Why don’t we have an integrated mechanism of entrepreneurship to consistently make new companies successful? Turns out that the Disruption experienced in the 20th century (cars, planes…) was fundamentally different from today’s Disruption (Airbnb, etc.). This article explains how the three types of Disruption help create predictable successful startups.
How High-End Disruption Completes the Disruptive Innovation Model
Let’s face it, innovation is hard. A recent Nielsen study pointed out that between 2012 and 2016, out of 20,000 new products evaluated, only 92 (0.46%) had sales of more than $50 million in year one and sustained sales in year two.1 Launching new companies is even more challenging, most startups cease operations after five years and most of the ones that are left standing find themselves stuck and have to make great efforts to make ends meet.2
At the same time, we need an explanation for companies such as Tesla, Airbnb, Infosys, Samsung, Sony, Dell, Apple, and many others that are so successful. And we need more than an explanation, we need a prescription, a recipe for creating successful companies.
Pundits might think that this is all very new, that this is why there is no prescription yet. But in reality, entrepreneurship is an old phenomenon and it turns out that it’s precisely when and how it was conceived that makes it so challenging – and surprisingly, this is the main reason that is confounding so many business school professors.
Let me put it this way; the people that were born in the late 1890s and onwards witnessed the greatest technological revolution ever – much more impactful than today’s. Hundreds of radical innovations revolutionised entire industries, think about cars, penicillin, electricity, airplanes, mechanised factories, chemical synthesis, radial tires and a very long etcetera. We take these innovations for granted today but there was a time where these radical technologies disrupted entire industries. For example, when Michelin introduced the radial tire in the US they took over all other the other tire manufacturers but Goodyear – who had to undergo a near death experience and needed decades to recover.
Industry after industry new companies with new technologies were taking over and disrupting very powerful companies that just a decade ago seemed invincible, and these companies fought as hard as they could before they vanish. Business schools professors started to investigate, in particular, Joseph Alois Schumpeter, that in 1934 wrote that the state is the key to industrial prosperity,3 would change his mind and would name “entrepreneurs” those individuals that introduce radical technologies and create industrial revolutions that rejuvenate and restructure, often quite dramatically, entire industries.4
But Schumpeter also noted that entrepreneurs were rare. He observed that more often than not entrepreneurs would fail, and most importantly, that the mechanism that describes when the entrepreneur will fail or not was unclear. He left us with a question: “how does the mechanism of entrepreneurship work?” This is the main question in entrepreneurship, and it has been formally under study for decades. Still today there is no unified explanation of the entrepreneurial mechanism – that will come with the introduction of Disruptive Innovation.
As noted, the term entrepreneurship was created to describe what was being observed. How new radical technologies took over industries, as a result, business school professors started equating entrepreneurship success with the ability of superior technologies to “capture” an established firm’s premium customers, leaving them with no option but to disappear (remember that this was very observable back then). In this process the entrepreneur would make money rather quickly because premium customers are very profitable, so the new company will recoup the initial investment in a reasonable amount of time. That’s what was observed when electricity took over candles. When planes took over transatlantic cruise lines or, more recently, when the first iPhone disrupted regular mobile phones. Over time, this idea became commonly accepted, even today, most business schools don’t approve business plans that do not include a superior technology. For many business schools it seems to be a self-evident truth that because the new technology is so much better it will be unequivocally accepted in the market. For instance, a few years ago, entrepreneurs created new advertising agencies that using the internet would let customers select the target audience for their ads, premium customers (big companies with big advertising budgets that advertised in mainstream media) would get much more granular data on how well did they spend their budget, this was much more precise than what TVs or radio stations were willing to offer. All these companies failed, and most of them came from very prominent business schools, and all their business plans (with no exception) had an Internal Rate of Return of at least 40%.[ms-protect-content id=”9932″]
But what if entrepreneurship doesn’t only happen “like an H-bomb” where the new company takes all established firms out of business in a short period of time? In the late 1970s a new trend started to become more noticeable, it had always been there, but for the first time a few business school professors started noticing that new or inferior technologies could also enter a market by targeting other customers that were not necessarily the premium ones. And that by targeting low value customers, that were at the bottom of the market, and improving from that position, they could also change the industry and disrupt established firms.5 Then, in 1992, Clayton Christensen formalised this process by introducing to the world the theory of Disruptive Innovation,6 a new approach to entrepreneurship, not incompatible with the established one, but certainly different. A new approach that challenged the conventional wisdom by claiming that if companies start at the bottom of the market and focus on making money, instead of trying to recoup the investment fast by targeting premium customers, that over time these new firms will take over established firms without a fight – mostly because established firms will be motivated to flee and relinquish their position.
