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How and Why

Can Collaboration and Community Serve as Catalysts For Innovation in Supply Chain?

September 12, 2019 by Brian Laung Aoaeh

Note: A version of this article was first published on July 31, 2019 at Port Technology.

The innovations required to reinvent global supply chains will not happen without collaboration. This article describes our experience facilitating such collaborations, starting in late 2017.

In late 2016 and early 2017, I spent a lot of time studying trucking and shipping, with a view to understanding the industry dynamics at play, and to see what opportunities might exist for software startups. What I learned about the trucking industry piqued my interest in logistics overall, and ultimately led me to a decision to focus on early stage technology investing in supply chain by building REFASHIOND Ventures to invest in early stage technology startups reinventing supply chains.

Through that work it became painfully clear to me that there is a need for closer collaboration between software startups and established, mature companies. 

This article will explain why there’s a need for such collaboration. I will also discuss the approach our community, The Worldwide Supply Chain Federation, has taken to enable such collaboration. Although it is still early, we will end with a discussion of some early indicators of the results we might expect in general.

Note on prior and recent work: Disruption, supply chain management, supply chain finance, and supply chain logistics are topics I have been studying for some time – from the perspective of an early stage venture capitalist specializing in supply chain; Notes on Strategy; Where Does Disruption Come From? (2015), Industry Study: Freight Trucking (#Startups) (2016), Updates – Industry Study: Freight Trucking (#Startups) (2016), Industry Study: Ocean Freight Shipping (#Startups) (2017), Updates – Industry Study: Ocean Freight Shipping (#Startups) (2017), Where Will Technological Disruption in The Fashion Supply Chain Come From? (2018), Is disruption finally underway in the freight brokerage industry? (2019), and Why digital freight brokers might fail to disrupt the freight brokerage industry (2019).

Identifying The Chasm

A consequence that arose from my decision to publish my articles on trucking and shipping is that it prompted several executives at established companies to reach out to me to talk about my findings. The same happened with startup founders – though, they mostly wanted to meet an early-stage venture capitalist who cared about supply chain logistics.

Those conversations made it painfully clear that: On the one hand, executives at established companies know the business problems in supply chain operations for which they desperately need new innovations. However, they typically do not have sufficient time to meet their daily responsibilities at work and scour the globe seeking out such new innovations. Moreover, their companies might not be plugged into the right communities to find such innovations through tradition RFP processes. Moreover, such executives also tend not to have a very good sense of how much certain emerging technologies have matured, and if such technologies might be applicable to the problems they need to solve. I call such executives BUYERS: these are people and organizations who want to buy new technology innovations for supply chain operations. This is particularly true in a nascent area like cryptocurrencies and blockchain.

On the other hand, founders of software startups that are creating new innovations for supply chain tend to understand the technology well, but they lack a deep and nuanced understanding of the business problems that potential customers face. They lack a sufficiently mature understanding of the value proposition they must offer to the BUYERS if they are to win market adoption. I call such startup founders BUILDERS: these are people and organizations who are building new technological innovations for supply chain operations.

For this conversation to make sense, it is critical that we share a common understanding of what I mean by supply chain. 

The definition I have adopted is from the 4th edition of Martin Christopher’s Logistics & Supply Chain Management: Creating Value-Adding Networks. A supply chain is: “A network of connected and interdependent organisations mutually and cooperatively working together to control, manage and improve the flow of materials and information from suppliers to end users.”

Crossing The Chasm

In order to bridge this chasm between BUYERS & BUILDERSTM, Lisa Morales-Hellebo and I founded The New York Supply Chain Meetup in August 2017. We started with a very simple premise: Once a month, for about 9 out of the 12 months each year, we would bring these two groups of people together to:

  • Network, 
  • Talk to one another about the problems they were trying to solve and the products that they were building, and
  • Participate in curated programming that is based on relevant and topical themes related to supply chain. 

Each event would last about 3 hours. The format of a meetup appealed to us because it is inherently grass-roots driven, and emerges spontaneously based on a shared enthusiasm among a group of like-minded people for a particular topic. 

We ultimately settled on a mission for The New York Supply Chain Meetup: To nurture and grow the world’s foremost open, global, multidisciplinary community of people devoted to building the supply chain networks of the future – starting in NYC.

Even before we held our launch event on November 16, 2017 people in other parts of the United States, and in other countries asked us if we would be live-streaming the event. We took this as a promising sign. As we approach 24 months since we initially started working on this, our tentative first efforts have grown into an initiative to build The Worldwide Supply Chain Federation; A collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry. The New York Supply Chain Meetup is its founding chapter. 

The initiative is entirely grass-roots driven. Our community includes:

  • Startups,
  • Mature Companies – across all industries,
  • Academics from research institutions,
  • Early-stage technology venture capitalists, and other late-stage investors, and
  • Journalists, regulators, professional services providers, and any other groups of people with interests and skills relevant to innovation in supply chain.

We have 1900+ members in The New York Supply Chain Meetup – the founding chapter, 2700+ members around the world, an active chapter in Charleston, South Carolina, and chapters in the process of being formed in several other cities around the world. 

The Worldwide Supply Chain Federation held its inaugural global summit, #SCIT2019, on June 19 and June 20 in NYC. 

  • We had 1000 people sign up for the event before we closed registration. 
  • During the event we had about 400 people attend on each day of the summit. Attendees came from 15 countries. 
  • We had 31 speakers: With 11 startup showcases, and a presentation by the Singapore Economic Development Board on June 20. Video of the event is available on our YouTube channel. 

Also:

  • Here’s a short 2-minute video featuring people who attended the summit: #SCIT2019 Highlight Reel 
  • I wrote a summary blog about it: Supply Chain, Innovation, & Technology (#SCIT2019) – Event Summary

In An Age of Platform Competition, Open Collaboration, Open Communities, and Open Ecosystems Matter A Lot

Why are companies like Amazon, Apple, AirBnB, Microsoft, Alibaba, Google, JD.com, Uber and others, posing a threat to companies in traditional industries? Why are startups that many people have never heard of beginning to attack and threaten companies in mature, established industries that one may have considered immune from such threats as recently as even just half a decade ago?

It is because the companies I have listed, and others I have not, understand the importance of business models that are built on open ecosystems rather than proprietary and linear value chains owned by a single company. 

Using the internet and other maturing software-enabled technologies as the foundation, these companies are launching demand-side and supply-side attacks on industries that have become accustomed to relatively sanguine competition among well established companies. 

That raises the question: What is an ecosystem? A business ecosystem has three main characteristics;

  • First: It is a network of networks.
  • Second: The focus of the ecosystem orchestrator must be on enabling and facilitating the creation and exchange of value, between all participants of the ecosystem.
  • Third: The creation and exchange of value must occur in a way that increases the aggregate well-being of the entire network over time.

When executed well, platforms and ecosystems give rise to powerful network effects. Network effects matter because, in the most extreme cases they can lead to winner-take-all outcomes. At best, they lead to winner-take-most situations. 

What’s are network effects? 

As I explained in my September 2014 article on the topic Revisiting What I Know About Network Effects & Startups: “A network effect occurs when the value of a good or service increases for both new and existing users as more customers use that good or service. The network effect is a virtuous cycle that allows strong companies to become even stronger. Network effects are also known as direct-benefit effects.”

The Results Are Early, But The Signs Look Promising 

As I have pointed out already, our effort is entirely grass-roots driven. We are yet to attract significant outside support to accelerate our efforts. Nevertheless we are showing promising early results in the 24 months during which we have been working on this. Here are just a few highlights.

  • A startup in our community is working with a very large shipping company that is seeking software technologies that enhance its ability to make decisions under uncertainty. Such software can be applied in various aspects of the shipping company’s global operations. The software could also be introduced to the shipping company’s customers who also need to optimize their own supply chain operations. The shipping company gains new technology, while the startup wins a channel partner to aid its go-to-market efforts.
  • A handful of startups in our community are building software to enable established freight forwarders modernize their business operations without bearing the expense of developing software from scratch. Many such efforts are led by people with significant experience in the freight forwarding business who have teamed up with technologists to build the technology. For such startups, a community like ours provides a great, low-pressure opportunity for them to connect with potential customers as well as potential investors.
  • Another startup in our community is building a derivatives exchange for the freight markets, creating a new suite of tools that shippers and carriers can use to manage risk.
  • One startup in our community is building a communication platform to enable communication around the transactions that take place between shipping companies and beneficial cargo owners, freight forwarders, and other parties involved in the shipping of cargo. Currently that communication happens over email, and relies on manual, paper-based processes. The team already has significant experience building software for the maritime shipping industry. The need for the product it is building is confirmed by the explosive rate of growth in adoption by very large shipping companies around the world. Where our community can help is with advice about the startup’s interactions with potential venture capital investors, and providing opportunities for the startup to tell its story to a wider audience. In one instance, after presenting at one of our events, a real estate broker told the startup’s founder that the same problem exists in the real estate industry. He also met an executive from a large shipping company who offered to introduce him to the shipping company’s corporate venture capital arm.   

Collaboration Is Especially Critical in Blockchain + Supply Chain

Like everyone who is enthusiastic about supply chain and technology, we are exploring how blockchain and other distributed ledger technologies will affect the supply chain. Here are some of the things I have learned;

In relation to blockchain, one of the lessons I learned while studying the shipping industry in early 2017 was this: 

“One product that it appears the industry would gravitate towards is a system of record that connects all participants in the supply chain, from end-to-end. This would be a platform into which various shipping industry data could be input, and other data can be obtained as outputs. Probably most input data would come from other platforms and data repositories, while output data would be fed to different counterparties based on their access rights and information requirements.” 

In that blog post, which I published in June 2017, I went on to say that this product seemed to be one ideally suited to be built on a blockchain. The platform would need to allow several independent parties to collaborate with one another while providing each of them with anonymity for certain aspects of their interactions. 

For example: Customs agencies around the world might demand special access rights to enable them monitor international trade transactions happening under various national regulatory jurisdictions. Such agencies could desire anonymity under certain scenarios.

About a week after I published the blog, I discovered that IBM and Maersk were beginning to release more details about their plans for TradeLens to the public.

During our meetup in January 2018, we hosted a discussion featuring speakers from UPS, SAP, Sweetbridge, Blockcience, and MState. The keynote speaker at that event was Dr. Michael Zargham, CEO and Founder of Blockscience, and at the time, also a technical advisor to Sweetbridge. The overarching conclusion I reached by the end of the event was this:

 “Successful implementations of cryptocurrencies and blockchains in supply chain will require more collaboration than the traditional industry is accustomed to.” — Why? The technology combines: digital systems; physical systems; social and political organization; economic structures and incentives; finance; and capital markets. No single organization is expert enough in all those fields to go it alone.

At our meetup in April 2018, we had speakers from: Algorand, Maersk, IBM, TigerTrade, EY, MState, Celsius Networks, and Sweetbridge. Professor Silvio Micali of MIT’s Computer Science and Artificial Intelligence Laboratory was the keynote speaker at that event. He described the key ideas behind Algorand, a blockchain he invented expressly to satisfy the demands of businesses. The other speakers discussed what it would take to bring blockchains out of the lab and into the real world of supply chain. Based on the discussions that day, I reached the conclusion that: 

Blockchain applications for supply chain must be interoperable with other blockchain platforms, and they also must be interoperable with the older technologies that businesses have relied on up till now.

TigerTrade started a conversation with IBM as a result of initial informal interactions at our in April 2018. Ultimately, this led them to partner and collaborate on the creation of TRADEFLO, a blockchain-powered platform for global trade facilitation and financing. Tanjila Islam, CEO and founder of both TigerTrade and TRADEFLO presented TRADEFLO at The Worldwide Supply Chain Federation’s inaugural global summit in New York City on June 20, 2019. Tanjila’s experience building TigerTrade directly informed her understanding of the need for a platform with TRADEFLO’s attributes. 

Conclusion

Platforms and ecosystems work well because they allow each participant of the platform to play to its unique strengths, while relying on its ecosystem partners for capabilities that it does not have in-house. This is not an issue that has mattered for shipping companies in the past. But, it is becoming more of an issue now, and it will continue to become a more acute problem in the future as beneficial cargo owners demand more sophisticated services from their supply chain partners. 

Collaboration is difficult because it requires a change in culture. It requires an openness that is not customary in many organizations. Collaboration for the purpose of discovering and nurturing innovative new ideas, products, services, and business models is even more difficult because it requires a commitment from senior leadership. Given how often individuals are shuffled around in organizations, it can be difficult to get anyone to focus appropriately on the long and difficult work that is required to build collaborative partnerships.

However, those companies that do not partner with others to meet their customers’ demands stand the risk of losing those customers to companies that come to grips with platform-and-ecosystem-driven competition more quickly. 

Filed Under: #TNYSCM, #TWSCF, Business Models, Communities, Entrepreneurship, How and Why, Innovation, Investing, Long Read, Startups, Strategy, Supply Chain, Technology, Venture Capital Tagged With: Blockchain, Disruptive Innovation, Distributed Ledger Technologies, Early Stage Startups, Innovation, Startup Communities, Startups, Supply Chain Finance, Supply Chain Logistics, Supply Chain Management, Technology

Where Will Technological Disruption in The Fashion Supply Chain Come From?

October 25, 2018 by Brian Laung Aoaeh

If you know how to learn, you know enough.

Originally published at www.refashiond.com on October 25, 2018.

