The finance industry is facing large disruption, and it isn't coming from within. The industry needs to consider the reasons they will be disrupted, be prepared for radical new business models, and look to outsiders who aren't afraid to break the status quo in order to understand why the real disruption is not the incremental tech innovation that they are so enamored with.
I often start by reminding clients and prospects -- anyone who will listen -- that an innovative technology is a nice thing to have, and can certainly enable market disruption if it uniquely enables a large sustainable cost advantage, or a new way of doing things that is easier or more convenient. But technology is neither necessary, nor sufficient for disruption to occur.
Disruptive innovation is not about technology
Netflix was a good example in their early days. Yes, you placed orders for movies through a website, but there was nothing about the website that was novel or necessary in order to disrupt Blockbuster. In fact, they were considered a tech play because of the website, but there was nothing about technology that made Netflix successful (something they would have done well to remember when they tried to force an ill-advised price change on customers last year to combine streaming video and mailed DVDs). When Blockbuster added their own website and copied much of the mechanics of Netflix's ordering, it made no difference to their survival and did not enable them to prevent being disrupted.
Netflix's disruptive innovation was driven entirely by their business model. Apparently inferior to Blockbuster in the lack of physical presence to visit and browse movies and take something home to watch NOW (at least that's how Blockbuster positioned themselves against Netflix), they identified unmet and underserved market needs and created a new business model to serve them. By sending DVDs mail order from a central location, Netflix eliminated the huge cost of stores, and having inventory where it wasn't needed, and in the process enabled:
- limitless catalog
- convenience of not having to make a trip to the store either to pick up or return videos
- low cost for high volume renters aka the best customers (flat subscription pricing rather than per video)
and removed friction in the rental process:
- no late fees -- the number one complaint against Blockbuster and traditional video rental models
- frustration when a desired title wasn't on the shelf
Dramatically lower costs could be passed on to consumers (and sustainable cost advantage is one of the key drivers of disruption), enabling rapid growth, and strong word of mouth helped Netflix avoid big marketing costs to grow.
What does this have to do with Febreze? Well, I started with Netflix because it is an example commonly misunderstood to be a technology-based disruptive innovation, when it really has nothing at all to do with technology, but is entirely about the process, the business model and the marketing. It's a company that most of us are familiar with, especially after its recent missteps, and it helps us make the leap to talking about a disruptive innovation that doesn't have any "tech" in it at all.
How the heck is an air freshener in a crowded marketplace an example of disruptive innovation?
Febreze is fascinating, because it started its life doing everything wrong, the way most "big company" new products are introduced to market. It was a product designed to be sprayed on draperies that reeked of cigarette smoke, a smelly sofa that was frequently inhabited by a wet family dog, or a room where cats had done their thing on the floor. It's purpose was to neutralize the odor.
The problem was, this was a made-in-the-boardroom problem. Although it seems reasonable to imagine that people are embarrassed and repulsed by these smells and would want to get rid of them, in the real world, the people who most needed to fix this problem didn't believe that they had a problem to fix. In the real world, people build up tolerances to smells the more they are exposed to them, and may even associate that "wet dog" smell with positive feelings. So, while any visitor to such a home might be hit in the face with detestable odors and wonder how people could live that way, the person who lives there has masked the smells in their mind and has no idea that their house smells like smoke, or like cat pee. And, even if they smell it a little bit, they certainly don't perceive their house to be unclean and in need of yet another kind of air freshener product.
So, when P&G launched Febreze as an odor-killing unscented spray in the mid-90s with ads targeting the homeowner's love for their pets, but hate for their smell, there was no resonance in the market with this messaging (might they have done better to target visiting friends instead?), and it was a complete dud in the market, with sales falling each month, rather than growing.
This scenario is laid out in a New York Times article (see pages 4 and 5 for the bit about Febreze) that details the work of behavioral researchers in understanding habits to influence purchasing decisions. The company was perplexed and sent researchers out to the field to try to understand what was happening with happy users of Febreze who were using lots of it, and what was different about them. Did they have more sensitive noses? Were they more anal about cleaning? Were they more socially embarrassed about the smells when visitors came over?
