You've created an innovative product. Customers love it and pay you quite well for it. You plow your profits back into R&D, making your product ever better, more powerful, and more useful to your customers. This may sound like a formula for success but it's actually the opposite, according to Clayton Christensen, Harvard professor and author of the bestseller The Innovator's Dilemma.
Christensen explained the innovator's dilemma at the Qualtrics Insight Summit earlier this month. "If you look across history, many companies that are seen as unassailable are at the bottom or the middle of the pack after a few years," he said. "It turns out good management causes companies to fail." In a few brilliant minutes, he explained why.
Begin by thinking about three concentric circles, representing your potential market. At the center of the inner circle are the customers with the greatest interest in your product and the most money. "Almost always, companies begin there because customers with money are the only ones who can afford your new innovation," he explained.
You introduce your product, your customers love it and they're happy to pay for it even at a high price. To keep these key customers happy, you begin making improvements to your product as soon as you can. "Companies keep introducing better and better products," he explained. At first, those improvements really help customers, as when personal computers gained faster processing speeds and you no longer had to wait 30 seconds to open a file. But he said, "technological progress almost always outstrips customers' ability to use it." For instance, today most of us only use a small percentage of the processing power in our desktop PCs.
Still, in an effort to better serve that core of high-paying customers, innovative companies keep adding improvements to their products. "We call this sustaining innovation," he said. "Incumbents dominate sustaining battles, but by definition, sustaining innovations do not drive growth." For instance, he said, Toyota's innovation may lead you to buy a Prius, but then you won't also buy a Camry.
Disrupters open new markets.
"What creates growth is disruptive innovation," he explained. "What we find is that entrant companies, rather than make good products better, make a more affordable product and open it to a whole new customer base." A great example is Salesforce.com, he said. By making cloud-based CRM available for as little as $25 a month, it badly disrupted Oracle's more expensive offering.
Or take a look at the history of Digital Equipment Corporation, or DEC. Founded in 1957, DEC built minicomputers designed to compete with the mainframes most large companies were using. It was hugely successful--in fact its minicomputers were the top sellers in that category.
It's not hard to see why. A mainframe in those days cost around $2 million, while a minicomputer only cost about $200,000. DEC had a great thing going--until the 1980s, when personal computers started penetrating the market. At that point, DEC's leadership faced a choice. They could make even more improvements to their minicomputers, making them as powerful as mainframes. Or they could try making personal computers. "People came to senior management and said, 'Everyone is making PCs--can't you see it?'" Christensen said.
But DEC's leadership had some reservations. "They saw some troubling things," he said. "Those early PCs were crummy. None of DEC's customers would have been able to use one." Also, minicomputers required a lot of training and servicing. To make that work, DEC had been seeking, and getting, margins of about 45 percent on the minicomputers it sold. Even in those early days, margins that high were out of the question when it came to PCs. The best they could expect to get was a margin of about 20 percent.
And so, Christensen said, DEC's leadership had to ask themselves this: "We can make better computers that give us a higher margin, or we can make crummy computers our customers can't use with a smaller margin. What should we do?"
The answer seems obvious, doesn't it? It certainly did to DEC's leadership. They stuck with the minicomputers until late in the game. Eventually they tried to make something like a PC, but it was much more powerful than any PC on the market and very high priced compared to other PCs. In 1998, DEC was acquired by Compaq, which was then acquired by HP later that year.
That seemingly obvious decision, to stick with what's working and profitable and serve your best customers rather than abandon them--that's the dilemma that plagues most innovators. The only way out of it, if there is one, is to disrupt your own company and products, just when you're having your greatest success.