By Brian Laung Aoaeh and Lisa Morales-Hellebo

Authors’ Note: This is the second in a series of six articles about problems and opportunities in global supply chains, with a focus on the fashion industry. In this article we focus on trying to learn how executives at fashion industry incumbents may learn how to predict technological disruption in order to develop appropriate responses to the evolving environment that surrounds their companies. We start by briefly surveying some of the theory about disruption. Then, we delve into a series of brief historical analyses of technological disruptions in a number of industries. We try to understand those episodes by using the theoretical foundations developed earlier. Finally we ask the question that forms the basis for this article, by posing questions about potential sources of disruption in the global fashion industry, the issues that every team of c-level executives in the industry worries about daily. If you have not read the first article in the series you may do so using this link: The Fashion Supply Chain Is Broken. However, reading the first article is not a prerequisite for following this discussion.

Acknowledgement: We are grateful to Tayo Akinyemi for reading and critiquing previous versions of this article.

The fashion supply chain is broken and must be refashioned. This is the conclusion we have come to after studying the issue, starting in 2014.

Background

We each independently became interested in supply chains in 2014. We have collaborated with one another in learning about supply chain since June 2016. In August 2017 we teamed up to start The New York Supply Chain Meetup, and building on that work are on the verge of launching The Worldwide Supply Chain Federation when The Bangalore Supply Chain Meetup hosts its kickoff event in November. In September 2018, we teamed up to start building REFASHIOND: a venture firm that will invest in early-stage startups creating innovations that make global supply chains more efficient. We will initially focus on startups at the intersection of fashion and retail. You can learn more about us by visiting REFASHIOND’s website. We also provide more detail about our background in the first article in this series.

In order to ensure that everyone is on the same page about disruption, we have chosen to conduct a brief survey of the key ideas that underpin the concept. We believe this is necessary to ensure that any dialogue that ensues is on the basis of a shared mental model. In writing this article we took inspiration from the work of Joshua Gans, author of “The Innovation Dilemma.” His work has greatly helped our understanding of innovation and disruption theory.

We do not claim to have a special talent for predicting disruption, however Lisa has a track record of leading disruptive innovations and has been featured in the book, “Disrupters: Success Strategies from Women Who Break the Mold.” This is not an article in which we are going to provide canned answers. Rather, our focus in writing this article is two-pronged: First, we will briefly examine the theory behind disruption, and attempt to connect the dots between various schools of thought on the subject. Second, using the lessons from that exercise, we will then look at some historical examples of disruption and see what insights we might glean from them.[1] We conclude the article by considering where disruption in the fashion industry may come from.

Our goal is to foster and participate actively in industry-wide dialogue about the future of the global fashion industry. We hope the result of such dialogue will be inter-industry collaboration aimed at making the future reality more prosperous and sustainable than the present or the past. We’re excited about participating in such conversations with startup founders and fashion industry executives.

Do not hesitate to email us if you would like to speak with us about our work, and possible collaborations in the future.

We can be reached at:

  • Lisa Morales-Hellebo — lisa@refashiond.com, and
  • Brian Laung Aoaeh — brian@refashiond.com.

What Is Disruption?[2]

Creative Destruction — A Result of Fundamental Market Shifts

Joseph Schumpeter (1883–1950) is the first person to have clearly described the concept on which subsequent work on developing a theory of disruption is based.[3] He describes “Creative Destruction” as:

“The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

He goes on to say that Creative Destruction is about more than price competition:

“But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) — competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether competition in the ordinary sense functions more or less promptly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff.”

Finally, he makes the observation that:

“The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.”

Disruption — A Result Of Movement Up The Technology S Curve

Richard Foster examined the role that technology plays in disruption, and used technology S curves to advance our understanding of disruption in his 1986 book, “Innovation: The Attacker’s Advantage.” An S curve is a graph of a logistic growth process. In such a process, growth is initially slow, speeds up in the middle period, and then levels off after that, as it approaches some upper maximum limit at the end of the growth period. Foster’s key realization was that technological innovations can result in a change in the underlying process, leading to a fundamentally new S curve with a discontinuity between the original S curve and the new S curve. Using this formulation, disruption happens during the shift in customer demand from the products along the old S curve trajectory to those products along the new S curve trajectory. On a long enough time-horizon, it should be easy to understand that an industry may experience multiple waves of disruption depending on the rate of technological advancement and entrepreneurial innovation within the industry.[4]

Disruptive Innovation — S Curves & Discontinuities in Market Structure

Clayton Christensen pushed our understanding of disruption further with the publication of “The Innovator’s Dilemma: When New technologies Cause Great Firms to Fail.” Below, we highlight and summarize some of the main ideas.[5]

A Sustaining Innovation: leads to product improvements without fundamentally changing the underlying structures of the market to which it applies; it enables the same set of market competitors to serve the same customer base, while typically extracting more value from them. It is important to note that sustaining innovations may lead to a rearrangement of the competitive landscape, but rarely will they lead to the outright failure of a leading incumbent. Sustaining innovations can be radical, revolutionary, or discontinuous if they lead to dramatic and unexpected product improvement. In Foster’s formulation, a sustaining innovation merely advances a technology up the same S curve.

A Disruptive Innovation: starts out with worse product performance relative to the available alternative from market incumbents, and is often not very complex technologically. As a result the new product is attractive to a small niche of the customer base. However, if product performance improves quickly enough, at a certain point the new product provides superior product performance relative to the alternative that is available from market incumbents. This process leads to a significant, dramatic, and fundamental shift in market structure, that is to say, suddenly the new entrants go from serving a niche customer base to gaining a majority of the market while, at best, erstwhile incumbents become mere shells of their former selves or even go out of business entirely. To use Foster’s formulation, a disruptive innovation moves the product to a new S curve.

Clayton Christensen also differentiates a low-end disruption from a new-market disruption. In a low-end disruption, the attacker enters the market with a product that is inferior relative to the needs of mainstream customers. In a new-market disruption the attacker enters the market by serving a customer niche that was previously unserved by the existing incumbents.[6] A low-end disruption results from a low-end innovation while a new-market disruption is the result of a new-market innovation.

Architectural Innovation — A Fundamental Change in Systems

Rebecca Henderson and her co-author, Kim Clark, focus on another important component that adds to our understanding of disruption: Why is it so difficult for incumbent firms to respond even when they possess the technical expertise to do so? In “Architectural Innovation: The Reconfiguration of Existing Product Technologies and the Failure of Established Firms,”[7] they make the distinction between the components that are combined to form a product and the system that makes it possible to combine disparate components into a single product or a unified service offering.

Component Innovation: is innovation in the modular design of a product. Such innovations are easy for incumbents to respond to because they arise from using technical knowledge about each component of a product to make improvements to the overall product, within existing organization structures and business models. Component innovation arises from component knowledge.

Architectural Innovation: is innovation in the end-to-end system that enables the combination of various, disparate components to form a product. Incumbent firms find it difficult to adapt to such innovations because the innovations render the incumbent’s component knowledge useless, given that the innovation is in a new organizational structure or a new business model that reconfigures the end-to-end system leading to the creation of a product using the same core body of component knowledge. Architectural innovation arises from architectural knowledge.

A key observation in Henderson and Clark’s work is that a market disruption — the attacking new entrant quickly supplants the incumbent in terms of market share and market power, leading to financial distress for the incumbent, can occur in a market when a sustaining innovation is married with architectural innovation. This helps explain certain market disruptions that would not qualify as disruptions if we only used the Christensen formulation.

Technology, Innovation, and Disruption — Two Sides To The Story

Joshua Gans helps us connect the dots more fully between Clayton Christensen’s Disruptive Innovation and Rebecca Henderson and Kim Clark’s Architectural Innovation. In “The Disruption Dilemma” he introduces us to the concept of a Demand-Side Disruption and Supply-Side Disruption. Below, we explore those ideas in more depth.[8]

The Demand-Side Theory of Disruption is an outgrowth of the Christensen School, wherein as attackers enter a new market incumbent firms perform a demand-based risk assessment and decide that mainstream customers are highly unlikely to desire the product on offer from the attackers. In fact, in many cases, the appearance of such inferior products is welcome because unprofitable customers move to adopt the products now being offered by the upstart attackers, freeing incumbents to focus all their resources on their most profitable customers. This is all well and good, until, through the process of iterative improvement, the attacker’s product moves rapidly up the new technology S Curve and quickly achieves performance-parity with the incumbents’ product at a significantly more attractive price-point. It is at this stage that customers abandon the incumbent in favor of the attacking firm in cascading waves, causing seemingly sudden failures of once dominant incumbent firms. This is a vast simplification of the discussion by Gans, however the key to understanding demand-side disruption is that it is driven by changing consumer tastes and expectations.[b]

The key to understanding demand-side disruption is that it is driven by changing consumer tastes and expectations.

The Supply-Side Theory of Disruption is an outgrowth of the Henderson-Clark School, wherein as attackers enter the market it becomes extremely difficult for incumbents to respond because the basis on which they have achieved success attaches them to a certain foundation of architectural knowledge from which they cannot detach themselves even if they admit that that their core business is at risk. To respond, incumbents must develop an entirely new system of doing things. This is difficult for incumbents to do since, at the outset, there is no guarantee that the new system will succeed any better than the existing architecture which has been the basis of the incumbent’s historical success. In other words, uncertainty causes incumbents to drag their feet about making the difficult choices they must make in order to adapt, assuming they know what changes need to be made. Remember that the architectural knowledge which forms the basis on which attackers enter the market is invisible to incumbents, and the attendant uncertainty makes an already daunting task even more difficult.[c]

The architectural knowledge which forms the basis on which attackers enter the market is invisible to incumbents, and the attendant uncertainty makes an already daunting task even more difficult.

So What?

Now that we have surveyed some of the key ideas in disruption theory, we’ll explore how disruption has played out in a few industries. Before we do so, it is worthwhile to reconcile the ideas we have encountered in the preceding discussion.

First, if emerging technologies progress quickly enough up the technology S Curve and gain sufficient customer adoption, the probability that a disruptive event will occur in a given industry increases until it becomes practically inevitable. This evolution is accompanied by a high degree of uncertainty about future states of the world. The uncertainty complicates decision-making for the executives who must decide how incumbent firms should react when attackers enter the market with a low-end or new-market offering.

Second, architectural innovation will always lead to a degree of market disruption if it catches a wave of changing and favorable consumer expectations. A sustaining innovation that is combined with architectural innovation will lead to an outcome to which incumbents cannot respond even though they possess the technical knowledge to respond to the component-level innovations. Since architectural knowledge is invisible, there is no way for incumbent’s and other competitors to respond to architectural innovation without assuming risks of an existential nature given that they have no real understanding about how the innovation works, assuming they recognize and admit there’s an innovation before it is too late.

A disruptive innovation married with architectural innovation will lead to potentially more extreme market dislocations because incumbents can only respond to the component-level innovation on the basis of old architectural knowledge. This will cause their offerings to consistently underperform the products introduced by the attacking firms along the dimensions that now matter most to customers. Eventually waves of customers will abandon the incumbent product in favor of the new product offered by attacking new entrant firms. In other words, the new architecture supplants the old.

Third, the forms of innovation we have discussed above are not mutually exclusive. Rather, it is often the case that each form of innovation is present to a certain degree in any case of market disruption that one studies

Fourth, and this bears repeating, it is a mistake to ignore the role that uncertainty plays in complicating the decision-making process that individuals in positions of authority within incumbent firms face.Uncertainty is the factor that causes decision-paralysis, buying attackers time to gain strength and ultimately dislodge once powerful incumbents.

Uncertainty is the factor that causes decision-paralysis, buying attackers time to gain strength and ultimately dislodge once powerful incumbents.

Does this sound frightening? It is. Why? It means that, on average, chief executives, chief technology officers, chief strategists, heads of innovation, and other senior executives, are altogether incapable of protecting leading incumbent firms from failure. Not unless the entire firm adopts a culture whose strategic choices are informed by assessments of demand-side and supply-side innovations. Even then, as Schumpeter observed, it’s just a matter of time before every incumbent is overwhelmed by waves of creative destruction. To a certain extent, this may explain why over the course of the recent past, companies that continue to be led by members of the founding team demonstrate a greater capacity to cause and respond to potential market disruptions than incumbents managed by teams of professional executive managers who did not found the company.[9]

We now turn our attention to some historical examples of disruption. For brevity’s sake, we have intentionally left out many details.

Disruption In Action

Tech Ate Books

Between 1960 and 1970 mall-based chain bookstores started supplanting independent bookstores. This process continued till about 1980, when mall-based chain bookstores suffered a similar fate with the rise of big-box bookstore chains. By 2000 big-box chains like Barnes & Noble, and Borders dominated the market. However, with the advent of the internet and its adoption for online retail; Borders is already out of business, while Barnes & Noble is struggling to reorganize and sustain its business.

We believe this is an example in which architectural innovation is the dominant factor at play. However, one should not underestimate the contribution of changes in consumer behavior. As our teenage and pre-teen children remind us; “Amazon’s supply chain is so awesome! You do not have to go anywhere, they will just bring your stuff to you while you stay home and play video games.” As time has progressed and digital media technology that is delivered over the internet has improved, disruptive innovation has come increasingly to the fore as ebooks and audiobooks began gaining in popularity.[10]

Tech Ate Video

Film projection technology started to become available between 1900 and 1930. As the technology matured, the period between 1930 and 1950 came to represent the Golden Age of Hollywood. Between 1950 and 1960, broadcast TV, small screen, and videotape recording gained a foothold in the market. The three decades between 1960 and 1990 saw the proliferation of color TV, and home video recorders. Notably, Blockbuster was founded in 1985. From 1990 to 2000 flat screen TVs, laser discs, and video CDs appeared as technologies in this market. Netflix was founded in 1997. Between 2000 and 2010, DVDs and mobile viewing become more mainstream. Netflix expanded its DVD rental business by introducing an over-the-top (OTT) streaming option in 2007. Since 2010, Video-Over Internet Protocol (Video-Over IP) and OTT video have gained dominance in terms of consumer consumption of video content. Blockbuster filed for bankruptcy protection in 2010, eventually becoming part of DISH Network which acquired the assets of Blockbuster in a bankruptcy auction in 2011. In 2013, DISH announced that it would close all of Blockbuster’s store and DVD-by-mail operations in early 2014. Meanwhile, Netflix is now available in 190 countries with 130.1 million paid subscribers and 137.1 million subscribers overall. Netflix generated more than $11 billion in global revenues in 2017.[11]

Once again, from the perspective of an incumbent’s chief strategist, or a head of innovation worried about protecting the incumbent from disruption, a more complete explanation of the circumstances that surrounded this episode can only be found by combining the Christensen School’s Theory of Disruptive Innovation with the Henderson-Clark School’s Theory of Architectural Innovation.

