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Disruptive Innovation Strategy

Why successful businesses get disrupted by the innovations of cheeky upstarts

This report is intended to stimulate the kind of strategic thinking busy business owners and managers often find hard to make the time for, in the midst of the jungle of demands that most established businesses battle with on a daily basis. Steven Covey put it in the Important, Not Urgent quadrant. However, with the rate of change we’re experiencing, if we don’t all spend some time in that quadrant, we’re likely to find someone else in the jungle will push it into the Urgent quadrant, in the not too distant future, whether we like it or not.

Upstarts, by the way, are what Startups get called when you’re on the receiving end of their disruptions. So why, if you are a well-established business, generating good cash flow, might you be unable to see that some far less established business, with quite possibly less technically advanced products or services, is about to eat your lunch? According to Cyril Bouquet and Chloe Renault from the prestigious IMD business school in Lausanne, there are 3 things going on.

1. You’ve become ‘prisoner’ to the system you’re operating in.

2. You’re in denial.

3. You’re not innovating. Well, not enough, anyway.

Let’s look at some examples. The taxi industry had a system that was so ingrained it was unconscious to them, so they were unable to imagine a whole new way of operating. Enter Uber. Customer satisfaction with taxis, with few exceptions, was low, but for decades they had the hire car market locked up and so became imprisoned by their own assumption nothing was going to change their world. And even when Uber arrived, both drivers and taxi companies were in denial and couldn’t understand why customers were flocking to an alternative. Uber used the same technology that taxis could have used to locate cars and inform passengers of arrival and route, to automate payment and rate drivers etc., but there was no innovation going on of note within the taxi industry.

Blockbuster videos knew about Netflix, but considered them unable to compete with their stranglehold on the video hire market. Blockbuster even turned down the chance to buy Netflix for just $20m. Video stores were hooked on a business model that earned them the total cost of their videos after just a few night’s late fees. In fact, the creator of Netflix, Reed Hastings, got going after being stung $40 for his late return of Apollo 13. Kodak, whose own scientists invented digital photography, were so in love with their business model, based on a virtual monopoly of film sales, that they couldn’t contemplate doing business another way.

All these businesses and many more were prisoners of their own device, couldn’t see the need for change and weren’t looking for new ways to charm their customers.

Of course, it’s human nature when you’ve found a winning formula, to stick to it and not to want to throw it over for a new model that might not work yet. And any sound management, or board of directors is going to look sideways at a business case that puts their cash cow at risk to explore something foreign to their customers and employees that can’t reliably forecast what the ROI might be.

Established businesses are set up to execute a well understood business plan, with well understood products, or services, to well understood customers.

Startups, on the other hand, are exploring who their customers are, what their problems and desires are, how to satisfy them, with new products or services that are still in development, what business model to use and how to make money from the enterprise. This is a process that doesn’t readily blend with an existing operation that is focussed on the next quarter’s results, trying desperately to increase sales by 5% and decrease costs by 5%. And yet if you want really game-changing innovations of the kind that can transform your business, or prevent you from being the next statistic in the global disruption trend, then you need to consider how to take some of the methods Startups use to develop those innovations.

We’re not talking here about incremental innovations. The kind that can be gleaned from suggestion boxes, surveys of employees or customers, or simply an intelligent engineering based consideration of how to improve your product or service for next year’s model. Those improvements are important and necessary – once you are onto a winning formula. What we’re discussing is how and when to find the next quite different winning formula.

Take Apple as an example. Their invention of the first smartphone was a game changing new formula that disrupted the phone market and led to business breaking problems for the previous dominant players, Nokia and even Blackberry, who themselves had disrupted the market. However, once they had introduced the smartphone, Apple’s annual updates, though important, can be considered to be incremental. Apple were also willing to disrupt their own winning formula for the iPod, which put ‘a 1000 songs in their customer’s pocket,’ with the creation of the iPhone. In this way, while iPod sales plummeted, they continued to capture music hungry customers, as well as a whole new market who were delighted to find the iPhone put ‘a computer in their pocket.’

