[notes] The Innovator’s Solution

The Innovator’s Solution: Creating and Sustaining Successful Growth (2003) by Clayton M. Christensen and Michael E. Raynor #

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NOTE: Bewarned, these notes are un-edited, un-revised, and un-styled. I plan on cleaning them up eventually, but until then, I apologize.

The Growth Imperative #

basically doing an overview of the innovator’s dilemma

• companies need to grow
• stock based companies need to grow more than predicted (because their stock price takes into account the potential growth from new business)

theories

• start by categorizing observations

“The Innovator’s Dilemma summarized a theory that explains how, under certain circumstances, the mechanism of profit-maximizing resource allocation causes well-run companies to get killed”

How can we beat our most powerful competitors? #

circumstance of innovation

• sustaining circumstance - improving an existing product - incumbents usually win
• disruptive circumstance - entrants likely to beat incumbents

sustaining

• bring better products to established customers in existing markets
• try to move their project towards customers with higher level product margins

disruptive

• introduce products and services that are not as good as currently available products, but offer other benefits - typically being simpler, more convenient, or cheaper - to appeal to new or less-demanding customers.
• once it gains a foothold, the improvement cycle begins
• this works because asymmetric motivation
• competitors are not motivated to defend low-end markets
• instead they are motivated to head up-market (basically sell products that sell for higher profit margins)

new-market disruptions

• compete with “nonconsumption”

low-end disruptions

• low end of original or mainstream value network

“If the technology can be developed so that a large population of less skilled or less affluent people can begin owning and using, in a more convenient context, something that historically was available only to more skilled or affluent people in a centralized, inconvenient location then there is potential for shaping the idea into a new market disruption.”

“Often the innovations that enable low-end disruptions are improvements that reduce overhead costs, enabling a company to earn attractive returns on lower gross margins, coupled with improvements in manufacturing or business processes that turn assets faster.”

What products will customers want to buy? #

market segmentation

• “identifying groups of customers that are similar enough that the same product or service will appeal to all of them.”
• currently these delineations are defined by the attributes of products and customers
• this can reveal correlations between attributes and outcomes
• but we want to show causality
• “what features, functions, and positioning will cause customers to buy a product.”
• to get this use circumstance-based categorization

• requires and understanding of the circumsance in which users buy or use things

• metaphor of users having “jobs” to be done and “hiring” products or services to help get that job done

• this is also useful for “inventing” the upward path of a new-market disruption to obtain bigger margins

reasons we don’t do this:

fear of focus:

• focusing on making a product that does a single job well means accepting that it won’t do other jobs well
• this gives the illusion of a smaller market for the product
• it is an illusion because people wouldn’t have hired that product to do other jobs anyway though
• basically like one size fits all solution which ends up not fitting anybody

quantification of opportunities

• opportunities are quantified in an attribute based way (there are so many females between the age of 25 and 35) because that’s the way that data is found and structured
• the structure of this data is misleading however
• don’t rely on it, instead try to quantify the size of the circumstance

structure of channels

• distribution channels are organized by product category rather than according to the jobs that customers need to get done

advertising economics and brand strategies

• company should communicate to the circumstance and not necessarily to the consumer
• can do this using a brand
• doing this badly can confuse product development and cause the company to create a product that does several things poorly instead of one thing well.
• can expand this idea by adding a secondary “purpose” brand
• basically for branching out and creating multiple disruptive and differentiated products

be super cautious when asking consumers to change jobs

• it usually doesn’t work
• instead, solve a job that they currently have, and then slowly transition and expand the business to incorporate the job they should have

Who are the best customers for our products? #

low-end disruption

• “current users of a mainstream product who seem disinterested in offers to sell them improved-performance products”

new-market disruption

• compete against nonconsumption
• “target customers that are trying to get a job done, but because they lack the money or skill, a simple, inexpensive solution has been beyond reach”
• these customers compare the product to having nothing at all, and are thus delighted by it even though it may have only modest performance
• this creates a whole new value network

• which typically includes new channels for purchase and new venues for usage

• humans are wired to have a bigger psychological response when something is framed as a threat