At the outset, Netflix entered the market with an architectural innovation: Blockbuster was not designed around a system of mailing videotapes or DVDs to people’s homes. As internet technology matured and broadband connections to people’s homes became ubiquitous, the low-end innovation of streaming video provided the final punch required to send Blockbuster crashing to the proverbial canvas of bankruptcy court. As OTT and Video-Over IP technology travelled up the technology S-Curve, Netflix had the advantage of far less in overhead costs than Blockbuster, allowing it to invest more aggressively in streaming technology, and winning the market.

Tech Ate Music Stores

The Acoustic Era stretched from 1877 to 1925. During this period the phonograph and the theremin resulted from experiments in sound recording and the technology started being applied to recording music. This was followed by The Electrical Era, when electrically recorded LP records supplanted acoustic phonographs. It extended from 1925 to 1945. Between 1945 and 1975, The Magnetic Era, magnetic 8-Track Tapes and cassette tapes supplanted LP records and other electrically recorded media. The Magnetic Era was followed by The Digital Era, between 1975 and 1993. It is during this period that MP3s started supplanting magnetic tapes and LPs. The Streaming Era started around 1993 and extends till today, MP3s lead to an explosion in peer-to-peer (p2P) file-sharing platforms. These platforms have supplanted old ways of packaging and selling music, and physical music stores have now largely been replaced by online streaming services.[12]

Although, it is popular to assume that the music industry was disrupted by MP3 technology, it is not so clear to us that such a sweeping statement captures the nuance of the situation. It is certainly true that music stores as a channel of distribution for the music industry have succumbed to digital formats and channels. It is also true that sales of physical albums have plummeted as the Streaming Era has progressed. However, Warner Music Group, Universal Music Group, and Sony Corporation together control more than 70% of the market. As a result streaming platforms like Spotify, Pandora, and Soundcloud are subject to the pricing power of the big music companies. Apple’s iTunes, Amazon’s Music, and Google’s Play are somewhat protected from the supplier power wielded by the music companies because of the power that is in turn wielded by Apple, Amazon, and Google respectively.[13]

Tech Ate Phones

The history of telephony dates as far back as 1876, when Alexander Graham Bell placed the first phone call. Early advances in telephony were made by the U.S. Army Signal Corps Engineering Laboratories, Motorola, Bell System, and Ericson between 1915 and 1956. By 1956, Bell Labs had begun work on conference calling systems, and in 1964, the first video conference call was made between New York and California using a Bell Labs Picturephone. Phones began to get lighter, but they still weighed 20 pounds or more. The first mobile phone call was made in 1973 using a Motorola DynaTac prototype which weighed 2.5 pounds. The technology continued to mature after 1973, with notable developments in 1989 when Motorola introduced the MicroTac, the world’s first flip phone.

In 1992, Motorola introduced the 3200, a hand-sized digital mobile phone that used GSM technology. That was followed in 1993 by the IBM Simon, arguably the world’s first smartphone, with a pager, a fax machine, a PDA, a calendar, an address book, a calculator, a notepad, email, games, a touchscreen, and a QWERTY keyboard all included in the same mobile phone. In 1997, Nokia kickstarted the smartphone era with the Nokia 9000 Communicator. Nokia continued to improve on its phones with the 8810 in 1998, and the 3210 in 1999 — selling over 160 million units. The Nokia 7110 introduced web access to mobile phones, and GeoSentric brought GPS navigation to mobile phones. Sharp introduced the J-SH04 in 2000 — it was the first camera phone. In 2002, the Sanyo 5300 became the first camera phone to be sold in North America. Also in 2002, RIM introduced the BlackBerry 5810, it was the first device to combine a mobile phone with a data-only device that targeted white-collar professionals. Mobile phone technology kept improving incrementally, with Nokia, RIM, and Motorola featuring as dominant incumbents in the North American Market.

Apple introduced the iPhone in 2007. Google introduced its Android OS for smartphones in 2008.[14] Since then Apple’s iOS and Google’s Android OS have gone on to dominate market share in the mobile phone OS market. Apple, Samsung, Huawei, Xiaomi, and OPPO occupy the top 5 spots in terms of smartphone shipments and market share as of the fourth quarter of 2017, according to IDC Worldwide.[15] Nokia sold its mobile phone business to Microsoft in 2014 and has instead shifted into telecommunications infrastructure and network equipment manufacturing. Motorola was bought by Google in 2012 and then sold to Lenovo in 2014. RIM has ceased manufacturing mobile phones and is now focused on developing software.

Is the iPhone disruptive? Clayton Christensen did not think so in 2006, 2007, or even in 2012. Is Android OS disruptive? From the outside looking in, it appeared that the iPhone + iOS, and Android OS represented sustaining innovations based on the Christensen School, or component innovations only, based on the Henderson-Clark School.

But, what was really happening? First Apple and Google shifted the focus away from being entirely focused on hardware engineering as a source of competitive differentiation and moved the focus more towards software platforms as the source of competitive advantage. Second, this shift coincided with a growing desire from consumers for mobile devices that performed more functions than Nokia, RIM, Motorola, and the other incumbents in the market at the time offered on their mobile devices. It is generally difficult for firms that grew to prominence on the basis of skill in hardware engineering disciplines to adjust to a market where skill in software engineering forms the basis for survival.

Tech Ate Cameras

The history of cameras and photography goes farther back in history than one would ordinarily think. Although the historical details are useful,[16] we will skip the vast majority of them up to the point in 1884 and 1888 when George Eastman patented photographic film, and the Kodak roll-film camera respectively. Edwin Land launched the Polaroid camera in 1948. Eventually Kodak, Agfa-Gevaert, and Fujifilm dominated the market for analog photography and camera equipment.[17] The market for analog cameras and photography was characterized by very complex and advanced manufacturing processes, and high barriers to entry, enabling Kodak and its peers to build highly profitable consumer franchises on the basis of that technology.

Ideas and concepts related to digital photography first appeared in the early 1960s and 1970s. In 1975, an engineer at Kodak invented and built the first digital camera. Digital Single-Lens Reflex (DSLR) cameras appeared on the market in the 1980s and 1990s, and had supplanted analog film cameras by the mid-2000s. In 2000, Sharp introduced the first mobile phone that incorporated a digital camera. Now every smartphone has an integrated digital camera.

Polaroid, Agfa and Kodak filed for bankruptcy in 2001, 2005 and 2012, respectively. Meanwhile, Fujifilm continues to record some of the most profitable years in the company’s history. What gives?

Most analyses about Kodak’s fate focus on explanations based on the Christensen School of Innovation. Others assume that executives at Kodak sought to protect its photographic film and analog camera business, the company’s cash cow. However, in “The Real Lessons From Kodak’s Decline”, Willy Shih points out that such arguments mischaracterize what was really happening within the company.[18] He arrived at Kodak in 1997, and ran a division of the company charged with exploring how Kodak might exploit the opportunity presented by digital photography.[19]

The shift from analog to digital photography posed challenges on many levels. First, there were dramatic shifts in the technology of photography. Second, the nature of the technological shifts lowered barriers to entry and significantly increased the scope of the competitive landscape. Third, as a result of these shifts in the market, Kodak’s legacy business, once the source of its unrivaled dominance, now became an albatross around its neck, imposing a severe handicap from which it could not very easily escape to contend with the horde of attackers. Fourth, these changes introduced a shift in the balance of power between the players in the market, weakening Kodak’s hand while strengthening that of its ecosystem partners and counterparts.

How did Fujifilm navigate this crisis? This is the focus of Shigetaka Komori’s book: “Innovating out of Crisis: How Fujifilm Survived (and Thrived) as Its Core Business Was Vanishing.”[20] Mr. Komori is CEO of Fujifilm. In reading the book, it becomes clear that Fujifilm is alive today because it accomplished the rare feat of adjusting its business to account for both the demand-side (disruptive) and supply-side (architectural) innovations that were taking place in the global camera and photography market. Fujifilm developed three strategies to help it contend with the coming digital era: First, Fujifilm invented original digital technology of its own — it affirmatively chose to adjust and adapt to the unfolding architectural innovation. Second, the company extended the life of its analog photography business by developing innovations to increase the gap between its existing analog products and the attacking wave of early digital alternatives — responding to disruptive innovations by building sustaining innovations to buy itself some time for its efforts in adapting to the new architectural innovations to bear fruit. Third, recognizing that the digital photography business would impose low margins on the market overall, it developed new businesses that were peripheral to its analog and digital photography businesses, but that could command high margins — though, some of these businesses were sold as revenues and profits from the analog business deceptively continued to rise and show strength. Quoting Mr. Komori;

No matter how good business is, you have to foresee and prepare for a coming crisis. Looking directly at reality, you have to recognize what is happening at the moment, as well as what is going to happen in the future. You have to read the situation, understand it, think about it, and decide what needs to be done. This is what management is all about.

Tech Is Eating Tech

In “The Scale of Tech Winners”, Benedict Evans discusses how Google, Apple, Facebook, and Amazon have supplanted the companies that defined the the preceding technology era which was characterized by the partnership between Microsoft and Intel, and IBM to some extent. Here are some quotations from that blog post:[21]

1. “So, the four leading tech companies of the current cycle (outside China), Google, Apple, Facebook and Amazon, or ‘GAFA’, have together over three times the revenue of Microsoft and Intel combined (‘Wintel’, the dominant partnership of the previous cycle), and close to six times that of IBM. They have far more employees, and they invest far more.”

2. “Scale means these companies can do a lot more. They can make smart speakers and watches and VR and glasses, they can commission their own microchips, and they can think about upending the $1.2tr car industry. They can pay more than many established players for content — in the past, tech companies always talked about buying premium TV shows but didn’t actually have the cash, but now it’s part of the marketing budget. Some of these things are a lot cheaper to do than in the past (smart speakers[22], for example, are just commodity smartphone components), but not all of them are, and the ability to do so many large experimental projects, as side-projects, without betting the company, is a consequence of this scale, and headcount.”

3. “Google, Facebook, and Amazon are still controlled by their founders, and they are aggressive street fighters.”

In Essence, Ben is saying that no industry that offers attractive enough margins is immune from the attentions of large tech companies with ambitions of global domination. Or, as Jeff Bezos of Amazon puts it;

Your margin is my opportunity.

What Factors Lead To Market Disruption?

When an attacker emerges with a new design concept, it is rational for incumbents to ignore it, since it is uncertain whether the new design concept will gain overall market acceptance. Moreover, evidence may suggest that mainstream customers do not value the new product that the attacker is introducing to the market. This is true, up until the point at which the new design introduced by the attacker wins the allegiance of customers and other parties in the market — in effect making the new design the dominant design. In the process the design standards on which incumbents built their businesses become obsolete, and incumbents now need to adjust to a fundamentally new and unfamiliar basis of competition. It is at this inflection point that attackers start to pull away from, or catch up with, incumbents with such speed that it is rare for any of the incumbents to recover, or protect, a position of dominance.[23]

As incumbents struggle to adjust to the new paradigm, their efforts fall short of customer expectations because they may have component knowledge, but insufficient architectural knowledge to enable them to build products that meet the entirely new performance thresholds established by the attacking firms. In the examples we have discussed above;

  • Ecommerce has become the dominant distribution channel for book retail.
  • OTT and video-over IP has become the dominant distribution channel for video content.
  • Streaming platforms have become the dominant distribution channel for people who wish to buy and consume music.
  • Mobile phones now function as small computers, with software design being as important, if not more important, than hardware engineering. Moreover, despite the ridicule that mobile phone industry executives first showered on the iPhone after its initial launch, the design it introduced in 2007 now dominates the market.
  • A smartphone that incorporates a digital camera has become the dominant design for the consumer photography market with further differentiation arising from computational photography, building on the strengths both Apple and Google possess in software engineering.
  • Finally, technology companies that embraced the internet as a platform for their business models are supplanting those technology companies that were slow to recognize the internet’s promise.

Conclusion: Will Tech Eat Fashion?

Yes. It is just a matter of time. We believe that the global fashion industry is approaching a tipping point that is similar to one of those we described in the preceding examples. Consumer perceptions and expectations in the major fashion markets of Western Europe and North America are slowly beginning to favor speed, customization or personalization, and environmental sustainability, over lowest price. These are issues we have already touched on in the article preceding this one, and that we will discuss again in a subsequent article, so we will not belabor the point here.

