Disruptive Innovation and the Business Models That Make Them Successful06/22/21
The theory of disruptive technology was first introduced in 1995 by Clayton M. Christensen, a late American academic and business consultant, and Joseph L. Bower, Harvard Professor, in their Harvard Business Review article Disruptive Technologies: Catching the Wave. The term was used to describe technological innovations that significantly alter the way consumers, businesses or industries operate.
Christensen wrote more on the theory in his Wall Street Journal, Business Week and New York Times business bestseller, The Innovator's Dilemma. Written in 2011, this revolutionary business book forever changed corporate America by introducing the idea that companies can fail precisely because they do everything right. In it, Christensen explains how many successful companies are pushed aside by disruptive technologies because they fail to abandon traditional business practices and outdated business models; it's innovate or die; disrupt or get disrupted.
In his 2013 sequel, The Innovator's Solution, Christensen and Michael Raynor, director at Deloitte Services LP, expanded on the ideas from the first book and extrapolated on a new term, disruptive innovation. Disruptive innovation refers to any innovation that creates a new market by providing a different set of values, which ultimately and unexpectedly overtakes an existing market. One typical way innovation starts is when a disruptive market entrant introduces an inferior, yet inexpensive and accessible product or service to the market. Because larger companies often have a superior offering, they ignore the new entrants as competitors in their industry. As the innovation process unfolds, the disrupter increases their offering's value while still maintaining low cost and convenience, ultimately edging out the established companies, taking their market shares on the strength of a new business idea. Finding a new way to produce or deliver an existing product or service is the most common type of innovative disruption.
Examples of Disruptive Innovations
Our first example takes us back in time to the late 1800s when the first automobile was invented. Of course, the invention of the first automobile was exciting and did pave the way for future automotive innovation, but it was not immediately disruptive. The first cars were expensive and unattainable and therefore didn't disrupt the market for horse-drawn carriages right away. However, the invention of the assembly line and mass-produced automobiles in 1908 completely disrupted manufacturing, the transportation industry and life as people knew it — in the first year, 15.5 million factory-made vehicles were sold in the U.S. alone.
There are a lot of other examples of disruptive innovation throughout history — the invention of steel mini-mills, the transistor radio, and the LED lightbulb, to name a few. In the dot-com era, we saw an increase in disruptive companies and technological innovations.
The business model of Netflix is a great example of disruptive innovation. Netflix introduced its monthly DVD subscription service in 1997. For the low price of $8.99/month, Netflix customers could rent an unlimited number of DVDs. Netflix would mail out the DVDs, customers would watch at their leisure and then pop it in the convenient return envelope and send it back. A couple of days later, another DVD from their queue would be delivered by mail. It was inexpensive, easy and highly accessible but didn't have the same wide selection or instant gratification that its large-scale competitor, Blockbuster Video, could offer.
However, while Blockbuster wasn't paying attention, Netflix expanded their offering (allowing customers to rent more than one DVD at a time, for example) and experienced rapid growth. By 2002, Netflix was mailing about 190,000 discs a month to its more than 670,000 subscribers. In 2007, as bandwidth costs and data speeds were improving significantly, Netflix introduced their online streaming service, available on almost any device with an internet connection. Meanwhile, Blockbuster was still operating business as usual. By the time its executives realized they needed to innovate, it was too late. In 2010, Blockbuster filed for bankruptcy with more than $900 million in debt.
Netflix created a brand new market and radically transformed the entertainment industry, changing the way consumers view and interact with content. Today, people watch more movies at home than at the theater (even pre-COVID), more people are getting rid of cable and more people can watch content anywhere, anytime. Netflix paved the way for video streaming to become a multi-billion dollar market and arguably made a huge impact in consumer technologies as well by driving higher demand for smart TVs and other connected devices.
Another innovation that has caused great disruption in the last decade is the use of digital currencies like Bitcoin and Cardano. This disruptive innovation has bypassed the red tape of conventional banking with blockchain technology. Cryptocurrencies are capable of making money more digitized, dematerialized and democratized. Cryptocurrency and blockchain are disruptive innovations that can take money out of the bank's and government's hands and put it in people's hands. As news headlines have demonstrated, this disruption can also be exploited by criminals such as hackers who demand ransom payments in a digital currency like Bitcoin. Cryptocurrency is still in its infancy, but already it is disrupting the financial sector, especially the banking industry, and transforming the way we think about money and what constitutes a value chain.
Most technologies and innovations are not disruptive by default. Rather they require a disruptive business model to take the breakthrough to market and make it successful. Disruptive business models become vectors for change. However, even a traditional model can disrupt when a novel product is innovated. It often takes a long time from invention to widespread adoption. Mobile phones are a salient example of how ubiquitous uptake of a newly innovated product slowly followed the implementation of a conventional service structure. Instead of having one phone bill, many American adults who could afford a mobile phone opted to take on a second phone bill.
