Clayton Christensen and the “4 Types of Innovation”

Innovation is a challenging topic to address: it can be really broad and difficult to navigate. Thankfully, Prof. Clayton Christensen from Harvard Business School has developed a really effective framework to help us simplify the subject.

According to Prof. Christensen, there are essentially 4 types of innovation:

1. New Product Innovation.
2. Sustaining Product Innovation.
3. Disruptive Innovation.
4. Efficiency Innovation.

Each type of innovation is usually liked to a different type of company or a different stage in the company’s growth. In this post, we’re going to discuss them all, and help you understand which one can be a better fit for your organisation. We’ve divided the article into different sections to help you find what you’re looking for right away. Enjoy!

1. New Products Innovation
2. Sustaining Product Innovation
3. Disruptive Innovation, Understanding Disruptive Innovation
4. Efficiency Innovation
5. Which Innovation to Pursue?
6. Choose the Right Metrics
7. Conclusions and Further Readings

1. New Products Innovation (JTBD)

This is the type of innovation which revolves around understanding what new products companies need to develop. Historically product development was grounded on Personas, or a marketing approach focusing on profiling consumers. However,  as discussed in this post, the Jobs to Be Done Theory is able to do a much better job at assisting entrepreneurs and businessmen more accurately predict where to drive innovation.

Jobs to Be Done postulates that people don’t simply buy products, they ‘hire’ them to get a job done. This job represents a problem or issue they need to solve in their lives that drives them to spend money and find a solution.

Even if the products that people hire to get their ‘jobs done’ can change at a fast pace, the jobs in themselves tend to stay the same for a very long amount of time. They are usually functional, social or emotional.

• Functional jobs, as in solving a material problem.
• Social jobs, as in owning goods which are indicative of social status.
• Emotional jobs, which provide us with particular emotional feedback, such as entertainment, excitement or thrill.

In this sense, Jobs to Be Done is a great tool to direct your research and development division towards the development of products that really help people solving problems which they may experience on a daily basis.

We explore JTBD in great detail in our blog, if you look at the bottom of this post you’ll find more resources that go into this topic in depth.

2. Sustaining Product Innovation

Once we have developed a product that does ‘the job’ well, what we need to do is improving on the product.

This type of innovation represents the most common form of innovation that happens around us. Sustaining Innovation is the typology of innovation that helps companies maintain healthy profit margins. New and innovative products cannot be developed easily, and unfortunately most of our efforts can go unrewarded whenever we are trying new things.  Companies cannot afford to come up with the ‘next big thing’ every year, and this is why, through sustaining innovation they can make successful products better and extend their product life cycle.

However – cynically speaking –  all these products do, is replacing older products with new ones, not creating any actual growth. This is why these first two typologies of innovation are not what you want to really shoot for. What you want to achieve is a type of innovation that forever changes the market by building a new ‘blue ocean’ of untapped market opportunities. What you want to find is a disruptive innovation, the innovation typology we are going to address in the next section of our post.

3. Disruptive Innovation

This is in fact, a type of innovation which actually creates growth, not only for your company but for the whole economy. To explain how disruptive innovation works, Prof. Clayton Christensen actually uses the image of three concentric circles. Circles represent audiences, or possible customers who are able to purchase your product or service.

The innermost circle represents customers who have the most money, the mid circle represents the upper class, the last circle represents more economically challenged individuals, which are unable to afford your business.

Disruptive innovation is the type of innovation that turns products which are initially available only to the first circle of individuals (the most wealthy), into products that become available to the other circles too.

Disruptive innovation, allows to identify technological breakthroughs that allow products that are very expensive to become accessible to wider and wider circles of the population. By broadening the market you are broadening your sales, and as a result you can scale your organisation to serve a wider and wider population.

Moreover, this innovation allows companies to compete against ‘non-consumption’, meaning that people who would not have been able to access that market before are now compelled to become consumers.

This is an incredible source of growth, which develops a lasting competitive advantage, as competitors will need to replicate your technological advancements successfully before being able to start competing with you.

Understanding Disruptive Innovation

So when contemplating which type of innovation to pursue, the following considerations can be made:

If one the one hand starting a business with sustaining innovation borders impossibility (because of the competition one would experience), on the other hand starting a business with disruptive innovation is much more doable.  This is because disruptive innovation amplifies the number of people who access a market, or industry, therefore creating growth, profits and a lasting competitive advantage.

Christensen analyses the impact of disruptive innovation on the competition with ‘The Innovator’s Dilemma’. This dilemma states that when a ‘disruptive’ company comes around, making products  -which have historically been very expensive- and turning them into affordable commodities to the wider public, all competitor companies have to face a big decision.

• On the one hand, they can keep doing what they are doing, retaining their premium market segment, making better cars, and selling their products to more wealthy customers for better margins.

• Or they can start competing on the disruptor’s market, by selling cheaper-to-make products, to a market that is not part of their marketing strategy, will very little margin.
  

The solution seems simple: go for the first alternative: keep your premium market.
Unfortunately, that’s wrong, if you leave your competitor unchallenged, it will build a larger consumer base, as it is able to go after new customer segments and eventually build the momentum that will lead to going after your premium market segment, putting you out of business.

