Jim, the Boston band analogy is terrific. And agreed – when companies solely focus on cutting costs in their core business via sustaining and efficiency innovations, and neglect funding R&D for new product/service development, or as Professor Christensen terms it, a new Market Creating Innovation (MCI), there’s no conversion of non-consumers to new customers. They’re just pruning and harvesting the same fruit tree (not as good as your analogy, I know).
To seed new growth, it’s essential for companies to find their next act. Apple and Amazon have been particularly apt at doing just that. Amazon, originally just an online bookstore, expanded into all facets of retail, then pivoted into businesses such as web services with its cloud computing and storage service, AWS. And now AWS has become the biggest cloud service company in the world – bigger than its next 14 competitors combined. Amazon’s AWS is growing at 40% a year and on track to make $16 billion this year, dwarfing its online retail business. Many analysts reported that despite robust sales from their online retail business, Amazon would have actually posted huge losses were it not for AWS.
So, you’re definitely right that companies have to adopt an “expanding view” of their products and services if they hope to thrive and not just try to survive.
A really good analysis of the impact VCs have had on MCIs and the economy since 1979 (after a regulatory change known as the Prudent Man Rule allowed pension funds to invest in VC) was done by finance professors, Ilya A. Strebulaev and Will Gornall. In their paper for Stanford Business School titled, “How Much Does Venture Capital Drive the U.S. Economy?” the authors assert, “the VC industry specializes in investing in innovative companies with a huge potential for growth. Because these investments are risky and most of these companies fail, VC funds seek to invest in companies where small investments can generate huge returns. That naturally leads to a focus on certain industries. The industries most impacted by investment have been technology (for example, Apple, Google, or Cisco), retail trade (Amazon, Starbucks, or Costco), and biotechnology (Amgen, Celgene, or Genentech).
VC-backed companies play an increasingly important role in the U.S. economy. Over the past 20 years, these companies have been a prime driver of both economic growth and private sector employment. VC-style financing is not the sole reason these companies succeeded; in fact, VC was not even the sole source of financing for many of these companies….However, large and growing fractions of entrepreneurs are choosing VC financing. These entrepreneurs think VC financing is the best way to grow their companies. That makes it clear that VC is an important part of the innovation ecosystem and has helped some of the world’s most successful companies to grow.”
First, thanks for referring me to the article! A great read. I found the article contextualizes much of the Capitalist’s Dilemma and BSSE theories within healthcare really well. By looking at the “true” value vs. compensational and social values of “incrementalism” (long-term investments) vs. those of “rescue” medicine (“high-yield” immediate gains), it also addresses the problem with resource allocation, another significant factor contributing to the failure to commercialize disruptive innovations.
Very interesting point about CMS fee-for-service reimbursements. There’s an argument that CEO and investor incentives need revision if long-term sustainability and more qualitative yield are true goals. As in healthcare, industry culture and incentives as whole in many industries need review if traditional, recurring problems are to find solutions beyond band-aids.
With regard to the FDA and to your point, many disruptive innovations (wearables being among the most exciting and accessible) are indeed succeeding with a high entry bar (which healthcare seemingly should have), so does the FDA regulatory approval process need significant or any correction to benefit the marketplace?
I’m glad to see you addressed healthcare, Austin. Disruption and innovation in healthcare are of particular interest to me. It’s somewhat telling that the innovators you list are almost all India-based. It leads me to ask, could the MCIs in India be possible in the U.S. given the culture of healthcare we have here? Culture and market-creating innovation are inextricably linked. It seems a lot of healthcare innovation is stymied in the US, not so much by safety regulation (as the FDA and safety regulatory agencies are often accused of being too lax), but by 2 other factors: 1. A seemingly ingrained culture of aversion to anything that resembles socialized medicine, and 2. Conflicting ideologies within bio-ethics. While I feel it’s crucial to properly look at bio-ethics when talking about healthcare, I also feel that perspective is often skewed politically and therefore not applied objectively enough to gauge the true social benefits of a healthcare innovation. For example, I recently heard about a potentially game-changing innovation to treat severely premature births; very premature babies who, if they beat the odds and survive, often incur severe, chronic, and debilitating health issues. A new medical technology has been successfully developed to mimic the womb environment as much as possible and enable prematurely born infants to continue normal development outside of the mother’s body. The animal testing that’s been done reveals premature births placed in this artificial womb and developed to term result in near perfect health. However, the innovation could be slowed or halted due to a host of bio-ethics (could legislation arise to use this technology on aborted fetuses, could employers view this as an alternative to women needing maternity leave, etc.) So my question is, does culture in the U.S. contribute specifically to the failure to commercialize disruptive technologies in healthcare here?
