By entering the market with products and services that are every bit as good as those offered by legacy companies, a new breed of disrupters is making it harder than ever for traditional businesses to compete.

Clayton Christensen’s Theory of Disruptive Innovation first came to public attention 25 years ago. Christensen presciently explained that fast-moving disrupters entering the market with cheap, low-quality goods could undermine companies wed to prevailing beliefs about competitive advantage. In the last decade, however, the profile of disrupters has changed dramatically. The critical difference is that they now enter the market with products and services that are every bit as good as those offered by legacy companies. Their ascendance doesn’t undermine Christensen’s theory. In fact, they expand its reach and vitality — and make it harder than ever for traditional companies to compete. 

The Classic Theory of Disruption

Before we look at how things have evolved, let’s briefly review why Christensen’s theory proved so influential and, indeed, disruptive to existing ideas of competitive advantage.1 Traditional strategy had been anchored on the notion of “generic strategies” in which a company could compete at the high end by differentiating, at the low end by pursuing cost leadership, or focus on serving a specific niche exceptionally well.2 Christensen illustrated a way for new entrants to cheerfully ignore these basic strategy dynamics. He showed how a new kind of dangerous competitor could wreak havoc by entering at the low end of a market, where margins are thin and customers are reluctant to pay for anything they don’t need. 

The new entrant comes in with a product or service that’s cheaper and more convenient but that doesn’t offer the same level of performance on the dominant criteria that most customers expect from incumbents that have been working on the technology for years. The incumbents feel they can ignore the newcomer. Not only are its products inferior, but its margins are lower and its customers less loyal. Incumbents choose instead to focus on sustaining innovation — making improvements to the features that have been of most value to their high-end customers.

Christensen showed the downside of ignoring the newcomers. Eventually, as these upstarts improve, they become pretty good at the old dominant criteria. They also develop such solid innovations at the low end that they bring new customers into the market. Having doubled down on what has always worked, the incumbents fail to notice two things. First, they miss out on the meaningful value of the low-end innovations developed by newcomers. Second, they are late to recognize that their own customers are less willing to pay more for more of the old attributes. Their key product has been commoditized, supplanted by a new technology that better suits the changed needs of customers. 

A prime example of this process occurred at Intel. The chipmaker enjoyed decades of high margins by selling high-end, powerful, and fast computer chips for laptops, desktop computers, and servers that allowed users to get the most out of increasingly power-hungry software. The company (and its customers) didn’t care much about power consumption because personal computers were either permanently plugged into a power source or had sufficiently large batteries to go hours between charges. Dominant to the point of near-monopoly, Intel dismissed and largely ignored a new set of less powerful, albeit less power-hungry, chips based on the ARM architecture (created by a once-obscure British company). 

The smartphone revolution of the late 2000s exposed the fatal flaw in Intel’s offerings. The company’s chips were power-hungry, but now users wanted light mobile devices that could last all day. Chips based on the ARM design were far more efficient — the new differentiating quality. Intel managers had been focused on making its core microprocessors better at what had always seemed to matter most. So the company missed the potential of mobile device chips, which more than made up for their lower margins by finding their way into billions — not millions — of devices. 

Intel’s struggles with chips for mobile devices illustrate two dimensions of the disruption described by Christensen. The first is the market entry of a new competitor whose offerings are not good enough to meet the needs of established customers (PC owners). The second is the moment when that entrant creates a market by selling solutions to users who were never customers before, like smartphone manufacturers.3

Christensen’s theory also highlighted the powerful way that management metrics and incentive structures reinforce this pattern. In his view, many of these combine to discourage executives from investing in innovation. Financials expressed as ratios, accounting-driven depreciation schedules, conventional business plans, and stock- or time-based rewards to managers all detract from a leader’s willingness to pursue uncertain (though potentially high-payoff) innovations. This has all been exacerbated by outsize rewards to executives and investors in the short run, which undermine investment for the long run.

