[00:02:29] What Christensen found was both unsettling and unintuitive. The factor causing this lag effect, where industry leaders were eventually surpassed by new competitors, stemmed in part from the ill effects of the conventional wisdom often taught in business school. That is, that companies should always listen to and respond to the needs of their best customers, and that you should focus investments on those innovations that promise the highest returns.

[00:02:52] In practice, Christensen says these two principles sow the seeds of every successful company’s ultimate demise. That is why it’s called The Innovator’s Dilemma. Doing the right thing is often actually the wrong thing. And explaining this paradox is the book’s purpose. The term disruptive innovation is thrown around all the time in tech and finance circles, yet it traces its roots to Clayton Christensen and the Innovator’s Dilemma, who coined the term to describe the sort of technological changes that fuel the creative destruction that drives progress forward and is so synonymous with capitalism.

[00:03:23] The venture capital industry is built up largely around investing in disruptive technologies, but even among the best and most experienced VC investors, their success rates are only 10 to 20 percent. The vast majority of innovative startups will fail, and VCs have embraced that by hedging their bets across a number of companies.

[00:03:41] Christensen’s research finds that disruptive innovation is inherently unpredictable. No one can know where it will come from next, and even VCs most in touch with new technologies fail to reliably foresee which bets will work and which will lose. But the book, and Christensen’s research, set the foundation for changing that dynamic, empowering investors to recognize the fingerprints of companies best positioned to change the world with their disruptive innovations.

[00:04:04] Companies can fail for many reasons, from bureaucracy to tired management, inadequate resources, short term decision making, and plain old bad luck. But these are not the types of companies that are studied in the innovators dilemma. Instead, the book focuses on companies with the most envious track records.

[00:04:19] You might say those who for a period of time had every advantage going in their favor until eventually they did not. It seems unfair that great companies who knew their customers intimately and thoughtfully tended to their every need could soon be left by the wayside, taken out of business by some new competitor who came on their radar almost out of nowhere.

[00:04:37] But this is the exact thing that we’ve seen happen recurringly across the last century. Few companies, if any, are truly immune to such potential disruptions either. Whether a firm competes in building cutting edge electronics or something as boring as chemical processing, the potential for disruptive innovation to emerge is always there.

[00:04:55] I don’t say that to strike fear into you and make you paranoid about your portfolio of companies being displaced by new technology, but it is something we should take seriously. I’m guilty of this myself, but it’s really easy to look back on history and think that it was obvious that certain companies would be displaced.

[00:05:11] And it’s even easier to get trapped by inertia and the status quo and look around at today’s best companies and think they will be around indefinitely. That is just not reality though. Many of the companies profiled in the innovators dilemma were the undisputed titans of their industry. They were the best of the best and they were so for long periods of time.

[00:05:30] It was unimaginable to any sensible investor that they could be displaced. Blockbuster is an easy example that probably everybody can relate to, but also consider Sears Roebuck. Sears had a pristine reputation for retail excellence, and it pioneered innovations critical to retailers today like supply chain management, catalog retailing, and even credit card sales.

[00:05:50] At its peak, Sears accounted for a breathtaking 2 percent of all retail sales in the United States. Excellence seemingly came naturally to Sears, and the company was perceived as always making the right strategic moves. Competitors spoke with reverence about Sears. It was truly a beloved American brand.

[00:06:06] But based on Sears reputation today though, you’d be forgiven for wondering if I was even talking about the same company. I actually had to Google whether Sears was still operating today. I remember going there as a kid, but I haven’t been for years.

[00:06:19] Founded in 1892, Sears entered bankruptcy 127 years later in 2019. As of April 2024, only 11 Sears stores remained in operation, but as recently as 2007, Sears was valued at 23 billion. At the time The Innovator’s Dilemma was published in the 1990s, Sears was already clearly in decline, promising turnarounds that never manifested while sales continued to fall. The peak of Sears clout in the 1960s is the exact time when it was ignoring the rise of discount stores that would undercut its business to say nothing of the emergence of Amazon in the 21st century, which is what put the final nail in the coffin for the company.

[00:06:57] Despite its huge head start with credit cards and retailing, Sears lead was usurped by Visa and MasterCard at a time when the company’s management was still praised for its prowess. It was a similar story for Xerox. These are not isolated failures of iconic brands that disastrously imploded, but rather these are just well known illustrations of what has happened to thousands of smaller companies in the last century.