Febreze became an innovative market disruptor, almost by accident
It turned out that there were some avid users who had built spraying into their regular cleaning habits as a reward for finishing, so when the bedroom was finished being cleaned and tidied, a quick spray of Febreze on the comforter was the icing on the cake. When the laundry was clean, a spray of Febreze confirmed it. When the living room was cleaned and the sofa vacuumed off, Febreze was the finishing ritual. It wasn't that they perceived their homes to be dirty or in need of de-smelling, but that the spray at the end was a finishing detail to signal completion and get that little endorphin high that comes with completing something.
The happy ending is that P&G discovered this counter-intuitive behavior, and built this notion into their marketing. Sales exploded, to the point that it is today a best-selling $1B franchise. The now familiar ad template shows a giddy, self-gratified housewife who has finished the cleaning, gives it a shot of Febreze and closes her eyes to breathe in the warm fuzzy feelings. Or, more prosaicly, a quick spray when finished the task was the reward for finishing - the idea being to associate the product with habit formation and the good feeling of being done with the work and knowing that things were clean. In other words, rather than promoting it as a cleaning product, they are promoting it as something you should do after cleaning was complete.
So, the NYT article is about how statisticians and behaviorists are decoding habits and using them to sell to us, and the Febreze story is just a small piece of it, but it got me to thinking. What's interesting is that the original launch of Febreze was supported by conventional wisdom and conventional marketing. I'm sure they did research that confirmed everyone would like their homes to smell cleaner (a common symptom of bad market research is "confirmation bias", where people selectively remember things that confirm what they already believe to be true, or in this case, remember how much they dislike the smell in everyone else's home even when they don't recognize it in their own). Febreze would have been just another incremental and sustaining cleaning innovation, but for the discovery of this anomalous behavior of a few avid users. It may even have been cancelled for lack of sales had behavioral researchers not discovered the pattern of women using it when finished cleaning a room, rather than as a way to deodorize pet smells.
But hidden in the research story is that Febreze's ultimate success points to some critical factors that all "new market" disruptive innovations exhibit. Most notably:
job to be done. Early on, marketers positioned Febreze as an air freshener because they didn't understand the "job" that consumers were hiring it to do. It turns out that people didn't believe they had a smell problem. But, a quick spray at the end of cleaning a room created a habit-forming ritual that said "I'm done. This is clean and fresh and I can move on to the next room." A reward, and a signal of being clean, rather than a coverup of something shameful. Had the real job not been discovered, Febreze likely would have failed in the market as one of thousands of similar cleaning product innovations. By precisely targeting the job that the consumer identified with, they created positioning that is virtually impossible to dislodge them from. (Download this classic article which describes why identifying the job to be done is so important.)
target non-consumption. There were a small number of people who felt they needed a bandaid solution to mask disgusting smells. However, most people didn't recognize or agree that their house smelled bad, but did see a quick spray as a finishing touch -- almost like putting some sparkle on their lip gloss. By targeting the larger market of people who did not think their houses stunk and needed air fresheners as masking agents, but who did clean their houses, Febreze was able to identify a unique niche to dominate and grow from (now, people do buy Febreze as a quick fix to mask unpleasant odors, but that came later).
serve an unmet need. There was clearly an unmet need to signal "I'm done" and have a little celebration before moving to the next room. I suspect we all have this little celebration, whether we use Febreze or not, we step back and admire our work, smell the air. Febreze sprinkles the fairy dust that completes the job (that's how the ads seem to portray it). Originally unscented (because it was to mask odors, not replace them), Febreze now comes in many perfumed scents to leave behind the smell of "being done".
identify a new market. The new market for a deodorizing spray was people who viewed it as a finishing tool for cleaning. The people who it was originally designed for (those with smelly houses) didn't think they needed it, so the only way to sell it was to identify a new (adjacent) market where there was an unmet need.
