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Creating new growth through disruptive innovation

How can disruptive innovation help utilities? We asked Harvard Business School’s Rory McDonald.
Rory McDonald
Rory McDonald
Assistant Professor of Business Administration Harvard Business School

Should utilities be worried about the disruption happening in the industry?
There seem to be a few perspectives around whether disruption is happening, and how pervasively. I like a different perspective, which is all about framing the problem. How utility executives choose to frame the issue of disruptive change will determine outcomes.

How can markets be disrupted?
We often see two types of disruption. Low-end disruptions come in at the bottom of the market and take hold within an existing value network before moving up-market and attacking incumbents. Incumbents often sensibly retreat from the attack because they prefer to serve their higher margin customers.

New market disruptions take hold in a completely new value network and compete against non-consumption. This means there’s a need in the market no one is taking advantage of, maybe because the existing solutions are too complicated or too expensive. If a player can come in and offer a less-complicated, less-expensive solution, then suddenly there might be a market there that didn’t previously exist.

How do you view disruptive innovation?
My colleague, Clayton Christensen, first noticed the phenomenon and pioneered the development of the original ideas about disruptive innovation. At the Harvard Business School, we’ve conducted research on many industries, and we continue to refine and teach his model of the process of disruptive innovation, which has three core principles.

The first principle is that in many markets, the pace of technological progress outstrips a market’s demand for higher performing technologies. The idea is that firms can overserve the market by producing more advanced, feature-rich products than customers need—leaving a gap at lower market tiers.

The second principle is that there is a strategically important distinction between different types of innovations that emerge. The most common of these are sustaining innovations, which improve products and services along dimensions of performance that mainstream customers care about, and that major markets have historically valued.

A bit rarer, and also vexing for many incumbents, are disruptive innovations. While they tend to be initially inferior on historic performance, they offer a novel mix of attributes that appeal to fringe customers.

The third principle is that existing customers and established profit models constrain firms’ investments in new innovations. Incumbents are typically not motivated to pursue disruptive innovations that could have lower margins and smaller markets, or may not be interesting to the existing customer base.

How do disruptive innovations impact incumbent companies?
Disruptive innovations can successfully challenge leading incumbents. What we found is that, in the case of sustaining innovations, incumbents nearly always win, because they offer better products and services. However, with disruptive innovations, new entrants nearly always win. This is because while targeting an incumbent’s lower-value customers with products and services that start off with inferior quality and/or performance, they’re on a trajectory of improvement that eventually intersects with the mainstream customer in that market.

Is there such thing as a disruption-proof industry?
There are a few industries that have been described as disruption proof, such as financial services, hospitality and higher education. Historically, we’ve seen that these industries, like utilities, have some sort of regulation feature, yet new innovations happen outside the purview of these regulations. Eventually, the innovations can spur regulatory changes.

Financial services has seen a shift in the conventional way that we save and invest. We’re starting to see some online peer-to-peer lending, some things happening in terms of online platforms for investment management, and other innovations like digital currencies.

In hospitality, consider Airbnb, which started off offering short-term living quarters for people unable to afford a hotel room or book one in a crowded market. Over time, they’ve improved their offering with more features, functionality and technology. They’ve enhanced their business model and now have this sophisticated service, with more than 2 million listings in 34,000 cities around the world.

In higher education, we are seeing alternative offerings emerge, such as online learning and corporate universities. While traditional universities have many advantages, we certainly want to watch the trajectory of improvement of these alternative options.

How does disruptive innovation interact with consumer innovation?
It is important to listen to your customers, but you really need to understand your customers. And the idea is that if you understand your customers, then you can develop well-tailored products and services that will have unbelievably custom features and functionalities able to serve customers better.

We often think about competitors as similar companies selling similar products and services to our existing customers. But we should be thinking about alternative products or services that will fulfill the same customer need. The implication is that the market we think of as very small can actually be much broader.

The famous Professor Ted Levitt said: people don’t want to buy a quarter-inch drill, they want a quarter-inch hole. This makes sense, and yet, as my colleagues have observed, companies continue to segment the market by the type of drill and price point and benchmark the features and functionality of their products against rival makers of similar products.

Rory McDonald is the Assistant Professor of Business Administration at Harvard Business School, where he focuses his research and teaching on how firms innovate effectively in new technology-enabled markets. Drawing on in-depth fieldwork and archival data, Professor McDonald studies how executives develop viable strategies, navigate disruptive threats and opportunities, and acquire resources that improve their chances for success.