Innovations that grow your business by 800%, as the iPhone did for Apple, take fresh thinking.

We call it Unicorn Thinking. We’re not talking about the magical kind of unicorns, although the kind of innovations that result might seem like magic to competitors and delighted customers alike. We’re talking about the thinking that leads to private Startups growing to valuations in excess of $1 billion. And yes, perhaps it does help to have a child’s willingness to entertain ideas we too readily dismiss as world weary adults.

At the end of 2017 there were 197 such companies, known as Unicorns, according to a survey from CB Insights. You’ll be familiar with some of the better-known ones, such as Airbnb, Canva, Dropbox, Pinterest, Slack, SpaceX, Spotify, Stripe, WeWork and Xiaomi. Australian software enabling company Atlassian was a Unicorn before it floated on Nasdaq for $10 billion. So were the tech giants of today, colloquially known as FAANG Facebook, Amazon, Apple, Netflix and Google. We should add the Chinese tech success stories Alibaba and Tencent to our list of super unicorns. Of course, these stocks have moved a very long way from being Startups, but in most cases, they are still drawing on what they learned about developing game changing innovations to continue to grow their businesses.

We believe virtually all businesses can benefit from putting some resources into understanding how these kinds of Startups developed their innovations.

In our view, there are 7 main steps.

But first, here’s where not to start. With an idea.

Most people will jump to an idea and then look for supporting justification. Again, that’s just human nature. So, if you have ‘a good idea’ already, try to park it for a while and start back with your target customer’s desires and no preconceived ideas on how to satisfy them.

Here are the steps:

1. Find an important unsolved problem

2. Ignore the competition and start over from a blank slate

3. Imagine the ideal solution regardless of accepted wisdom, or obstacles

4. Search emerging technologies for ways to do what wasn’t possible before

5. Make the simplest possible prototype and test with customers

6. Use feedback to improve it multiple times before production

7. Make a business case with reverse income assumptions

The world’s capitalist system basically operates by creating products and services that persuade customers they will solve their problems, or fulfil their desires. Jeff Bezos says customers are always unsatisfied, even if they don’t know it. The trick though, is how to discover an unsolved problem and a fresh and better way to solve it. Unicorns use Design Thinking processes to explore it.

Design thinking stems from the way designers investigate solutions to problems in a human centric manner. It’s found a strong following outside of pure design circles in recent years, because the method can be broadly applied to solving complex problems, including business problems of most kinds. The UK Design Council coined the term the double diamond to describe how you initially diverge from an assumed problem to explore, then converge to define the key issue, then diverge again to explore possible solutions, before testing and feedback helps to converge and deliver a specific solution.

Don’t rush to conclusions on what your customer problems are. Empathise and explore what’s really going on for customers in the setting of their lives and work, before defining their most critical issue and developing a solution that emphasises the customer experience.

Sometimes the problem you begin with turns out not to be the critical problem you need to solve.

I had my own experience of innately using this process many years ago, when working as a marketing consultant. I was commissioned by the advertising agency for Qantas domestic, or TAA as they then were known, to come up with a new ad campaign to differentiate them from Ansett, their fierce rival at the time. In those days planes were divided into First Class and Economy. I started my assignment by spending a week flying around the country in both TAA and Ansett and seeing what the travel experience was like for various customers.

It soon became apparent there were two main groups of travellers in Economy. People flying for business reasons, who wanted to get there on time in a rested state of mind ready for a busy working day. And people who were travelling for social reasons, often going on holidays, who wanted to start their holiday fun the moment they got on the plane. It quickly dawned on me they needed to be treated differently. So, the problem I went in with, to write an ad campaign, became redefined as a challenge to reconfigure the cabin and the in-flight experience.

I recommended that Economy be split into Business Class, up the front, with passenger entering via the front stairs to an oasis of peace and calm and Holiday Class, at the back with passengers entering from the rear stairs to a livelier reception. After a while they implemented Business Class, but missed what I thought was another good opportunity to create a Holiday Class experience.

