Let me start with a confession: Professor Fréry, I was wrong.
As part of my MBA’s strategy course I had to write a strategic diagnostic of my company. As any former student of Prof. Fréry will tell you, this is a brutal and extremely demanding assignment, easily 3 to 4 weeks of full-time work. The first and most crucial part of the assignment is to split the company into strategic business units. An SBU is basically the only unit it makes sense to study from a strategic perspective. Anything smaller, and you don’t have a full-fledged entity. Anything bigger, and you’re mixing different contexts (customers, competitors, channels, resources, etc.) and your analysis makes no sense. So it’s crucial to define your SBU correctly, or the rest of the diagnosis is flawed.
Guess what? I got it wrong.
At the time, I was working for a managed service provider of public and private cloud solutions. How to segment the company came down to this question: should public and private cloud services be considered separate strategic business units?
The criteria to identify an SBU are:
- does it have specific customers?
- does it address specific markets?
- does it have specific competitors?
- does it leverage specific technologies?
- does it require specific resources?
- does it have specific sales channels?
Applying these criteria didn’t give a clear-cut answer, but I decided that, in the company’s context, public and private cloud businesses belonged to the same SBU.
It’s only a few years later, when I read The Innovator’s Dilemma by Clayton Christensen, that I understood how wrong I’d been.
The Innovator’s Dilemma
It’s hard to summarize a book1 in a single paragraph, so if you haven’t read The Innovator’s Dilemma, I can only encourage you to do so. That being said, here is my attempt at a summary (if you’re already familiar with the book’s thesis you can skip directly to how it applies to cloud computing).
The book aims to answer the question “Why do new technologies cause great firms to fail?” through numerous case studies in different industries. To understand the book’s thesis, it’s worth taking some time to qualify what Christensen means by “great firms” and “new technologies”.
Great firms
In the book’s context, a great firm is one that is well-managed and efficiently organized to pursue high-value opportunities and meet its customers’ demands. This means that such a company will:
- seek to maintain or increase revenues and margins, and therefore
- prefer higher-margin products to low-margin products,
- prefer larger markets to smaller or unknown markets;
- work within its value network (meaning its network of suppliers and customers) to evaluate and request new features from their suppliers, and surface new needs from their customers;
- focus on and improve product features which are most valuable to its customers;
- build processes, incentives and a company culture that enforce all the traits listed above.
New technologies
Christensen distinguishes two kinds of innovation, sustaining and disruptive.
Sustaining innovations are the next wave of an S curve. They bring continuing improvement to a given market, i.e. they improve products along the qualities that matter to the existing value network. An example of a sustaining innovation from the disk drive industry (which Christensen analyses extensively in the book) is the introduction of magneto-resistive heads, which improved reading speed and disk density –two traits prized by the existing disk drive customers.
Market leaders manage to ride sustaining innovation waves, no matter how technologically complex, because a sustaining innovation ticks all the boxes of what great firms are good at:
- it brings improvements which are sought after by their customers;
- it can bring larger market share and improve margins;
- it can give access to higher-margin markets (more on this later);
- all this happens in the company’s existing value network, which means customer demand is known and management can build a solid business case and prioritize the project.
Disruptive innovations, on the other hand, do not bring improvements that the existing customers value; they do, however, have qualities which can make them a good fit for a different market. An example of a disruptive innovation from the disk drive industry is drives with a smaller form factor (e.g. going from 5.25-inch drives to 3.5-inch) but with less capacity than existing drives. The new 3.5″ drives were of no interest to the existing market: makers of desktop computers had no need for the smaller form factor, seeking instead improvements in storage and speed. However, the new drives’ smaller size was an asset in the new (at the time) notebook market.
Disruptive innovations are often technologically straightforward, reusing well-known tech. As such, it is extremely common for market leaders to experiment with (or even invent) the innovation, and to then discard it for business reasons: their existing customers don’t want it, there’s no clear market for it, etc.
This means that disruptive innovations initially thrive in adjacent markets, which value different qualities. In this context, a disruptive innovation’s “flaw” can actually become an advantage. To take another example from the book, when hydraulic back-hoes first appeared they were dramatically underpowered compared to the cable excavators of the time: they had smaller buckets and less reach, which made them unusable for the large construction sites and public works that were the existing market for excavators. However, their small buckets and small size (which made them more maneuverable and easier to move from one dig to the next) made them a very good fit for residential work and sewage projects which were previously dug by hand.
It hasn’t escaped you that we don’t see 5.25-inch drives anymore, and that hydraulic excavators have conquered the construction market. This is the central thesis of the book: disruptive technology eventually displaces the previous wave of innovation.
How does this happen?
Technology supply outpaces market demands
The final piece of the puzzle is that innovation progresses faster than market demand. That is, a given innovation wave (i.e. series of sustaining innovation) will add performance faster than the market requires. This is illustrated in the graph below by the fact that the green lines (innovation growth) grow faster and eventually outgrow the red lines (market demand).
Technology progress vs market demand (source)
Let’s illustrate this graph with our previous example of 5.25″ drives (first green line) and 3.5″ drives (second green line), in the desktop computer market (red lines).
| Time | Desktop PC market demand | 5.25″ drive capacity | 3.5″ drive capacity |
|---|---|---|---|
| a | 200 – 400 MB | 350 MB | 200 MB |
| b | 250 – 500 MB | 500 MB | 350 MB |
| c | 300 – 600 MB | 700 MB | 600 MB |
Before point a, 3.5″ drives simply
