competitive strategy

What Causes Market Disruption? (Part 1)

Christensen's model of disruptive innovation tells us that when new market entrants offer products that are inferior to incumbents, at a lower price point, targeting non-consumers of existing products with solutions that are simpler, easier to use, more convenient and/or more accessible, that the upstarts will almost always win the competitive battle. We see this recurring pattern frequently, and it's easy to mistake these attributes as causing disruption, rather than as signals that disruption is happening. This two part series examines the root causes that enable disruption to occur.

Disruption by Design: The Book

Historically, virtually all disruptive innovation has happened by accident. Even though there is a distinct pattern to disruption that the theory describes, before Christensen observed and synthesized the mechanics of the pattern we weren't aware of it, and it certainly hasn't been obvious how to create that pattern on purpose.

After all, if you used theory to build:

  • an inferior product
  • with a low price
  • targeting an undesirable market that incumbents will run from rather than fight for

you'd have a product that bears the hallmarks of disruption as described in The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. But you wouldn't have any guarantees that your product is a disruptive innovation. In fact, it could be that you’ve simply built a crappy product that no one wants.

Strikingly, although many have tried to use Christensen's theory to design disruptive products, it's noteworthy that Clay's books were not written with that purpose in mind. In fact, he writes in the introduction to The Innovator's Dilemma that his research and writing was motivated by the desire to help executives “do what is right for the near term health of their established businesses, while focusing adequate resources on the disruptive technologies that ultimately could lead to their downfall”. In other words, his goal was to help industry incumbents recognize and avoid disruption.

About 2 years ago, I set out to do exactly the opposite.I wanted to create a handbook for entrepreneurs, startup founders, and marketers of potentially disruptive products that would help them to disrupt markets on purpose.

After a long gestation, that book "Disruption by Design: How to Create Products that Disrupt and then Dominate Markets" has arrived. (if you hurry, you might still find some sites selling it at pre-release prices -- take advantage because in a few days, if not sooner, the price will go up significantly).

Disruption by Design is intended to be a self-contained book that guides you through all of the key things you need to know, from a quick review of the most important elements of the theory, to how to predict market disruption, to creation of product and marketing strategy with disruptive potential, to designing a disruptive business model and ultimately, how to go to market, disrupt, and stay on top for the long term.

If you want to build disruptive products on purpose, you need this book

I don't often "sell" in this space, but I did want to let my readers know why I'd been absent for a long while, and also beat my chest a little today. I've worked hard to distill the things I've learned about disruption from working as a consultant in the field into a guide which is easy to read and follow. I did that because if we're ever going to reinvigorate our economy, we need 10x more disruption and we need it 10x faster than we're currently innovating. We need disruptive innovation because it is the economic engine of growth that moves us forward, and creates jobs and wealth.

Over the coming months, I'll be highlighting some of the key ideas from my book in this space, and hope you'll join me in discussing how to create disruptive products by design.

To learn more about the book, visit this page: Disruption by Design.

Update: The People Have Spoken

It's been very gratifying to get lots of positive feedback about my book. The widget below collects review comments from a variety of sites, which I thought might be a useful update to share here. You can click on the profile that's displayed to learn more about the reviewer, and follow or connect with them.

Disrupt, or Be Disrupted: Are There Only Two Choices?

Solving the Innovator's Dilemma

There's a question that I'm frequently asked that goes something like "So, I've read/heard about the Innovator's Dilemma and disruptive innovation. I get it -- interesting idea -- we all need more innovation. But what difference does it make whether innovation is disruptive or not? What can I do about it / how can I use it?"

Generally, the question is posed as a challenge -- a conversation starter when people are trying to understand what I do for a living and whether my services have any relevance to them. Sometimes it is the challenge of a skeptic: someone who doesn't believe disruption theory is valid, and they're looking for logical holes to punch through.

Normally, I use this space to discuss causes and effects of disruption, and case studies and disruption analysis that (I hope) is instructive and interesting. But my business is more than an intellectual exercise, so today I'm going to address this question head-on, and I hope you'll excuse if a tiny bit of selling creeps in. Hopefully, you won't even notice.

