Disruptive innovation suggests that successful companies engage in practices that reduce their ability to respond to disruptive market entrants. This presentation looks at the process in detail. Along the way it suggests an "innovation lifecycle" similar to a product lifecycle and asks whether we can find key financial metrics that suggests a company is losing its responsiveness. The results are inconclusive.

1. Bio-X Title slide
The Innovation Lifecycle
A Disruptive Innovation Thought Exercise

2. Disclaimers
This presentation involves several premises used in the context of
Disruptive Innovation
This deck reflects my own take on Disruptive Innovation
Most of the useful work in Disruptive Innovation is done by Innosight LLC. I
am not a part of Innosight, LLC.
The ideas in this deck center on consumer goods and services and may
not be relevant to commodities et al
The presentation is very general. One can find counterexamples to every
statement made. No investment advice intended except, perhaps, “be
careful and do your homework.”
2014 John Boddie
1

3. Low End Disruption
A common form of disruptive innovation
Here, a product or service marches upmarket over time by
peeling successive layers of “low value” customers [i.e..
customers that will not pay top dollar for fully featured goods]
away from sector leaders in a given market.
This new product or service offers a differently-featured
substitute with new value proposition that is appealing to these
disaffected customers
2014 John Boddie
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4. The concept was developed at Harvard
Business School
Photo Taken from onpoint.wbur.org
Prof. Clayton Christensen developed these theories in the 1990’s
2014 John Boddie
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5. Disruptive theory stemmed from a
management question
Prof. Christensen looked at innovative companies with
great technology, capable staff and strong mangers, and
noticed that these companies were losing market share
despite doing everything right.
2014 John Boddie
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6. What do we mean by “Doing everything right?”
By taking all of the steps required to become a world class company…
Identify your
best customers
Improve
operational
efficiency
Develop higher
margin
products
Drop
underperforming
parts of your
portfolio
You narrow the range of customers whose needs you can address
…and lose the ability to respond to new market entrants
2014 John Boddie
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7. Let’s look at a hypothetical example
2014 John Boddie
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8. Suppose that your firm has developed a new
good that serves a new and interesting market
The Butterfly Labs Bitcoin Miner
Runs a decryption algorithm in
order to “mine” bitcoins
2014 John Boddie
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9. The big break has finally happened and your
product is attracting notice
… You are now one of a few leading players in
the market. You see regular (if small) profits
and sheer survival is less of a struggle.
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10. … lessons learned during the struggle to
develop a profitable product drive all four of
you to compete over similar features
Hashing speed
Plug and play
High security
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11. … going forward, you (and your competitors) try
to grow sales volume through similar channels
… these channels give each of you great data on
very similar customers, improving your forecasts
while driving common customer segmentations
2014 John Boddie
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12. Obtaining data from similar channels, the
major players in your space begin to cluster
consumers in similar ways
Secure comm
8%
Gold Farming in
MMORPGS
2%
1GH to 250GH
17%
below1GH
2%
Over 1TH
1%
USB Stick
9%
Home
Hardware
25%
Currency
Mining
90%
Hosted
Hardware
34%
Cloud Based
12%
250 to 500 GH
80%
You need to grow quickly to carve out lasting
positions in these rich markets
2014 John Boddie
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13. In order to gain more money for expansion,
you grow your investor pool
We have 35% of
this market
We expect 20% sector
growth this year and we
are releasing 3 new
products that should
capture an additional
10% of the sector…
…so, given our
margins, investors
should see 5% to 6%
profit growth over the
last quarter
Investors love your projection-friendly
market cycle
2014 John Boddie
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14. Over time, your market saturates and it
becomes more expensive to reach new
customers
2014 John Boddie
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15. But you’ve been able to entice your core
customers with improved products, allowing
you to maintain profitability…
Faster
Can be run in parallel
Cloud management software
You remain innovative but you’ve
started to focus on improvements
rather than new product lines
2014 John Boddie
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16. At some point a competitor will start invading
your customer base by driving down prices.
