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Four Reasons Today's Disruptive Innovations Are Better And Cheaper, And What To Do About It

March 2016

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The distinguishing feature of a Big Bang Disruption, one that seemingly comes out of nowhere and devastates incumbents, is that it enters the market both better and cheaper than the products and services with which it competes, and sometimes those it doesn’t even consider competitors.

Consider how Google and Apple more or less eliminated the market for standalone GPS navigation products from established providers including Garman, TomTom and Magellan. By putting better and more integrated map functions into smartphone apps, they were able to offer this service not for hundreds of dollars but for free.

What made free an achievable price? It was actually several technology trends that came together at once that permitted it. One was the exploding volume of smartphone ownership, saving the app providers the cost of delivering a technology platform. The displays, antennas and other key components of the phones were dramatically improving at the same time their costs were being driven down, making personal ownership cheap and pervasive. The consumers and network providers were absorbing the sunk costs of the smartphone platform and network.

Further, Google and Apple had already developed mapping and location technology for other applications, and were piggy-backing them like everyone else on GPS data from government satellites.  So, as with all software, manufacturing and distribution of the app generated virtually no costs at all, at least not for Google and Apple.

The navigation service also provided Google with more opportunities to integrate information and advertising, its core source of revenue. And it helped Apple maintain a premium price for its phones. In both cases, the standalone GPS market they disrupted wasn’t the intended victim—they were simply collateral damage.

Charging nothing for a valuable product was not an act of charity for the companies, then, but instead part of a long-term business strategy based on predictable technology trends. Navigation services were an obvious and low-cost extension to existing information services the companies and their partners were already delivering.

The pace of this new and dangerous form of disruptive innovation—higher value offerings at lower cost—is rapidly increasing. As the navigation example shows, that acceleration is being driven by at least four closely-related trends that are worth exploring in detail:

  • Price Deflation—The continuing and predictable decline in the price of core technologies, not only in computing, and the decline in related costs that that drives;
  • Platform Exploitation—The increasing ability to use spare capacity on existing infrastructures like smartphones, security cameras, cloud-based software services, etc.;
  • Cross-Subsidization— Increasing opportunities to supplement revenue through other sources, such as advertising and the sale of business insights from so-called “big data,” allowing producers to offer them very cheap or even for free; and
  • Marginal-Cost Elimination – The growing number of products and surfaces susceptible to the power of zero digital production costs, making it possible to offer products and services with very low marginal costs at very low prices.

Our on-going research into Big Bang Disruption suggests these four economic trends are converging to create an epidemic of products and services that are better and cheaper, displacing competitors virtually–and sometimes literally–overnight. For incumbents and entrepreneurs alike, understanding both the source and interaction of these trends is crucial, not just to surviving Big Bang Disruption, but to harnessing its power for competitive advantage.

Start-ups, unencumbered by the costs of amortizing investments in older technologies, physical supply chains, and legacy products and customers, reflexively adapt to the opportunities being created by these trends. They can launch a constant stream of better and cheaper disruptors, risking relatively little in the quest to construct one that will take off with a big bang.

Incumbents also have the opportunity to exploit these trends. But doing so requires a dramatically new approach to strategy and execution, one that few senior executives are emotionally prepared to embrace. They are too tied, like their balance sheets, to the value of today’s physical assets, many of which can quickly flip to the liabilities column. And they are often committed to a closed, proprietary model of research and development that cuts them off from the latest technologies and leaner methods of prototyping and product launch.

That will need to change, and fast. These trends are almost certain both to accelerate in pace and expand in influence for at least the next decade. They have already begun to spread well beyond information-intensive industries such as consumer electronics and financial services, into industries that had long been protected from digital disruption such as manufacturing, agriculture, transportation and education.

The Four Economic Trends

  1. Price Deflation

Prices have been falling for many products for decades. Some of the decline stems from broad improvements in business operations, driven by the improvement and declining cost of technology. Moore’s Law—which predicts that computing and related costs will drop by 50% every 12 to 18 months—is at the root of lower costs for many products. But something radically new is now afoot.

