Disruptive vs. Incremental Innovation

March 27, 2018

For the ones who have read the first two articles, as mentioned several times, to be able stay relevant and deliver a long-term shareholder return, there is one silver bullet for all (CPG) companies. It is to create and capture more value through innovation. Not all innovations are created equal tough as per the value they deliver. There are different approaches to classify the types of innovation in different business books. Let’s take the simplest one. And here comes the third article/dilemma.

Disruptive vs. Incremental Innovation

Let’s first start with the definition of a disruptive innovation? Harvard Professor Clayton M. Christensen (who is the father of the term) defines disruptive innovation as an innovation that creates a new market and value network and eventually disrupts an existing market and value network, displacing established market leading firms, products, and alliances.

Incremental innovations come more in the form of upgrades of existing products/services via better performance, more/different features or different pricing.

iPhone was a disruptive innovation when it is first launched in 2007 as a smartphone shaking not only the telephone industry but also personal computers with creating a new value network having an open platform app ecosystem that thousands of developers will contribute to its growth. iPhone X is more of an incremental innovation to previous iPhone. The share price of Apple grew more than 15X since the launch of iPhone in 2007 and incremental innovations followed it like iPad. However, it has not much changed after iPhone X launch even it is the best iPhone ever.

A sigmoid curve can best illustrate the economic life of innovations and the growth behind them. To maximize the value of this economic life you probably would need one big disruptive innovation and a series of incremental innovations building on it. Inevitably there will be a saturation of the existing curve if not replaced by the next one like the iPhone case.

Having said that we do not see allot of incumbent companies like Apple to deliver disruptive innovations. According to a research covering the last 100 years and 300 disruptive innovations less than 35% of them are coming from the incumbent companies after 2001. This number was even lower than 18% before 1981. We can talk about a positive trend but a huge gap remains.

Why is it less likely to come from incumbents?

1)   Different financial expectations: Looking at the examples, many disruptive innovations start with smaller margins and/or take longer time to return the investment than the incremental innovations (if they ever) and thus not financially attractive for the incumbent businesses until they are done by someone else and become large enough and/or up their game with higher quality/price product expansions to eat more from the incumbent businesses (Dollar Shave Club vs. Gillette)

2)   Different business model: Incumbents do not usually question their business models. It is safer to design their innovation strategy against more/better/different products to be sold with the existing business models. This makes them exposed to be disrupted from the business model side (Netflix vs. Blockbuster)

3)   Different thinking and organization design: The usual innovation flow in an incumbent CPG player would start with analyzing the existing market landscape, talking to existing consumers of that existing market and try to address the possible gaps in their portfolio vs. existing incumbent competition and/or vs. the existing consumer expectations. They employ in house marketing, R&D people who are experts of the existing product categories working based on these insights to innovate. Thus, their innovations are more likely to be incremental vs. disruptive. It would be very unlikely for Apple in a focus group to hear from its existing customers that they would love to have a telephone that can replace their personal computers in many aspects.

To summarize what we learn 1) Disruptive innovations are far bigger value drivers than incremental ones with higher risks for sure 2) Disruptive innovation is (still) less likely to come from incumbent players 2) More and more incumbents come up with disruptive innovations than before (so it is doable) 3) Incremental innovations can extend the value creation of disruptive innovations for a period (sigmoid curve). So, both is needed 4) Disruption innovation needs a different approach than incremental.

What is that different approach?

First companies should have a strategy where they clearly articulate where and when they need a disruptive innovation (based on the sigmoid curve) and where they need incremental innovations to extend the value creation of disruptive innovations and to be able to allocate resources accordingly. We do not need to get into what it takes for incremental ones as it is already there.

Based on everything we learned, the next big disruptive innovation is more likely to come from outside the company. Possibly it is already a prototype at a university lab or an MPV (minimum viable product) of a start-up or it will be there soon. The shape of your sigmoid curve will depend on if or when you are able to be aware of and act on them.

To make this happen; companies need separate independent dedicated structures (company-in-company, people and funds) mandated solely to find out the next big disruptive innovation for their businesses outside the company having below elements:

–     Own venture capitals meeting hundreds of start-ups/year, listen to their pitches, invest into them, join start-up events, be an organic part of the start-up eco-system. People who will work in these VCs should come from start-up world to lead the company in this different world. Your regular M&A people would not be the right fit for this task. There are already good examples like Johnson&Johnson VC with >1bn USD invested and more than 140 exits in the last 40 years. It is no surprise that J&J is able to deliver a good long-term shareholder return. There are more CPG companies creating their own VCs in different forms who will eventually be competing in given sectors.

–     Digital transformation experts beyond typical IT organizations coming from hi-tech companies or start-ups. People who will be able to connect the dots between the technological developments (AI, Big Data Analytics, Virtual/Augmented Reality, Voice Search etc.) and your business. This is also happening in many companies but the success will depend on how it is executed; internally or externally focused.

–     Scientists/R&D people working outside the company lab; in tech hubs, with universities, with start-ups.

I believe the winners will be the ones who embark into this faster and dare to have more independent and externally focused organizations who is able to challenge unchallengeable to disrupt their own when needed.

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