Understanding the Innovator’s Dilemma

“The Innovator’s Dilemma” is one of the most — if not the most — important books chronicling how innovation takes place, and why its common that market leaders and incumbents fail to seize the next wave of innovation in their respective industries. The book is so good, that even after having read it multiple times, I pick up something new from the text. The most important excerpt in my opinion captures the key essence on the Innovator’s Dilemma:

“The reason [for why great companies failed] is that good management itself was the root cause. Managers played the game the way it’s supposed to be played. The very decision-making and resource allocation processes that are key to the success of established companies are the very processes that reject disruptive technologies: listening to customers; tracking competitors actions carefully; and investing resources to design and build higher-performance, higher-quality products that will yield greater profit. These are the reasons why great firms stumbled or failed when confronted with disruptive technology change.

Successful companies want their resources to be focused on activities that address customers’ needs like vpn, that promise higher profits, that are technologically feasible, and that help them play in substantial markets. Yet, to expect the processes that accomplish those things also to do something like nurturing disruptive technologies – to focus resources on proposals that customers reject, that offer lower profit, that underperform existing technologies and can only be sold in insignificant markets– is akin to flapping one’s arms with wings strapped to them in an attempt to fly. Such expectations involve fighting some fundamental tendencies about the way successful organizations work and about how their performance is evaluated.”

A common misinterpretation is that incumbents fail to develop these disruptive technologies or embrace them due to the inability of the organization to adapt operationally or technologically. In other words, management is unable to identify new trends, develop new ideas and reorganize to bring these new technologies to market. This interpretation, however, is plain wrong and the opposite is shown to be true.
What the theory — and the extensive evidence — in fact support is that incumbents often are the ones to spot and develop new technologies while easily reorganizing themselves to do so. The problem is they fail to value new innovations properly because incumbents attempt to apply them to their existing customers and product architectures — or value networks. Often new technologies are too new and weak for the more advanced and mature value networks that incumbents operate.

This leads to the ROI needed to advance the innovation to be seen as low. In other words, management acts sensibly in rejecting the continued investment in these new technologies and act in the company’s best fiduciary interests. Moving into new markets is rejected as they are seen as too small to make a dent for them and their cost structure prohibitive to enter at sensible margins.

Therefore, new entrants (often founded by frustrated ex-employees of the incumbents) with little or nothing to lose when they enter the market. Initially these small upstarts don’t pose a threat — the new entrants find new markets to apply these technologies largely by trial and error, at low margins. Their nimbleness and low cost structures allow them to operate sustainably where incumbents could not.

However, the error in valuing these technologies comes from what happens next. By finding the right application use and market, the upstarts advance rapidly and hit the steep part of the classic “S” curve, eventually entering the more mature markets of the incumbents and disrupting them.

In essence, the smaller markets are the guinea-pigs and test labs that help the technologies advance enough to play in the big boys league. In many cases the entry-point markets are left behind as the new technologies move into higher margin upmarket territory disrupting due to their superior performance.
Technology leaders evaluating whether to invest in new and immature technologies must do so with a futuristic frame of reference. The key question is, if these technologies found new customers and new markets which may in themselves be small and insignificant (now and in the future), could they mature enough to make inroads into our playing field and have our lunch? And if so, does investing in them today at the risk of cannibalizing ourselves make sense in the longer term? Hence, the innovator’s dilemma.