It would seem that the most obvious threat comes from digital native marketplaces like Alibaba, Amazon, Asos, Farfetch, JD.com, and Yoox Net-A-Porter Group. The next most obvious potential source of danger are the vertically integrated digital native brands like Bonobos, Boohoo, Eloqui, eShakti, Everlane, Fame Partners, Forever 21, Lesara, ModCloth, Outdoor Voices, and Reformation. Another obvious potential source of threat is sharing economy and recommerce digital native companies and startups like Ebay, Gwynnie Bee, LePrix, Material World, Rent The Runway, and ThredUp.[24]

Uncertainty stems from sources one least expects. So, we decided to analyse the financial statements of the tech companies, to see what we would find. We have been surprised by how much cash they carry on their books. Leading us to conclude that tech incumbents have the cash, knowhow, appetite for risk, and other resources to initiate experiments in any industry they determine provides attractive opportunities. Along those lines we have been asking ourselves many questions, here are a couple — note we do not know if these are the right questions, but we have to start somewhere:

  • Could the global fashion and accessories market attract the interest of companies whose core competence is building and deploying general-purpose software technology platforms[25]? If it did, how might that play out over time?
  • Are the technologies on which global fashion industry supply chains run at risk of becoming modularized into interchangeable and rapidly evolving components? What impact will that have on the specialized knowledge that current fashion industry incumbents have accumulated? Will it make that knowledge more valuable or less valuable? How will that affect profit margins?
  • How will legacy assets enable or hinder fashion industry incumbents’ ability to respond to demand-side or supply-side disruption?
  • How will the competitive landscape shift if fashion industry incumbents come under increased and sustained attack from digital native competitors? This is already happening and the large incumbents — digital immigrants, are responding by acquiring digital native brands. It remains to be seen if this will enable or hinder the acquired companies’ once they become attached to incumbents. How will these digital native brands be integrated into an existing incumbents’ culture, systems, and marketing strategies?
  • In what ways will concerns and awareness about climate change, and environmentally sustainable supply chains impact how the fashion industry evolves over the next decade or two? Can the industry approach this proactively?
  • Is there anything fashion incumbents can do beyond iterative improvements to their existing supply chains? Circularity, customization, and localization require an entirely new supply chain architecture. How will incumbents adapt? How should they adapt? The MacArthur Foundation is doing a lot of work on this topic through its Make Fashion Circular initiative. We refer to that shortly.

The Role of Leadership

After we published the first article in this series, we received some comments from people who read the article. The following comment comes from Steve Hochman. Steve was chief operating officer at Bolt Threads from April 2017 till September 2018 after serving as an executive at Nike for over nine years. Bolt Threads harnesses proteins found in nature to create fibers and fabrics with both practical and revolutionary uses, starting with spider silk. Here’s Steve’s comment:

“Nice post today. A few thoughts: It seems there’s growing consensus that speed and flexibility is key to brands’ and suppliers’ survival and much more inter-enterprise collaboration is needed to achieve it. Thanks to Zara and others, that’s an increasingly visible insight. The harder question to me is about the leadership required to make it happen. Who will emerge to make it safe to behave this way, ie to drive and choreograph the necessary confidence and trust between historically adversarial members of the same ecosystem, and what are the first moves that will bridge us from old to new? Would love to see us explore that question, because all the technology and process investment in the world is for naught without that other answer first, I think! Thanks again for pushing the dialogue.”[26]

Steve’s comment reflects our beliefs. As Fujifilm demonstrates, proactive leadership makes it more likely that entrenched incumbents can predict and react quickly to impending market disruptions. Indeed, that is the topic of Clayton Christensen’s most recent book, “Competing Against Luck.” To paraphrase his words: Fashion industry incumbents must proactively decide that surviving market disruptions is not something they can afford to approach with a hit-or-miss attitude. Rather, they must proactively choose to predict what demand-side or supply-side innovations have a potential to disrupt their business, and then act to ensure they are among the beneficiaries of these developments. As Andy Grove, former CEO of Intel put it: “Only the paranoid survive.”

Taking control of uncertainty is the fundamental leadership challenge of our time.

– Ram Charan, The Attacker’s Advantage

We are in full agreement with the following statement from The Ellen MacArthur Foundation’s report: “A New Textiles Economy: Redesigning Fashion’s Future.”

“Transforming the industry to usher in a new textiles economy requires system-level change with an unprecedented degree of commitment, collaboration, and innovation. Existing activities focused on sustainability or partial aspects of the circular economy should be complemented by a concerted, global approach that matches the scale of the opportunity. Such an approach would rally key industry players and other stakeholders behind the objective of a new textiles economy, set ambitious joint commitments, kick-start cross-value chain demonstrator projects, and orchestrate and reinforce complementary initiatives. Maximising the potential for success would require establishing a coordinating vehicle that guarantees alignment and the pace of delivery necessary.”[27]

Transforming the industry to usher in a new textiles economy requires system-level change with an unprecedented degree of commitment, collaboration, and innovation.

We believe it is the responsibility of leaders within the global fashion industry to strive to understand the causal mechanisms of disruption, and to ask the questions that lead them towards answers that enable their respective companies to successfully navigate the waves of creative destruction that characterize capitalist economies. This is a dialogue in which we are eager to participate as early stage venture capitalists investing in supply chain startups, and as thought partners working with executives in the global fashion industry.

Next in the series: What Are The Established and Emerging Business Models in The Global Fashion Industry Today?

About REFASHIOND Ventures: REFASHIOND Ventures is an early-stage venture capital investment firm that is being formed to invest in early-stage startups creating innovations that make global supply chains more efficient, starting with startups at the intersection of fashion and retail.

About REFASHIOND CO:LAB: REFASHIOND CO:LAB is the systems design, research, and strategy consulting arm of REFASHIOND Ventures. REFASHIOND CO:LAB helps organizations create competitive advantage through supply chain innovation.

About The Worldwide Supply Chain Federation: The Worldwide Supply Chain Federation is the collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry. The New York Supply Chain Meetup is its founding chapter.

________________

[1] We realize there’s a great risk of hindsight bias. However, analyses of this sort is one of the best tools in chief executive officers’, chief strategists’, or chief innovation officers’ toolkits and we feel it would be foolish not to use it if it helps us develop a good theoretical framework for correctly predicting, reacting to, and exploiting new innovations that threaten to reorder an industry.

[2] This discussion builds on Aoaeh, Brian Laung. “Notes on Strategy; Where Does Disruption Come From?” Innovation Footprints, 19 July 2015. innovationfootprints.com/notes-on-strategy-where-does-disruption-come-from/.

[3] Schumpeter, Joseph Alois. Capitalism, Socialism and Democracy. Routledge, 1994. Chapter VII

[4] Foster, Richard N. Innovation the Attacker’s Advantage. Summit Books, 1986.

[5] Christensen, Clayton M. Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Management of Innovation and Change Series). Harvard Business Review, 1997.

[6] The Innovator’s Solution: Creating and Sustaining Successful Growth, by Clayton M. Christensen and Michael E. Raynor, Harvard Business Review Press, 2013, p. 45.

[7] Henderson, Rebecca M., and Kim B. Clark. “Architectural Innovation: The Reconfiguration of Existing Product Technologies and the Failure of Established Firms.” Administrative Science Quarterly, vol. 35, no. 1, 1990, p. 9., doi:10.2307/2393549.

[8] “Chapter 3.” The Disruption Dilemma, by Joshua Gans, MIT Press, 2016.

[9] For an accessible discussion of the issues see: Kidder, David, and John Geraci. “CEOs Should Think Like Founders, Not Just Managers.” Harvard Business Review, 13 Nov. 2017, hbr.org/2017/11/ceos-should-think-like-founders-not-just-managers. Accessed 25 Oct. 2018.

[10] The Case for E-Commerce Acceleration (Aka, Bye Bye BBY?), by Jeff Jordan, a16z.com/2012/06/29/the-case-for-e-commerce-acceleration-aka-bye-bye-bby/. Adapted. Accessed October 21, 2018.

[11] Boricha, Mehul. “A Brief History of Video Technology [Infographic].” Tech Arrival, 12 May 2018, www.techrrival.com/video-technology-history-infographic/. Accessed 21 October 2018.

[12] Wedding, Nicole. “How Tech Disrupted The Music Industry: A Timeline.” Hybrid World Adelaide, 20 Sept. 2018, hybridworldadelaide.org/2018/03/27/tech-disrupted-music-industry-timeline/. Accessed 21 October 2018.

[13] In this case, generally, the music companies extract profits from the streaming platforms because there are fewer music companies than music streaming platforms. See Porter, Michael E. “The Five Competitive Forces That Shape Strategy.” Harvard Business Review, January 2008.

[14] Meyers, Justin. “From Backpack Transceiver to Smartphone: A Visual History of the Mobile Phone.” Gadget Hacks, Gadget Hacks, 5 May 2011, smartphones.gadgethacks.com/news/from-backpack-transceiver-smartphone-visual-history-mobile-phone-0127134/#ixzz1La40vQTO.

[15] Samsung, Huawei, Xiaomi, and OPPO all ship smartphones using Google’s Android OS.

[16] “Timeline of Photography Technology.” Wikipedia, Wikimedia Foundation, 4 Sept. 2018, en.wikipedia.org/wiki/Timeline_of_photography_technology. Accessed 22 October 2018.

[17] Analog photography relies on a chemical or electronic recording medium, with photographs ultimately printed on paper through chemical processing. In digital photography, arrays of electronic photodetectors capture and store images which are then processed as digital files only. Computational photography refers to the application of algorithmic processing to digital photography.

[18] Shih, Willy. “The Real Lessons From Kodak’s Decline.” MIT Sloan Management Review, 20 May 2016, sloanreview.mit.edu/article/the-real-lessons-from-kodaks-decline/?use_credit=a6ae29dde4b8fea84677452a90228c83. Accessed 22 October 2018.

[19] Kodak is trying to resurrect itself by focusing on new consumer demands and connecting with millennials — see Kodak + Forever21, InstantPrint Cameras, KodakOne and KodakCoin.

[20] Komori, Shigetaka. Innovating out of Crisis: How Fujifilm Survived (and Thrived) as Its Core Business Was Vanishing. Stone Bridge Press, 2015.

[21] Evans, Benedict. “The Scale of Tech Winners.” Benedict Evans, 13 Oct. 2017, www.ben-evans.com/benedictevans/2017/10/12/scale-wetxp.

[22] Amazon Alexa, Google Dot, Apple HomePod, for example.

[23] Gans, Joshua. “The Disruption Dilemma”, MIT Press, 2016. Page 40.

[24] This list is by no means exhaustive.

[25] Such a platform would make it relatively easy for a team of engineers to establish competing fashion companies using modular technology-enabled components which replicate everything large fashion incumbents do well, while simultaneously doing something that is valued by customers but which current incumbents cannot replicate without significant effort.

[26] Comment sent by Steve Hochman, via LinkedIn Messaging to Lisa Morales-Hellebo, on 15 October 2018.

[27] Ellen MacArthur Foundation, A new textiles economy: Redesigning fashion’s future, (2017, http://www.ellenmacarthurfoundation.org/publications). Accessed 23 October 2018.

Filed Under: Entrepreneurship, How and Why, Innovation, Investment Themes, Investment Thesis, Startups, Strategy, Supply Chain, Technology, Venture Capital Tagged With: Early Stage Startups, Entrepreneurship, Fashion, Innovation, REFASHIOND, Supply Chain, Technology, Venture Capital

#ChainReaction: Notes on Centralized, Decentralized, and Distributed Systems

February 18, 2018 by Brian Laung Aoaeh

Brian + His Pencils

This blog post is the first in a series of blog posts I will write as part of my effort to take an inventory of what I am learning about supply chains, digital tokens, and distributed ledger technologies.

I expect these blog posts to be frustrating for most people to read because I suspect they will come-across as disorganized, and confused. That is a reflection of the complexity of the topics I am trying to learn.

If you feel I have got something completely wrong, please do not hesitate to let me know. As Marcus Aurelius puts it;

If anyone can refute me—show me I’m making a mistake or looking at things from the wrong perspective—I’ll gladly change. It’s the truth I’m after, and the truth never harmed anyone.

First, some context; I am a seed-stage VC who has been studying supply chain for sometime. I believe that the greatest technological shifts of the next 3 or 4 decades will happen at the intersection of supply chain, industrial processes, data and analytical decision-making. I believe this shift will transform the way global supply chains function in many different industries.

If you follow technology and business news then you know what some of the trends are that will lead to the kind of shifts I believe we are about to witness. They are; increasing efficiencies in industrial automation, exponentially faster, more powerful, and cheaper computing technology, the proliferation of electronic sensors capable of capturing large amounts of data in almost any industrial or non-industrial setting one can imagine, software that is capable of analysing huge troves of data in order to aid people in making decisions about complex processes and systems, and ubiquitous computing. The list goes on. A more recent addition to any list of ground-breaking technological developments is Bitcoin and its related technologies, including the Bitcoin blockchain, as well as other cryptocurrencies and their accompanying blockchains or distributed ledger technologies.

There is currently a lot of ongoing enthusiasm, and perhaps, even hype, about Bitcoin, the Bitcoin blockchain, other cryptocurrencies or digital tokens, and their accompanying blockchains or distributed ledger technologies. Mainly, the excitement is around the belief that this group of technologies has the potential to “disrupt” any number of existing business or social structures. Personally, I agree with the following statement by Marco Iansiti and Karim R. Lakhani;

True blockchain-led transformation of business and government, we believe, is still many years away. That’s because blockchain is not a “disruptive” technology, which can attack a traditional business model with a lower-cost solution and overtake incumbent firms quickly. Blockchain is a foundational technology: It has the potential to create new foundations for our economic and social systems. But while the impact will be enormous, it will take decades for blockchain to seep into our economic and social infrastructure. The process of adoption will be gradual and steady, not sudden, as waves of technological and institutional change gain momentum. ((Iansiti, Marco, and Karim R. Lakhani. “The Truth About Blockchain.” Harvard Business Review. February 17, 2017. Accessed February 04, 2018. https://hbr.org/2017/01/the-truth-about-blockchain.))

If you agree with the preceding statement, then you should also agree that, perhaps, before one dives into the intricacies of digital tokens and distributed ledger technologies it is useful to study centralized and decentralized systems in a broad, general sense. Therefore, though I will ultimately migrate to discussing centralized systems, decentralized systems, and distributed systems in relation to information technology systems, at the outset I am thinking more broadly in terms of social structures that exist in economic, political, and cultural organizations.

