1. © 2004, Clark Gilbert, Harvard Business School Page 1 Professor Clark Gilbert Harvard Business School A New Path to Growth Using Disruption to Drive New Growth at McNeil

2. © 2004, Clark Gilbert, Harvard Business School Page 2 Sustaining versus Disruptive Innovation Product Performance Time Performance that customers can utilize or absorb New performance trajectory Disruptive Innovation Pace of Technological Progress Sustaining Innovation Breakthrough Incremental Source: The Innovator’s Dilemma

3. © 2004, Clark Gilbert, Harvard Business School Page 3 Disconnect with Resource Allocation Disruptive Proposal Targets Different Customers in New Ways Introduces Different Performance Criteria Under Valued by Leading Customers Lowers Performance along Traditional Trajectory Lowers Gross Margins Marketing Manager Production Budgeting Committee

4. © 2004, Clark Gilbert, Harvard Business School Page 4 Performance E-mail applications Home-use Applications Disruptive technology: digital film Children’s Game Toys Applications for Silver Halide Film Technology Established players force new technology into old markets Disruption in digital photography Kodak’s Response ($1B in R&D)

5. © 2004, Clark Gilbert, Harvard Business School Page 5 Definition of a Fanatic : Someone who doubles his speed when he has lost his direction --George Santayana

6. © 2004, Clark Gilbert, Harvard Business School Page 6 The Benefit of Staged Learning Discovery of New Market and Business Model Replication of Old Market and Business Model

7. © 2004, Clark Gilbert, Harvard Business School Page 7 Different Types of Innovations Low-End Disruption New Market Disruption Sustaining Innovation CUSTOMERS Overserved customers in low-end of existing market New customers or new contexts of use Most profitable customers in existing markets BUSINESS MODEL New financial or operational model that earns attractive returns at low prices New business model, often lower price points, new sales model & distribution channels Similar to existing model, improves or maintains margins TECHNOLOGY “Good enough” on traditional metrics but lower prices Improved performance on new attributes (e.g., simplicity, convenience) Improvements along dimensions valued by current customers New Market Disruption New customers or new contexts of use New business model, often lower price points, new sales model & distribution channels Improved performance on new attributes (e.g., simplicity, convenience)

8. © 2004, Clark Gilbert, Harvard Business School Page 8 Steel Minimills: A Low-End Disruption

9. © 2004, Clark Gilbert, Harvard Business School Page 9 7% 4% Quality of minimill-produced steel 12% 8% 18% 22% % of Tons Steel Quality 1980 1975 1985 1990 Rebar Angle iron; bars & rods Structural steel Sheet steel 25–30% 55% % of Margin Steel Minimills: A Low-End Disruption

10. © 2004, Clark Gilbert, Harvard Business School Page 10 Different Types of Innovations Low-End Disruption New Market Disruption Sustaining Innovation CUSTOMERS Overserved customers in low-end of existing market New customers or new contexts of use Most profitable customers in existing markets BUSINESS MODEL New financial or operational model that earns attractive returns at low prices New business model, often lower price points, new sales model & distribution channels Similar to existing model, improves or maintains margins TECHNOLOGY “Good enough” on traditional metrics but lower prices Improved performance on new attributes (e.g., simplicity, convenience) Improvements along dimensions valued by current customers

11. © 2004, Clark Gilbert, Harvard Business School Page 11 Minicomputers: A New Market Disruption The DEC Programmable Data Processor 8: 1965

12. © 2004, Clark Gilbert, Harvard Business School Page 12 Established Markets Continue to Grow even as the Disruptive Markets Take Root 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 11000 12000 13000 14000 15000 1965197519811983198519871989199119931995199719992001 Source: ITI, Industry Statistics Programs; U.S. Microcomputer Statistics Committee Forecast, Data Analysis Group Mainframe Computer Market Minicomputer Market First Revenue Lead Sustained Revenue Lead Minicomputers Disrupt Mainframes Dollars ($billions) Phase I Phase II Phase III

13. © 2004, Clark Gilbert, Harvard Business School Page 13 Disruption in Print Media “All the News that Fit to Pixel”

14. © 2004, Clark Gilbert, Harvard Business School Page 14 Disruptive Proposal Targets Different Customers in New Ways Introduces Different Performance Criteria Under Valued by Leading Customers Lowers Performance along Traditional Trajectory Lowers Gross Margins Marketing Manager Production Budgeting Committee Disconnect with Resource Allocation

15. © 2004, Clark Gilbert, Harvard Business School Page 15 Missing Revenue: Online Advertising Market 45% 15% 20% 10% Old Business Models Make It Very Difficult to Realize 45% Missing!

