Disruptive Innovation

Model of Disruption Steel Industry Two ways of making steel Massive integrated steel companies $10 billion to start Mini Mills Melt scrap in electric furnaces Don’t have to scale up the down stream process Make steel at any given quality 20% lower costs Steel is a commodity If you were a integrated company would you adopt the mini mill?

Flee or Fight Sheet Steel Quality Structural Steel Quality of integrated mill’s steel Bars and Rods Rebar 1975 1980 1985 1990 1995

Flee or Fight Prior to the late 1960s, integrated mills were doing all types and were making buckets of money Late 1960s mini mills came on to the market Melting scrap, quality was low and could only participate in rebar market

Flee or Fight Sheet Steel Quality Structural Steel Quality of integrated mill’s steel Quality of mini-mills steel Bars and Rods 12% GM 7% GM Rebar 1975 1980 1985 1990 1995

Flee or Fight Integrated mills were happy to get out of rebar Why fight for a 7% gross margin? Profitability of integrated mills increased as they left rebar Profitability of mini-mills increased as they entered rebar Everyone was happy But then in 1979 last integrated mill exited rebar Price of rebar collapsed Competition drove prices down to where mini mills were barely making money. Becoming more efficient only a recipe for survival Looked up!

Guess what happened? Sheet Steel Quality Structural Steel 18% GM Quality of integrated mill’s steel Quality of mini-mills steel Bars and Rods 12% GM 7%gm Rebar 1975 1980 1985 1990 1995

Flight or fight? Same thing happened Integrated mills were happy to leave Mini-mills were 20% cheaper so made profit Until 1984

Guess what happened? 24% GM Sheet Steel Quality Structural Steel Quality of integrated mill’s steel Quality of mini-mills steel Bars and Rods 12% GM 7%gm Rebar 1975 1980 1985 1990 1995

Flight or fight? Same thing happened Integrated mills were happy to leave Mini-mills were 20% cheaper so made profit Until 1996

Guess what happened? 24% GM Sheet Steel Quality Structural Steel Quality of integrated mill’s steel Quality of mini-mills steel Bars and Rods 12% GM 7%gm Rebar 1975 1980 1985 1990 1995

Eventually integrated mills only producing specialty steel Mini mills 65% of market All but one integrated mill has gone bankrupt “stupid manager”? No stupidity involved Innovators Dilemma

Innovator’s Dilemma Firms have a choice: How to defeat a giant? Toyota Make better products that we can sell for more profits to our current customers? Or make worse products that none of our customers would buy and would ruin our margins? Companies can put too much emphasis on customers' current needs, and fail to adopt new technology or business models that will meet customers' unstated or future needs How to defeat a giant? Go after best customers? Enter the bottom Giant is motivated to flee rather than fight Toyota Entered in the 1960s Corona Ford GM, were happy to let them have it Today Kia and Hyundia

Three types of Innovations Disruptive Innovation Sustaining Innovation Efficiency Innovation

Disruptive Innovation Large $ Medium $$ Small $$$

Disruptive Innovation Personal Computer P=$2,000 GM=$700 Mainframe P = $2,000,000 GM=#1,200,000

Disruptive Innovation Smartphone/Tablet P=$200 GM=$80 Personal Computer P=$2,000 GM=$700 Mainframe P = $2,000,000 GM=#1,200,000

Disruptive Innovation People making the early products tend not to make the new products: It doesn’t make sense to make products that don’t make cents Disruptive innovation transform complicated products into simple products Takes something that was very expensive and hard to produce and only a few could afford, and converts it into something that is much simpler to produce, is cheaper, and many can afford it.

Disruptive innovations create jobs More people can buy them, need more people to make them service them sell them Data show that almost all of the net jobs created in our economy were created through disruptive innovation Disruptive innovation requires capital

Sustaining Innovation Making good products better Better mainframe computers Better personal computers The iPhone 4, 4s, 5, ….. On average, they don’t create jobs When we buy the new product, we stop buying the old product Don’t use a lot of capital

Efficiency innovation Sell the same products to the same customers for cheaper Walmart Process Improvement Tend to eliminate jobs But will free up capital Prior to Toyota, it took 60 days for GM to assemble a car Toyota did it in 2 days Frees up lots of capital (inventory)

The three together? Sustaining Innovation Disruptive Innovation Efficiency Jobs Creates Little Eliminates Capital Uses Frees Efficiency Innovation

How does this apply to Healthcare? Most innovation in healthcare has been sustaining To understand this first describe the basic components of a business model

