Disruption is such an overused buzzword. But the word itself does have meaning: As defined by the Oxford and Merriam-Webster dictionaries, it is a “disturbance…that interrupts an event, activity, or process” and that causes something “to be unable to continue in the normal way.” It’s also the name for an influential theory about innovation first coined by Clayton Christensen in a 1995 article and later publicized through his 1997 book, The Innovator’s Dilemma.
But that was nearly two decades ago! Not only has the concept been much misunderstood and mangled since then, surely it’s changed given the advent of new tech and business models today? Is it still relevant, given cases that seemingly defy the theory and its application? Are we at risk of overfitting this “verbally inflated” term to everything, and in doing so, are we missing what disruption theory really says — and doesn’t?
Michael Raynor, co-author of the followup book on disruptive innovation with Christensen — and author of another book that later tested the predictive power of the theory — joins this episode of the a16z Podcast, in conversation with Sonal Chokshi, to answer these questions and more. He also hints at some nuggets from an upcoming article in Harvard Business Review with Christensen and others that addresses the latest formulations of this theory of innovation.
- What disruption theory is, and how it’s been misunderstood [0:34]
- Popular examples of “disruption” that do not conform to the formal definition [10:23]
- The difference between disruption and innovation [24:42]
Sonal: Hi, everyone. Welcome to the “a16z Podcast.” I’m Sonal Chokshi, and today we have as a guest on the pod Michael Raynor, who is a director at Deloitte Services and a co-author on one of the seminal books on disruption, with Clayton Christensen, “The Innovator’s Solution.” Raynor also later wrote a book called, “The Innovator’s Manifesto,” which is one of the very few works out there that actually tests the predictive power of disruption theory. We invited Raynor on the podcast today, since he, Clayton Christensen, and Rory McDonald have a new paper coming out this December in Harvard Business Review, defining what disruption theory is and what it isn’t. Welcome, Michael.
Michael: Thanks. It’s great to be here.
Sonal: Thank you for coming. So, actually, why don’t we just jump right in, and let’s just start with talking about what disruption is. And I think it’s come top of mind, because there’s been a lot of articles written in the last year that, sort of, slam it. And, to be clear, I think people are slamming both the word, because it is very overused, and I think part of it is also slamming the theory, which is what we’re talking about here — disruption the theory.
Michael: Yeah, I mean, as I read it, I’d say it’s even more than part of it. I mean, there have been a couple of critiques that have come out. There was a piece just over a year ago in the New Yorker that was very pointedly about Clayton and disruption theory. There’s a piece [that’s] come out recently in the Sloan Management Review that’s similarly, sort of, an attempt to look at the theory and say, “So, here’s where it goes too far, where it makes mistakes, where…” And I think that’s important, actually. I mean, that’s how we progress, right? Constantly saying we got it right the first time doesn’t take you anywhere new. Conceptually, at least, it’s easy to embrace that kind of give and take, that kind of discussion.
Sonal: Yeah, no, I think that’s great. What was the gist of the critiques? I mean, I agree that conceptually, it’s important to have that kind of — but what were people, sort of, slamming about the theory?
Michael: Yeah it’s — I guess, in the first instance, they were going after a phenomenon that I think is definitely something worth trying to, I’ll say, combat at the risk of overstating the case. Which is that the term “disruption” I think has come to be used far too frequently with far too little precision, and I think that’s unfortunate. I mean, in the first instance, disruption is a well-formed English word. You can look it up in the dictionary, right? But when people use it, especially when it comes to — in a business context, they forget what the word actually means. So, disruption means to hold up something, to slow it down, to interrupt an otherwise smooth and even flow. So, a disruptive student is not something that makes class better. That’s someone who makes class worse. A disruption in subway service doesn’t help you get where you want to go better or faster or cheaper.
Sonal: Yeah, you’re right. It doesn’t have a positive connotation at all.
Michael: It’s just a bad thing, but people that’s not what people say. People say, “Oh, you know, this company is disrupting things.” And that’s supposed to be good. So, when they say that, they’re invoking — whether they know it or not, they’re invoking the connotation that Clayton gave to the word, with disruptive innovation and disruption theory. But unfortunately, they’re using it, then, in a way that is, to my way of thinking at least, more often than not entirely disconnected from the specifics of what disruption theory actually describes. So, we’ve run into a circumstance where people use the word very frequently to describe all manner of phenomena. And the downside of that and this — and here’s why this matters — the downside of that is that as a consequence of that verbal inflation, we actually lose our grip on the power and the insights that disruption theory brings, and that would be a shame.