Startups who are designing groundbreaking technologies that they believe are "disruptive" do well to remember these lessons. Disruption is a theory about marketing, not about product development or technology. To disrupt a market, you must be able to articulate a "job to be done" for which your target audience believes there is no better solution. You must meet an unmet or under-served need -- it's easier to sell to people who aren't part of the existing market (non-consumers who have opted out, and indicated that no available solution either satisfies the "job to be done" or is priced affordably), than to compete against incumbent solutions claiming to be better. And, you either need to be a "low-end" disruption (one which is targeted at the least demanding market segments based on pricing and sustainable cost advantage) or a "new market" disruption (create a market where none existed before).
Marketing and business strategy drive disruption
None of these characteristics have anything to do with building technology, but everything to do with appropriate segmentation, product positioning, messaging, and the compelling reasons why I would select your solution over all other available alternatives (which aren't necessarily products in the same "category"). Febreze ended up being a disruptive innovation because it succeeded (albeit after the fact) in marketing strategy, not because of how the product was designed.
Is Disruptive Innovation important to your business strategy? Download a free copy of the eBook 'Disruptive Confusion Unraveled' to learn:
- the 6 most common misconceptions about disruptive innovation
- how disruption creates growth
- what it means to be disruptive and why the definitions matter
- how to predict market disruption
- how to measure the market value of being disruptive
The discussion begins with how to accurately identify a disruptive innovator, and why most companies that claim they are, actually aren't. Our ebook "Disruptive Confusion Unraveled", and Innovative Disruption's analytic tool, the Disruption Report Card are mentioned in the discussion.
The podcast goes on to cover a wide range of material, including discussion of Apple's success and how they fit the disruptive model, why it's almost impossible to find a disruptive large company, to suggestions for how to give Justin's product, Pluggio, more disruptive potential.
The discussion centered around the relevance of key factors in achieving disruption, including:
- sustainable cost advantage / pricing strategy
- market segmentation
- targeting non-consumption
- choosing the right competition to position against
- business model
- ease of use
- targeting undesirable users
- identifying the "job to be done" for a product
- addressing unmet or underserved needs
Warning: we get down in the weeds with some deep theory and detailed analysis of examples. If you prefer lightweight, breezy material, this isn't for you.
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?
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".
My old guilty pleasure, American Idol, ended a few weeks ago, and I got to reflecting on the dynamics of the show itself and whether an article I wrote just before last year's finale would prove to be prophetic on review.
Last year's analysis discussed how AI was being disrupted, and whether the producers were either ignoring the problem, or didn't get it. In my review, I suggested some prescriptive changes that they needed to undertake to avoid an otherwise inevitable fate.
So, how did I do?
Last Year's Analysis and Predictions, Issues and Opportunities
- American Idol rules the roost; as #1 rated show, it has become complacent and resistant to necessary change and highly susceptible to disruption
- Any changes have become largely cosmetic (incremental "sustaining" innovations), and they've "overshot" the audience needs on the "slickness dimension" and no longer approximate an "authentic" experience
- The reality that creates ratings for Fox is that only a couple of the top 12 are actually good enough to have a chance at winning. The rest are there to become the train wrecks we want to vote off, to sass back at Simon, to sing gloriously out of tune and make us laugh, to impress with their self-absorption or self-delusion or just plain wacky personalities, to do whatever they do with Paula, and most of all, to give the audience time to get to know the eventual winner and build a following to buy their records.
- The ruse being perpetrated is that the show is really a singing competition, when in reality the producers have constructed a promotional stage which sells lots of advertising (because of the entertainment value in seeing train wrecks get voted off the island) and a vehicle for selling pop records, crafted in the form of a quasi-reality show
- A large minority of the audience has seen the wizard behind the curtains and tired of the deception, and using the power of the web, started to turn the tables on the show's producers, exposing the sham and actively working as a block to "Vote for the Worst", keeping the train wrecks going as long as possible at the expense of singers that the judges and producers actually wanted to "win". Last year, this resulted in the best singer (by any objective measure) being voted off early and two mediocre performers making it to the finale. The resulting winner's album was awful, and sold miserably (opening week sales for Jordyn Sparks first AI record were less than 1/2 same stat for Fantasia, the previous worst-selling AI winner, and only about 40% of the same stat for Taylor Hicks, who was generally considered a bomb and was dropped by his label).