• use this to acquire funding and support inside an existing company

• but we still need to be flexible in finding out what the opportunity is

reaching new market customers often requires disruptive channels

• “there needs to be symmetry of motivation across the entire chain of entities that add value to the product on its way to the end customer”
• e.g. sales people have to be motivated to sell it, designers have to be motivated to design well for it
• note that retailers and distributors grow through disruption too

Getting the scope of the business right #

• how do we decide what to in-source and what to procure from suppliers and partners
• traditionally use a “core competency” way of thinking
• e.g. if it’s you core competency then integrate it else outsource it
• this is bad
• instead “take a job-to-be-done approach: Customers will not buy your product unless it solves an important problem for them.”
• but this depends on whether the product is not good enough or more than good enough
• when product is not good enough, integrate
• when product is more than good enough, outsource (or rather, “specialize and dis-integrate”)

product architecture and interfaces

• architecture: determines how constituent components and subsystems interact in order to achieve target functionality
• interface: place where two components fit together
• interdependent: an interface where one part cannot be created independently of the other part

Interdependent architectures

• “interdependent architectures optimize performance, in terms of functionality and reliability.”
• optimized and proprietary
• companies must be integrated. e.g. control every critical component of the system in order to make any piece of the system

modular architectures

• clean interfaces
• specifies fit and function of all elements so it doesn’t matter who creates them
• optimizes flexibility, but because of tight specification, gives engineers fewer degrees of freedom in design. which results in a sacrifice in performance
• modular designs work best in an era of performance surplus

most companies exist somewhere in between

what usually happens is integrated companies with cutting edge technology create new products. eventually these products overshoot the required functionality, then modularized companies come up and start taking market share

• this leads to commoditization of the product
• e.g. anyone can assemble the parts together so there is not much value in doing so
• which is bad for profit margins

How to avoid commoditization #

• “the process that transforms a profitable, differentiated, proprietary product in to a commodity is the process of overshooting and modularization”

integrated companies that design and assemble the not-good-enough end-use products

• interdependent proprietary architecture of their products makes differentiation straightforward
• high ratio of fixed to variable costs is inherent in the design and manufacture or architecturally interdependent products creates steep economies of scale that give large competitors strong cost advantages, and create formidable entry barriers against new competitors.
• this ends when companies overshoot their mainstream customers

1. in a new market a company develops a proprietary product that is better than its competitors and earns attractive profit margins
2. in striving to keep ahead of competitors that company overshoots the functionality that customers in lower tiers of the market can utilize
3. this precipitates a change in the basis of competition in those tiers
4. which precipitates an evolution toward modular architectures
5. which facilities the dis-integration of the industry
6. which makes it difficult to differentiate the performance or cost of competitors

this functional overshoot occurs first at the bottom of the market, and then moves up inexorably to affect the higher tiers

“disruption and commoditization can be seen as two sides of the same coin”

• a company in a more-than-good-enough circumstance can’t win: either disruption steals its markets or commoditization steals its profits
• “The only way modular disruptors can keep profits healthy is to carry their low-cost business models up-market as fast as possible so that they can keep competing at the margin against higher-cost markers of proprietary products.”
• “Competitive forces consequently compel suppliers of these performance-defining components to create architectures that, within the subsystems, are increasingly interdependent and proprietary.”

1. low-cost strategy of modular product assemblers is only viable as long as they are competing against higher-cost opponents thus they must constantly strive up market
2. the mechanisms that constrain how rapidly they can move up-market are the performance-defining subsystems, these elements become not good enough
3. competition among subsystem suppliers causes their engineers to devise designs that are increasingly proprietary and interdependent
4. the providers of these subsystems therefore find themselves selling differentiates, proprietary products with attractive profitability
5. the creation of this profitable, proprietary product is the beginning of the next cycle of commoditization and de-commoditization

roa - return on assets

• “creates strong incentives for assemblers to skate away from where the money will be”
• basically don’t be a big company and optimize for this value because it means that you’ll willingly outsource valuable subsystem work

the value of brands

• “When overshooting occurs, the ability command attractive profitability through a valuable brand often migrates to those points in the value-added chain where things have flipped into a not-yet-good-enough situation.”

