their drives. Because profit margins were progressively lower on each disk drive generation, no wonder 14-inch drive makers saw 8-inch drives as unattractive, and the makers of 8- inch drives disdained desktops. Each generation of drives existed in a distinct value network. It is difficult for companies to switch value networks.

Trying to Join In - Too Late

Established companies’ efforts to commercialize disruptive technologies often go like this:

1. Established firm develops disruptive technology - Very often, paradoxically, engineers at established firms develop disruptive technologies. Engineers at Memorex, manufacturers of 14-inch drives, first designed 8-inch drives. Engineers at Seagate Technology, maker of 5.25-inch drives, pioneered the 3.5-inch disk drive.

2. Established company shows the innovation to important customers - Marketers show key customers the innovations. Because the innovations usually offer lower performance in dimensions that customers value, typically they are not interested.

3. Established firms shelve the disruptive innovation - They invest more in sustaining innovations, responding to customer demand by giving them more of what they want. The firm focuses on the competitive threat from other high-end manufacturers, not the threat from disruptive innovators below. Thus, although its engineers developed the 3.5-inch drive, Seagate shelved it to focus on improving its 5.25-inch drives.

4. New companies form and find markets for the disruptive technologies - Employees of 14-inch drive maker Pertec left to found 8-inch drive manufacturer Micropolis. Employees of Seagate and MiniScribe, the 5.25-inch drive manufacturers, founded Conner Peripherals to enter the 3.5-inch drive market. Disruptive startups concentrate on new customers, not the leading firms’ old customers. By trial and error, the innovators find applications for their new products. Micropolis served the minicomputer market; Seagate sold to the embryonic personal computer market.

5. Disruptive innovators move up the chain - Once innovators establish a market base, they improve their technologies and move up. Customers who initially rejected the low performing disruptive innovation eventually adopt it because the established firm’s sustaining innovations improved the product beyond market needs and made it too expensive. Meanwhile, the disruptive innovators improved their product enough that it came to meet the user’s needs, usually at a much lower price.

6. Established firms enter the market as latecomers and fail - Typically, by the time established firms enter a market, disruptive innovators have an unbeatable lead. Control Data, leader in 14-inch drives, could not penetrate minicomputers. Seagate, maker of 5-inch drives, offered a 3.5-inch version, but could not break into laptops.

Value networks have an important, even defining influence on what a company can or cannot do. Most companies’ capabilities apply only within the context of a given value network. A company that is well adapted to one network will be ill adapted to another. To succeed at disruptive innovations, companies may need capabilities very different from the ones that brought success in their existing networks. Thus, a firm that addresses the needs of customers in its value network is apt to find it difficult to satisfy customers in a different network. So, customers cannot lead a company to disruptive innovations. In fact, customer feedback may lead companies to avoid the most important innovations. Companies pursuing growth through disruptive innovations must find new markets, outside their existing customer base, that value the disruptive technology for what it delivers. Thus, disruptive technology investment is a marketing initiative, not a technological initiative.

Companies almost invariably do not have adequate information to justify large investments in disruptive technology. Disruptive technology investments are hard to justify at precisely the point when that investment is crucial to develop a first mover advantage. Established companies must create the right environment, with capabilities that fit the new market. Risk is high. Failure and learning from failure are part of the path to disruptive technology success. Although any individual disruptive technology may fail, companies that treat disruptive technologies as a portfolio, making small investments and learning from mistakes, can succeed.

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