Ok, this makes sense, but can a company who retains the high-end of the market, become a disruptor of a new wave of businesses?  Yes! This can happen, but it’s rare. Usually, technological advancements by young, agile companies are really difficult to counter by more established, slow firms.

4. Efficiency Innovation

This is the type of innovation which allows us to do more with less. This type of innovation is able to increase cash flow, but as a counterpoint efficiency tends to decrease jobs.

This type of innovation is what companies are going into through their processes of digitisation. In other words, apps, Saas businesses (software-as-a-service) and so forth are great examples of organisations who entered h market with a product that makes processes more efficient, by having the customer save time and money.

Now that we’ve reviewed each innovation model individually, we need to ask ourselves: which is the right innovation to pursue with my company? This is what we’re going to talk about in the next section of the article.

5. Which Innovation to Pursue?

Understanding these 4 types of innovation can assist us in understanding how companies can move from one innovation typology to the next in a chronological order which is aligned with the development stage of the firm.

Let’s look at each:

• Step 1. With Jobs to Be Done, your firm can understand what is the motivation that pushes consumers to buy new products. Understanding what is the ‘Job to Be Done’ allows us to put our product at the centre of the marketing strategy, by connecting it clearly with the benefits it will provide to customers.

• Step 2. With Disruptive Innovation,  you can make products accessible to more and more people. This is the step that allows your company to grow and create profits.  Disruptive innovation may take longer to become profitable, as it’s more asset-intensive, but nonetheless, it’s the one which grows the economy and leads to lasting competitive advantage.

• Step 3. Sustaining Innovation can help you build upon your technological advantage by making your product better.  With this innovation stage, your firm acquires sustainable profitable margins, increasing the quality and features of a product, while retaining a large consumer market.

• Step 4. Efficiency Innovations is the last stage of innovation as it is the one which allows us to cut costs and to streamline our services. This creates less economic growth but more capital return.

Hypothetically this would create a growth loop, but unfortunately, this does not happen.

The reason why business growth is hard to sustain is due to issues which Prof. Christensen blames on the world of finance. He is actually able to specifically pinpoint this to mainly two problems in finance:

• The Doctrine of Abundance and Scarcity, whereby we can waste things that are abundant and cheap, while we are very careful with the things that are scarce and expensive. This is relevant to innovation as the capital used to invest in companies used to be very costly and expensive, whereby now it’s more abundant and cheap, therefore investors tend to have low thresholds while assessing the actual impact of a startup business.

• The Measurement of Success in Ratios as opposed to whole numbers.  Historically, after the ‘creation of the spreadsheet’, analysts struggled when comparing companies in whole numbers. This was especially hard when companies varied in size. If, on the one hand comparing companies with ‘whole numbers’ didn’t make much sense, using ratios was much more effective. Ratios allowed to compare ‘like with like’ regardless of the size or market of a company to understand which investments made more financial sense.

Let’s look into one of these ratios in more detail in the next paragraph.

6. Choose the Right Metrics

Ratios are fractions, which have a numerator and a denominator. One of the ratios which are mostly used is called RONA or Return on Net Assets, another widely used ratio is the IRR internal rate of return.

RONA (net income/ fixed assets + net working capital) measures a company’s financial performance. The Net income is the money left in the company after operating expenses,  preferred stock and dividends are deducted. Fixed assets are a company’s long-term, tangible equipment or property used to produce the company’s products (real estate for instance). Net Working capital is a company’s assets minus its liabilities. 

The issue with the use of ratios is that at the beginning having ‘good ratios’ was the result of developing a healthy business, now the reasoning that entrepreneurs seek is inverted: businesses need to do everything they can to make sure they get the ratios they need in order to look healthy.

As a manager, if you want to take the RONA value up, then you have two options: either increasing the numerator or decreasing the denominator.  In other words, you could be more profitable, by being more innovative, so that I can focus on the innovation OR  you could just decrease the denominator, by outsourcing all assets. Either way, RONA goes up. As it’s easier to outsource and reduce costs than to make more profit in the pursuit of a high RONA, we may end up outsourcing more and stop innovating.

Let’s look into another example.

IRR (internal rate of return) is also a ratio: the numerator is profit, and the denominator (in simple terms) is how quickly I get my money out after I’ve put my money in.

In order to increase this value – instead of making more money – you could simply focus on short-term returns which pay sooner. In which case I’m only growing the company on paper and not in the real world.

But unfortunately, this strategy does not allow for disruptive innovation as disruptive companies take much longer to become profitable and pay off in 5 to 10 years.  As a result, short-term efficiency-driven firms are a much better fit for investors and end up attracting capital more easily.

If capital is invested in efficiency innovations, we are likely to get our money back sooner but this leads to a vicious circle whereby investment does not lead to actual growth, but to the creation of more capital. 

And money is a means, not an end.

As a result of the metrics that investors have chosen, businesses will lead to economies to flat-lining growth. This is because their metrics suggest investing in efficiency innovation, or in other words to use capital to create capital rather than to grow the economy.

So what metrics should we use? None of the ones that currently exist, because in terms of assessing success there is no one-size-fits-all approach. The best approach is to create our own. Innovation and entrepreneurship are fascinating topics, which we address in depth in our blog. At the end of the post, you’ll find other sources that can help you learn more, enjoy!