Note that this happened at the end of a century that had witnessed the greatest technological revolution of all time. It was a new depiction of the entrepreneurial mechanism that was very much at odds with business school professors’ conventional wisdom of new radical technologies taking over by leveraging on premium customers. Needless to say, professors were outraged.
Reactions didn’t take long. Business school professors started writing dozens of articles and even an entire issue of a well renowned scientific journal7 claiming that Disruptive Innovation was incorrect because it didn’t fit what they believed was the “right” way to understand the entrepreneurial process. Then they were even more outraged when Disruptive Innovation gained so much widespread popularity between managers and CEOs, because of its ability to explain what is going on. Criticisms intensified. Over time, Christensen and his colleagues and former students continued improving the theory (no theory is born complete) to continue accommodating unexplained phenomena. Then something unexpected happened, an historian (yes, an historian) read Christensen’s first book on Disruption8 and overlooking more than a decade of improvements wrote a harsh critique in a manager’s journal (normally theories are discussed in specialised academic journals), this was subsequently followed by another business school professor that conducted an empirical study that, again, largely overlooked 20 years of research on Disruptive Innovation.9
As said no theories are born complete. When Disruptive Innovation was presented to the world it described how new technologies that made products more affordable and simple and that were initially targeted at low margin consumers would become successful.8 This phenomenon was dubbed Low-End Disruption and was exemplified in a variety of non-related industries such as fast food restaurants, mechanical excavators, the steel industry and more recently Dell Computer. A few years later the theory improved with the introduction of New-Market Disruption.10 Which are startups that again use new technologies but that target adjacent markets that are populated with non-consumers (people that cannot consume because of price, time, access or skills). For instance, Google in the search engine market helped many medium size businesses to advertise in a mainstream channel for the first time, ING-Direct helped people manage their savings for customers that were not attractive for retail banks or the famous Airbnb that found growth nearby the hotel industry. These are all poster child cases of New – Market Disruptions.
But in today’s Disruptive Innovation model companies such as Tesla, Uber or Chobani are identified as non-disruptive.11 These companies target premium customers, were very expensive to fund, target exclusively premium customers and are putting established firms in trouble. In Disruptive Innovation parlance, we say that they fit Disruption but that they are not Disruptive, which is observable because established firms, instead of not presenting a fight, have been quite responsive to these new entrants.
The two types of Disruptive Innovation identified are both based on having established firms “not react” to the new ones because they don’t perceive them as a threat. But a third type of Disruptive Innovation is starting to emerge. High-End Disruption is based on the idea that established firms will “react” but that their response won’t be effective because the new company has deliberately placed itself in a position that the established firms can’t reach.12 It turns out that this is precisely the answer to Schumpeter’s initial question and the main area of research in entrepreneurship. For instance, consider Skype in the national calls market (e.g., inside the US), Skype tried to capture customers by trying to disrupt the phone line, what did established firms do? They made bundles between fixed-lines and internet access so customers would pay a flat rate for national calls. But now consider Skype for international calls, this was a much more profitable market than national calls market for operators, but here they could not collude (colluding is illegal, but keep in mind that there is a very long record of established firms doing everything and anything to survive) like in the national market to block Skype. They reacted in both cases but in the national market they had “reach” so they kept the market, and in the second they had to watch how a newcomer was taking over one of their most profitable markets – in the very same fashion that Schumpeter described. Another example is Uber, the company is only banned in countries where the national taxi lobby has deep ties with the government, the weaker the taxi lobby the more leeway Uber has enjoyed in that particular country.
Since Schumpeter’s time, the word “Disruption” inherited a strong connotation of something to be revolutionary, and even though it is not what Christensen defined, the latest improvement to the theory of Disruptive Innovation, High-End Disruption, can bring business school professors much closer to an integrated model of entrepreneurship that lowers the failure rate of launching new firms. By understanding the three types of established firm’s response to a new firm and uncovering in detail the mechanism of how these three types of Disruptive Innovation work entrepreneurship can become a predictable and reliable process – not a bad alternative considering that last century’s technological revolution came with great increases in job creation, something that is clearly not happening this time.
About the Author
Dr. Juan Pablo Vazquez Sampere is Professor of Business Administration at IE Business School in Madrid. He is specialised in Disruptive Innovation and Entrepreneurship.
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12. J. P. Vazquez Sampere, “Uncovering the High End Disruption Mechanism: When the Traditional Start Up Wins,” in Global Perspectives on Technological Innovation, Management and Policy, 1st. Ed., R. Bing, Ed. Volume 1. Pennsylvania State University at Harrisburg: Information Age Publishing, 2012, p. 516 pages.