The Innovation Show

In Greek mythology, Cerberus is the multi-headed hound that guards the gates of hell. In the underworld, Cerberus prevents the dead from leaving. In the business world, customers can prevent an organisation from leaving their current paradigm.

In marketing, the voice of the customer (VOC) summarises customers’ expectations, preferences and aversions. However, in strategy, the voice of the customer can pave the road the failure. In this Thursday Thought, we explore why we can become captive to our customers, using themes from our current series on the life and work of Clayton Christensen as a guide.

“Using the rational, analytical investment processes that most well-managed companies have developed, it is nearly impossible to build a case for diverting resources from known customer needs in established markets to markets and customers that seem insignificant or do not yet exist.” Joseph Bower and Clayton Christensen 

An excellent example of a cycle of disruption comes from the horse and the mass production of the motorcar. As with any paradigm shift, it was not an easy ride (ahem, excuse the pun.) Imagine you live in the late 1890s; most people travel by horse-driven coach, railway and streetcar. Rail is more comfortable than horse and cart because roads are glorified dirt tracks. When you hear rumours of this thing called a motorcar, “a mechanical horse”, you dismiss it as a passing craze. After a while, you see more motorcars appear. These first cars are so unreliable and smelled so bad that people call them “stink chariots”.

This is a flavour of the environment in which Henry Ford pursued his vision of a high-quality car at an affordable price. Many obstacles stood in the way of that vision: trust in cars, the (lack of) transport ecosystem, and even securing investment in his company. Take, for example, Horace Rackham, one of the early investors in The Ford Motor Company. With great uncertainty and against the advice of countless others, Rackham bought 50 shares of Ford stock (from a total of 890 shares). The president of the Michigan Savings Bank strongly advised Rackham not to invest, reportedly saying, “The horse is here to stay, but the automobile is only a novelty – a fad”. In retrospect, this seems like an awful prediction, and perhaps we might even think we would never make that mistake. However, we must consider the paradigm, the ecosystem and the prevailing conditions when such decisions are made.

In the context of this article, Ford’s famous quote, “If I had asked the customer what they wanted, they would have said a faster horse.” is applicable. If you ask someone who is only ever familiar with a horse how you can improve the product, they will request “a faster horse”.

Now, imagine you run the best horse market in the country. You hear rumblings about the motorcar. Some people claim it will disrupt your business. What do you do? You send out your best sales reps to ask your best customers what they think. What do they want? Your top sales reps will be biased and ask leading questions. “Hey, Jim, what do you make of these fancy toys, the motorcar, bit of a fad, eh?” That aside here is the rub; your best customers are also biased. They are so busy making profits, and your product/service/component plays an integral part in their success, so they simply want harder/better/faster/smaller/bigger versions. And herein lies a mammoth challenge for the incumbent, especially regarding disruptive innovations.

The personal computer provides a more recent example of becoming captive to your customers. From the 1950s to the 1970s, companies like IBM dominated the market for mainframe computers. These vast machines took up whole rooms, and businesses paid millions to buy them.

Companies like IBM focused on their strengths, making bigger and better mainframes. After all, when they asked their customers what they wanted, they said more computational power: faster horses! In a steady, predictable business world, when Moore’s law was in its (relative) infancy, such an approach offered a stable competitive advantage. However, in a world of disruptive innovation, the tectonic plates of disruption reshuffle the landscape and your competitive moat quickly becomes a sandcastle on the seashore. We are in the world of what our friend Rita McGrath calls “transient advantage“. In this world, your competitor is no longer just an established player that offers a similar product; your new competitor can come from below, offering an inferior product in the near term. As Clayton Christensen tells us, “A disruptive innovation is not a breakthrough improvement. Instead of sustaining the traditional improvement trajectory in the established plane of competition, it disrupts that trajectory by bringing to the market a product or service that is not as good as what companies historically had been selling.” Because it is not as good, your existing customers cannot use it; they want a better mainframe. However, by making the product affordable and straightforward, the disruptive innovation benefits people unable to consume the mainframe computer; these people are called “non-consumers.”

This paves the path for the Innovator’s dilemma. Because companies like IBM needed to meet the needs of their best customers, they have difficulty engaging simultaneously in the new, disruptive playing field while maintaining their existing transient advantage.

