Tag Archives: clayton christensen

Innovation: Agility is Not What Your Organization Needs

We live in a world of uncertainty and disruptions. To survive in this world, organizations should be agile. The word Agility is now everywhere. This would be the miracle solution to lack of innovation as it emerges every six months. But this is not the case. Agility is not what your organization needs. Let’s see why.

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Immunity to change: these rational commitments that prevent innovation

There is a paradox in the field of innovation: everyone is in favor of it, I never meet a manager who explains to me that he does not want to innovate, quite the contrary; They all want to innovate. And yet in most companies, innovation is blocked. An important cause of this paradox lies in a conflict of commitment between the present and the future. Let’s look at it in more detail.

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Why Holding a Disruptive Technology to a Standard of Perfection is a Mistake

Recently, Erik Brynjolfsson remarked, about artificial intelligence (AI), that we tend to hold it to a standard of perfection, and therefore can be pessimistic about its prospects. It is a very common mistake in the case of a disruptive technology. In fact it is not so much that we hold disruptive technologies to a standard of perfection as we judge their performance based on the existing technology’s dominant criteria. Let’s explore this and see why it matters, and how it leads to disasters.

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Nespresso: victim of a low-end disruption?

Interestingly, the posts on Nespresso are among the most popular on this blog. Every time I write about this product, audience shoots up, so why not continue… especially given that there is an interesting news with the launch of Nespresso compatible capsules by a new company called Ethical Coffee Company (ECC).

It is well known that Nespresso’s business model is mostly based on selling capsules on which Nestlé is able to make a very high margin. This margin is significantly higher than for the traditional filter coffee, Nestlé’s main business. This is in fact the same model as that of ink jet printer manufacturers: you buy a printer at a very low price; it usually barely covers the cost of the printer. The manufacturer makes its margin not on the printer, but on the cartridges, which are (relatively) very expensive.  This model comes from the razor and the blades model invented by Gillette. This model is not without benefits for some users, in particular for those who have limited needs in terms of quantities. In that case, the high relative cost for one page matters less than the low absolute one. What is interesting in the case of Nespresso is that Nestlé has been able to position the product in the premium segment, so they are able to sell the machines at a high price as well, thus having it both ways…

This positioning helped fuel the success of the product and drove its exceptional profitability. It was reinforced by the creation of the Nespresso Club, adding a sense of exclusivity, and the use of actor George Clooney in the ads. In addition, the Club provides valuable customer information for Nestlé, another innovation for a company that had until then always sold only through distribution channels.

Of course, the idea of a high-quality coffee at home quickly attracted competitors such as Senseo, a partnership between coffee house Douwe-Egberts and home appliance manufacturer Philips, or Tassimo. However, despite their success, and quite unlike what Pr Clayton Christensen would predict, these lower end competitors have not been able to really to “go up” and threaten Nespresso’s position in the higher end of the segment.

This could change thanks to the entry of a new type of competitor having a different strategy: Ethical Coffee Company (ECC). ECC’s idea is quite simply to create capsules that are compatible with Nespresso machines, yet cheaper. This is a strategy that has already been successful for printers and that manufacturers were not able to successfully counter. ECC, which like Nestlé is based out of Switzerland, assures that they have found a way not to violate Nespresso’s patents and produce perfectly legal compatible capsules. ECC’s threat should be taken seriously by Nestlé because its founder is no other than Jean-Paul Gaillard, the man who successfully launched… Nespresso back in the early 1990s. Gaillard is the manager called “Yannick Lang” in the infamous and controversial Nespresso case study from IMD written by Joyce Miller and Kamran Kashani. In addition, ECC has raised €20 million in private capital and is already in production.

ECC’s capsules are legally compatible with Nespresso machines, but 20% cheaper. In addition, they can be completely recycled, a very important point as the use of aluminum capsules by Nestlé has long been criticized by environmentalists. Each Nespresso user has probably experienced a growing sense of unease when throwing away the capsules. Lately, Nestlé has undertaken a recycling program but the way it is organized does not seem to be environmentally friendly.

What can Nestlé do? Moving “downwards” is difficult for two reasons. First, because the success of Senseo and Tassimo in the mid-range market means competition is solidly present, with big brands that have strong experience of the business and the distribution network, and for which the segment is core. So expect strong resistance here. Second, because ECC’s entry will quite likely successfully occupy the “value” segment of the capsule market. Third, because it is always difficult for a firm to move downwards, regardless of the competition: margins are lower but the cost base is the same, a sure crash. This would mean hurting the brand, a key issue as the brand, more than the quality of the coffee, is what drives Nespresso’s success since the beginning. It is difficult to imagine Nestlé introducing “value” (ie low end) coffee machines or selling the capsules in supermarkets (which would instantly mean losing 25% of the margin), sitting next to Tassimo’s.

The question is whether Nespresso’s positioning can be sustained. One can certainly expect a “Clooney fatigue”, not to mention the risk, shown recently by Tiger Woods, of associating a brand with a star who is also a human being, and as such subject to image problems. Despite all the talk about experience, Club exclusivity, and choice of over dozens of coffee types, what customers want is a nice cup of coffee, and too much complexity risk turning them off. Even a visit to a Nespresso shop can be an unpleasant experience when facing the snobbery of the clerks. Last time I went there, I felt like a peasant visiting the castle.

