You’ve
probably heard people compare the Fortune 500 from a few decades ago with today,
noting how fallen greats like Sears, American Motors, and Zenith Electronics have
been eclipsed by innovators. The reason seems clear enough. We’ve seen
considerable technological and regulatory change over the past 50 years, so the
rules of the game keep changing in business and there appears to be no end in
sight. In fact, globalization may even be accelerating the rate of change we
see around us.
For business leaders, these changes can be daunting. Companies routinely take their leadership teams off-site to discuss the challenges and opportunities implied by the latest innovations. How will augmented reality affect the gaming market? How will mesh computing affect the financial technology space? How will the internet of things affect, well, everything? The idea seems to be that if we can forecast future technology, we will be more likely to survive or even prosper from the changes to come.
For business leaders, these changes can be daunting. Companies routinely take their leadership teams off-site to discuss the challenges and opportunities implied by the latest innovations. How will augmented reality affect the gaming market? How will mesh computing affect the financial technology space? How will the internet of things affect, well, everything? The idea seems to be that if we can forecast future technology, we will be more likely to survive or even prosper from the changes to come.
Not
so. It turns out that often the very technologies that seem to have upended the
great firms of the past were well understood, and sometimes even created, by
those very firms: the Swiss invented quartz watches; Kodak invented the digital
camera; Sears was a pioneer in inventory and brand management; and the list
goes on. A number of different theories have been proposed to explain this
puzzle. This note briefly summarizes a few of the major theories, and offers a
way that business leaders can constructively think about leading amidst change.
Discontinuous
Innovation Theory
As
early as the 1960s, writers on technology management distinguished between
continuous and discontinuous technological changes (albeit using various terms
for the same idea). Continuous, incremental advances happen all the time,
gradually improving the state of a given technology. Such changes are typically
straightforward for existing firms to accommodate. Discontinuous changes, by
contrast, represent a radically different approach to a technology, and often
bring about an order-of-magnitude improvement in performance. For instance,
adding functionality to an old-style “feature phone” would be a continuous
innovation, while the invention of the smart phone could be seen as a
discontinuous innovation.
This
idea has appeared in hundreds of published academic articles since the 1960s,
but its implications for business leadership were best explained in a classic
article by Professors Michael Tushman and Phillip Anderson.[1]
The breakthrough in Tushman and Anderson’s study was to note a key distinction
between different types of discontinuous innovations. Some of these changes,
while quite significant in technological terms, build nicely on the
capabilities of existing firms. Such “competence enhancing” discontinuities
retrench the status quo, giving incumbents even more of an advantage over new,
upstart organizations. By contrast, other discontinuities render irrelevant, or
even counter-productive, the capabilities of existing firms. These “competence
destroying” discontinuities are difficult for industry incumbents to employ
profitably, since by doing so they harm their existing operations. For that
reason, such changes are more likely to be brought to market by new entrants to
a business.
Using
discontinuous innovation theory as her lens, a business leader will pay
attention to how new technologies either enhance or destroy the value of her
firm’s existing capabilities. For example, consider the iconic case of the Bank
of America confronted by new innovations in electronic funds transfer
technology. This technology would be at the heart of many new innovations in
retail banking, including the spread of distributed networks of ATM machines.
Prior to this discontinuous change, the Bank of America was the unparalleled
leader in geographically distributed retail banking, operating a massive
brick-and-mortar branch system across California’s 900 miles and hundreds of
cities. Decades of experience honed the bank’s capabilities, as it daily
cleared millions of paper transactions into its system regardless of where they
originated across the state. With over 2,500 branches, the bank had a branch in
every town in that state, and so attracted customers wanting convenient access
to their accounts. The spread of ATM machines dramatically reduced the unique
value of this system, making widespread geographic access to bank accounts
commonplace. Although ATM technology was embraced by Bank of America, its
competitive standing clearly was set back in the new era. By the late 1980s,
the bank saw record losses in part due to its outdated brick-and-mortar system
– the very system that had been key to its competitive advantage – and so it
laid off tens of thousands of employees, closed branches, and consolidated
functions into regional centers. In this way, electronic funds transfer
technology can be understood as a competence destroying discontinuity from the
perspective of incumbent banks in the era of brick-and-mortar branching.