Sonal: I totally agree. And I think that’s actually a great turn of phrase — verbal inflation — and one could argue it’s a disruption bubble. When Clay originally coined the phrase — used the word “disruption theory” — like, what was the intent behind the original meaning?
Michael: So, his first book came out in ’97. It was called “The Innovator’s Dilemma,” and it started slow. It came out in ’97, sold, you know — I’ll get these numbers precisely wrong, but close enough, close enough. Sold a few thousand copies over the next couple of years, and then it exploded in 1999. I think it was the January issue of — I think it was the cover of Forbes, and it had Clay with Andy Grove. Caption read, “Andy Grove’s big thinker.” And Clay is 6′8″ for those people who haven’t met him, and Andy Grove is probably, I don’t know, 5’6” so it was a clever turn of phrase.
In any event, then the book took off. And what that book described is a particular class of phenomena whereby companies are able — small, under-resourced startups, very often — are able successfully to enter markets that are dominated by well-managed incumbents. And so, that was a puzzle. How is that possible? How does this small, you know, scrappy, little upstart — how is it able to successfully overturn a successful incumbent? And so, Clay chose the word “disruption” to describe that phenomenon. And it captures half of what’s going on, right? The disruption is to the incumbent, and it describes a very particular pathway by which a startup and a new entrant, more generally, is able to enter an established market.
Sonal: Right, and if I remember correctly and, actually, I remember learning this from you a few years ago. It’s, sort of, the startup comes, in traditional disruption theory, from the lower end of the market, usually with either lesser features, or just reaching a niche customer set that no one is otherwise reaching. And then the other part of it, the second part of it, I remember, was really key — is that there’s some kind of accelerator through technology that then drives them to be able to go upmarket.
Michael: So, this notion of what you call an accelerator, what I refer to as an enabling technology — what Clayton has referred to as an extensible core. So, the fact that the language hasn’t quite settled down shows that this is a relatively new addition to the theory, but I think a critically important one is one that a lot of people have walked past and fundamentally ignored.
Sonal: Right. Are they able to ignore it because they’re just, sort of, fitting the theory to everything? Or is it because you don’t actually require that accelerant in order to reach that sort of quote disruption?
Michael: No, I think it’s a necessary condition. You don’t have that, you don’t have a disruption. So, you pointed to a couple of things, which is that a disruptor starts at the low end, a niche market. That’s a defining feature. There are really three necessary and sufficient conditions, right? The first one that we pointed to was where you start. So, first and foremost, disruption theory is a theory of customer dependence. You tell me who you’re selling to, and I’ll tell you whether you’re embarking on a potentially disruptive trajectory of innovation. So, disruptors start in segments of the market that incumbents aren’t motivated to fight for, or fundamentally don’t see. So, we refer to that as either the low end, or an entirely new market competing with non-consumption. So, that’s step one.
Second is, you have to have a fundamentally different business model that allows you to serve profitably the niche that the incumbents don’t want. There’s a reason the incumbents don’t want to serve those niche markets — because they can’t do it profitably enough, right? And so, you have to come up with a way to serve those segments profitably. If they lose money there, and you say, “Well, I’ll go lose money there too,” that’s not gonna be a disruption. That’s just losing money. So you have to have a different way of serving those segments. Then the last piece is this enabling technology. It’s something that allows you to now take that same business model and begin to serve the mainstream markets that the incumbents do care about. But now it’s too late, because the incumbents can’t respond, because you have broken the trade-offs that they were depending on. The trade-offs that made it impossible for them to serve the low end, you have now broken.
Sonal: So then what has changed today? Because one of the observations that I have, and some of this is definitely anecdotal, is that there seems to be — it seems to be happening a lot faster, for one thing, because of “software eating the world.” There are arguably new patterns. I mean, I’d love to hear your thoughts on this.
Michael: So, I guess what I’d say is that when it comes to things happening faster, that speaks to the rate of change in the underlying enabling technology. So, if you look at disruption in the steel industry, right, how long did that take? So Nucor is the archetypal disruptor in the steel business. Where did it start? It started with rebar, which is a low-volume, low-margin segment of the steel business that incumbent steel makers were not motivated to defend. Nucor built a fundamentally different business around the mini-mill, and then it took 43 years for Nucor to become the same size as some of the largest integrated mills in the U.S.
