NOTE: My *only* motivation in promoting this book, is the simple fact tha=
t
it's a great book on innovation, an excellent source of subjective refere=
nce
for entrepreneurs and VCs alike, and IMHO, highly recommended to VENTCAP
subscribers.
The following Q&A with Christensen appeared in Businessweek, June 28, 199=
9
issue.
[It was published in conjunction with the cover story, Internet Anxiety (=
US
edition)].
A Brutal Survival Plan
By Paul C. Judge
Copyright =C2=A9 1999, The McGraw-Hill Companies Inc.
Q: What's the lesson today's managers should take away about the Internet=
?
A: There are certain dimensions of managing the flow of information over =
the
Internet that help make your product or service better in the marketplace
you currently serve. Using the Web in ways that can sustain your existing
business model is an absolute imperative. But in other ways, particularly=
in
retailing now, the Web can be what I call a disruptive technology, and
historically, those are what cause companies to fail.
Q: Do you see those disruptions now?
A: Oh yeah. Online trading of securities is creating an enormous disrupti=
on
to the full-service brokerage firms. It's gone from 3% of trades in 1997,=
to
14% in 1998. And underwritings are beginning to be done over the Internet=
,
as well.
Q: What's the most common mistake made by managers confronting disruption=
s?
A: The typical pattern is that your best customers will be among the last=
to
embrace this sort of disruptive technology, because usually a disruptive
technology does not provide the same kind of service and performance that
your best customers prefer. The people who will embrace these technologie=
s
first are the ones that you have trained yourself to pay the least attent=
ion
to. It can creep up on you like a stealth attack, until it's right on you.
Q: How are the fundamental measures of business value being challenged?
A: Look at bookselling. Once you've got a bookstore, the way to make more
money when you're starting out is to try to operate the store at full
capacity -- pack in as much selection and as many customers as you can fi=
t.
But after you've achieved capacity, the only way to increase business is =
by
boosting margins. On the Internet, there is no limit on the capacity of =
the
store, or the number of customers who can come in. Therefore, percentage
margins really aren't important. What's important online is the total
dollars you can bring in divided by the total amount of capital required =
to
get those customers. I calculated that Amazon could equal the return on
investment capital that a bricks-and-mortar bookseller achieved if Amazon
had only 5% gross margins, vs. 30% for a traditional retailer. It's so
different because of the scale available to stores online.
Q: Can you point to others?
A: Financial services. The impact the Web will have there is to fragment =
and
render irrelevant the integrated financial institutions like commercial
banks. It will take time for this to happen. But consider a business like
credit cards, where four variables determine 99% of the variance of wheth=
er
someone will pay their debts or not. You can apply for a credit card over
the Net, get it over the Net, and have it serviced over the Net. Because =
of
that, nonbanks, and ultimately Internet banks, will capture that business.
Ten years ago, that was a very profitable piece of business for banks lik=
e
Citi. But that will just go away. Same for the mortgage business and auto
loans and small-business loans. Those kinds of things will begin to be
conducted more and more by specialized financial services companies using
the Net.
Q: Can old-line companies that excelled before the Internet master this n=
ext
phase?
A: They can do it, but the only way is if they set up a completely
independent organization and let that organization attack the parent. If =
you
try to address this opportunity from inside the mainstream, the probabili=
ty
of success is zero. I've never seen it happen.
Q: Do you expect a new business hierarchy to emerge led by the Net
companies?
A: You won't see the old-line retailers or brokers disappear. But to
survive, those guys will have to move toward products whose metrics can't=
be
clearly specified and measured. In retailing, there's already been one bi=
g
disruptive wave: discount retailers disrupting traditional department
stores. Look at the patterns: They stole the market dominance by starting
with branded household goods -- not big appliances, but little ones, kitc=
hen
goods where clear metrics existed. Things you did not need to try on.
Gradually, they migrated their product lines to higher and higher
gross-profit-margin tiers in the market. The Internet is the ultimate wav=
e
coming in that way.
Q: How can executives balance managing for a future that's being changed =
by
the Internet without sacrificing results today?
