Companies located in developing countries are currently serving billions of local consumers with innovative and inexpensive products. What happens when more of those companies make the leap into more developed markets?
Image courtesy of chotuKool.
Disruptive innovation has been credited as the strategy that led to Japan’s dramatic economic development after World War II. Japanese companies such as Nippon Steel, Toyota, Sony and Canon began by offering inexpensive products that were initially inferior in quality to those of their Western competitors. This allowed the Japanese companies to capture the low-end segment of the market. As the performance of their products improved, they began to move upmarket, into segments that allowed them more profitability. Eventually, they captured most of these segments and pushed their Western competitors to the very top of the market or completely out of it.
A number of scholars have argued that a similar disruption process is brewing in today’s emerging markets, especially in China and India. Perhaps the best-known example is the Nano, an inexpensive car introduced by Tata Motors in India in 2009. Other examples that are often mentioned include the Tata Swach, an eco-friendly, portable water purification system; the chotuKool, a portable, low-cost refrigerator that can be battery powered, introduced in India by Godrej & Boyce; and the LePhone, which was introduced by Lenovo as China’s less-expensive answer to the iPhone.
These examples are just the tip of the iceberg. Numerous and less-well-known companies and entrepreneurs are currently serving billions of local consumers with low-cost products without significant competition from global corporations. But once the local entrepreneurs establish themselves in their home markets, they should also make the leap into more developed countries. There, they will probably start with the low-end segments and gradually make their way upmarket. The fear among companies in more developed economies is that history is about to repeat itself, this time with companies from markets like China and India at the forefront.
But how inevitable is this threat? To answer this question, I examined 21 low-cost disruptive innovations that took place in Europe and the United States over the last 40 years; my sample included not only successful but also unsuccessful disruptors. As a result, we can compare the successful disruptors to the unsuccessful ones and so identify the differences between the two. We can then use these insights to discuss what kinds of disruptions from emerging markets stand the biggest chance for success in more developed economies.
The Disruption Process
Just because a product is very inexpensive or targets non-consumers of existing technologies does not mean it is disruptive. To be disruptive, a product has to meet two conditions: First, it must start out as inferior in terms of the performance that existing customers expect, but superior in price. As a result, existing customers will initially ignore it, but other customers (usually non-consumers of the incumbent products) will be attracted by its low price. Then, for a product to truly become disruptive, it must evolve to become “good enough” in performance (attracting mainstream customers from the earlier generation of incumbent products) while at the same time remaining superior in price. In other words, it must become “good enough” in performance and superior in price.
There is a dynamic element here: What makes a product disruptive is how it develops over time and how incumbents respond to it. This has the important implication that you can never tell ex ante whether a product will be disruptive or not. To consider the potential of emerging-market innovations to be disruptive in more developed economies, we must first answer the following two questions:
- Will the emerging-market innovators continue to have a significant price advantage over competitors from more developed countries?
- Will the emerging-market innovators succeed in closing the performance gap so that customers in more advanced economies come to see their products as “good enough”?
These are obviously hypothetical questions but we can begin to understand the factors that determine their answers by examining the success (or failure) of other disruptions originating in Western markets over the past 40 years. For example, in the razor business, Bic emerged as a huge, low-cost disruption to Gillette in the 1970s and quickly succeeded in capturing 25% of the disposable razor market by the early 1980s. Yet Gillette countered with its own line of inexpensive disposable razors, and Bic ceased being a major threat to Gillette in razors by the early 1990s.
On the other hand, low-cost, no-frills airlines disrupted and continue to disrupt traditional airlines quite successfully. The same could be said for private label supermarket brands (which now account for more than 60% of the supermarket shelf in Europe and the United States). Why did some low-cost disruptions transform industries while others didn’t? It turns out that there are some pretty predictable factors that explain the difference in success rates.
Maintaining a Price Advantage
For disruptors to have a chance of winning against incumbents, they must invest in improving the performance of their products while maintaining their significant cost and price advantages over the incumbents’ products. Whether they will succeed in maintaining this advantage depends on the source of their cost advantage and how sustainable it is.
If the source of the cost advantage is low labor costs or a reengineered product that requires fewer or cheaper components, incumbents can find a way of neutralizing these advantages. For example, if the source of the cost advantage is a reengineered product, the incumbent companies could undertake a similar reengineering process with their own products. The Swiss watch industry did this successfully after it came under attack from Japanese watches in the 1970s. In response, the Swiss developed the lower-cost Swatch; in the Swatch, the Swiss reduced costs by eliminating product attributes that they decided were unnecessary while enhancing certain other product features like style and design. The end result was a watch that almost eliminated the disruptors’ price advantage while offering a new differentiation benefit — style. As a result, the Swiss regained much of their lost market share in watches.
A cost advantage is difficult to sustain over time, especially if incumbents cut their costs in an aggressive and committed way. For example, generic drugs use low price to attack branded drugs that come off patent. But there’s little that can prevent big pharmaceutical companies from doing the same. Novartis, GSK, Merck and Sanofi are examples of incumbents doing very well in producing and selling generic drugs.
