customer trap

‘The Innovator’s Dilemma’ is a highly revered business book published by late Harvard Business School professor Clayton Christensen which illustrates a surprising pattern consistently observed among established businesses based on a maze of rich historical data he gathered. The surprising pattern observed among the established businesses which performed really well on various business metrics is that they ended up failing at a later point in time in spite of adopting all the seemingly right business practices which include capturing decent market shares in large established markets, being able to command a high profit margin from customers who are willing to pay, adopting efficient business operation methodologies and consistently innovating in order to provide better utility to customers. So, what exactly is the cause of failure among these established businesses that did all the seemingly right things? Before I get into this, I would like to first mention that the book was published in 1994 and hence uses case studies of slightly primitive industries (disk drives, mechanical excavators, steel manufacturing) in order to make its case but the underlying reasoning shared is nevertheless deeply insightful and potentially relevant for businesses of any nature operating in any time frame. While the established businesses did focus on technology innovations in order to better service their customers, they were ironically led to their downfall due to technology innovations of a different nature termed as disruptive innovation which at their onset provided no utility to the relevant customer base and hence were not adopted by the established businesses but eventually ended up very unpredictably displacing both the incumbent technology and the established businesses which manufactured the incumbent technology at a later point in time. Let’s take the example of the disk drive industry to understand this better : the prominent customer base for early disk drive manufacturers were large mainframe computers which required higher storage capacity per unit and disk drive manufacturers consistently innovated in order to increase their performance i.e. the storage capacity per unit. At the time, a new disk drive technology was released which was smaller and cheaper but packed lower memory capacity per unit due to which they were not suitable for the needs for mainframe computer manufacturers which prioritized high memory capacity over other benefits like size or cost. The new disk drive technology which had no market in the mainframe computer industry, serendipitously found a market in the smaller personal computers industry which due to its nascency at the time was a very small and undefined market but they were willing to forgo the lower memory capacity drawback in exchange for the benefits of smaller size and lower cost which were prime requirements for the smaller personal computers. The personal computer market which as I mentioned was small and undefined at the time, ended up taking off unexpectedly accomplishing very aggressive growth due to unpredictable customer demand which at the time could not have been predicted by conventional market research. The aggressive growth in the personal computer industry provided an impetus to the smaller low storage capacity disk drive industry and much like how the established incumbent disk drive manufacturers innovated to service the needs of their mainframe computer customers, the entrant companies which sold the smaller disk drives innovated in order to service the needs of their personal computer customers. Driven by the aggressively growing demand for personal computers with more functionality, the entrant companies innovated at an extremely fast pace in order to increase its memory capacity where it surprisingly reached a point where the small disk drives finally matched the memory capacity requirements of the mainframe computer manufacturers which had previously rejected these smaller disk drives at their onset. The established disk drive manufacturers had reached a point of saturation in terms of further technological innovation that could be done on the larger incumbent disk drive technology which put them in a bit of a pickle as their prominent customer base i.e. mainframe computer manufacturers now found better utility in the disk drives sold by the entrant companies which along with having the required memory capacity also had benefits like smaller size and the mainframe computer manufacturers were now willing to buy them at a premium. So, the entrant disk drive companies ended up capturing an entirely new market i.e. personal computer market which unpredictably exploded in size and eventually captured the incumbent market of mainframe computers as well thereby displacing the established disk drive manufacturers from their initial position of dominance. The glaring question here is why the established disk drive manufacturers didn’t briskly adopt the new disk drive technology in spite of having the necessary resources and capabilities? The established companies were held captive by their prominent customer base i.e. mainframe computer manufacturers which had no utility for the newer disk drive technology, so from a purely rational business standpoint it really didn’t make sense for them to invest time and resources in a technology that didn’t serve their requisite customer base which generated their current profits, instead it made better sense to divert all their time and resources towards innovating on the existing technology and make incremental improvements that would better satisfy the needs of their mainframe computer customer base. At the time, the established disk drive companies could not have predicted the explosive growth of a very new personal computer industry that completely changed consumer preferences and market dynamics. Additionally, the entrant disk drive manufacturers sold the smaller drives to personal computer manufacturers at profit margins that were much lower than that of the incumbent disk drives sold to mainframe computer manufacturers, which made the business opportunity of manufacturing smaller disk drives more unappealing to the established disk drive manufacturers as it would not satisfy the large financial growth requirements of established businesses which require surefire avenues of high cash flow generation from established and predictable markets to satisfy its seasoned investor base. On the other hand, entrant businesses are more like startups which are not bound by the same financial obligations of larger established businesses and can afford to dabble in an unpredictable unestablished market. The beauty of economics lies in how market forces can dynamically change in ways that can never be predicted by detailed market research typically employed by established businesses in their decision-making process and thereby lean iterative experimentalism is the only way forward to always maintain an upside in the unpredictably changing waves of the market which requires swiftly adapting to new paradigms and being able to throw away well-established business practices of the past if need be. Entrant businesses have the liberty to explore new processes that can best cater to the changing market dynamics and thereby end up potentially capturing a large future upside. Established businesses are inertially constricted by their well-established processes which drove them to their present success but can very easily drive them to their future failure. In the disk drive example, the established disk drive manufacturers neglected the power of market dynamics by solely prioritizing the requirements of their already established customer base of mainframe computer manufacturers which generated the requisite profits and treating their requirements as absolute which prevented them from capitalizing on a new technology their established customer base did not need at the time and eventually ended up putting them out of business. ‘The Innovator’s Dilemma’ is a strong testament to the fact that there are larger factors at play that decide the sustained success of a business than solely serving the needs of the requisite customers as diligently serving the needs of the same customers can be the very trap that leads to the eventual downfall of a business.