Sustaining vs. Innovative Disruption

We’ve been talking a lot about the definition and nature of innovative disruption in these pages and in conversations with clients and prospects as well. More than “where’s the market going?” or even “what do I buy here?”, this is the single most popular discussion point just now. The same goes for social media, by the way… When we post to LinkedIn or Twitter on anything disruption-related it gets 2-3x the attention of more prosaic material like stock/sector valuations.

Within this framework, the difference between “Disruptive” and “Sustaining” innovations invariably draws the most debate. It is a hugely important demarcation to understand. As a review (and link below to a great piece by Clayton Christensen, the godfather of disruption):

Disruptive innovation:

  • Always starts at the low end of a market with a product the mainstream thinks is inferior to existing offerings
  • Comes only from new entrants with a different business model that allows them to make reasonable profits even at the low end
  • Accelerates as those new entrants climb the value chain and displace entrenched competitors, still using their differentiated model as an edge
  • Ends when the new entrant dominates the market or when established players adopt the disruptor’s business model
  • Example: Amazon, which started by selling books (a low end offering) online (who would buy a book without leafing through it first?) rather than in physical stores. It then climbed the value chain by selling other items, leveraging its online processes to maintain a competitive advantage.

Sustaining innovation:

  • Make existing product offerings better, often with new technology
  • Sometimes comes from existing companies as a way to increase market share with their most profitable/highest end customers
  • Can eventually take over a whole market, as higher volumes reduce prices sufficiently to make the product affordable to a mass audience
  • Example: flat screen TVs, which went from high end novelty to market dominance in less than a generation

Why should public equity investors care about the difference? The short answer is that there is a global bubble in the market psychology around “Disruption” at the moment, but it does not differentiate between truly disruptive business models and those that merely offer sustaining innovation. History shows the former can be deadly to incumbents (i.e. Amazon), while the latter can actually strengthen existing competitors if they adapt in time.

Now here’s where things get tricky: consider the original Apple iPhone. Priced at a premium, it was clearly not a disruptive innovation. In fact, it looked very much like a sustaining one: a better product at a premium price.

Rather, it was all the subcomponents and services IN the phone that were the disruptors.

  • Cell phone cameras used to be cheap (free with most handsets) and awful (low-res). They’ve improved dramatically, and only photo bugs/pros actually buy cameras anymore.
  • Mobile web browsers, instant message/social media platforms, and gaming fit the same paradigm. Initially, they were all cheap low-end substitutes for “real” desktop/laptop applications. They got better – a lot better – and are now in many cases are more popular than PC based platforms.
  • Music players used to be separate devices; the iPhone (and other smartphones) combined them into one package.
  • Widespread global adoption of 4G cell service and better microprocessors allowed for further disruption of everything from music/video distribution to mobile payments.

In fact, the “iPhone-as-disruptor” model, a Trojan Horse hybrid of sustaining (expensive phone) and disruptive (cheap/free other items) innovation, is now the default strategy for a host of companies. Consider:

  • Tesla is a premium priced product, so it is a sustaining innovation. But buried inside the car is the possibility of autonomous driving, and removing the implicit and explicit costs of human manipulation is a disruptive innovation.
  • Uber is a sustaining innovation as well – a better, more convenient car service. It may even be slightly disruptive in densely populated suburbs for some commuters, displacing a car due to cost efficiency. But add autonomous driving to the equation – something the company is working on – and you get a service that can be meaningfully more affordable than current taxi fleets.
  • Didi Chixing, the Chinese Uber, is going in a different direction. They offer a wide array of travel options, from their own cabs to car sharing, vans and even bikes. By plugging into a municipal traffic management/monitoring grid (something they do with local governments), Didi uses their real-time tracking to show consumers the most efficient way to move around a city. Not necessarily cheaper for the customers, but faster and better. And since time is money, that’s disruptive.

The upshot here is that “Disruption” is a very specific set of phenomena, not just adding fresh technology to old problems. Much of what excites venture capitalists and strikes fear into equity investors are actually sustaining innovations, not disruptive ones. In order to move into the more powerful model of “Disruptive innovations”, they need the iPhone/Trojan Horse theme. Or, as we’ve seen with headlines like Softbank’s stake in GM’s Cruise operation, a foothold in the old world.

Our bottom line, and the message we leave when we discuss this in person: be smart and use the disruption/sustaining categories when assessing public company investments. Disruption always starts at the low end and will always be a threat to existing businesses. Sustaining innovations need some other hook to really make a difference.

Source (Christensen article): https://hbr.org/2015/12/what-is-disruptive-innovation

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