Book summary “The Innovator's Solution”: summary

Introduction

You face a relentless corporate dilemma when your core markets mature and investors demand predictable new growth. Traditional management tools, market research, and financial metrics often fail you because they are designed to manage existing operations rather than build new markets. You repeatedly invest in sustaining innovations that appeal to your best customers while disruptive threats quietly steal your future. Clayton M. Christensen addresses this failure in The Innovator's Solution by replacing guesswork with a causal theory of innovation.

To achieve predictable, disruptive growth, you must target nonconsumption, align your product with the customer's job to be done, and separate disruptive ventures from mainstream corporate values.

The book guides you through building new-growth businesses with systematic precision. You will discover how to shape disruptive strategies, spot unmet customer needs, and organize your company for success.

• How do you reliably identify disruptive opportunities?
• What determines which customers you should target?
• When should you integrate vertically versus modularly?
• How do you align organizational capabilities with new growth?

1. The Growth Imperative and Good Theory

Most corporations fail to sustain growth because their internal filtering processes reject disruptive ideas in favor of me-too sustaining innovations.

The Brutal Reality of Stall Points

A study by the Corporate Strategy Board examined Fortune 50 companies between 1955 and 1995. Only 5 percent of companies sustained a growth rate of more than 6 percent. Of those that stalled, only 4 percent of stalled companies successfully reignited their growth. Furthermore, 28 percent of stalled companies lost more than 75 percent of their market capitalization.

Aggressive attempts to grow by entering new, unfamiliar markets often destroy massive amounts of shareholder value when executed without the right strategic alignment. Following deregulation, AT&T attempted to find growth through computer manufacturing and acquisitions, wireless expansion, and cable television. This resulted in tens of billions of dollars wasted and destroyed shareholder value.

AT&T acquired NCR for $7.4 billion in 1991, lost another $2 billion, and sold it in 1996 for $3.4 billion. Later, it acquired TCI and MediaOne for $11.2 billion combined price to acquire TCI and MediaOne and sold its cable assets to Comcast for $72 billion. These moves show how difficult it is to expand outside your core expertise.

Stock prices reflect the market's expectations of future growth. You must exceed consensus forecasts to boost your share price. Dell Computer's valuation on August 21, 2002, relied heavily on future investments, with 78 percent of its share price valuation was based on expected new investments on August 21, 2002. By comparison, only 5 percent of General Motors's stock price was predicated on future investments on the same date.

The core reason you struggle to launch disruptive growth is not a lack of creative ideas. Middle managers use a shaping process to vet proposals. They must secure funding by presenting credible data from existing customers. As a result, innovative ideas are unconsciously filtered and reshaped into me-too innovations for existing customers.

The Big Idea Group invites everyday inventors to pitch toy ideas, successfully developing high-potential products. Large toy companies experience a dearth of exciting ideas due to their internal filtering process.

The Power of Circumstance-Based Theory

Sound management theory must be built systematically through three stages. You must describe the phenomenon, classify it into categories, and articulate causal mechanisms. Bad management theory results from observing isolated success stories prematurely.

Early aviation pioneers observed that flying things had feathers and wings. They strapped feathered wings to their arms and jumped off cliffs until fluid mechanics explained actual lift. Valid theory requires moving from attribute-based categories to circumstance-based categories that explain cause and effect.

The predictability of business management increases only when theories are circumstance-contingent rather than based on superficial attributes. A boundary between circumstances is only meaningful if you must use fundamentally different management techniques to succeed across that boundary.

The Innovator's Dilemma showed how the same resource allocation mechanism caused established leaders to fail across diverse industries like disk drives, retailing, steel, and motorcycles.

2. The Disruptive Innovation Model

Disruptive strategies dramatically increase your odds of success by targeting low-end overserved customers or creating new markets against nonconsumption.