The Law of Conservation of Attractive Profits

• “in the value chain there is a requisite juxtaposition of modular and interdependent architectures, and of reciprocal processes of commoditization and de-commoditization, that exists in order to optimize the performance of what is not good enough.”
• “when modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits with proprietary products will usually emerge at an adjacent stage.”

Is your organization capable of disruptive growth? #

RPV framework:

• resources: “people, equipment, technology, product designs, brands, information, cash, and relationships with suppliers, distributors, and customers.”
  — usually people or things
  — can be hired and fired, bought and sold, depreciated or built
  — easily measurable

• most managers selected based on “right stuff” thinking
  — based on being successful in the past
  — this is not good

instead, use a circumstance-based theory

1. “management skills and intuition that enable people to succeed in new assignments were shaped through their experiences in previous assignments in their careers” – think of business units as schools for training managers – use them to “train” managers for the situations they need

RPV framework:

• processes: “Organizations create value as employees transform inputs of resources into products and services of greater worth. The patterns of interaction, coordination, communication, and decision making through which they accomplish these transformation are processes.”
  — include the ways that products are developed and made and the methods by which procurement, market research, budgeting, employee development and compensation, and resource allocation are accomplished.
  — can be formal: “explicitly defined, visibly documented, and consciously followed”
  — or informal: “habitual routines or ways of working that have evolved over time, which people adopt simply because they work or because ‘… that’s the way we do things around here’”
  — or cultural: “methods of working and interacting have proven so effective for so long that people unconsciously follow them”
  — these all constitute the culture of the organization

• Processes are defined or evolved to address specific tasks.

• trying to solve a different task with that same process is unlikely to work

• particularly using sustaining processes to create new growth business

RPV framework:

• values: “the standards by which employees make prioritization decisions – those by which they judge whether an order is attractive or unattractive, whether a particular customer is more important or less important than another, whether an idea for a new product is attractive or marginal, and so on.”
  — employees at every level make prioritization decisions
  — “The larger and more complex a company becomes, the more important it is for senior managers to train employees at every level, acting anonymously, to make prioritization decisions that are consistent with the strategic direction and the business model of the company.”
  — companies’ values change as the migrate up-market

• use the RPV framework to decide what type of organization structure an innovation idea needs to succeed
  — poor fit with organization’s values -> disruptive -> create an autonomous organization to be responsible
  — good fit with organization’s values -> sustaining -> use mainstream organization
  — poor fit with organization’s processes -> use a heavyweight team (“group of people who are pulled out of their functional organizations and placed in a team structure that allows them to interact over different issues at a different pace and with different organizational groups than they habitually could across the boundaries of functional organizations”) -> create new processes
  — medium or good fit with organization’s processes -> use a lightweight or functional team -> exploit existing processes

• note, on a heavyweight team, members bring their functional expertise to the group, but they do not represent their functional group’s ‘interests’ on the team. they should focus on solving the task that needs to be done.

there is a dilemma: training managers to be good in situations requires putting untrained managers in situations
— “those who have the most to learn bring the least experience to the task”
— “those who are deemed to be fully qualified to handle a given job, by definition have the least to learn by doing it.
— could just buy talent
— but can be difficult because managers have to get used to new processes and values

instead of focusing on right stuff attributes, focus on "ability to learn”: ‘seeks opportunities to learn’, ‘seeks and uses feedback’, ‘asks the right questions’, ‘looks at things from new perspectives’, ‘learns from mistakes’

Buying Resources, Processes, and Values

• make sure you know what you’re buying
• if a company is expensive because of it’s processes, don’t buy it and then remove those processes

Managing the strategy development process #

• more important than having the right strategy is having the right process of strategy formulation
• “… managing the process used to develop the strategy – by making sure that the right process is used in the right circumstances.”