Pricing for new features begins to flatten out
quickly while old features are commoditized
250 to 500
GH/Second
2010
USD 4,000
Hosting
services
Exclusive
mining
pools
250 to 500 TH/
second and low
power
2012
USD 1,000
Solve for all 10
established
currencies
Manage
Derivatives
Banking services
2020
USD 500
2025
USD 200-400
Adapted from http://www.marketingtechblog.com/history-mobile-phone-cost/
2014 John Boddie
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17. At the same time…
Sales peak in accepted consumer segments, making
it even harder to find “new growth” customers
Cryptocurrency mining
service subscriptions
per 1000 people
2014-2023
2014
2015
2014 John Boddie
2016
2017
2018
2019
2020
2021
2022
2023
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18. Despite these challenges, investors expect
consistent quarterly earnings forecasts
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19. It starts to look tough when things were finally
supposed to become easy
You start to worry
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20. You start to look for growth within the existing
market rather than outside
I need to lower prices
I need to take customers
from the competition
Lower production costs!
Remove low margin products
and standardize components
Create internal cost savings
initiatives for production
managers
Enter large volume contracts
at better prices with bigger
supply chain partners
2014 John Boddie
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21. You might improve profitability by reducing
overhead costs
Combine jobs and reduce
headcount. Focus on
terminating underperformers
I need to reduce my
overhead costs
Let’s identify pipeline products that
really help the bottom line and shelve
those that don’t promise good returns
Set higher productivity metrics
for my departments and
pressure managers to succeed
2014 John Boddie
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22. Sales and distribution may also contribute
Who is the best at selling my
high-margin goods?
I should focus on developing
better deals with my top 5
distribution and sales
partners…..
Who has the best
geographic reach?
Who is offering the
best customer
incentive programs?
Who will help me I reduce
my service costs?
Who offers the best data?
2014 John Boddie
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23. Whew! After some struggle, you’re able to confidently
project quarter-to-quarter earnings growth
You are able to meet your targets
You have some great core product variations in your
pipeline… you are innovative
You might be able to do this for years
But there is a small, low end company on the horizon
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24. A (Hypothetical) large-scale,
distributed computing approach to
cryptocurrency mining. Uses mobile
phone processors. No separate
hardware component. Users get
fractions of mined currency.
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25. At first...
Nope, too busy
engineering this
new processor
Hey, have
any of you
heard about
bitcrowd?
I’ll ask our
marketing
partners
Yeah, but I
wouldn’t take
distributed
computing too
seriously. You can’t
do much with it.
Software, not
hardware. Not
my problem.
2014 John Boddie
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26. Then...
Hey,
bitcrowd has
over 1 m
users
We don’t know
mobile phones.
You’d need to
give us $$ for a
new team.
We are making a
ton of money from
our new services
software. I can’t
afford to lose focus
Yeah, but that 1m
would never be
our customers
anyway
I’m going all out here.
I’d need a command
from the top to shift
resources
2014 John Boddie
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27. Eventually...
We really
need to kill
bitcrowd..
We have specs from
software. We can do the
chips and get them into
production in the next year
Our software team has put
together something similar
called Bitsource. Given
Bitcrowd’s apparent
market we should make a
kajillion dollars.
I will press our
channel partners
to push it once it is
ready to go
We have a mobile
phone partner who
may be willing to install
the chips
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28. We needed to spend extra time
debugging our next gen platform.
We lowered our projections for the
mobile phone chip volumes
anyway so this was the correct
approach.
Finally...
The software was good but
marketing couldn’t design
a user friendly interface
that attracted customers
I told our
investors
that we’d win
this. What
happened?
Don’t blame us. It
tested well with our
current customers. Our
channel partners hate
it anyway.
I couldn’t get them to
prioritize production of
the new mobile
phones
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29. It seems that the drive to grow within a mature
market often comes with a cost
Remove low margin products
and standardize components
The company sets a new, higher bar for product
margins, making it more difficult to experiment
with products that don’t project great returns
Enter large volume contracts
at better prices with bigger
supply chain partners
It becomes harder to set up small product test
runs and large scale suppliers may be less able
to help with custom work.
Create internal cost savings
initiatives for production
managers
2014 John Boddie
Managers may respond by pressuring staff
members to focus solely on products that
support the current bottom line. There will be
less time for experimentation.
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30. Combine jobs and reduce
headcount. Focus on
terminating underperformers
Identify pipeline products that
really help the bottom line and
shelve those that don’t promise
good returns
Set higher productivity metrics
for my departments and
pressure managers to succeed
2014 John Boddie
Average workloads rise and employees have
less time to experiment with new ideas.
