Monday, 25 April 2011

A little bit about Nokia's fall and more about Clayton Christensen's The Innovator's Dilemma

Clayton M. Christensen wrote a book over ten years ago, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. I first read it in 2004 as part of my studies in the Tampere Polytechnic University. Following the news about Nokia's demise I felt like reading it again.

The question Clayton Christensen presented is at the very core of any business: how come companies that were at the very top of their game eventually failed. These are the companies that dominated their markets and were hailed for their good management and yet, somehow, eventually dropped the ball in a very profound way. This very much reminds me of Nokia these days: Nokia used to be leading innovator with mobile phones, utterly dominated the markets, made billions and yet, Nokia is now in a desperate struggle against Apple and Google and is probably going to sack thousands following the co-operation deal with a former enemy, Microsoft.

A story I've heard few times (don't know how true this is) tells that Nokia had a working touch screen mobile phone some seven or eight years ago, but the back-then management did not think it had any call in the markets. Oops. Around 2004 - about three years before first iPhone - Nokia published 7710 multimedia phone with a colour LCD touch screen, but because it did not become an instant commercial success it was quickly discontinued and all the time and resources spent on the development of the technology was essentially scrapped ... until Apple came along and proved Nokia wrong.

Consider reading the following article by Mikko-Pekka Heikkinen:

But back to Christensen's Innovator's Dilemma.

Why market leader companies almost invariably fail when markets change? How come a company that had a finger so well placed on the market's commercial pulse at one time so easily flatlines in the next generation market? Christensen writes that
Precisely because these firms listened to their customers, invested aggressively in new technologies that would provide their customers more and better products of the sort they wanted, and because they carefully studied market trends and systematically allocated investment capital to innovations that promised the best returns, they lost their positions of leadership.
Now that should give most managers a pause. They are doing things exactly right and then, somehow, it turned out to be the completely wrong thing? Well, yes and no. No, because they in fact did do the right things at the given time and situation and yet, yes because they failed to understand that their status quo would not be permanent. The decisions they did while everything was going so well prevented them to come up with the next good thing.

Christensen talks about sustaining technologies and disruptive technologies. The former is essentially about improved performance of established products that the current mainstream customers value. For example, ever faster CPUs or 3,5" hard-drives with more and more storage capacity: the underlying technology is the same, it just gets more efficient and often eventually exceeds what the customers actually want and need.

The latter, disruptive technologies when they emerge typically offer worse product performance when compared against products in the mainstream markets so why invest time and resources required by development? Because of this: disruptive technologies are not based on the same value proposition as the mainstream technology but instead brings forth a completely different value proposition. Initially disruptive technologies tend to be valued by few fringe customers and products based on disruptive technology are often cheaper, simpler, smaller but more importantly, more convenient to use, as Christensen puts it.

However, what is often overlooked is the fact that once technology is establised the iterations of sustaining technologies quickly catches up and then exceeds what the markets and customers really need. Therefore a disruptive technology that is underperforming today when compared to mainstream technology, is likely to be performance-competitive in the same market tomorrow. For example, consider disk-based hard-drives and solid-state hard-drives few years ago and again today.

Take a moment to think about the following quote from Christensen:
[The] conclusion by established companies that investing aggressively in disruptive technologies is not a rational financial decision for them to make, has three bases. First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits. Second, disruptive technologies typically are first commercialized in emerging or insignificant markets. And third, leading firms' most profitable customers generally don't want, and indeed initially can't use, products based on disruptive technologies. By and large, a disruptive technology is initially embraced by the least profitable customers in the market. Hence, most companies with a practiced discipline of listening to their best customers and identifying new products that promise greater profitability and growth are rarely able to build a case for investing in disruptive technologies until it is too late.
In his book Christensen presents the five laws or principles of disruptive technology stating that "if managers can understand and harness these forces, rather than fight them, they can in fact succeed spectacularly when confronted with disruptive technological change". There are no simple answers, mind you, but rather the important thing is to to attempt to understand the underlying point.

Principle #1: Companies Depend on Customers and Investors for Resources
In short, managers in successful companies tend to think that they control the flow of resources in their organisations, but by doing so they often seem to forget that those resources come from their customers and investors and if the company does not produce what the customers and investors want, they will take their money elsewhere. Christensen says it well:
The highest-performing companies, in fact, are those that are best at this, that is, they have well-developed systems for killing ideas that their customer's don't want. As a result, these companies find it very difficult to invest adequate resources in disruptive technologies - lower-margin opportunities that their customers don't want - until their customers want them. And by then it is too late.
Christensen points out that this makes certain sense as companies whose cost structures have been tailored for competing in high-end markets cannot be profitable in low-end markets as well. One possible solution? Creation of an independent organisation that can become profitable with the lower margins of disruptive technology's emergent market. This way the company can establish a beachhead in the new market while still reaping rewards from the mainstream market.

