Managing innovation is key to driving and maintaining growth. Yet many companies fail to foster and capitalize on innovation. Find out what it takes to stay on top of the “next great wave:”

It’s imperative for both managers at established companies and entrepreneurs developing new businesses to manage innovation. In fact, according to Deloitte, global companies view innovation as the most important factor in driving revenue growth, overshadowing economic factors. And to manage it, businesses must recognize how the “next great wave” begins—with a disruptive offering—a new, cheaper innovation that initially targets a small customer segment but evolves to displace the reigning product.

Managers and entrepreneurs must learn how to recognize potentially disruptive innovations and how to identify the initial customers for a disruptive product, pinpointing the channels they can use to reach those customers. Second, they must figure out the right scope of activities in order to capture profits and how that scope changes as the industry matures. Deloitte Research, the thought leadership arm of Deloitte Consulting, refers to this area as “value chain dynamics,” a concept that the consultancy says will become a standard approach to understanding profit flows. Finally, companies must successfully develop disruptive businesses, by putting in place the right—and sometimes non-obvious—resources, processes and values.

Disruption Theory

Large, well-established companies have a habit of getting in their own way when it comes to fostering innovative businesses. In the worldwide bestseller The Innovator’s Dilemma, author and Harvard Business School professor Clayton Christensen exposed the unavoidable paradox behind the failure of many leading companies. By doing what good companies were supposed to do—focus on pleasing their most profitable customers—leading companies were paving the way for their own demise. How? By ignoring “disruptive technologies.”

Indeed, the Dilemma—now an essential reading for managers—was groundbreaking because it contained a powerful insight: that some technologies are disruptive to established businesses because companies are motivated to ignore those new technologies until it is too late.

Many of the classic “disruption” examples are from the high-tech industry. Apple, IBM and Compaq disrupted the minicomputer market with personal computers that initially were not good enough for anybody who used a minicomputer, but as microprocessors improved, PCs pushed proprietary minicomputers aside. And disruption is not only relevant to high-tech industries. Discount department stores such as Wal-Mart and Target are “disrupting” full-service department stores. At the outset, the discount stores offered a broad array of basic products in a low-service, low-rent location model, but now they are moving up-market into higher margin goods, such as clothing.

Applying the Theory

Companies of all sizes can realize growth through disruption. The concept is also relevant across a wide range of industries. In The Innovator’s Solution: Creating and Sustaining Successful Growth—the sequel to The Innovator’s Dilemma—authors Christensen and Michael Raynor show how the principles of disruption are applicable to all industries, whether high-tech, transportation, consumer goods, industrial equipment, or services. The book includes case studies on the transistor, the steel industry, the computer industry, discount retailers, heart surgery, online trading, and solar energy, among others.

The book’s advice can be counterintuitive and an anathema to traditional business development. For example, rather than recommending that managers target the most profitable customers, the authors show that pursuing the consumers who spend the least, or those who do not buy at all is a winning approach for developing new businesses. Another example is that focusing on growth above profitability can be deadly, and that creating the right “organizational habits” is dependent on insisting on profits as soon as possible. Growth can be built from a profitable base, but profitability may not be a consequence of growth.

The conventional emphasis on core competence, particularly when considering outsourcing, is also challenged. As the authors point out, the questions that must be answered are—what needs to be core changes through time, and how are managers to know what will be critical in the future?

Using the insights gained from studying disruptive innovations, companies can determine when an activity should be outsourced and when not. All activities related to products (or functions or product components) that are not good enough for most customers’ needs should remain in house, and activities related to products that are too good can be outsourced.

When is a product not good enough? The answer is: when customers are willing to pay a higher price for an improved version of that product. A product is too good when customers are indifferent to improvements because existing products are satisfactory for their needs.

The firm in control of the “not good enough” part of a value chain is the one that will capture the most profits in the industry. For example, in the PC industry, profits flow right through the value chain parts that are “too good” (e.g. desktop PC companies and disk drive makers) and accumulate in the parts that are “not good enough” (e.g. microprocessors and chip manufacturing equipment). The challenge for managers is understanding how what is “not good enough” changes through time so they can prepare to remain on top of those areas of competition.

Both managers in established companies and entrepreneurs creating new businesses can benefit from these insights. The former, who are often playing defense, can understand whether their industry or product market is susceptible to disruption and can learn to spot nascent disruptions. They can also find out how to turn disruptive threats to their established businesses into opportunities for growth. Usually by the time it’s obvious that an industry is being disrupted, it’s too late. Meanwhile, entrepreneurs developing brand new businesses can consider Solution as a playbook for the offense, providing rich examples of what works.

Further Reading

The Innovator’s Solution: Creating and Sustaining Successful Growth by Clayton Christensen and Deloitte Research’s Michael Raynor will be available to the general public shortly. This promises to be one of the most important books on the management of innovation, as it helps firms identify and deal with disruptive innovations. The Solution shows how managers can pilot their companies across disruptive transitions in their industries.

Deloitte is applying many of these ideas within its Product Innovation practice. For more discussion, go to www.deloitte.com.

For comments, questions, and to exchange information on how to use what you have read, contact Ximena Leroux at xleroux@deloitte.com.

Ken Hutt of Deloitte’s Product Innovation practice will be describing how these ideas may impact outsourcing and supply chain strategy at the Agility conference in November 2003.

Using the lessons of successes and failures from leading companies, the revolutionary bestseller The Innovator’s Dilemma presents a set of rules for capitalizing on the phenomenon of disruptive innovation.