[00:07:19] As we talk about the book, it’s important to distinguish between what Christensen refers to as sustaining innovations and disruptive innovations. Sustaining innovations are more like incremental improvements, new developments from companies meant to improve upon the status quo. That is, not to say that the improvements cannot be significant, they don’t fundamentally invent a new category of product.

[00:07:39] Instead, they improve the performance of existing products in line with the desire of companies most important customers. Most technological advances are sustaining innovations, and Christensen found that sustaining innovations rarely precipitate a great company’s downfall. Instead, the emergence of disruptive innovation that brings forth a very different value proposition is most often the cause of great companies demise.

[00:08:03] Disruptive technologies are usually valued on the fringes at first by early adopters. Just look at Tesla. The company was conceived in 2003 and didn’t sell its first car until 2008. Its sales for years were only to wealthy, tech focused consumers intrigued by the company’s novel electric vehicles.

[00:08:19] Combustion engine vehicles have improved hugely over time, but these were all mostly sustaining innovations since a gas powered car today is still inherently the same thing as a gas powered car from 1980. But electric vehicles are structurally different types of vehicles. They’re something new and different.

[00:08:35] So, electric vehicles are a disruptive innovation to gas powered cars. The iPhone is another example of this. Whereas BlackBerry dominated the cell phone market in the mid 2000s, Apple created the smartphone market when it released the iPhone. The iPhone changed the status quo. It wasn’t just a cell phone, it was something entirely different.

[00:08:55] Any new iterations of flip phones were sustaining innovations, whereas the iPhone was a disruptive innovation that changed people’s habits and took the industry in a new direction. Going back to the Tesla example, success with wealthy and adventurous early adopters, including celebrities like George Clooney who were willing to pay 100, 000 for the first model, enabled Tesla to scale, bring down costs, refine its technology, and begin to manufacture more affordable vehicles that helped bring the company mainstream a decade or so later.

[00:09:23] But, Tesla couldn’t have started by selling affordable EVs to the public because no one was interested in them. It had to focus on appealing to atypical car buyers to build its reputation. Yet it was gaining traction and the disruptive new technology of electric vehicles under the nose of the major car makers.

[00:09:41] While most car makers have responded now with their own EVs, they are by no means guaranteed to earn back the market share they already lost to Tesla. Nor is it even likely they won’t continue to lose market share to Tesla. While electric vehicles were once underperformers unwanted by any sizable customer group, they’re now a fast growing chunk of all cars on the road, desired by customers across demographics.

[00:10:02] That move from the fringes to the mainstream is common with many disruptive technologies. I think this is a really good illustration of the types of case studies Christensen goes over in the book. There is an incubation period with disruptive technologies before they go mainstream and Tesla is a really tangible example of that.

[00:10:18] On top of that, while disruptive technology is incubating, existing industry leaders tend to overlook the promises of new technologies since their businesses are working so well and since so many new technologies ultimately fail. But all it takes is one company like Tesla to break through and suddenly you’re playing catch up from a position of weakness.

[00:10:37] It’s funny because at the end of the book, Christensen actually reflects on how EVs are a potentially disruptive technology just waiting to be taken mainstream, so he very much foresaw what Tesla would do a decade before it happened. Past examples of disruptive technologies include things as important as the personal computer, as well as innovations like the small off road motorcycles by Honda, Kawasaki, and Yamaha that disrupted companies like BMW, which made powerful over the road motorcycles.

[00:11:04] What’s interesting about disruptive technologies is that customers initially don’t want them typically. However, as their advantages become clearer, customers preferences can change quickly to the surprise of existing market players. Industry leaders, accustomed to listening to their most profitable customers, can overlook disruptive technologies since they first get adopted on the fringes by customers who are either less profitable on the margins or who make up a negligible share of overall revenues.

[00:11:30] As a result, more entrenched companies can seldom make a business case for investing in the disruptive technologies they might identify until it’s too late. Even more challenging is that there’s an illusion of CEOs having lots of control over corporate resources, but in reality, companies financial resources come from customers by way of what they purchase and from investors who approve of a company’s business plans.

[00:11:52] Companies that survive then become extremely adept at catering to investors and customers interests, which makes them very efficient at killing off things that customers don’t want at the moment. Again, the problem is that disruptive technologies aren’t taken seriously until they’re mainstream, so CEOs are pressured to allocate capital toward proven initiatives, which leaves them behind the curve on disruptive innovation.

[00:12:13] On top of this is that industry leaders are big companies, and big companies, to maintain their target percentage growth rates, need to go after big opportunities. Since disruptive technologies create new markets that are at first small and have unknown potential, investing in them may not move the needle enough until, as I’ve said, it’s too late and someone else is a first mover advantage in the new market.

