203. Why do great companies fail? Innovator's Dilemma part 1

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Episode Transcript

What does it take to stay successful in the face of change? Is it inevitable for companies to decline with time? Find out in this lesson.

Hello smart people!

How are you today?

I am feeling a bit perturbed, because the book we’re going to cover in this lesson, literally says that a lot of the skills I learned at business school are exactly the same skills that can destroy a company.

My name is Sophia Matveeva, and I am the founder of Tech for Non-Techies, an executive education company. I’ve also lectured on tech and entrepreneurship at Oxford University, London Business School and Chicago Booth, and written for the Harvard Business Review.

Today, we are going to cover some key lessons from a book called The Innovator’s Dilemma: when new technologies cause great firms to fail.

If you work in tech, digital transformation or anything to do with innovation, you have to know about this book and the theories in it. It’s basically Silicon Valley’s Bible.

The Innovator’s Dilemma is written by Clayton Christensen, who was a professor at Harvard Business School, and also a founder of a venture capital fund and a management consultancy.

In the business world, he was a really big deal. Christensen developed the theory of disruptive innovation and The Economist called him "the most influential management thinker of his time.”

He passed away in 2020, and his ideas are still used as a guide by venture capitalists, founders and innovative boardrooms worldwide.

I found the book quite hard to read. The prose doesn’t flow, like it does in other business books, and I personally did not enjoy the in depth case studies about excavators.

These are not hands made for excavators!

So if you pick up the book and find it hard going, I’ve got you. I’ve made two lessons based on the book, to help you learn its main lessons and apply them to whatever you’re working on.

The main question that Clayton Christensen asks is what does it take for a company to stay successful in the face of change?

Great companies are like empires: they rise, they seem all powerful for a while, and then they fall. Look at Standard Oil, or the East India Company, or Sears.

But not all of them fall. JP Morgan has been successful for a very long time, and has weathered many different storms, technological changes, economic upheavals and political administrations.

So, what can we do to be more like JP Morgan and less like Sears?

Well, paying attention to this lesson is great place to start.

The Innovator’s Dilemma is divided into two parts, today we will cover part one, and next week, we will do part 2.

The main premise of the book is that companies can do everything right and fail anyway. I’m going to read a quote from the book:

The author talks about the demise of companies like Sears, which used to be at the top of their game, and other great companies like IBM and Xerox, which missed huge market opportunities.

“The research reported in this book shows that in the cases of well managed firms such as those cited above, good management was the most powerful reason they failed to stay atop their industries. Precisely because these firms listened to their customers, invested aggressively in new technologies, that would provide their customers more and better products of the sort they wanted, and because they carefully studies market trends and systematically allocated investment capital to innovations that promised the best returns, they lost their positions of leadership.”

Isn’t that disheartening. This makes me feel really sorry for all those people who worked at these companies, and did their best, and it still wasn’t good enough.

And this is the most important message from the book, because even if you forget the rest of this episode and the next one, just remember the idea that traditional business skills are not all encompassing.

If you are already working in a successful business, congratulations. But what got you here, won’t get you there.

So why does this happen? Why can you do everything right and still drive a big rich successful company into the ground?

The first part of the book answers that question, and is what we are covering in this lesson. Next week, we will cover what to do about it.

Why does this happen reason 1:

When a company makes a new invention, or if they hear that a start-up in their sector has made a new invention, they go to their best paying customers and ask if they want this new thing. Those customers usually don’t want it, so the firm doesn’t build it.

This is because, disruptors usually make cheaper crappier products at the start, that the top of the market doesn’t want.

And big established companies are usually working with customers at the top of the market, and make products that are the most expensive to make and sell at the highest margin.

So the fancy customers of the big company don’t want the cheapo thing that the start-up makes.

The best illustration of this is Airbnb. This case study is not in the book, because it happened way after the book was published, but it’s a great illustration for how the book’s principles apply to a business most of you recognise.

When Airbnb was first founded in 2008, it was advertising spare rooms and couches. It was for broke people. The people who were using Airbnb back in 2010 could not have afforded a room at the Marriott, so the Marriott didn’t care about what Airbnb was doing.

They served very different customer segments and were not competing.

But, Christensen says that eventually, the innovator moves up market, and by then it’s too late.

And this is literally exactly what happened with Airbnb and the hotel industry. You can now rent really nice apartments on Airbnb, I got a villa in Ibiza on Airbnb in fact.

And by the time this started happening, it was too late. Yes, hotel groups have moved into the home rental space now, but by the time they did it, Airbnb was already the undisputed champion and had changed the entire hotel industry.