At the end of this process, I hope to have developed a good frame of reference for understanding why and how digital tokens and distributed ledger technologies will combine with other prevailing advancements in technology to cause the transformation in global supply chains that I believe is upon us. I hope this helps me see what is coming next – in a manner of speaking, and that the knowledge I will develop in the process helps me make better investment decisions.

If you have read any articles that discuss Bitcoin and its accompanying technologies, then you will recognize the recurring themes of centralization versus decentralization. So perhaps the place to start is in understanding when centralized structures should be desired and maintained versus when decentralized structures should be desired and maintained.

The following discussion is motivated by, and borrows heavily from, “Centralization and Decentralization: The Compunications Connection” by Stephen H. Lawrence. ((Lawrence, Stephen H. “Centralization and Decentralization: The Compunications Connection.” Accessed February 4, 2018. http://www.pirp.harvard.edu/pubs_pdf/lawrenc/lawrenc-i83-2.pdf. I am basically paraphrasing pages 6 – 26.)) In that paper there’s a quote from “The Computerization of Society”, a report prepared for the French Government by Simon Nora and Alain Minc;

It allows the decentralization or even the autonomy of basic units. Better still, it facilitates this decentralization by providing peripheral or isolated units with data from which heretofore only huge, centralized entities could benefit. Its task is to simplify administrative structures by increasing their effectiveness and improving their relations with those under their jurisdiction. It also allows the local municipalities more freedom. It reinforces the competitiveness of the small and mid- size business vis-a-vis the large enterprises.

Centralized Systems

A centralized system is a system in which a master-node makes decisions or performs systemwide functions on behalf of all the other nodes within the system – subordinate-nodes. Subordinate-nodes only follow instructions issued by the master-node. It should be obvious that centralized systems depend on a reciprocal relationship of trust between the master-node and every subordinate-node. Centralized systems are also described as command-and-control systems.

Advantages of Centralized Systems

  1. Returns to Scale: Centralized systems generally benefit from increasing returns to scale, meaning that the system generates outputs at a rate that is proportionately greater than the rate at which it consumes inputs. More specifically, the value of a centralized system’s outputs should be proportionately more than the value of the inputs consumed by the system. This happens because resource-intensive decisions and functions can be performed by the master-node only, without burdening the entire system with performing those same functions. As a result, as the system grows, the per-capita system costs can decrease substantially. Increasing returns to scale are generally closely associated with increasing efficiency.
  2. Optimization: It is easier to optimize the outputs of a centralized system given a set of inputs because the effort that goes into optimizing the system’s output need only be expended by the master-node and not by every node within the system. As a result, in a centralized system optimization contributes to the system’s overall efficiency.
  3. Standardization or Uniformity: The hierarchical structure of centralized systems makes it easier to maintain standardization or uniformity within the system. Such standards are determined at the level of the master-node, and then they are implemented and enforced at each subordinate node according to rules established and maintained by the master-node. Standardization and uniformity ensures that the entire system operates as one unit, rather than as a collection of disparate, non-uniform, non-standardized entities. In certain instances, standardization and uniformity may be especially useful qualities if the system is to serve its intended purpose.
  4. Criticality or Importance: A centralized system is preferred when there is a disproportionately high cost associated with the commission of errors or mistakes at the level of a subordinate node. In other words, centralized systems are prefered when the weight of responsibility for avoiding mistakes is high, and the costs of this responsibility are borne by the master-node.
  5. Coordination & Interdependence: Centralized systems perform better when one must account for economic externalities. An economic externality is a positive or negative consequence that is borne by an entity which did not participate in taking the actions that led to that outcome. In other words, it is easier for the master-node in a centralized system to also account for systemwide externalities before choosing an action that is implemented by all the subordinate-nodes in the system.

Disadvantages of Centralized Systems

  1. Information Overload: Centralized systems can experience breakdowns in systemwide performance if the master-node experiences an information overload.
  2. Compulsion: Centralized systems are associated with bureaucracy and lack of freedom – from the perspective of subordinate-nodes. For example, centralized systems do not freely admit new nodes to the system unless such nodes are first approved by the master-node.
  3. Lack of Flexibility: Centralized systems are characterized by an inability to respond with agility and flexibility in the face of changing conditions. This can make centralized systems more fragile in the face of threats to the entire system.

Decentralized Systems

By contrast, a decentralized system is one in which there is no single master-node issuing systemwide instructions that subordinate-nodes must follow. Rather, in a decentralized system every node is responsible for its own decision-making and, is capable of taking whatever actions its independent decisions require it to take relative to agreed systemwide goals. It should be obvious that the trust-relationship in a decentralized system differs from that in a centralized system in an important way.

A decentralized system is one which requires multiple parties to make their own independent decisions.

– Rohit Khare

Advantages of Decentralized Systems

  1. Impartial Standards: Decentralized systems are better suited when the emphasis is on effectiveness rather than efficiency. As a result decentralized systems tend to exhibit standards that stress the results that each node in the system produces and how those results contribute to overall system wide goals rather than how each node accomplishes the desired results.
  2. Initiative/Innovation: Since each node in a decentralized system is free to independently experiment with an eye towards maximizing system wide outputs, there tends to be a higher degree of innovation within decentralized systems. Once a superior method of accomplishing systemwide goals has been identified by one node within the system, other nodes will quickly copy that method if it increases their wellbeing. All else equal, this will lead to a higher level of system wide output.
  3. Responsiveness: In decentralized systems, individual nodes are more responsive to local conditions. This is because each node in the system is free to determine local priorities on an ad-hoc basis given information available to that node even if this information is not available to other nodes within the system. It is not difficult to see how this quality of decentralized systems contrasts with the standardization/uniformity quality that is present within centralized systems.
  4. Simplified Decision-making: Decentralized systems exhibit a simplified decision-making relative to centralized systems. This is because for a given situation, decisions can be made by only the relevant subset of nodes within the system while  non-relevant nodes conserve system resources. In such a situation, simplified and localized decision-making is an advantage of non-relevant nodes are not adversely affected by the decisions that have been made, and the resulting actions that have been taken, by relevant nodes.
  5. Minimize Information Resource Requirements: A decentralized system could be designed such that each node only processes information relevant for its role within the system. This way, systemwide resource requirements can be minimized since each node conserves resources by focusing only on information and activities relevant to its specific functions and does not concern itself with matters outside that sphere of relevance.

Disadvantages of Decentralized Systems

  1. Duplication of Effort: Decentralized systems can be designed such that each node within the system attempts to solve similar problems as other nodes in the same system – leading to duplicated effort. It is easy to see how this can lead to more waste than one would observe in a similar, but centralized system.
  2. Suboptimization: In decentralized systems, a single node or a subgroup of nodes, might decide to pursue activities that increase their own well being at the expense of the well being of the entire system. Trade-offs have to be made within a decentralised system to ensure that suboptimization is minimized by keeping incentives between all the nodes within the system aligned with one other, and with the entire system as a whole.
  3. Less Amenable to Standardized Change: Since each node is responsible for making its own decisions and taking actions independent of a master node, standardization takes a much longer time to diffuse through, and become adopted by the nodes within a decentralized system. As a result decentralized systems characterised by a lack of uniformity, whereas centralized systems are characterized by systemwide uniformity.

In a quest to find examples of decentralization in action within organizations that I am somewhat familiar with, I went looking for a book that discusses the topic. I found that in The Starfish And The Spider: The Unstoppable Power of Leaderless Organizations, a book by Ori Brafman and Rod A. Beckstrom, where they  introduce us to the major principles of decentralization; ((Brafman, Ori, and Rod A. Beckstrom. The starfish and the spider: the unstoppable power of leaderless organizations. Portfolio, 2006.))

  • When attacked, a decentralized organization tends to become even more open and decentralized.
  • It is easy to mistake a decentralized organization for a centralized organization because we are far more accustomed to centralized organizations. It is also easy to vastly underestimate the power of decentralized organizations.
  • A decentralized system does not have central intelligence; the intelligence is spread throughout the system. As a result the best information and knowledge is located at the edges of the organization, close to where things are actually happening.
  • Decentralized, open systems can easily mutate.
  • Decentralized organizations can seemingly appear out of nowhere because they can mutate so quickly, and because they are easily overlooked at the outset.
  • As decentralization takes hold within an industry, overall profits decrease.
  • The power of decentralization comes from the phenomenon that when people are put into a decentralized system they automatically want to contribute, and their contributions are usually remarkably of a high quality relative to what one might find in a centralized system.

So far I have not said much about distributed systems. Think of a distributed system as a hybrid between a fully centralized system and a fully decentralized system. Businesses that blend the best of both types of organizational architecture in their business model are not that uncommon, and when they do so successfully the results can be overwhelmingly successful . . . But, we can discuss that another time.

In my next post, I will more directly delve into cryptocurrencies and distributed ledger technologies. Till then, you may delve further into this topic by reading Chris Dixon’s “Why Decentralization Matters“.

Filed Under: Computer Science, How and Why, Innovation, Organizational Behavior, Sociology, Startups, Strategy, Supply Chain, Technology, Venture Capital Tagged With: Blockchain, Business Models, Cryptocurrencies, Distributed Ledger Technologies, Early Stage Startups, Innovation, Supply Chain, Supply Chain Finance, Supply Chain Logistics, Supply Chain Management, Technology, Venture Capital

Economic Moats – For Early-Stage Tech Startups (Presentation)

July 28, 2016 by Brian Laung Aoaeh

This presentation distills the essence of the following blog posts into a presentation format. The target audience is early-stage startup founders, and investors.

Economic Moats Blog Post Series

  1. Network Effects
  2. Switching Costs
  3. Intangibles
  4. Efficient Scale, and Cost Advantages
  5. Connecting The Dots
  6. #OpposingViewpoints: Do Economic Moats Happen By Accident?

[slideshare id=64490076&doc=economicmoats-innovationfootprints-160728202937]

Filed Under: Business Models, Entrepreneurship, How and Why, Innovation, Startups, Strategy, Technology, Uncategorized, Venture Capital Tagged With: Business Strategy, Competitive Strategy, Early Stage Startups, Economic Moat, Venture Capital

#NotesOnTactics: Relationship Management Hacks For First-Time Early Stage Tech Startup Founders

July 23, 2016 by Brian Laung Aoaeh

View Over The Manhattan Bridge
View Over The Manhattan Bridge

Note: I published a post titled “Relationship Management for Your Startup” on January 13, 2014 at Tekedia.com. This post is inspired by that one, and portions of this post are exactly identical to the original. It appears the post at Tekedia is no longer online. This post updates that one, with lessons I have learned since that time and advice I share with first-time founders with whom I have the privilege of meeting as they embark on trying to build their startups.

How should an entrepreneur manage the relationship with investors who say “no” to that entrepreneur’s pitch for capital? As I have noted above, I first tried to tackle this question in a post in 2014.

Before I suggest an answer to that question, I will propose some assumptions.

  1. The interaction between the entrepreneur and the prospective investors has been one of respect, and professional courtesy. In other words, you have not been treated badly or insulted by any of the investors you have met.
  2. The investors you have met are honest people, who would tell you if there is absolutely no instance under which they would invest in your startup. They do not have to tell you why, although it would be great if they did.
  3. Irrespective of how things play out now, there is every possibility that you will speak with investors at a subsequent stage of the current project you are working on, or, Insha’Allah, you will become a serial entrepreneur who seeks funding for a new startup in the future.

If my assumptions hold true, then it does not work to your advantage to “cut-off” an investor just because that investor did not fund your startup during your current round of financing. This is especially the case if that same investor might be able to invest in your next round of financing – for example, a venture fund which makes institutional seed-stage and series A investments, but which passed on your seed-stage round of financing.

Every venture capital fund’s primary responsibility is to make money for its limited partners. Venture capitalists do not invest because they like an entrepreneur or an idea, or because they feel obligated to provide capital. No. Venture capitalists invest in entrepreneurs and startups that they believe will make them money, lots of money . . . enabling them to fulfil the obligations they have made to the LPs in their fund.

It is your responsibility as the entrepreneur to connect the dots, and to help the investor understand how they will achieve that aim by investing in your startup. That is a very difficult task. Dealing with the inevitable rejection that comes with fund-raising for an early stage startup is jarring, for anyone . . . and it is especially so for first-time founders.

Are there any hacks that a first-time startup founder can use to make the journey less fraught with frustration? I think there are. Below, I share some suggestions.

Preparation is key; It is better to be over-prepared than it is to be under-prepared.

It is easy to assume that one will be able to tell one’s story in a way that makes sense to one’s audience. That’s a fatal mistake. If fundraising is important for the startup’s survival then founders should practice the pitch . . . Fundraising is about narrative and storytelling. Founders must practice telling the story until it becomes second nature.

This involves both qualitative and quantitative aspects of the startup’s story. It is important to note that this kind of storytelling differs from others in the sense that a startup founder seeks to persuade the listening audience to take a specific action that will work to the startup’s benefit. Write a check. Become a user. Become a customer. Spread the news about the startup’s product. I do not know if there’s a recommended amount of time that one should devote to preparing for something of this sort. When founders ask me privately for help preparing for a do-or-die pitch that is a few months away in the future, I recommend 80 – 100 hours of preparation; something like 1 or 2 hours of daily preparation devoted to making sure they know the story inside-and-out and that telling it is as normal as breathing. I also recommend that they practice delivering the pitch to different types of audiences to get input on the delivery from different points of view.

When founders ask me privately for help preparing for a do-or-die pitch that is a few months away in the future, I recommend 80 – 100 hours of preparation; something like 1 or 2 hours of daily preparation devoted to making sure they know the story inside-and-out and that telling it is as normal as breathing. I also recommend that they practice delivering the pitch to different types of audiences to get input on the delivery from different points of view. Toastmasters International is a useful resource for this, but founders will need more than Toastmasters offers.