[00:12:34] One solution that Christensen proposes is that company spinoff subsidiaries devoted to experimenting with disruptive technologies So that their operations are more sheltered from the pressure of addressing customers current but ephemeral preferences, which we’ll discuss later in this episode. In the first section of the book, Christensen does a case study on the hard drive industry with companies competing to make devices that store data for computers.

[00:12:57] These used to be pretty huge disks, but they have obviously shrunk over time. So just keep in mind that this book is from the late 1990s as you try to imagine the types of computers we’re discussing. for listening. The technology surrounding disk drives has just evolved incredibly rapidly over the years, as is true with much of the computing industry.

[00:13:15] Biologists like to study mice or fruit flies when trying to better understand evolution because they have short lifespans relative to humans, meaning many generations can be produced quickly. In the same way, Christensen says the hard drive industry makes for a great case study on business evolution because the field has evolved so fast.

[00:13:32] While this has been a nightmare for the managers of these companies to deal with, it makes for fertile research ground. The first hard drive was actually developed as early as 1950 and was the size of a large refrigerator, holding 50 24 inch disks, but it could only store 5 megabytes of information. By 1995, the computer hard drive market had grown to $18 billion, and along the way, the industry structure and makeup of competitors underwent a handful of facelifts.

[00:13:59] In the 1970s, 129 new firms entered the hard drive market, and 109 of them failed. By the mid 1990s, all of the industry’s leaders were firms that had begun as startups just 20 years or so prior. This was an industry with an extremely high mortality rate, at least in part due to the unfathomably high rate of technological change.

[00:14:19] From 1978 to 1993, the size of a 20 megabyte hard drive shrank by 35 percent per year. That breathtaking pace has continued to this day. Now you can get a 2 terabyte hard drive for your MacBook Pro for less than 50 bucks, and For context, a terabyte is 1, 000, 000 megabytes, so a 2 terabyte hard drive stores 100, 000 times more information than a 20 megabyte hard drive.

[00:14:43] I know I’m throwing a lot of numbers around, but the point is that hard drives are exponentially better than they were just a few decades ago. And the same was true in the 1990s. Hard drives had improved to an almost unimaginable degree relative to the 1960s and 1970s. A chart of the cost per megabyte for computer storage over time would slope dramatically downwards as storage has just gotten cheaper and cheaper.

[00:15:06] When looking at the relentless pace of change in the hard drive industry, Christensen formed what he calls the Technology Mudslide Hypothesis. That is to say, trying to cope with technological changes was akin to trying to climb an uphill mudslide. You have to scramble with everything you’ve got to get up it.

[00:15:21] And even if you stop for a moment to catch your breath, you get buried. After further research though, he realized this was wrong. Technological change is not what fundamentally caused companies that were once industry leaders to lose market share. In fact, industry leaders have often been quite good at pushing for technological improvements.

[00:15:38] Intel improved the processing speed of its computer chips by almost 20 percent per year from 1979 to 1994. A mark of disruptive innovations is that it can be difficult to make an apples to apples comparison with the status quo. If laptops were suddenly invented today, and all we had previously were desktops, the industry leaders in making desktops might have been very skilled at pushing ahead with improvements in the areas that matter to desktop users, But with laptops, there are just other metrics to measure performance by.

[00:16:07] What matters more, for example, with laptops is convenience, ease of use, and portability. The point being, industry leaders may be straight A students in their class, but disruptive technologies introduce a new grading curve. You might have the most powerful desktops, but that doesn’t mean you’re positioned to create the most appealing laptop if you’ve never had to focus on creating a portable computer before.

[00:16:27] Going back to the disk drive industry, the reason Christensen thinks the mudslide hypothesis is flawed is because most advancements were sustainable innovations, not disruptive innovations. Industry leaders like IBM were actually quite innovative, it’s just that these innovations were sustaining in nature and not disruptive.

[00:16:45] The difference being the industry leaders were the best at giving customers what they wanted. Or at least what they thought they wanted. Disruptive innovations are instead what customers don’t realize what they want. No one in 2004 could have told you that they wanted an iPhone because no mainstream consumer could envision that they had no idea It was a possibility if you ask them what they wanted They would have said things like, you know more cellular coverage easier texting maybe even unlimited free texting but no one would have requested an app based touchscreen phone with just a home button and volume buttons where its role as a phone was almost secondary to everything else it could do or think about Google as another illustration of this.