Starting over from first principles

Elon Musk, the co-founder of PayPal, and founder of Tesla and SpaceX, recommends starting by going back to a clean sheet of paper and first principles. Here’s how he describes it.

“Historically, all rockets have been expensive, so therefore, in the future, all rockets will be expensive. But, actually that’s not true.

If you say, what is a rocket made of? It’s made of aluminium, titanium, copper, carbon fibre. And you can break it down and say, what is the raw material cost of all these components? If you have them stacked on the floor and could wave a magic wand so that the cost of rearranging the atoms was zero, then what would the cost of the rocket be? And I was like, wow, okay, it’s really small - it’s like 2% of what a rocket costs.

So clearly it would be in how the atoms are arranged - so you’ve got to figure out how can we get the atoms in the right shape much more efficiently. And so, I had a series of meetings on Saturdays with people, some of whom were still working at the big aerospace companies, just to try to figure out if there’s some catch here that I’m not appreciating. And I couldn’t figure it out. There doesn’t seem to be any catch.

So, I started SpaceX.”

Elon also reasoned he could cut the cost of space travel by 90% if he could make rockets reusable, enabling them to land safely, rather than tossing them into the sea, so to speak. That took several very expensive failures to get right, but he and his team finally succeeded.

Instead of assuming things have to be done the way they always have been, start from scratch and imagine new possibilities that will empower you to achieve your mission.

Test your value proposition, then your prototype and only then your market.

It seems extraordinary, but true that the most common reason new products fail is that nobody wants to buy them. Unicorn companies have learned they need to test their assumptions at every step of the way.

First of all, they need to be tested in what Steve Blank termed a Customer Discovery Process in his book, The Startup Owner’s Manual. Steve and Eric Reis who recently updated his thoughts in his book, The Startup Way, realised the startup journey often failed because enthusiastic entrepreneurs rushed their ideas into production and launched them without thoroughly testing their reception with the target market first.

Even global companies can fall for this trap as I found out, when I was working for the British pharmaceutical company GSK, or Glaxo as they then were. At the time Valium, made to treat anxiety by Hoffman La Roche, was the biggest selling drug in the world, selling over 2 billion tablets a year, however within Glaxo it was considered to have a problem, in that it had the side effect of making people sleepy. So, Glaxo chemists set out to see if they could make a benzodiazepine analogue, in effect a chemical cousin of Valium, with less of a soporific effect. They succeeded and spent some years and many millions getting it through clinical trials to show it was as effective as Valium at reducing anxiety, with less of the soporific side effect. However, when we launched it in Australia, sales were very disappointing. Initially they thought the marketing was at fault so that was rejigged, but still the sales were slow. So finally, they sent a market research firm out to interview GPs to ask why they weren’t prescribing this great new drug. The answer came back, “Well, if someone comes in with anxiety serious enough to warrant treatment it’s not such a bad thing if they end up napping during the day and getting an undisturbed sleep at night.”

So, it’s clearly a better idea to test these things before spending years and millions launching the product. The Lean Launch Method and the Business Canvas provide tools to test first your ideas and then your prototypes, for your new products and services, and also your new business models. This is usually a challenging process. Steve Blank said no business idea survives its first encounter with a customer. Or as Mike Tyson put it, “Everybody has a plan until they get punched in the mouth.” It’s better to take your punches early. Fortunately, there are now quite well established protocols for testing your hypotheses before you lock in your blueprint. Sprinting to the finish line.

Getting your new product developed used to be guided by spreadsheets and Gantt charts with finely constructed critical paths. That is still appropriate for a well understood process, but for an innovation that breaks new ground for your company, you’re better off using what has become known as Agile Project Management. Innovations necessarily involve experimenting and that necessarily involves surprises, both of failure and success. But they cannot be rigorously plotted on a Gantt chart. Instead they are best tackled as a series of Sprints with a small co-operative team accepting it’s a fast learning exercise, with frequent check ins on feedback and what remains outstanding in the work plan.

