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Insights / Blog / Business

Why Industries and companies get tangled up in the vortex of disruption!

October 29, 2015
Alain VeuveAlain VeuveManaging Director, AOE Switzerland

Disruption is one of the buzzwords of our time. What we mean with the term, in a business context, is the complete upheaval of an industry through new solutions that are better able to meet the needs of the customers. Disruption is feared by established industries, in startups it’s the explicit goal. Ever since I published the explanatory model on digital transformation I have been asked repeatedly how the interaction between technological progress and its adoption by society and corporations affects individual industries. Most prominent is the question whether I think that industry XYZ is impacted by digitalization. Foreseeable answer: “Yes, of course.” Here is why, illustrated by the “Industry Disruption Model.”

The ultimate purpose of an industry is solving a user problem

It’s the economy’s task to always solve people’s problems. As a whole, mankind is always trying to achieve the maximum benefit with the least possible effort – this applies at all levels. It applies to larger issues, such as eliminating hitherto incurable illnesses (not yet fully resolved) as well as to the mundane, for instance the tedious task of changing the TV channel on the device itself (comprehensively resolved by the remote control). Regardless, all issues must be mastered. As sarcastic as it might sound, what drives the solution is always the same: People want to be better off – in big ways and small.

Solving problems follows a logical hierarchy

In the process of solving problems a simple rule applies: A partial solution leads to the realization of a new problem. An example: Before the introduction of the washing machine, drying laundry was not perceived as a real problem – simply because manual laundering was a large, wearying project and manually drying laundry, by comparison, was relatively easy. Once the laundering problem was solved, manually drying the laundry came next. That is why we will not run out of challenges and problems – even in our highly technological society.

Condensing smaller user problems into user stories

To stay with the laundry imagery: These smaller user problems, i.e. collecting laundry, washing and drying it, and then ironing and putting clean laundry in a closet can be summarized into a single user story: As a human being I would like to have clean laundry with as little effort as possible. In a business context, we’re talking about the lowest possible costs that an individual would like to invest in such a user story. Costs are everything where the individual has to expend effort, independent of whether this effort is of a fiscal nature or not.

Within this context an industry usually handles various user problems along the lines of this user story. This is done to create synergies. To stay with our example above, it is easier for vendors of washing machines to also introduce dryers, it makes sense for vendors of printers to also offer paper, etc.

How are industries formed? How do they perish?

The following graphic illustrates how industry are created and how they are newly formed or destroyed by disruption.

Let me explain:

On the y-axis we see the costs of the user problem for the customer; the timeframe in which the costs are lowered is displayed on the x-axis.

The orange-colored line represents the expectations of the user. He expects that the problem can be resolved, with the solution becoming progressively easier. He does not expect the problem to be resolved overnight – he presumes that there will be a continuous, linear improvement.

The green line reflects the ability of vendors to provide commercial solutions supported by the majority.

Here are the individual phases:

1. Knowledge of the problem and initial solutions

A vendor recognizes that a solution can be developed for a problem. One generally speaks of a gap in the market, which is actually a bit confusing because what we’re really talking about is a solution gap. To begin with, products are introduced into the market that already show some promise – at least in part – but can’t really meet the expectations of the customers.

You know what I’m talking about. Take, for example vacuum robots. After the purchase one begins to realize that these devices will soon be useful in the household – but the first model isn’t really practicable. This phase is important because society accepts the new technology only gradually. It must become used to it first.

2. Product(s) meet the expectations of the users

When the capabilities of the vendors enable the fulfillment of users’ expectations, then a relevant market is created. Product improvement automatically slows down, since manufacturers want to recover their development costs. This works as long as customer expectations don’t once again far exceed the level vendors are able to meet.

3. Disruption

What happens now is the actual disruption: On the one hand a group of vendors has been created that has lost momentum and motivation to innovate through continuous revenue. At the same time, customers are again expecting solutions that are able to solve the problem at significantly lower costs.

This environment is the perfect breeding ground for new vendors who utilize new or vastly improved technologies in order to be in a far better position to resolve user problems. Since they, in contrast to existing players in the market, aren’t restricted by organically grown and bogged down structures, they can usually accomplish market entry with much less effort and quite a bit faster.