Structural
Inertia Theory
Large,
well-established organizations are notoriously difficult to change. The leading
theory to explain this fact is known as “structural inertia theory,” pioneered
by sociologists Michael T. Hannan and John Freeman in their seminal 1984 article[2],
and since then supported and developed by a large body of research.[3] In
this theory, the authors assume that modern society favors the creation and
development of organizations that perform reliably and that can account for
their actions rationally. Further, they assume that accountability and
reliability are greater for organizations that have reproducible structures –
meaning routinized, bureaucratic structures. Finally, they assume that such
structures are more difficult to quickly change, that is, more inert. These
premises lead them to the essence of their theory: Modern society favors the
development of inert organizations.
Hannan
and Freeman further argue that when inert organizations do change, these
changes are hazardous to their performance and their life chances. Especially
as they age, grow, and become complex, increasing inertia renders attempts to
change difficult and fraught with risk. If the organization survives the
change, it may be better off – at least as long as the change keeps pace with
the demands of the environment. Stated in terms of a large-scale strategic
change, this basic prediction is illustrated below:
Structural-Inertia
Theory:
The
Effect of Change at time T1 on Organizational Performance
In
this illustration, an organization makes a large scale strategic and
organizational change as of time T1, and as a result suffers a
dramatic decrease in performance. (In fact, Hannan and Freeman state this
prediction in terms of the organization’s likelihood of outright failure.) But
over time, if the organization does survive, its performance improves. And, if
the organization’s new strategy is better aligned to its situation, then its
performance may even be better than at the start of the ordeal.
The
evidence suggests that two distinct effects can be usefully separated when
looking at this theory empirically.[4]
The initial decrease in performance has been widely documented, and can be
thought of as the “process effect” of change. This effect captures the various
difficulties that come up as large-system changes cascade through an
organization, creating various misalignments along the way. As these
difficulties are worked out, eventually the organization reaps the “content
effect” of the change – the improvement in performance due to the new strategy
being better aligned with the environment.
Structural
inertia theory highlights a problem inherent to strategic leadership. If
leadership does a good job aligning the different aspects of organization and
strategy, then changing that complex, aligned system will be especially
difficult. And even if leadership does manage to change that system, the
consequential drop in performance is likely to be extreme. Looking again at the
Bank of America example, many pundits criticized the company for taking so long
to shift away from the earlier strategy and structure centered on
brick-and-mortar branches, skilled loan officers in every location, and
decentralization to allow for extreme localization. Only after nearly failing did
the bank’s leadership manage to break with that strategy and structure. Yet,
when seen through the lens of structural inertia theory, this resistance to
change is precisely what one would expect from such a well-managed
organization. Years of fine tuning had created a complex organization including
various, well-aligned features that made the bank particularly good at
geographic localization. In this way, the difficulties involved with changing
Bank of America were more a measure of its excellence than an indictment –
albeit excellence that had become outdated. And this example suggests a caution
to business leaders: Your good work aligning your strategy and organization
today is precisely what will make changing that strategy so difficult and
hazardous tomorrow.
Disruption
Theory
By
far the most popular theory of strategic and organizational change these days
is disruption theory, developed by Professor Clay Christensen and his
colleagues beginning with its introduction in 1995.[5]
The theory restricts its attention to change involving technologies and
innovations, and assumes a market context with differentiation between a
low-end of the market, a mainstream market, and a high-end. The product
performance, expectations of customers for product performance, willingness to
pay for performance, and potential for profitability are all assumed to be low
at the low end, middling for the mainstream, and high at the high end.
Incumbent firms are assumed to use a well-established technology and focus on
the mainstream market. Over time, they are assumed to improve their
technologies gradually in an attempt to serve the high-end of the market, where
profitability is greatest. In so doing, they are assumed to “overshoot” the
needs of the low end and middle of the market. Furthermore, focusing on
profitability, they are assumed to largely ignore the low-end of the market.
Under
these assumptions, new entrants can enter with completely different
technologies. These technologies assumedly will not initially perform as well
as the established technologies used by incumbents, but they are good enough to
give the new entrant a foothold market: either serving the underserved low-end
of the market, or serving previously unserved “non-consumers” in a new-market
foothold. Incumbent firms, meanwhile, pay no attention to the new entrant,
because they are serving different customers. As time passes, however, the new
entrant’s technology improves greatly, ultimately moving the firm into the
mainstream and high-end of the market. At that point the new firm gains an
advantage over the incumbent, often because the new firm’s technologies are
part of a business model that is incompatible and superior to that of the
incumbent.