So, why did it take 43 years? Well, it took 43 years. What was Nucor’s enabling technology? Well, it was electric arc furnaces and continuous casting. And those big iron — both, literally and metaphorically — those big iron technologies improve relatively slowly. They improve on a mechanical clock speed, and so it took 43 years. And then you look at disruptions in the tech space, and you say, “Well, what about the personal computer?” So, the personal computer is clearly a disruption to mini computers and mainframes for all the same reasons. Started as toys, sold to hobbyists that couldn’t do anything. What was the enabling technology there? Well, it was the microprocessor, and the microprocessor — that gets better pretty quick. The difference is not the underlying phenomenon, nor the theory — it’s an empirical observation. Which is, how fast does the enabling technology get better? That will tell you how quickly it will break the trade-offs that preclude it from serving mainstream markets.
Sonal: Actually, I’ve actually heard from Alvy Ray Smith, the co-founder of Pixar, that they used that exact formula in their head to actually then map out how they would intentionally disrupt the making of animated films.
Sonal: Because they were able to actually use it to, like, almost predictive power in a sense.
Michael: Part of the reason that I find disruption theory so powerful is that now when people say, “Well, this is completely different because it’s so much faster,” I’m like, “Actually, no, it’s not completely different. It is a quantitatively different outcome, but it is qualitatively the same phenomenon.” We can use the same theoretical toolkit to understand what’s happening. The specifics are different — that’s why we play the game — but we can use the same theory to understand and, to your point, predict and maybe even control.
What disruption theory is not
Sonal: So, speaking of prediction, you know, again — you’re one of the few people who actually applied and studied the predictive power of disruption theory. What are some of your high-level findings from that work?
Michael: “The Innovator’s Manifesto” came out in 2011, and it was an attempt to do, as you say, to actually use the theory to predict outcomes. And it’s tricky. It was a lab experiment, and it was done using MBA students largely. I’ve had a chance to replicate it using executives now, and have achieved essentially the same results.
Sonal: Oh, that’s good to hear so that reproducibility… <crosstalk>
Michael: Right, exactly, yeah. Although the executives weren’t too thrilled to hear that they weren’t doing any better than the MBAs but, you know, sometimes the truth hurts. And we did that using a portfolio of businesses that had been launched by Intel over the years. And it was a randomized, double-blind, you know, study to say, “Right, we went to the MBAs and gave them a bunch of business cases and said ‘Pick winners and losers’ and then we taught them disruption theory, and we said, ‘Now, try it again.'” And I’m glossing over all the details that make the findings, I hope, believable. But what we found is that the users of disruption theory improved their accuracy by up to 50%. That said, in absolute terms, we have to be modest. Their success rate was around 10% at picking winners, and it was about 15% picking winners with disruption theory, because it’s a big, noisy world.
Sonal: And you also have a sample set that’s an internally captive VC arm, essentially, a venturing arm that’s inside a company.
Michael: Right. All kinds of delimitations. You know, my experiment, you know, like, every other has its share of imperfections. But to your point, it was an attempt to actually try and take seriously the notion that the theory can be used to predict, and I found the findings encouraging.
Sonal: We do have a tendency. You know, I think the predictive power matters, because there are entire businesses built upon this theory, and some of them which have become incredibly successful. One question we have is — there’s a tendency to, kind of, equate technology means disruption. Just sort of, you know, to over-apply and overfit the phrase to everything. So, what is disruption theory not? Like, what’s not disruption theory then, to help people kind of understand what it is?
Michael: That’s a great question. In fact, both Clayton and I and another professor at HBS named Rory McDonald have a piece coming out in the December issue of the Harvard Business Review that tackles that.
Sonal: Oh, give us the early preview.
Michael: Yeah, exactly.
Sonal: That’s why I want you to tell us all your secrets.
Michael: Sure. Well, I’ll give you an example. It’s — and I’ve asked this question at various conferences and workshops I’ve been part of — I ask for a show of hands. How many people think Uber is disruptive? Every hand in the room goes up.
Sonal: Ours included. One of ours went up.
