The End of the Innovator’s Dilemma?

The Innovator’s Dilemma is a famous business book written by Clayton M. Christensen on why successful, well-managed companies so routinely fail to see (and adapt to) changes in their market, allowing upstart entrants to take the lead while the incumbents stumble and fall.

The basic premise of the dilemma is simple:

The leading incumbents, by focusing on their existing customers and successful business model, simply can’t justify diverting resources into much smaller, nascent and unproven opportunities.

This leaves an initially small space open for startups to apply their disruptive technology in (note that disruptive technology doesn’t have to be super advanced, and in actuality, is often simpler technology that would be available to the incumbents, should they want to use it).

However the customers in this new market value different things than customers in the mature market, and so startups find a product-market fit (to use modern parlance), and start to expand.

As the new market grows in size, so too do the capabilities and sophistication of these startups, who advance the disruptive technology to a point where they’re now able to compete directly in the larger, mature market.

Suddenly, by being customer centric and, in theory, focusing on the right things, leading businesses find themselves outmanoeuvred in their own markets, often fatally so, ultimately going out of businesses, or at least never recovering as a leading firm.

The power of the theory is that it can be applied to many industries, from technology to manufacturing, to retail and pretty much anything else.

And it largely seems to have held up since it was published 20 years ago.

For example, in computers, both IBM and Microsoft were once the dominant players, with Apple an incumbent. Ditto Nokia, Siemens, Blackberry etc. before Apple launched the iPhone.

AOL and Yahoo! were the big players in town when Google was still tiny.

Friends Reunited, MySpace, Bebo…all huge social networks before Facebook.

And while there were no major online retailers like Amazon before Amazon, there were plenty of giant retailers (and publishing houses) that would have looked daunting to challenge. But we see how their valuations have changed over time.

Courtesy: The Visual Capitalist

And it’s these four companies: Google, Facebook, Apple and Amazon (together worth well over 2 trillion dollars) that I’ll focus my attention on here.

These are the modern day incumbents of some very profitable, fast-moving industries where the innovator’s dilemma has happened time and again: Advertising, Search, Social, Mobile, Computing and retail/eCommerce.

All have seen the leading firms in each industry toppled (sometimes several times), and these are the latest wave of ultimately successful challengers. Now they’re the incumbents, but who can topple them?

There are some good reasons to think they may have transcended the innovator’s dilemma.

Reason #1: Cash

One of the main reasons that many firms will fail under the model laid out by the innovator’s dilemma, is that they can’t (or won’t) allocate precious resources to small, unproven markets.

This is for three main reasons:

  1. If your competitors are aggressively trying to outgun you at the upper-end of the (more profitable) market by outspending on R&D, then you can’t afford to divert funds away from developing sustaining technology that will help you compete with them for your existing customers. Particularly not for a small, untested market. How can you justify that?
  2. If your business and operational model is based on building more expensive, higher margin products, then moving downmarket to simpler, cheaper products with smaller margins seems like a poor allocation of resources – one that investors and the stock market would be particularly unimpressed with.
  3. If you’re a particularly large company with revenues in the high hundreds of millions or billions, then to grow at 5 or 10% a year, you have to find very significant new product lines that will support that growth. Again, untested and relatively minor markets don’t fit that criteria, so you’re not going to put resources into one area, when they could be spent elsewhere to help you hit your quarterly and annual growth targets.

So why should we think Apple, Google, Facebook and Amazon are any different?

Firstly, they have so much money, there’s less of a chance they have to balance investment decisions that will mean they undervalue emerging technologies.

They’re incredibly cash generative businesses, with generally healthy margins (Amazon being the exception here). They record profits in the billions per quarter, and Apple alone is reportedly sitting on almost $250 billion in cash reserves.

Google has its ‘Moonshot’ division, which for years has been losing hundreds of millions of dollars in R&D every quarter. This is not a company that’s having to make a lot of tough decisions about resource allocation. They can have their cake and eat it.

Essentially this means they’re much more able to avoid playing a zero-sum game when it comes to internal resourcing. They can spend on extending their existing competitive advantage and make forays in smaller, untested but promising markets without being in danger of misallocating precious resources. Because they’re not so precious.

However cash isn’t the only reason they’re able to avoid this mistake of resource allocation.

Secondly, they’re mostly all still led by founders with a commendable long-term vision that can eschew the market pressures of quarterly results (somewhat), to make bets on their long-term future.