Employees that do try new things need to create
outsized justifications for side work, setting
impossible benchmarks for side projects.
This favors products with the best, most airtight
market data (i.e., those in existing markets).
Managers inflate returns beyond all reason in
order to preserve projects, raising the risk that
they will be killed prematurely.
Managers will resist any new initiatives that
might risk their KPI’s; understanding that it is
safer to promote similar products using known
suppliers through proven sales and distribution
channels.
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31. Who is the best at selling my
high-margin goods?
These partners may be far less willing to sell a
mix of goods or experiment with lower-margin
goods
Who has the best
geographic reach?
Who will help me I reduce
my service costs?
These partners may offer great prices and
incentives but may make aftermarket service
problematic, alienating customers that were best
served by older (essentially de-featured) product
models.
Who is offering the
best customer
incentive programs?
Who offers the best data?
2014 John Boddie
Even if you get the best, most airtight data for
existing products, this data is often only useful
for similar/ next square products. The quality of
the data, however, may increase the perceived
risk of the unknown.
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32. To Summarize So Far…
After a period of often desperate competition, a few small
companies will finally figure out how to profitably bring a new
good or service to a new customer base, opening a new market
These few companies will grow rapidly, often pursuing customers
through similar channels. Data from these channels drives
common, highly-trusted, customer segmentations
Companies grow their investor base in order to expand their
reach. Investors love the steady sales growth and the profits
Eventually the market will mature. New growth will slow and
pricing will flatten, leading companies to compete for an
increased share of existing customers
This struggle to preserve profit growth within a mature market will
drive increased focus on efficiency, reducing the flexibility and
responsiveness required for out of category competition
2014 John Boddie
These companies
become more
vulnerable to disruption
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33. Companies remain innovative, but much of
this innovation focuses on variations
around a core product line
Total
Sales
Volume
Time
2014 John Boddie
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34. Many of the improvements boil down to
better data, better margins, better efficiency
The need for
better market
projections
Profitability
pressures raise
new product risks
Favors well
defined markets
Drives a focus on
value
Favoring batter
market projects
and lower costs
And makes it
hard to see
emerging
customer
segments
2014 John Boddie
Competition for
existing
customers
Forcing
companies to
preserve profits
by reducing
internal costs
Leading
companies to
double down on
existing product
lines
33

35. This cycle feels inescapable, a bit like the
product lifecycle
Sales
Volume
Development
Growth
Maturity
Decline
Levitt’s Product
Lifecycle
Time
2014 John Boddie
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36. It is worth thinking about an innovation
lifecycle that leads a product lifecycle
High
Resources
allocated to
innovation
work that can
impact the
trajectory of a
firm
Development
Targeted
Innovation
In-Category
Innovation
Stagnation
Low
Time
2014 John Boddie
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37. Companies are often highly innovative when
developing new products for new markets
Development
• Innovation work speeds up after the
company is able to get money
• Actively searching for customers
• Profitability is enough- willing to live with
low margins
• Products are refined continually in order
to find the best possible customer fit
• The company is small so it behaves like
one big team with constant
communication
Time
2014 John Boddie
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38. They can do their best work once a direction
is established
Targeted
Innovation
• The company knows it’s customers and
how to reach them
• Innovations are increasingly focused on
performance breakthroughs that make life
easier for these customers
• The company is larger and decisions are
more formalized. This often free
engineers and market testers to do their
best work
Time
2014 John Boddie
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39. Eventually the desire for low risk, profitable
goods and services drives a company to
focus on “variations on a theme”
In-Category
Innovation
• Market projections are
overweighted, favoring
existing customer data
• The company is big and
investors expect returns
• It becomes safer to release
differentiated core products
than to investigate
fundamentally new product
lines
• Engineers adopt incategory tech
breakthroughs quickly
Time
2014 John Boddie
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40. Eventually the company focuses on cutting
costs while struggling to respond to new
market pressures
• Sales volumes and profits begin to drop
• Underserved customers and finding substitute
goods that offer a better fit
• Innovation increasingly focuses on cost
reductions
Stagnation
Time
2014 John Boddie
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41. Companies can remain profitable even while losing
the ability to drive non-core innovations
Are there any metrics to suggest that a company is
on the far side of the innovation lifecycle?
2014 John Boddie
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42. What have we surmised so far?