The Innovator’s Business Case

As fabulous as your innovation may be, it probably still has to pass the screening of a diligent, if not sceptical board of directors, or in a smaller company the CFO and key investors. Discovery driven planning uses a reverse income statement to address this problem.

Wharton's Ian MacMillan and Columbia's Rita Gunther McGrath, developed a system they called "discovery-driven planning" in their book, The Entrepreneurial Mindset. “Discovery-driven planning, acknowledges that at the start of a new venture, little is known and much is assumed." They contrast this with conventional, "platform-based" planning, in which "assumptions underlying a plan are treated as facts - givens to be baked into the plan - rather than as best-guess estimates to be tested and questioned." Startups used to write long Business Plans of 50 to 100 pages with reams of financial projections forecasting what the income and expenses would be 5 years into the future, or even went further to generate a Net Present Value for the company from a discounted cash flow analysis of the effective life of a company’s core assets. Investors and Directors would then beat up the CEO if these fanciful projections weren’t met with some exactitude. I know, because I went through it with a biotech company I took to an IPO on the ASX as CEO. The reality is of course that a Startup is in an exploratory stage and doesn’t know exactly what profit or losses it will make. The same is true for a truly new endeavour inside a large established business.

However, you still need some sensible method of assessing commercial viability.

The key with using discovery driven planning is to list and honestly test the key assumptions you are making that underlie the belief the new venture will be profitable. Rather than pretending all will go to plan the reality is accepted that some assumptions will be proved wrong and that you expect some surprises as the business develops. But by laying out the assumptions you are checking and adapting as you proceed.

The reverse income statement, rather than starting with income and cost forecasts to see what profit or loss that generates, begins instead with the required profit after a period of time and then sees what costs are tolerable in order to achieve it. The focus then shifts to the creative challenge of how to produce the product or service within those costs. The same challenge is set for creatively achieving the necessary revenue. Required profits equals necessary revenue minus allowable costs. With this approach, the emphasis shifts from being right, or being blamed for not meeting forecasts, to being creative as a team, in order to meet the cost and revenue challenges, while openly and transparently checking whether or not key assumptions are holding up as the adventure unfolds.

Mapping your own areas of disruption risk

Unicorn Thinking is a very useful set of tools for developing major innovations, however how do you know in the shorter term in what areas of your business you might be at risk and what you can do to defend yourself?

Customers tend not to desert companies who are hitting their mark in 8 key areas of business.

One of these key areas is Intrinsic Brand Value.

Are you competing on price, as a commodity, or are your customers willing to pay more to get your brand?

The goal of branding is to allow your product to be sold for more than competitors with similar products.

Rolls Royce is owned by BMW. The Rolls Royce Ghost is built on a modified version of the BMW 7 series platform and shares a modified version of the 7 series V12 engine. No doubt there are refinements with the Rolls, but it’s substantially the intrinsic perceived value that allows it to be sold for 3 times as much as the BMW. Apple iPhones sell at a premium to their competition. Blind taste tests of different whiskies, conducted by Dr. Stephen Chadwick and Dr. Hugh Dudley, both surgeons at St. Mary’s Hospital and Medical School in London, showed that most people can’t tell the difference between single malts and cheaper blends without the knowledge of which one they’re drinking. As advertising guru David Ogilvy said, “They’re tasting images.”

Whether you’re at risk of having your market disrupted may depend on how firmly your customers have bought into a belief in your intrinsic value. Customers can’t always be fooled, of course. The perceived intrinsic value must be backed up by exceptional user experience to maintain leadership. As Clay Christensen explained in the Innovators Dilemma, with innovations such as smaller disc drives, their initial inferiority led them to be dismissed by the dominant players. But, it was also the lack of intrinsic brand value with older formats that meant customers had no compunction in buying the cheaper product as soon as the improving performance got within range of the existing devices.

Building intrinsic brand value provides not only higher profit margins, but also higher safety margins against disruptive newcomers.

InnovationConsult has developed a tool to map all 8 areas of business disruption risk and will be providing an opportunity for business owners and managers to use it soon.

Copyright InnovationConsult 2018.

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