However, there is one source of cost advantage that is more sustainable than others. This is the business model of the disruptors. A cost advantage that comes on the back of a business model that is not only different from but also conflicts with the business model of the established companies is more sustainable than other cost advantages. This explains the success of low-cost airlines over traditional airlines.
Business models are difficult to imitate. What makes the task even more difficult is the fact that the disruptors’ business models often conflict with the incumbents’ business models. For example, if Unilever PLC moves aggressively into private label consumer goods, it risks damaging its existing brands and diluting the organization’s strong culture for innovation and differentiation. The existence of such trade-offs and conflicts means that a company that tries to compete in both positions simultaneously risks degrading the value of its existing activities. This is the logic that led Michael Porter of Harvard Business School to propose more than 30 years ago that a company could find itself “stuck in the middle” if it tried to compete with both low-cost and differentiation strategies.
When there are inherent conflicts between their traditional business model and the disruptor’s business model, incumbents will think twice before attempting to imitate the disrupting business model. And even when they do adopt it — in a separate subsidiary, as often advised by academics — they are likely to fail. For example, in 1993 Continental Airlines Inc. created a separate subsidiary called Continental Lite and set about to capture market share in the low-cost, no-frills, point-to-point airline market that Southwest Airlines Co. had pioneered. Unfortunately for Continental, the strategy adopted by its Lite subsidiary was virtually a replica of the Southwest strategy. As a result, it failed to make inroads, and Continental shut the unit down in 1994. European airline companies like British Airways (with its Go Fly subsidiary) and KLM (with its Buzz subsidiary) had similar experiences and ended up selling or shutting down their operations within a few years of entry.
It is possible for incumbents to respond successfully to disruptors that base their attacks on a different business model. But the task is very difficult, and most incumbents do not do a good job at it. This suggests that a cost advantage that’s based on a different and conflicting business model is the disruptor’s best chance to make inroads against incumbents.
Closing the Performance Gap
In developed economies, emerging-market disruptors not only have to maintain their price advantage over incumbents but also must find ways to improve the performance of their products so that consumers in advanced economies begin to look at these products as “good enough.” There are two major factors that will influence the disruptors’ success rate: what disruptors do and what incumbents do.
Disruptors have a number of options in how they go about closing the performance gap. They could develop technology or knowledge by acquiring companies in more developed countries (for example, Tata’s acquisition of Land Rover); they could invest heavily in their own R&D (for example, Zhengzhou Zhongxing Medical Equipment); they could license the necessary technology (for example, China International Marine Containers Group entering into a licensing agreement with Graaff Transportsysteme GmbH); or they could enter into partnerships and alliances with companies from more developed countries (for example, Huawei Technologies with 3Com).
Less obvious is the proposition that whether the disruptors’ products come to be seen as “good enough” depends not only on what disruptors do, but also on what incumbents do to influence consumers’ expectations of what is “good enough.” In particular, incumbents must continue to innovate in their products so that consumers in more developed countries continue to see a big gap between what the potentially disruptive product can offer them and what is available from the incumbents.
There are two major ways to do this. The first is to focus on the product’s existing value proposition and raising that to higher levels. Doing so will keep raising the bar on what is good enough and make life more difficult for disruptors. Gillette did exactly this with the introduction of new products such as the Sensor, the Mach 3 and the Fusion.
A second way for incumbents to innovate is to shift the basis of competition altogether, away from what the disruptors are trying to catch up with and toward another product benefit. The introduction of the Swatch shifted customer attention away from watch performance to style and design, an area where the disruptors had no advantage. Before the introduction of Nintendo’s Wii, the three-way battle among Sony, Microsoft and Nintendo focused the manufacturers on a continual and seemingly unending battle for technological advancement and superiority of hardware in the home games console market.
Nintendo’s response to all of this was a classic strategy of shifting the basis of competition and changing consumers’ perceptions of what is “good enough” in this market. Rather than follow Sony and Microsoft down the performance trajectory, Nintendo introduced the Wii on the basis of family entertainment, a benefit that the disruptors were not paying attention to. Nintendo’s strategy was essentially to expand the market by developing consoles that would support simple, real-life games that could be learned quickly and played by all members of the family, including the very youngest and the very oldest. By 2007, the launch of the Wii led to household penetration of consoles rising for the first time in 25 years. The console outsold the PS3 three-to-one in the Japanese market and five-to-one in the United States.
The Gillette and Nintendo examples highlight a simple point: How incumbents respond to a disruptive innovation could have a big effect on how successful the disruptors are in closing the performance gap. This implies that whether innovations from emerging markets succeed in disrupting more developed markets depends on how aggressively incumbents in those markets respond to them. The more successful the incumbents are in increasing consumers’ expectations of what is “good enough” in their markets, the less successful the entrants from emerging markets will be in disrupting them.
In short, whether low-cost innovations from emerging countries end up disrupting markets in developed countries depends not only on whether the disruptors succeed in putting in place an innovative business model that supports their cost advantage but also on how aggressively the incumbents respond. For incumbents, knowing that much of their fate rests in their hands is half the battle won.