In sustaining circumstances, you race to sell better products for more money to attractive customers. In disruptive circumstances, your challenge involves commercializing simpler products that sell for less and appeal to new or unattractive customers. Incumbents almost always prevail in sustaining circumstances, whereas entrants are likely to win in disruptive circumstances. Following a strategy of disruption raises your success rate from 6 percent to 37 percent.

Low-End Versus New-Market Disruption

Low-end disruptions take root at the low end of the original value network using low-cost business models. New-market disruptions use affordable, simple products to enable a completely new population to consume something they lacked the money or skill to own. Integrated steel mills happily abandoned the low-margin rebar and bar-and-rod markets as minimills attacked. This allowed minimills to capture half of North America's steel production, operating with a 20 percent cost advantage while integrated producers earned 7 percent gross margins on rebar that accounted for 4 percent of industry tonnage.

Asymmetric motivation creates a paralyzing effect on industry leaders. Established firms pursue higher-margin opportunities with demanding customers and never defend low-end or new markets attacked by disruptors. An innovation that is disruptive to one company can be a sustaining improvement to another. You must ensure your strategy is disruptive relative to all established competitors.

Testing for Disruption Potential

Entrepreneurs must pass three specific sets of questions to determine whether a business idea can be shaped into a disruptive strategy:

• Is there a large population of people who historically have not had the money, equipment, or skill to do this thing for themselves, and as a result have gone without it altogether or have needed to pay someone with more expertise to do it for them?
• To use the product or service, do customers need to go to an inconvenient, centralized location?
• Are there customers at the low end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price?
• Can we create a business model that enables us to earn attractive profits at the discount prices required to win the business of these overserved customers at the low end?
• Is the innovation disruptive to all of the significant incumbent firms in the industry?

3. What Products Will Customers Want to Buy

Over 60 percent of all new-product development efforts are scuttled before reaching the market. Of the remaining 40 percent that launch, 40 percent fail to become profitable and are withdrawn. Three-quarters of the money spent in product development investments results in commercially unsuccessful products.

You must segment markets around the circumstance-based jobs customers need to get done rather than demographic averages or product attributes.

The Jobs-to-Be-Done Theory

Customers experience life by recognizing regular jobs that arise and hiring products or services to get those jobs done as effectively, conveniently, and inexpensively as possible. The critical unit of analysis is the circumstance, not the customer. Customers evaluate products based on the functional, emotional, and social dimensions of the job they need done in a specific context.

A quick-service restaurant chain attempted to boost milkshake sales by profiling customers through psychobehavioral dimensions and altering thickness, chocolate flavor, or price. None of these attribute-based modifications significantly altered sales or profits until researchers studied the actual jobs customers were trying to get done. Researchers discovered that nearly half of a quick-service restaurant's milkshakes were bought in the early morning by commuters who faced long, boring, and constrained commutes with only one free hand. The milkshake was hired to make the commute interesting, stave off hunger until 10:00, and last up to twenty minutes without spilling, whereas bagels created crumbs and bananas were eaten too fast. Later in the day, the same customers hired milkshakes as an emotionally exhausted way to placate their children and feel like reasonable parents.

Overcoming Countervailing Corporate Forces

Four countervailing forces in established companies cause managers to target attribute-based market segments instead of jobs-to-be-done: fear of focus, demand for quantification, channel structures, and advertising economics. Corporate IT systems and market research reports systematically pervert market concepts because they aggregate data around products, customers, and organizational units rather than jobs. Senior executives typically hire market research to quantify the size of opportunities in the resource allocation process rather than to understand how customers live.

Intuit disrupted the small business accounting software market with QuickBooks by observing that users of Quicken were employing it to keep track of cash rather than running complex accountant-designed reports. Intuit launched QuickBooks to fulfill the specific job of helping small business owners avoid running out of cash, seizing 85 percent of the market within two years.

Using purpose brands to communicate directly to a specific circumstance and building job-aligned channel structures protects corporate brands and facilitates disruptive growth. Traditional retail channels are organized by product categories and reject job-specific tools that do not fit existing plan-o-grams, forcing disruptors to build new channels.