Two Processes of Strategy Formulation

1. Deliberate
2. conscious and analytical
3. based on rigorous analysis of data on market growth, segment size, customer needs, competitors’ strengths and weaknesses, and technology trajectories.
4. typically implemented ‘top down’
5. are appropriate if three conditions are met:
6. 1. strategy must encompass and address correctly all of the important details required to succeed, and those responsible for implementation must understand each important detail in management’s deliberate strategy.
7. 2. if the organization is to take collective action, the strategy needs to make as much sense to all employees as they view the world from their own context as it does to top management, so that they will all act appropriately and consistently
8. 3. the collective intentions must be realized with little unanticipated influence form outside political, technological, or market forces

9. it’s difficult to meet all three of these requirements, so usually the emergent strategy making process alters the strategy that the company actually implements

10. Emergent

11. bubbles up from within the organization

12. “is the cumulative effect of day-to-day prioritization and investment decisions made by middle managers, engineers, salespeople, and financial staff”

13. tend to be tactical day to day operating decisions that are made by people who are not in a visionary, futuristic, or strategic sense of mind

14. emergent processes should dominate in circumstances in which the future is hard to read and in which it is not clear what the right strategy should be

• basically, use emergent strategy when you’re not clear what the strategy should be but switch to deliberate strategy once the right strategy has become clear

• the strategy defining process is highly impacted by resource allocation

• “…strategy is determined by what comes out of the resource allocation process, not by the intentions and proposals that go into it.”

• values that guide prioritization decisions in resource allocation should be carefully tied to the company’s deliberate strategy

• if they are not, then the company’s actual strategy will diverge from it’s deliberate strategy

• managing this is difficult

• each resource allocation decision shapes the emergent strategy of the organization

• resource allocation process is heavily influenced by an organization’s values

• primarily:

• cost structure, which determines the required gross profit margins

• size threshold for new opportunities

• “The switch from an emergent to a deliberate strategy mode is crucial to success in a corporation’s initial disruptive business.”

• after switching, it can be hard to launch new waves of successful disruptive growth because of the organizations embedded deliberate strategy

• this is a challenge that executives have to solve

Points of Executive Leverage in the Strategy-Making Process

“… defining and implementing strategy entails managing the conditions under which the strategy and resource allocation process operate so that the strategy process can work efficiently, given the circumstances that each of company’s organizations is in.”

Managers must:

1. Carefully control the initial cost structure of the new-grown business, because this quickly will determine the values that will drive the critical resource allocation decisions in that business.
2. Actively accelerate the process by which a viable strategy emerges by ensuring that business plans are designed to test and confirm critical assumptions using tools such as discovery -driven planning.
3. Personally and repeatedly intervene, business by business, exercising judgment about whether the circumstance is such that the business needs to follow an emergent or deliberate strategy-making process. CEOs must not leave the choice about strategy process to policy, habit, or culture.

Discovery driven planning

1. make targeted financial projections (required financial performance of the venture)
2. what assumptions must prove true in order for these projections to materialize?
3. implement a plan to learn - to test whether the critical assumptions are reasonable
4. invest to implement the strategy

There is good money and there is bad money #

“… the best money during the nascent years of a business is patient for growth but impatient for profit.”

impatient for profit

• accelerate a disruptive venture’s initial emergent strategy process (management is forced to test the assumption that customers will pay a profitable price for the product)
• help keep an early venture’s fixed costs low, which helps them make money at low costs per unit (which is helpful in new-market and low-end disruptive strategies)
• protects the venture from cutbacks when the corporate bottom line turns sour

Death Spiral From Inadequate Growth

• essentially company doesn’t invest in new growth business early enough, then is forced to invest in new growth the will grow big fast (impatient for growth) which is difficult to be successful at. when it fails, they are even more impatient for growth in new growth business. eventually the fail so much that they have to retrench the core business to please stockholders, and then the death spiral starts again.

“The dilemma on investing for growth is that the character of a firm’s money is good for growth only when the firm is growing healthily. Core businesses that are still growing provide cover for new-growth businesses.”