Components of a business model Value proposition Product or service that helps customers get a job done more effectively, conveniently, and affordably Resources People, supplies, intellectual property, equipment, cash required to deliver the value prop

Components of a business model Processes As resources work together to produce the product, process emerge and become ingrained in the business model Profit Formula Defines the pricing, mark-ups, gross and net profit margins, and volumes necessary to profitably cover the costs of the resources and processes that are required

The Business Model Value Proposition Resources Processes Profit Formula

Over time, the causation reverses: Value Proposition Resources Processes Profit Formula

Once the die is set… Once the pieces are in place to deliver a particular value proposition Only value props that fit the existing recourses, processes and profit formula of the organization can be successfully taken to market. Kodak

Where Capabilities Reside Three factors determine what an organization can do: Resources Processes Values

Resources Tangible Intangible People equipment technology cash Product designs Information brands relationships

Processes Patterns of interaction, coordination, communication, and decision making that employees use to transform resources into products and services of greater worth. Designed not to change or to change in very prescribed ways Both formal and informal

Values The standards by which employees set priorities that enable them to judge whether: an order is attractive or unattractive A customer is more important or less important An idea for a new product is attractive or marginal

Two values that affect innovation Acceptable profit margins Tend to rise over time Toyota Corona – Honda et al. entered Camry, Lexus – higher cost structure meant exiting low end market. Its values had changed

Two values that affect innovation How big an opportunity needs to be before it is interesting A company’s stock price represents its discounted present value of its projected earnings stream. Most managers feel compelled to maintain a constant rate of growth For a $40 million company to grow by 10%, they need $4 million in new business this year For a $40 billion company, however, they need $4 billion in new business. So an opportunity that excites a small company might not be big enough to excite a large one As companies become large, they loose the ability to enter small, emerging markets. This is a result of a change in values, not a change in resources

Fitting the Tool to the Task B Use a heavyweight team within the existing organization C Use a heavyweight team in a separate spinout organization Poor A Use a lightweight or functional team within the existing organization D Development in-house through a heavyweight team, but commercialization usually requires a spinout Fit with an organization’s processes Good Good Sustaining Poor Disruptive Fit with an organization’s values Will the organization commit the required resources?

Definitions A functional team works on function-specifc issues, then passes the project on to the next function A lightweight team is cross-functional, but team members stay under the control of the respective functional managers – don’t need new processes. A heavyweight team – members work solely on the project and are expected to behave like general managers, shouldering responsibility for the project’s success. Designing new processes and new ways of working together is required.

Typology of business models Solution Shops Value-adding process business Facilitated user networks

Solution Shops Built to diagnose and solve unstructured problems Consulting Advertising R&D Deliver value primarily through people

Value-adding process businesses Transform inputs of recourses into outputs of greater value Repetitive Capabilities are built more into its processes than its resources Focus on process excellence – high quality, low cost Retailing, restaurants, automobile manufacturing

Facilitated user networks The same people buy and sell and deliver and receive things to and from each other Successful business are those who can facilitate the effective operation of the network and its user transactions Telecommunications, stock exchanges, bank activities

Health care? Hospitals and physician practices: Solution shops Rely on intuition of highly skilled professionals But over time many activities that are based on value adding process or user network models. “Jumbled mixtures of multiple business models struggling to deliver value out of chaos, incorporating indecipherable systems of cost accounting, excessive overhead, pervasive cross-subsidization, and an unacceptable amount of variability and medical error.”

Innovation in Health Care The successful innovators are those who will be able to un-jumble the mix Simplify the process Where is “the bottom”? Minute Clinic: value adding process business Facilitated user networks? User networks shift care of chronic diseases out of intuitive based practices (solution shops)

Challenges to new business models Fragmentation Some of this innovation could create more fragmentation – carving out focused factories Coordination is critical Interoperable health information technology PCMH

Challenges to new business models Lack of a retail market Consumers need the proper incentives to shop Health Savings Accounts? Population Health Management? Regulatory barriers CON and other laws make innovation difficult Incumbents will often use regulation as a cover “What’s good for GM is good for America”

Challenges to new business models Reimbursement First, think about what this term implies Cutting reimbursement as an attempt to force a solution shop to figure out how to be more efficient will probably not get us very far in improving health care delivery

The ACA and Disruptive Innovation

The ACA and Disruptive Innovation

What do we take away? Disruptive, Sustaining, Efficiency Innovation Disruptive innovation makes the complex simple Starts at “the bottom” The lack of response of incumbent is not typically the result of stupidity, but result of change in values -- LEADERSHIP?