Today, the costs of production and innovation are falling at the same time.

In everything from health-tracking devices to 3D printers and drones, the impact of Moore’s Law has only just begun to wreak its disruptive potential. Sensors, gyroscopes, accelerometers, radios, magnetometers, commodity processors and other micro-electro-mechanical systems (MEMS) can now be sourced globally at steeply falling prices, driven largely by the cooling of demand for the smartphones and tablets they were originally created for. Thanks to new levels of supply chain visibility and modularity, these components can be easily designed into new disruptors in industries that have, until now, been largely immune to the information revolution.

Deflation in the price of core technology components goes far beyond Moore’s Law, though. Thanks in part to improvements in information technologies generally, exponential improvements in price and performance are also now being seen in other commodity technologies, including lighting, materials, energy storage, nanotechnology, biotechnology, imaging and genetic sequencing.

Graphene, a one-atom thick sheet of carbon that has exhibited profound conductivity and strength, is now being made in quantities large enough to begin serious experimentation. A complete sequencing of a person’s DNA has fallen in price from $3 billion a decade ago to less than $1,000 today. In displays, HD LED is being replaced by 4K OLED displays, which improve the number of pixels by another factor of four and makes possible curved displays. All the while, the price of displays predictably declines.

What do falling production and innovation costs mean for industries? Consider the automotive industry, where despite countless innovations the average real dollar selling price of a car has been declining for decades.

  1. Platform Exploitation

A second important trend is the rise of technology platforms. Platforms allow businesses to develop, make and distribute new products and services at a fraction of the cost of traditional R&D and delivery.

Better-and-cheaper Big Bang Disruptors are being launched on robust hardware and software platforms featuring cloud-based computing and storage, mobile broadband networks and app-based tools. Apps that piggyback on existing cell phones, security camera networks, and the emerging Internet of Things, for example, can be sold at the cost of just the additional investment required to develop a new combination of existing components.

The value of using a platform built and paid for by others is obvious. Releasing new products on digital platforms not only lowers the cost of manufacturing and distribution, it also gives disruptors immediate access to millions (and soon billions) of users and devices. It also aids inactivating the social networks that can drive rapid product adoption for new offerings that consumers find compelling.

Many smartphone-based apps, for example, have rapidly made obsolete all manner of standalone electronics and analog products. The smartphone has become your boarding pass and train ticket, and will soon become your smart key at home and away. It may also replace much of what is still in your wallet, including cash and credit cards.

The fallout from this change can land on many an unintended victim. Consider the impact on alkaline battery manufacturers. Though still a multi-billion dollar business, battery sales fell four percent in 2014 alone, making batteries the worst performer among the top twenty-five categories of household products. Procter & Gamble, which owns Duracell, plans to spin off the division next year; Energizer Holdings is moving its vulnerable household-products into a separate business.

And it’s not just in consumer electronics that the impact is being felt. In agriculture, another kind of digital platform is emerging, as better and cheaper drone aircraft (whose parts largely come from mobile phone component producers) are giving rise to what is known as precision agriculture. This new platform is being built on autonomous tractors, GPS-based harvesters, wireless networks and sensors that report in real-time on soil condition, hydration, nutrients, weather conditions and pests.

In the energy market, the emerging platform is known as the “smart grid.” In Denmark, the government is pushing a smart grid strategy that will include deployment of smart meters, real-time monitoring of energy use and variable rates driven by high-volume data analysis. Eventually, the smart grid platform will balance demand and automatically create price incentives to encourage efficient energy use. And it will curb waste by identifying failing and inefficient devices.

  1. Cross-Subsidization

Goods and services can be sold cheap—and sometimes even given away for free—when their cost is being paid for, in part or in full, out of the revenues of a different business. Google can provide many of its services at no charge, for example, because the company can sell advertising and related marketing services through its core offering, online search.