Research in Motion found the BlackBerry's disruptive foothold by helping users be productive in small snippets of waiting or commuting time. Its true competitors in the customer's mind were wireless phones, the Wall Street Journal, CNN Airport News, boring presentations, and doing nothing.

4. Finding the Best Customers

The most solid foundation for a new-market disruption is targeting nonconsumption, where people are trying to get a job done but lack the money or skill to use existing solutions.

New-market disruptions enable a larger population of people who previously lacked resources to buy and use a product. These customers compare the disruptive product to having nothing at all. The performance hurdle required to delight them remains modest, and initial R&D costs stay lower.

In the 1950s, Sony targeted teenagers with its battery-powered pocket transistor radio rather than competing against tabletop vacuum tube radios.

Successful new-market disruptions follow a consistent four-element pattern across industries and eras.

• Target customers who lack money or skill to use existing solutions for a job they need done.
• Ensure customers compare the disruptive product to having nothing at all.
• Deploy technology to make the purchase and use of the product simple, convenient, and foolproof.
• Create a whole new value network with new channels and venues.

Sony targeted people who could not afford large televisions with its twelve-inch portable black-and-white television in 1959.

Securing Commitment and Flexibility

Established companies fail to pursue disruptive innovations because they frame them as threats to their core business, triggering a rigid command-and-control response.

Drawing on research by Clark Gilbert, Daniel Kahneman, and Amos Tversky, framing a phenomenon as a threat elicits a rigid response focused on protecting current mainstream customers. This causes you to force the disruptive technology into the mainstream market where it must compete on a sustaining basis, leading to failure.

Newspapers that kept online editions inside the mainstream news organization offered digital versions solely to defend their physical core business.

To succeed with a disruptive innovation, you must initially use threat framing to secure resource commitments, and then shift responsibility to an independent organizational unit. Senior management must first approve funding by framing the innovation as a threat during the resource allocation process. Once the commitment is secured, the project must be placed in a stand-alone profit center where it is framed purely as an upside opportunity for growth.

Newspaper organizations that spun off their online groups into independently managed, stand-alone profit centers evolved beyond mere physical paper replications.

• Get top-level resource commitment by framing an innovation as a threat during the resource allocation process.
• Shift responsibility for the project to an autonomous organization that can frame it as an opportunity.
• Approve or kill project budgets based on fit with the disruptive pattern rather than numerical rules.

Reaching new-market customers requires disruptive channels whose entities are motivated to move up-market along their own trajectory. A channel includes wholesalers, retailers, salesforces, and value-added partners who must find the new product to be fuel that propels their own business toward higher-margin opportunities. If the channel's economic model is tied to mainstream products, they will reject the disruptive offering.

Intel and SAP's joint venture Pandesic failed because IT implementation consultants preferred selling multi-million-dollar SAP enterprise software packages over lower-ticket Pandesic software, which had targeted the $200 price point for internet appliance computers attempted by Oracle and others in the 1990s.

5. Getting the Scope of the Business Right

You must integrate proprietary architectures when product functionality is not good enough, and shift to modular interfaces only after performance overshoots customer needs.

Product Architecture and Integration

Managers often rely on core-competence theories to decide what to outsource. This approach ignores how competitive circumstances change over time.

IBM outsourced its PC microprocessor to Intel and its operating system to Microsoft in the early 1980s, enabling them to capture most of the industry's profits.

Product architectures range from interdependent proprietary designs that optimize performance to modular open designs that optimize flexibility. When product functionality is not yet good enough for customers, you must compete with proprietary, interdependent architectures and vertical integration. Engineers cannot use standardized modular components without sacrificing performance during this era.

The Cycle of Modularization

Once functionality is more than good enough, customers stop paying premium prices for further performance gains. This performance surplus forces companies to adopt modular architectures, enabling specialist firms to enter and disrupt leaders.

IBM responded to cost pressures by introducing the modular System 360 in 1964, which inadvertently allowed plug-compatible peripheral suppliers to disrupt its monopoly power.

