Established industry incumbents perpetually face the risk of being disrupted by new entrants using new technologies, business models, or approaches to capture marketplace leadership. Are there ways for incumbents to recognize these threats in advance?
"How can I anticipate the unexpected threats that could devastate my business?" This is the question that keeps us up at night. We fill our days with managing the expected, the things we can control: having the right talent, developing the right capabilities, getting resources to the right place at the right time, maintaining margin, growing revenues, delighting customers. These expected challenges are challenging enough. But what about the unexpected, the disruptive?
Unexpected, disruptive types of threats tend to be based in a new approach, a disruptive strategy, that was not previously feasible or viable in a given market.1 Something changes in the larger environment—technology or customer preferences or supporting infrastructure/ecosystem—to make the new approach possible and profitable. The incumbent, preoccupied with the status quo, doesn't recognize that the ground beneath it is shifting. Hampered by the nature of the existing business, the incumbent struggles to respond effectively as the new entrant takes market share. The same aspects of the incumbent's business that made it successful also make response difficult and tend to act as blind spots, preventing it from fully recognizing the threat when it is still on the horizon.
As the first of a two-part series, this article takes an incumbent's point of view to understand what turns a new technology or new approach into something cataclysmic to the marketplace—and to incumbents' businesses. Why are these developments hard to see coming, and why are they difficult to respond to effectively? In search of patterns, we looked far and wide across arenas as varied as voice-over-IP, furniture manufacturing, fantasy sports, and travel guides. We analyzed dozens of cases from the past 20 years, including some favorite "unicorns"—the unprecedented pool of tech start-ups with funding-based valuations of $1 billion or higher2—to home in on the specific ways threats manifest in a world rapidly becoming digital. We also considered how the next wave of exponentials (including the Internet of Things, 3D printing, and Blockchain) might fit this dynamic. We looked for cases where a leading incumbent had been displaced from its market—either by being marginalized within an existing market or by failing to capture enough of a growing market—and tried to identify what they might have seen coming if they'd known where to look and what to look for.
In doing so, we have identified nine patterns of disruption. These patterns are more than "one-off" occurrences, but they also are not universal forces; they are disruptions that will likely occur in more than one market but not in all markets. Each delivers new value through a new approach subject to a set of market conditions. Each brings its own challenges for the incumbent. These nine patterns can't describe every possible challenge a business will encounter, but, individually and in tandem, they do help make sense of the changing environment and competitive dynamics that many companies are experiencing.
So how can incumbents avert disaster? First, see it coming: Understand the shape new threats are likely to assume (patterns of disruption); understand what particular disruptive strategies your market is most vulnerable to; and understand what will act as catalysts for those threats. Armed with this understanding, you can start asking the right questions of your business and the world around you to not only anticipate changes but make the "unexpected" expected—to begin making the choices and taking the actions needed to control your destiny and see the opportunity on the flip side of the threat.
In part two of this series, we'll explore the strategies that will be most effective in preparing for, responding to, or taking advantage of the particular patterns that are most relevant to a given market or business.
In January 2012, Eastman Kodak Co. filed for bankruptcy after a tumultuous decade that saw the 130-year-old company rapidly lose relevance as picture-taking consumers switched from film to digital photography. The company had lost money for nine of the previous twelve quarters, and employed fewer than 20,000 workers from a high of over 145,000 in the late 1980s.3
Our approach: Seeking displacement
In this report, our first task was to identify cases where leading incumbents had been displaced from their markets. Although we were looking for loss of market share by revenue, in cases where significant value was removed from specific markets, we considered proxies such as loss of share of total number of users.
We looked broadly across a variety of tech, non-tech, digital, and non-digital arenas in search of displacement. We discovered that this type of enduring displacement of leading incumbents (versus the period-to-period jockeying for position between multiple established competitors) was relatively difficult to prove, given the subjectivity in how markets are defined.4
Why displacement? The persistence of corporations is such that even businesses that have been significantly weakened, with their revenue streams depleted and/or their business model undermined, tend to continue for a surprisingly long time. Bankruptcy laws allow companies that have been significantly weakened to restructure debt and get out from under labor obligations. These businesses may take several years after being disrupted to actually fail, or they may not fail at all. Some companies, by virtue of size and cash reserves, can survive despite losing market after market. Nonetheless, to company leadership, investors, and certainly the employees of the main business at the time who suffer layoffs or restructurings, disruption has occurred.
The story of Kodak's decline is well known. And, especially among a population whose days are permeated with digital technologies, one can only shake one's head and wonder, "How did Kodak miss out on digital photography?" This is an important question for executives today who want to avoid losing the market they lead or even going out of business entirely. Strategic analysis with the benefit of hindsight, however, is easy. Embedded in Kodak's story are other, more useful, questions: Why was the technology so disruptive to this established business? Why couldn't the company react? How could leaders have identified the significance of this new technology amid the noise of so many other changes in the global business environment? What trends within and beyond the industry catalyzed what might have been an interesting new product technology into a disruptive force? What aspects of Kodak's market, and adjacent markets, rendered the company unable to recover from the turmoil wrought by the new technology?
