This article was originally published on the Innovation Enterprise Channel.
Disruptions can be both threats and opportunities, and there are three fundamental ways companies can respond
Disruption is a fact of life in the tech sector today. While companies should invest in innovation to differentiate and attack new markets, they must also be prepared to respond to a disruption in their core markets from a new business model, potentially enabled by a new technology.
Disruptions can be both threats and opportunities1, and there are three fundamental ways companies can respond: ignore, fight, or embrace the change. Which response (or responses) a company selects should be based on what it believes about the nature of the disruption, its power to combat adoption, and its ability to successfully pivot its business model. This requires a comprehensive evaluation of the drivers of the disruption (e.g., the players, technology, business model), which customer segments are vulnerable, and the range of options available.
Not all disruptions are threatening. Choosing to ignore a disruption means continuing to operate the business as usual without changing any processes or products, while maintaining a watchful eye over any further industry changes. To choose this response, the company must believe:
– Disruption will not grow to significantly impact profitability (customers will not find the disruption’s value proposition compelling enough to switch, or the disruptor’s lower cost/pricing model will not exert pricing pressure on current products).
– Competitors will not embrace the disruption, thus discouraging adoption.
– Incremental profitability from fighting or embracing the disruption is not compelling versus the investment it would require.
A market incumbent can acknowledge the impact a disruption may have, but might not be ready to embrace it. Instead, the company can fight adoption of the disruption by trying to make it less attractive from an economic or technological perspective. An example is the hotel and taxi industries, which have aggressively lobbied for tougher regulations against booking networks, such as Uber and Airbnb, which have increased competition. Choosing to fight makes sense if the incumbent believes:
– The disruption could negatively impact revenue and profitability if left unchecked.
– It has the power to suppress adoption of the disruption.
– The incremental profitability from embracing the disruption is not compelling versus the investment required to fight it.
– Embracing the disruption is not possible due to limited assets, technology, capabilities, and resources.
There are many ways an incumbent can fight adoption of a disruption. The goal should be to minimize the disruption’s specific perceived value advantage and/or limit customers’ ability to select it. Strategies that include more than one approach are most successful:
– Launch bridge products built on core strengths that remove many of the gaps between current offerings and the challengers’ offerings.
– Offer favorable terms to lock existing customers into longer contracts in order to gain time to react with more competitive offerings.
– Shift competitive messaging to focus on capabilities where there is a clear advantage over the challenger.
– Adjust pricing models (or lower pricing) to make adopting the disruption less attractive to customers who are at risk of shifting.
– Lobby for new regulations that remove/limit the challenger’s ability to compete.
The software industry serves as an excellent example. When B2B cloud software began to gain traction, traditional on-premise software companies struggled1 to match economics enabled by subscription pricing of managed hardware and software. To slow the rate of deal losses, some on-premise companies responded by offering steeper license fee discounts, introducing subscription pricing for their traditional on-premise software, and offering favorable long-term renewal deals to existing customers. While they did not have the market power to stop the growth of cloud software, they were able to improve the economics to keep revenues growing, while developing cloud capabilities in parallel.
Embracing a disruption often means large investment for the incumbent company as it shifts its business to stay relevant in the new world. It will likely have to build new capabilities in parallel with running its legacy business. This is a big decision and should be embarked upon if it believes:
– The company doesn’t have the ability to successfully fight adoption of the disruption.
– Incremental profitability from embracing the disruption outweighs the cost of investment1 and/or the cost of fighting it.
– The management team has the ability to transform the company to succeed in the disrupted world.
Embracing a disruption implies some level of transformation, and management teams must consider balancing legacy operations and revenues with what it will take to succeed in the disrupted world. The key is to separate legacy and new to the degree that makes sense. Sometimes the incumbent can take a measured pace to adopting the disruption by introducing a new product line while maintaining legacy product families. This is particularly true when the incumbent has long-standing customers who will work with the company to transition on a multi-year journey. When faster change is required or there is a vast operational difference in delivering the new products versus legacy products, the better approach is often to stand-up a new business unit or acquire a challenger.
The underlying strategy of the response should:
– Allow the new team to ‘own’ the disruption and focus on developing winning strategies while allowing the legacy business to fight the disruption and capture as much economic value as possible.
– Create a brand that can communicate strong positioning around the disruption while the legacy business can communicate the continued ability to meet customer needs.
– Manage the businesses according to the metrics that make sense for the investment and revenue strategies, and compensate management teams accordingly.
– Continue to support legacy business in case disruption turns out to be more hype than reality.
– Give product management and development teams freedom to optimize offerings for their segments without having to make trade-offs that would make their offerings less compelling than their competitors’ offerings.
– Develop new partnerships even if they might create conflicts for the legacy business.
– Compensate sales teams on metrics appropriate for their respective products.
The decision to introduce a new product line within an existing business unit or to stand-up a new business unit should be informed by the degree to which there are overlapping elements (e.g., governance requirements, underlying technologies, product development organizations, etc.).
Incumbent companies that successfully develop a business to compete with a disruption often find that the legacy business can continue operating profitably for a number of years. During that time, the new business unit should communicate to legacy customers that it can help them migrate to the new world when they’re ready—through services, by the nature of their product line, etc. Eventually, management teams may decide that the legacy business should be discontinued or divested.
An example of a company embracing a disruption is Netflix, which disrupted the video rental market with its DVD mailing service, but soon found itself at risk of being marginalized by internet video rentals. To respond, Netflix acknowledged and embraced the shift towards online videos by developing a web streaming service. This was challenging because all of Netflix’s assets supported the mailing service (e.g., inventory, logistics, reservation system, etc.), and a streaming offering could significantly reduce the value of those investments. At first, the streaming service was included as part of the traditional mailing service plan, but eventually, the offerings were split, and Netflix acknowledged there would be cannibalization. DVD sales declined significantly, and today, the streaming service is considered Netflix’s core business.
BARRIERS TO RESPONSE
Companies facing industry disruptions oftentimes find their ability to respond hindered by internal factors, including assets that are optimized for the legacy model, inflexible pricing models, and conflicts of interest within the organization and even in customer accounts.
It is also critical that companies being disrupted not underestimate the challenger’s ability to be a viable threat. Sentiments similar to ‘we don’t compete with them’ have been group-think harbingers of doom to many companies that fail to recognize that the challenger’s unique value proposition might be valued more than its own.
ADJUSTING YOUR RESPONSE OVER TIME
As industries evolve, companies need to continually adjust their strategies and tactics1. The responses are not mutually exclusive. Oftentimes, an incumbent company’s best response to a disruption will change over time and can include more than one response type. When a disrupting technology first appears, it might be best for a company to ignore it. Only when the disruption has enough momentum should they consider fighting or embracing it. Even then, those two can be done in parallel with different business units.
There is no universal response strategy that will work in all industries and for all types of disruptions. In-depth analysis of the value drivers and projected impact of the disruption is required1, as is the careful evaluation of the universe of potential responses and the management team’s ability to execute them.