Industries cycle repeatedly between vertical integration and modular stratification as waves of disruption occur. A firm can successfully outsource or procure from a partner only when specifiability, verifiability, and predictability are present:

• Ensure both suppliers and customers know what to specify regarding crucial and non-crucial product attributes.
• Verify that those attributes can be measured to confirm specifications have been met.
• Ensure there are no poorly understood or unpredictable interdependencies across the customer-supplier interface.

Attempting to launch a nonintegrated specialist business when product functionality is still in the interdependent realm leads to severe failure. Following 1996 legislation, billions of dollars were funneled into competitive local exchange carriers like Northpoint Communications to offer high-speed DSL, but most failed due to unpredictable interdependencies with telephone company billing systems.

6. How to Avoid Commoditization

When commoditization destroys profits in one part of the value chain, the law of conservation of attractive profits shifts wealth to adjacent interdependent components.

Clayton M. Christensen calls the cycle of margin loss a predictable sequence. You must understand how profits vanish as markets mature.

The Six Steps of Commoditization

The natural process follows a precise path. You can track how unique advantages erode over time.

• A company develops a proprietary product that, while not good enough, comes closer to satisfying customers' needs than any of its competitors through a proprietary architecture and earns attractive profit margins.
• As the company strives to keep ahead of its direct competitors, it eventually overshoots the functionality and reliability that customers in lower tiers of the market can utilize.
• This precipitates a change in the basis of competition in those tiers, which...
• ... precipitates an evolution toward modular architectures, which...
• ... facilitates the dis-integration of the industry, which in turn...
• ... makes it very difficult to differentiate the performance or costs of the product versus those of competitors, who have access to the same components and assemble according to the same standards.

Steel minimills enjoyed high profits against integrated mills in rebar until they drove out high-cost competitors, leaving themselves to fight in an identical-cost commodity market with a 20 percent cost advantage over integrated mills.

Protecting Attractive Profits

Pressure to increase return on assets pushes modular assemblers to systematically outsource assets. You risk entering a death spiral as suppliers eat their way up the value chain.

Components Corporation incrementally took over circuit boards, motherboards, full assembly, supply chain management, and finally product design from Texas Computer Corporation under the guise of core competence. General Motors spun off Delphi Automotive and Ford spun off Visteon Corporation, mirroring the computer industry's historical trajectory.

• 60 percent gross margins earned by 1-gigabyte 3.5-inch disk drive manufacturers when introduced in 1992.
• 15 percent margins disk drive companies struggled to make later on drives sixty times better.

7. Is Your Organization Capable of Disruptive Growth

An organization's capabilities and disabilities are defined by three factors: resources, processes, and values.

While resources are flexible and tangible things that can be bought, sold, or moved, processes and values become rigid over time and define what an organization cannot do. When disruption happens, the same strengths that make a company successful in sustaining circumstances become disabling constraints.

Processes are established to execute recurrent tasks consistently, which simultaneously creates disabilities when applied to different tasks. An organization's values act as constraints that define what the company cannot do by setting the criteria for prioritizing decisions.

The RPV Framework

Over time, an organization's capabilities migrate from its people-based resources toward visible processes, values, and eventually embedded culture. When you need to create new processes rather than exploit existing ones, heavyweight teams become necessary.

Chrysler organized its development teams around vehicle platforms like the minivan rather than technical subsystems to accelerate automobile development.

Selecting the Right Organizational Home

Sustaining innovations should be handled within mainstream organizations, whereas disruptive innovations require autonomous organizations. Dell treated Internet retailing as a sustaining innovation and succeeded, while Compaq, Hewlett-Packard, and IBM found direct marketing disruptive to their channel partners and struggled.

F.W. Woolworth established Woolco as an autonomous discount division in 1962 with 23 percent gross margins and 5 inventory turns, but integrated it in 1971, raising margins to 34 percent and forcing its closure.