- The voting system that Idol uses is suspect to begin with. By asking the audience to vote for their favorites, and as many times as they want, they have created a system which generates revenue but can't reliably identify either the best singer or the audience favorite(s). Even superior voting systems (audience votes for the worst and the person getting the most negatives is eliminated, one vote per person, one ballet with yays and nays for all contestants tabulated, it is open to manipulation, but the way it is, the best singers and performers are routinely voted off several weeks too early.
- Because of the above, the grand prize of a recording contract has become meaningless, and even a bit of an albatross. The contestants voted off early routinely get recording contracts and outsell the winners, because they a) can sing better, b) have more control over their albums (AI doesn't dictate what they can sing or how it gets produced), and c) therefore better songs, or at least songs they are better suited to sing, get on their albums.
Note that to try to deal with the last point, the judges practically fell over themselves this season to tell the voting audience as bluntly as possible who they thought needed to go and who should stay in an apparent effort to ensure that one of their favored singers actually won this time. They became so transparent about it, that Paula got caught offering judgment about a song that hadn't yet been sung, casting the wizard's curtain wide open.
Our conclusion: the above factors are causing audience disenchantment, and eating into viewership. The cynical business model that AI uses to milk the show for maximum revenue was easily disrupted by a little website exposing the underlying deceit.
The Results Are In
So, are these predicted results actually happening? If so, how are they manifesting?
- Viewership in 2008 was down an astounding 7% from 2007
- In a year where the two stars were considered "hot" guys, the primary viewing audience of women aged 18 to 34 was down by 18%
- The median age continues to skew ever upward, from mid 30s a few years ago, to 42 today. Hardly the prime music buying age group.
- The over 50 age group has increased in viewership.
All this suggests increasing irrelevance to the trendsetting youth audience, boredom among core fans, and disenchantment and disenfranchisement from the process. Typically when this sort of thing begins, it is irreversible because by the time executives acknowledge it is a serious problem (whether the product is a tv show, a newspaper, or a me-too generic cell phone, it's too late to make the major changes necessary to right the ship.
Will American Idol will take my advice? There's no doubt they have to do something and we're highly likely to see some changes next year, but the question is, how will they diagnose what's going on, and therefore come up with appropriate solutions. (It's at this point that I should helpfully point out that if they want to get the skinny on how to counter this disruption before it kills the show, I'm available as a consultant.) Here's a little free advice:
- The dynamics are old, and some highly visible changes are necessary. First to get the shake up should be the judging crew. Only Simon is core to the program -- it's time for Paula and Randy to go. Besides, the show needs more authenticity, and you can always count on Simon to say what he thinks in an entertaining way.
- Sacrifice some of the revenue stream from voting to create a system that isn't as vulnerable to manipulation (people need to believe that their votes are meaningful if they're going to keep paying attention and spending money to vote).
- Recognize that music trends don't stay the same forever. There was a minor nod in this direction this year as David Cook got more kudos and promotion from the judging crew as the show progressed. The interesting thing about him was that he already sounded like a lot of what's on the radio, and his looks and personality didn't hurt either, so it was easy to imagine him as the winner.
Most of the material that gets sung on the show is from a time before these kids were born (was it such a big surprise that Jason didn't know that CATS showstopping Memory was sung by an old dying female cat?), so it isn't that surprising that it's more popular with people older than 50 than with teenagers and 20 somethings.
It would help the producers to look at this from a "jobs to be done" perspective, rather than a "what we want to sell" perspective. The job to be done is to engage the youth audience (primary music buyers), identify a new "star" that they relate to, and create records that are current and interesting to that audience. Like Chris Daughtry did (but then, he had the advantage of being voted off and picking his own band and music -- hmmmm.)
Understand that superstar singers and bands sing hit songs. After spending most of the season telling contestants that song selection is critical, how much sense does it make to give your winner songs which don't fit their style (make a blues guy sing a sugary pop song, for example), or which are simply crap (letting amateur song writers write stuff that is total trash musically and lyrically) and then asking a newly minted winner to make it a hit song is absolutely nuts.