16. © 2004, Clark Gilbert, Harvard Business School Page 16 Online Revenue Per Unique User

17. © 2004, Clark Gilbert, Harvard Business School Page 17 The Irony of Disruptive Innovation Growth Starts in New, Not Established Markets Product Performance Time Performance that customers can utilize or absorb New Net Growth

18. © 2004, Clark Gilbert, Harvard Business School Page 18 Established Business Established Business Disruptive Business Disruptive Business Net New Growth Net New Growth Starts Outside Established Business Displacement "Overall, the newspaper industry's involvement with the Internet has been one where it had a lot to lose and it's been trying not to lose it, as opposed to starting from scratch and having a lot to win." --Steve Yelvington, President of Online Newspaper Division Finding New Market Growth

19. © 2004, Clark Gilbert, Harvard Business School Page 19 Why is this so difficult for otherwise successful firms?

20. © 2004, Clark Gilbert, Harvard Business School Page 20 RPV: Strengths Become Weaknesses Hiring & Training Product development Manufacturing Planning & Budgeting Market Research Resource allocation People Technology Products Equipment Information Cash Brand Distribution Processes Resources Values Ethics Cost structure/ income statement Size of opportunity The criteria by which prioritization decisions are made Core Competence vs. Core Rigidity

21. © 2004, Clark Gilbert, Harvard Business School Page 21 Capabilities in One Context Become Disabilities in Another Big enough to be interesting? Processes:How? What Margins Are Attractive? Cost structure Product Quality Resource Allocation Customer Feedback Planning Cycles Market Research Values:Why? “Organizational DNA”

22. © 2004, Clark Gilbert, Harvard Business School Page 22 Disruption through Portable Ultrasound “I had a call with a nephrologist where I literally told the sales rep to take the product out of the bag and show it to the physician. He didn’t do it. And I’m the President of the company…...We have all of these sales leads, but some of my reps are afraid of cannibalizing sales of higher-end hand carried systems.” President, Hand-Carried Ultrasound Company “I need to look at the kidney myself and see what’s going on. Every time I want to look I have to send the radiologist a patient… That’s not good. It doesn’t help me get my job done. I want to do it myself.” Nephrologist

23. © 2004, Clark Gilbert, Harvard Business School Page 23 Develop Separate Business Development Processes Performance Time

24. © 2004, Clark Gilbert, Harvard Business School Page 24 Separate Disruptive Ventures Integrated Sites Millions of Page Views / Month Separated Sites Separated sites had nearly 4 million more page views 0 2 4 6 8 10 12 Penetration 6.5 10.4

25. © 2004, Clark Gilbert, Harvard Business School Page 25 Implications Disruptive technologies attack an established business, but provide enormous opportunities for new net growth Focusing on your core market can lead to organizational rigidity – Trying Harder Can Be Part of the Problem! Identifying these opportunities requires different lenses: Reconsidering technologies viewed as “inferior” in your core market Targeting “overshot” where the primary alternative is non-consumption Developing these opportunities requires different tools: A different development, review, and funding process than the core business A venture process that is patient for growth, not for proof of concept A willingness to look outside of core business—venture autonomy, talent, partnerships, and acquisitions Disruption can provide competitive advantage is the search for growth

26. © 2004, Clark Gilbert, Harvard Business School Page 26 Managing Uncertainty in New Venture Creation Clark Gilbert Harvard Business School

27. © 2004, Clark Gilbert, Harvard Business School Page 27 HBS Definition of Entrepreneurship Pursuit of Opportunity Without Regard to Resources Currently Controlled Managing Uncertainty 1.Identify Critical Risks 2.Design Experiments 3.Stage Investment

28. © 2004, Clark Gilbert, Harvard Business School Page 28 Technical Operating Market Distribution /Pricing Team Environmental Which is the most important risk to understand and remove? Deal Killers, Path Dependencies, Costs, Investor Needs, Greatest Uncertainty 1) Identify Key Sources of Risk Total Venture Risk