In this Apple is the exception, so we’ll see whether Tim Cook runs Apple based on market pressures to deliver strong quarterly results, or with a founder’s conviction that allows him to weather some stormy investors calls in order to invest in their long term future health (and avoid become the largest ever casualty of the innovator’s dilemma).

Third, not only can they afford to invest in areas of potential growth even when they’re relatively small and untested, but it often makes strategic sense to do so because of their own business models and operating structures.

While these companies are all famously managed differently, with different kinds of org chart, they are all sprawling conglomerates made up of many different, massive business units with distinct products; yet incredibly integrated.

org charts big 6

This kind of corporate structure – experience integration – is reasonably new. There have been plenty of very large, vertically integrated companies before; and plenty of large, diversified conglomerates still exist.

But these are a hybrid of both, which means they can invest in new technologies because they will ultimately support their overall business models, whether that’s adding more eyeballs (and attention) to their network (Facebook), selling more ads (Facebook and Google), or goods (Amazon), or entertainment services (Apple), or hardware (Apple, Amazon and Google…plus Facebook if you now include Oculus).

Hardware investments support their software businesses; and software advances make their hardware more desirable. It’s a win-win.

And if a bet doesn’t pay off, they can just shrug off the loss or hold out long enough for it to come good (think Fire phones for Amazon, Google+ for Google, smart watches for Apple, Poke for Facebook)…all have had either out and out failures, or significant investments in markets that they had high aspirations for, where the reality has yet to meet those lofty expectations.

As Ben Thompson, the founder of Stratechery points out:

“One of the things that makes Amazon such an impressive company, though, is that modularity and willingness to make multiple bets: on October 24, 2014 Amazon took a $170 million write-off on the Fire Phone business; two weeks later, the company launched the Amazon Echo.”

Reason #2: Difficult to find a foothold in an underserved market

Second, disruptive technology provides startups with a foothold in underserved markets, usually with lower margins and/or a different use-case for the technology to begin with.

But for me, it’s hard to see where existing, simpler technologies could be applied to a different set of customers (the customer base of these companies is absolutely huge, ranging from general consumers, to SMBs, to larger enterprises and everything in between.

In other words they have such massive reach, it’ll be hard to find segments or a niche large enough to sustain a business that might one day challenge them.

The only obvious place to look is at emerging markets like Africa, India, LatAm, Asia etc. but even there, Facebook and Google in particular are making significant investments to be the first to serve those markets too.

Reason #3: The future is complicated and expensive

Another issue with trying to displace these giants is that challengers need to find ways to attack from below by first utilising cheaper, existing technology to provide simpler solutions.

Yet what’s simpler than one click buying on Amazon, opening up the same Facebook App you’ve opened for the last 10 years, taking a photo or listening to your music on the iPhone, or searching on a page that’s continued to remain this clean and simple?

Google home page

Even on the B2B/enterprise side of their business, they’ve made accessing their advertising, infrastructure and ecosystems radically simple, for small SMBs up to corporate giants.

It’s not obvious where they’re overshooting the market at this point.

Not only that, but the technology that looks most likely to displace (or disrupt) existing tech ecosystems is really expensive (though arguably this falls into the ‘radical sustaining’ technology category, and not disruptive).

This is technology like machine learning and AI, which is dependent on building out hugely expensive and complicated neural networks, and having to compete for the best (and most expensive) talent to do so.

It doesn’t feel like an area very easily occupied by a scrappy startup.

And new consumer-facing tech like VR/AR will likely rely on their existing infrastructure for achieving mass adoption, distribution and commercialisation, which again just feeds into the advantage of their ecosystem, giving them an unfair advantage in the race to be #1 in the nascent AR/VR market.

Reason #4: They can just buy threats

If a startup does somehow carve out a promising new niche with a disruptive technology, do the Big 4 start to get worried? Of course not, they just get their corporate credit card out and do a little shopping.

In 2016 alone Google bought 17 companies, Apple 8, Facebook 6 and Amazon 4.

It’s an incredibly effective way to neutralise any potential threat, and the only company that’s managed to resist the allure and go on to be a significant challenger to one of their businesses is Snap, which is why Facebook were so keen to buy them (and now spend every waking day copying them instead).

The end of the story? (Spoiler: probably not)

So for all these reasons, I started to wonder if they had finally transcended the innovator’s dilemma. Perhaps the advertising, search, social, mobile, computing and retail/eCommerce markets will be forever dominated by the existing incumbents.

But surely not!

How boring would that be?

So I thought I’d try and think a bit harder about where they are vulnerable.

