Creative Innovation & Disruptive Innovation

FEBRUARY 18, 2020
Dr. Ajay Sethi
18
min read

Introduction

Over the last 25 years (since the start of the Internet era, i.e.), entrepreneurs have created more value by innovating and building new solutions than by disrupting existing products/services. In this regard, Clayton Christensen’s “Disruptive Innovation” theory (introduced in 1995 — just before the start of the Internet era, coincidentally) needs a close examination and evaluated whether it is relevant for digital-first startups and companies.

This is how Christensen, Raynor, and McDonald explain their theory of Disruptive Innovation [link]:

“Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality — frequently at a lower price. Incumbents, chasing higher profitability in more-demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

Christensen’s theory was highly influential because it provided a systematic way for startups to create value and for the incumbents to innovate in order to avoid getting disrupted. The theory also helped popularize concepts such as JTBD (Jobs To Be Done; JTBD helps to understand the needs of the overlooked segments), MVP (Minimum Viable Product; the light-weight product that has more-suitable functionality), etc.

Disruption-from-below was a necessity in the era that required high amount of upfront investment costs in order to build products and then required some more capital to build distribution networks. The examples used by Christensen reveal the scenarios that fitted this paradigm: for example, how mainframe computers were disrupted by mini-computers and subsequently by personal computers; how disk drive industry innovated and evolved; or, how the mini steel mills disrupted the larger steel mills; or, how Intel worked to avoid getting disrupted by developing lower-power Celeron chips; etc. [link]

However, in the Internet-first era, these are no longer valid concerns. Increasingly, the infrastructure needed to build the products is available with usage-based payment model that enables startups to avoid the upfront capital expenditure required earlier. With the availability of all layers of the infrastructure (from storage to compute; from database to middle-tier; from backend tools or frontend tools; myriad of online distribution channels; etc.), the costs of building and launching a product has drastically come down. Moreover, building offline distribution networks can be deferred (or avoided completely) due to the availability of plethora of online distribution channels.

For example, Google, famously, started with less than $1M investment from four angel investors ($200k by David Cheriton, $100k Andy Bechtolsheim, $250k by Ram Shriram, and $250k by Jeff Bezos). Facebook started with $500k initial investment from Peter Thiel. Both Google and Facebook, incidentally, started before the cloud infrastructure revolution had started.

Evolving customer requirements and expectations, shifting competitive patterns in an industry, technological breakthroughs, etc. help trigger innovations, often creating value by uncovering new opportunities. In this context, disruption-from-below is just a piece of the overall innovation and value creation jigsaw. Given this, there is a need for a new and comprehensive theory of innovation that provides a framework to the startups and companies looking to create value in the Internet era.

By analyzing innovation since the start of the Internet era, we propose a new theory that not only subsumes the scenario covered by Christensen, et al but also two new mechanisms that have driven much of the innovation in the Internet era.

Engagement Graph

All the activities done by people — whether in personal or work context — can be viewed from the perspective of the “Frequency of activity” and “Importance of activity”. Let’s start by defining the scale for “frequency of activity”. Tasks that correspond to daily (or a few times a week) use-cases are considered to have “high” frequency of activity; weekly (or a few times a month) use-cases have “medium” frequency of activity; all other use-cases have “low” frequency of activity. The scale for “importance of activity” can be defined likewise. Tasks that have large implication and, therefore, require consultation with other stakeholders (such as family members or corporate committees) can be classified to have “high” importance of activity; tasks that trigger users to diligently evaluate pros/cons amongst alternatives as “medium” importance; utility-like tasks that can be performed without much thought are “low” importance tasks.

Engagement Graph below shows various personal activities. First-mile and last-mile commute, food ordering, cab service are amongst the most frequent activities (with more than once-a-day frequency). E-commerce has approximately once-a-week frequency and lower importance. Education-related activities also have once-a-week frequency but higher importance while activities such as personal finances (including investments and lending), travel for leisure, real-estate transactions, and healthcare-related activities have much lower frequency but high importance.

