Creating and Sustaining Profitable Growth Clayton M Christensen

Creating and Sustaining Profitable Growth Clayton M. Christensen Harvard Business School

Principles we’ve taught that aren’t universally true • Listen to and respond to the unmet needs of your best customers • Focus investments in those opportunities that promise the most attractive profit margins • You should ignore fixed and sunk costs, and make investment decisions based on future, marginal outlays and revenues • Large markets represent the biggest growth opportunities • Understanding the customer is key to successful innovation. • Outsource those activities that are low value-added that are not your core competencies © 2007 Innosight LLC 2

Market Understanding that Mirrors how Customers Experience Life “The customer rarely buys what the company thinks it is selling him” - Peter Drucker © 2007 Innosight LLC 3

Three levels in the architecture of a job What is the fundamental job or problem the customer is facing? This includes its political, functional, emotional and social dimensions. § • What are the experiences in purchase and use which, if all provided, would sum up to nailing the job perfectly? ► The “HIRING CRITERIA” – The factors that constitute the basis for choosing one “job candidate” over another. - What are the product attributes, technologies, features, etc. that are needed to provide these experiences? © 2007 Innosight LLC 4

When companies segment their markets by job, they find… • The market is much larger • Their share is smaller • Their real competitors aren’t in their product category • Growth potential is greater, because nonconsumption is usually a major competitor • They understand the constraints that keep more customers from hiring their product for the job(s) © 2007 Innosight LLC 5

What is a business model, and how is it built? PROCESSES: PROFIT FORMULA: Assets & fixed cost structure, and the margins & velocity required to cover them THE VALUE PROPOSITION: A product that helps customers do more effectively, conveniently & affordably a job they’ve been trying to do © 2007 Innosight LLC Ways of working together to address recurrent tasks in a consistent way: training, development, manufacturing, budgeting, planning, etc. RESOURCES: People, technology, products, facilities, equipment, brands, and cash that are required to deliver this value proposition to the targeted customers 6

Disruptive Innovations: A driver of leadership failure and the source of new growth opportunities Performance Incumbents nearly always win s on vati in a t s Su Disruptive innovations no n i ng of al c e i c g Pa nolo h Tec gress Pro i customers t a th e c n a rm o Perf sorb can utilize or ab Entrants nearly always win Time © 2007 Innosight LLC 7

Beat competitors with asymmetry of motivation % of tons Steel Quality 25– 30% ra g e ed t m f yo m t li ua Q 1975 © 2007 Innosight LLC 18% eel Structural St l o il ty c u rod a Qu Sheet steel el e st ’ ills nt i f 55% ll-p i m ed e ste 12% 22% 8% rs & rods a Angle iron; b ini Rebar 4% 7% 1980 1985 1990 8

Expensive failure always results when disruption is framed in technological rather than business model terms. Performance Tabletop Radios, Floor-standing TVs Different measure Of Performance Path taken by vacuum tube manufacturers Time Portable TVs Pocket radios or Hearing Aids s er g um min s on nsu c - o on n-c ons N o si N cca © 2007 o Innosight LLC Time 9

Getting the team structured properly is a critical step in every innovation project Level of change Product Process Business model in which product is used Business model in which process is used Product architecture: what components interface with other components Process architecture: What are the steps in the process, and what is their sequence? Team Type VP VP VP VP Autonomous Business Unit Heavyweight Team Specifications for how components must fit together How must the steps in the process interface in time and space? Lightweight Team Improve performance of each component Improve individual steps in the process Functional team © 2007 Innosight LLC VP 10

Performance Integrated firms have the advantage when products aren’t good enough. Focused firms overtake over-served markets. Compete by improving functionality & reliability res u t c ite rch a y t, en d en ep tar e i r p o pr erd es r tu Int c ec t i h la r ra M u od Compete by improving speed, responsiveness and customization Time © 2007 Innosight LLC 11

Changes in product architecture have profoundly changed the architecture of the computer industry 1960 - 1980 - 1990 Teradyne, Nikon, Canon, Applied Materials, Millipore, etc. Equipment Monsanto, Sumitomo Metals, Shipley, etc. Materials Intel, Micron, Quantum, Komag, etc. Sales & distribution Field service © 2007 Innosight LLC Apple Computer Applications software IBM Assembly Control Data Product design Digital Equipment Components Operating system 1990 - Present Micro. Center Compaq, Dell, Gateway, Packard Bell Compaq Contract assemblers Microsoft Word Perfect, Lotus, Borland, etc. Comp. USA Dell Independent contractors 12

Integrated companies with proprietary products typically commoditize their suppliers Performance Commoditizer Commoditizee IBM Applied Magnetics General Motors Dana Corp. P&G Dow Corning es r u ct ite h c r t. A en d n pe e d er Int la u d es r tu c rc A r e hit Mo Time © 2007 Innosight LLC 13

The law of conservation of attractive profits De-Commoditization: services & products that make use of the product more effective Add features Commoditization thru modularity, over-shooting Copy features De-Commoditization: sub-systems that drive the performance of the modular product © 2007 Innosight LLC 14

Outsourcing often sets in motion disruptive business model liquidation Compaq Flextronics Brand Product design Supply chain & logistics Computer assembly Mother boards Simple circuit boards © 2007 Innosight LLC 15

Outsourcing often sets in motion disruptive business model liquidation Customer Supplier IT departments TCS, Infosys, Wipro Auto companies Tier One Suppliers IC companies Fabs: TSMC, UMC Commercial banks State Street, First Data Wall Street Analysts Bloomberg © 2007 Innosight LLC 16

The common methods of financial analysis systematically bias managers against innovation Magnitude of cash flows + - Foreseen cash flows from investing in an innovation Present cash flows: The base case of doing nothing DCF and NPV methodologies implicitly make this contrast Time Returns from innovation realistically must be contrasted to the deteriorating stream of cash (and share price) likely to result from doing nothing

Steel Quality Evaluating investments on marginal rather than full costs biases incumbent leaders to leverage what they have, instead of building what they need Existing Minimill Marginal Price $350 Cost 340 285 15 Net 10 65 335 ra g e ed t f yo m t li ua Q 1975 © 2007 Innosight LLC 55% Sheet steel m 18% eel Structural St l o il ty c u rod a Qu 25– 30% el e st ’ ills nt i f % of tons ll-p i m ed e ste 12% 22% 8% rs & rods a Angle iron; b ini Rebar 4% 7% 1980 1985 1990 18