And here’s what I’ve got.

Facebook: Generations

IMHO Facebook is most vulnerable, as we can see from the emergence of Snap and their clear nervousness about it.

But for me, the problem Facebook has to contend with is more macro than just the rise of Snap.

As new generations come online, I think they will struggle to stay the biggest game in town.

They’ve been savvy to now, getting on top of the shift from desktop to mobile (if a little belatedly), from text to images (Instagram) and from 1-to-mass updates to messaging communications (WhatsApp)…and while Snapchat is their most worrisome competitor, it’s not been for want to trying to buy them. In other words they weren’t blind to the threat.

But I fundamentally think new generations will see Facebook as boring and old hat, new viewing habits will develop, and the constant flow of ‘next generation’ 11-21 year olds will eventually spawn enough new competitors that either one will rise up and replace Facebook; or more likely they’ll suffer death through a thousand cuts as millions of fresh faced digital natives choose to spend more and more time on other networks (think Musical.ly, Whisper and Flipagram/Toutiao) as just a few examples.

Not only that, but I think Facebook are also vulnerable to many of the same shifts in values that could eventually put a dint in Google, which we’ll explore next.

Google: Creepy Uncle Al-phabet

More than anything, I think shifting consumer values, rather than functional needs might actually be the disruptive force that provides a gap large enough for challengers to topple to incumbents.

The shift in values most likely to affect Google are:

  • Privacy (no tracking)
  • Depersonalisation
  • Choice
  • Simplicity (i.e. an alternative to the internet)
  • Ad free experiences
  • Fake news / trust

Privacy

I can see a future – perhaps not too far away – where people start to value their privacy again. Probably to the point that they’ll trade the value they get from deep personalisation based on their own data, with the benefit of feeling like they’ve gained control over their personal data again.

This will be huge for companies like Google (and Facebook) whose major utility to the end users and their biggest customers (advertisers) is being smart at tailoring their experience of the service, and targeting the relevant ads, based on consumer’s personal data.

If they start to shift to alternatives like DuckDuckGo, or a Facebook alternative that promises not to track them, then the incumbent’s business model and competitive advantage disappears.

This would also have the classic make-up of an innovator’s dilemma, because offering a search and social experience that doesn’t rely on incredibly expensive machine learning to drive personalisation would be cheaper and simpler than the existing alternatives too.

Depersonalisation

Directly related to a resurgence in privacy as a primary value for consumers, is the idea that they’ll actually come to value a less personalised service.

There will come a point when software – and hardware – just becomes too personal, to the point it feels intrusive and creepy. At that point, people will start flocking to less personal services where they feel they enjoy a more comfortable degree of separation and anonymity.

Choice 

Another correlated value that could drive people to newer upstarts is the idea of having choice.

This is such a fundamental idea to humanity and democracy, and yet it’s being rapidly eroded by the advance of machine learning and AI.

Increasingly consumers are not being asked to choose – algorithms are making those choices for them – and I can envisage a large-scale public backlash against this.

Simplicity

The internet is complex, and quite frankly scary a lot of the time. It’s hard to know who is behind what, whether things are legitimate (whether it’s a service, news or goods), and which ones you should choose.

Google aims to simplify the internet by presenting the best options to you at the top of their search results, but it’s been shown recently to frequently get it wrong.

As massive and smart as it is, it still can only go skin deep when suggesting results i.e. it won’t guarantee you won’t get ripped off, lied to or otherwise be worse off by clicking links served up to you by Google.

Perhaps that offers a chance for entrepreneurs to build extremely well-vetted mini-internets, where only a handful of services are allowed after extensive pre-vetting, and consumers would value the knowledge that anyone they use within this walled garden are legit, with a guaranteed recourse if not.

Ad free experiences

This is nothing new, with ad blocking quickly becoming an issue for publishers, while now seeming to have stabilised in terms of adoption rates.

However if future generations continue to value ad-free experiences above almost anything, then ad-based services like Google and Facebook might find themselves on the wrong side of history if startups can find new ways to create sustainable businesses that don’t rely on ads.

Fake news and trust

Finally, both Google and Facebook have come under intense scrutiny for their roles in spreading fake news, which has diminished the trust people can place in them.

Much like the of favouring simplicity over comprehensiveness, it might be that people flock to services that are human-curated rather than the algorithm-powered worlds of Google and FB.

Apple: Utility Matters

What could topple Apple, still the world’s most valuable company? With the world’s most valuable brand?