Value Creation: Three Strategies

Let’s consider that an entrepreneur wants to build a new product in the Education category (or, the “EdTech” sector, as is popularly known today). Before getting started, one has to look at the incumbents in the market and their products. To make this concrete, let’s consider the largest EdTech company (as of Feb 2020) in India: Byju’s. Byju’s has raised $1.2B at $8B valuation. The valuation is based on more than $200M revenue that the company generated last year and, more impressively, the 3x revenue growth during last year. Byju’s has 40M registered users and approximately 3M paying customers. Last but not the least, it has reported 85% annual renewal rate.

So, how can a startup compete with this behemoth?

It can do so by identifying the target personas being addressed by Byju’s and by understanding the “frequency of activity” and “importance of activity” for each of these personas. Based on this analysis, the startup will be able to explore three options:

For the sake of illustration, these three different personas might benefit from services mentioned below:

And, indeed, there are companies that are building solutions along these three dimensions in the Indian market. These companies have demonstrated significant growth over the last few years and, therefore, shown that it is possible to create value even while competing with a highly-funded and fast-growing incumbent.

Innovation & Disruption

Based on this, we can divide the Engagement Graph into different zones, which we refer to as Innovation Zone 1 (Frequency-led Innovation), Innovation Zone 2 (Importance-led Innovation), and Disruption Zone.

Companies in Innovation Zone 1 create value by providing an easier and more convenient solution to a more frequent activity.

Companies in Innovation Zone 2 create value by providing a better solution to a problem and, thereby, increase the reliability and trust in the offerings. Better quality of product/service provided by these companies helps to match customer expectation in terms of functional needs as well as non-functional goals.

Companies in the Disruption Zone create value by providing a not-as-good solution to a problem at a lower price. These companies don’t offer cheaper or inferior products — they, instead, build products that offer higher “value for money” to the target personas.

Let’s look at each of these three Zones in more details.

Innovation Zone 1: Frequency-led Innovation

Companies that fall in Innovation Zone 1 have, inevitably, chosen a more frequent problem to solve. In order to do so, it was important for these companies to understand which needs of the target personas were not being met efficiently and effectively by current solutions. Innovation is centered on building a product that caters to the under-served frequent activities.

A more frequent problem demands a simpler solution — a lower-effort product that users can start using quickly and derive value almost instantaneously. It is often the case that these solutions are made possible by the increasing availability of new technologies at affordable costs.

Consider the example showcased above. In the urban mobility space, we can see that a lot of innovation has happened over the last two decades. Zipcar (following Mobility Cooperative’s footsteps in Europe) was amongst the first set of companies that attempted to tackle car sharing opportunity in the USA market. [link] Zipcar’s typical usecase was once- or twice-a-week car rental (where users paid hourly usage fee along with a membership fee). By offering a lower effort solution, Zipcar created a new market and, eventually, started disrupting the car rental companies (it was acquired by Avis for approximately $500 million in 2012).

Zipcar, however, was not suitable for frequent, short-distance commute in and around the central business district areas in the larger cities in the USA. This need was served by taxicabs that operated with permits that were artificially restricted (to limit the supply and to ensure that the prices remained high). Uber and Lyft tackled this problem by building a service that made it easier to book and get cabs (via an easy-to-use app that provided cabs within 5 minutes; moreover, users could track the assigned cab from their office instead of standing on the road side). Uber & Lyft assiduously worked to signup drivers and increase the cab supply in the beginning — which not only helped to reduce the waiting time but also helped to reduce the cab fares. By offering a lower effort solution, Uber and Lyft created new markets across the world and, eventually, started disrupting Zipcar and the car rental companies. Together, Uber and Lyft created more than $90 billion, based on IPOs market caps.

Typically, users take a few cab rides in a week. However, there is an even more frequent problem in urban mobility and this is related to the first-mile and last-mile commutes. Uber & Lyft are not suitable for this because of the five minutes wait time (and, to some extent, the price points of these services). Bird and Lime are tackling these even more frequent problems via dock-less bikes that can be picked up and dropped off at any location. Users typically take such rides a couple of times every day. As we can see, these companies innovated within the urban mobility space by tackling a more frequent problem. We have noticed that more frequent products inevitably disrupt less frequent products in the same category. In this regard, Uber’s investment in Lime and Ola’s investment in Vogo makes eminent sense.