Use Pattern Recognition, Not Financial Results, to Signal Potential Stall Points

• outsiders typically measure a company’s success by its financial results
• don’t

• “Financial results measure how healthy the business was, not how healthy the business is.”

• “Executives should gingerly use data of any sort when looking into the future, because reliable data are typically available only about the past and will be an accurate guide only if the future resembles the past.”

Create Policies to Invest Good Money Before it Goes Bad
“… the policies force the organization to start early, start small, and demand early success.”

1. Acquire new-growth business in a predetermined rhythm. Launch new-growth business regularly when the core is still healthy – when it can still be patient for growth – not when financial results signal the need.
2. Keep dividing business units so that as the corporation becomes increasingly large, decisions to launch growth ventures continue to be made within organizational units that can be patient for growth because they are small enough to benefit from investing in small opportunities.
3. Minimize the use of profit from established businesses to subsidize losses in new-growth business. Be impatient for profit: There is nothing like profitability to ensure that a high-potential business can continue to garner the funding it needs, even when the corporation’s core businesses turn sour.

The role of senior executives in leading new growth #

Three jobs:

1. near term assignment: personally stand astride the interface between the disruptive growth businesses and the mainstream businesses to determine through judgment which of the corporations’s resources and processes should be imposed on the new business, and which should not.
2. longer-term responsibility: shepherd the creation of a process that we call a ‘disruptive growth engine,’ which capably and repeatedly launches successful growth businesses.
3. perpetual responsibility: sense when the circumstances are changing, and keep teaching others to recognize these signals.

A Theory of Senior Executive Involvement
when should senior management get involved in a decision?

• currently on of the most common theories is based on attribute of the decision, usually the magnitude of money at stake
• not always good — there is an asymmetry of information along the vertical dimension of every organization — so senior management might not know the right questions to ask

• “Because the senior-most executives in reality cannot participate when and where these decisions actually get made, decision-making processes that work well without senior attention are critical to success in circumstances of sustaining innovation.”

• another theory is the “size theory”
  — large businesses require more active senior management, smaller organization units can be handled by lower-level managers

• also bad

• a better circumstance-based theory:

• “For those decisions that the mainstream processes and values were designed to make effectively (sustaining innovations, primarily), less senior executive involvement is needed. It is when senior executives sense that the processes and values of the mainstream organization were not designed to handle important decisions in an organization (which is typically the case in disruptive circumstances) that a senior executive needs to participate.”

• there seems to be a trend where large companies can continue producing new-growth business better when it is their founder that is still leading them

• professional managers seem to find it more difficult to push in “disruptive directions that seem counterintuitive to most other people in the organization.”

disruptive growth engine

• embedding a predictable, repeatable process for identifying, shaping, and launching successful growth business

1. Start before you need to
2. Appoint a senior executive to shepherd ideas into the appropriate shaping and resource allocation process
3. Create a team and process for shaping ideas
4. Train the troops to identify disruptive ideas

• basically leads right into The Lean Startup

Passing the baton #

1. Never say yes to a strategy that targets customers and markets that look attractive to an established competitor.
2. Try to compete against non-consumption.
3. If there are no non-consumers available, explore low-end disruption.
4. Try to help customers get done more conveniently and inexpensively what they are already trying to get done.
5. Segment the market in ways that mirror the jobs that customers are trying to get done.
6. Look to the low end to see the opportunity to change the basis of competition.
7. Don’t switch too soon or too late from a proprietary architecture to modularity and open standards.
8. RPV framework 8.1. Do we have the resources to succeed? 8.2. Will our processes facilitate what needs to be done in order to succeed in the new business? 8.3. Will our values enable the critical people to give the needed priority to this initiative when compared with the other initiatives that compete for their time, money, and talent.
9. Ask these same questions to each of the entities that constitute the venture’s channels as well.
10. In choosing the management team for your new venture, don’t look at the attributes or magnitude of past responsibilities. Instead, look for validation that they have grappled with problems in the past that this venture will face in the future.
11. Insist that team give you a plan to accelerate the emergence of a viable strategy.
12. Be impatient for profit.
13. Keep your company growing so that you can be patient for growth.