Where in the value chain does the company earn money in the future? What new business models emerge at the periphery of the market? Which tech domains are substantially (vc) funded? These signals can indicate a possible disruptive threat.
The paradox about disruption is that the success of the theory itself is also the reason that we use the word ‘disruption’ a lot but don’t really define or understand the meaning and mechanism behind it.
Let’s start with the idea that disruption is the result of the limited innovation capability of corporates itself. Large companies are in general not designed to identify early or weak signals from the market that may cause disruption threats. How is this possible? The short answer; big companies are not focussed on small numbers in different markets, cause it does not solve their growth dilemma. Big companies need big numbers. Lets elaborate.
The curse of big thinking
Teams that accelerate their business with us most of the time ask the following question; when can we can scale in ten different countries? We call this the curse of big thinking. Let me explain. One of the biggest reasons product launches fail is two-folded;
- They build something nobody wants.
- They scale to early
For big companies, the modus operandi is to execute a product in ten countries because it will bring economies of scale and major revenue. This only works if you know how the business model (value, segment, resources) works in a certain market. A well managed corporate is an execution machine that has repeatable processes to perform on scale. Main cultural values in the execution engine are ‘stabilization’ and ‘risk avoidance’. The upside is that if executed perfectly you have the ultimate money machine on scale.
In general, big corporations have trouble with validating and scaling disruptive business models for two reasons;
- The way big companies are structured to make money is organized around the existing customers with premium margins. Disruption possibilities emerge in the low-end of the market or through non-consumption/ new markets. Disruptive innovations offer better accessible products at a cheaper price. This can dilute earnings and/or cannibalize existing business.
2. The financial metrics and processes are designed to improve existing products and services because they are the least uncertain in their development trajectory and not a threat to the current business.
Why does this matter? The origin of economic growth
The speed of creative destruction is accelerating. According to the SP 500, the longevity of companies has shrunk to an average lifetime of 15 years. The problem is big companies are designed to become better in what they do and have challenges with tapping into new market opportunities. The reason the Japanese economy was flourishing was because of the amount of disruptive innovations they produced, disruptive innovations are new growth and job creators. Think of Sony’s transistor radio, Honda’s convenient motorcycle the Cubb, or the mass production of affordable cars by Toyota. Nowadays growth has stalled in Japan. This has a lot to do with the introduction of financial KPI’s as ‘return on investment’ and ‘return on net assets’. These KPI’s are focused on short-term growth and eliminate new market innovations.
If a company wants to grow on the short and long term it should focus on three types of innovation;
- Disruptive innovations/create the future; creates better accessible and customer friendly products or services. This creates new jobs, but to grow it needs capital. Think of the iPod or Netflix or the Toyota Corona in the United States (this last one was also disruptive)
- Sustaining innovations/renew the core; These kinds of innovations make sure that existing products and services become better. Think of the iPhone 3 to iPhone 10 evolution. Margins getting better, market growth becomes bigger. Though it does not create the new wave of growth that for example, the iPod/iTunes combination delivered.
- Efficiency innovations/improve the core; make more with less. Think of the Toyota management system. It will not create jobs, rather destroy jobs. But it creates a better cash flow position.
The ideal investment pattern that should occur is that the capital freed up by efficiency innovations will be partly invested in disruptive innovations where new growth comes from. Because of the financial systems in place, the idea to invest in disruptive innovations looks less attractive then to invest in efficiency innovations. What happens is more investments are being made in efficiency innovations. We free up cash for freeing up cash?
What are the mechanics that cause the outcome of investing in efficiency innovations? You can call it financial doctrines, the most important are;
- Inputs that are abundant can be wasted, inputs that are scarce should be treated carefully. Bandwidth was scarce, through innovations it became very cheap and abundant. Netflix and Google could create their business model because of this and change the industry.
- Then we have the financial ratio’s, for example; Return on net assets (RONA), Return on capital employed (ROCE), internal rate efficiency (IRR). Problem with these ratios is that the profitability of efficiency innovations are always better on the short term. A good example is Dell, it started outsourcing their production capacity to external parties, this created a better ‘return on net assets’, though the party that was executing the production for Dell, started to build the ‘do it yourself’ computer capability Dell was famous for. This almost killed the business for Dell. The problem with these short-term financial ratio’s is that the money and people in the resource allocation process will follow the shortest route to efficiency innovations.
The dilemma of financials is investing in a new cycle of disruptive innovations or in sustaining innovations. The problem with disruptive innovations is they pay out in 5 till 10 years, under the condition that the execution is flawless. IRR en RONA will go down when you start investing in disruptive innovation. So it is more appealing to invest in efficiency innovations in which RONA en IRR go up. It is a vicious circle.
How to escape the pattern and build a growth machine?
Innoleaps developed an integrated approach in which we tackle crucial elements that can kill or make new long-term revenue models.
First of all, we deep dive into your market and identify growth opportunity areas from the perspective of disruption. We seek for low- and new market disruptions in your market, learn from their business models and create a portfolio of growth opportunity areas. Together with your board, we decide which opportunities should be understood more in-depth. Based on market size opportunities (TAM), untapped or underserved customer problems, we build the first solutions directions, test them in the market, and learn what we need to grow further. At the same time, we prepare with the internal sponsor team the right metrics for startup accountability and the process in which we validate, evaluate and finance new growth models. In this way, we ensure that we use the right metrics for evaluation and have a set of milestones in place to decide if a project should stop or get more investments. We dramatically increase your time to market, save costs and de-risk future growth models in a milestones process.
We focus on a balanced portfolio (improve the core, renew the core and build future growth projects) in which we will fix your current business where necessary, free up cash, so we can invest in more long-term disruptive business models. Take your innovation efforts to the next level while your core business is still healthy!
In the new year, we organize a masterclass in which we explain how we built a Growth machine within large companies so we can systematically de-risk and build new growth models. If you are interested please sign up here.
Misha de Sterke
Chief corporate innovation Innoleaps