Research is key; Know who you should be talking to.

It is easy for a first-time founder to get suckered into thinking it’s imperative to speak with “every investor known to mankind” . . . Meeting lots and lots of investors can really give a founder’s ego the kind of massage that market realities aren’t willing to dish out without herculean effort from the startup. Also, an investor’s willingness to “meet for coffee to discuss your feedback on our model and your perspective on the opportunity” can seem like positive confirmation that the founder did not make a huge mistake by pursuing this goal of creating something from nothing.

Here’s the thing; That is not always true. Often an investor might just want to find out what’s happening in a given market, and coffee with a founder who has initiated the meeting is a low-cost way of getting educated by someone who’s currently and actively solving problems in that area.

Obviously, the opportunity cost of such a meeting is far higher for the startup founder than it is for the investor.

What is a founder to do? Think carefully about which investors have the highest propensity to invest in the startup; at this stage, given its current levels of traction . . . within the timeframe in which the startup must raise capital. Create a short-list and focus primarily on those investors who fit the bill. This is easier said than done since investors do not often state their investment parameters publicly.

That said, for founders in the United States there are a few tools one can use. Shai Goldman, currently a managing director at Silicon Valley Bank, has created an open-source GoogleSheet’s document that is a good starting point. Samir Kaji, currently a managing director at First Republic Bank, has also created a body of research on micro-vc that is another great starting point.

These two pieces of work complement one another quite well, and should be every first-time founder’s BFF every weekend after the decision to build a startup has been made. There are other pieces of information that a first-time founder should use. These two are especially key . . . but also most likely to be unknown to most first-time founders. I maintain an email I send the founders I encounter who evidently could benefit from having these resources at their fingertips. I will post links to those resources at Hack Your Startup: Pitch.

I spent some time explaining why this matters in The Path To Disaster: A Startup Is Not A Small Version of A Big Company – The Office Hours Remix.

It’s nothing personal, it’s just business; Manage your investor relations with email.

After every meeting with a potential investor, or quite frankly, with anyone who could be helpful to your startup in any way, I think it makes sense to ask if they would be willing to be added to a “Friends of Awesome Early Stage Technology Startup” email distribution list. The most common response will be “Yes. Please add me to your distribution list for updates.” These updates will be very general in nature and should be a stripped-down version of the email updates that investors in the startup get. No confidential information should be included in this email – only information you do not mind being in the public eye.

While the periodic updates are interesting on their own, to my mind they are not the point of this exercise. The primary purpose of this exercise is to split the universe of so-called “Friends of Awesome Early Stage Technology Startup” into three categories.

First; the people who unsubscribe from the updates. I do not know a more explicit signal that they have no interest in what the startup is doing but simply did not have the courage to tell the founder so directly. There’s no point devoting much more energy pursuing these people.

Second; the people who have not unsubscribed but have never engaged directly based on a prompt in any of the periodic updates. It is probably worth sending people in this group an email saying you are going out to raise a financing round for which they might have interest based on developments since the previous round . . . If they do not respond after two or three attempts . . . Move on.

Third; the people who have engaged with the founders after an update was sent. Perhaps the startup needed to hire an engineer and they responded with a recommendation or offered to share the job description with their network . . . They have demonstrated some interest in what you are doing. Even if they do not invest themselves, they are likely to be a positive reference to someone else for whom there’s a better fit. Focus on these folks.

These 3 suggestions are the big ones. I make other suggestions to founders I meet in person. Those are minor in comparison. For example, don’t let a friendly investor who passed on investing in a prior round for a specific reason find out about a new round in which they might still be able to invest with only a week left before your anticipated close. It’s unlikely they can conclude their due diligence that quickly.

It’s not personal Sonny. It’s strictly business.                                          – Michael Corleone, The Godfather

Financing a startup’s operations is a crucial part of every founder’s responsibilities . . . In fact, it might be the most important. If financing from external investors is part of the plan, then founders need to find ways to make it less of a hit-or-miss affair. I hope these suggestions provide some food for thought about how to do that effectively without spending an inordinate amount of time.

Source Unknown
Source Unknown

Further Reading

  1. When The VC Says “No” – a great discussion by Marc Andreessen. You must read this.
  2. Dear Dumb VC – a post by Andy Dunn, the founder of Bonobos and Red Swan Ventures.
  3. As Populist As it May Seem, 98% of VCs Aren’t Dumb – a rebuttal by Mark Suster of Upfront Ventures.
  4. How LinkedIn First Raised Money (and Endured Rejection) – a post by Lee Hower.

Filed Under: Entrepreneurship, Funding, How and Why, Innovation, Operations, Pitching, Startups, Venture Capital Tagged With: #NotesOnTactics, #Remix, Early Stage Startups, Investor meeting, Investor Relations, Persuasion, Pitching, Venture Capital

Notes on Strategy; Where Does Disruption Come From?

July 19, 2015 by Brian Laung Aoaeh

Marc Andreessen’s brilliant explanation of @claychristensen‘s disruptive innovation theory in 15 tweets: pic.twitter.com/3ic1teQbRW

— Vala Afshar (@ValaAfshar) June 24, 2015

Introduction

You can imagine my surprise when I was browsing my Twitter feed one night last month and came across one of Marc Andreessen’s tweetstorms. This time he was tweeting about Clayton Christensen’s Theory of Disruptive Innovation.

Coincidentally, I have been thinking about writing a blog post on the subject since the Fall of 2014 – after a string of successive meetings with startup founders in which it became starkly clear to me that they were using the term “disruption” without actually understanding what it meant, or perhaps I should say, they used the term in a context that differs markedly from my understanding of what it means.

The purpose of this blog post is to; ((Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained them.))

  1. Synthesize my understanding of Disruptive Innovation as popularized by Clayton Christensen’s work,
  2. To examine instances in which that process has unfolded in various industries,
  3. To develop a framework by which I can analyze a startup founders’ claims about “being disruptive” during my conversations with them, and
  4. Examine extensions of, and arguments against, Clayton Christensen’s work on Disruptive Innovation

I am thinking of this from the perspective of an early stage Seed and Series A investor in technology startups, not from the perspective of a management consultant advising market incumbents about how to avoid or prevent competition.

To insure that we are on the same page; first some definitions.

Definition #1: What is a startup? A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model. ((I am paraphrasing Steve Blank and Bob Dorf, and the definition they provide in their book The Startup Owner’s Manual: The Step-by-Step Guide for Building a Great Company. I have modified their definition with an element from a discussion in which Paul Graham, founder of Y Combinator, discusses the startups that Y Combinator supports.))

Definition #2: What is Sustaining Innovation? A “sustaining innovation” is an innovation that leads to product improvements without fundamentally changing the nature or underlying structure of the market to which it applies; it enables the same set of market competitors to serve the same customer base. ((Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition.))

In other words; a sustaining innovation solves a problem that is well understood within an existing market. The innovation improves performance, lowers costs and leads to incremental product improvements. The customers are easily identified, and market reaction to the innovation is predictable. Lastly, traditional business methods known within that market are sufficient to bring the innovation to market. ((Brant Cooper and Patrick Vlaskovits, The Lean Entrepreneur. Wiley, 2013, pp. xx.))

Additionally;

  1. A sustaining innovation is evolutionary if it leads to product improvements that are gradual in nature, progressing along what might be described as a gradual step function.
  2. A sustaining innovation is revolutionary, discontinuous, or radical when it leads to product improvements that are dramatic and unexpected in nature, but that nonetheless leaves the market structure largely intact – even if there is a rearrangement of counterparties within the existing competitive hierarchy.
  3. Even the most dramatic and difficult sustaining innovations rarely lead to the failure of leading incumbents within a market. ((Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. xviii.))

Definition #3: What is Disruptive Innovation? A “disruptive innovation” is one that starts out being worse in product performance in comparison to the alternative, in the immediate term. However, as time progresses the disruptive innovation leads to a significant and fundamental shift in market structure – new entrant competitors serve an entirely changed customer base. ((Ibid.))

In other words; a disruptive innovation solves a problem that is not well understood by the market, thus creating a “new market” for the new entrant. The innovation is dramatic and game-changing in ways that initially elude the mainstream customers as well as market incumbents serving those customers. The customer is often difficult to identify at the outset, and market reaction toward the innovation is unpredictable – from the perspective of the mainstream. Traditional methods and business models that have served the market can not support the innovation. ((Brant Cooper and Patrick Vlaskovits, The Lean Entrepreneur. Wiley, 2013, pp. xx.))

Additionally;

  1. A disruptive innovation introduces a different and “comparatively inferior” value proposition than the value proposition the existing market is accustomed to; as such
  2. Disruptive innovations start out being attractive only to a relatively “fringe” and “new” but altogether “unprofitable” customer base with products that are;
  3. “Cheaper, simpler, smaller, and more convenient” for the customers that find them most attractive at the outset, and
  4. These products perform so “poorly” that mainstream customers in that market will not use them, and incumbent players are happy to keep “their best, and most profitable customers” while ceding “their worst, and unprofitable customers” to the startup bringing the disruptive innovation to market, but
  5. Eventually the disruptive innovation leads to market shifts which cause leading incumbents to fail as the new entrants supplant them.

Image Credit: Vadim Sherbakov
Image Credit: Vadim Sherbakov

Understanding What is Happening When a Market Undergoes Disruption

So what exactly is going on when a market experiences disruption? Contrary to what the term “disruptive innovation” suggests . . . the process is not sudden.

As Clayton Christensen states; Disruptive innovations are generally straightforward technologically. They consist of off-the-shelf components combined in a product architecture that is far simpler than existing alternatives or substitutes in a way that does not meet the needs of the core customers in an established market. They will often be derided and dismissed by incumbents as “inferior” because they offer benefits prized by an emerging class of customers in an emerging, but as yet unnoticed market. The disruptive innovation starts out being unimportant to the mainstream customer and so it is unimportant to the mainstream incumbent. ((Clayton M. Christensen, The Innovator’s Dilemma. 2006 Collins Business Essentials Edition, pp. 16.))

Mainstream customers and mainstream investors hold mainstream incumbents captive – with demands for sustaining innovations, and demands for meeting or beating financial performance metrics like internal rate of return, net present value, return on equity, return on invested capital, gross margins, net margins etc. Faced with the choice between pursuing an unprofitable emerging class of customers or doubling down in the competition for the most profitable mainstream customers in that market, management teams running mainstream incumbents do the rational thing; they double down in heated competition for profitable customers.

The disruptive innovation improves so rapidly, that it soon starts to meet the needs of segments of the mainstream customer base. As the cycle continues, it reaches a stage where the incumbents find themselves squeezed into a tiny corner of the market, driven out of it altogether, or dead.

This process describes a “low-end disruption.”

Disruptive innovation might take another form; in a “new market disruption” the startup initially sets its sights on customer segments that are not being served by mainstream incumbents within a given market. A new market disruption starts by competing “outside” of an existing market; in new use-cases, or by bringing in customers who previously did not consume because of they lacked the know-how or financial resources needed to use the incumbent product. The new market is “small and ill-defined” . . . However, as the new entrant grows and improves its product, customers begin to abandon the incumbent in favor of the disruptive innovation. Usually, the incumbent cannot compete with the new entrant because the new-market disruption is accompanied by a structurally distinct business model which makes it feasible for the new entrant but infeasible for the incumbent, for example a cost structure that is so thin that it could not support the incumbent’s fixed costs. ((Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, pp. 45.))

What Is The Innovator’s Solution; For Early Stage Startups and Early Stage Venture Capitalists?


Of the many dimensions of business building, the challenge of creating products that large numbers of customers will buy at profitable prices screams out for accurately predictive theory.

– Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution


First: Understand Why Customers Buy What causes customers to buy a product? A startup wishing to disrupt an established market needs to be able to answer this question in a way that existing incumbents have not. The “Jobs-To-Be-Done” (JTBD) framework enables a startup to develop its product at the “circumstance” in which its customers find themselves at the time they need its product, and not directly at the circumstances. As Christensen and Raynor put it: “The critical unit of analysis is the circumstance and not the customer.”

The basic idea behind the jobs-to-be-done framework is that customers “hire” a product when they need to get a specific “job” done. The entrepreneur who understands what job the startup’s product is being hired to do can also develop an understanding of the other jobs that might be related and ancillary to the primary job. The regularity and frequency with which customers need to get that job done plays a role in product development; what features should be prioritized? Which features should be de-prioritized even though they at first seemed important? How should the product’s value proposition be communicated? What other features should be built so that customers need not combine several different products in order to complete the job, or if they do how does the startup capture those markets too?  ((Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution. 2003, Harvard Business School Publishing, chapter 3.))

In my opinion startups stand an even better chance of success if they can combine the JTBD framework with an understanding what broad needs their product satisfies for their customers using the parameters laid out by Maslow’s Hierarchy of Needs. This matters especially in the determination of how a startup should communicate the product’s value proposition to its target customer base. An incongruence between the startups marketing message and the customers’ psychological notions about the product will lead to missed opportunities for the startup. It might also lead a startup to chase after the wrong customer base at the outset. ((Startups building products for the enterprise customer should be able to develop an analogous framework, assuming one does not already exist.))


When new ventures are expected to generate profit relatively quickly, management is forced to test as quickly as possible the assumption that customers will be happy to pay a profitable price for the product.

– Clayton M. Christensen and Michael E. Raynor, The Innovator’s Solution


Second: Be Patient For Growth But Impatient For Profits The investors and founders of a startup that claims to be disrupting a market must quickly test if the market dynamics the startup must confront are such that it can earn a profit given its business model. This is important because it indicates that for those startups that answer those questions positively, it is possible for them to pursue growth in a way that is healthy and sustainable irrespective of the magnitude of the growth.