The Rise of the Cheap, Convenient, and High-Quality Startup

Today’s direct-to-consumer (DTC) disrupters illustrate a next evolution in the theory of disruption. These disrupters target the very core of incumbents’ existing businesses by using today’s broad array of powerful digital technologies to offer products or services that are cheaper, more convenient, and every bit as good as existing offerings. The combination of “just as good” with new digital technologies creates a massive inflection point, putting more pressure on incumbents than ever. 

The traditional assumption underpinning most retail businesses was that the gatekeeper for product sales would be large distributors like Walmart, Target, or Carrefour. Vendors had to demonstrate large enough demand for a big enough customer segment to earn space on a distributor’s shelves. This gatekeeping function created several side effects. The first was that products themselves needed to be fairly standardized to offer consistency across the many distributor locations. The second was that the manufacturers had relatively crude information about who the buyers were, how the products were stocked and displayed, and how they performed relative to competitors sold by the same vendor. The producer had relatively little control over the buying experience. For many producers, the most important “customer” was the retailer, not the end user. 

The 2010s saw an explosion of consumer-products companies that dispensed with the gatekeepers to offer their products directly to consumers, hence the moniker D2C, or direct to consumer. Companies such as Warby Parker (founded in 2010), Dollar Shave Club (2011), Glossier (2010), Away (2015), Casper (2014), and Bonobos (2007) are upending categories as varied as eyeglasses, men’s grooming, skin care, travel, mattresses, and clothing. Their value proposition to customers almost always features a comparable product at a lower price. More important, it always offers a shopping experience that eliminates many of the frictions and irritants of conventional retail. 

Dollar Shave Club (acquired by Unilever for $1 billion in 2016) made a point of criticizing flaws in the existing business model of conventional men’s shaving products. In a hilarious video that went viral on social channels, cofounder Michael Dubin mocked the incumbent’s practices. “Do you like spending $20 a month on brand-name razors?” he asks his mostly youthful audience. “Nineteen goes to Roger Federer! … Stop paying for shave tech you don’t need.” Gillette, the incumbent, was forced to react by reducing prices, launching a shave club of its own, and even venturing into edgy advertising (to mixed reviews). Still, its market share has suffered, both from the competition with D2C companies like Dollar Shave Club and Harry’s and from the trend among men, particularly younger ones, to wear beards.

In a short period of time, new competitors have radically changed customer behavior in three significant ways:

• Consumers are now happy to purchase hard goods like mattresses, furniture, and even cars online. Previous generations found it unthinkable to do so. Making a wrong choice could involve expensive returns, lots of wasted time, ongoing quality and safety worries, and potentially even financial losses. Since making a wrong choice was seen as risky, the assumption was that consumers would always want to touch and feel such goods before making a big-commitment purchase.

The new disrupters have eliminated that risk and complexity. Don’t like your Casper mattress after 99 days? No problem — the company will come pick it up from you, free of charge. Casper has reduced the risk of making what once was a high-stakes decision. In 2019, the company’s revenues topped $500 million, taking a chunk out of an industry whose sales were reportedly $27 billion the same year.

• Almost everything can be sold as a service. While the idea started with software (the famous software-as-a-service, or SaaS, model), you can now utilize clothing, furniture, cars, trucks, heavy equipment, and even pets on a subscription or limited-trial basis. Why bother to own products when you can get the same benefits only as needed, with flexible spending?

• Excess capacity is a consumer asset. The poster child for this trend is Airbnb, which created a marketplace in which ordinary people with underutilized real estate could make money by renting their space to strangers. As of 2019, Americans reportedly spent more money with Airbnb than they did with Hilton, accounting for some 20% of consumer money spent on lodging. The model is now extending to other asset classes, with startups like Neighbor.com, which connects homeowners with excess room at home to people who need storage space.

Given the success, reliability, and proven value of these new D2C competitors, it’s hardly surprising that the value of many established brands is in sharp decline. Just as digital technologies allow companies to build businesses almost overnight, social media, digital channels, and online influencers can help new brands build meaningful identities and reputations at warp speed.

The Digital Elements of the New Disruptive Model

These new D2C businesses have several similarities, each driven by digital technologies, algorithms, data analytics, and new forms of connectivity.

