Disruptive Innovation (Part 1)

LightCastle Analytics Wing
July 8, 2014
Disruptive Innovation (Part 1)

Let us start with the story of computers- a technology that we cannot imagine our lives without. Many of the core activities in our daily lives depend solely on computers, starting from school assignments to international espionage (Yes NSA, I am talking about you). Devices such as laptops and personal computers have made their way into households, educational institutions, businesses, security services and every single arena of the world we live in. However, this was not the case when this revolutionary technology was first introduced. The first ever computer was called a “mainframe computer”. The set up and efficient operation of this device required an entire room’s space. Each computer would be priced at no less than $2,000,000. The mainframe, without a doubt, only catered to the elite of society. And there were no real complains about the restricted market either, since each computer was sold at a gross margin of $1,200,000. Therefore, the millions of people who could not afford this luxury had to remain discontented.

That is when personal computers entered the market. Unlike mainframes, this device only cost $2000 and could easily fit on a desk. Unlike the mainframe, this device was quite inferior, since it only allowed a very limited set of low spec activities such as creating basic spreadsheets and editing documents. Unlike the mainframe, this device was affordable by all segments of society. This new product did not threaten mainframe manufacturers, since the gross margin of $700 was not appealing at all. Moreover, the target customers of the two technologies were completely different, and drew no conflict of interest. With time, personal computers improved in quality while maintaining the price advantage. With an increasing scope of operation with the PC, there was a decreasing need for expensive mainframes. And quite inevitably, personal computers replaced mainframes completely.
This phenomenon is known as disruptive innovation. The term was first coined by Clayton Christensen, a professor at Harvard Business School. The idea is quite simple. According to him, disruptive innovation transforms a complicated, expensive product into a simpler, affordable one, which eventually replaces the prior version of the product completely. The story of personal computers that we discussed earlier delineates this concept quite vividly. The approach that disruptive innovation takes in market penetration is “bottom-up”. In the initial stage, disruptive technology is generally targeted to the bottom of the pyramid- people who cannot currently afford the existing version of that technology. As popularity for the product increases, new features are constantly introduced to gradually match and eventually exceed the quality of the prior version of that technology, all the while maintaining a distinct price advantage.
Notice how I did not question the intellect of the managers of the mainframe manufacturers even once. On their end, it made perfect sense to continue operations in high end products, since the gross margin is generally much higher. Therefore, it is not profitable to employ additional assets to compete in a lower yield product line. In the case of mainframes, the $1200000 gross margin always seemed more profitable than the $700 reward from personal computers.
There is also the issue of Innovator’s dilemma. It is difficult for a company to forgo their current technology and move to a new one to adjust to the market demand. This is for two reasons:

  • There has already been a high investment in research and development. This investment needs to be recovered before starting a new R&D program.
  • The existing technology is still more profitable at the current stage. Shareholders tend to be hind sighted about corporate policy. The failure to deliver dividends, or the inability to raise share prices may cause a loss of investor’s confidence in that company. This creates an imperative to create as much profit from the existing technology as possible, and essentially creates a pathway for the disruptive technology into the market.

The beauty of disruptive innovation is that it caters to a wider range of consumers. Godrej, for instance, introduced a refrigerator that is 75% cheaper than regular refrigerators. Godrej realized that India has one of the largest pool of consumers at the bottom of the pyramid, and that refrigeration is an increasing need due to climatic conditions. This simpler, cheaper form of refrigerator is now highly popular in India, and has the potential to disrupt the refrigerator industry.
Lastly, disruptive innovation has the potential to create jobs. The introduction of a new product line which is targeted towards the bottom of the pyramid creates a massive customer base. Catering to this customer base generates a demand for labor.
The fittest will always survive. And in today’s world, change defines that fitness. Change that is not just more convenient, but also more affordable. Disruptive innovation, as a result, seems like the perfect path towards survival, and a recipe for success. We will end this article with the story of Japanese cars. During the 1900s in the US, General Motors had an absolute monopoly in the automobile industry. Their designs were majestic, engine power was mammoth, and most importantly, GM products were a symbol of respect. When Toyota entered the Japanese market, their weak, small cars were laughable to the managers of General Motors, and were considered no threat at all. However, what GM did not realize was that USA had a huge market for cheap cars. There were many who could not afford the mighty Cadillac, and simply needed a convenient means of transportation. This need was amplified due to the rise of price of gasoline due to the Gulf War. Toyota therefore introduced simpler, cheaper cars into the American market to meet these demands. Today, Detroit has sunk into the depths of the loss-making ocean, while Toyota is the number one automobile brand in the world.

WRITTEN BY: LightCastle Analytics Wing

At LightCastle, we take a systemic and data-driven approach to create opportunities for growth and impact. We are an international management consulting firm which creates systemic and data-driven opportunities for growth and impact in emerging markets. By collaborating with development partners and leveraging the power of the private sector, we strive to boost economies, inspire businesses, and change lives at scale.

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