[00:17:22] Encyclopedia Britannica was probably brilliant at incorporating customer feedback into improving their books. By all measures, they dominated the search for information, and customers were happy with their products, but that’s only because they didn’t know the alternative. They did not realize that a completely different reality was possible, where search engines would be available to instantaneously distill down the entire world’s known information sources at their fingertips.

[00:17:46] Obviously, I’m oversimplifying things, but I think you get the idea. A disruptive innovation imagines a whole new way of doing things that rewrites the status quo. The most refined and easy to use encyclopedias could never compete with Google, and thus encyclopedias and the companies that produced them got left behind.

[00:18:04] It’s not even that the industry leaders of the old technology became passive, arrogant, or complacent, though. Rather, at least in the hard drive industry, they were held captive by customers current needs. Customers wanted one thing until suddenly they wanted something else. It’s not that industry leaders and producing hard drives in the 1980s didn’t have the resources or expertise to produce the types of hard drives being made by new and disruptive competitors.

[00:18:26] It’s that they didn’t think that it was worthwhile to invest in these potential markets because they were already competing fiercely over the largest customer segments. I think you can probably make a fishing analogy here to better understand it. The presiding leaders in the hard drive industry were fishing in the biggest pond, using a technique that had long worked for them.

[00:18:45] As they continued to stack up the most fish, they looked around and saw people trying to fish with new types of rods and bait in much smaller ponds. As others toiled with unproven fishing techniques in sparse ponds, they kept refining their usual fishing process and it kept working. People would occasionally try their rods and bait out in the big pond, but their attempts never really worked.

[00:19:05] Until one day, one of those people who had been fishing in the small pond with a new type of rod and bait came to the big pond and started taking all the fish. All of a sudden, the incumbents were left scrambling, trying to recreate what had worked for this one innovative fisherman. It’s probably not a perfect analogy, but I think it’s helpful for imagining how incumbents get displaced.

[00:19:23] Up until that moment, countless others had tried to compete with various unique approaches in the big pond, and none of them had paid off. So, of course, the incumbent and successful fisherman wanted to keep focusing on what was working for them. Again, I don’t think that’s laziness or even stupidity. If anything, that’s just being pragmatic.

[00:19:41] Focusing on what works is certainly not a mistake in many cases. The dilemma comes from simultaneously knowing that someone could come in with a new phishing technique that completely derails your own, while also recognizing that the vast majority of new techniques will fail, so you can’t know what will work besides a strategy you’ve already been following yourself.

[00:19:59] There are also instances in the study where fears of cannibalization were obstacles. Going back to the fishing analogy, anytime spent fishing in a smaller pond with fewer fish is time not spent fishing in the biggest pond. That is to say, at various points, leaders in the hard drive market were hesitant to embrace disruptive but less proven products because they were concerned doing so would cannibalize their bread and butter products.

[00:20:23] Where the fishing analogy falls apart is that disruptive technologies create new markets that may or may not cannibalize existing markets. It would be more akin to discovering how to ice fish. Fishing in frozen ponds is a new market that expands the universe in which you can fish as opposed to competing with your existing fishing operations.

[00:20:42] That isn’t true in all cases, but there are definitely instances where disruptive technologies aren’t entirely cannibalizing. Unfortunately, the fear of cannibalization can be a self fulfilling prophecy in some cases. When it comes to explaining why companies are able to capture market share early on as they hit the scene with their own disruptive innovations, only to become secure as an incumbent and get displaced by a newcomer down the road, people usually point to managerial, organizational, and cultural shortcomings.

[00:21:10] Those are all valid explanations, but they don’t explain things in all instances. Christensen proposes an alternative explanation based on what he calls value networks. A value network is the context within which companies identify customers needs, solve problems, react to competitors, and strive for profit.

[00:21:27] The idea is that corporate outcomes are path dependent in a way. Companies past decisions and their corresponding tradeoffs shape the structure of the company, its values, and its competitive positioning. In a way, value networks are an attempt at reverse engineering a company to understand its biases.

[00:21:42] Aspiring companies are biased toward breaking into a market, and because they have comparatively nothing to lose, they’re willing to risk it all with disruptive innovations. Established companies, though, have everything to lose, and across all their value networks, people’s decisions are biased toward focusing on what has generated success so far and catering to existing customers needs.