Why We Care About Disruption

In a nutshell, disruptive innovation catches competition off guard, and leaves them without adequate response. If you could design it as an attribute of your business, it is the ideal strategy, because it creates new markets, satisfies needs that are unmet or underserved ("Blue Oceans") by existing solutions, and determines who the dominant players with the highest margins will be for years to come.

Where They Ain't

"I skate to where the puck is going, not to where it is," is a quote famously attributed to Wayne Gretzky, the greatest hockey player ever. He was explaining to a reporter why he always seemed to be in the right place at the right time, and to have the best and easiest scoring opportunities.

Going where the puck isn't is the essence of disruptive innovation. If you solve the problems that no one else is solving (and that potential customers are willing to pay to have solved), at order-of-magnitude lower cost, and with the highest degree of simplicity and convenience, then you'll generally have a disruptive innovation on your hands.

The trouble is, how do you find those sweet spots in your industry, or in your business? It's easy to see the next incremental step in innovation -- make the 'off button' bigger and red, make the product smaller, add another function (whiteners in your detergent). But going in a contrary direction, or one that others don't see the need to, is a lot harder to do. For that, you have to ask the right questions, and I know, that's also easier to say than do. Unless you are starting with the right framework or lens for examining what people really need.

Apart from the natural resistance that many have to stepping out of line and being different, this is what is so challenging about disruptive innovation, and why disruption is so rarely initiated from within the industry being disrupted. Regardless, to be disruptive, you have to hit the competition "where they ain't" (see "Wee Willie" Keeler), and do it in a way that isn't possible for market incumbents to match easily.

Identifying the Value

As a disruption consultant, the principle benefits my clients identify with implementing a disruptive business strategy or disruptive business model include:

  • creation of new revenue streams
  • easier sales
  • much higher than average margins
  • lower cost of doing business
  • larger markets and largest market shares

Coincidentally, when you achieve those things, you also create the positive perception of being a trendsetter, an industry (market and/or thought) leader, and a supplier who is better able to serve your customer's needs. So, those are the simple surface answers to the questions raised in the first paragraph, but there is a deeper underlying question of how that opportunity can be leveraged. How do we create value from disruption?

Being Disruptive

I don't want to spend time here describing the services Innovative Disruption offers as a consultancy -- you can visit the pages of our website for that information. Simply understand that creating disruption and leveraging its value is done through a number of deliberate tactics, and that this process can be learned. Some of the key activities and priorities include:

  • identifying "jobs to be done"
  • radical simplification (of products especially)
  • dramatic improvement in accessibility, flexibility and/or convenience
  • change that enables nearly the same product/service to be done (or a "good enough" facsimile) for a fraction of the price
  • find ways to bring products to, or service market niches that are undesirable to incumbents

and, these are accomplished with a methodological framework, specialized analysis tools, Disruption Report Cards, and a mentality that experimentation and (fast) failure is part of the lifecycle of product introduction to be embraced because it is necessary to establishing product/market fit, not something to be punished. Lean startup behavior, in other words, is compatible with disruption (though neither necessary nor sufficient to create it).

Eat, or Be Eaten

We increasingly face a world where everyone is on one side of the equation or the other: disrupt, or be disrupted. The reality is that long term viability and sustainability of the business does not require disrupting to avoid being disrupted, but it does require the mindset of a disruptive innovator, and a willingness to seize disruptive opportunities when they are present. It also requires sustaining innovations 90% of the time, and the sort of operational efficiency that is often at odds with experimentation and innovation.

In other words, business needs a left brain and a right brain. You can't remain viable in the long term if you aren't constantly aware of when disruption is possible; on the other hand, maximizing the potential of disruption requires sustaining innovation and the sorts of activities that established companies excel at, and do every day. The key is to allocating a percentage of business activity to each of these dual modes, evaluating threats that could disrupt your business or industry, and being willing to cannibalize your own products and lines of business before someone else does.

