What is disruptive innovation?

It’s a phrase bandied about by entrepreneurs, particularly in Silicon Valley, and is often associated with tech start-ups that topple bigger incumbents. Yet the man who invented the theory of disruptive innovation, Harvard Business School professor Clayton Christensen, says the term is “widely misunderstood” and commonly applied to businesses that are not “genuinely disruptive”.

Take Uber: a company that is often referred to as a beacon of disruptive innovation because of its seismic impact on the taxi-cab industry. However, according to Christensen, who coined the term in his 1997 book, The Innovator’s Dilemma, the ride-hailing app isn’t an example of true disruptive innovation.

So what is disruptive innovation?

In a December 2015 article for the Harvard Business Review, Christensen and co-authors Michael Raynor and Rory McDonald set out to clear up confusion over what disruptive innovation is – and what it isn’t.

The theory goes that a smaller company with fewer resources can unseat an established, successful business by targeting segments of the market that have been neglected by the incumbent, typically because it is focusing on more profitable areas.

As the larger business concentrates on improving products and services for its most demanding customers, the small company is gaining a foothold at the bottom end of the market, or tapping a new market the incumbent had failed to notice.

This type of start-up usually enters the market with new or innovative technologies that it uses to deliver products or services better suited to the incumbent’s overlooked customers – at a lower price. Then it moves steadily upmarket until it is delivering the performance that the established business’s mainstream customers expect, while keeping intact the advantages that drove its early success.

Disruption happens when the incumbent’s mainstream customers start taking up the start-up’s products or services in volume. Think Blockbuster and Netflix.

These upheavals occur, according to Christensen, not because established companies do not innovate (they do), but because they’re focusing on making good products better for their existing customers. (This is called "sustaining innovation" and it is different from disruptive innovation.)

“These improvements can be incremental advances or major breakthroughs, but they all enable firms to sell more products to their most profitable customers,” Christensen, Raynor and McDonald write.

Meanwhile, disruptive companies are exploiting technologies to deliver new or existing products in radically different ways. (Netflix moved away from its old business model of posting rental DVDs to customers to streaming on-demand video.) Their offerings are initially inferior to the incumbents’, and, despite the lower price, customers are usually not prepared to switch until the quality improves. When this happens, lots of people start using the product or service, and market prices are driven down.

What about Uber?

Uber has not moved up from the low end of the market: it targets customers who already use cabs. Nor is it primarily going after people who take public transport or drive themselves. And the service, while competitively priced or slightly cheaper than traditional taxis, is not generally regarded as inferior.

“Disrupters start by appealing to low-end or unserved consumers and then migrate to the mainstream market. Uber has gone in exactly the opposite direction: building a position in the mainstream market first and subsequently appealing to historically overlooked segments,” write the authors.

Tesla Motors, Elon Musk’s electric car company, is another Silicon Valley firm they say has been wrongly labelled as “disruptive”. In fact, Tesla started at the top end of the market and now, with the Model 3, is offering an affordable electric car to mainstream customers.

How can companies survive disruption?

Google is developing self-driving cars, Amazon is experimenting with drones to deliver shopping, and there’s a chance that in future we could 3D print medication in our own homes. With these potentially disruptive innovations on the horizon, how should existing companies respond?

While the mantra “disrupt or be disrupted” may strike fear into the heart of many a large firm, true disruptive innovation is surprisingly rare.

Companies need to react to disruption, but they should not overreact, say Christensen, Raynor and McDonald, for example, by dismantling a still-profitable business.

The answer is instead to bolster relationships with key customers by investing in "sustaining innovations".

In addition, companies can create a new division tasked with going after the growth opportunities resulting from disruption.

“Our research suggests that the success of this new enterprise depends in large part on keeping it separate from the core business. That means that for some time, incumbents will find themselves managing two very different operations,” they write.

“Of course, as the disruptive stand-alone business grows, it may eventually steal customers from the core. But corporate leaders should not try to solve this problem before it is a problem.”

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