The economy is experiencing successive waves of change in industry after industry.
It is important to understand the common themes behind these changes and have a model that helps executives anticipate and manage the impact of disruption or to devise disruptive strategies. Increasingly executives are talking about change as “disruption” and many smaller companies are positioning themselves as “disruptors” of a sector. Arguably “disruption strategy” is taking over from competitive strategy. If so then we need to clarify terms and grasp what this means.
As identified by Christensen, disruption typically creates new markets. If it doesn’t do this then strategy is typically competitive rather than disruptive. If we bear that distinction in mind then the idea of disruption becomes a useful way of looking at enterprise behavior and market change in the great transformation.
People talk about disruption in terms of the historical movement towards new types of productive enterprise, but they identify the root cause of transition as digitization. Given that a digital paradigm has existed for thirty years, this seems ill-conceived. In this post I will dig deeper into the background of disruption thinking and arrive at a simple model of its main characteristics and drivers.
There are five main contributions to thinking on business disruption but do any capture the essence of change that we face in the Great Transformation?
- In the 1930s Kondratiev explained disruption as 60 year cycles (or waves) in which commodity prices become too high for incumbents to sustain business as normal and therefore needed radical innovation. For Kondratiev disruption was a periodic renewal that took an economy into a different set of relationships around commodity utilization. Technological innovation typically does just that by making business activity and scale cheaper;
- Schumpeter used this wave theory to suggest that capitalism becomes increasingly corporatist and concentrated; corporatism would alienate key thinkers because it would produce an economy that made entrepreneurism impossible – this would lead to creative destruction or, in other words, an ideological attack on capitalism;
- In the 1990s Christiansen described disruption as a process where even good companies could be hoodwinked by smaller companies with low cost products picking off low-end customers, meanwhile gaining experience to broaden and change the basic conditions of the market and customer needs, and compete by changing market structure;
- More recently Larry Downes and Paul Nunnen have described a new form of disruption that they call Big Bang; an example is Twitter that began as an experiment and grew into the world’s largest broadcaster of personal information. Big Bang disruptors can be strategically inept and accidental, yet still very powerful suggesting that some elements of disruption are not that strategically controlled.
- There is a fifth school of thought that has been given less attention, Steven Klepper’s work on firm survival and new entrants.
Klepper found that firms tend towards oligopoly. They survive for as long as they keep the barriers to entry high and they often do this through high levels of investment in R&D, which in turn gives strong returns to the investment community.
However, complex decision processes at the senior level of firms is are also associated with an inability to respond to competitive pressure. While discussions of disruption tend to focus on singular cases, Klepper illustrated the impact of complex decision processes on whole sectors.
The US Tire industry in the 1930s, TV manufacture from the 1960s and autos from the 1970s all suffered the effects of decision processes that were unresponsive to change – in all three cases the attack came from the rise of cheaper sources of production in Asia. In all three cases the problems lay in complex decision process in publicly quoted firms. Firms that had previously maintained entry barriers through high R&D investment were unable to respond to changes in processes elsewhere.
In contrast to these public firms, private ownership allows for longer-term investment decisions. In banking for example, in a recent unpublished study I found the Bank of New York Mellon, family owned, was far more adept at innovation decisions that the publicly owned Citi.
Klepper also found that in many instances competition arises from the employee-base of an oligopoly. People denied resources internally tend to quit and start their own competitive enterprise.
Klepper did not consider the possibility that whole industry structures can be transformed in ways that destroy oligopoly power very quickly from within, i.e. without competition from low-cost sources of production and without the successive incidence of smart people leaving to join the start-up pool (a process that roughly equates with creative destruction). Indeed the industries he studied were marked also by intense competition from developing economies. In the case of Nokia, the failed European mobile phone maker, competition came from high cost, high price Apple as well as low-cost Google working on a different operating model. This s another important point – we focus on business models when process models are significant sources of advantage.
Drawing on Klepper’s thinking and Schumpeter’s it is possible to identify a five step process that leads to structural disruption that affects all firms in a sector.
- Concentration and hubris. The consolidation of market structure into an oligopoly, with satisfactory margins, but often accompanied by the growth of hubristic management.
- The experimental era. What forces change on a highly concentrated industry? In the silicon industry Klepper identified early pressure coming from talented people working in oligopoly firms. This resulted in employees of existing oligopolists leaving to create their own companies because of dissatisfaction with how their innovative mindset is treated. Often accompanied by moves toward open source technologies; these socially organized movements also provide entrepreneurs with access to people whose work-values are part of a broader movement to democratize access to an industry – and today the Cloud makes experimentation and failure much easier to bear.
- The new content layer. The growth of awareness, or a new content layer or changed information market, as consumers experience alternatives to oligopoly offers, often as co-creators or participants, is an often overlooked aspect of change. Awareness is also about consumer preferences and consumer access to information for making informed choices has never been easier.
- Ecosystem consolidation. The consolidation of a durable start-up community with continuity of personnel and objectives over time, often represented as an ecosystem that takes on innovation risk is a consequence of an early experimental period. For example, there is a community around BitCoin that is destined to fail with its initial experiments but bound to succeed in the longer term task of disrupting finance through code and a global community.
- Platform and price. The arrival of a platform company as an organising hub for a new industry, intensifies horizontal pressure on a whole sector and triggers multiple random adjacencies as platform providers can choose their ground – for example can Uber resist going into parcel delivery? Typically there is also a radical price reduction; apps for example, became free; new payments platforms today are radical on price. Platforms often represent the devolution of risk to ecosystem members, a factor that might explain why price reduction is possible. Platforms represent an organizing hub, a radical price point and devolved risk.
In a second post I will summarize disruption forces in the IT and telecoms space and look at how this applies to finance.