On p. 214 of “The Second Machine Age” by Erik Brynjolfsson and Andrew McAfee, it reads:
“[Schumpeter] also argued that innovation was less likely to take place in incumbent companies than in the upstarts that were trying to displace them. As he wrote in The Theory of Economic Development, “New combinations are, as a rule, embodied . . . in firms which generally do not arise out of the old ones. . . . It is not the owner of a stage coach who builds railways.”12 Entrepreneurship, then, is an innovation engine. It’s also a prime source of job growth. In America, in fact, it appears to be the only thing that’s creating jobs. In a study published in 2010, Tim Kane of the Kauffman Foundation used Census Bureau data to divide all U.S. companies into two categories: brand-new startups and existing firms (those that had been around for at least a year). He found that for all but seven years between 1977 and 2005, existing firms as a group were net job destroyers, losing an average of approximately one million jobs annually.13 Startups, in sharp contrast, created on average a net three million jobs per year.”
Firm size is certainly just a correlation, but that doesn’t mean one should overlook the correlation as causality being wrapped up in there somewhere. While it may be worthwhile to study the anomalies to this pattern (i.e. large incumbents who are creating jobs), overall, it’s still seemingly disproportionately the startups/new firms which are more likely to invest in market-creating innovations that lead to job creation? Why is that? What would a study of that pattern reveal?
Great question. I would be curious if investing in MCIs is a common intention and practice correlated to steady revenue growth, or if intention is rare considering many MCI’s are accidental. Does revenue growth automatically prompt sustaining and efficiency innovations since the company wants to build on a winning formula? Investing in finding a market-creating innovation is risky, possibly costly, and time consuming. Do companies have to feel “financially secure” before pursuing an MCI? I would also be curious if there’s correlation between certain market cap valuation levels and inclination to invest in MCIs. Is there a somewhat common stage at which a company will look to invest in more innovations?
I definitely agree with you on this, Ishan. The embedded and sustained culture is certainly an influential aspect of the investment decision making process. It seems sensible that managers would pursue sectors with which they’re familiar and follow the “stick with what you know” dictum. And often the companies we tend to think of as innovative are tech-heavy (Amazon, Google) and therefore culturally and logistically set up for diversified R&D. I would probably think it questionable if the top management of a well-known candy company suddenly started heavily investing in R&D for self-driving cars. So perhaps, yet another archetype is sector? Are MCI’s largely sector specific?
I think that’s certainly a substantial part of the reason, Ishan. Investing in disruptive innovation doesn’t cater to the risk-averse. CEOs and managers who aggressively pursue disruptive innovation often have the trust of their investors to do so, or don’t pander to investor sentiments. Of course much of that may have to do with a proven success rate. Amazon’s shareholders and investors seem to readily defer to Jeff Bezos’s long-term directional decisions because it’s been a winning formula. I think that’s why Question 3 asks “How Much Should Companies Focus on Quarterly Earnings vs. Long-Term Growth?” isn’t an intuitively easy one to answer.
Good point, Adam. Clay Christensen refers to the the customers the incumbents have overlooked as “non-consumers” or the non-consumption segment of the market. Most incumbents continually invest upmarket, but ignore the non-consumers they have already excluded. That’s often a huge segment of the population. Low-end disruption and new market-creation occurs when innovators target non-consumption. Suddenly the population that was too low-end to have access to the incumbents’ products, is given access with products that are “good-enough” for them to get the job they need to be done, done. Time and again we see this phenomenon of disruption via exploitation of non-consumption.
A very compelling counter argument. I agree that a comprehensive cost/benefit analysis of automation vs. skilled manufacturing labor over an extended period may show there’s not that significant of a long-term advantage for automation, but I think much of that (as most economic analysis) is contingent upon metrics used.
But automation that enables scalability seems an inevitability regardless of any past training investment or even future training costs. For instance (much to Nate’s pt), automation of bank-tellers (ATMs) increased both non-manufacturing jobs in its sector and created new manufacturing and service jobs that hadn’t existed.
I’m still unsure about an answer to commoditization of education….
Very interesting take, Gavin. In reference to your comment about reading that “innovative periods had less patent activity,” could some of that have to do with the way patents and licensing are structured as well as economic means toward developing an invention? Here’s an interesting HBR article titled, “When America Was Most Innovative, and Why?” that addresses the correlation between innovative periods and the number of patents. Much of what was historically true seems to apply today as well. https://hbr.org/2017/03/when-america-was-most-innovative-and-why
Very interesting article and perspective! I found it interesting that NAFTA and other factors were successfully decried by Trump as primary contributors to loss of manufacturing jobs, when in reality automation (which was not scapegoated or even really addressed in his campaign) trumped (pun intended) other causes.
I’m currently on the side that while automation does replace jobs in the short-term, it’s a job-creator in the long-term, with the number of eventual jobs created likely significantly exceeding those lost.