Principle #2: Small Markets Don't Solve the Growth Needs of Large Companies
Disruptive technologies usually enable new markets to emerge instead of offering better solutions for current markets. It will take time for the new markets to mature and once they have matured they tend to provide products and services that better suite the needs of the customers in the old market. At that point it is already too late for the big companies of the old market to transition to the new market and expect to maintain their market shares. In fact, they are lucky to even survive.

Why then the big companies fail to catch up with a new technology wave? After all, many of them initially started as a small company looking for their fortune in a new market. Much of this follows from the companies way of measuring success through growth: while a $40 million company can achieve 20% annual growth by coming up with $8 million worth of revenue growth, a $4 billion company would require $800 million to achieve annual growth of 20%. Because no new market can provide this it seems to follow that the bigger the company is the more difficult it becomes to see new growth potential in emerging markets.

Personally, I think big companies should see new markets as long term investment opportunities but this comes with risks that some managers just don't want to take. After all, waiting and seeing is so much more safer. I also think that Google has figured this out as it is constantly finding new growth from new markets; however, nothing lasts forever so it is likely that Google's continuing growth already contains the seeds of its eventual downfall.

Principle #3: Markets that Don't Exist Can't Be Analyzed
Probably all business schools are teaching that a proper market research and good planning based on known market attributes followed by timely and determined execution is the road to success. Christensen agrees that this is indeed how things should work - when dealing with sustaining technologies. 

The problem with disruptive technologies is that their markets are only now emerging. They don't really exist and therefore cannot be evaluated in the same way as existing markets are.
Companies whose investment processes demand quantification of market sizes and financial returns before they can enter a market get paralyzed or make serious mistakes when faced with disruptive technologies. They demand market data when none exists and make judgements based upon financial projections when neither revenues or costs can, in fact, be known. Using planning and marketing techniques that were developed to manage sustaining technologies in the very different context of disruptive ones is an exercise in flapping wings.
So a different approach is called upon. Christensen proposes a discovery-based planning which suggests that forecasts are assumed to be wrong rather than right and as such the strategies based on those forecasts are likely to be wrong as well. Instead managers should "develop plans for learning what needs to be known" as a more flexible and realistic approach to mastering disruptive technologies.

Principle #4: An Organization's Capabilities Defines Its Disabilities
Organisations are comprised of people that work in them and yet, Christensen points out that organisations have capabilities that exist independently of the people. First, there are processes as in ways of working and producing things of value. Second, there are organisation's values (which in my experience are not always the same as the ones found in PR-materials) that the organisation's managers and employees use to decide how work should be prioritised.

While people who work in the organisation can be very flexible, the processes and values usually are not. To certain extend this makes sense since a process is usually a practical result of trial and error and embody many best practices that lead to effective work. However, this is true only within certain context: Christensen points out that a process that is effective at managing the design of a minicomputer would be ineffective at managing the design of a desktop personal computer. Similarly, says Christensen, values that cause employees to prioritise projects to develop high-margin products, cannot simultaneously accord priority to low-margin products.
The very processes and values that constitute an organization's capabilities in one context, define its disabilities in another context.
Principle #5: Technology Supply May Not Equal Market Demand
Disruptive technologies, though initially can only be used in small markets remote from the mainstream, are disruptive because they subsequently can become fully performance-competitive within the mainstream market against established products.
This usually happens at a point when both the old and the new technology has exceeded in performance and capabilities what the customers actually need, so they begin to make their purchase decisions based on other values: "the basis of product choice often evolves from functionality to reliability, then to convenience, and, ultimately, to price".

The point is that market leaders tend to keep improving their products over many iterations of sustaining technologies believing that their superior products will keep competition behind them. While doing this they fail to notice that they have over-shot their original customer needs which can have an unexpected consequence in that "they create a vacuum at lower price points into which competitors employing disruptive technologies can enter".
Only those companies that carefully measure trends in how their mainstream customers use their products can catch the points at which the basis of competition will change in the markets they serve.
This was just a short introduction to Clayton M. Christensen's book so I recommend that you read it, if you found the topic interesting. The observations and lessons covered in this book are technology and market independent so in our quest to come up with the next Nokia (or preferabbly several smaller ones) there is much we can learn from it.

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