These questions, and their answers, become even more important if we consider the accelerating changes in the forces that catalyze disruption—changes that we believe will increase the pace and frequency of dramatic market displacements.
To attempt to answer these questions and, in so doing, better understand what market leaders might do to avert this type of devastating loss, we looked for clues in the past and present. We had a sense that, just as markets in the 20th century followed certain patterns around scale and efficiency, there would be patterns to how 21st-century markets worked as well. We looked for examples of companies that had lost market leadership to new approaches that they seemingly could not reconcile with their core business. We also looked at incumbents that are currently suffering under an onslaught of new entrants wielding new technologies—the so-called unicorns and exponential organizations (see sidebar, "Unicorns, exponentials, and black swans"). Finally, we considered these cases in light of evolving underlying technologies, shifting consumer dynamics, the rise of platforms, and other changes in the global environment that might inform our understanding of the nature of unexpected threats in the 21st century.
Unicorns, exponentials, and black swans
"Unicorn," a name popularized by venture capitalist Aileen Lee in 2013 and a phenomenon that has captured both the imagination of would-be tech moguls and the angst of an economy in transition, refers to any of the tech-based start-ups that, based on fundraising, have achieved valuations of over a billion dollars. As Fortune points out in "The age of unicorns," this phenomenon did not exist prior to 2003.5 Neither Google nor Amazon had such valuations as private companies, but now there is a long and ever-changing list, headed by the likes of Uber and Airbnb. It has also been noted that these soaring valuations are on paper only and represent a break from traditional pre-2000 valuation models.6
"Exponential organizations," a phrase coined by Singularity University founding executive director Salim Ismail, refers to companies that are designed to leverage the abundance of resources afforded by exponentially advancing underlying technologies (for example, core digital components like computing power, storage, and bandwidth, as well as second-order technologies like social, big data, analytics, and synthetic biology). Exponential organizations have a disproportionate impact relative to traditional, linear companies organized for command and control.7
"Black swan" describes a rare, unexpected, high-profile event that has a significant impact (across societal, geographic, economic, and chronological boundaries). It derives from a theory developed by Nassim Nicholas Taleb and can be thought of as disruption on a broad, universal scale.8
WHY IS DISRUPTION SO HARD TO SEE?
Of course, the problem with disruption is that we tend not to recognize it for what it is until it's too late. Just ask Encyclopedia Britannica. With the benefit of hindsight from the vantage point of a world where Wikipedia almost always comes up in the first three results for any online search, the expensive and massive collection of heavily edited, bound volumes seems an anachronism, both ostentatiously authoritative and hopelessly static, out of touch, and out of date before the ink even dried upon the page. But what did it look like in 1993 when Microsoft introduced Encarta Encyclopedia for PC, or in 2001 when Wikipedia began attracting contributors?9 Or imagine that you are a hotel executive hearing murmurs of a service for renting out a spare room or sofa bed. Does Airbnb look like a threat to your continued viability? And if it does, what constitutes an effective response?
As straightforward as it may sound, one part of the problem is simply recognizing that market leadership is being lost. New entrants wielding new approaches uproot incumbents in five ways (figure 1), some of which take longer to manifest; with these slower ways, the length of the process breeds false security.
In its most familiar form, displacement can be as clear-cut as Amazon taking customers and revenue from Borders in the US book market. The incumbent simply loses customers because the value delivered is no longer sufficient to win the market. In this scenario, given most companies' focus on short-term metrics like revenue and profitability growth, the incumbent quickly recognizes the new entrant as a threatening competitor.
Similarly, the incumbent will likely notice loss of share to fragmented new entrants, although a large company accustomed to one or two main rivals may underestimate or misunderstand the threat of a multitude of small players in aggregate. When independent music artists, enabled by digital tools, began to find an audience in the early 2000s, the four major record labels, which had collectively controlled over 80 percent of the market, continued to compete with each other for hits while a host of non-major labels with niche artists stole nearly 30 percent of their market share.10
What about when a new approach grows the market significantly and the incumbent stays roughly static, neither losing nor gaining an appreciable amount? The incumbent might not consider itself displaced. Eventually, however, failing to capture growth in a growing market will catch up to the incumbent through lack of investors, flight of talent, and fewer opportunities to learn and position oneself for industry evolution. Again, the incumbent may not recognize the competition because of market myopia: that is, it defines its market and competitors too narrowly. Yet the incumbent has no incentive to think about its market in any other way, particularly when the analysts say it dominates that market.
Counting on the market to continue to be defined as it has traditionally been defined can lull an incumbent into being blindsided by another form of displacement: collapse or dramatic contraction. This can happen when a new approach sucks a significant amount of value out of a market, either through demonetization or through eliminating the demand for an entire type of product. Classic examples include refrigeration eliminating the market for ice delivery and, more recently, the smartphone eliminating much of the demand for point-and-shoot cameras, calculators, flashlights, and travel clocks.
