1. Disruptive Innovation Last Update 2015.02.10 1.0.0 Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 1

2. What is Disruptive Innovation What is disruptive innovation This concept comes from Clayton Christensen The question asked by this author is –Why do good firms fail He has, not really a theory, but a guideline based on some examples from industry Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 2

3. What is Disruptive Innovation The original example he used for this was the hard disk drive industry Let’s review what he found concerning it He writes as edited for space –Disk drives comprise read-write heads mounted at the end of an arm that swings over the surface of a rotating disk in much the same way that a phonograph needle and arm reach over a record Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 3

4. What is Disruptive Innovation –The parts consist of aluminum or glass disks coated with magnetic material; at least two electric motors, a spin motor that drives the rotation of the disks and an actuator motor that moves the head to the desired position over the disk; and a variety of electronic circuits that control the drive's operation and its interface with the computer One like this Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 4

5. Hard Disk Drive Development Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 5

6. Hard Disk Drive Development –A team of researchers at IBM's San Jose research laboratories developed the first disk drive between 1952 and 1956 –Named RAMAC (for Random Access Method for Accounting and Control), this drive was the size of a large refrigerator, incorporated fifty twenty-four-inch disks, and could store 5 megabytes (MB) of information It looked like this Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 6

7. Hard Disk Drive Development Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 7

8. Hard Disk Drive Development He goes on to state that initially he had a different idea of why firms fail This first idea was that –The next dozen years unfolded a remarkable story of rapid growth, market turbulence, and technology-driven performance improvements –During this period an additional 129 firms entered the industry, and 109 of those also failed Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 8

9. Hard Disk Drive Development –Aside from IBM, Fujitsu, Hitachi, and NEC, all of the producers remaining by 1996 had entered the industry as start-ups after 1976 –Some have attributed the high mortality rate among the integrated firms that created the industry to its nearly unfathomable pace of technological change Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 9

10. Hard Disk Drive Development –This figure shows that the slope of the industry's experience curve, which correlates the cumulative number of terabytes of disk storage capacity shipped in the industry's history to the constant-dollar price per megabyte of memory, was 53 percent Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 10

11. Hard Disk Drive Development –Meaning that with each doubling of cumulative terabytes shipped, cost per megabyte fell to 53 percent of its former level –This is a much steeper rate of price decline than the 70 percent slope observed in the markets for most other microelectronics products Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 11

12. Hard Disk Drive Development –The price per megabyte has declined at about 5 percent per quarter for more than twenty years Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 12

13. Hard Disk Drive Development Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 13

14. What is Disruptive Innovation Back now to the author’s main point Christensen argues that this means –This study of technological change over the history of the disk drive industry revealed two types of technology change, each with very different effects on the industry's leaders –Technologies of the first sort sustained the industry's rate of improvement in product performance and ranged in difficulty from incremental to radical Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 14

15. What is Disruptive Innovation –The industry's dominant firms always led in developing and adopting these technologies –By contrast, innovations of the second sort disrupted or redefined performance trajectories--and consistently resulted in the failure of the industry's leading firms Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 15

16. What is Disruptive Innovation Why were the older firms so more successful The author says money –As was the case with thin-film disks, the introduction of thin-film heads entailed the sort of sustained investment that only established firms could handle –IBM and its rivals each spent more than $100 million developing thin-film heads Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 16

17. What is Disruptive Innovation –The pattern was repeated in the next- generation magneto--resistive head technology: The industry's largest firms--IBM, Seagate, and Quantum--led the race Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 17

18. Why Do Firms Fail The next point he addresses is why firms succeed or at least appeared to In reality they failed The traditional feeling concerning why some firms succeed and other fail centers on the idea that –A firm is initially successful due to their bringing to market an innovation Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 18

19. Why Do Firms Fail –Subsequent success is due to listening to existing customers so as to best meet their needs –Failure to do this results in failure of the firm Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 19

20. Why Do Firms Fail In contrast Christensen argues that –Simply put, when the best firms succeeded, they did so because they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers' next-generation needs Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 20

21. Why Do Firms Fail –But, paradoxically, when the best firms subsequently failed, it was for the same reasons - they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers' next-generation needs Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 21

22. Why Do Firms Fail –This is one of the innovators dilemmas –Blindly following the maxim that good managers should keep close to their customers can sometimes be a fatal mistake Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 22

23. Why Do Firms Fail For example, what caused the established disk drive firms to fall behind –The most important disruptive technologies were the architectural innovations that shrunk the size of the drives--from 14-inch diameter disks to diameters of 8, 5.25, and 3.5-inches and then from 2.5 to 1.8 inches Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 23