[00:22:01] Value networks are a subtler way to describe organizations. It’s less that incumbent companies explicitly value the wrong things, and more that they are implicitly biased toward preserving and augmenting the status quo, not trying to flip everything upside down with disruptive innovation. For example, the research and development department is an internal value network at most companies, and it creates value when R& D personnel interact with other departments to create new products that increase the company’s profitability.

[00:22:30] Building off the company’s past products and research will shape the type of new products it develops in the future. As in, if a car manufacturer has built up 20 years of research and development around improving internal combustion engine cars, shifting away from that to get engineers and project managers to suddenly prioritize the development of electric vehicles can be a gargantuan effort.

[00:22:50] It’s possible, but it wouldn’t come naturally at all to the company once it has set down a certain pathway. And if there was interest in designing an EV, the R& D department might show those plans to marketing, who might tell them that the EV market is too small to focus on selling to. And then, with the marketing team’s forecast for how many EVs could be sold, the company’s financial analysts would conclude that a new EV program would be too expensive relative to the expected sales they could generate, so they’d nix allocating any more resources to moving forward with EVs.

[00:23:20] And that would be a sound and logical decision because the company is built around creating value from selling gas powered vehicles. So, of course, no one throughout the organization will think unproven EVs are an attractive opportunity. That is, until Tesla proved that there is a large and profitable addressable market for EVs.

[00:23:37] But at that point, the incumbents were already behind. Another example of a value network is to think of the web of external relationships influencing a company. Maybe your company makes gourmet chocolate chip cookies to sell at retail stores. The company has established relationships for sourcing all its ingredients and distribution partners for its products and it knows that certain grocery stores have carved out room to sell its products.

[00:23:59] Past decisions on who to, say, source sugar from create an institutional inertia. If things are working for the business, it’s not going to suddenly change sugar suppliers. From the other direction, in selling the end products, if the cookie company knows that retailers have space for its type of cookies at a given price point, That pressures them not to dramatically change the recipe, branding, or pricing because that might risk rocking the boat and losing that shelf space that it has already carved out in its stores.

[00:24:26] So there is pressure from multiple directions to not really do anything too disruptive. There might not be a ton of disruptive innovation in the cookie industry, but you can imagine how these networks of supplier relationships, distributors, customers, and so on can exert their influence on companies that bias their decisions.

[00:24:42] Another way to say all of this is that incumbent companies in a market build up networks of relationships built around supporting what has worked for them and what has satisfied customers. Everything is configured to keep the boat chugging along in a certain direction. It’s like a big shipping vessel and there’s a lot of momentum going in one direction.

[00:25:01] Disruptive companies come in and force a change of direction that incumbent companies aren’t prepared for because everything they have done for years is oriented around the ship sailing north. Suddenly, the ship must now sail south, and it takes a tremendous amount of effort to get that boat turned around.

[00:25:15] While disruptive innovation is slower moving in some industries than others, it is everywhere. If you don’t believe me, just look at the excavation industry for moving crushed rock. While disruptive innovation unfolded over a longer time horizon of almost 20 years, the invention of the hydraulic press was just as disruptive and hard to fend off for incumbents in the excavation business as any change in computing.

[00:25:38] From the 1830s to the 1920s, excavation equipment was steam powered. As a boom in building railways and waterways took off, excavation equipment was vitally important. The transition to gasoline powered excavators was by all means a disruptive innovation. And the mechanics of excavators intrinsically changed.

[00:25:56] These gas powered excavators were cheaper, more efficient, and more powerful than virtually all steam shovels. Yet the industry leaders in excavation were able to orchestrate a transition to this new technology without too much friction. Instead, the later disruptive innovation of hydraulics is what left them blindsided.

[00:26:13] By the 1970s, only four of the industry’s past 30 major companies had survived and embraced hydraulics, which extend and lift the buckets that dig into the ground. The new industry leaders were the newcomers who embraced hydraulic technology. But just a few years earlier, hydraulic excavators operated only in narrow niches.

[00:26:31] They were much less flexible than the more common types of excavators at the time, and they didn’t have nearly as long reach or as much turning radius. Because their reach and capacity was so limited, hydraulic excavators were of little use for mining, general excavation, or for sewer contractors. The industry leaders and industrial excavators saw no market for hydraulics, and new companies specializing in hydraulic excavation focused on building products that could be attached to the back of trucks and sold to farm workers.

[00:26:59] And then small residential contractors began purchasing these hydraulic excavators to dig narrow ditches for water and sewer lines in the streets for new houses under construction. Because small housing projects never had the budget to bring in giant excavators, they were always dug out by hand before, but now the smaller hydraulic powered ones were the perfect size to help out with that.