• 35 percent gross margins and 3.4 inventory turns per year for Woolworth's variety stores
• 23 percent average gross margins and 5 inventory turns per year for discount retailers
• 34 percent gross margins and 4 inventory turns for Woolco after integration

Hiring managers based on right-stuff attributes frequently fails because it ignores the specific problems they have previously wrestled with.

Intel and SAP hand-picked some of their most successful executives to lead Pandesic, a joint venture selling ERP software to small businesses, but none had ever wrestled with establishing an initial market foothold with a disruptive product. Pandesic achieved 100 employees in eight months and announced 40 strategic partnerships within a year, yet spent 100 million dollars before shutting its doors in February 2001.

To evaluate candidates effectively, you must follow specific practices:

• Specify the circumstances in which the new team will be asked to manage.
• Match those circumstances against the challenges with which managers need already to have wrestled.
• Compare the needed experiences with the résumés of the candidate managers.

8. Managing Strategy, Capital, and Leadership

Every company operates through two simultaneous strategy-making processes: deliberate, which is analytical and top-down, and emergent, which bubbles up through day-to-day operational decisions. You must match the strategy-making process to the stage of business development. Successful ventures must start with an emergent learning process and shift to deliberate execution only after a winning strategy becomes clear.

You must balance deliberate and emergent strategy-making processes while funding ventures with patient growth capital that is impatient for profit.

Sam Walton built his second discount store in a small town near his first location for logistical efficiency, which unexpectedly birthed Wal-Mart's winning strategy of dominating small-town markets.

Discovery-Driven Planning

Discovery-driven planning reverses traditional budgeting steps to actively manage the emergent strategy process and test critical assumptions early. You can implement this method through specific steps:

• Make the targeted financial projections.
• What assumptions must prove true in order for these projections to materialize?
• Implement a plan to learn—to test whether the critical assumptions are reasonable.
• Invest to implement the strategy.

Handheld computer makers like Apple spent 350 million dollars developing the Newton based on deliberate assumptions before writing off the projects, whereas Palm used an emergent trial-and-error approach.

Good Money and Bad Money

The ideal capital for a nascent disruptive business is patient for growth but impatient for profit. When a successful core business hits a growth gap, executives often make the fatal mistake of injecting impatient capital into disruptive ventures, triggering a self-reinforcing downward spiral.

When Honda entered the U.S. market in 1958 with a meager government-approved budget of 250,000 dollars, its large motorcycles initially failed with leaky oil and broken clutches. Running low on cash, Honda personnel relied on their small 50cc Super Cubs for personal transport around Los Angeles, sparking unexpected retail interest from sporting goods shops and giving birth to the off-road motorbike market.

10 Key Ideas

1. A study by the Corporate Strategy Board examined Fortune 50 companies between 1955 and 1995 and found that only 5 percent successfully sustained a growth rate exceeding 6 percent.
2. Customers experience life by recognizing regular jobs that arise and hiring products or services to get those jobs done as effectively, conveniently, and inexpensively as possible.
3. Established firms pursue higher-margin opportunities with demanding customers and never defend low-end or new markets attacked by disruptors.
4. Low-end disruptions take root at the low end of the original value network using low-cost business models, whereas new-market disruptions use affordable, simple products to enable a completely new population to consume something they lacked the money or skill to own.
5. When product functionality is not yet good enough for customers, you must compete with proprietary, interdependent architectures and vertical integration.
6. When commoditization destroys profits in one part of the value chain, the law of conservation of attractive profits shifts wealth to adjacent interdependent components.
7. An organization's capabilities and disabilities are defined by three factors: resources, processes, and values.
8. Every company operates through two simultaneous strategy-making processes: deliberate, which is analytical and top-down, and emergent, which bubbles up through day-to-day operational decisions.
9. The ideal capital for a nascent disruptive business is patient for growth but impatient for profit.
10. The predictability of business management increases only when theories are circumstance-contingent rather than based on superficial attributes.