• Access to assets, not ownership of assets. Traditional organizations used the assets they owned to both create competitive differentiation and establish entry barriers. The D2C organizations, instead, participate in digital platforms that can virtually represent both sides of an on-demand transaction, removing friction and risk. Contracting for asset usage on an open market allows them to scale quickly. However, it also makes their business models relatively easy for others to copy. The online mattress-in-a-box business, for instance, is thought to have as many as 150 new entrants. The amount of new entry echoes what Harvard professors William Sahlman and Howard Stevenson years ago called capital market myopia, in which startups charge into a category that can’t possibly sustain all of them.4
• Cocreation with customers. Digital channels eliminate middlemen. As their name implies, D2C companies create a direct relationship with their customers. This gives them powerful feedback loops in which they can more rapidly experiment, iterate, and customize offerings with far more flexibility than a traditional retailer. The best D2C brands create a complete end-to-end experience, capturing the customer’s attention, loyalty, and data through the entire process rather than sharing it with anyone else.
• Always-on and mobile. There have always been organizations that sold directly to consumers (think L.L. Bean or Lands’ End). The new breed of D2C companies, however, uses mobile technology and mobile infrastructure to make interaction a 24-hour, always-on experience. Consumers have come to expect that a D2C company is an easy and accessible partner for transactions and support, giving them what they want when they want it.
• Capital-light ecosystem business models. One common hallmark of D2C startups is that they require relatively little in terms of conventional capital. They outsource much of the operations, joining ecosystems built on digital platforms, where infrastructure becomes a shared resource. These companies don’t compete on better distribution or supply chains — they can put together complex supply chains in a fraction of the time and expense it would take in an analog world. Instead, they compete on what really matters: a better customer experience.

The Theory of Disruption: What Stays the Same

Christensen’s original theory of disruption has held up very well in explaining why startups with little in the way of assets or existing brands can capture market share from well-entrenched incumbents. Just as the theory predicted, incumbents considering investments in innovation that has the potential to cannibalize the existing business still find it unattractive and dangerous. They have little incentive to pursue opportunities with thinner margins than those enjoyed by their core business, and their corporate metrics tend to reinforce this status quo. 

As Christensen also predicted, the “jobs” customers seek to get done in their lives remain remarkably stable5 — even though digital technologies have created entirely new ways to get those jobs done. Consider the job of making an apartment comfortable by furnishing it. Today’s young, nomadic urban workers often find that it’s more convenient to accomplish that job by leasing furniture than buying it. Incumbents can get blindsided by this kind of shift in how a job gets done. In particular, they may find that their competitor isn’t a traditional one but a company from a different industry altogether that has mastered the new digital technologies. Apple, for instance, is partnering with Goldman Sachs to issue an Apple-branded credit card. You might also think of e-retailer Alibaba’s threat to banks with its payment systems, Amazon’s move into groceries and brick-and-mortar shops, or Uber’s effort to dominate third-party food delivery.

Christensen’s theory also holds for the fact that creating new customers by lowering prices enough to compete with nonconsumption is still a viable opportunity for crafty newcomers. Just as traditional disruptive competitors pulled new buyers into new markets by lowering prices, digitally disruptive companies make it radically cheaper, easier, and faster to become customers. Consider, for instance, what has happened in the market for hearing aids. A traditional fitting for a hearing aid required a labor-intensive and extremely expensive visit to an audiologist and a cumbersome process of fitting and adjusting the devices. Eargo, a venture-backed startup, dispenses with all that. Its “invisible” hearing aids (inspired by a fishing fly) fit in your ear. You can fit them yourself. They recharge in a special case — no more hunting down and changing batteries. And the Eargo comes at a lower price point than traditional hearing aids, potentially opening a vast market of people who need hearing assistance but can’t afford the traditional model (especially when hearing aids are not covered by most medical plans). 

Finally, Christensen’s perspective on what he called the capitalist’s dilemma is still with us.6 In many large organizations, incentives are not aligned with the market-creating innovation. One prominent example: Massive share buybacks, which handsomely reward executives while draining companies of cash that could be invested in innovation designed to win new customers by transforming exclusive products and services into simpler, inexpensive ones.7

The Theory of Disruption: What Has Changed

Christensen described disruption as a process that takes some time, as new entrants slowly progress from the fringe to the mainstream of an incumbent’s business.8 The most significant change since he first laid out his theory is that digital competitors can now move with unprecedented speed. 