One possible voting system that could work better would be to count song downloads from iTunes in the 24 hours following the performance show. Even if it cost the same as texting in a vote, the fact that you get the song with it would be a big discouragement to VFTW, and iTunes doesn't let you buy the same song twice (at least not easily).
These are some easy big things that would make things more authentic, freshen things up, and introduce some sustaining innovations to counter the disruption to American Idol's artful guise. There are several smaller things as well, but the above would be a healthy start. If not, watch for even bigger declines next year, and a franchise that may not recover from disruption.
I suspect most people have heard by now of the kerfuffle about an internal memo, leaked through a popular Starbucks fan blogsite and ultimately covered by BusinessWeek, The Wall Street Journal, Forbes, CNN, etc., which was penned by the founder and chairman of Starbucks, Howard Schultz. Certainly the blogosphere is a-buzz with the come-to-Jesus nature of Schultz's personal revelation that Starbucks may have lost its mystique. I counted hundreds of blog postings - right up there with Britney Spears haircut and Anna Nicole Smith in popularity.
The memo itself was an interesting document that raises eyebrows and questions: although addressed to the president and other senior execs, was it always intended to be leaked via social media, into the mainstream press and back to the blogosphere? It has certainly created a lot of passionate commentary and free advertising for Starbucks.
Was it really intended to tell the public that Starbucks knows that people are complaining and that the competitive sands are shifting? Was it a message to investors that the company needs to slow growth and fix the experience to save the brand and that it's going to cost a bundle?
Or was it just the confessions of a founder and Chairman, purging feelings of guilt about a loss of soul, and a plea to executives for salvation? (Which, incidentally made Starbucks look good while rallying those who are still passionate about the brand experience to Starbucks' defense?)
No matter which of these it was, it was a brilliant document, but it may be too little too late.
Too Little, Too Latte? Starbucks is the World's Pre-eminent Coffee Brand: How Can it Be So?
It really depends on whether the executives realize that disruption is afoot, and that there's much more going on here than the diminution of brand experience. To properly address this question, and explain why disruption is the real problem, it helps to go back to the beginning, and define the innovation that led to Starbucks becoming a household name approaching 15,000 stores around the world.
What problem did Starbucks solve for its customers?
Anyone who travelled in Europe BS (Before Starbucks) would have marvelled at the quality and variety of coffee, and the cafe culture there. Especially in places like Italy and France.
The coffees were strong, but fresh, well-prepared and a perfect complement to a day of sitting on a sidewalk under an umbrella people-watching, or to end a perfect meal, or a delightful jolt to start the day with a pain chocolat or even just toast and eggs. You would have wondered how everywhere you went, coffee could taste so strong, yet be so delicious and universally good.
On this side of the pond (outside of your favorite Little Italy restaurant), it was almost impossible to get a decent cup of coffee, and especially to get a strong cup that was drinkable. I remember wondering after every trip why it was that good coffee on our side of the pond was an oxymoron whilst on their side, it was impossible to get a bad one.
It wasn't just that most (North) American coffees were made from Robusta versus the superior Arabica beans. It also had to do with poor roasting, poor quality control, and the fact that we got used to crappy coffee during the second world war when everything was rationed and/or watered down.
By the 50s, everything was about speed and automation, and so we made matters worse by going from percolated to instant to freeze dried to Coffee-Mate powdered creamer (another oxymoron). We drank it by the gallon, rotting our stomachs, taste buds and brains in the process.
It was purely about the caffeine and the speed. (Wonder why we never distilled out the caffeine and dispensed it straight via injection?). Yes, in a few big cities, you could find that rare place that would serve a great European-style coffee, and sometimes even with a bit of the ambiance, but that was so small a percentage of consumption that it barely qualified as an exception to the rule.
The story is apocryphal, and published on Starbucks website, and in Schultz's book, about how Schultz felt exactly this way on visits to Milano, and decided that it was time Americans got to upgrade their coffee experience. And, not just create a better cup of coffee, but the same smell and feel and cultured experience and ambiance that you felt in a great Italian coffee bar. That was the beginning of Starbucks as we know it.