Finally, although it is less of a threat to large companies, fragmented incumbents can be displaced from the market through consolidation. Scale becomes the dominant competitive advantage where before it was not; the remaining fragmented players cannot compete in the general market and either consolidate or specialize.
In recognizing threats, much depends on identifying the potential ways in which the relevant market might be redefined. That is why understanding the multiple forms of displacement is so important. It is too easy for incumbent leaders, engaged in the day-to-day business of maintaining an existing competitive advantage, to overlook potential challenges from beyond the narrow arena where they are, like the mythical children of Lake Wobegon, "above average."
Another part of the problem is that the world is volatile and full of noise. On the surface, many of the cases of disruption feel strikingly similar (and are lumped together by headlines and conference breakouts about the "sharing economy" and "collaborative consumption"). However, they are also different in important though hard-to-articulate ways. For example, many disruptors—Amazon, Salesforce, Uber—employ platforms, yet most prove threatening to the incumbent through a different source of value creation. It wasn't the platform per se that was disruptive so much as the usage-based pricing for Salesforce or the unlocking of private assets for Uber. For Amazon, on the other hand, it was the extended market reach of its aggregation platform that gave it its disruptive power.
By the time Encyclopedia Britannica shut down its print edition in 2012, it had sold only 8,000 units of its print publication over the previous three years.11 Newspapers everywhere similarly suffered drops in print sales as free, crowdsourced sites like Reddit competed against newspaper-based journalism. The leaders in those industries probably could not have imagined a scenario where people would accept the word of faceless, uncredentialed peers over the authority of an august institution. But with platforms that allow many faceless peers to come together, adding to, editing, and moderating each other's work, it turns out that the average consumer is more willing to trust faceless peers than anyone had thought.
Disruption happens when a new approach meets the right conditions. And the conditions, it turns out, are always changing.
1. The existing literature suggests an evolving array of possible definitions for disruption and how it unfolds. One option: Initially, disruptive technologies were described as "innovations that result in worse product performance, at least in the near term...(that) bring to a market a very different value proposition..." The products are "typically cheaper, simpler, smaller, and, frequently, more convenient to use." They subsequently become "fully performance-competitive in that same market..." Clayton Christensen, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail (Harvard Business Review Press, 1997). Another possible definition: "Innovation is any combination of activities or technologies that breaks existing performance tradeoffs in the attainment of an outcome in a manner that expands the realm of the possible." Michael Raynor, Introducing perspectives on innovation, Deloitte University Press, April 30, 2013, http://dupress.com/articles/introducing-on-innovation.
2. Erin Griffith and Dan Primack, "The age of unicorns," Fortune, January 22, 2015, http://fortune.com/2015/01/22/the-age-of-unicorns/.
3. Economist, "The last Kodak moment?," January 14, 2012, http://www.economist.com/node/21542796.
4. In the fall 2015 issue of MIT Sloan Management Review, Andrew A. King and Balijir Baatartogtokh report on their own analysis of cases that have been identified as disruptive. Andrew A. King and Baljir Baatartogtokh, "How useful is the theory of disruptive innovation?," MIT Sloan Management Review, September 15, 2015, http://sloanreview.mit.edu/article/how-useful-is-the-theory-of-disruptive-innovation/.
5. Griffith and Primack, "The age of unicorns."
6. Aileen Lee, "Welcome to the unicorn club: Learning from billion-dollar startups," TechCrunch, November 2, 2013, http://techcrunch.com/2013/11/02/welcome-to-the-unicorn-club/.
7. Salim Ismail, Michael S. Malone, and Yuri van Geest, Exponential Organizations: Why New Organizations are Ten Times Better, Faster, and Cheaper than Yours (and What to Do About It) (Diversion Publishing, 2014).
8. Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, Second Edition (Random House: 2006).
9. Shane Greenstein and Michelle Devereux, "The crisis at Encyclopædia Britannica," The Kellogg School of Management, July 28, 2009.
10. Stuart Dredge, "Indie music service Bandcamp reaches $100m of payments to artists," Guardian, March 9, 2015; Jacqueline Rosokoff, "TuneCore driving strong gains for music business," TuneCore Blog, April 16, 2014; Chris Robley, "This week's CD baby artist payout crushes record at $3,800,000," DIY Musician Blog, March 05, 2013; Jacqueline Rosokoff, "TuneCore pays out $33.2 million in artist earnings," TuneCore Blog, July 16, 2014; Kevin Cornell, "TuneCore pays artists $32.7 million for music distribution," TuneCore Blog, October 15, 2014; IBIS World Industry Report no. 51222, March 15, 2005; IBIS World Industry Report no. 51221, March 18, 2005; IBIS World Industry Report no. 51222, October 2015; IBIS World Industry Report no. 51221, August 2014.
11. Greenstein and Devereux, "The crisis at Encyclopaedia Britannica."
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