The Startup Genome Report reached conclusions that support this notion. In an extra to the 2011 version of that report they study the effect of premature scaling on the longevity of startups. They found that 70% of the 3200+ high-growth technology startups scaled prematurely along some business model dimension.

Before delving deeper into the findings from the Startup Genome Report, we should understand “Product-Market Fit“. An early stage startup is approaching the product-market fit milestone when demand for its product at a price that is profitable for the startup’s business model, begins to outstrip the demand that could have been explained by its marketing, sales, advertising, and PR efforts.


Product/market fit means being in a good market with a product that can satisfy that market.

You can always feel when product/market fit isn’t happening.The customers aren’t quite getting value out of the product, word of mouth isn’t spreading, usage isn’t growing that fast, press reviews are kind of “blah”, the sales cycle takes too long, and lots of deals never close.

And you can always feel product/market fit when it’s happening. The customers are buying the product just as fast as you can make it — or usage is growing just as fast as you can add more servers. Money from customers is piling up in your company checking account. You’re hiring sales and customer support staff as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it. You start getting entrepreneur of the year awards from Harvard Business School. Investment bankers are staking out your house. You could eat free for a year at Buck’s.

– Marc Andreesen ((Marc Anrdeesen, Product/Market Fit, Jun 25, 2007. Accessed on Jul 18, 2015 at http://web.stanford.edu/class/ee204/ProductMarketFit.html))


In other words, the product-market fit milestone is that milestone at which we start to realize that the startup has an opportunity to grow in sustainable and profitable way. As organic demand for the product starts to overwhelm the startup – i.e. as the market starts to pull the product out of the startup, that is the point at which it makes sense for investors to become impatient for growth. Before Product-Market Fit (BPMF) a startup must “push” its product onto the market – customers and revenue grow in direct, linear proportion to sales and marketing expense. After Product-Market Fit (APMF) the market “pulls” the product out of the startup – customers and revenue grow positively, disproportionately, and exponentially out of proportion to any sales and marketing expense incurred by the startup. Investors and startup founders should become impatient for growth when the startup is in the APMF phase of its life-cycle. This approach should hopefully avoid situations like: Case Study: Fab – How Did That Happen?

According to Startup Genome Report Extra on Premature Scaling:

Note: They use the term “inconsistent startups” to describe startups that scale prematurely and “consistent startups” to describe startups that scale successfully.

  1. 74% of startups scale prematurely.
  2. Startups that scale appropriately grow about 20x faster than startups that do not.
  3. Inconsistent startups that raise funding from investors tend to be valued 2x as much as consistent startups and raise about 3x as much capital prior to failing.
  4. Inconsistent startups have teams that are 3x the size of the teams at consistent startups at the same stage.
  5. However, once they get to the scaling stage, consistent startups have teams that are 1.38x the size teams at inconsistent startups.
  6. Consistent startups take 1.76x as much time to reach the scale-stage team size than their inconsistent peers.
  7. Inconsistent startups are 2.3x more likely to spend more than one standard deviation more than the average cost to acquire a customer than their consistent peers.
  8. Inconsistent startups write 3.4x more lines of code and 2.25x more lines of code in the discovery and efficiency stages of their life-cycle. Discovery and efficiency are the first and third stages of the startup lifecycle, as described in the report. ((In their report they describe the stages of a startup’s life-cycle as Discovery, Validation, Efficiency, Scale, Sustenance, and Conversation. The report covers the first four.))
  9. A majority of inconsistent startups are more likely to be efficiently executing irrelevant things at the Discovery, Validation, and Efficiency stages of their life cycle, while a majority of consistent startups seek product-market fit during those stages.
  10. The following attributes have no correlation to the likelihood that a startup will be inconsistent or consistent: market size, product release cycles, educational attainment, gender, age, length of time over which co-founders have known one another, location, tools used to track KPIs etc.

What are some of the mistakes that inconsistent startups make as they travel from launch to dysfunctional scaling to failure? The Startup Genome Report provides some examples:

Customer

  1. Spend too much on customer acquisition BPMF and before discovering a profitable, repeatable and scalable business model, and
  2. Attempt to ameliorate that problem with marketing, press, and public appearances.

Product

  1. Build a “perfect product” before knowing enough about the “Problem-Solution Fit”, and
  2. Investing into scaling the product BPMF, and
  3. Focusing on advanced product features which are later proven to be unimportant to customers.

Team

  1. Growing the team too fast,
  2. Hiring specialists and managers too early and not having enough people who can or will actually do the work that needs to get done, and
  3. Having too much hierarchy too early.

Finance

  1. Raising too little money at the outset,
  2. Raising too much money. ((This is a risk for early stage investors as well as startups.))

Business Model

  1. Not spending enough time developing the business model, and only realizing after the fact that revenues will never support the startup’s cost structure.
  2. Focussing too much on maximizing profit too early in the startup’s life-cycle,
  3. Executing without observing and analysing the input from customers and the market, and
  4. Failing to pivot appropriately in the face of changing market conditions that are relevant to the startups based on its discovery-focused experiments.

The 4 Stages Of Disruption

In his article, Four Stages of Disruption, Steven Sinofsky describes the process of disruption using an analogy to the well known and well understood rubric for understanding the experience of someone experiencing significant loss.

The 4 stages of disruption are:

  1. Disruption: A new product appears on the market but is seen to be inferior to the existing mainstream alternative.
  2. Evolution: The new product undergoes rapid sustaining innovations.
  3. Convergence: The new product is now seen as a plausible replacement for the incumbent mainstream product because it has undergone enough sustaining innovations to make it comparable to the incumbent.
  4. Reimagination: During this stage there is a complete re-examination of the assumptions on which the market operates and new products are brought to market.

Sinofsky describes them as a process, as shown in the following diagram:

The 4 Stages of Disruption (Credit: Steven Sinofsky)
The 4 Stages of Disruption – Process (Credit: Adapted from Steven Sinofsky)

 

I think the framework is better understood as a cycle; because every incumbent must face a new entrant or new entrants seeking to disrupt the market and eventually every successful new entrant that disrupts a market itself becomes an incumbent facing disruption by a successive hoard of disruptive new entrants. The cycle is ongoing and continuous, and is driven by more than simple advances in technology. Human behavior plays a central role in shaping the cycle that creates room for disruption to occur because our tastes change over time, and as time progresses we begin to value things that we did not value in the past, and it is that insight into the confluence between technology and human behavior that enables certain entrepreneurs to build startups that become industry disruptors.

 

4 Stages of Disruption - Cycle
The 4 Stages of Disruption – Cycle (Credit: Adapted from Steven Sinofsky)

 

How Did That Happen? – Disruption in Action; Industries

Digital Cameras vs. Film Photography: Digital cameras threatened to disrupt film photography, but they mainly represented a sustaining innovation – largely improving on existing form factors already in use in that market and fulfilling the needs of people one would consider casual or professional photographers. It was not until digital camera technology was integrated into smart-phones that the photography market started to experience disruption. They appealed to anyone who had the desire to take a picture, photographer or not, it did  not matter. As Craig Mod argues in his 2013 New Yorker article Goodbye, Cameras: “In the same way that the transition from film to digital is now taken for granted, the shift from cameras to networked devices with lenses should be obvious.” Standalone cameras are simply no longer good enough because: “They no longer capture the whole picture.” Kodak’s demise follows the classic format of every great incumbent that has fallen into obscurity in the face of an onslaught from new entrants. Kodak was itself a disruptor at one point – taking photography out of the sole preserve of professionals and putting it in the hands of every casual photographer seeking to preserve memorable moments. In his 2012 Wall Street Journal article, Kamal Munir outlines the rise and fall of Kodak in The Demise of Kodak: Five Reasons. It is important to note that Kodak developed technology for a digital camera in 1975, yet it failed to understand why customers bought its products and so failed to shift its business model as aggressively as it could have to avoid the fate that began staring it it in the face in 1975, nearly 4 decades before it filed for bankruptcy. ((Theodore Levitt’s seminal HBR article “Marketing Myopia” first introduced this concept in 1960. You should read the original article as well as this update from 2004.))

Mobile Phones vs. Fixed Line Telephones: One sign that mobile and broadband telephony is disrupting fixed line telephony is the European Commission’s 2014 decision to stop regulating fixed line telephony. The situation for fixed line telephony is no different with telephone companies announcing that they are abandoning their landline telephone infrastructure in favor of mobile and broadband phone service. Their reaction is being driven by consumer’s willingness to rid themselves of landlines in favor of cellphones for individual personal use and/or VOIP-enabled phones at home. Liquid Crystals were first discovered by the Austrian physicist Friedrich Reinitzer in 1888. Nearly 7 decades later, engineers and scientists at RCA were conducting research that led them to file the first LCD patent on November 9, 1962. The USPTO granted them the patent on May 30, 1967. However, RCA did not move aggressively enough to make the LCD technology that had been developed by its employees the center of its business model.

Liquid Crystal Displays vs. Cathode Ray Tubes: The emergence of LCD technology marked the beginning of the end for CRT technology in the TV market. The technology that led to the development of LCD televisions originated in 1888, when an Austrian Physicist, Friedrich Reinitzer discovered the strange behavior of cholesteryl-benzoate. Nearly 4 decades later, scientists and engineers working at RCA filed a patent application based on LCD technology on Nov 9, 1962. It was granted on May 30, 1967. Predictably, RCA did not do much with its head-start in the development of LCD technology, instead it gave up its advantage to Japanese, Korean, and Taiwanese upstarts.

 

Statistic: Global market share held by LCD TV manufacturers from 2008 to 2014 | Statista
Find more statistics at Statista

 

How Did That Happen? – Disruption in Action; Companies/Products

Google – Launching Sustaining and Disruptive Innovations:

Google was the 21st search engine to enter the market, 1998. Know your competition, but don’t copy it. pic.twitter.com/NUH8f65Ak8

— Vala Afshar (@ValaAfshar) December 30, 2014

 

While Google’s innovation in search are impressive, and helped it win that market at the expense of other search engines, it gained near absolute dominance in that market by developing a sustaining innovation in the form of its PageRank Algorithm, which is described in the paper by Sergey Brin and Lawrence Page: The Anatomy Of A Large Hypertextual Web Search Engine.
Statistic: Worldwide market share of leading search engines from January 2010 to April 2015 | Statista
Find more statistics at Statista

 

Rather, the industry that has been disrupted by Google is the online advertising market. Describing this in his article “What Disrupt Really Means” Andy Rachleff writes: “It was AdWords, its advertising service. In contrast with Yahoo, which required advertisers to spend at least $5,000 to create a compelling banner ad and $10,000 for a minimum ad purchase, Google offered a self-service ad product for as little as $1. The initial AdWords customers were startups that couldn’t afford to advertise on Yahoo. A five-word text ad offered inferior fidelity compared with a display ad, but Google enabled a whole new audience to advertise online. A classic new-market disruption. Most have forgotten that Google added significant capability to its advertising service over time and then used its much-lower-cost business model (enabled by self-service) to pursue classic Internet advertisers. Thus it evolved into a low-end disruption.”     Statistic: Net digital ad revenues of Google as percentage of total digital advertising revenues worldwide from 2012 to 2014 | Statista Find more statistics at Statista   Salesforce – Launching New Market and Low-End Disruptions: When Salesforce launched in 1999 it did so as a software-as-a-service (SaaS) platform that enabled companies that needed sales management software but could not afford the cost of annual multimilion dollar licenses for the mainstream products of the day. It’s initial product was lacking in features, and unreliable for the mainstream customers of the incumbent players in the CRM software market at that time. It built its business on non-consumption. As time progressed and its product matured in terms of reliability and features, Salesforce caused a low-end disruption as customers adopted its product while abandoning the more expensive CRM products sold by CRM market incumbents like Siebel Systems, Amdocs, E.piphany, PeopleSoft, and SAP.     Statistic: Market share of vendors customer relationship management software worldwide from 2012 to 2014 | Statista Find more statistics at Statista   Apple: Has Apple launched any disruptive innovations? Not if you asked Clayton Christensen in 2006 or again in 2007, or even in 2012. Yet I suspect that Nokia and Research in Motion feel differently about that question. The chart below is instructive.     IDC: Smartphone Vendor Market Share 2015, 2014, 2013, and 2012 Chart   Apple’s products have not been disruptive in the way that one might think of disruption if one adheres strictly to the line of analysis followed by Clayton Christensen and his collaborators. Perhaps one can argue that the iPod, the iPhone, and the iPad, each taken individually represents a sustaining innovation in the personal music player, the mobile phone, and the personal computer markets respectively. However, when one combines each of those products with the other elements in Apple’s product lineup there’s no denying that Apple has been disruptive to more than one industry. The “iPod + iTunes” has reshaped how people consume music, and has upended the music industry. The iPhone has led to a rethinking of what people expect from a mobile phone, and “iPod + iTunes + iPhone + AppStore” is responsible for the demise of Nokia and Research in Motion’s Blackberry as it has redefined how people consume media of all types. The “iPad + AppStore” combination is redefining how people consume media of all types, and redefining the relationship people have with their personal and laptop computers. Apple demonstrates the power of technology + design + branding + marketing as a powerful force in the process of disrupting established industries in consumer markets. ((It is worth noting that Clayton Christensen’s analysis and research focuses on business-to-business markets.))     Statistic: 4G mobile device shipments worldwide from 2009 to 2020 (in 1,000 units) | Statista Find more statistics at Statista   Infographic: Has the PC Industry Bottomed Out? | Statista You will find more statistics at Statista   Netflix: At the outset Netflix seemed like a joke to executives at Blockbuster which dominated the US market for home-movie and video-game rental services, reaching its peak with 60,000 employees and 9,000 physical stores in 2004 after its launch on october 19, 1985. Netflix was founded in 1997 and started out as a flat-rate DVD-by-mail service in the United States using the United States Postal Service as its distribution channel. Presumably, the idea for Netflix was born after Reed Hastings, one of its co-founders was hit with a $40 late-fee after returning a DVD to Blockbuster well after its due date.  