Michael: Yeah, exactly. And it’s not. In fact, it’s the…
Sonal: So why?
Michael: Well, let’s review the theory, right? I mean, disruption theory is, first and foremost, a theory of customer dependence. Whom are you selling to? So, whom did Uber sell to? Was it selling to a niche of the market, the low end of the taxi market that established taxi simply couldn’t be bothered to serve? Was it selling to people who found hailing a cab and paying for it so inconvenient and so expensive that they just had never used cabs before? No.
Sonal: So, it’s not capturing that different consumer market, right.
Michael: They were going after, and continue, for a large part of the business, to go after folks who want a cheaper, more convenient, cleaner, nicer cab ride, right? There was an article in Businessweek — again, I think I’m remembering this largely correctly — and it was stating that Uber had gone from — again, close enough, close enough — 350,000 rides a month in Manhattan to 3 million rides a month in Manhattan. And over that same period of time, what do you think the drop off in yellow cab rides was? Son of a gun, about 3 million rides a month.
Sonal: So, ride-sharing is clearly a huge market, but you’re saying that because they’re competing with the same exact customers as the taxi industry, it doesn’t count on that one criterion, so far, as disruption.
Michael: Well, exactly. And so, remember, what disruption describes is a pathway — a particular way in which a small under-resourced entrant can succeed against well-managed, dominant incumbents. So, it’s a pathway. It’s not a description of your impact on the established market, which is how people have tended to use it. Say, “Oh, Uber is disruptive because it’s turned the industry upside.” Well, it has revolutionized the industry. It has had a huge impact on the industry. It is not…
Sonal: But it’s not technically disruption.
Michael: Well, but you say that as if somehow it were a minor distinction.
Sonal: No, right.
Michael: Yes, it’s not technically — it’s not disruption and that matters, because if we think it’s disruptive, then other folks who want to pursue a disruptive strategy will think, “Well, I need to do what Uber did…” What did Uber do? Uber did something that, to my mind, at least, is a fairly long-odds proposition. Which is, they just built a better mousetrap.
Sonal: So, that’s interesting, because one of the theses that one of our partners put forth a couple of years ago is something called the full-stack startup, which — you know, he sometimes jokes about how he regrets even calling it that, because it’s sort of like an analogy…
Michael: You should talk to Clay about regretting having called disruptive technology.
Sonal: Oh, I know, right. Clay is probably the one who has a lot of regrets around those things. But the way Chris Dixon articulates the thesis is that, in the past, companies like Lyft and Uber would have tried to build software and then sell it to the taxi industry. But there weren’t even people in the industry who could even have the skill set, let alone to appreciate the software — to evaluate that software and actually say, “Okay, this is what’s going to help us with the problem we have.” Nor were they incented to solve for that problem.
And so, he argued that instead of trying to go down that path, there’s been a new wave of startups that’s actually been able to “disrupt” — and, yes, I agree, this is not in the technical form of disrupt, but now I’m using it as more of a descriptive adjective — that they’re able to overturn and shake up, so to speak, the taxi industry, because they built something full-stack. Like, from end to end, so they can control the entire experience. And by doing so, they essentially stopped trying to sell their software to the taxi industry and just built an alternative. Like, to your point, a better mousetrap.
Sonal: Yes. They built a better mousetrap, and as Emerson said, the world beat a path to their door. In fact, they probably took an Uber to their door.
Michael: Right. But I do wanna just protest for a second, Michael, because I’m having a really hard time letting go of this belief, and you’re gonna have to convince me a little harder.
Michael: You and everybody else, I’m sure.
Sonal: Right, I am. I’m fighting it. But the reason is because it does feel that — what if it means that disruption theory could be adapted for the software world?
Michael: Well, no, it’s a different phenomenon. And, now, when I say adapted for that — we kind of talked and touched on that earlier. If we are describing a phenomenon in which software is the enabling technology for an entrant on a disruptive path, we’re describing something that starts over on the fringes and works its way into the mainstream, with a fundamentally different business model that is powered by — and this is key — in fundamental improvements in the software over time. All of those things have to be there. And it’s important to understand that, because it feeds into the choices that you make as a manager along the way. How do you deploy resources? What R&D strategy do you follow? What customer segment do you target?
Sonal: Right. Do you build self-driving cars or not?
