Founders pour blood, sweat, and tears into their startups. Often, it pays off when they're able to "disrupt" their industry, taking on pre-existing inefficient methods, industries, institutions and market leaders.

Netflix killed the video store. Wikipedia killed the encyclopedia industry. Uber is killing the taxi industry.

How can you tell which industries are ready for a change? Scholars from the Wharton School of the University of Pennsylvania took a look at that question, and published their findings earlier this month in the Summer issue of the MIT Sloan Management Review.

The researchers "looked at common patterns among more recent business model innovations and determined three major signals that your industry could be on the precipice of major change." While I agree with most of their findings, my 20 years of listening to startup pitches tell that they've missed on key thing.

Unfortunately, that one missing thing invalidates every one of their predictions. 

The three signs of an industry ripe for disruption, according to Wharton researchers

The first sign, according to the study, is significant regulatory burdens. Industries with high regulation often suffer from complacency, since they don't have to worry much about customer experience or optimizing operations. But startups aren't well regulated, often deploying radical approaches that fall outside current regulations.

As entrepreneurs. we tend to ask for forgiveness rather than permission--and we don't have a long history or sunk infrastructure to defend. By the time regulations catch up, we hope, we'll have enough customers and market share to thrive.

The second sign is opaque costing. Consumers are demanding transparency in pricing, which is causing a shift away from traditionally opaque middlemen.

In other words, more and more industries are experiencing what economists call disintermediation--or what we'd call cutting out the middleman. If you find an industry that still uses this strategy, you have a great opening.

The third sign is customer dissatisfaction. This is a natural result of the first two signs, according to the study. Where consumers are not delighted, you can step in to delight them--and quickly capture the hearts and minds of that industry's customers.

This often happens when consumers don't have a lot of choice--with phone carriers or internet service providers, for example--or when they've been forced into an oligopoly. Look for industries that are often the target of negative customer interactions, like health care or banking.

Based on these three signals, the Wharton researchers flag the following industries as ready for a change: air travel, real estate, and heath care.

The key sign they missed, and why it matters

I can confirm first-hand that the best and brightest seed stage investors--from angel investors to accelerators like Techstars and Y Combinator--proactively seek out these sort of opportunities to fund often using these three signals. I'd also add a fourth sign to the list: "10x innovation."

Creative destruction is only possible when technology can support it. Netflix couldn't have thrived until broadband internet came about.

You need a 10x increase in customer value to change an industry. It takes exponential innovation to overcome historical norms, adversity to chance, brand loyalty, incumbent market share, sunk costs, and other pre-existing factors.

Let's look at the study's list of industries ripe for disruption. None of them have 10x solutions available. Until exponentially better alternatives become technologically available--flying cars, underwater habitats, or A.I. doctors--the need for creative destruction in these longstanding industries will remain unrealized.

So which industries really are ready for creative disruption, if not those three? Here are my picks, using all four signals as criteria:

  1. Call centers. Conversational A.I. is almost able to replace an entire building of call center representatives. Remember Google Duplex's big unveiling earlier this summer? Plenty of new startups are also jostling for position in this space.
  2. Medical diagnostics. When was the last time you waited to see a doctor? When was the last time you were fully satisfied with your medical care? When was the last time a doctor could actually confirm a diagnosis for you with 100 percent certainty? Any startup that can address this unmet market has a huge opportunity.
  3. Insurance. The insurance business has been innovation-free for decades--and people are getting increasingly frustrated with the business model. I'm not the first person to notice this--plenty of startups are already trying to disrupt this market. Sooner or later, one of them will succeed. 

These picks aren't theoretical--I put my money where my mouth is, which is why my firm has invested in startups across all three of these industries. That's how confident I am in using these four signals as a guide.

You can do this, too. Use them to figure out where your startup should go. You might even change an industry for good.

Published on: Jul 12, 2018