Modern business allows no complacency. If you want to explore these questions more fully, I encourage you to download our ebook "Disruptive Confusion Unraveled".

Fighting Back Against Disruption: Has Starbucks Gone Far Enough?

'Bean' there before

A little over a year ago, Howard Schultz, then chairman of Starbucks wrote an internal memo lamenting the loss of Starbucks' distinctiveness. He wondered openly whether in the mad rush to expand and grow ever more operationally efficient (as measured by speed and same-store sales increases, rather than quality of experience), the company had lost a bit of its soul.

This memo was reported in all the major business papers and spurred a flood of blog postings from Starbucks critics and fans as Schultz seemed to have captured what was on everyone's minds, although still at that time, a largely unspoken feeling.

I too wrote an article taking a very different slant and documenting how and why Starbucks had allowed itself to evolve from being the market disruptor to the disruptee as a number of major foodservice chains began to compete on many of the now commoditized (and watered-down) features of the Starbucks experience -- better quality coffee, much lower price, more inviting workspaces to stay the afternoon and work or lounge, free WiFi, faster service and so on.

Through the remainder of 2007, it became increasingly clear that the days of heady growth, at least in North America, were indeed over, and that Starbucks competitors were taking direct aim at the weaknesses in Starbucks' business model armor that had crept into their operations over the preceding 10 years.

The company still looked healthy on paper, with year-over-year revenues in 2007 22% ahead of 2006 and record net income (profit). But, trouble signs included dramatically slowing same-store sales growth which had clearly reached a limit, and a large number of customers opting for the improved, more widely available and cheaper coffee solutions of the competition as I predicted in last year's article.

Additionally, by the end of 2007, long-time Starbucks loyalists were increasingly grumbling about what was wrong with the company and voting for change by going less frequently, or going elsewhere entirely.

Hello. My name is Howard. Remember me?

As if sensing that the tide of success was turning against his prodigy, Schultz moved back into the driver's seat at the company he built in January 2008, reassuming the CEO role and announcing a return to the basics of Starbucks vision and identity. While acknowledging that the competitive landscape was different, Schultz asserted that the problems at Starbucks were internally generated for the most part, and that the solution lay in self-examination, putting the primacy of the customer experience first again, and getting back to the core mission that had made Starbucks successful in the first place.

Since January, Schultz has been busy righting the ship with a number of dramatic changes, many of which were easy to predict and well-designed to rally the faithful. Last week, the most significant (economic) announcement was made, with 600 store closings and up to 12,000 layoffs coming, and it caught the attention of the business media, partly as a bellwether indicator of the down economy. Certainly that's the way Starbucks spun it, but is it the whole story (or even the right story)?

Slow train coming

Starbucks pre-bagged beans. Might be fresher, but that sweet coffee smell just isn't the same when you walk in the door.

Starbucks pre-bagged beans. Might be fresher, but that sweet coffee smell just isn't the same when you walk in the door.

In last year's article I identified several signs of disruption and difficult decisions for Starbucks to avert or at least parry with the competition disruption that Starbucks own mistakes had enabled (although in their defense and viewed from an internal "operations" perspective, these would have been perfectly logical innovations to improve efficiency, profitability and leverage the brand through extensions). These included:

  • pre-bagging coffee beans to preserve freshness (in the process, killing the distinctive coffee smell of an authentic neighborhood coffee bar, and the sensuality of sounds and sights such as scooping of beans, weighing and pouring them into custom bags, etc.)
  • expansion of chain to be almost as ubiquitous as McDonalds (turning them into a "true chain" experience, common but still expensive)
  • conversion from manual expresso machines to automatic to improve speed, efficiency and consistency of coffee making (at the expense of smells, theatre and "hand-made" quality)
  • dilution of brand experience due to rapid expansion, higher staff turnover and lower training standards, resulting in surly and uncaring baristas
  • introduction of warmed breakfast sandwiches and other foodservice items as a further brand extension (more brand and customer experience dilution)
  • expansion of music retailing operations (more brand and experience dilution)
  • expansion of branded non-food and non-music retail operations (more brand and experience dilution)
  • new "low end" competitors entering market serving "good enough" coffee options (upgraded coffee roasts, espresso and capuccino, "third place" alternatives) at significantly lower prices