Michael: These are all things — so it’s important, I think, to underline that — I’m not, sort of, being picky. At least, I hope I’m not being picky here.
Sonal: No, it’s great. That’s why we wanna have this discussion.
Michael: The phenomenon you describe — that one is describing and the meanings that one attributes to these words are critically important, because they determine the choices we make. The way we use the words is critically important because, ultimately, what happens is that everything is disruptive. And when everything belongs to a category, then the category is useless.
Sonal: So then, how has the theory changed? You are already talking about what disruption theory isn’t. Are there any other examples along those lines? And I’d love to hear your thoughts about what has, sort of, updated around here.
Michael: So, I guess there’s a couple of things that I’ve observed that people have — that threatened to lead folks astray. One is, sort of, it happened fast, you know, it’s a big bang disruption. Well, no, we actually don’t need that because we have this concept of the enabling technology, and it’s the rate of improvement in the enabling technology that determines whether or not it’s a disruption. Now, there may be complete transformations of an industry that happened very quickly, for reasons other than the disruptive entry of the startups — and that’s fine. But then we need to be clear, that’s a different phenomenon.
Sonal: Even if the outcome may be the same, actually, in some cases.
Michael: Absolutely. These are, you know, to use a medical analogy, these are different conditions, and you need to get the diagnosis right. So, that’s fine. The other thing that I think leads people astray is the notion of — and you hear this, you know, kind of, top-down disruption — and people will point at Tesla, and they’ll say, “Tesla is a — they’re disrupting the car industry, but they’re doing it from the top.”
Sonal: So, they’re not disruptive.
Michael: They’re not disruptive at all.
Sonal: Okay, so let’s talk about why.
Michael: Well, same reasons, right? Was Tesla targeting a small, unprofitable, unattractive segment of the car market that was of no interest to incumbent car companies? No, they’re targeting people willing to spend 100 grand on a car, which is very interesting and important to companies like Mercedes and BMW and Lexus and, and, and…
Sonal: Right. But it was an underserved market, in the sense of — those folks were not having a car that has software at its center.
Michael: No, no. They weren’t — you think they didn’t have a car?
Sonal: Of course, they had a car.
Michael: Well, then they were consumers.
Sonal: No. Okay, I’m gonna fight this one too. Again, this is different because, yes, you’re right. They would have bought another car. They would have been — they are the typical segment for other car companies, so that’s not a new market in that sense, but they weren’t having — their needs were not being met.
Michael: They were underserved?
Sonal: They were underserved.
Michael: Absolutely. And that’s the sustaining innovation. Disruptive innovations target overserved customers.
Sonal: There we go.
Michael: Customers for which established solutions are too good, too expensive, inaccessible.
Sonal: Okay. So that’s another precision thing that helps us define what disruption is and isn’t.
Michael: So, Tesla goes after a critically important segment of the market, and shows up with, you know, its own version of a better mousetrap and appeals to those they’re willing to buy, and away we go. And so, in fact, if I were to point to somebody that explains the path that Tesla appears to be following, I point to Jeff Moore in “Crossing the Chasm.” As I read it, the way you cross the chasm is that you find very demanding customers, and you create a highly effective solution that solves their problems really well. And then, basically, you ride a cost-reduction curve into the mainstream, right? So, you find the really demanding, early adopters. In a sense, it’s an adaptation of Everett Rogers’s diffusion theory.
Sonal: That’s actually where the whole “Crossing the Chasm” thing actually was hinged on?
Michael: Yeah, so you find those really demanding early adopters, you solve their problem because they’re demanding, they’re willing to pay, you use the profits that you generate from serving those high-demand, very profitable, early adopter customers, and then there’s a lot of things you have to do in order to cross the chasm into the mainstream. That’s completely different from what disruption describes. Disruption describes a very different path from the fringe to the mainstream.
Disruption vs. innovation
Sonal: So, so far, we have Uber and Tesla, which a lot of people — including me, apparently — thought were disruptive and really aren’t. So, are there any examples where the company is actually disruptive but no one really knows it is?
Michael: Well, that I can’t speak to, but you’ve probably heard of Theranos.
Sonal: Of course.