[00:27:20] Hydraulic excavators were soon an essential ingredient to the post WWII housing boom that enabled suburbia to sprawl out around major cities. These new users of excavators were much, much different from the traditional customers who might want excavators for big urban projects or for mining. However, it was not that leading excavator producers at the time were ignorant of hydraulics.

[00:27:41] In fact, it was actually the opposite. Some of the companies were quite excited about hydraulics and wanted to test them out, but they bumped up against the fact that their largest customers had no use for these smaller excavators. Incumbents tried to build hybrid designs that captured the best of both worlds, but eventually they gave in to the pressure of their established customers and lost interest in hydraulics, since it didn’t seem like there was a very large market for them.

[00:28:04] The emerging disruptors who began building out hydraulic excavators for farm use and small residential products filled a void that industry players had intentionally left open. Where the new entrants in the excavation industry took the promise of hydraulics as a given, the incumbents took their primary customers needs as a given, and thus overlooked the potential of hydraulics.

[00:28:24] But it’s not just a story of losing out on growth opportunities. Once it became clear that hydraulics were safer and more reliable, all customers began demanding them, even though other types of excavators still had advantages like being more powerful. In other words, not only did the disruptive technology of hydraulics initially cater to new types of customers.

[00:28:42] But as the technology proved itself and was refined, it stole market share from all excavators, including customers who previously saw hydraulics as inferior, leaving the incumbents who had adhered to that customer feedback left in the dust. The incumbents did not fail because they couldn’t see any merits of hydraulics, nor because they couldn’t produce them.

[00:29:01] They made the choice to focus on improving upon the existing products that their customers wanted, hoping to steal market share from their rivals who were all doing the same. To do anything else would have been borderline reckless by using precious resources to invest in products that their customers had told them they didn’t want.

[00:29:17] The dilemma is that customers didn’t know they wanted hydraulics until suddenly they did. The change didn’t literally happen overnight. But in terms of the corporate life cycle and businesses ability to dramatically reorient themselves toward producing new types of products, the change might as well have been overnight.

[00:29:32] Not investing in hydraulics was logical all the way up until the moment it wasn’t. So how can companies manage disruptive innovation? If disruptive innovations often emerge from less profitable niche areas of a market and may even be initially rejected by the largest customer segments, how can companies avoid the trap of continuing to improve primarily upon their most popular products rather than looking elsewhere?

[00:29:55] It really is a vexing problem, I’d say. Everything in an established company might be oriented against moving towards smaller, unproven, and less profitable markets where disruptive innovations are likely to emerge from. Imagine that you worked at one of the major car manufacturers in 2006. You’d be taking considerable career risk if you pushed a project related to electric vehicles.

[00:30:15] Nobody wants to be associated with failed projects because that can set their career back, so at different levels of the organization, managers make decisions that filter out ideas seen as less credible. Even if you really believed in the promise of electric vehicles, you’d have to convince the engineering team of that too, so they’d spend the time building a proper prototype.

[00:30:34] And even then, you might have a prototype for a product that the marketing and sales team don’t want to sell. If they work on commission, no salesperson is going to waste their time selling something as unproven as an electric car, when they could continue earning huge bonuses from selling this year’s most popular gas powered cars.

[00:30:50] So at multiple levels, people following their own incentives, such as what is the least risky to their career, or what is likely to earn them the most money, push aside ideas like seriously moving forward with electric vehicles, especially if you look around and none of your major competitors are prioritizing EVs either.

[00:31:05] And while executives higher up think they’re the ones making the most important strategic decisions, they may not realize just how many ideas are being filtered out that don’t ever reach them. Serious plans for an affordable EV might never have even made it to their desk. Yet, as we know, this was the exact time that Tesla had little to lose, a lot of conviction in the promise of EVs, and was thus preparing to fundamentally change the automotive industry.

[00:31:28] In Christensen’s study, he did find some patterns among companies that have successfully defended themselves from attacks via disruptive innovators. Companies that successfully dealt with disruptive innovations were those that could identify which customers were interested in a given disruptive product.

[00:31:42] They also tended to establish smaller subsidiary companies focused solely on disruptive innovation. Where the operations were just separate enough that they could get excited about disruptive opportunities, even if they were small in scale for the parent company. Just as important, these companies plan to fail frequently, but quickly, to minimize costs when looking for promising disruptive technologies.

[00:32:02] Google is probably most famous for doing this, since they have a pretty large division of their company devoted to just exploring moonshot bets. They’ve accrued something like 37 in a range of speculative ideas, yet they have largely seen that as a cost of doing business to disrupt themselves before someone else does.