Our recommendations included:

  • undoing the conversion of coffee bars into retail emporiums, restoring the "third place" ambiance and experience
  • improving training
  • getting rid of automatic espresso machines that made Starbucks just equal (in perception) to the lower-priced competitive options for many consumers
  • acknowledging that new "low-end" disruptors (McDonalds, Dunkin Donuts, local gas stations) selling fresh-brewed espresso at 25% of Starbucks price changed the game and required a specific competitive response
  • closing stores because the "coffee aficionado" market was already over-served (in the US market) given "good enough" competition at much lower price points

It's important to note that a few of these are counter-intuitive (at least to most by-the-book MBAs), and options that most businesses wouldn't consider.

For example, when I discussed the installation of automatic espresso machines last year, it was noted that the original decision to do this had cost millions of dollars. Replacing them would potentially both slow down service and retire perfectly good equipment before it was fully depreciated and had reached its natural end of life. (Although the equipment was a "sunk cost", most businesses that had made such a decision in the first place would not easily reverse it and incur additional expenses to restore an "experience" and recreate the lost competitive differentiation.)

And what has Schultz done?

The Clover Coffee Machine will elevate the quality and freshness of regular brewed coffee to the premium level that coffee enthusiasts expect, but not so for Starbucks espresso coffees, which will be even more automated than before with the Mastrena, reducing baristas to button pushers. Click on the image to read how the Clover system works.

The Clover Coffee Machine will elevate the quality and freshness of regular brewed coffee to the premium level that coffee enthusiasts expect, but not so for Starbucks espresso coffees, which will be even more automated than before with the Mastrena, reducing baristas to button pushers. Click on the image to read how the Clover system works.

  • get rid of breakfast sandwiches by end of 2008 (announced Jan 30), to eliminate strong smells that compete with coffee
  • slow pace of new openings and close 100 underperforming stores in US (announced Jan 30)
  • stop reporting on year-over- year same-store sales growth (announced Jan 30), which could only be achieved in long term by continued dilution of brand experience through increased retailing options
  • upgrade "partner" (i.e. barista, counter clerks, store management) training to re-focus on exceeding customer expectations and improve the overall experience (announced Jan 30)
  • acquisition of The Coffee Equipment Company for its Clover brewing system -- a method which creates a vacuum to suck the steeping coffee through a filter to create an individually brewed cup similar to French press (which pushes the filter through the steeping coffee) to create a superior flavored cup of "traditionally" brewed coffee, with enhanced richness and body (announced Mar 19)
  • introduce Mastrena espresso makers to replace current generation of automatic machines. (Although Schultz announced this, development of this machine, exclusive to Starbucks, was underway for 5 years.) Billed as enhancing the theater (because you can once again see the barista over its lower profile, and offering more control, it is still an automatic machine whose exclusivity doesn't address the quality and theatre lost with the old manual machines. (announced Mar 19)
  • Loyalty rewards added to Starbucks cards. (announced Mar 19)
  • Close 600 under-performing stores (up from only 100 under-performing stores in January).  12,000 employees will lose their jobs.  (announced July 01)

Overall, the emphasis of these changes is essentially the same as the recommendations I made last year, with the exception of two key points, which I'll discuss below.

The stated purpose has been to:

  • bring back the sense of theater
  • enhance the Starbucks experience consistent with brand expectations
  • put the emphasis back on coffee and hopefully undilute the brand identity

Unquestionably for drinkers of traditionally brewed coffee, the use of Clover machines to individually brew whatever you want from fresh ground beans (rather than chose from one of the three pre-selected coffees of the day) is a large improvement. Closing stores was expected because Starbucks was overbuilt, although Starbucks is blaming closures on the economy.