9 Important Types of Disruptive Business Models
Freemium Model - Freemium is the combination of "free" and "premium." The freemium business model refers to offerings that are free of charge to use but require consumers to pay a premium to unlock more advanced features. Skype is a great example of this disruptive model. Skype offers a free video calling service for anyone in the world. The first of its kind, Skype made it easier for people to connect with their family, friends and colleagues in all parts of the globe. For a low monthly fee, customers can upgrade to a premium account and get unlimited national and international phone calls and text messaging. Compared to a traditional telecommunication provider, Skype provides an easy, effective and low-cost way to communicate with almost anyone in the world. But being the first is no guarantee of long-term market dominance. In just the last couple of years, for example, Zoom has gobbled up much of Skype's market share by offering a more user-friendly video chat application.
Subscription Model - The subscription business model has become more prevalent as the internet has become more embedded in our everyday lives. This business model allows customers to pay a flat fee (typically monthly or yearly) for unlimited access to a service or product. Netflix is the perfect example of this operating model. Another great example is Amazon Prime. For a relatively low monthly or yearly fee, Amazon Prime members can order goods and have them delivered within a matter of days or sometimes hours. Amazon's disruptive model has completely changed the retail shopping landscape.
Free Offerings - The free offerings business model exemplified by Facebook and Google is becoming more popular. These services are free to users, so the providers don't make money via traditional means. Facebook and Google, for example, sell data to other companies for marketing and advertising purposes and serve personalized ads on their sites. Instead of getting paid by the customer, they get paid by the companies advertising on their platforms.
Marketplace Model - The marketplace business model connects buyers and sellers on a common platform. eBay was the first company to use this business model in 1995 and since then there have been many others that have joined in the rankings — dating sites, home-share sites, review sites and more. Marketplace models make money through combinations of commissions, transaction fees, memberships and advertising.
Sharing Economy or Access-Over-Ownership Model - Similar to the marketplace model, this peer-to-peer business model also connects people through an online platform to acquire or share access to goods or services. Airbnb is a classic example of a disruptor using this model. In the beginning, Airbnb offered a low-value solution for a low-value customer, enabling travelers to sleep on an air mattress in a host's living room for a fraction of the price of a hotel. As Airbnb expanded and improved the quality of its offering, it became more popular and more accessible. It became more appealing to high-value customers because of its safety precautions, high standards and peer-review feature. Airbnb revolutionized the travel and leisure industry by creating a new market for people looking for convenient, affordable, high-quality travel accommodations.
User Experience Premium - People don't just buy a Tesla or an iPhone, they buy the customer experience these brands offer. Both brands have a strong competitive advantage because they are highly focused on making the user experience easier, better and more innovative. And because of that, Tesla disrupted a segment of high-end, luxury sedans, which is an incredibly difficult market to penetrate. Tesla was able to bypass the dealer so that customers can have a superior buying experience either online or at one of their state-of-the-art showrooms. And the experience doesn't end there. As it proudly states on Tesla's website, the Model S "is an app on four wheels". The vehicle is connected to wifi and software updates are delivered automatically to the car. Because they are so focused on consumer centricity, Tesla has a growing community of loyal and passionate customers.
Pyramid Model - In this business model, the company will recruit a large number of affiliates or resellers who advertise their offering to boost traffic and sales. The affiliates get paid on a commission basis. Amazon Affiliate has successfully implemented one of the largest affiliate programs in the world. It helps content creators and bloggers monetize their traffic by linking their audience to their Amazon recommendations. If anyone uses that link to purchase the item, the affiliate makes a percentage. Especially with the prominence of social media influencers, the pyramid business model is highly attractive. It's a low-cost and easy way to increase traffic and sales.
Ecosystem Model - This disruptive business model is used by companies that sell a suite of interconnected and interdependent products that work best when they work together. Take Apple for example. Apple has the iPhone, the iPad, Mac laptops and desktops, the Apple Watch and AirPods. They also have iTunes, the App Store and Apple TV. All of these products sync up and work together to give consumers a seamless and connected experience. The same is true for Google with their suit of computers, phones, tablets and connected home products. This business model drives brand loyalty and brand dependency.
On-Demand Model - Time is money with this business model. Businesses that use this model take a commission from people with money but no time who pay for goods and services delivered by people with time but no money. A good example of this is Amazon Prime. Amazon Prime uses their own fleet of delivery vehicles, USPS, FedEx, UPS and Amazon "flex drivers" to deliver goods to customers in a matter of hours. Because it's easier and more convenient for consumers to get what they want and need, they're willing to pay a premium for on-demand delivery.
This is not a complete list of disruptive business models, but these have led to some of the biggest disruptions in the last two decades. As we progress into the Fourth Industrial Revolution, we will see the rise of even more disruptive companies and new technologies that will fundamentally alter the way we live, work and interact with the world.