Tackling a more frequent problem allows companies to even overcome strong network effects established by incumbents. For example, WhatsApp started its operations in Feb 2009 and raised $250,000 seed round of funding in October 2009 (and released WhatsApp 2.0 to iPhone App Store in Aug 2009). For the sake of reference, during the same time (i.e., from February 2009 to November 2009), Facebook grew from 175 million active users to 300 million active users (and to 350 million active users by end of 2009) [link].

Unlike Facebook, WhatsApp focused on a more frequent problem: short messages amongst a network of closely connected people. This resulted in WhatsApp being used more frequently than any other social networking or social communications app. As a result, WhatsApp is used more frequently than Facebook — almost 60% of WhatsApp users use the product more than once every day (as compared to 50% of Facebook users)!

By focusing on a more frequent problem, WhatsApp was able to beat Facebook at its own game: building a stronger social network while competing with a behemoth with incredibly strong network effects! This also helped WhatsApp to grow faster than every social networking and messaging apps (such as Facebook, Gmail, Twitter, and Skype) [link]:

Innovation Zone 2: Importance-led Innovation

Companies that fall in Innovation Zone 2 come up with a better solution to a problem. They compete with and beat the incumbents by offering superior end-to-end user experience that satisfies either the functional needs or non-functional goals of the under-served customer personas (or both). In order to do so, it is important for the companies to understand what is important to the target personas.

There are two possibilities: (1) the current products don’t fully or satisfactorily cater to the functional needs of the customers or (2) the current products don’t fully or satisfactorily cater to the non-functional goals of the customers. A startup can innovate by improving the products along either (or both) of these dimensions. In the first case, startups build products that offer better quality of service to customers; in the second case, startups build products that establish better emotional connect with customers.

An example of the first case is Urban Company — a company that provides consistent home and beauty services via managed marketplace in India and globally. Urban Company not only short-lists partners to work with very selectively but also trains them extensively to ensure that they are able to delivery better quality of service. In addition, Urban Company is constantly innovating to identify newer ways to measure the quality of service in order to ensure consistent quality of service. This innovation has helped Urban Company to create a new category and, in the process, disrupt the earlier market leader — JustDial — that provided a marketplace to match customers with relevant service providers. JustDial, itself, had earlier disrupted the “yellow-page” companies by enriching the listings with customer ratings and reviews as well as by verifying the service providers.

AirBnB is a great example of the second case: establishing better emotional connects with customers (in addition to building a better functional product). Initially, AirBnB (short-from of AirBed & Breakfast) started as an organized and better version of the traditional Bed & Breakfast lodging units. After the initial validation (partially by timing their launch to coincide with high demand periods and Craigslist growth hacks), AirBnB found it difficult to drive growth. AirBnB fixed it by focusing on activities that helped generate higher trust: better quality and consistent pictures of the properties (and paying for the professional photographers to achieve this) and by emphasizing the need for detailed host and guest profiles (which help to build trust amongst hosts and guests).

The next phase of evolution (leading to the “Belong Anywhere” brand campaign) happened when AirBnB focused on helping tourists “travel like a human” and to allow hosts to connect with the guest while providing personalized local experience to them. By enabling guests to get authentic local experience (instead of shallower and commercialized touristy experience), AirBnB increased the quality of solution offered to the customers. More importantly, AirBnB catered to the non-functional and emotional needs of the guests and the hosts to connect with each other as humans and to learn about different cultures and races. This was captured brilliantly in the company’s “Belong Anywhere” brand marketing campaign.

Both AirBnB and Urban Company, therefore, disrupted the incumbents by making the services more consistent, reliable and trustworthy as well as by enriching the experience provided to the customers. As we can see, these companies innovated within the hospitality and home services space by tackling a more important problem and by building better products.

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