Random Talkers E18: The Innovator's Solution

Random Talkers is the show where two data scientists (aka myself and Matt McKim) review tech books and analyze breaking news. New clips uploaded bi-weekly. Available in podcast form via iTunes or SoundCloud. Help Google's algorithms view us in a favorable light by subscribing on YouTube!

This week we breakdown "The Innovator's Solution," the 2003 follow-up to Clayton Christensen's business classic “The Innovator's Dilemma." Fifteen years on, do Christensen’s theories on growth and disruption still hold true? I'm a believer. Matt?…not so much

---

A lightly edited and condensed transcript for your reading pleasure:

ADAM
So Matt, today we're reviewing The Innovator’s Solution by Clayton Christensen, the follow-up to his tremendously successful Innovator’s Dilemma - a book we previously reviewed and you didn't really like that much - hoping this one changed your mind. So in the first book Christensen unveiled a famous theory of disruption whereby a traditional incumbent, say a Fortune 500 company, is upended by an upstart that’s wielding a technology that the incumbent doesn't usually take seriously until it's too late.

MATT
The set-up of this book is you're a Fortune 500 executive, you've read the Innovator’s Dilemma and you're worried - disruption could come from anywhere, any angle, but good news - Clayton Christensen is here to help you out! He's written the Innovator’s Solution which will help you maybe even disrupt your own business.

ADAM
In my notes for this book I had down that it’s essentially “The Empire Strikes Back” of business books, as it’s trying to help Fortune 500 companies regain the upper hand. And like any Star Wars movie you're going to have seen some of it before. There's quite a bit of rehashing in this book of the first book. In particular, we hear about Christensen's classical model of disruption whereby disruption really comes from downmarket to upmarket.

To give a tangible example we can look at something like TVs. A premium TV, perhaps a flat screen costing thousands of dollars, is an upmarket product, whereas a portable TV you might find in a college dorm is a downmarket product. Christensen argues that disruptors or upstarts start downmarket, build a base there, and then move more and more upmarket to where the profits are (thereby slowly eating more and more the incumbent’s business).

Matt, I know you're itching to critique this theory, why don’t you go ahead...

MATT
You said a rehash but that's putting it mildly: the entirety of Innovator’s Dilemma is included in this book! This would be fine other than it's completely wrong! Christensen messes up the entire last ten years of tech development when he lays out this theory. You can use Tesla as an example. This is a company that started with a very upmarket product, as the Roadster basically only appealed to rich Silicon Valley millionaires and billionaires, and then suddenly has now moved all the way downmarket with the Model 3 to capture a much wider audience. So if you're a CEO at Ford you have been deceived by Clayton Christensen - you were looking for this low-end competitor to put you out of business but instead Elon Musk has dropped this ultra expensive vehicle on you taking away your market.

ADAM
Yes, every business theory has counter-examples, right? This one is no different but I agree we have seen a lot of times where there has been upmarket to downmarket disruption that Christensen doesn't really consider feasible in this book.

But to his credit I do think Christensen builds out his theory more in Innovator’s Solution than he did in Innovator’s Dilemma. For example he talks about how disruption can not only come from downmarket but also can come from a separate market altogether. In fact when he's advising would-be disruptors or would-be upstarts he says you really want to compete against non-consumption. You want the customer to either buy your product or not buy anything at all, you don't want them to be choosing between your product and a market leader because it's just never going to go well. This actually echoes advice we saw from Peter Thiel when we reviewed "Zero To One" whereby he advocates going after a very small untapped market and just trying to absolutely monopolize it.

MATT
In theory I completely agree with this approach but in practice I think it is so hard to do. The example that Christensen gives in the book is that you're the CEO of a fast food restaurant and you found out that you're selling lots of milkshakes in the morning. Great problem to have! So you go and you look at your demographics and you say “oh maybe I should make it a little bit sweeter to appeal to this group or a little chunkier for this group.” Christensen though when he looks at the example says actually don't look at any of that: what you should look at is why people are buying milkshake. Why are they “hiring” the milkshake to use his vernacular? And he says that really you should look at the need states, which basically go back to people are buying milkshakes in the morning because they want something interesting to do on the morning commute. They want something that keeps them occupied without creating a big mess and a milkshake just fits the bill perfectly. It's great that he can do this here but I think in reality this is so, so difficult that it's kind of a useless example...

ADAM
Well actually since reading this Matt I've started a very successful milkshake business where I now collect millions of dollars in revenue, so thank you Clayton for that. One of the critiques I had about this book, and I'm surprised you have not mentioned yet, is the very post-hoc nature of the analysis. Christensen lays out 30-40 examples of successful disruptors: Southwest Airlines is one, for instance, but all of his analysis is done very much in retrospect where it is obvious now that a particular company that was once a lowly upstart has become a very successful disruptor.

MATT
Yes this was my chief complaint about the Innovator’s Dilemma, which is that a sustaining change is one that helps the existing industry grow and a disruptive change just completely up-ends the existing players...but you can't tell any of this until you have some period of time to do this post-hoc analysis! It basically means that all of it is completely arbitrary until you can look at it in the past. If you were going to believe Clayton Christensen here you should buy companies like RIM (Research In Motion) and Cisco but I would argue you would probably be pretty upset with your ten-year returns if you followed his advice! But regardless Adam I think we should switch gears a bit and talk about the disruptive technology of our day: Bitcoin. What are your thoughts?

ADAM
So if you put Bitcoin into Christensen’s model of disruption you basically have it going up against an established incumbent, which in this case would be US dollars and the general financial system of the world. In terms of performance attributes you would say that Bitcoin underperforms on things like transaction speed and having a value that doesn't move by 30% every day. On the other hand Christensen would potentially argue that Bitcoin is serving an underserved market right now, which would be people who want to launder money. For that reason you could grow this underserved market, get better on the other attributes, and eventually maybe overtake the current incumbent.

