Clayton Christensen has been working to limit the meaning of “Disruptive Innovation” to the definition the one that he uses in his books. By this, he aims to counter the absurd notion that “Disruptive Innovation” was supposed to explain every kind of market upheaval, hence its inability to do so suggests that the theory itself is invalid.
Some people have suggested that since Christensen stressed that “Disruptive Innovation” is not everything, a new theory for explaining the other phenomena is required. For example, in the HBR article, Christensen said that Uber is not disruptive. Then what theory can explain the market upheaval that Uber is causing?
My suggestion is that we don’t actually need a new theory. All we need is a good understanding of what areas “Disruption Theory” covers, and a little bit of common sense.
Let me explain.
First, we have to start with a good understanding of exactly what “Disruption Theory” covers and does not cover, and to see what the theory omits. To do this, I will focus on what I think is the core tenet of the theory; how the incumbent will respond.
In “Disruption Theory”, Christensen covers two options that the incumbent may take. These are,
- The incumbent responds directly to the entrant, and competes with it to drive it out, or to severely limit its penetration.
- The incumbent decides that it is not worthwhile to compete with the entrant at the low-end, and focuses on the high-end. The word that Christensen often uses is “flee to the high-end”.
Both of these options assume that the incumbent is capable of responding to the entrant, and beating it if it so wishes. Although this may be more common, there is however little reason why this should always be the case. This is the omission. It is very possible that in some cases, the incumbent is simply incapable of responding.
It is also clear from a logic point of view, that adding this will fully cover the scope of possible options. The incumbent either chooses to respond, or not respond. In the case he chooses to respond, he either succeeds in launching a response, or fails. There are no other alternatives, no holes left open to consider.
In the following table, I have added this third possibility in pink. This is the possibility that the incumbent did not have sufficient resources to launch an effective response to the entrant.
On observation of this third option, it becomes clear why Christensen did not bother to spend time elaborating this option. It is just common sense. That is why I took the liberty of filling up the pink boxes with what I consider to be straightforward reasoning.
In this third option, the incumbent is unable to mount a response, simply because it is weaker. It might be a smaller company with fewer engineering responses. It might not have the marketing might of the entrant, or its brand appeal may be much weaker. It might lack the bundling opportunities that the entrant has. Or, in the case of the quickly changing tech landscape, it might lack the expertise that is required of the next phase of computing.
In fact, I would say that a better explanation of why Christensen failed to predict the success of iPhone is because he misunderstood how difficult it would be for Nokia to adequately respond. He underestimated the resources required to create an iPhone competitor, and the know-how that Apple (and Google) had accumulated as software companies. He overestimated Nokia, Palm and Blackberry’s ability to create a similar operating system, despite trying hard either in conjunction with Microsoft, or by bringing in Jon Rubinstein to head the WebOS effort. Christensen failed to correctly assess the huge advantage that Apple had in terms of resources relevant to smartphone R&D, and instead only evaluated the resource advantage Nokia had in distribution, etc. He failed to understand that the R&D resources required to compete in the post-iPhone world were not the same as what Nokia already had, and were instead abundantly available at Apple and Google.
If the entrant’s new product is well received by the market but the incumbent cannot create a product that is competitive, then the incumbent will lose. The entrant does not necessarily need to position its product at the low-end because it can win at the high-end. There is absolutely nothing surprising about this; it is simply common sense.
To summarise my table, I believe that “Disruption Theory” left out just one option, and that has caused confusion. By filling this in, I think I have fully covered the options regarding what an incumbent could do (luckily, the omitted option was common sense, and so filling it in was trivial). It is my belief that how the incumbent responds is critical, and very often the key turning point. This is why I do not think that it is necessary to further sub-divide each incumbent response category based on other facets like cost-structure, for example. I believe that the outcome will mostly be determined by the incumbent response, and that sub-divisions will not lead to substantially different outcomes, hence sub-division loses any practical utility. (This is to say that sub-divisions that only predict the same result as the parent category are not very useful. For example a sub-division inside the “cannot respond” category that predicts that the incumbent will fall is not really worthwhile, because the “cannot respond” category already predicts the same.) Furthermore, I doubt that a detailed analysis of the “cannot respond” category is necessary since it is already common sense for the vastly more powerful to prevail. I would however appreciate any discussion on any aspect of my table.
Finally, I would like to discuss what this means for Uber, the controversial example that Christensen touched.
My understanding of Uber is the following.
- Uber is the entrant but is also the Goliath. As such, the Uber vs. taxi companies battle sits in the pink area of my table, the area where entrant Goliath predictably slays David.