Can Nestlé move upwards? One could imagine Nestlé introducing diamond plated Nespresso machines at €1,000 and partnering with some luxury house. Despite the fact that times of economic recession are usually not appropriate for such positioning, this would smell classic “retreat in the high-value segments”, giving away lower segments to the competition, and putting itself into a corner eventually, something that GM has experienced with SUVs.

Clearly, Nestlé seems concerned. The Swiss firm recently sued a French Web site comparing prices for “disparagement” because the site had contended that Nespresso’s capsules where expensive and environmentally unfriendly. This is surprising because these are two well recognized facts. Nespresso is clearly positioned in the high-end of the market and Nestlé gets good margins on it. This is not a crime and nothing to be ashamed about, simply a positioning that has help fuel Nespresso’s success. Similarly, the environmental unfriendliness is still very common in manufacturing, and Nestlé has made efforts recently to address this question, albeit insufficiently. The trial seems to reflect more on Nestlé’s disarray and lack of strategic clue than anything else. Let’s hope the company will find better ways to deal with its strategic problem. ECC is now sold in France through the Casino supermarket chain. Let the consumers decide…

My previous post on the Nespresso innovation story here.

Note: I no longer update this blog. Instead, I am now writing a blog with a slightly different focus with my colleague Milo Jones on geopolitics, strategy, disruptions, and intelligence. Find it here: http://silberzahnjones.com.

The loss of creative capacity as a cause of organizational decline

I was recently invited to give a keynote speech at the 3rd Journées Georges Doriot, an annual academic and practitioners’ conference organized to honor the great inventor of venture capital, and it seemed to me that the topic of this year – Intrapreneurship- was ideal to test an idea that I had had for some time, that of applying the thesis of Arnold Toynbee on the decline of civilizations to the world of organizations.

Toynbee is the author of “A study in history“, the landmark book on the history of civilizations. The book comprises 6,000 pages, no less. Fortunately, a professor decided to write an abridged version, which allows normal people like you and me to grasp the virtuosity and knowledge of Toynbee for only… 1,200 pages in two volumes. What does Toynbee write? According to him, a civilization grows when its elite is creative enough to attract inside and outside constituents. The civilization breaks down when the elite gives way to, or transforms itself into, a dominant minority. When this happens, the driver of the civilization becomes control, not attraction, and its unity ends.

Interestingly, Toynbee observes that the consequences of the breakdown are not felt immediately. The civilization can continue to exist and keep a momentum if only because the logic of control brings an overall efficiency in its working. To summarize, the three key points of Toynbee’s thesis are:

  1. The source of breakdown is the loss of the creative capacity of the elite;
  2. The consequences of the breakdown are not felt immediately;
  3. When losing its creative capacity, the elite gives way to a dominant minority working on a logic of control.

It is tempting to try to apply Toynbee’s thesis to the corporate environment. In doing so, we can define the creative capacity as the ability to successfully create and introduce new products and services (renew its engine of growth). We can define growth in terms of overall economic performance.

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Robert Burgelman conference at Vlerick: cross-boundary disrupters

Robert Burgelman was at Vlerick Management School on February 5th for a conference on cross boundary disrupters, ie existing firms entering industry by disrupting its prevailing rules. He started by summarizing his work on intrapreneurship and more generally his methodology. Initially, his PhD was about communication between the R&D and marketing departments. He realized, however, that there were research projects that did not fit the company’s strategy. Put otherwise, whereas Chandler was predicting that structure would follow strategy, here was a case where structure preceded strategy. When the project was eventually approved by top management, strategy was modified as a result, which meant that strategy had followed structure.

Hence Burgelman’s model of intrapreneurship identified two types of projects: those resulting from the official strategy, and those resulting from the autonomous action of middle management sometimes in opposition to the official strategy. The model was further developed when combined with the work of Hannan and Freeman on the ecology of organizations in the 1970-1980s. According to this view, industries evolve through a mechanism of variation (creation of diversity), selection, and retention (reduction of diversity through mortality). Applying this model from the industry to the inside of an organization, Burgelman showed how a firm could manage this ecology of projects, the basis for maintaining an innovation edge. Thanks to this, the firm is not dependent on the official strategy and preserve the ability to create real options on different strategies.

Then Burgelman moved on to the main topic of the conference. Often, disruptions in an industry are described as being originated by entrepreneurial firms. However, cases show that startups are not often successful in their efforts and are successfully fended off by incumbents. However, their efforts do not go unnoticed and open the way for existing firm in other, adjacent industries, which “recognize” the opportunity and attempt a disruption, but from a much stronger base. The typical case in point is Apple with the iPod. Apple’s growth was constrained in the PC segment, but the firm could leverage its expertise in software and design to succeed where Napster had failed after the music industry’s lawsuits. Burgelman tried to formalize the conditions under which a cross-boundary disruption can be successful: an initial attack by a relatively weak startup fails, but still manages to undermine the incumbents; a stagnant existing industry stuck in business models undermined by a disruptive technology; and a potential new entrant limited in its growth but having relevant assets that can be exploited to cross the boundary.