24. Why Do Firms Fail Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 24

25. Why Do Firms Fail –Generally disruptive innovations were technologically straightforward, consisting of off-the-shelf components put together in a product architecture that was often simpler than prior approaches –They offered less of what customers in established markets wanted and so could rarely be initially employed there Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 25

26. Why Do Firms Fail –They offered a different package of attributes valued only in emerging markets remote from, and unimportant to, the mainstream –As the 8-inch products penetrated the mainframe market, the established manufacturers of 14-inch drives began to fail –Two-thirds of them never introduced an 8-inch model Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 26

27. Why Do Firms Fail –The one-third that introduced 8-inch models did so about two years behind the 8-inch entrant manufacturers –Ultimately, every 14-inch drive maker was driven from the industry –Why were the leading drive makers unable to launch 8-inch drives until it was too late –Clearly, they were technologically capable of producing these drives Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 27

28. Why Do Firms Fail –Their failure resulted from delay in making the strategic commitment to enter the emerging market in which the 8-inch drives initially could be sold –Interviews with marketing and engineering executives close to these companies suggest that the established 14-inch drive manufacturers were held captive by customers Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 28

29. Why Do Firms Fail –Mainframe computer manufacturers did not need an 8-inch drive –In fact, they explicitly did not want it: they wanted drives with increased capacity at a lower cost per megabyte –The 14-inch drive manufacturers were listening and responding to their established customers Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 29

30. Why Do Firms Fail –And their customers - in a way that was not apparent to either the disk drive manufacturers or their computer making customers - were pulling them along a trajectory of 22 percent capacity growth in a 14-inch platform that would ultimately prove fatal –In 1980, Seagate Technology introduced 5.25-inch disk drives Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 30

31. Why Do Firms Fail –Their capacities of 5 and 10 MB were of no interest to minicomputer manufacturers, who were demanding drives of 40 and 60 MB from their suppliers –Seagate and other firms that entered with 5.25-inch drives in the period 1980 to 1983 had to pioneer new applications for their products and turned primarily to desktop personal computer makers Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 31

32. Why Do Firms Fail –By 1990, the use of hard drives in desktop computers was an obvious application for magnetic recording –It was not at all clear in 1980, however, when the market was just emerging, that many people could ever afford or use a hard drive on the desktop –The early 5.25-inch drive makers found this application by trial and error, selling drives to whomever would buy them Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 32

33. Why Do Firms Fail –Once the use of hard drives was established in desktop PCs, the disk capacity shipped with the median-priced machine (that is, the capacity demanded by the general PC user) increased about 25 percent per year –Again, the technology improved at nearly twice the rate demanded in the new market: The capacity of new 5.25-inch drives increased about 50 percent per year-between 1980 and 1990 Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 33

34. Why Do Firms Fail –As in the 8-inch for 14-inch substitution, the first firms to produce 5.25-inch drives were entrants; on average, established firms lagged behind entrants by two years. –By 1985, only half of the firms producing 8- inch drives had introduced 5.25-inch models –The other half never did Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 34

35. Key Point –The fear of cannibalizing sales of existing products is often cited as a reason why established firms delay the introduction of new technologies –As the Seagate-Conner experience illustrates, however, if new technologies enable new market applications to emerge, the introduction of new technology may not be inherently cannibalistic Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 35

36. Key Point –But when established firms wait until a new technology has become commercially mature in its new applications and launch their own version of the technology only in response to an attack on their home markets, the fear of cannibalization can become a self-fulfilling prophecy Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 36

37. Summary The author summarizes his argument in this way –There are several patterns in the history of innovation in the disk drive industry –The first is that the disruptive innovations were technologically straightforward Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 37

38. Summary –They generally packaged known technologies in a unique architecture and enabled the use of these products in applications where magnetic data storage and retrieval previously had not been technologically or economically feasible Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 38

39. Summary –The second pattern is that the purpose of advanced technology development in the industry was always to sustain established trajectories of performance improvement: to reach the higher-performance, higher-margin domain of the upper right of the trajectory map Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 39

40. Summary –Many of these technologies were radically new and difficult, but they were not disruptive –The customers of the leading disk drive suppliers led them toward these achievements –Sustaining technologies, as a result, did not precipitate failure Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 40

41. Summary –The third pattern shows that, despite the established firms' technological prowess in leading sustaining innovations, from the simplest to the most radical, the firms that led the industry in every instance of developing and adopting disruptive technologies were entrants to the industry, not its incumbent leaders Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 41