“Although most managers like to think they are in control, customers wield extraordinary power in directing a company’s investments. Before managers launch a technology, develop a product, build a plant, or establish new distribution channels, they must look to their customers first: Do they want it? How big will the market be? Will the investment be profitable? The more astutely managers ask and answer these questions, the more completely their investments will align with their customers’ needs.” – Clayton Christensen

Before the introduction of the personal computer, the least expensive computer was called a minicomputer because it was much smaller than a mainframe computer. While an IBM mainframe cost millions of dollars, during the 1970s and 1980s, minicomputers were manufactured by companies like Digital Equipment Corporation (DEC) and still sold for over $200,000 (depending on the spec). These machines, like mainframes, were complicated to use. Despite its transient dominance, DEC missed the personal computer revolution. In some ways, sound business management and listening to their customers led to their demise.

“There is nothing in a caterpillar that tells you it’s going to be a butterfly.” – Buckminster Fuller

Apple, one of the pioneers in personal computing, originally sold its model IIe computer kids’ toy. Kids didn’t care that the product was inferior to the existing mainframe and minicomputers. While it was good enough for children or hobbyists, DEC’s existing customers had no use for a personal computer for the first ten years it was on the market because it wasn’t good enough for their needs. The more carefully DEC listened to its best customers, the more those customers indicated that the personal computer did not matter to them.

Of course, it took years before the disruptive innovation evolved from caterpillar to butterfly, and when it does, it almost always takes incumbents by surprise. In the years when market leaders should invest in innovation, disruptions are unattractive because their best customers can’t use them, and they promise lower profit margins. Therefore, investment dollars are always more likely to go toward next-generation sustaining innovations instead of disruptive ones. The initial size of a disruptive opportunity is generally too small to justify any substantial investment or even management attention. DEC’s managers were not stupid; they were very logical as they improved their company in the way it was built to succeed.

“While managers may think they control the flow of resources in their firms, in the end, it is really customers and investors who dictate how money will be spent because companies with investment patterns that don’t satisfy their customers and investors don’t survive. The highest-performing companies, in fact, are those that are the best at this; that is, they have well-developed systems for killing ideas that their customers don’t want. As a result, these companies find it very difficult to invest adequate resources in disruptive technologies—lower-margin opportunities that their customers don’t want—until their customers want them. And by then, it is too late.”― Clayton Christensen

When you ask your existing customers how your products should evolve so that you can continue to serve them, they will give you incremental marching orders. As a result, you improve your products for those “existing” customers. In parallel, you develop a product even more removed from a budding new customer. Today’s non-consumer is fuel for tomorrow’s competitor.

Because an entrepreneur can’t even get an audience with a big customer, where do they start? They start with the non-consumer. The customer that the incumbent creator is not even interested in. As Michael Raynor told me on the forthcoming episode of The Innovation Show, “The Innovator’s Solution”, an incumbent feels like sending the startup a bouquet of 12 red roses for taking that unprofitable and demanding customer off their books so they can focus on their most profitable customers. After all, according to good management practice, the Pareto principle makes sense; 80% of your profits come from 20% of your customers. Unfortunately, this is part of the Innovator’s Dilemma. Somewhere in that messy, demanding, unprofitable customer lies your future product but uncovering that future takes time, effort and investment that does not make sense to today’s bottom line.

Why would you bother wasting your energy defending your lowest margin when you can pursue profit at the top of the market? As Clay Christensen always highlighted, “The customer is the wrong unit of analysis for innovators to focus on.”

“Smart companies fail because they do everything right. They cater to high-profit-margin customers and ignore the low end of the market, where disruptive innovations emerge from. Should we invest to protect the least profitable end of our business so that we can retain our least loyal, most price-sensitive customers? Or should we invest to strengthen our position in the most profitable tiers of our business, with customers who reward us with premium prices for better products?” ― Clayton Christensen

A dilemma indeed!

Thanks for Reading

(This Thursday Thought leans heavily on the collective work of Clayton Christensen and his collaborators. My goal is to summarise the work to make it accessible.)

We have convened an incredible group of those contributors for our series to celebrate Clayton’s life work and theories.

The latest episode, three and four, feature Rita McGrath and Clark Gilbert