We'd been upgrading the experience for ourselves, as much as we could with drip coffee becoming more the norm in the 70s and 80s versus instant, but the vast majority of Americans had never had a quality cup of coffee nor enjoyed the sensuality of the European coffee culture. So, when Starbucks hit Seattle, we were ready for something different.
So What About Disruption?
Disruption theory says that products or services evolve incrementally to better meet the needs of the most demanding customers, but eventually overshoot the needs of most consumers. In this process, the incumbents that dominate the existing market build processes and operational efficiencies that enable them to maximize profitability and continually introduce new "sustaining innovations".
In the short term, these series of decisions that improve processes and efficiency are seen as good management, delivering better profits. In the long term, however, they create the opportunity for a disruptive innovator to enter the scene.
At the time when Starbucks began, the big coffee suppliers had enormously overshot the needs of their customers for a cheap, fast cup of coffee. Yet, each "innovation" they introduced kept on making the product either cheaper or faster to prepare, stripping the product of the original reasons we became addicted to it - its flavor first and foremost, but also its ability to facilitate social interaction, savor a great meal, sit and relax, etc.
So Starbucks was a disruptive innovator. It brought flavor, a friendly social setting (the "third place"), quality, plus the consistency that only a chain can do. They brought back the smells, the sensuality, and introduced to Americans a "European experience" -- and, what Schultz has described as the sense of theater.
But isn't disruptive innovation "low-end"? How does a $5 cuppa disrupt?
But, you might be saying, Starbucks introduced a high-end innovation -- disruptive innovations typically are aimed at the low-end markets and low-end needs. Well, you'd be right, usually, but the question is: what needs were low-end, or more accurately underserved?
The characteristic that initially made Starbucks a small niche disruption was the speed. The big producers were optimized for speed above all else, not flavor and certainly not the organic pleasure of a gathering place with great smells where you hang out with your friends.
The characteristic of Starbucks' innovation that was just good enough for the original niche of coffee culture appreciators was the speed. They were happy to sacrifice the speed of picking up a pot of coffee off the Bunn burner (ironic that they called these things burners, because that's what they did/do to most pots left longer than 5 minutes) and pouring it straight to the cup and from there to the lips, in order to drink something they truly enjoyed, and to experience the coffee bar ambiance.
Initially, potential competitors to Starbucks ignored them because the market wasn't big enough for Dunkin Donuts or McDonalds to care about. To them, Starbucks coffee drinkers were aficionados -- a tiny specialized segment that had nothing to do with the mainstream, who they perceived still mostly wanted speed.
This ignorance is typical (and logical) to mainstream vendors who aim to maximize profit by serving the largest market as efficiently as possible. It also allowed Starbucks to "fly under the radar" for a long time -- over 20 years of strong growth -- allowing them to build their market unimpeded by real competition.
Yes, there are smaller chain coffee brands, like Caribou and Peets, etc., but their presence serves to expand the market for all specialty coffee vendors, and benefits the leader, i.e. Starbucks, disproportionately. But, Starbuck has become mainstream, and they can no longer hide -- they are officially perceived as a real threat to the foodservice business of other big companies.
But Starbucks is the leader and still growing. Are you seriously saying they might be "disrupted"? By who, and how?
As noted, disruption can take a long time to play out, and the seeds are sown long before the heavy damage is done.
As Starbucks has grown, they have focused on operational efficiencies to grow faster and more profitably. Efficiencies such as automatic espresso machines, flavor-sealed packaging (which eliminates the great smell of a real coffee shop), and expanding merchandise options ("would you like some fries with that doppio mocha latte half-caf with low fat milk?") to extract every last penny of same-store sales growth.
In the process, they have incrementally sacrificed seemingly small parts of the experience -- the smell, the theater, the ambiance (who wants a line snaking around the tables while you're trying to relax or have a conversation over a cuppa?), the service quality (rapid growth almost always comes with higher turnover and poorer training -- by now, we've all experienced the surly baristas who won't go the extra mile, but still make too many mistakes), etc.