Still in the case of Apple,the theory does not apply so well to the iPhone: it cannot be said that mobile telephony was stagnant with irrelevant business models and slow moving industry participants. Indeed, if the iPhone has been very successful, it can hardly be said that Apple changed the rules as it did in the music indusry where it essentially set the price for digitized music. Proof that this is an area where predictions are difficult, Burgelman, in his Strategic Entrepreneurship Journal article on the topic was skeptical about the chances of success for Apple, observing that Microsoft was better positioned and, with 10% of the smartphone market, already ahead. Since then, Apple has been able to gain a significant market share and Microsoft presence in mobile phones has all but evaporated even though a come back is in preparation at the time of writing. Another example of potential disruption in a completely different industry was given by Burgelman with Wal-Mart possibly moving in the low-end health-care provision. This is a question that Christensen has explored in the innovator’s prescription, his latest book on disruptions in the US healthcare system.

The distinction between Radical and Incremental innovation is not relevant

The opposition between radical and incremental innovation is one of the enduring themes of the innovation literature, both academic and managerial. While incremental innovation consists in improving existing products, radical innovation is about inventing completely new product, or more precisely new product categories. They are new to the market, but also to the firm that creates them.

Clayton Christensen‘s seminal book, the “Innovator’s dilemma”
shows how incumbent companies take advantage of incremental innovation, which play on their strengths, but are disrupted by radical innovation. Names such as Kodak, NCR, Digital Equipement, for instance, come to mind when evoking the innovator’s dilemma syndrome.

Initially, Christensen framed the discussion in terms of technologies, building on the S-curve framework, (introduced by Richard Foster) which describes the non-linear progression of a technology in terms of performance. In the beginning, the new technology – say the automobile – is less performing than the old one – say the horse – on the key dimensions (reliability, speed, simplicity for instance). But it gradually improves, slowly at first, then more quickly until the time it becomes more performing than the old one. At this stage, the new curve breaks past the old one and the old technology is abandoned. However, several counter examples showed that there were incumbent companies able to withstand a disruption by a radical innovation, and sometimes even thrive on it. IBM is a good example, having gone through at least five major radical changes in its environment (mainframes, minis, PCs, product to service, open source). The distinction between radical and incremental is therefore not a relevant categorization to explain why in some cases, incumbents fail and in others incumbents survive and thrive.

Later on, Christensen refined the theory and defined the issue in terms of sustaining versus disruptive innovation. By that he meant that what matters in a disruption is whether the incumbent’s business model can leverage the disruption or not. For instance, mobile telephony is really a radical innovation, a completely new category both to the users and to the operators. However, many competencies required to manage a mobile business are very close to those required to manage a fixed line network. In that sense, mobile telephony is not disruptive to the fixed telcos, but sustaining. This is why in most countries, the incumbent mobile operators are also the incumbent fixed line operators.

If, however, the disruption is incompatible with the business model, then the incumbent is in trouble. This is the case, for instance, with SAP. SAP’s is in the business of selling very complex IT systems able to manage the complete business of large, global companies in an integrated way. A typical price tag runs in the millions of US dollars. SAP’s business model is a combination of license fee for the software and service fees (development, maintenance, training, etc.) In addition, an army of consulting firms live off this business by selling their own services. A few years ago, a disruption started to develop in the form of Web-based IT solutions, a typical leader being Salesfore. Because it is a pure Web solution, Salesforce is sold as a service (subscription) for a few dollars per month. Salesforce is certainly not as sophisticated as SAP, but for small and medium business it is good enough, especially because you can sign up and start using it in less than five minutes, and one doesn’t need any infrastructure or service provider. The real problem for SAP is that its market is saturated and it needs to grow, so the untapped market of small to medium business is appealing. So SAP wants to go downmarket. But Salesforce, being established in the low end of the market, also needs to grow, and by tapping the upper side of its existing market, it can get higher margins. So Salesforce improves its product. Hence the collision course between SAP, going down, and Salesforce, going up.

The real problem, as Christensen remarks, is that it’s always easy to go up (same cost base, increased margins therefore very beneficial, and shareholders are happy) but very difficult to go down (same cost base, lower margins, reluctant sales people and partners, unhappy shareholders). SAP’s way to address the lower end market is to create a cut-down version of its product, but the motivation to sell it is not there. SAP could also create a clone of Salesforce (they actually have a Web version); the problem is not a lack of competencies. But the result would be the same. Put otherwise, SAP’s business model is not compatible with a lower end segment: customers are different, its sales force is not adapted to small sales, the distribution network is different, etc.

As a result, SAP is locked into its existing business model, and cruises in a frenetic inertia mode, while Salesforce grows and grows, moving up in terms of segments. It’s unlikely that Salesforce will ever target very large, global companies, but it certainly will be very happy with the rest of the market, which probably represents 90% of the total. SAP will have been reduced to a high-end, highly profitable small niche, just like Apple was in the PC sector. Not a bad place to be, but certainly a missed opportunity to reach mass market.