[00:32:22] Google’s investments in Waymo and its self driving cars are a pretty good illustration of this. This unit has also invested in everything from quantum computing and robotics software to contact lenses that measure your glucose levels. Of course, when things don’t pan out, it’s really easy to point fingers and call these bad investments.

[00:32:39] But at the same time, if you want your company to not only survive, but thrive in the coming decades, you have to use your advantages to lean into disruptive bets that will mostly fail with the hope that just one breakthrough can be a game changer. Like at Google, my takeaway from reading the innovators dilemma is that it’s particularly important to carve out a subsidiary focused on disruptive innovations as much as possible.

[00:33:00] With Google’s moonshot bets, you wouldn’t want that disruptive subsidiary to be biased at all by the parent company. You’d want the culture, operations, and decision makers to be as independent as possible, with really only funding coming from the parent company. And as long as sufficient financial resources are being provided, those biases can be minimized too.

[00:33:19] Google, though, is a hugely profitable, multi trillion dollar company, meaning it can embrace filled bets on disruptive technology in ways that other types of companies might not be able to. Your average manufacturing company may face more structural limitations. For example, if a manufacturer of tires for cars is structured around producing high end products that have higher gross margins, but greater overhead costs, the company would be completely organized around making those premium products.

[00:33:44] Trying to switch over production lines to produce a new type of disruptive tire with lower profit margins risks pushing the company in a less profitable direction, while also risking that the adjustments could cause it to lose its competitive advantages for those higher end tires. That is why, if possible, it’s so important for subsidiary companies focused on disruptive technology to be completely independent.

[00:34:06] It’s not just so the subsidiary can succeed, but also so the focus on exploring disruptive technologies doesn’t literally disrupt the company’s main business. Perhaps for a manufacturing company that would mean setting up new production lines, warehouses, and supply chain relationships that are completely separate from the parent company.

[00:34:22] That would be an expensive and maybe even impractical option in the short term, but may very well be critical to the organization’s long term success. This is actually similar to what IBM did to take advantage of the rise of desktop computers at a time when it was primarily a leader in large mainframe computers, which are like massive central computers that could be used by an entire organization.

[00:34:42] To take advantage of this rise in personal computing, IBM created an autonomous organization based in Florida, intentionally far away from the company’s New York headquarters. And that subsidiary proved a major difference maker in enabling IBM to survive while most of its peers collapsed. This subsidiary was free to procure its own components from any source, sell through its own channels, and forge a cost structure built around the personal computing market.

[00:35:06] Christensen concludes that companies must boldly be leaders in commercializing disruptive technologies, And that they should match the size of the independent subsidiaries they spin off to the size of the addressable market they’re focusing on. These disruptive technology focused subsidiaries also don’t have to be built from scratch, they can be acquired.

[00:35:24] At the risk of turning into a bloated conglomerate, there is precedent for companies making strategic acquisitions of smaller peers focused on being disruptive innovators. Johnson and Johnson, at various points, for example, has had hundreds of such subsidiaries on which it relies on to push forward with a range of novel medical treatments.

[00:35:41] There’s also a really interesting anecdote about Honda from the book about how they sort of stumbled into a disruptive innovation that created a new product market thanks to their willingness to continue funding yet to be profitable expansions. In the aftermath of World War II, Japan was an impoverished, damaged country and Honda came to specialize in designing powerful but cheap little motorbikes that could navigate its cities.

[00:36:03] Becoming a beloved product across Japan, Honda sent three employees to California hoping to convince dealerships to sell their bikes. Dealers were hesitant to sell these unproven products, and when some finally did, the bikes flopped because they couldn’t hold up on highways driving at high speeds for long periods.

[00:36:20] Frustrated with their failed efforts, Honda’s executive, who was overseeing the expansion into North America, took his bike out to ride around the foothills outside of Los Angeles, and while riding, others asked him where he’d gotten such a durable little bike that was so perfect for off road riding.

[00:36:34] Honda’s bikes were never meant for off road riding, and it was a category of products that didn’t even really exist yet, but as more and more people asked them about how they could get a Honda bike to ride in the foothills, Honda pivoted away from their long time strategy of selling bikes for highway use in the US, and instead embraced the emerging market for off road bikes, which they quickly became a leader in.

