Start Early, Start Small, and Demand Early Success

Discussion Point 3: Chapter 9: There Is Good Money and There Is Bad Money

Key passage: “We suggest three particular policies for keeping the growth engine running. Taken together the policies force the organization to start early, start small, and demand early success. (Page 246)

Key Takeaway: The time to work on growth is while the firm is still growing.

Start Early.  Christensen’s point here is that a firm should not wait until the signs of a crisis emerge to think of how it will remain competitive.  Though Christensen does not mention him by name, a few of his critiques of management literature are undoubtedly addressed to Jim Collins, famed author of Built to Last, Good to Great and most recently How the Mighty Fall and Great by Choice.  Though Christensen’s caveats of Collins’ conclusions and recommendations are noteworthy, there are still a lot of valuable insights in Collins’ work.   In his book, How The Might Fall, Collins writes: “Every institution is vulnerable, no matter how great. No matter how much you’ve achieved, no matter how far you’ve gone, no matter how much power you’ve garnered, you are vulnerable to decline… Anyone can fall, and most eventually do.”⁹ Despite extensive literature warning managers of the hubris of success, too many firms still fail to pro-actively, and in a disciplined fashion, seek new opportunities.  Collins and Christensen agree that firms can never rest on their latest achievements, and both theories do complement each other well.  When a firm does not become blinded by the hubris of its success, does not enter an undisciplined pursuit for more and acknowledges the risk and peril it faces⁹, it is more likely to “launch new –growth businesses regularly, [while] the core is still healthy.”¹⁰ I really like what Collins writes on this subject, as he encourages firms to ask the following three questions as they pursue disciplined continuous (Christensen would say “rhythmic”) leaps.  These questions are: “1. Do [the moves] ignite passion and fit the company’s core values? 2. Can the organization be the best in the world at these activities or in these arenas? 3. Will these activities help drive the organization’s economic or resource engine?”¹¹ For all their differences, both authors agree that firms should start early.

Start Small.  The idea of “start small” really relates to firms remaining decentralized, more entrepreneurial, as “more managers [seek] disruptive growth opportunities.”¹² Though Christensen only discusses the idea in a very narrow sense, and only over the course of one page, Jason Jennings, in his book “Think Big, Act Small,” expands on the idea and offers a compelling case as to why this is indeed a really good idea.  Using a research and writing style similar to that of Jim Collins, Jennings was able to identify several behaviors successful companies demonstrate, and he generalizes these into a theory where a long-term future is achieved through meeting short-term objectives.   In the chapter most closely related to Christensen’s context of new business creation, Jennings describes how “acting small” translates into the arena of new business invention.  Companies that “act small” mind their resources, maintain utilitarian facilities, put the people with the most to gain or lose on the front lines (this one sounds like what we read in the M-Tronics case, doesn’t it?), let volume drive the need for expansion, never forget their roots, control their growth and stay true to their principles and values.¹³ Jennings’ concrete steps help elaborate on Christensen more general point.  Additionally, there is well-documented research, British anthropologist Robin Dunbar’s in particular, that indicates that groups or organization should be careful when surpassing 150 members.   Malcolm Gladwell recounts Dunbar’s work and, in reference to the 150 member tipping point, writes: “above that point, there begin to be structural impediments to the ability of the group to agree and act as one voice.”¹⁴ This is certainly another good reason to keep new ventures initially small in order to leverage flexibility and adaptability.

Demand Early Success.  What Christensen really means by “early success” is early financial returns.  Indeed, Christensen writes that “being impatient for profit is a virtuous characteristic of corporate capital.”¹⁵ Christensen expands on this idea in his latest book, How Will You Measure Your Life?, and gives another reason why this rule is fundamental.  He writes:  “Good money from investors needs to be patient for growth but impatient for profit.  It demands that a new company figures out a viable strategy as fast as and with as little investment as possible—so that the entrepreneur don’t spend a lot of money in pursuit of the wrong strategy… Once a profitable and viable way forward has been discovered—success now depends on scaling out this model.”¹⁶ This line of thought aligns very well with the self-reinforcing spirals from adequate and inadequate growth Christensen describes in figure 9-2. McGrath and McMillan echo Christensen’s exhortation to built profitability into the venture early. They also provide concrete advice on how to achieve this goal using “discovery-driven planning.”  The initial step is the generation of a reverse income statement.  McGrath and MacMillan explain: “Instead of starting with estimates of revenues and working down the income statement to derive profits, we start with required profits…  The underlying philosophy is to impose revenue and cost disciplines by baking profitability into the plan at the outset.”¹⁷ Discovery driven planning is a thought-provoking process that should help companies identify flags early in the venturing process.