The company’s search-based advertising revenues have in turn funded not just better search technology, but hundreds of subsidiary products including video hosting (YouTube), maps, photo management (Picasa), mobile device operating systems (Android), travel, office productivity tools, cloud storage, and much more.

In most of these examples, Google had no particular interest in disrupting or even competing with the travel agents, navigation device makers, and paid video and music providers that once sold those services. Google’s attention was instead focused on assembling world’s greatest collection of reusable information assets. Google’s strategy is being duplicated by many information-intensive disruptors, including most social networking companies such as Facebook, Twitter, and Instagram.

Some companies are also succeeding with another form of cross-subsidization: selling insights derived from large databases. Google draws on a massive number of customer interactions to improve its products, making, for example, its search and navigation databases and algorithms even better.

As the consumer experience improves, the user base continues to grow. Google can then refine its pricing model for advertisers, charging higher premiums for its larger base of customers and for its data-driven insights about those customers. In effect, the cross-subsidized offering, like free Google Maps, becomes a kind of perpetual motion machine, driving further innovation and spreading the often unintended disruption of incumbents farther afield.

Still, it must be noted that subsidization based big-data insights only works when the data comes from public sources of information, or from information that can be licensed for free or at very little cost.

Consider the problem faced by music services such as Pandora. Like Google, Pandora can increase its ad revenue and refine its music recommendation services by engaging more users, pushing the company to continue subsidizing its core product. And as mobile broadband networks become better and cheaper, consumers are likely to increasingly prefer “renting” music from companies like Pandora, rather than owning it in the form of CDs or mp3s.

But at the heart of Pandora’s strategy is a ticking time bomb. The music it provides to consumers is licensed on a use-based model. Estimates are that for every million songs listened to by users, the company must pay licensing fees of about $1,500. That means the more consumers they sign up and the more each customer uses the service, the more fees Pandora pays.

Pandora makes nearly all of its revenue by advertising to listeners who sign up for the free service—so rising licensing fees for the music itself are causing the company to lose money. As things stand now, the more successful the company’s subsidization strategy, the faster it goes into the red.

  1. Marginal-Cost Elimination

Many goods and services cannot be exhausted through use or replication. This is true of most information goods. These might be thought of as the ultimate “sustainable” goods, in that heavier consumption does not require additional resources, nor does it exhaust supply. But it is not easy to make a profit on goods or services that cost nothing to make. Finding enough users willing to pay enough even to cover modest operating costs is challenging. And it puts incumbents holding debt for sunk costs in production assets at a distinct disadvantage.

Newspapers have been victims of this phenomenon, in some cases contributing to their own demise by offering digital versions of their content and allowing consumers to unbundle it, choosing the parts they like (the news) and ignoring the parts that paid the bills (the classifieds). While digital competitors with zero marginal costs experimented with alternate revenue models, the newspapers, with one foot still in the analog world, fell into a whirlpool of accelerating disruption.

The trend is now expanding to disrupt professional services, as the more mundane work of expensive human experts is being replaced by much cheaper digital alternatives. These new applications can perform increasingly sophisticated and repeatable tasks—reading X-rays, for example—at a marginal price at or close to zero.

In financial services, Intuit’s TurboTax software collects the same interview information as a human tax preparer, but then automatically generates the return. As the product’s users have grown into the millions, the company improves the product by observing the most frequent areas where customers rely on Intuit’s human backstop of tax advisors and then programs that knowledge into future releases. Software that learns can replace more functions currently assigned to human labor, erasing marginal cost as it moves up the evolutionary ladder toward true artificial intelligence.

A similar phenomenon is now beginning to transform the $200 billion market for legal services, stealing the low-end work done by lawyers and, at the same time, offering legal advice to many consumers who simply couldn’t afford the high-cost human alternative. Startups including LegalZoom, Shake, and Rocket Lawyer have already automated the easiest tasks, such as the creation of simple contracts and estate planning documents. Some of the services connect users to real lawyers for help preparing documents the software can’t do—yet.