Given the expense and complexity of developing hardware and distribution to rival a company like Apple’s, it feels like they have a higher defensive wall than software companies like Google and Facebook, where the main hurdle faced is entrenched user behaviour (which can be fickle).

But that doesn’t mean they’re unassailable, and the forces most likely to affect Apple are:

  • Utility over aesthetics
  • Different use case for phones
  • Future generations

Utility

The most obvious way for competitors to steal Apple’s crown will be to offer the utility that Apple seems desperate to take away, such as head phone jacks and ports, in their quest for thinness and aesthetics.

If they keep ignoring what people want, thinking they know best, then at some point they’ll score an own goal that it’s hard to recover from, and there are plenty of competitors waiting in the wings when that happens.

Different use cases 

One of Apple’s core strengths is the ecosystem it’s built around its hardware, primarily through the App Store.

But the use of apps is already falling; breakthrough innovations like iTunes are rivalled by the likes of Spotify; and many of their core software benefits – which promised a seamless, integrated experience within their ecosystem of devices – can be rivalled by Google, while consumers may want to break out of such a restrictive and expensive restraint.

Essentially it feels like the diffusion of innovation has hit a point where smartphones and the other hardware that Apple makes are now overshooting the market, which makes progress on this front less relevant; and it opens the door to smaller upstarts to find the next big thing, on a more level playing field.

Future generations

Finally, generations simply change. And what was cool, exciting and innovative to one generation may become mundane and uncool to the next.

It’s absolutely conceivable that Microsoft could capture the zeitgeist of the next generation – as could anybody else – which leaves Apple vulnerable simply to a changing of the guard.

Amazon: Size Matters

Shift in value most likely to affect Amazon

  • Support local
  • Fraud
  • Next generation 

Loco for local 

One of the most obvious shifts in consumer behaviour that could a big upset for Amazon would be a continued rejection of globalisation – even at the expense of convenience – in order to support local businesses.

With the rise in nationalist sentiment, this may even be backed by governments putting trade tariffs in place (which could easily happen post-Brexit and under Trump), thus making international goods more expensive than those produced locally.

Even without those structural political changes, there’s a reasonable chance new generations will highly prize authentic, artisan goods and services, delivered not just with the incredible speed and efficiency of Amazon, but with a human smile and on-going personal relationship.

While that concept seems odd right now, this is exactly the kind of fundamental shift that could go mainstream 5-10 years from now and blindside the current incumbent.

Fraud

There has been more noise made lately about Amazon’s seeming inability or unwillingness to tackle fraud in its marketplace.

Just look at the related uptick in people searching for the issue on Google.

Amazon fraud

They should be treating it as a number one priority, because while much of Amazon’s tangible value comes from its operations, I would argue that trust is an even more valuable asset for the company.

I buy from Amazon because it reduces the cognitive burden of buying online, thanks largely to the fact I believe when I click ‘Buy’ I’ll receive the goods I’ve ordered, on time, in good condition – and have swift recourse if I don’t.

Should that trust erode, a huge amount of Amazon’s utility will erode too, leaving room for challenger upstarts who promise a slightly more restricted range, but absolute trust in those goods being high quality and authentic.

Next generation

Yes, this has been included as a potential threat for every company, but that’s because ‘next generations’ are so unpredictable, and their tastes can be wildly different from the previous generation.

In fact, many generations very specifically set their agenda and values in direct opposition to their parents or grandparents, as I way to define themselves and to assert authority.

Right now Millennials are in the ‘hot seat’ of economic activity, but they’re about to be displaced by ‘Gen Z,’ who are coming into adulthood.

However all of these labels are pretty lazy generalisations. What is more useful is to realise that every 5-10 years, a new generations of kids become adults, and their life experiences (being brought up under a Trump administration, post-Brexit etc.) will be radically different to the previous cohort.

This means they could quite easily turns their backs on the current incumbents, including Amazon, in favour of as yet unknown challengers that more neatly align with their worldview.

Conclusion

While many of these shifts might seem outlandish right now, in today’s climate, they’re all based on trends that are clearly visible, if only in a very small way; and embraced enthusiastically by a small subset of society.

But that’s how disruptive innovations begin – with those who zig while others zag – before being adopted across the mainstream as they build credibility and momentum.

The point is that incumbents won’t be toppled by 10x better products, because they’ll buy them or out-innovate them. They’ll be toppled by the weird and wonderful, the unthinkable today that becomes blindingly obvious tomorrow. Such is the innovator’s dilemma.

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