Disruption
theory is extremely popular, and this popularity leads to some problems for the
theory’s use. For many business leaders, especially in information technology
businesses, the pattern described by Christensen and his colleagues reflects
their context well. For these leaders the theory is useful – at least if they
can spot potential disruptors while still in the “foothold” stage. (A theory is
not helpful if you must wait until you see a success to then identify it.) In
many other instances, however, the term “disruption” is widely used to mean any
change that has a big effect on business regardless of whether the change
resembles that addressed by the theory. In these instances, the theory will not
apply and in fact could be misleading. Christensen and his colleagues have
recently voiced concern about this. In a recent article, they explain that many
big, important business changes are not disruption as the theory defines it.[6]
Uber, they note, is not a disruptor (based on their understanding of Uber).
For
business leaders, the lens of disruption theory directs attention to those
start-ups just getting a foothold either in a new market segment or in an
underserved low end of an existing market. And the theory helps to evaluate
these new entrants not on the basis of how well their technology performs when
it starts out, but rather in terms of its potential to become disruptive as it
improves over time. To some extent, the theory also directs attention to the
new business models that often accompany such start-ups.
Leading
Amidst Change
For
you as a business leader, all three of these theoretical perspectives direct
attention, first and foremost, to what makes your organization compete well.
Discontinuous innovation theory highlights the importance of knowing the
capabilities that give your organization a strategic advantage, and how a given
technological change affects the value of those capabilities. Structural
inertia theory directs your attention to the complexity and intricacy of your
organization in order to understand the cascade of misalignments that moving to
a new strategy will trigger – if even temporarily. And, for some, disruption
theory directs your attention to potential threats that, while benign in their
infancy, have the chance to mature into something strategically significant.
One
way to sum up these implications is to note that they draw attention to the
importance of strategy, and in particular to the logic of your firm’s strategy. Big changes that leave the logic of
your strategy intact are not a threat. Discontinuous innovation theory calls
such changes “enabling.” Structural inertia theory notes that such changes do
not require a fundamental alterations to your organization. And disruption
theory would say that such changes are not likely to be problematic for you as
an incumbent. But when a change threatens the logic of your firm’s strategy, it
is time to act. The changes you set in motion will be difficult and costly for
your organization, especially if you have done a good job aligning your
strategy and organization around a clear and compelling logic. But the
alternative is to become yet another example in the failure lexicon of business
school professors.
What’s
more, looking to see how changes affect your strategy’s logic gives you a way
to identify and diagnose what matters
before your performance suffers. As a leader, you do not have the luxury of
waiting until changes play themselves out. You must make the call early on in
the game, while there is still a chance to affect the outcome. Going back to
the Bank of America, the logic of their branch strategy was crystal clear, even
as technological changes were afoot that would threaten that logic. Had their
leadership honestly reviewed how those changes were likely to affect the bank’s
strategic logic, steps could have been taken long before red ink ultimately
drove action. This lesson applies to every business leader. The logic of your
strategy can be identified today, as can the implications of the changes you
see around you for that logic. Use your strategy’s logic as the lens through
which you understand and manage change.
[1] Tushman, Michael L. and Philip
Anderson. 1986. “Technological Discontinuities and Organizational
Environments.” Administrative Science Quarterly, 31: 439-465.
[2] Hannan, Michael T. and John Freeman.
1984. “Structural Inertia and Organizational Change.” American Sociological Review, 49: 149-164.
[3] Carroll, Glenn R. and Michael T.
Hannan. 2000. The Demography of
Corporations and Industry. Princeton: Princeton University Press.
[4] Barnett, William P. and Glenn R. Carroll.
1995. “Modeling Internal Organizational Change.” Annual Review of Sociology, 21:217-236.
[5] Bower, Joseph L. and Clayton M.
Christensen. 1995. “Disruptive Technologies: Catching the Wave.” Harvard Business Review, Jan-Feb.
[6] Christensen, Clayton M., Michael E.
Raynor, and Rory McDonald. 2015. “What Is Disruptive Innovation?” Harvard Business Review, December.