29. © 2004, Clark Gilbert, Harvard Business School Page 29 Driver 3 Driver 2 Business Models: Fishbone Diagrams profits costs revenues Driver 1 Driver 2 Driver 3 Driver 1 Driver 2 Driver 3 Driver 1 Driver 2 Driver 3 Using the tool 1. Draw the key drivers of revenue and costs 1. Draw the key drivers of revenue and costs 2. Identify key drivers and assumptions 2. Identify key drivers and assumptions 3. Test sensitivity to changes in key drivers 3. Test sensitivity to changes in key drivers 4. Analyze how reasonable key assumptions are 4. Analyze how reasonable key assumptions are 5. Use the tool to surface key assumptions, logical inconsistencies, critical sources of uncertainty and important questions to ask 5. Use the tool to surface key assumptions, logical inconsistencies, critical sources of uncertainty and important questions to ask

30. © 2004, Clark Gilbert, Harvard Business School Page 30 2) Types of Experiments Partial experiments –buy information on “deal killer” source of uncertainty good when you know you don’t know something, risk of failure is high –case examples customer research before introduce product (Parenting, Tally Up) hire as consultant before hiring full time (Tally Up) background check on job candidate Holistic experiments –test entire model on small scale good to reveal ignorance-I.e., things you didn’t know you didn’t good to tests interaction between variables –case examples introduce product in trial before full launch (Onset vs. Knight Ridder) develop prototype with development partner (Tally Up’s beta version, E Ink) projection and reflection (ONSET ask VCs evaluate whole plan)

31. © 2004, Clark Gilbert, Harvard Business School Page 31 2) Risks of Experiments Experiments can be expensive –(Knight Ridder, E Ink, Segway) They can take too long –What if you finally get it right, only to find out that the market has moved or someone else has beat you to the punch? They can perpetuate –“Given the pace of our expansion, I don’t think we made mistakes fast enough and we didn’t learn from them often enough. The problem wasn’t just turning them on, sometimes it’s turning them off.” »-Bob Ingle, Executive Editor, San Jose Mercury News

32. © 2004, Clark Gilbert, Harvard Business School Page 32 2) The Value of Experiments Value greatest when: –Significant cost of failure –Significant probability of failure –Cost of the experiment is a small percentage of the total investment –The experiment yields fairly accurate results You can increase the value when: –Minimize both costs and timing –You impose variance on key questions, but control for other variables (Onset) –Have key milestones and ways of measuring progress –Change behavior as a result  enter vs. exit, product adaptation, adaptation subsequent roll-out

33. © 2004, Clark Gilbert, Harvard Business School Page 33 3) Staging Investment Lock-in on Early Assumptions Market and Business Model Discovery of New

34. © 2004, Clark Gilbert, Harvard Business School Page 34 3) Staging Investment Only spend significant sums of money after big risks have been reduced. Examples –R&R doesn’t place manufacturing order until after K-Mart order is received –Knight Ridder waits on registration until execution and sales risk are reduced

35. © 2004, Clark Gilbert, Harvard Business School Page 35 SUCCESS INVEST NOW FAILURE SUCCESS Payoff - Investment - Cost of Test GOOD RESULTS INVEST - Investment - Cost of Test FAILURE RUN AN EXPERIMENT ABANDON - Cost of Test BAD RESULTS ABANDON Payoff - Investment - Investment 1 1 (1-P G ) 1 PGPGPGPG PSPSPSPS (1-P S ) P S|G (1-P S|G ) 3) Staged Investments and Value of Information

36. © 2004, Clark Gilbert, Harvard Business School Page 36 Capital Funding to Milestones aka “Old-Fashioned Venture Capital” Risk (ß) Valuation Idea is Feasible Technology Works A Customer Buys Seed Funding R&D Capital Go-to-Market Capital Expansion Capital P(success) = 30% Req’d IRR = 100% P(success) = 40% Req’d IRR = 70% P(success) = 50% Req’d IRR = 50% P(success) = 80% Req’d IRR = 30% Source: Lou Mazzucchelli, Ridgewood Capital

37. © 2004, Clark Gilbert, Harvard Business School Page 37 The “Fully Funded” Folly A Customer Buys Fully Fund IPO (……….pray……………….) Capital Risk (ß) Valuation Idea is Feasible Technology Works Source: Lou Mazzucchelli, Ridgewood Capital

38. © 2004, Clark Gilbert, Harvard Business School Page 38 Implications Risk is inversely related to value Entrepreneurial managers don’t take risk, the manage risk New ventures will: Develop in an highly iterative and staged process Employ a series of risk reducing experiments Business models will change multiple times Reviewing of new ventures requires that board members can: Considered plans that will change considerably Demand results, but on different metrics—opportunity recognition and milestone achievement Identify risks, stage investment, and value risk reducing experiments Embrace outside perspectives Creating the right context for reviewing new ventures is key—simply having powerful ideas and opportunities is not enough