The Challenge of Disruptive Competition
The fallacy of marginal cost thinking.
Businesses in the Northwest and across
the country have traveled a relatively
rocky road over the past five years.
Many have failed or been absorbed by competitors.
Survivors have slimmed their cost
structures and focused on core businesses
and customers, re-establishing a successful
business model for the new environment. A
large number of managers have learned that
cutting marginal customers, employees, and
products has contributed to a winning strategy.
We sense in many industries a degree of
As we enter a new year, it seems appropriate
to remind business owners and managers
that today's winning strategy provides little
assurance of continued success as conditions
change. Innovation eventually impacts all
businesses and industries. The failure to detect
and respond to innovative challenges
serves as a primary reason why long-standing
successful companies end up faltering and fading
away. It is not always the emergence of a
superior mousetrap that catches everyone off
guard. Often it starts with lesser, non-competitive
firms nibbling at the margin, taking
unwanted scraps, serving those marginal customers
with a lower cost structure and inferior
products, eventually growing into a true competitor
for core customers and products.
Clayton Christensen, at the Harvard Business
School, introduced a concept in the mid-1990's that he labeled disruptive innovation.
He defined this as a product or service directed
toward a new group of customers. More
often than not, the new product is neither
technologically complex nor cutting edge. It
is generally the introduction of a product configured
in a simpler, lower-cost package than
prior alternatives. According to Professor
Christensen, disruptive competition generally
manifests itself in one of two ways:
No stronger example exists of new market
disruptive innovation than the now ubiquitous
cell phone. A new industry sprung up
and the giants of wired telephony have gone
by the wayside. Moreover, cell phones continue
to disrupt. Here is a modest list of products
that cell phones have or are supplanting:
watches, cameras, wallets, calendars, credit
cards, event tickets, maps, flashlights, notepads,
photo albums, thermometers, music
players, TVs . . . the list goes on.
Everywhere one looks in the economy
there is evidence of "disruptive innovation"
undermining the market share, and hence,
the profitability and value of well-managed
companies with longstanding track records of
stability and earnings.
- Low-end disruption encroaches on the
most price sensitive segment of an existing
market, which is over-served by established
providers in terms of quality and/or features.
The introduction of a simpler, less costly approach
attracts low-end customers. Over
time, these new competitors steadily refine
this cheap, yet functional, alternative to increasingly
garner greater defections from traditional
A classic example of low-end disruption
began in the steel industry in the late 1970's
when mini mills (e.g., Nucor, CMC) used
low-cost scrap steel to drive vertically integrated
producers (e.g., US Steel, Bethlehem)
out of the low-margin, niche rebar market. In
the ensuing years, these mini mills honed the
quality of their product and progressively captured
the much larger, higher margin markets
for structural and sheet steel. By 1990, virtually
the entire steel industry had been rationalized
- New-market disruption targets customers
in fringe markets that are deemed too
small to attract the interest of the existing incumbent
market leaders. Targeting these unserved
customers with new products/services
triggers the creation of a new market niche.
Incremental product improvements over
time lead to customer defections from traditional
market leaders. By the time the market
incumbent begins to notice defections to the
new market, it's simply too late. Market disruption
has set in.
In reality, this is merely the process of
creative destruction at work, as described by
the economist Joseph Schumpeter in 1942,
with a bit of a twist. The challenge of disruptive
competition to existing business models
is not easily thwarted. Few companies detect
the threat of disruptive competition. Often,
it is only identified in hindsight. It is Professor
Christensen's view that, "all innovative ideas
start out as half-baked propositions." Even
when it is identified early, managers of existing
market leaders often view defection of
low-end customers as beneficial. It reinforces
the conventional business wisdom—tighten
the focus on its best (i.e. most profitable) customers.
Managers seldom imagine the potential
of a completely new market. Experience
has shown that incumbent businesses rarely
overcome disruptive entrants.
Clayton Christensen, at the
Harvard Business School,
introduced a concept in the
mid-1990's that he labeled
disruptive innovation. He
defined this as a product or
service directed toward a new
group of customers.
THE CONSTRAINTS OF MARGINAL THINKING
Upon detection of disruptive threat, the
response is invariably influenced by:
The conventional bias puts forth the view
that the business has far too much invested
in infrastructure, systems and talent to move
away from a successful business model to address
a marginal competitor. Management
often fails to see that the status quo leads to
a deteriorating slope of performance as competitiveness
erodes, rather than the stable
cash flow trajectory they imagine. Future marginal
costs associated with new processes or
products might be materially less than today's
marginal costs. Upstart disruptive competitors
are not encumbered by this paradox. The
full cost and marginal costs of competing are
one and the same to them.
Henry Ford summed up this problem very
simply: "If you need a machine and don't buy
it, then you will ultimately find that you have
paid for it and don't have it."
- An unwillingness to impair existing fixed and sunk costs;
- An inability to imagine that the future dynamics will differ from the present; and
- An overweighting of the risk of change relative to the risk of failing to change.
Firms that effectively respond to disruptive
challenges pursue a two-prong approach to
addressing the genuine needs of the customer:
Maintaining a successful business over
the long haul is difficult. One must continually
look beyond the horizon to plot a course
while keeping a watchful eye in the rearview
mirror, because competitors, both new and
old, work constantly to pass you by.
- They reposition their core business to
focus on their strongest customer relationships
and competitive advantages in a disrupted
market by revisiting what the customers
value and willingly pay for.
- They concurrently develop a separate
business, with its own profit formula, that
adopts and builds on the disruptive innovations
to compete head-to-head with the new