• Rahul Rao

David and Goliath

by Rahul Rao, Varun Rao and Yasir Aheer


Summary:

  • History is littered with the remains of giant companies that were upstaged by smaller players. How do these large, successful companies with all their resources fail to adapt to a changing world?

  • Clayton Christensen’s Theory of Disruption provides a lens with which to view these disruptive transitions. When viewed through this lens, the behaviours of the incumbents and the new entrants follow a distinct pattern.

  • Several real world examples of disruption are playing out around us right now. Can you pick the winners and the losers?

Sometimes Goliaths fall. Despite healthy cash flow, best-of-breed business practices and intelligent, hard-working managers and employees, the biggest businesses have been driven out of the market by one of many Davids with their slingshots of new technology. How do the Goliaths of this world, with their endless resources and entrenched status in the market, permit even a foothold for David? In this article, we explore the fall of Goliath and the ascendance of David.


We open with the story of Blockbuster and the internet. Many of our readers will have heard of Blockbuster, but few will have actually visited a store, despite Blockbuster having become the top movie rental business in the US. Blockbuster first opened its doors in 1985 and rapidly expanded to a USD 5 billion business with 9000 global stores and 60,000 employees.


In 1997, the launch of Netflix allowed customers to order movies online and receive DVDs in the post. The convenience of ordering a movie from home appealed to a small fraction of Blockbuster’s customers over the immediacy of picking up a movie at a store. Blockbuster chose to not target this tiny portion of the market and instead focus their efforts on the much larger segment of in-store customers.


Meanwhile, things were changing for companies that did business through the internet, particularly where multimedia was concerned. Internet bandwidths had been (and still are) growing at roughly 50% per year from the 80s onwards, adding to the complexity of the underlying infrastructure as we have previously explored. This opened the door to video streaming, a technology Netflix was in pole position to exploit, given its online-only nature. In 2007, Netflix introduced a video-on-demand service, which, in retrospect, was the beginning of the end for Blockbuster.


The rest is history. Netflix grew to be a global giant of media distribution. In April 2018, it was worth more than Disney. At the time of writing, their market capitalisation is hovering north of USD 220 billion. Blockbuster shuttered all of its 9000 stores bar one - the sole remaining store at Bend, Oregon (pictured below) is now listed on AirBnB for USD 3.99 a night.


The last remaining Blockbuster at Bend, Oregon is now a movie-themed AirBnB (source: AirBnb.com)


This transition makes complete sense when viewed through the lens of the Theory of Disruption, first postulated in 1997 by the late Clayton Christensen, a professor of Harvard Business School. This theory has since been a mainstay of disruptive thought and has described the journey of many industries through disruptive periods.


Although the theory has since been updated to include one extra type of innovation, this article discusses the two described in the book - revolutionary (disruptive) and evolutionary (sustaining).


Well-established firms are fully incentivised to keep their most profitable customers happy with incremental improvements on their current technology; they are therefore at the forefront of evolutionary innovation.


Newcomers to the field, on the other hand, struggle to corner market share using fundamentally the same technology as incumbents - they lack the pedigree and the contacts to do so. Instead they must focus on providing the low end of the market with lower cost solutions than the incumbents with revolutionary innovation.


Incumbents are happy to cede the low end, low margin part of the market to upstarts so they can concentrate on the medium to high end of the market where margins are higher. What’s wrong with that? Their dilemma appears in full force when the implications of the below plot are understood.

Disruptive Innovation model (Source: hbr.org)


The slope of the red lines (loosely, the “pace of technology”) is generally greater than the slope of the blue lines (the “pace of demand”). Crucially, this means that a revolutionary piece of technology that once could only serve the low end of the market will later be of use at higher and higher points, driving the previous solution into the very top end of the market before it is pushed out entirely.


This all happens while the incumbent is doing the logical thing - pleasing the customers that provide it with the highest margins. This logical act spells the death knell of such a company.


Tales that fit the theory of disruption, either closely or loosely, abound. The rise and fall of the digital camera industry is one that comes vividly to mind.


Steven Sasson, an engineer working at Eastman Kodak, invented the digital camera in 1975. His first prototype weighed 3.6kg and shot photos at a measly 0.03 megapixels. Of course, these were inferior to Kodak’s film cameras at the time and, given Kodak’s dominance of the film and film camera market, it is unsurprising that they chose to shelve the prototype and instead concentrate efforts on their core market.


As technology progressed, digital cameras improved in quality and manoeuvrability, gaining popularity with casual photographers. Digital cameras thus entered at the low end of the market and film camera manufacturers such as Kodak retreated to the market’s top end, where the biggest margins were to be made. In doing so, Kodak was tracing the path of incumbent players described in the Theory of Disruption.


As with video streaming, digital camera improvement outpaced customer demand. Digital camera sales took off in the 1990s and early 2000s. In 2003, digital cameras outsold film cameras in the US for the first time ever. A poll in 2019 concluded that more than 60% of Gen Z owned a digital camera of some sort. In the face of such an overwhelming shift to digital, Kodak, once the “800 pound gorilla in the world of photography”, was forced to declare bankruptcy in 2012.


Digital cameras have their own sets of problems today, with the mobile phone making serious inroads into the photography market. Early mobile phones had low quality cameras - in the sub-megapixel range - and no self-respecting photographer would be caught dead with one. But they filled an important niche - people carried mobile phones everywhere and even low quality cameras were sufficient to capture fleeting moments.


Once again, technology improvement outpaced customer demand and camera phones began to rise up the ranks. Nokia released the 5 megapixel N95 in 2006. In 2011, the newly-launched iPhone 4s boasted an 8 megapixel camera. In 2013, the Samsung Galaxy S4 upped the ante to 13 megapixels. Apple has touted its latest iPhone, the 11Pro as a genuine camera replacement.


As the below image shows, these developments have taken their toll on the digital camera industry. Worldwide shipments of cameras from major Japanese players in the market dropped 84% between 2010 and 2018.

The sharp decline of the camera industry (source: CIPA)


Smartphones continue to march on and become ever more interwoven into our lives. Their place in our lives is not guaranteed though; much like digital cameras, they too will likely be supplanted by newer technology that first corners a little niche and then takes over completely. We covered one such vision in a recent article on wearable technology but doubtless myriads of possibilities exist.


Parting thoughts

Disruption is an age-old phenomenon. From Oldowan tools which appeared some 2.5 million years ago to the modern day internet and IoT, humans have constantly been both agents and victims of disruption. New technology supplants old, whether quickly or over years. In turn, it is supplanted by fresher ideas and implementations.


Business is no exception. Companies rise and fall like the ebbing of the sea. Every so often there comes a rapidly rising tide of growth followed by the wave breaking leaving ruined companies - think the Dotcom bubble. From the rubble rise new contenders vying for top spot. A battle of ideology and technology ensues, leaving behind one victor.


There are several stories like this playing out all around us. Gene-editing, 3D printing, blockchain, drone technology, quantum computing… innovation is relentless, ruthless and rapid. Some of these innovations we have previously discussed; others remain untouched. If you would like to explore some of these concepts with us, drop us a line and become a member.

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Disclaimer: This article is based on our personal opinion and does not reflect or represent any organisation that we might be associated with.