Notes

9.     J. Collins, How the Mighty Fall, HaperCollins, New York, 2009, p. 8, 20-22

10.  C. Christensen, The Innovator’s Solution, Harvard Business Review Press, Boston, 2003, p. 246

11.  J. Collins, How the Mighty Fall, HaperCollins, New York, 2009, p. 8, 63

12.  C. Christensen, The Innovator’s Solution, Harvard Business Review Press, Boston, 2003, p. 250

13.  J. Jennings, Think Big, Act Small, Portfolio, New York, 2005, p. 103-105

14.  M. Gladwell, The Tipping Point, First Back Bay, New York, 2002, p. 182

15.  C. Christensen, The Innovator’s Solution, Harvard Business Review Press, Boston, 2003, p. 254

16.  C. Christensen, How Will You Measure Your Life?, Harper Business, New York, 2012, p. 87-88

17.  R. McGrath and I. MacMillan, Discovery-Driven Planning, Harvard Business Review, Boston, 1995, p. 5

Law of Conservation of Attractive Profits

Discussion Point 2:  Chapter Six: How to Avoid Commoditization

Key passages:  “A company that finds itself in the more-than-good-enough circumstance simply can’t win: Either disruption will steal its markets, or commoditization will steal its profits.” (Page 152) and “The bedrock principle bears repeating: The companies that are positioned at a spot in a value chain where performance is not yet good enough will capture the profit. That is the circumstance where differentiated products, scale-based cost advantages, and high entry barriers can be created.” (Page158)

Key Take-away:  Firms ought to use the law of conservation of attractive profits to identify high profitability areas.

The two sentences in this key passage are very rich in insights, as they really tell us where to dig to strike gold.  In this chapter, Christensen sets up his argument using two extremes on the spectrum of product/service fulfillment of the customers need to help us understand the benefits of one, and the problems with the other.

The More-Than-Good-Enough Circumstance

To delve deeper into this idea, it is useful to refer to Richard D’Aveni’s work on hyper-competition.  He echoes Christensen’s assessment when he writes: “Thus, the process of competition forces firms to offer a line of high-quality, low-priced goods that eventually make high quality and lower prices a necessity for survival.”⁴ This concept relates to what Christensen calls commoditization, and clearly supports the idea of dwindling profitability.  Furthermore, as described in the first discussion point, mature industries are susceptible to creative destruction, which addresses the threat of disruption.  So if well-served markets are problematic, Christensen offers an alternative, which can help both new ventures and established firms to improve their odds of growth and profitability.  He makes a very well supported point that the best avenue for growth and profitability is to deliver quality where quality has been lacking up to this point.  This is consistent with D’Aveni’s price-quality competition escalation ladder, which culminates with a “need to move to a new arena of competition.”⁵ This ladder of escalation when competition is based on cost-quality advantages is similar to the process of commoditization and de-commoditization Christensen describes on pages 151 to 154. 

The Not-Yet-Good-Enough Circumstance

As firms uncover “not-yet-good enough” products of processes, Christensen explains that they can pursue a differentiation strategy, leverage scale-based cost advantages, and establish high barriers to entry.  He is a little short on details here, so let us turn to D’Aveni’s work and develop these ideas further. These three ideas actually parallel his research, as they correspond to the three arenas of competition he identified in addition to cost-quality.  What Christensen calls “differentiated products,” D’Aveni defines as “timing and know-how.”  D’Aveni does a really good job showing how the first mover has the choice between using a “leapfrog strategy” (successive investments in innovation) or moving downstream into higher value-added products. Sony is a good example of former: “Early on, it built tape recorders and used the know-how and resources from that project to fuel it production of transistor radios.  It brought out a pocket-sized transistor radio… Then Sony built on that success with the development of the Trinitron television in the late 1960s… Sony used and extended its skills in miniaturization and audio technology to develop this next innovation.”⁶   Christensen uses the computer industry in the 1990s to illustrate how money can flow when following the latter strategy.  Next, when addressing cost advantages, D’Aveni looks at competitors with “deep-pockets,” where resource escalation is one of the strategic options for the incumbent.  Finally, we get to barriers of entry.  Some strategies that D’Aveni gives to building barriers are customer familiarity, customer loyalty to a local brand, government barriers to foreign entry, control over domestic distribution systems, local customs, unique factor advantages (lower cost of labor or capital), and dominance of domestic market share.⁷   In every case however, D’Aveni, also gives possible course of action for new entrants to address and overcome these tactics.

Law of Conservation of Attractive Profits

Ultimately, Christensen wraps this chapter in the book by giving us law of conservation of attractive profits.  This law, inspired from famous laws of physics, states that: “When the modularity and commoditization cause attractive profits to disappear at one stage in the value chain, the opportunity to earn attractive profits with proprietary products will emerge at an adjacent stage.”⁸ This can actually be seen as good news, since this opportunity is equally available to both the incumbent and the new entrant.  