MATT
So reading for this book I just felt that Clayton Christensen wrote this perhaps a bit too soon. Maybe his publishers were too eager to get this book out in 2003, because shortly after everything changed. I think this is one of the traps we fall into where we look at societal changes and tech changes and we didn't actually realize that 1999 to 2003 had really the same exact technology: we had large, centralized servers and people were on desktop computers. But then shortly after we have this huge revolution largely driven by the iPhone and other smartphones where now we have mobile devices, we have cloud computing, and all of the paradigms that are set up in this book just completely fall over in the face of that. Making a callback to my previous statement Cisco is now in trouble because all of its architecture was built on things staying the same...and it all changed, and so this is this is one of those where really would have been better served just to wait a couple couple years.

ADAM
Right, you mention Cisco, and you also mentioned RIM who built the BlackBerry. There’s a very long, extended discussion on the Blackberry in this book where the entire time you're reading it you're just yelling at Christensen “the iPhone is coming, just wait a couple years and everything is going to change!” But I think Blackberry in their position is instructive of the flaws of Christensen's theory. So he lays out this very nice idea that products arrive below customer needs or above customer needs, so what I mean is that when you're below customer needs you are not delivering the performance that a customer would really want. So now to improve your product you have to have a very integrated product, all those systems need to be self-contained, and you're really just focusing on maximizing performance. But eventually you're gonna get to a stage where you actually exceed the performance your customer wants - your products is really too good, and at that time your product would be modularized as Christensen call it, whereby you basically outsource different bits of the product because the technology is basically stable and it's good enough for the customers needs. By outsourcing to different suppliers you're going to be lowering the overall price of the product.

Now Christensen's argument (this has been a long-winded wind-up) is basically to say that Blackberry iwas potentially at the point where their product was too good for the market, so he would say but rather than being an integrated product he would have expected them to become modularized over time, different supplies making different pieces, and that would bring down the price of a Blackberry because it was already too good for customers. Now of course in retrospect we know that the iPhone is going to come along which is going to be so much better than anything Blackberry can do that Blackberry was actually not meeting the needs of the customers fully. But if you're in BlackBerry's position of a time there's absolutely no way to know where you are on this integration versus modularization spectrum, because how do you really know what true customer needs are?

MATT
This is a great example of how the milkshake scenario just completely falls over in reality! I'm sure RIM would have loved to figure out that the real needs state of customers was to check Tinder while waiting in line at the airport, but just couldn't figure that out! But all kidding aside I think this theory works a little bit better for physical goods than it does for things that are a little bit more intellectual or a little bit more hard to define. For example I don't even know how you would apply this to the current state we are in with tech where basically everything is free, your attention is what you're paying to get access to these products, and there's no real cost the customers directly paying to use any of them.

ADAM
Right I think Christensen's theory works well for physical goods like you said, especially like business-to-business (B2B) scenarios and it doesn't work well for this really weird tech paradigm has that developed. In particular he gives you some advice that anywhere else would really seem quite sensible - he says for example but you need to be impatient for profit but patient for growth, meaning when you start a new venture you should see very early on if it's actually capable of making money and worry about building it out until later. Of course this runs completely counter to the philosophy of companies like Uber who are all about growing, growing, growing as fast as you can and getting profits at some farflung point in the future.

MATT
Yet another area where Christensen has whiffed, the theory is not working out as intended! If you look at all of the recent VC investment it's all towards growth, everybody wants to grow as fast as they can. You can look at a company like Amazon which went 15 years without ever making a profit and just completely violates every theory in this book. You can even look to their modern development of AWS and sort of leaving the cloud computing revolution and again this is something that's not predicted: Amazon are one of the largest companies in the world and yet they're creating a extremely disruptive technology, which Christensen says shouldn't be possible but yet it happened.

ADAM
To be fair to Christensen I think if you told someone in the early 2000's that we'd be in 2018 and Amazon still wouldn't really care about making a profit, they would have called you absolutely insane, so I don't really knock him too much for missing the boat on that one. But I would say something like Ben Thompson's aggregation theory has become the prevailing wisdom around here like how tech works rather than Christensen’s disruption theory. Switching gears though, I don't want to spend this entire review bashing the poor man. I think he has written a tremendously influential book even if some of its theories don't quite hold up today.

In particular I think Christensen actually has good views on hiring. So in the book he talks about how you shouldn't just hire people for having what he calls the “right stuff” or kind of the conventional wisdom of how a salesperson should look or an analyst should look, you should really focus on hiring for a specific circumstance, where they're going to fill a very particular need for your company. This of course reminds me of something we saw in our last book review of the hard thing about how things by Ben Horowitz where Horowitz actually advocates for a very similar principle.

MATT
Absolutely I loved the theories in the book that really you should look for people who have tried to do something and failed, or tried to do something and pivoted, because those people got experience. If you look for people who only had a string of successes and then you try to do a new venture, these are probably not the right people to pick for those roles, and so I thought that was really smart. I thought the other thing that he talked about a lot was the power of middle management. That oftentimes middle management is the first filtering layer in any company to decide what the company does and doesn't do and if senior managers are trying to pick different projects and they're they're choosing the ones that they think will lead to the most financial growth, then this actually leads them down the path of peril whereby they ignore all the new changes. He also makes a great point I thought about senior management which is that that senior management oftentimes feels like they have a great view of the business and of what's going on, but in reality they usually only see what middle management is willing to pass up, and pretty soon at any organization middle management becomes really good at tuning the type of project they're gonna present. It’s stuff that they know that senior management will already accept. So this area of the book I really liked and I thought it was extremely solid.