Words ought to be a little wild, for they are the assault of thoughts on the unthinking
- J.M. Keynes

Sunday, 30 September 2018

Responding to disruption

Really liked reading 'The Disruption Dilemma' by Joshua Gans. Quite relevant to what I’m doing currently. The logical framework presented resonated, especially Gans’ distaste for the current hype that 'every start-up is disruptive and disruption is everywhere'. He has also outlined well the strategic choices which firms need to make.

The book defines disruption as the failure of successful firms because they continue to make the choices that drove their success. Using several examples, Gans shows that firms are rarely blindsided by technology. However, they fail to counter new competitive threats by continuing to follow what seems to be a rational course. Citing the popular Blockbuster / Netflix case, he talks about how Blockbuster’s customers were happy going to stores when Netflix started its postal delivery model which initially only appealed to a niche segment. Blockbuster emulated the mailing model but decided to stick to its tried-and-tested approach. Its decision making was guided by available knowledge and its existing operating model. Blockbuster arguably made the “right” choices for an incumbent, as they would have looked without the benefit of hindsight. However, Netflix moved so fast in improving its offering and broadening its appeal that Blockbuster was never able to catch-up and compete. This is quintessential disruption.

The dilemma for incumbents is the need to make choices under uncertainty about the impact of emergent business models and new technology. Ex ante it is hard to know whether an innovation is disruptive. Making it harder is organisational inertia of moving away from a tried and tested course. (As an aside, ‘Essence of Decision’ by Graham Allison on the Cuban missile crisis is a great read to understand decision making inertia and challenges).

Firms need to counter two different types of disruption:
1. Demand side disruption where new entrants initially target underserved or unserved customer niches and use them to grow and eventually win.
2. Supply side disruption where new technology leads to changes in the way components of a product or service are combined to serve customer needs making incumbents' existing products uncompetitive as customer preferences change (e.g. iPhone)

Demand side disruption is more familiar and responses are well known based on likelihood of change. If a firm assesses likelihood to be low, it pays to focus on core strengths and continue with incremental improvements to the business model. All this requires is the ability to “keep your head while all about you are losing theirs”. However, if disruption appears likely, firms should aggressively invest in new technology or product and move away from the old model. In this instance, the value of the old model should be discounted far more than what a traditional approach might dictate because demand shifts are large and quick. This creates conflict as it requires firms to move away from the tried-and-tested approach of leveraging what exists to building what is needed in the future. A middle way is to create an option by monitoring developments and later acquiring new entrants when disruption appears likely. However, it requires the firm to be ready to pay a premium since valuations will reflect the higher likelihood of change. Interestingly, Blockbuster had the opportunity to buy Netflix for $50 million in 2000 which it passed on.

Responding to supply-side disruption is harder since it requires a change in the way an organisation structures itself and collaborates. In most firms, division of labour and areas of expertise create a narrow focus on parts at the expense of the whole. Also, ways of collaboration are embedded making it harder for innovative ideas to flow from one part to the other. There is a great anecdote in the book about the creation of Blackberry Messenger, the 'killer app' of its time. It was developed by three engineers taking the initiative on their own despite active resistance from the organisation. In fact, the manager of one of the developers gave him a bad performance review for spending time to develop what would be used by 50 million users and be a much-loved feature of Blackberry!

The book is less detailed on how to effectively respond to supply-side disruption. It makes the general point on creating organisations where different areas / divisions are able to collaborate easily and gives examples of organisations like Canon which have done this successfully. To my mind, this is where cross-functional Agile teams become critical. Countering supply-side disruption requires awareness of the overall system, the changes impacting it and how the various components should fit together. Isolated areas of expertise with well-defined hierarchies and formalised communication channels will fail.

In my opinion, banking is undergoing supply side disruption as technology enables parts of the value chain to be done independently (i.e. modularisation) and combined based on customer preference. For example Monzo takes standard bank products and provides them in an innovative way e.g. a deposit facility, a cashless payment service, an information service and a marketplace for financial products. For incumbents, countering the disruptive threat is not about optimising components by making the deposit account better or digitising loan decisions but requires coming up with an overall experience and proposition which delights the customer and is built around them. This requires a fundamental shift in culture and organisation for most.