Technology, Venture Capital, Private Equity

One of the most common ways in which one tends describe technological innovation is that it is “disruptive”. Ask an entrepreneur what he is upto and chances are he will say that he is working on a “disruptive idea”. Ask a VC what his funding theme is and he’d probably say that he is looking to invest in the next “disruptive technology”. Yet, not too many people really understand what this concept of “disruption” actually stands for. One is generally inclined to believe that anything that is cutting edge or novel is “disruptive”. However, thats not the case. The phrase “disruptive technology” has a specific connotation and was actually coined by a Harvard professor, Clayton Christensen, which he later elaborated on in his book “The Innovator’s Dilemma”. It was borne out of a study conducted by him, which tried to ascertain why established companies found it hard to keep pace with innovation. He concluded that it was not poor management or even the failure to detect technology trends in big companies that prevented them from nurturing these new technologies. It was the fact that the economics for building a successful business on such new technologies was unviable under their present cost structures that made such the commercialization of these new technologies difficult. Such “disruptive” technologies are typically inferior to existing technologies to start with and hence command a far less price as compared to existing technologies. Therefore, the market for these relatively inferior low cost technologies is not the one that consists of existing customers of large companies but a new one, which is less attractive to such companies. However, with time, such “disruptive” technologies undergo dramatic improvements to the extent that they become capable of threatening even the established hi-end technologies. Therefore, these technologies present a great conundrum to managers. How should companies go about transitioning from a sustaining to a disruptive technology?

For instance, lets say, Apple’s engineers discover a new storage technology that is not as good as the one in the existing iPods, but would bring down the cost price of an MP3 player by half. What should Apple do? Not only would the market for such a product be less lucrative but also, any attempts to commercialize this technology would meet with a lot of internal resistance from existing iPod managers since it would cannibalize its sales. Ok, so, should Apple sleep over it and allow someone else to harness this? The answer according to Christensen’s thesis is – no. Reason being, though this technology may not be adequate to cater to the mainstream (and attractive) market currently, if the technology finds home in another less attractive market, with time, the technology can mature to a level where, it will be “good enough” for the mainstream as well. And armed with a huge price advantage, this innocuous inferior technology can soon sweep the incumbent technology off the floor.
The solution that Christensen presents to deal with this issue is for such companies to nurture such potentially disruptive technologies in separate entities that would be amenable to the economics of that technology. They would then be free to develop the technology with a separate cost structure and also market it to a separate market under a lesser price point.
This is where I feel there is a strong connection between innovation and emerging markets (ref my previous post). Low cost product development centers in emerging markets not only enables tech companies to maintain separate cost structures in a single organization just as Christensen prescribes, but also gives ready access to a market which will be suitable for such technologies in the beginning. This means that technology companies need to see offshore centers in a whole different light as not just means of cutting costs, but also as incubators of “disruptive” technologies. However, it is not all roses as we will discover in my next post on the same topic. Stay tuned.