Common customer
segmentations
This is a bit tricky to quantify. For consumer goods, check to see whether
Amazon et al have distich product categories. For more opaque items,
check industry surveys.
A Mature Market
Again, this requires a bit of judgment. Is the majority of the market held by
a handful of major competitors?, Are each of the competitors making
similar breakthroughs and offering similar new features on their flagship
products? Does pricing seem to flatten out? Is geographic growth
slowing?
Price pressure/
Rapid
Commoditization
Internally, companies may try to standardize new product features as
quickly as possible, making the COGS appear to spike with each product
release and then fall. Similarly, Gross Profit margins may spike then fall.
A drive toward
efficiency to
preserve profits
Revenue per employee may rise as headcounts are trimmed and
efficiency drives are launched. Similarly, the operating margins should
rise.
Erstwhile happy
investors
Stock prices should remain steady or rise.
2014 John Boddie
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43. A warning and a reminder
This presentation talks about conditions that may leave companies within a sector
open for disruption. This does not mean that these companies will invariably be
disrupted
These are only theories, drawn from common observations about problems that
face companies in mature markets. As we will see on the next pages, associated
key financial measurements are problematic at best.
Every company deals with challenges using its own mix of approaches. In larger
companies, weakness in a product line may be entirely hidden.
Even if metrics are refined and a more exacting approach evolves, guidance will
never reach beyond “it’s time to pay attention to small, emerging companies in a
space.” Anyone who buys or sells stock or options based solely on the listed metrics
is an idiot
2014 John Boddie
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44. Sample Troublesome Data
Some potential problems:
1) Data prior to 1995 can be
difficult to obtain.
Remove low margin products
and standardize components
Operating Margins Rise
Create internal cost savings
initiatives for production
managers
Set higher productivity metrics
for my departments and
pressure managers to succeed
Combine jobs and reduce
headcount. Focus on
terminating underperformers
2014 John Boddie
Revenue per
employee rises
2) It may be difficult to separate a
natural growth in revenue per
employee (the result of common
technological advances) from
revenue growth driven by cost
cutting measures.
3) Large companies have a
variety of products across several
divisions. Data within a particular
product division is normally
unavailable. It may be hard to
detect changes within a particular
product division at a large
company.
4) Mature markets often undergo
a round of M&A, making it more
difficult to track individual
company performance
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45. Example: Mahindra enters the US tractor
market in 1994 and is 4th largest mfr. by 2005
Ford 7810- 6 cyl, 90 hp,
81 L fuel tank
John Deere 6900- 6 cyl,
130 hp, 264 cm wheelbase,
5391 kg, 250 L fuel tank
New Holland 9880- 6 cyl,
400 hp
In 1994, Mahindra
launched M&M USA with
a 45HP consumer grade
tractor.
We are interested in the
tractor market between
1990 and 1998 or so,
when companies finally
began responding to
pressure in the consumer
segment.
Mahindra 575- 4 cyl, 45 hp,
194 cm wheelbase, 1876
kg, 35 L fuel tank.
2014 John Boddie
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46. Let’s look at the tractor market in the
US in the 1990s
Was the majority of the market held by a
handful of major competitors in 1990 to
1995?
Were each of the competitors making similar
breakthroughs and approaching similar
customers with similar new features?
Did pricing seem to flatten out?
Was geographic growth slowing?
2014 John Boddie
Highly fragmented (150 companies) but
fewer than 10 owned 80% of the market
Most of the market targeted big farms,
innovations focused on horsepower, cab
comfort, electronics
Old features were quickly commoditized.
Companies seemed to price in similar
horsepower bands
Strong round of M&A in India, China etc.
in the 1990’s, suggesting maturing
overseas markets
45

47. Competitors focused on in-category
innovation while losing consumer market
share
Mahindra vs John Deere
new product
launches by horsepower 1992-1998
HP
High Power Tractor
Segment
Consumer
Tractor
Segment
2014 John Boddie
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48. In 2004, John Deere overhauled their marketing
department in order to fight for the consumer sector
[1]
They were developing products and then trying to
find consumers
John Deere’s
marketing
director
identified 3
interesting
problems
They were basing market research on current
customers rather than potential customers
They were hiring too many people internally, failing
to diversify their talent base
[1] marketingsherpa.com. Jan 19th 2004 How John Deere Increased Mass Consumer Market Share by Revamping its Market Research Tactics
2014 John Boddie
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49. AGCO (purchased Massey Ferguson in 1995),
and John Deere COGS and Gross Profit
Margins* 1992 to 1999
Gross Profit Margins
and COGS were
cyclic, suggesting
price pressure and
commoditization of
new tractor features.
