The customer rarely buys what the company thinks it's selling him

from Strategy Speaks: a Peppers and Rogers Blog by Don Peppers

Clayton Christensen classifies sustaining innovations as those that continue to improve a product or service, and move it up and up and up along the customer's need. Often, sustaining innovations achieve a quality far in excess of what most customers actually need, and as quality improves, price and margin improve as well. In fact, Christensen says, competition in sustaining innovations has a tendency to increase the price of the product (in contrast to the common economic wisdom that competition reduces prices). However, at some point below this level of high product quality and innovation, there are disruptive technologies that will always chip away at the higher end products.
He had a table showing different companies that had created innovative products at one time, then been successively replaced by cheaper products always moving up up up in this sustaining innovation trend. So disrupting technologies earn their place at the table at the low end - the simple end, the part of the product category that is either not served at all or very poorly served by the high-end products - and then they too migrate up and devour the incumbents. But soon another wave will come behind them. So General Motors had its business slowly eaten by Toyota, from the bottom up. And now Toyota, competing with Mercedes and BMW at the high end, is going to have its business eaten by Hyundai, and maybe Tata.
Now consider green energy: think about solar power. US and European govts have spent about $16b on this so far. But we have big problems - clouds, air conditioning, nighttime. Solar electricity has been 7 years away from cost-competitiveness for 30 years. So is there any hope for it? Christensen said his daughter was a missionary in Mongolia, and she took him into the capital city, and they happened on a bunch of vendors selling dirt-cheap solar panels, shrink-wrapped with rabbit-ear TVs. But the Mongolians are all NON consumers of electricity, so even this level of inconvenience is still infinitely preferable to non-consumption, right? There are 2 billion people in Asia who are non-consumers of electricity and among this population, solar energy is a booming business, with lots of cottage businesses meeting this need.
One of the other issues Christensen promised to cover was debunking what he called the "gospel of outsourcing."



He told a story about Flextronics, a company that supplied small circuit boards to Compaq. They did a reasonable job with these circuit boards, then Flextronics proposed doing the mother boards also, to both companies' benefit. Then Flextronics suggested they could assemble the computer as well, and so Compaq outsourced this to them, and improved their own margins even more. No more manufacturing OR assembly. Then Flextronics suggested they could manag Compaq's supply chain for them. They could handle the logistics and it would be another big savings. Compaq's revenues were unaffected, and their return on assets looked very good because they now had almost no assets! Then Flextronics said why don't we design computers for Compaq also, and so Compaq's analysts looked at it and realized this would be good, too! Compaq's revenues remained the same.
But the next step in the value chain didn't involve Compaq. Flextronics went to Best Buy and proposed that they could do the whole thing for them, provide very inexpensive new PCs for retail sale, and they don't need Compaq's brand, do they?
As you liquidate your business model, Christensen says, all that's really going on is you're pursuing profits. Lopping off the lowest margin product lines is always an attractive proposition. And the low-margin folks have to carry their model up market in pursuit of margins, also.
Where is this outsourcing happening?
• IT outsourcing to Tata and Infosys
• Auto companies outsourcing to Tier One suppliers (like Magna Corp in Canada, which we wrote about in our book Return on Customer). By the way, Magna is now one of the companies trying to acquire some Chrysler assets.
• Commercial banks outsource to State Street and to First Data
• Wall Street analysts are being outsourced to the Bloomberg terminal, as more and more analytical screens and tools are provided on that computer system
This looks inevitable and it's really the pursuit of profit that makes it inevitable.
Nevertheless, there are a few companies that have survived, and in every case they did it by setting up a separate operation and giving it a license to kill the parent. For instance, in department stores, the whole range of hard goods and soft goods were sold. There were 316 dept stores in America when Target, K-Mart and Wal-Mart attacked, driving the dept stores out of hard goods altogether, and dept stores were reduced to selling clothing and other soft goods.
Dayton Hudson was the ONLY dept store that made the transition successfully, by setting up a separate operating unit which operated as a discounter designed to destroy its parent. The Dayton-Hudson subsidiary operation was Target.
IBM caught the first disruption in their business, the minicomputer. But IBM went to Rochester and set up a completely separate operating unit at a lower margin, and then with the PC they went to Florida and set up yet another business operating at an even lower margin.
The problem, Christensen says, is that business units cannot evolve, just like single organisms can't. A population of organisms can evolve over time, but a single organism doesn't evolve by itself. The only way to evolve is to shut down one operation while opening others.
Marginal costs are also a villain threatening innovation. Big companies always have low marginal costs when they leverage what they have, whether it's Nucor leveraging its existing sheet-steel capacity rather than building a new mini-mill, or a company setting up a new sales force rather than piggy backing on the one they already have, or establishing a new brand. If we need different capabilities in the future to deal with an innovation, the marginal cost logic traps us in the past.
And, he says, in the NPV calculation, there is an inherent bias against innovation. The method of discounting always compares a projected cash flow against a base case. But this "do nothing" base case inevitably assumes the infinite preservation of the status quo, when what is really going to happen is that the base case will slowly but inexorably deteriorate.
Another theory about why companies don't innovate well has to do with how we segment markets. His theory is that focusing on the customer is not the right thing. If you're looking out at your market, you have to segment to see whom to sell which products to most appropriately. We innovate by slotting a new product into a particular product category believing it will compete with other products in that category segment, or we target it at a particular customer group.
But if you're the customer, that's not the way it appears. As a customer, you "hire" products to do certain tasks or jobs, and really you have to understand the job being done in order to innovate. [This would be what Martha and I call a needs-based analysis of customers.]
The customer is not the right unit of comparison for innovation, says Christensen, but the job your product is being hired to do is the right unit of comparison. He told a story about a company selling milkshakes which found some early morning commuters like very viscous milkshakes because they last for the whole drive, while a milkshake with a meal in the afternoon is made better not by more viscosity but by less, so it can be consumed with the meal itself.

Or, as Peter Drucker says "The customer rarely buys what the company thinks it's selling him."