Netflix DVD Mailer (Image Credit: Netflix)
Netflix DVD Mailer (Image Credit: Netflix)

Automated Netflix Mailer Stuffer (Image Credit: Netflix)
Automated Netflix Mailer Stuffer (Image Credit: Netflix)

Order Processing & Shipping Center (Image Credit: Netflix)
Order Processing & Shipping Center (Image Credit: Netflix)

Order Processing & Shipping Center: Sleeve Labels (Image Credit: Netflix)
Order Processing & Shipping Center: Sleeve Labels (Image Credit: Netflix)

  As you might imagine, executives at Blockbuster did not see the threat posed by Netflix and passed on 3 opportunities to buy Netflix for $50 Million. They failed to understand that people would rather not pay exorbitant late fees and that people valued the convenience of dropping the DVD from Netflix in the mail more than they enjoyed driving to Blockbuster’s physical retail stores. In other words; Netflix fulfilled the JTBD of “entertain me at home with something better than my options on TV” more conveniently than Blockbuster. The challenge that netflix must now face is how that original JTBD that it was hired to do by consumers is changing given the proliferation of mobile devices and the shift in consumer preferences away from physical media towards streaming media.      Infographic: Netflix' Successful Transition | Statista You will find more statistics at Statista


 

 But management and vision are two separate things. We had the option to buy Netflix for $50 million and we didn’t do it. They were losing money. They came around a few times.  – Former High-ranking Blockbuster Executive ((Marc Graser, Epic Fail: How Blockbuster Could Have Owned Netflix. Nov 12, 2013, accessed on Jul 18, 2015 at http://variety.com/2013/biz/news/epic-fail-how-blockbuster-could-have-owned-netflix-1200823443/))

 


 

To anyone that ever rented a movie from BLOCKBUSTER, thank you for your patronage & allowing us to help you make it a BLOCKBUSTER night. — Blockbuster (@blockbuster) November 10, 2013

Blockbuster filed for bankruptcy in 2013. Today Netflix is streamed online through many internet-enabled smart tvs, streaming media players, game consoles, set-top boxes, blu-ray players, smartphones and tablets, as well as personal and laptop computers.

What Common Traits Do the Startup Founders Who Lead Disruptive Startups Share?

Disruptive innovation is built on much more than technology innovation. The startups that go on to disrupt markets combine innovation in technology with innovative approaches to market segmentation, product positioning, marketing strategy, business model innovation, business strategy, corporate strategy, customer psychology, and organizational design and culture.

As an investor in early stage technology startups that are still in the searching for and trying to validate a repeatable, profitable, and scalable business model it is critical that I become good at recognizing startup founders who can successfully see disruption through to a profitable harvest for the founders, and the LPs to whom I am responsible.

According to The Innovator’s DNA, startup founders capable of leading disruptive new market entrants display the following traits:

  1. Association: They make connections between seemingly disparate areas of knowledge, leading them to novel conclusions that elude other people.
  2. Questioning: They exhibit a passion for questioning the status quo.
  3. Observing: They learn by watching the world around them more closely than their peers and competitors.
  4. Networking: They have a social network that is wide and diverse, which enables them to test their own ideas as well as seek ideas from people who may see the world from a  distinctly different point of view.
  5. Experimenting: They continuously test their assumptions and hypotheses by unceasingly exploring the world intellectually and experientially.

These skills are echoed in The Creator’s Code, which describes extraordinary entrepreneurs as people who:

  1. Find The Gap: by staying alert enough to spot opportunities that elude other people by transplanting ideas across divides, merging disparate concepts, or designing new ways forward.
  2.  Drive For Daylight: by staying focused on the future, and making choices today on the basis of where they see the market going instead of where the market has been.
  3. Fly The OODA Loop: by continuously and rapidly updating their assumptions and hypotheses through the Observe, Orient, Decide, and Act framework. Fast cycle iteration helps them gain an edge over their competition, and catchup with the mainstream market incumbents. ((See statements like: “Move fast and break things.” or “Let chaos reign.”))
  4. Fail Wisely: by preferring a series of small failures over a few catastrophic setbacks by placing small bets to test new ideas in order to gain further insight before they place big bets. By doing this they create organizations that learn how to turn failure into success and develop an inbuilt structural resilience.
  5. Network Minds: by harvesting the knowledge and brainpower from cognitively and experientially diverse individuals they develop unique approaches to solving multifaceted problems, problems whose solution might elude competitors.
  6. Gift Small Goods: by behaving generously towards others they strengthen relationships and build goodwill towards themselves and the organizations that they lead.

In The Questions Every Entrepreneur Must Answer, Amar Bhidé outlines a number of questions the feels every entrepreneur must answer in order to determine fit of the entrepreneur to the startup venture and of the startup venture to its context. ((Amar Bhidé,The Questions Every Entrepreneur Must Answer. From The Entrepreneurial Venture, readings selected by William A. Sahlman et al. 2nd edition, pp. 65 – 79.)) The questions are as follows;

  1. Where does the entrepreneur want to go?
    1. What kind of enterprise does the entrepreneur need to build in order to get there?
    2. What risks and sacrifices does such an enterprise demand?
    3. Can the entrepreneur accept those risks and sacrifices?
  2. How will the entrepreneur and the startup get there?
    1. Is there a strategy that can get the startup there?
    2. Can that strategy generate sufficient profits and growth within a time-frame that make sense for the entrepreneur and for the startup’s investors?
    3. Is the strategy, and the startup’s business model defensible and sustainable? ((I have discussed economic moats here: Revisiting What I Know About Network Effects & Startups and here: Revisiting What I Know About Switching Costs & Startups))
    4. Are the goals for growth too conservative, or too aggressive?
  3. Can the founder or co-founders do it?
    1. Do they have the right resources and relationships?
    2. How strong is the relationship between the co-founders with one another, how strong is the organization’s team cohesion?
    3. Can the founder play her role?

The Role of Experts in Predicting The Success or Failure of Disruptive Innovations

Early stage investors often rely on the advice of subject matter experts as part of the due diligence process. Experts are great for determining if the technical innovation works as the founders say it does, however where investors can go wildly wrong is when they rely on subject matter experts for investment recommendations for disruptive innovations.

It should be obvious by now that most experts are poorly placed to offer advice that will be seen as correct when examined in hindsight if they are faced with a disruptive innovation.


The Only things we really hate are unfamiliar things.

– Samuel Butler, Life and Habit


The difficulty subject matter experts face in predicting how markets will evolve is captured in The Lexicon of Musical Invective, where the author captures the vituperous reactions of music critics to works that are now widely considered as masterpieces in the pantheon of Western music history. Why did these experts fail? They did not allow for the possibility that the future might differ from the present in which they were performing their analysis, nor did they allow for the possibility that people’s tastes in music would evolve away from what they had grown accustomed.

Experts experience too much cognitive dissonance when they have to make an investment recommendation regarding a disruptive innovation; what does it mean for their personal career security, what does that mean for the skills that they have worked so hard and so long to accumulate, what does that mean for their employer’s business?

Moreover, the fact that an individual is an expert in the technology behind the disruptive innovation does not mean that the same individual is an expert in all the other disciplines that are required to turn the technological innovation into a disruptive innovation.

Here are a few examples of instances in which experts got things horribly wrong: ((Adapted from Top 10 Bad Tech Predictions, by Gordon Globe. Nov 4, 2012, accessed on Jul 19, 2015 at http://www.digitaltrends.com/features/top-10-bad-tech-predictions/5/))

  1. In 1977 Ken Olson said: “There is no reason anyone would want a computer in their home.” He was an engineer by training, and president, chairman and founder of Digital Equipment Corporation. Microsoft and Apple were startups.
  2. In 1956 Herbert Simon said: “Machines will be capable, within twenty years, of doing any work a man can do.” He made this statement after attending an AI conference at Dartmouth.
  3. In 1946 Darryl Zanuck said: “Television won’t be able to hold on to any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.” He was a Hollywood magnate.
  4. In 1995 Robert Metcalfe said: “I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.” He co-invented Ethernet technology and co-founded 3Com in 1979 with 3 other people. 3Com develops computer network products.
  5. In 1995 Clifford Stoll said: “The truth is no online database will replace your daily newspaper, no CD-ROM can take the place of a competent teacher and no computer network will change the way government works.” He was an astronomer, a hacker, and author, and a computer geek.
  6. In 2007 Steve Balmer said: “There’s no chance that the iPhone is going to get any significant market share.” He was the CEO of Microsoft. ((Mark Spoonauer, 10 Worst Tech Predictions of All Time. Aug 7, 2013. Accessed online on Jul 19, 2015 at http://blog.laptopmag.com/10-worst-tech-predictions-of-all-time))

Criticisms of Clayton Christensen’s Theory of Disruptive Innovation

  1. In her 2014 New Yorker article; The Disruption Machine: What The Gospel of Innovation Get’s Wrong,JillLepore argues that:
    1. The theory is based on handpicked case studies, and it is not clear that these case studies are provide a sound basis upon which to build a theory.
    2. What Christensen describes as “disruption” can often be more accurately described as “bad management”
    3. The theory of disruption is built on retrospective analysis, it is unclear how useful it is in predicting how events will unfold.
  2. In his 2013 blog post: What Clayton Christensen Got Wrong, Ben Thompson examined the theory of disruption in the context of Apple’s introduction of the iPod, and later the iPhone. He argues that:
    1. The theory works well when we consider new market disruptions, but fails when we consider low-end disruptions, in consumer markets.
    2. The theory fails because consumers do not behave rationally.
    3. The theory fails to account for product attributes that cannot be documented but which consumers prize highly, all thing being equal.
    4. Vertical integration is a competitive advantage in consumer markets, because it allows vertically integrated producers to exert control over product attributes that customers value, but which would be near-impossible to control using a modular production framework.

Closing Thoughts

  1. The ideas on which “disruptive innovation” is built are not inviolable and permanent laws of nature. Early stage investors and startup founders should subject them to testing on a frequent basis. Disruption works in different ways in consumer markets than it does in enterprise, or business to business markets.
  2. Startup founders and their investors should combine Clayton Christensen’s ideas with those of Michael Porter in order to build a more complete strategic plan that can stand the vicissitudes of competition from the startup’s peers and the reaction from mainstream market incumbents.
  3. Good strategy is not a substitute for good management. Good strategy does not make good management obsolete.
  4. Building a better mousetrap is not necessarily the path to disruptive innovation and winning the market in which a startup is a new entrant.
  5. Low end disruptions almost always begin with a product that is significantly inferior in comparison to the product embraced by the mainstream market. Low end disruptions also have to be simpler, cheaper or more convenient than the mainstream product.
  6. New market disruptions do not necessarily have to be less expensive than the comparable product that is embraced by the mainstream market.
  7. Disruptive innovation entails much more than technological disruption. Incumbents can compete with technological disruption, and they always win in those scenarios. To succeed, startups seeking to disrupt a market must design business models that support their effort to bring their technological innovation to market and make it impossible for the mainstream market incumbents to respond in a manner that causes the startup to fail prematurely.
  8. The kernel of disruptive innovation is an insight that the mainstream market has ignored.
  9. Beware of investment advice from subject matter experts as it pertains to potentially disruptive startups. Test your biases against what can be proved by the market niche that the startup is first going to enter.

Further Reading

Blog Posts & Articles

  1. What “Disrupt” Really Means – Andy Rachleff
  2. The Four Stages of Disruption – Steven Sinofsky
  3. Marketing Myopia – Theodore Levitt, original 1960 HBR article
  4. Marketing Myopia – Theodore Levitt, 2004 HBR update
  5. How Disruption Happens – Greg Satell
  6. Good Disruption / Bad Disruption – Greg Satell
  7. Did RCA Have To Be Sold? – L.J. Davis
  8. What Clayton Christensen Got Wrong – Ben Thompson
  9. Clayton Christensen Becomes His Own Devil’s Advocate – Jean-Louis Gassée
  10. The Disruption Machine: What The Gospel of Innovation Gets Wrong – Jill Lepore
  11. Disruptive Business Strategy: What is Steve Jobs Really Up To? – Paul Paetz
  12. Clayton Christensen Responds to New Yorker Takedown of “Disruptive Innovation” – Drake Bennet
  13. How Useful Is The Theory of Disruptive Innovation? – Andrew A. King and Baljir Baatartogtokh, MIT Sloan Management Review Fall 2015 Issue
  14. What Is Disruptive Innovation? – Clayton Christensen et al, HBR December 2015 Issue
  15. Patterns of Disruption: Anticipating Disruptive Strategies of Market Entrants – John Hagel et al

White Papers

  1. Time To Market Cap Report
  2. Startup Genome Report Extra on Premature Scaling [PDF]
  3. Netflix: Disrupting Blockbuster [PDF]

Books

  1. The Innovator’s Dilemma
  2. The Innovator’s Solution
  3. The Innovator’s DNA
  4. Seeing What’s Next
  5. The Lean Entrepreneur
  6. What Customers Want
  7. The Creators Code
  8. The Entrepreneurial Venture
  9. Disruption By Design

Filed Under: Business Models, Entrepreneurship, How and Why, Innovation, Startups, Strategy, Technology, Uncategorized, Venture Capital Tagged With: Business Models, Disruptive Innovation, Early Stage Startups, Innovation, Long Read, Strategy, Technology, Value Creation, Venture Capital

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