The book explains that the incumbent firms are at disadvantage vs start-ups on disruptive technologies. The author lays a framework for the incumbents to overcome this hurdle.
There are two kinds of technologies:
a. Sustaining technologies – They improve the performance of the existing product to the existing customer. They improve the profitability of the incumbents. Shift from 3G to 4G/ 5G in telecommunication is sustaining technology.
b. Disruptive technologies – They challenge the established industry by fulfilling the needs of their customers in a new manner. Initially, they target unserved/cost-conscious customers/applications later with the fast pace improvement in the functionality/ fall in the cost, disruptive technologies supersede the established. The evolution of the mobile camera is a disruptive technology for the camera industry.
Incumbents always have the resource to develop both technologies. However, the incumbent’s failure rates are sky-high when facing disruptive technologies. Incumbents are good at sustaining technologies.
Why do incumbents fall prey to disruptive technology?
- The future pathway of an organization is driven by 3 factors: Resources, its processes, and the values which get inculcated in its manager’s decision-making. These factors work against the incumbent given its focus to maximize near-term profitability.
- Margin/ Return on Capital Employed (RoCE) dilutive projects are allotted the least resources. CEO/board/mid-managers everyone is hardwired for near-term profitability. For instance, DEC entered and exited the personal computer (PC) market four times over 1983-95 as its managers weren’t happy with the low margin of the PC business.
- Incumbents face sizing issues as at the start, the disruptive technology market is insignificant vs the incumbent’s size.
- Good management aligns its strategy close to its customers. Feedback from customers tends to work against disruptive technology. In the US, only four earthmoving equipment makers survived the hydraulics disruption as customers gave discouraging feedback on hydraulics.
- Incumbents over-invest in the new market in hopes of instant demand. Apple suffered a setback in 1994 by overinvesting in the PDA market.
Guidelines to withstand disruptive technologies:
- Establish distinct entities with different eco-system for the new technology. This is what IBM did when PC was yet to emerge; later its PC subsidiary contributed meaningfully to the group’s fortune. Even in India, few 2-wheeler companies are investing in electric 2-wheeler start-ups.
- When in doubt on which technology will succeed, form two distinct units and let them compete using different technology. Hewlett Packard’s (HP)’s laser printer division competed with its own inkjet printer business.
Learning for equity investors:
- Technology targeted at existing customers or expected by the majority to replace the mainstream products is a sustainable technology. We believe the shift towards Electric Vehicles (EV) in cars, fits the sustainable technology framework and not disruptive technology.
- Products with inferior performance can replace the mainstream products if the pace of improvement of the former exceeds later. For instance, falling cost/ improving efficiency imply battery-equipped solar panels can replace thermal power.
- Disruption can come from entirely different products/markets. For instance, wearable watches may disrupt the preventive medical check-up industry.
- Pioneer firm has no major advantage in sustaining innovation; however, it has an advantage in disruptive technology. Firms waiting for an inflection point to start investing are at major risk.
– Repost from UTI Mutual Fund