Michael: So, I would look at that one, and here — I’ll probably run out of facts sooner than I should. My understanding there is that they’ve created a whole series of blood tests that are able to give a high level of accuracy at very low expense and very low inconvenience. The way I think about that is that it’s an innovation, because it has broken trade-offs. And something that I think gets in the way, is that when we think about disruptive innovation, we can’t separate disruptive innovation from any other type of innovation, because we don’t have the larger class defined. So, an innovation for me is anything that breaks a constraint.
Sonal: I love that definition, by the way. I’ve actually stolen and used that definition for years since reading your book. I just want to tell people publicly — that that wasn’t my idea. I want to just confess.
Michael: Coming clean after all these years.
Sonal: I actually did credit you, in fairness, but I am gonna say that that is, I think, by far the best definition of innovation I’ve ever heard. I really mean that.
Michael: Well, thank you. We can stop here. So an innovation is anything that breaks a constraint and disruptive innovation is a particular path, right, from not being able to break those constraints to having broken them in the mainstream markets. So, when I look at Theranos, my understanding of it is that their solution right now is kind of — is more for less. They’re having difficulty, I think, finding adoption in, you know, mainstream hospital labs, and so they’re actually finding their foothold, their first commercial applications in clinics and drugstores and relative — essentially, if you will, on the fringes of the core mainstream blood testing market. So, you have something that is — that has broken certain constraints and is following a path from the fringe to the mainstream. What I don’t know enough about is whether there’s, at that core, the enabling technology that is going to allow the “Theranos solution” to, in scare quotes here, improve to the point that it can penetrate mainstream markets.
Sonal: Got it.
Michael: And this is important, because if it’s there already, right, if it’s already more than good enough, right, for those applications, then what we have is not bona fide disruption, what we have is a marketing strategy.
Michael: The need to start at the fringe and move to the middle. And so, the kinds of things they get caught up is people say, “Well, it started small and got big.” Well, that doesn’t make you disruptive. That just means you started small and got big. Almost nothing big starts big.
Sonal: That’s actually a good point.
Michael: Right? And so all of these other characteristics — when people say, “Well, it started small and got big and it revolutionized the industry, therefore, it’s disruptive.” Holy non sequiturs, Batman, none of those things have anything to do with whether or not you’re following a disruptive path. Disruption can be used very precisely, and it describes an important class of phenomena, but it’s not a theory of everything.
Sonal: Got it. So, let’s actually then take on the elephant in the room and talk about — and, again, I don’t wanna make this about Clay. I know we both have immense respect for him. But people often argue that he was wrong about the iPhone. And, I mean, I’ve made the argument. I know others have made this argument, that it was a category error. That he just got the category wrong for what he actually thought it should be when it was something else. What’s your, sort of, take on, sort of, why that did actually apply or didn’t apply in that case?
Michael: Sure. So, I think — and this is a subtle but critically important distinction to make between what I’ll call the cross-sectional problem and the longitudinal problem, right? So, Apple showed up with the iPhone in the mobile phone market with a better mousetrap. Apple did not enter the smartphone market disruptively. And, again, why do we say that? Let’s see. Whom are they trying to sell the iPhone to? People who had phones, right? People who wanted a better phone, right? People who wanted a phone that could do other stuff, right? It’s not as though they were appealing to a niche market…
Sonal: For underserved customers, right, exactly.
Michael: …that established phone makers said, all of them, “Apple can have them. We don’t really want those customers anyway. Who needs 18 million more customers?” Of course, right? So, they were selling to customers. And Clay, I think, was absolutely correct in the way in which he applied the theory. He said, “Look, the data say pretty clearly that if you kind of walk into a bar and punch the biggest guy there, you’re in for a fight, and chances are you’re gonna lose.” That’s not what happened, right? So Apple, in my view, beat the odds in the way that if Tesla is ultimately successful, Tesla will have beaten the odds, and that’s fine, right? That is a class of phenomenon that needs a theory to explain it. How is it that some companies enter well-established markets and prevail when that’s such a long-odds proposition?
Sonal: As you know, like — folks like Ben Thompson, John Gruber, myself — others have made the argument that it was disruption, but because it was a disruption to the PC industry.
Michael: But that’s the longitudinal problem. The cross-sectional problem is how did they enter the smartphone market? They entered it with a sustaining innovation, and it worked. Good for them. Now, how did they realize growth out of that? Well, they were busy racing up the disruptive trajectory displacing the personal computer. Terrific. Every company is playing both games at the same time. They have to be winning the cross-sectional battle they’re in…
Sonal: As well as gaining points for the long game, yeah.