The endgame: they've reduced themselves to serving a pretty-good-but-not-outstanding cup of coffee, too slowly and at too high a price. And, more importantly, they've overshot the needs of their customers, and are ripe for disruption.
To speed up coffee service in order to sell everything else too, they installed automatic machines. Automatic machines can be more consistent, especially for inexperienced operators, but they also reduce the flavor and the authenticity of the experience, and show competitors how they too can produce a cup just as good as Starbucks (i.e. open themselves to commoditization). This was an unnecessary and ill-advised "innovation".
Customers didn't ask for it, would probably agree that they didn't need it, and in general would feel that they are getting less for their money. Do I really need a bacon and egg (McMuffin) breakfast with my espresso?
Again, the more I overlap with my competition, the more I illustrate to them how to compete with me. And now I smell eggs cooking, not coffee beans and fresh espresso. Not wise.
Most fanatical customers who still are, were more fanatical 10 years ago, so what have these innovations added?
In becoming ubiquitous, the mystique is demystified, the coffee which was the central feature has become a means to sell myriad other food items and irrelevant merchandise (t-shirts anyone?), and the taste and smell and comfort have all been diminished. Yet, the high price remains. And, therein lie the seeds for potential disruption.
Because now, wanting a good cup of coffee has become mainstream, and Starbucks has become focused on speed (but not really), and efficiency, and foodservice, and add-on sales and rapid growth, they now face a new reality.
It's easy to add a pretty good cup of coffee to the menu. Especially for companies like McDonalds and Dunkin Donuts who already served coffee. All they have to do is add middle-of-the-road or better automatic machines to their operation, and they're almost as good.
But, they excel at real speed and efficiency, and are optimized to process customers in seconds or at most a minute or two, whereas Starbucks will never get that fast without redesigning every store and adding a lot more baristas. Moreover, they are value-oriented -- i.e. cheap. For McDonalds, $1.25 for coffee is an improvement in margin, but for Starbucks, it's impossible to go that low.
So, if I can get something almost as good for 1/3 the price, is that 'good enough'? Heck, even the the local QuikTrip service stations can create a relatively decent cup of coffee or espresso now.
And, more than commoditization, Starbucks' real problem now is that the competition is 'good enough' to be disruptive and undermine their business. But here's the real conundrum Starbucks faces. It will be almost impossible to go back.
Replacing the automatic machines with better quality semi-automatic or manual, and fresh ground and hand-tamped shots means throwing out a lot of expensive machines. It means they will go a bit slower for each coffee, which also means they'll need more people and more space for brewing. And, they'll need to increase their training expense enormously.
It will be hard to explain to investors why all the superfluous merchandise needs to come out of the stores, and why same-store sales will likely decrease. It will be even harder to recognize that for the mainstream coffee consumer, a $1.25 cup of coffee is good enough, even if I can't quite bring myself to visit McDonalds, and so there will be increasing downward pressure on price.
And, if they don't want to compete on price, then they probably already have too many stores, because the average consumer won't continue to spend a premium price for a commodity that is only marginally better than the competition.
Coffee Customization at Its Finest
To Schultz's credit, he recognizes that all is not well. And, he's recognizing it at a time of apparent strength. Starbucks just announced another record year where revenue grew 23%, 1177 new stores were added, and same-store sales increased 6% over the previous year (although the rate of increase is slowing, these are still impressive numbers for a $6.7B company.
If he can convince his executives and board and investors that a strategic overhaul is required to address the looming disruption, then he may well be able to avert it, but it isn't as simple now as returning to the good old days of better quality machines, better service, less merchandise, whole beans scooped out of bins rather than prepackaged in flavor-sealed bags, more uniqueness in each store, etc. They will need a plan designed specifically to address the disruption Starbucks faces from new competitors, or else the disruptor will become the disruptee.
Acknowledging that the market has changed irrevocably, and is now attracting disruptive 'good enough' solutions for quality coffee, but at a lower price and faster pace, what would you do to re-energize Starbucks and fend off a loss of leadership position in the coming years?
Links for coffee fans
There is a follow up article to this post here: Has Starbucks gone far enough?