Is it the economy stupid, or is it really disruption?

For the first time ever, Starbucks has experienced a year-over-year decline in same store sales. The economy explanation has been picked up and widely reported in the media (because it fits the story that they want to report), but we have a hard time believing that Starbucks drinkers are consuming less coffee because of the price of gas.

More likely the economy is providing an incentive to the most price sensitive of Starbucks customers to switch to cheaper McDonalds or Dunkin Donuts alternatives, accelerating a trend that would have inevitably have happened anyway, due to the increasing availability of good enough low-end alternatives. Starbucks claims to have done research that disproves this, but we think they'd be wise to ignore the research, which is harder to prove than this more rational explanation.

The problem with drinking your own koolaid on something as strategic as protecting erosion of the customer base is that once people make peace with the mental switch from a high-end to low-end disruptive product, rationalizing that the low-end low cost alternative is good enough, they rarely go back.

The two things in the list of strategic changes that Schultz has implemented that are still at odds with "undisrupting" Starbucks are the switch to Mastrena ultra-automatic machines and not fully addressing the low-end threat for what it is. While the Mastrena may be an improvement in visibility of the barista, enabling them to participate in the experience for the customer, it is still an automatic machine. In fact, it automates more of the process, not less.

The supposed expertise of the barista is therefore non-evident -- they can't do any more to improve the espresso shot than can the cashier at McDonalds. The emphasis of the Mastrena is on higher volume (operating efficiency), and any qualitative difference in the cup of coffee between it and the Verisimo machine is so minimal, it is unlikely to be noticed by the majority of caffeine addicts patronizing Starbucks.

Starbucks closes 600 stores. Did too fast growth make them less exclusive as a brand? Did we really need new Starbucks in Starbucks parking lots?

This is a key element, because in no way does the replacement of old machines with the Mastrenas differentiate the end product or in the consumers' mind justify the higher price for Starbucks versus their competition.

Proprietary is not equal to different, and this is a sustaining innovation that reinforces that Starbucks has overshot the needs of their customers, but yet still underperforms on a key dimension -- the expectation of a quality hand-crafted coffee. An expectation that Starbucks created, but has now walked away from.

Secondly, Starbucks gives the appearance of continuing to be in denial that speed and price are performance criteria that a large percentage of their customers deem important, and that many will sacrifice the brand image of Starbucks to get a good enough cup at McDonalds.

Admittedly, this is a very tough line to hold, since through its chain-store ubiquity, Starbucks has ceased to be a unique neighborhood place, becoming instead the middle-of-the-road McDonalds of premium coffee. The only problem is, McDonalds is better suited and better able to be the McDonalds of premium coffee.

How then can Starbucks respond? Can it be different enough to continue commanding a huge price premium over its competition? If not, will business continue to siphoned off by low-end disruptors?

Is there a counter-disruptive response that allows Starbucks to not concede the low-end to McDonalds and Dunkin Donuts while maintaining its higher end niche for hard-core loyalists? Will Starbucks realize that the Mastrena is masking the real problem and that by positioning it as an improvement to the coffee experience, may actually lose more customers as it rolls out (if there is no taste difference, has Starbucks reached the limits of innovation in the core experience).

Will they recognize that purists want a manual shot pulled, or minimally a semi-automatic (because the barista has more control than with a fully automatic)? Can all these needs co-exist?

While we must praise Schultz for the aggressive return to Starbucks origins and a stronger vision, the question now is has he gone far enough, or is the past year a harbinger of much greater disruption to come? Or, has he recognized that disruption is the problem, and there are more surprising announcements to come as a result?

More importantly for investors, is this the end of Starbucks as a growth stock (SBUX - click to see performance over past year compared with Dow Jone and S+P 500), or at about 1/2 the valuation of a year ago, and still dropping, is it a buying opportunity?

Wall Street has been betting against a return to the days of heady growth, but does it have to be that way? I don't think so, but it requires disruptive imagination to see a way out. Perhaps Schultz sees it too.

What do you think?

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