Notes
4.     R. D’Aveni, Hyper-Competitive Rivalries, The Free Press, New York, 1995, p.29 
5.     R. D’Aveni, Hyper-Competitive Rivalries, The Free Press, New York, 1995, p.36 
6.     R. D’Aveni, Hyper-Competitive Rivalries, The Free Press, New York, 1995, p.71 
7.     R. D’Aveni, Hyper-Competitive Rivalries, The Free Press, New York, 1995, p.99-100 
8.     C. Christensen, The Innovator’s Solution, Harvard Business Review Press, Boston, 2003, p. 168

The Innovator's Solutions Discussion Points - Part I of III

Discussion Point 1: Chapter Two: How Can We Beat Our Most Powerful Competitors?

Key passage: “The Innovator’s dilemma identified two distinct categories–sustaining and disruptive–based on the circumstances of innovation. In sustaining circumstances–when the race entails making better products that can be sold for more money to attractive customers–we found that incumbents almost always prevail. In disruptive circumstances–when the challenge is to commercialize a simpler, more convenient product that sells for less money and appeals to a new or unattractive customer set–the entrants are likely to beat the incumbents.  This is the phenomenon that so frequently defeats successful companies. It implies, of course, that the best way for upstarts to attack established competitors is to disrupt them.” (Page 32)

Key Take-away:  Firms can and must adapt to the type of innovation that is occurring at the moment. 

The idea Christensen develops here is initially useful in guiding innovation in firms at various stages of maturity.  A firm’s context has a large impact on which strategies will and will not be successful.  Since there are so many business books published, it can be very tempting for a leader to take a concept or idea that resonates with him or her, and has been successful at this or that company, and decide to execute the same strategy, wrongly expecting the same results under different circumstances.  Focusing on innovation, Christensen gives a simple, yet profound rule of thumb.  Incumbents are better positioned when innovation is of a sustaining nature and at a disadvantage when innovation is disruptive.  He gives two examples in particular that help strengthen his model. 

The first relevant example Christensen gives is that of Honda penetrating the US motorcycle market.  This example demonstrates his point about new comers having to focus on disruption.  Honda tried to go toe to toe with Harley Davidson using sustaining innovation and could not break into the market.  However, when it serendipitously stumbled onto the off-road bike market, it created a disruption and was able to establish a foothold from which it could then establish itself and grow.

Second, the advent of mini-mill in the steel industry created a disruptive innovation known as thin-slab continuous casting technology.  As the established steel giants continued to improve their processes, they did so focusing on sustaining innovations.  Now this brings up an interesting point.  The steel mills could have prevailed: though one can frame Christensen ideas as a rule of thumb for focusing on what strategy is more appropriate for a new or established firm, it is really the nature of the innovation that dictates what a successful strategy will be, regardless of whether it used by a newcomer or an incumbent. 

The role of technology in the long-term success of firms has become huge.  As long as all the innovation is confined to the sustaining circumstance, incumbents will continue to prevail.  But incumbents had better watch out when disruptive technologies emerge.  The problem (or opportunity) lies in the fact that disruptive innovation is ultimately inevitable.  It is this realization that led Joseph Schumpeter to formulate his theory of creative disruption: “The…process of industrial mutation…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 of capitalism.  It is not [price and output] competition that counts, but competition from the new commodity, the new technology, the new source of supply, the new type of organization.”¹  From Christensen’s point of view, this means that as long as a new breakthrough is not discovered, incumbents will tend to prosper, but that eventually new technologies will come about to disrupt and challenge their hegemony.  So what can an industry-leading firm do to prevent this inevitable challenge?  If destruction is inevitable, then it needs to find a way of doing the destroying.  One strategy is to foster an entrepreneurial culture.  The benefits of such a culture are many, but first and foremost come creativity and a pioneering spirit.  This often translates into corporately funded new-ventures, such as was seen at Boeing and Xerox (Internal Venture Divisions) and Chase and Intel (Corporate Venture Capital)². Alternatively (or concurrently), firms can offer structures that allow employees to devote time to side projects, like at 3M or Google.  Speaking of the “15 percent time” at 3M, Daniel Pink writes: “These walled gardens of autonomy soon became fertile fields for a harvest of innovations—including Post-it notes. Scientist Art Fry came up with this idea for the ubiquitous stickie not in one of his regular assignments, but during his 15 percent time.  Today, Post-its are a monumental business: 3M offers more than six hundred Post-it products in more than one hundred countries.”³ Neither strategy (entrepreneurial ventures or time for autonomous creativity) was present at US Steel and as a result, the biggest challenge US Steel faced was its blindness to fundamental changes in the industry.  The cause of its blindness? A deeply seated paradigm and unfounded faith that what had made them successful in the past would continue to make them successful…   To highjack Paul Revere’s famous words, “Disruption is coming!”  Successful firms must be primed and ready when it emerges.

 

Notes

1.     J. Schumpeter, Capitalism, Socialism and Democracy. Harper, New York, 1950, p. 83

2.     D. Garvin, A Note on Corporate Venturing and New Business Creation, Harvard Business Review, Boston, 2002, p. 9-11

3.     D. Pink, Drive, Riverhead Books, New York, 2009, p.95