- Uber has accumulated billions of dollars in venture capital which it spends heavily on customer acquisition, driver acquisition, marketing and government lobbying. This in stark contrast to the typically small and not-very-profitable taxi companies, which have not accumulated vast amounts of cash, and cannot spend tons of money for the same purposes as Uber.
- Uber is the world’s first global taxi company. It has benefits of scale in terms of its technology, branding and marketing.
- Uber’s valuation is dependent on its not being seen simply as a taxi company, but also as a company that can disrupt many other industries. None of these efforts have yet been successful, but nonetheless, investors are seeing huge potential opportunities. However, taxi companies have never been seen in this light. They cannot raise capital with the same promises as Uber.
- All this results in Uber being a Goliath in terms of the money it can spend, relative to local taxi companies. With vastly more resources at its disposal, it is able to invest in ways that its competitors simply cannot. Although there are no doubt other complicated reasons why taxi companies might have trouble launching an effective response, the enormous difference in cash cannot be ignored. Being Goliath, Uber will predictably slay the taxi Davids in the absence of regulation.
- Importantly however, the fact that Uber is not “Disruptive” limits its ability to fulfil its investors’ dreams, even if it demolishes taxis worldwide. Uber is definitely a better mousetrap, but the economics does not ensure sustainably low prices nor sustainable profits. It does not reduce the burden of insurance, gasoline costs, car maintenance costs nor car depreciation. It does not eliminate the fact that the driver still has to make a living. These are the major costs of a taxi ride, and without significantly reducing any of them, there is little systemic reason why an Uber ride would remain cheaper than a regular taxi. As a result, the market will not significantly increase. Most people are unlikely to suddenly be enlightened to the possibility that ditching their own cars and using Ubers exclusively would be cheaper for them overall. This is what it means to not be a Christensen “Disruption”, but merely my pink box upheaval.
- To be “Disruptive” to taxi industries, to bring taxi services to those who do not currently use taxis often, and to significantly expand the market, Uber has to either a) make taxis much easier to use for the people who currently have no access, or b) make taxis much cheaper. The first option is something that the green boro taxi program in August 2013 did in Brooklyn, with dramatic results. Applied to Uber, this would be like bringing taxis to rural areas where no taxi service is yet available. Option b) could be achieved by things like UberPool (which I don’t think is yet mainstream) or self-driving cars. UberPool is interesting and could fit the definition of “Disruptive Innovation” perfectly, if it worked. Of course, car pooling would compete more with busses than taxis, and we have to consider whether UberPool makes more sense. Self-driving cars are a bit too far out to sensibly evaluate.
- There remains the possibility that Uber will be disruptive to other industries, for example, automobiles. This is probably the rationale for its astronomical valuation. I personally don’t think much of the prospects, but instead of confusing this post with another controversial discussion, I will leave this for another time.
Cleared up the logic for Uber and added a few more details.
We might want to consider cases where the incumbent changes their mind. An incumbent may initially dismiss the entrant as non-significant and decide to “flee-upmarket”. After realising that the entrant is a larger threat then they initially envisioned, they may choose to respond. Whether that response is too late or not will depend on how strong the entrant has grown. If the entrant has grown to the point that the entrant is more resourceful than the incumbent, then the entrant will win. If the entrant has not, then the incumbent will win. This is a situation that is well documented in Christensen’s work.
With the pink category included, it is easy to see the large role that venture capital plays. Venture capital can instantly create Goliaths that dwarf the incumbents. Startups that have not accumulated any cash to date, can suddenly obtain resources many times larger than the incumbents’, if they can paint a picture that is sufficiently rosy to investors. Of course startups have to convince investors that the opportunity is much larger than the current market, much in the same way as Uber is pitching itself as more than a taxi company, but that is speculation-based, and startups do not necessarily have to provide hard figures.
In other words, the incumbents are at the mercy of the speculation that their industry could turn out to be but a small portion of a much larger enterprise. This does not always turn out to be true, as evidenced by how Google destroyed the RSS market (they obviously though that the RSS market would turn out to be something bigger that what it was), only to abandon it later.
Just to clarify, I do not wish to debate the adequacy of Uber’s current valuation, nor do I want to denounce it as a VC bubble. I am totally uninterested in how Uber managed to convince investors of its valuation. I do not care if Capital follows Opportunity, or if Opportunity follows Capital. The only thing I am interested in is that the entrant Uber has vast resources while the incumbent taxi companies do not. This to me is an indisputable fact.
I do say that the taxi business does not validate its valuation, but I do not intend to question its valuation based on future, speculative opportunities. That risk is for the investors to take. They’re not spending my money.