42. Summary –This book began by posing a puzzle: Why was it that firms that could be esteemed as aggressive, innovative, customer-sensitive organizations could ignore or attend belatedly to technological innovations with enormous strategic importance –In the context of the preceding analysis of the disk drive industry, this question can be sharpened considerably Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 42

43. Summary –The established firms were, in fact, aggressive, innovative, and customer- sensitive in their approaches to sustaining innovations of every sort –But the problem established firms seem unable to confront successfully is that of downward vision and mobility, in terms of the trajectory map Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 43

44. Summary –Finding new applications and markets for these new products seems to be a capability that each of these firms exhibited once, upon entry, and then apparently lost –It was as if the leading firms were held captive by their customers, enabling attacking entrant firms to topple the incumbent industry leaders each time a disruptive technology emerged –Why this happened, and is still happening, is the subject of the next chapter Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 44

45. Lepore Article Jill Lepore in an article published in 2014 argues that Christensen is incorrect She suggests the following –The Innovator’s Dilemma consists of a set of handpicked case studies, beginning with the disk-drive industry, which was the subject of Christensen’s doctoral thesis Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 45

46. Lepore Article –In his original research, Christensen established the cutoff for measuring a company’s success or failure as 1989 and explained that “ ‘successful firms’ were arbitrarily defined as those which achieved more than fifty million dollars in revenues in constant 1987 dollars in any single year between 1977 and 1989—even if they subsequently withdrew from the market” Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 46

47. Lepore Article –Much of the theory of disruptive innovation rests on this arbitrary definition of success –Most of the entrant firms celebrated by Christensen as triumphant disrupters, on the other hand, no longer exist, their success having been in some cases brief and in others illusory –The fleeting nature of their success is, of course, perfectly consistent with his model Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 47

48. Lepore Article –As striking as the disruption in the disk-drive industry seemed in the nineteen-eighties, more striking, from the vantage of history, are the continuities –Christensen argues that incumbents in the disk-drive industry were regularly destroyed by newcomers Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 48

49. Lepore Article –But today, after much consolidation, the divisions that dominate the industry are divisions that led the market in the nineteen- eighties –In some instances, what shifted was their ownership: I.B.M. sold its hard-disk division to Hitachi, which later sold its division to Western Digital Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 49

50. Lepore Article –In the longer term, victory in the disk-drive industry appears to have gone to the manufacturers that were good at incremental improvements, whether or not they were the first to market the disruptive new format –Companies that were quick to release a new product but not skilled at tinkering have tended to flame out Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 50

51. Lepore Article –The theory of disruption is meant to be predictive –On March 10, 2000, Christensen launched a $3.8-million Disruptive Growth Fund, which he managed with Neil Eisner, a broker in St. Louis –Christensen drew on his theory to select stocks Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 51

52. Lepore Article –Less than a year later, the fund was quietly liquidated: during a stretch of time when the Nasdaq lost fifty per cent of its value, the Disruptive Growth Fund lost sixty-four per cent Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 52

53. Lepore Article Perhaps the reason for this is –In the preface to the 2011 edition of “The Innovator’s Dilemma,” Christensen reports that, since the book’s publication, in 1997, the theory of disruption continues to yield predictions that are quite accurate Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 53

54. Lepore Article –This is less because people have used his model to make accurate predictions about things that haven’t happened yet than because disruption has been sold as advice, and because much that happened between 1997 and 2011 looks, in retrospect, disruptive –Disruptive innovation can reliably be seen only after the fact Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 54

55. Lepore Article –But among the many differences between disruption and evolution is that the advocates of disruption have an affinity for circular arguments –If an established company doesn’t disrupt, it will fail, and if it fails it must be because it didn’t disrupt Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 55

56. Lepore Article –In the late nineteen-nineties and early two- thousands, the financial-services industry innovated by selling products like subprime mortgages, collateralized debt obligations, and mortgage-backed securities, some to a previously untapped customer base –When the financial-services industry disruptively innovated, it led to a global financial crisis Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 56

57. Lepore Article –Disruptive innovation is a theory about why businesses fail. It’s not more than that –It doesn’t explain change –It’s not a law of nature –It’s an artifact of history, an idea, forged in time; it’s the manufacture of a moment of upsetting and edgy uncertainty –Transfixed by change, it’s blind to continuity –It makes a very poor prophet Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 57

58. Be Suspicious Anytime you encounter something like this –Ever since “The Innovator’s Dilemma,” everyone is either disrupting or being disrupted –There are disruption consultants, disruption conferences, and disruption seminars Copyright Kenneth M. Chipps Ph.D. 2015 www.chipps.com 58