A: The current business doesn't fall apart. You need to have a different
business organization concentrating on building a business model appropri=
ate
to the future, while the existing business organization can focus on bein=
g
as successful as possible with the client base that's still uncomfortable
with the Internet. Citi can't escape the cost of its legacy customers. Bu=
t
it simply can't burden the new Internet business with serving those
customers, because Citi will be competing against Internet banks without
those legacy customers. The only way to compete is to have an organizatio=
n
focused completely on the new opportunity.
Businessweek also published the following piece, in its June 14, 1999 iss=
ue.
(It is a commentary on Christensen's book, reflecting upon Merrill Lynch'=
s
decision to launch an on-line trading site).
Commentary: Can a Merrill Be a Maverick?
By Michael J. Mandel
Copyright =C2=A9 1999, The McGraw-Hill Companies Inc.
Aaargh! That's the sound of yet another industry--Wall Street, this
time--running headlong into the Innovator's Dilemma, the problem first
described by Clayton M. Christensen, a Harvard business school professor,=
in
his best-selling 1997 book of the same name. Christensen's argument is
simple: When successful companies are faced with a big technological leap
that transforms their markets, all choices are bad ones.
Doing nothing is not an option, as Merrill Lynch & Co. and other establis=
hed
outfits have learned. Facing a major innovation like the Internet with a
head-in-the-sand strategy can maintain profits in the short run. Long-ter=
m,
however, market share and profits are going to be eaten away by low-cost
upstarts.
RISKY BETS. And all the alternatives have their problems. Competing with =
the
startups by adopting their technology forces an established company to
behave like a startup itself. That means making big bets on unproven
technologies and markets that never may be capable of producing decent
earnings. Of course, venture capitalists make such risky bets all the tim=
e,
since they are prepared to accept big losses in exchange for the chance o=
f a
big gain. But at most established companies, managers, workers, and
stockholders are not ready to take such enormous risks. Or Merrill could =
try
and take a middle path--as it is already doing. Its latest plan calls for
offering low-cost online trading, while still using its existing brokers =
to
provide high-margin financial planning services. Such a fence-sitting
strategy may mean getting the worst of both worlds, since it keeps the hi=
gh
cost structure of the established company while simultaneously incurring =
the
enormous new expenses of setting up large-volume online trading. Indeed,
Christensen's conclusion is that it is very difficult for an existing
successful company to take full advantage of a technological breakthrough
such as the Internet--what he calls a ''disruptive innovation.'' Instead,=
he
argues that the best way to cope is to set up a completely separate
organization that can function as a startup.
Despite his depressing message, Christensen's book is drawing enormous
attention these days from top managers. In part, it's because he does not
blame the problems of established companies on stupid decisions by
executives. Rather, he explains how the habits that led to success make i=
t
tough to deal with new technologies. For example, successful companies ar=
e
usually very good at listening to what their customers ask for and then
delivering it. But a disruptive new technology changes the customer base.=
In
Merrill's case, online trading will bring in new customers with different
needs and requirements than those of its existing full-service customers.
What's more, under traditional planning processes, it's impossible to
justify enormous investments to compete in small, yet-to-be profitable
markets. Christensen writes: ''Investing aggressively in disruptive
technologies is not a rational financial decision for [established
companies] to make.'' The trouble is that by the time the new markets are
large and profitable enough to justify the investment, they are already
occupied by entrenched competitors. Merrill, for instance, is offering it=
s
retail customers low-cost online trading only after Charles Schwab & Co. =
and
E*Trade Group Inc. established themselves. Unfortunately, there is no
guarantee as to when a new market or a new innovation will be profitable-=
-or
whether it will make money at all. ''Not only are the market applications
for disruptive technologies unknown at the time of their development, the=
y
are unknowable,'' notes Christensen.
To be sure, a well-run established company can still survive a wave of
disruptive innovations, and perhaps even prosper. But if Christensen is
right, the spoils of the New Economy will go to the companies and people =
who
are willing to think like venture capitalists. That's not an easy thing t=
o
ask of managers who have succeeded by taking prudent risks with their
shareholders' money and following the wishes of their faithful customers.
It's a dilemma.
recommended - on-line reviews of the book at www.amazon.com
Tushar J. Mehta
email: [email protected]