Are You Ready?

Better and cheaper products undermine a hoary myth about disruptive innovation. In the work of Harvard’s Clayton Christensen, incumbents are told that disruptive products and services based on new technologies enter the market cheaper but worse (usually much worse)—meaning the vast majority of existing customers aren’t likely to see them as reasonable substitutes at any price.

The “innovator’s dilemma” that Christensen identified was that incumbents are likely to simply ignore these inferior offerings. Instead, he argued, they should see them as the warning signs of future disruption. As the price and performance of the disruptors quickly improves, Christensen noted, their trajectory eventually overcomes the old technology of the incumbents, at which point significant numbers of existing customers begin to peel off.

Christensen’s advice is to watch for such disruptors emerging in markets that are usually too small to be of interest to incumbents. Once they begin their march upward in performance, he said, the incumbents need to begin their own process of self-disruption, starting internal skunkworks to develop new products that integrate the disruptive technology once it reaches an acceptable level of performance

That advice, however, has become downright dangerous for at least two important reasons. One, as the navigation example reveals, is that the disruptor may come from so far outside the universe of existing and potential competitors that incumbents may not see it at all, or at least not see it as a potential disruptor.

The second and more deadly problem for incumbents is that when the disruptor enters both better and cheaper, there’s no longer time to develop a strategic response. The navigation apps reached millions of consumers within a matter of months. As the incumbents slept, the disruptors sucked the oxygen out of the market for GPS devices.

If incumbents don’t spot the emergence of disruptive technologies before someone turns them into a compelling offering and respond quickly either by building their own or buying the start-ups experimenting with them, there’s little chance of surviving better and cheaper. Following Christensen’s advice simply replaces one form of dangerous complacency with another, potentially even more tragic version.

Since the publication of our Big Bang Disruption book, we have continued to see the emergence of better and cheaper products that quickly disrupt existing markets even as they create and dominate new ones. The better and cheaper phenomenon is now driving industry transformation in manufacturing (3D printing), transportation (autonomous vehicles and smart roads), energy (smart homes, hydrogen fuel cells), consumer products (the Internet of Things), health care (genetic sequencing), lighting (programmable LEDs), aviation (drones) and more.

In India, for example, U.S.-educated entrepreneur Kanav Kahol is working to overcome the complacency of techno-phobic health care providers to develop better and cheaper diagnostic tools for a wide range of conditions. Using off-the-shelf computing products and increasingly faster, cheaper, and smaller sensors, he built a prototype tablet device he calls the Swasthya Slate, which performs over 30 diagnostic tests and is expected to cost $150 per unit when produced in volume.

In pilot uses in India, the Swasthya has been proven to improve health outcomes for populations that couldn’t afford many of the diagnostic tests it performs even when existing technologies were available, which they almost never were. The device can also be used remotely and by users with far less expertise than existing specialty technologies. At $150 per unit, it is the kind of better and cheaper disruptor that not only provides a solution to underserved markets, but could easily and quickly displace the more expensive and harder-to-use products available today costing tens of thousands of dollars.

As you evaluate the impact of better and cheaper disruptors on your own business, here are some useful questions to consider:

  • What is the trend for the real (inflation-adjusted) price of the goods and service you offer? What has it been in your industry?
  • What physical production assets do your offerings rely on? Can they be replaced with digital alternatives? Or are they even necessary any longer in any form?
  • At what point could your product or service become so cheap that others might simply give it away to support their own strategic aims?
  • What do you sell that has little marginal cost, making it easy to sell again? Who else owns or invests in these information assets who might undercut your sales?

Today’s technology trends are conditioning buyers to look for greatly improved levels of value at prices even lower than they have paid in the past. Under these conditions, every company needs a strategy focused on offerings that are better and cheaper.

 

This article was written by Paul Nunes and Larry Downes from Forbes. This reprint is supplied by BNY Mellon under license from NewsCred, Inc.  

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