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Why Do Great Companies Fail? A Foolish Book Review of “The Innovator’s Dilemma”

This one isn’t an investing book per se. But its insights are critical for investors, nonetheless.

You might be curious why I don’t recommend an investing book on my first book review for I’ll explain why.

My colleague Brian Richards, who oversees Motley Fool Asia, once conducted an hour-long interview with Fool co-founder David Gardner. One of the questions Brian asked David was to name some of his favourite investment tomes.

David’s answer surprised Brian—and me. In short, David said he doesn’t really read “investing” books. He reads “books about business” – because, in his words, businesses are what he’s investing in.

See, as investors, we are part-owners of a company. We own a “share” of that company’s future earnings stream, and have voting right commensurate with our ownership stake (in most cases).

The more you understand the business you buy, the more likely you would earn from your investments. Today, I want to bring to you the most important business books for bridging a background in the technology industry with investing in the industry. It’s called The Innovator’s Dilemma, written by Clayton Christensen.

This bestselling book has inspired many technology leaders—like Steve Jobs, Jeff Bezos, and Andy Grove. Nowadays, it’s a bit of a must-read book in Silicon Valley.

At its heart, The Innovator’s Dilemma looks at how a successful, profitable companies navigate the competitive threats brought by innovative startups.

Why do great companies fail?

Christensen is a professor at Harvard University who has become known for research about how disruptive technology is changing industries. His book explains how successful companies dominating their industries fail in the face of disruptive innovation.

Way too often, business leaders approach the investment in innovative technologies the wrong way. Most of them simply push their existing cultures and business models into new divisions or business lines, instead of providing a strong leader with the right tools and a team that can tackle the emerging market as a new business entity.

One of the things that makes the book so good is that Christensen uses lots of examples and actionable strategies of how to apply this in practice.

Sustaining Innovation vs Disruptive Innovation

In Christensen’s view, there are two types of innovation: sustaining and disruptive.

Existing successful companies are usually built on sustainable technologies. They improve their products based on valuable feedback from the loyal customers. It is usually about reducing defects and making the products more powerful and easier to use.

On the contrary, disruptive innovation is built on technology that the existing customers aren’t aware of and create a completely new business model to serve customers. For instance, the cell phone industry was completely changed when smartphones were introduced into the market.

The key difference is that sustaining innovation satisfies customers’ current needs while disruptive technologies evolving in new business models aim to meet customers’ future needs.

Existing companies follow a sustaining innovation path that makes a lot of sense in the short term due to their established brand and loyal customer base. However, Christensen argues, this approach can ultimately doom the company to failure—because while the company is paying too much attention to current customers, it may well be neglecting larger technological changes on the horizon.

Although allocating valuable resources to a niche and unproven opportunity sounds odd, it is often the future of the company. Disruptive innovation is born from a need existing in a niche market that’s ignored by current market leaders. That small market segment may not care about traditional performance features.

Why aren’t current market leaders at forefront of disruptive innovation?

Christensen posits three main reasons in The Innovator’s Dilemma:

1. Processes

A company typically builds up its internal processes based on a given strategy. For example, a company like Apple has high-margin products, so it allocates a lot of resources to branding and design to their existing customers.

2. Values

Current employees choose to work in a company because they value the brand and existing products. If top management decides to push down a disruptive product, the current employees will tend to allocate fewer resources—even if unconsciously. Existing culture and habits among employees are obstacles to disruptive technology.

3. Leadership

According to Christensen, companies in disruptive technologies needs to have a more focused leadership. For example, top management of a big company with $10 billion in revenue won’t be eager to invest required resources to the disruptive technology for an unproven opportunity with $2 million revenue currently.

However, smaller competitors will flock around disruptive technology and deliver more value to new niche markets and leave existing companies in the dust over time. Company size matters!

How to solve the dilemma?

Christensen suggests that existing companies should align their organization with the new disruptive technology by either spinning off an existing business unit with an independent leadership or simply building up a whole new organization. They also need to look at niche markets in order to identify potentially disruptive innovations and embrace them.

For startups building around disruptive technologies to be successful, they need to have the mind-set of making a difference in the world. This likely requires a unique culture and an exceptional leadership.

Large existing companies that are focusing on protecting their market share will have a hard time doing this. When it comes to disruptive innovation, it’s a good thing that the niche initial markets tend to be small. This gives them more time to fine-tune their technology. Many startups will continue to be surprised by larger competitors’ indifference.

A word of warning, and hope

The Innovator’s Dilemma delivers a key message of caution to great companies or current market leaders, but it also provides a message of encouragement for competitors venturing against these Goliaths.

Christensen explains why market leaders couldn’t afford to ignore innovations catering to niche markets while startups don’t need to worry about larger competitors. A small target market can be the beginning of something big.

(I think this last point is one that might be underappreciated. For example, the 2018-19 Hong Kong budget allots HKD$50 billion to developing innovations in the areas of biotechnology, AI, and fintech. The Secretary of Innovation and Technology said that even HKD$100 billion is not enough. But Elon Musk just used USD$165 million, less than HKD$1.3 billion, to found both Tesla and SpaceX!)

Undoubtedly, innovation and technology will continue to be economic drivers in the 21st century. The companies that can get it right will be long-lasting; the ones that fail will slowly lose their status.

As I hope I’ve made clear, I’d recommend The Innovator’s Dilemma to any long-term investor.

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