The conditions for entry into any sector that makes any margin at all have never been better. There’s ample available financing (as of this writing, anyway), talent aplenty in the gig economy, consumers who are comfortable buying just about anything sight unseen, and digital technologies to facilitate every operation that might previously have been an obstacle. As Warby Parker, Casper, and the like have shown, disrupters with a competitive value proposition can drive scale at previously unimagined speed. 

A second departure from the theory of disruption has to do with the relationship between the traditional, core business and innovative new ones. In the original formulation, the core part of the business had fairly predictable (if slowly declining) revenue numbers, customers whose needs could be identified, and rewards for replicating the existing model at scale. Innovative new businesses, on the other hand, have operated with a high ratio of assumptions relative to knowledge, leading to practices such as discovery-driven planning, test-and-learn, and rapid experimentation.

Today’s digital disruption is so fierce that core businesses are less reliable than ever, and their declines can sometimes be precipitous to the point of endangering the entire enterprise. Consider the fate of General Electric, once the darling of admiring business school cases and now described as being “on life support.”9GE’s management realized relatively early on that digital was likely to bring massive change to its businesses. In 2013, it embarked upon a digital transformation with the launch of a platform called Predix, which was supposed to harness the internet of things and bring disruptive change to the storied conglomerate. But GE failed to balance well its investments for the future with the need to meet quarterly numbers. When Predix failed, its demise adversely affected the health of GE’s other, core divisions, leaving the company in dire straits.

There’s one more important change that’s happened since Christensen’s early work was published. Incumbents have learned a thing or two about disruption. Leaders at German metals distributor Kloeckner, for instance, determined that if they didn’t create a digital platform for doing business, some upstart would do it to them, and they have been on a steady journey to digitize their industry. Other incumbents are willing to use their resources aggressively to combat disruption. They shell out eye-popping sums to acquire startups, they try their best to import a startup mentality and practices, and they leverage their own resources and heft to let their digital acquisitions or offshoots accelerate to scale. Walmart, for instance, spent $3.3 billion to acquire Jet.com, and millions more to acquire a string of D2C companies whose offerings are appealing to a younger demographic. GM and Ford spent heavily to compete in the emerging sector of autonomous vehicles. Incumbents have read Christensen, and the best ones are doing everything they can to avoid the slothful mistakes of the past.

In general, when seeing a disruption coming, incumbents seem to fall into three categories. The first are those that fall into the classic Christensen trap and ignore the potential change completely. The second are those that spot the disruption and overreact, spending vast amounts of money and time on efforts to jump right into whatever the disruptive market seems to hold. What I would observe is that companies such as Kloeckner that begin to make modest investments in potential disruptions gradually create the capabilities to segue into the next phase without a wrenching downfall or excessive shift. Toyota, for instance, created a mass market for hybrid electric vehicles without abandoning its core internal combustion business, and it is one of the few profitable players in the electric vehicle arena. 

The Road Ahead for Incumbent Companies

Every traditional company should be aware that the very concept of sustaining innovation is at risk when a digital assault on the core business is as easy, fast, and affordable as it is today. Digital puts the disruptive mantra of “faster, cheaper, and good enough” on steroids. Business models enabled by digital create potential inflection points for every traditional business. Senior leaders and board members must accept that there are no safe bets.

Yet, all too often, business leaders of incumbent companies spend way too much money on digital transformation efforts that fail to take the new economics and business models of digital disrupters into account. Automating old business models is nothing more than that — it doesn’t do a thing to help your company benefit from the disruptive price/performance ratios that digital tools can foster. 

There is a tremendous amount still to be learned about how to compete in a world moving at the pace of digital. This places a huge premium on being able to learn quickly, experiment, and then pivot to reflect the insights gleaned. Incumbents need to stop spending money trying to be a better version of their analog selves, and instead start approaching digital strategy with an eye toward discovery.

By Rita Gunther McGrath

Source https://sloanreview.mit.edu