Why Can’t Incumbents Respond To Disruptive Innovation?

When a new entrant to a market develops an entirely new business model, we call it disruptive innovation. This business model radically changes the way that the industry had operated previously, focusing on different customer KPI’s and delivering services that customers didn’t even know they wanted.

Let’s look to Blockbuster, Netflix and Red Box as examples of this.

Blockbuster was a bricks and mortar store, with a mix of new releases and a limited selection of older, popular movies. When there was a new major release, the God Father for example, Blockbuster would have to buy thousands of copies and distribute them to their stores. After a couple of months, the demand for those movies would diminish, so Blockbuster would start to sell those DVDs at a highly discounted price, probably at a lower cost than they had purchased them.

Red Box released a vending machine that offered new release films. They placed them in stores, gas stations etc… They had far lower costs than Blockbuster, as they had no physical premises. They placed the vending machines in high footfall areas, leading to a high number of impulse buys. Something, Blockbuster simply could not achieve with static bricks and mortar stores.

Netflix focused on older, less popular movies. This meant that they had much lower costs than Blockbuster (as they weren’t paying for new releases). Those movies that Netflix held and Blockbuster did not, accounted for 21% of Netflix’s revenue – clearly, there was high demand for these movies across the country but not enough demand to consider stocking them in every Blockbuster location.

Netflix took the industry by storm when they started to offer their streaming service. To add a new movie to a completely digital service only incured marginal costs, so they could start to rapidly expand their library, far outpacing the growth that Blockbuster could manage.

As part of this offering, Netflix developed complex algorithms which could recommend movies to customers. So, why when Blockbuster finally got online could they not copy this? Because, as we discussed in the previous article, Netflix had the network effect.

Ultimately it was a combination of Red Box and Netflix that killed Blockbuster. Below are some of the reasons that companies like Blockbuster are unable to respond to such disruptive innovation.

Why do incumbent players struggle to respond to disruptive innovation?

There are a number of reasons for this.

Firstly, the initial response for most incumbents is to carry out traditional market research and focus groups. The major issue with this is that customers will give you minor suggestions to incrementally improve your offering, they’re not going to change the world and they’re not going to catapult your business back to the forefront of the market. Speaking to executives in a large company, I put it bluntly, ‘your customers don’t know what’s wrong with your business and they shouldn’t, the person that should, is you’.

Next, we have the resource allocation processes present in large, established companies. In order to invest, the executives expect to see sophisticated financial analysis to prove return on investment. This sounds like a sensible approach, but, bleeding edge technologies and new concepts don’t always have known monetary benefits. So, the risk adverse organisation opts for incremental improvement, rather than the major overhaul that cannot be quantified.

Then you have the fact that the incumbents fear cannibalising their own market. They fear the impact that launching online will have on their bricks and mortar business.

Finally, you have the mental lock-in. This is where the business is stuck in their ways. They’re used to working with a particular business model, it’s worked for many years, so why would they change? This is a very dangerous attitude – new technologies often have a fundamentally different business model. Failure to adapt will result in failure of the business.

So to put it simply, failure to respond is usually down to the fear of failure and the rigid processes that have been implemented through many years of success. For a company to truly succeed, maybe it’s wise to launch a small ‘spin off’ company, left to it’s own devices to test the market for the wider brand. That way, the original business model remains in tact, keeping nervous executives happy and the small spin off can have the flexibility that the incumbent should have had all along.

All I know is risk adverse strategies rarely pay off.