Michael: We’ll go back — you know, sometimes with the benefit of, you know, the perspective that history provides. <Hindsight.> I’m not reinterpreting — if you look at say, Xerox and personal copiers.
Sonal: Right, we talked about this a few years ago.
Michael: Absolutely. This is near and dear to your heart, I know. So, the early personal copiers, they had a cross-sectional battle to win themselves. They were competing with carbon paper and Gestetner machines. So, they were more expensive than those — so they had to be better, right? They had to win the cross-sectional strategic battle for the niche market that they wanted. Now, it was niche to Xerox, but it wasn’t a niche market to the folks who made carbon paper and Gestetner machines, so the personal copiers had to win that fight. Right? And then they followed the disruptive path into commercial applications for photocopying technology. And, by the way, you need a different toolkit to understand how to win that cross-sectional battle. That’s a strategy problem, right? Strategy is about the constraints you embrace. The innovation problem is about the constraints you break, and you need a different toolkit to understand that. And I think a very powerful tool in that toolkit is disruption theory, and there are other tools — diffusion theory, crossing the chasm, there are others.
Sonal: So, another thing that people tend to equate when it comes to disruption — and this actually comes up in the case of the iPhone that we were just talking about — is that disruption equals money. Clearly, not all wildly successful products are disruptive. Is that true the other way around?
Michael: Yes. So, if disruption were defined as being successful, it would be useless as a theory.
Sonal: That’s a good point.
Michael: Right? And so there are any number of efforts that have tried to follow disruptive paths that have ultimately failed. We’ll go back to the core research that led Clay to create or discover the theory, depending on how you think about these things, in disk drives. So, each subsequent generation of disk drives — you start out with, you know, the Winchester drives, and then the eight-inch drives, and then the five and a quarter and then the three and a half. And with each generation of disk drives, there was a ravenous horde of companies that were seeking to deliver that new generation of technology, all eager — and, in fact, quite ably — following the disruptive path. And guess what? Not all of them succeeded. Some did, some didn’t. Back to my earlier observation — they have to win the cross-sectional battle as well as the longitudinal one.
Sonal: The longitudinal one, right.
Michael: And disruption theory doesn’t say anything about that. That’s not a shortcoming of the theory. That’s not, as they say around here — that’s not a bug, that’s a feature. Right? Because it’s not a theory. Theories are powerful when they have boundaries, when you know what phenomenon they are used to describe. It’s like an antibiotic. If you take antibiotics when you got a cold, you’re actually doing yourself harm. And the same goes for any good theory, right? If you start applying it when it doesn’t apply, you’re highly — in fact, you are more likely to make the wrong decisions than if you just didn’t use it at all.
Sonal: We have a lot of entrepreneurs in our audience, and I want to make sure that they — you know, that we’re not just talking theory, that there’s something concrete that we can do with this information. How do you resolve the tension between this — you know, if you’re focusing on the long game, the longitudinal battle, how do you, then, address, sort of, the cross-sectional reality that’s right in front of you?
Michael: Yeah, so that I would put in a category of a strategy problem, right? How do you actually create a strategy? How do you embrace different trade-offs in a different way from your competition, so that you’re differentiated in a way that customers find valuable? The good news is that there, once again, there’s a long stream of both scholarship, theoretical and applied, that seeks to tackle that problem. I’ve tried to make my own contribution to that body of work as well. In 2013, my book, “The Three Rules” came out with my co-author Mumtaz Ahmed, and that was an attempt to try and unpack — what does it take to win in the here and now? When you face trade-offs, which trade-offs should you embrace, and how do you go about remaining committed to those choices over time?
Sonal: How do people decide to make those trade-offs? Like, what should they know?
Michael: Better before cheaper, revenue before cost — and there are no other rules, if you’ll forgive me.
Sonal: That’s great.
Michael: And it’s intended to look at, kind of, the three core questions that I think define any business. In the first instance, how do you create value for your customers? And there’s basically two ways you can do that, right? You can provide superior value or you can provide lower price. And we’ve concluded that companies that deliver exceptional profitability over time focus systematically on better before cheaper. The second question is, how do you capture value for yourself in the form of profits? And here, the arithmetic of profitability is pretty straightforward, right? It’s just revenue minus cost. Guess what? Companies that deliver superior profitability focus on revenue before cost. And then, finally, what do you change when everything around you changes? And the answer is anything, except those first two rules.