[00:36:54] After that initial success, Honda had the foundation to dive back into designing affordable bikes for use on highways, which they became so effective at doing that they nearly drove Harley Davidson out of business. You could imagine an alternate reality where Honda’s executives back in Japan refused to trust their employees on the ground who told them that people wanted to use their bikes off roads and instead nixed the product and focused on pouring money into making bikes for highway use.

[00:37:18] As I said, they stumbled into what proved to be a disruptive innovation that created a new type of market for motorbikes, yet their willingness to invest in speculative expansions generally and trust their employees operating independently on the ground enabled that success to occur. The lesson for me is that having enough leeway with your investors, as well as not blowing your budget on new ideas too quickly, gives time iterate and incubate innovations.

[00:37:41] A company with a worse performance track record might have felt more pressure to abandon the expansion into the US after it didn’t initially work because they had insufficient credibility with investors such that that initial failure might have spurred a sell off in the stock that panicked management.

[00:37:56] Another takeaway for me is that no one can know what the demand for disruptive innovations will look like. Honda sat on disruptive technology with its bikes for years and didn’t even know it. Its management, both in Japan and those working in the U. S. on expansion, had a completely different concept for how their bikes would be used.

[00:38:12] And motorcycle dealers also didn’t want them because they had a different vision for how those bikes might be used. It took many months of people asking for Honda’s bikes to be used off road before it dawned on Honda’s U. S. team that this is where they should be focusing. And if you had asked the average motorcycle owner, most would have said they had no use for Honda’s tiny and unreliable bikes for dry run highways, since that is where most people rode motorcycles at the time.

[00:38:36] I hope you can see the theme here, which has been true with many disruptive innovations. Competitors, customers, dealers, suppliers, and even the company producing the innovation itself may not understand how and to whom this new technology will be most appealing. When listening to management talk about disruptive innovations, from within their own company or from competitors, I would highly discount what they say, because as Christensen shows in the book, they have a terrible track record in anticipating future demand for disruptive technology.

[00:39:03] Companies may be able to reliably predict sales for proven products that have been around for years, but by definition, they cannot understand the impact of disruptive technologies in real time, at least not before a mainstream use case has been accepted, and by that time, the technology is no longer considered disruptive.

[00:39:19] Overall, I think The Innovator’s Dilemma is a useful book to read, but it wouldn’t be my top recommendation to the average person. It’s very much an academic book based on case studies from decades ago. It is by no means light reading, but the book itself has been so impactful, some of its key ideas have lived on and been explored further in the years since it was first published.

[00:39:39] I did try my best to use some analogies that are more relevant in 2024, but they may not perfectly capture Clayton Christensen’s points as outlined in the case studies he did originally. If you are a manager at a medium to large size company, it would actually be a pretty useful book to read all the way through if you haven’t already.

[00:39:56] But for stock investors, I think my synopsis of the key ideas here is all that’s really needed to glean the most relevant information. So it’s not a book I’d say you should drop everything and read. Still, the Innovator’s Dilemma is fascinating to think about because there really is a paradox where great companies can seemingly do everything right and then simply get displaced.

[00:40:13] It’s also informative to learn that these companies are not displaced simply because their management isn’t hardworking or intelligent enough, or because of employee incompetence, as we’ve talked about relying too closely on customer feedback can actually be what blinds companies. Hence the paradox of innovation.

[00:40:30] While it is critical to listen to customers feedback on sustaining innovations, companies that survive disruptive attacks are able to recognize when to discount customer feedback on potentially disruptive technologies. Although disruptive innovations are infrequent for most industries, they do occur enough that any company hoping to survive for decades must have a plan for dealing with them.

[00:40:49] I know that as a stock investor, this book really enhanced my understanding of competitive dynamics between companies and the nuances of how corporate values, structures, and incentives can lead companies to dismiss the disruptive technologies more often embraced by new competitors.

[00:41:03] Managing innovation is something all types of companies must do well to survive, and that includes some degree of investment in speculative technologies and ideally, independent subsidiaries that can focus solely on certain innovations to ultimately support the parent company. I think this has become a lot more common since this book was first published, but it’s still a relevant message and a reminder for investors to tread cautiously if you’re looking at companies that don’t seem to have any in house processes for incubating disruptive innovations. If they aren’t disrupting themselves, eventually someone else will do it for them.

[00:41:33] With that, I hope you enjoyed today’s episode and I’d like to leave you with a quote on innovation before we end things today. As a great entrepreneur, Henry Ford put it, quote, I’m looking for a lot of people who have an infinite capacity to not know what can’t be done.

[00:41:47] That’s all for today, folks. I’ll see you again back here next week.

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