View slides from Harvard Professor Woodward Yang's talk on disruption at the Great Minds program at CES 2006
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To understand why great companies fail, you need to look at the many kinds of innovation-the ones organizations know and apply routinely, and the ones they often miss and trip over. Most companies understand the sustaining innovations that let them provide better, more-profitable products to their best customers. Fewer understand disruptive innovations, which often initially offer poorer performance along the dimension their existing customers care most about.

In every case we studied, the company that was disrupted knew of the disrupting technology prior to its demise but viewed the technology as unimportant and unlikely to pose a threat. In every case, the market leader believed that the future would look like the past.

Companies have strong incentives to innovate and move upmarket, because more-demanding customers tend to pay premium prices for products or services that solve the toughest problems. Well-run companies that listen to their best customers develop sustaining innovations that improve their products along the dimensions of performance that customers have historically valued. These sustaining innovations essentially take a good product and make it better. They are crucial to a company's growth and prosperity.

However, incumbent companies tend to create products and services at a pace that outstrips the ability of customers in various market tiers to use the improvements-a phenomenon we call performance overshoot.

By contrast, disruptive products or services initially are inferior to existing ones when measured by the attribute that matters most in the mainstream market. But these disruptive products are typically more affordable and easier to use than those in the incumbent's product portfolio. That's because all disruptions are predicated on creating growth opportunities in dimensions away from the core of the incumbent's market.

Because shifts to new dimensions of innovation are triggered by performance overshoot, they occur at different times in different tiers of the market. But they always begin in the least-demanding tiers, where overshooting-on any dimension-occurs first. In the most-demanding applications in a multitiered market, competition will revolve around functionality and reliability, just as competition for customers in less-demanding tiers revolves around speed, convenience and customization.

While initially the disruptive innovation is not good enough to meet the performance requirements of the mainstream market, the disruptive innovators aggressively move upmarket, pursuing their own sustaining innovations and more-attractive profit margins. Ultimately, when the disruptive innovation is good enough to meet the needs of larger swaths of the incumbent's customers, the incumbent is forced to move further upmarket or, eventually, out of the market entirely.

Think different
After the functionality of prevailing products has overshot what customers in the less-demanding tiers can use, companies must compete differently to win business. Although customers will continue gladly to accept products with even greater functionality, their willingness to pay premiums for them declines. Instead, improvements in speed-to-market and the ability to conveniently customize functions of the products become the trajectories of innovation that gain competitive traction and earn premium prices.

To compete on speed, convenience and customization, companies must figure out the level of traditional performance that is necessary to satisfy the market. They must also understand the type and level of newly defined performance metrics sufficient to gain competitive traction as the basis of competition shifts.

In mature markets marked by performance overshoot, proprietary product architectures tend to give way to modular ones, in which the interfaces among subsystems become well-specified and standardized. Although standard interfaces invariably force compromises in system performance, competitors aiming at overserved customers can comfortably trade off some performance to achieve speed, convenience and flexibility.

In turn, the modular architecture enables focused, independent companies to thrive by making only one component or subsystem and supplying the nonintegrated firms that design and assemble end-user systems. Integrated companies tend to be displaced by a population of specialists. In the semiconductor industry, for example, fabless companies and dedicated foundries have to some extent displaced vertically integrated chip companies.

New sources of value
The threat of disruption also gives rise to opportunity. While some industry incumbents may fall on hard times, new sources of growth and profits will emerge.

For example, Dell introduced the convenience of buying made-to-order PCs online, creating competitive differentiation and advantage just as many computer manufacturers were evolving into mere system assemblers.

Dell forged a tight supply chain and close links to end users to improve what was not good enough to satisfy the market-the speed of order fulfillment, customization and convenience-and outsourced what was more than good enough: PC design.

Dell rightly recognized that PC performance had begun to overshoot what the mainstream market could use, so it innovated in a new area: delivery. Dell's success is an excellent example of a general rule: To compete effectively, companies must figure out the level of traditional performance necessary to satisfy the market, while also identifying a new metric of performance based on convenience and customization.

Intel is another company that saw how overshooting performance in one area creates opportunities in another. The company realized customers were satisfied with the processing power of their laptops but would be willing to pay a premium for systems that had longer battery life and better wireless connectivity. The basis of competition shifted from processing performance to convenience.

Intel responded with its Centrino platform. Centrino sacrificed traditional metrics such as processor clock speed to provide a balance of wireless connectivity, battery life and adequate CPU speed. The new platform enabled Intel to demand premium prices.

Given what we have learned about disruptive innovation, we foresee almost a bifurcation of the semiconductor industry. Certainly, there will always be applications for which performance is not yet good enough. But increasingly, growth is likely to come from markets where consumers are already satisfied with performance based on historical definitions. This likely means that value will migrate to new playing fields.

The companies that emerge as the leaders in the next round will be the few that understand and respond proactively to the underlying disruptive changes.

-by Steven King and Matthew Verlinden, Innovo, Inc.; Woodward Yang, Harvard University; and Clayton M. Christensen, Harvard Business School
Innovo Inc. is a strategy consulting firm that has worked with Clayton Christensen for six years in applying his frameworks of disruptive innovation to the semiconductor and electronics industries.