Sonal: Oh, that’s great.
Michael: Which is why the third rule is, there are no others. So, those are rules that I think — they pass the test of being falsifiable, right? If I’d said the rules were cheaper before better, I wouldn’t be talking nonsense. There are people who actually think price-based competition is extraordinarily powerful. Look at the big discounters in any industry. What we found is the data point in the other direction. If I told you that, you know, being a cost leader is key to superior profitability, you probably think, “Yeah, that makes sense.” And it does make sense. It just happens not to be true, which is that systematically, over the long term, companies that focus on superior revenue, either through higher unit price or higher total unit volume, are more likely to deliver superior profitability than companies that focus on cost leadership.
Sonal: Yeah, I mean, just one last point on this. I think this is where the studies do get a little tricky, because we’re looking at larger data sets, but every success story — and I admit that there’s definitely a survivor bias when I make this claim I’m about to make — there’s an outlier of success that always just proves every theory. I’m thinking of Amazon, for example.
Michael: No, of course, which is why — no, no, no question, which is why it’s called “The Three Rules,” not the three laws. And here’s what we think the rules are good for — which is that some folks may be of a mind that look, “You can collect the data, analyze the data, and come up with the answer.” The data are always ambiguous, right? What data mean is as much a function of what we impose on them as what they say to us.
Sonal: That’s right. Exactly.
Michael: And so if you can’t be bias-free, because you can’t, the best you can hope for, perhaps, is to have the right bias, right? Play house odds, if you will. So, when we look at it, we say, “Look, the bias should be better before cheaper, revenue before cost.” If the data convince you otherwise, then you should go in the other direction. We’re not gonna say, “Well, I’m just going to ignore reality and follow the rules.” That would be silly. It’s better before — and note, better before cheaper. It’s not better, not cheaper.
Sonal: Right. You’re just saying how to prioritize and make those trade-offs, in that case.
Michael: Well-played. I would agree. Exactly.
Sonal: So, to wrap up a bit then let’s talk about — it’s a phrase that people here tease me about all the time — some “nuggety nuggets” that came out of your…
Michael: I can see why they tease you about that.
Sonal: I know, but I use it when I describe when we’re working on decks, like, “Where are the nuggety nuggets?” But, anyway, what are some of the nuggety nuggets coming out of your paper that you can share with us? Like, other things that, you know, are, kind of, some cool insights?
Michael: “Innovator’s Dilemma” was the first popular expression of disruption theory. It wasn’t the first. In fact, Clay’s theory of disruption was really born in his doctoral thesis. But ’97 is a long time ago, and the first article that introduced it to a popular management article was in the Harvard Business Review in 1995. So, it’s actually 20 years since disruption theory was kind of introduced. It’s not like it has been frozen in amber for that 20-year period, and so it’s important to remember that. Some of what’s happened is that people have picked up “The Innovator’s Dilemma” and read that very carefully, and said, “Okay, I’m gonna go after this.” Which is — again, that’s how we learn. That’s how science progresses. Absolutely. But it makes a lot more sense to grab ahold of the latest formulation of the theory that takes advantage of everything that’s been learned over the last 20 years.
Sonal: I know we have to read the December issue. We’ll wait. We’ll read it, but what are some of the other things you can share with us as an early preview?
Michael: One is that I think disruption has come to be used in a way that people say they are not using in a technical sense, and they do not mean to invoke Clay Christiansen but, indeed, if you use disruption to mean something has revolutionized and improved outcomes, then that’s what you’re doing, right? Because the English word means to introduce chaos, not to introduce a new and better order. Right? So when we use disruption with an innovation connotation attached to it, then disruption theory comes along for the ride. And the bad news is that when that happens, we’re back to the verbal inflation problem. We actually lose the power that disruption theory has to offer, and that’s what concerns me, right? So, my hope is to kind of — that the December piece, in part, will begin to save disruption from its own popularity.
Sonal: I love it. Saving disruption from itself. Well, Michael, thank you for joining the “a16z Podcast.” This has been a great conversation. I’m glad you disillusioned me. I’m gonna probably lose some sleep over some of those. No, I’m just joking. Not really. But, thank you.
Michael: My pleasure.
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