This point is especially important for people who work in the start-up ecosystem, like founders, investors and the strategic advisors who work with them.

Investors sometimes ask start-up founders: why isn’t the big company in the sector doing this? If they are not, it means that there is no opportunity.

As you can see, this assumption is misguided, and if you ever hear this question, you can now understand why big companies often just don’t see the threat coming until its too late.

And now let’s move on to Why successful companies fail using the strategies that make them succeed number 2:

Let’s imagine that you are a Senior Vice President at a large blue chip corporate, and you run a big division in that company. You get paid lots of money, you fly business class and your college classmates are jealous of you. Amazing!

You have a revenue target of $50 million per year that you have to deliver. If you don’t, you will lose your job.

Then, you hear about a new innovation in the marketplace, and you think it’s cool and you see how could work and might even be the future. Then you run the numbers, as any serious executive would.

What do you see? You realise that the revenue from this new invention would be $1 million this year, if you are optimistic, and the margins would be tighter than for what you are already selling. Even if you want to work on it, in the short term, doing so would be an extremely irrational decision.

You only have 24 hours in the day, you have limited resources and a big target.You know that to make an entirely new thing would take a lot of effort, and the reward wouldn’t even scratch the surface of the target you need to hit.

It’s really easy to make fun of the management Blockbuster when they missed Netflix, or of Kodak when they dismissed the digital camera, but when you look closely at how successful companies are ran, and the incentives they have, it makes total sense.

The revenues from a new invention are usually so tiny in comparison to what a big company makes, that they don’t bother pursuing it. Until it’s too late.

In the book, Christensen writes that “many large companies adopt a strategy of waiting until new markets are ‘large enough to be interesting.’” But he says that is not often a successful strategy.

By the way, this is when I see people leaving big jobs in successful companies to pursue their own venture. This is why, working in a big company can be a great foundation for entrepreneurship, because you gain a view that you couldn’t as an outsider, and you can understand where the market is going, and what the big players are missing out on.

And now let’s move on to Why successful companies fail using the strategies that make them succeed number 3:

It’s really difficult to estimate how successful or impactful a new innovation could be, and this really trips up big companies and traditional investors. This is why you need venture capitalists and angel investors to fund disruptive innovation.

Again, look at Airbnb: who in 2008 would have thought it was going to be a big thing? Most people didn’t and this is understandable.

Big successful companies have sensible processes for allocating their capital. They didn’t become successful by not tracking their cash, right?

And this is the thing that damages them when it comes to disruptive innovation. Here’s what Christensen says in the book:

“Companies whose investment processes demand quantification or market sizes and financial return before they can enter a market get paralysed or make serious mistakes when faced with disruptive technologies, The demand market data when none exists and make judgements based upon financial projections when neither revenues or costs can in fact, be known.

Using planning and marketing techniques that were developed to manage sustaining technologies in the very different context of disruptive ones is an exercise in flapping wings.”

So if you know people who have a very traditional MBA view of life, which I did before I went into the world of tech innovation and started a company, they might be making these mistakes. So, help them and send them this episode.

If you share this lesson just with one other ambitious person, you are helping them succeed in the Digital Age.

What I found most surprising, and also sad, from reading The Innovator’s Dilemma was that when a company was at the top of its game, is when it usually made these strategic errors.

He gave the example of Sears, the retail store that was huge in the 1960s in the US. In fact, it accounted for 2% of all retail sales in the US. The book quotes an excerpt from Fortune magazine in 1964, which calls Sears “an extraordinary powerhouse of a company” where everybody in the organisation simply does the right thing.

But, Christensen says that at exactly the time when Sears management read that accolade, they were ignoring the rise of discount retailing that ultimately led to its demise.

You are most vulnerable when you reach your biggest success.

There are lots more examples of this in the book.

This made me think of our personal success, because I think it translates there too.

I really agree with what Reid Hoffman, the co-founder of LinkedIn said “The success strategies for individuals and companies are shockingly similar”

When we have reached a summit we have been fighting for, we start feeling infallible, and like a brilliant genius that nothing could touch. This is when we become less careful, get driven by our egos, and make stupid mistakes.

For a really colourful example of this, look at Elon Musk’s purchase of Twitter.

Anyway, to sum up today’s lesson: the main point of part 1 of the Innovators Dilemma is that the skills that a company has to be successful are also the very same skills that can destroy it. So, to sustain success in the face of technological change (which is happening everywhere!) a company needs to add another skillset.

•  What got you here, won’t get you there.

In next week’s lesson, we are going to cover part 2 of the Innovators Dilemma to see what those news skills actually are.

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