*charts generated by Ycharts, Data unavailable for Harvester, Case,
Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford.
2014 John Boddie
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50. AGCO and John Deere Rev/Employee and
Operating Margins 1992 to 1999
Revenue per employee
rises for Deere but
remains flat for ACGO.
Operating margins seem
cyclic, within a rough 7%
variation
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51. AGCO and John Deere Stock
prices 1992 to 1999
Investors seem happy with Deere and AGCO until 2H 1998
2014 John Boddie
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52. So, was it helpful?
The Good
John Deere showed the cyclic COGS and Gross Profit margins that
we’d expect in a mature market where new products are rapidly
commoditized. They also showed rising revenue per employee, which
suggests that operations were being streamlined and becoming more
efficient. Last, investors, as is their wont, seemed to love both Deere
and AGCO until 1998, when they suddenly pulled away.
The Bad
The case is much less clear with AGCO. COGS seems cyclic but
muted while gross profit margins seem to hover around 20%. Revenue
per employee falls after 1995 while operating margins for both Deere
and AGCO seem to hover between 8% and 15%
Conclusion
COGS and Revenue per employee seem to be modestly promising
indicators. Operating margins and gross margins seem to be less useful
2014 John Boddie
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53. Example: The mobile phone market looks
mature
There are only a handful of major competitors?
AAPL, SSNLF, Motorola
(Stock info for HTC, LG
unavailable)
Are each of the competitors making similar
breakthroughs and offering similar new features
on their flagship products?
4G LTE, better screens, more
memory, faster processors
Does pricing seem to flatten out?
Old features are quickly
commoditized. Companies
seem to price in similar bands
Is geographic growth slowing?
Penetration is slowing in most
countries though many
consumers are purchasing
better and better phones
2014 John Boddie
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54. AAPL, SNSFL, SNE, MSI: COGS and Gross
Profit Margins June 2007 to present
Gross Profit Margins
and COGS are cyclic,
suggesting price
pressure and
commoditization of
new mobile phone
features.
*charts generated by Ycharts, Data unavailable for Harvester, Case,
Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford.
2014 John Boddie
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55. AAPL, SNSFL, SNE, MSI: Rev/Employee and
Operating Margins June 2007 to Present
Revenue per employee
has risen annually for
Apple and Samsung but
has remained steady for
Sony and Motorola
At the same time,
operating margins have
shown a slight climb for
Apple, Samsung and
Motorola over the last
two years while
remaining steady for
Sony
2014 John Boddie
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56. AAPL, SNSFL, SNE, MSI: Stock Price
June 27 to present
Apple and Samsung electronics have both
done very well, while Sony and Motorola
have remained relatively flat
2014 John Boddie
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57. So, is this useful
The Good
AAPL, MSI and SSNLF data seems to suggest that the phone market
has matured and that new features are being commoditized. All three
have also become slightly more efficient since 2011, suggesting that
they may be losing some flexibility.
The Bad
Three of the four companies are very large, with multiple product lines.
It is difficult to attribute any change in key data to maturation of the
mobile handset market.
Conclusion
Again, it seems as if companies in mobile handsets are facing
commoditization pressure. It is hard to tell whether they are trying to
support profits by becoming more efficient. They may do this in 2014
given the apparent downside risk of a missed profit forecast.
2014 John Boddie
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58. Next steps
More research. Additional key metrics should be tested on markets
where disruptive product trajectories have injured one or more major
players.
Better data. Baseline growth in revenue per employee should be
separated out. It is worth looking at data within a particular division or
product line (if possible).
Test the idea of a bellwether company. It appears that Deere and
Apple may rely enough on their core product categories (tractors and
phones) to act as effective signals that a market is suitably mature and
that company (or divisions) within a market may not be able to address
disruptive entrants.
Move beyond disruption. By characterizing the innovation cycle and
winnowing out the nest associated metrics, it may be possible to give
companies the tools needed to explain forays into new markets and lowermargin products despite enjoying record profits from established customers.
2014 John Boddie
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