In addition, they are usually attempting true innovation. Instead of the existing solution evolving a general paradigm shift takes place in order to solve the problem. This usually results in a business model that is completely new for the sector.

The effects of this process are well-known. Existing players, along with their trusted business models, experience serious pressure; new companies sometimes achieve what can only be described as a meteoric rise. The digital revolution is a sort of demonstration effect within this context.

4. Excessive innovation

This disruption is advanced as long as it’s worth it. Investments are piled up that must be repaid by the market sooner or later. Generally speaking, the impressive success of new players attracts new investors to a high degree. They continue to invest until they no longer see a chance to amortize. This is why we see these undulations in the venture capital world. A sector is hip, companies invest and all of a sudden many VCs back off again.

5. Iterations

This process usually takes place in iterations over several decades. The curves can be flatter or steeper. The chart only shows one iteration.

6. Process completed

These iterations repeat themselves so long until expectations by the customer flatten out. If this condition is reached, then the problem can be regarded as resolved – for the moment. This doesn’t mean that there aren’t technologically better or simpler solutions. But the ecosystem doesn’t see value in additional improvements. In other works, the risk that further investments in new products will fail to generate appropriate amortization is regarded as too high.

One example of such a resolved problem is making fire. The issue was laid to rest when practical, small and very cheap lighters were introduced. It isn’t worth improving the solution, even though this is very likely possible, technologically speaking.

Slow technological progress vs. rapid technological progress

Until now I haven’t mentioned the underlying technological progress in this article. As I’ve mentioned on several occasions this progress is exponential by nature. Due to this, the general rules don’t change completely, but new vendors that think “out-of-the-box” are favored. Here, also, I would like to explain why:

Once again the orange line reflects the user’s expectations.

The red line represents the adaptation of the solution offered to the customer’s expectations under the influence of small, slow technological progress.

The blue line shows the adaptation of the solution offered to the customer’s expectations under the influence of rapidly-accelerating technological progress.

a) Established companies can master small, quick technology adjustments

The main reason being that smaller leaps in technology can be done in the same business model. The product can be improved and thus the user expectations fulfilled without turning fundamental items such as the business model upside down.

b) Technological progress that grows exponentially changes everything

If the possible leaps in technology are now much bigger, then the sector loses its equilibrium, because new vendors can shine with radically improved solutions (i.e. products and services). Instead of merely meeting user expectations, they exceed them massively. The faster new products are adapted by users and the more successful these providers are in the market.

For one they create a shortcut in market development. For another, and this is particularly damaging for traditional providers, they drastically increase expectations for the new product. That’s why it seems so ridiculous to us when Volvo advertises the fact that its model “V60 Twin Engine” can run on electricity alone for up to 50 km, whereas the innovation leaders in the market achieve 450+ km. Our expectations are simply much higher already.

c) Competitive advantages

In this way competitive advantages are created within the different levels of technological adaptation for those providers that can utilize the rapid technological progress for themselves. Another competitive advantage exists because the long-established, comfortable market leaders (until now) have helped to keep price levels high. Therefore, new participants in the market can usually introduce new products at significantly lower costs. And, their products, which are generally better, reach break-even faster. Both of these factors, quicker “time-to-market” and lower basic costs are poison for existing vendors.

d) Transformational Gap

I’ve called what is created by all of this the “transformational gap.” A gap that existing vendors can only bridge by extensive transformation. And when I say “extensive” I mean exactly that – on all levels: Corporate culture, organization, financing, marketing and product development.

Where can I find it, this perpetual disruption?

The driving force behind all of these changes is the accelerating growth of technological progress. This is the core of the perpetual disruption thesis:

Alain Veuve

We must assume that these “transformational gaps” will follow one another in ever shorter intervals, while becoming increasingly larger.

If at all possible, market participants are therefore challenged to turn their dealings with these "Transformational Gaps" into an area of core competence. More than ever before, the fortunes of a company will be determined by how well it handles these changes. I regard the so-called “pop-up business models” as one possible concept – short-term concepts that combine the components of product development, revenue stream generation and marketing/sales. More to follow in a future article.