Professor Clark Gilbert Harvard Business School

1. A New Path to Growth Using Disruption to Drive New Growth at McNeil Professor Clark Gilbert Harvard Business School

2. Pace of Technological Progress Product Performance Performance that customers can utilize or absorb New performance trajectory Disruptive Innovation Time Sustaining versus Disruptive Innovation Sustaining Innovation Breakthrough Incremental Source: The Innovator’s Dilemma

3. Disconnect with Resource Allocation • Under Valued by Leading Customers • Lowers Performance along Traditional Trajectory • Lowers Gross Margins • Targets Different Customers in New Ways • Introduces Different Performance Criteria Budgeting Committee Disruptive Proposal Production Marketing Manager

4. Kodak’s Response ($1B in R&D) Children’s Game Toys Established players force new technology into old markets Applications for Silver Halide Film Technology Disruption in digital photography Performance Home-use Applications E-mail applications Disruptive technology: digital film

5. Definition of a Fanatic: Someone who doubles his speed when he has lost his direction --George Santayana

6. The Benefit of Staged Learning Replication of Old Market and Business Model Discovery of New Market and Business Model

7. New Market Disruption • Improvements along dimensions valued by current customers • “Good enough” on traditional metrics but lower prices • Improved performance on new attributes (e.g., simplicity, convenience) TECHNOLOGY • New customers or new contexts of use • Most profitable customers in existing markets • Overserved customers in low-end of existing market • Improved performance on new attributes (e.g., simplicity, convenience) CUSTOMERS • New customers or new contexts of use • New business model, often lower price points, new sales model & distribution channels Different Types of Innovations Sustaining Innovation Low-End Disruption New Market Disruption • New financial or operational model that earns attractive returns at low prices • New business model, often lower price points, new sales model & distribution channels • Similar to existing model, improves or maintains margins BUSINESS MODEL

8. Steel Minimills: A Low-End Disruption

9. Steel Minimills: A Low-End Disruption % of Margin % of Tons 25–30% 55% Sheet steel 22% 18% Structural steel Steel Quality 8% Angle iron; bars & rods 12% Quality of minimill-produced steel 4% Rebar 7% 1975 1985 1980 1990

10. Improvements along dimensions valued by current customers • “Good enough” on traditional metrics but lower prices • Improved performance on new attributes (e.g., simplicity, convenience) TECHNOLOGY • Most profitable customers in existing markets • Overserved customers in low-end of existing market CUSTOMERS • New customers or new contexts of use Different Types of Innovations Sustaining Innovation Low-End Disruption New Market Disruption • New financial or operational model that earns attractive returns at low prices • New business model, often lower price points, new sales model & distribution channels • Similar to existing model, improves or maintains margins BUSINESS MODEL

11. The DEC Programmable Data Processor 8: 1965 Minicomputers: A New Market Disruption

12. 15000 14000 13000 12000 11000 10000 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 1965 1975 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 Established Markets Continue to Grow even as the Disruptive Markets Take Root Minicomputers Disrupt Mainframes Sustained Revenue Lead First Revenue Lead Minicomputer Market Dollars ($billions) Mainframe Computer Market Phase III Phase I Phase II Source: ITI, Industry Statistics Programs; U.S. Microcomputer Statistics Committee Forecast, Data Analysis Group

13. Disruption in Print Media “All the News that Fit to Pixel”

14. Disconnect with Resource Allocation • Under Valued by Leading Customers • Lowers Performance along Traditional Trajectory • Lowers Gross Margins • Targets Different Customers in New Ways • Introduces Different Performance Criteria Budgeting Committee Disruptive Proposal Production Marketing Manager

15. 45% Missing! 45% Old Business Models Make It Very Difficult to Realize Missing Revenue: Online Advertising Market 15% 20% 10%

16. Online Revenue Per Unique User

17. Product Performance Performance that customers can utilize or absorb New Net Growth Time The Irony of Disruptive InnovationGrowth Starts in New, Not Established Markets

18. Displacement Net New Growth Established Business Disruptive Business Starts Outside Established Business Finding New Market Growth "Overall, the newspaper industry's involvement with the Internet has been one where it had a lot to lose and it's been trying not to lose it, as opposed to starting from scratch and having a lot to win." --Steve Yelvington, President of Online Newspaper Division

19. Why is this so difficult for otherwise successful firms?

20. Processes Resources Values The criteria by which prioritization decisions are made • People • Technology • Products • Equipment • Information • Cash • Brand • Distribution • Hiring & Training • Product development • Manufacturing • Planning & Budgeting • Market Research • Resource allocation • Ethics • Cost structure/income statement • Size of opportunity RPV: Strengths Become Weaknesses Core Competence vs. Core Rigidity

21. Market Research Big enough to be interesting? Planning Cycles What Margins Are Attractive? Customer Feedback Cost structure Resource Allocation Product Quality Capabilities in One Context Become Disabilities in Another Processes: How? Values: Why? “Organizational DNA”

22. “ I need to look at the kidney myself and see what’s going on. Every time I want to look I have to send the radiologist a patient… That’s not good. It doesn’t help me get my job done. I want to do it myself.”Nephrologist Disruption through Portable Ultrasound “ I had a call with a nephrologist where I literally told the sales rep to take the product out of the bag and show it to the physician. He didn’t do it. And I’m the President of the company… ...We have all of these sales leads, but some of my reps are afraid of cannibalizing sales of higher-end hand carried systems.”President, Hand-Carried Ultrasound Company

23. Develop Separate Business Development Processes Performance Time

24. Separate Disruptive Ventures Separated sites had nearly 4 million more page views Penetration 12 10 10.4 Millions of Page Views / Month 8 6 6.5 4 2 0 Integrated Sites Separated Sites

25. Implications • Disruptive technologies attack an established business, but provide enormous opportunities for new net growth • Focusing on your core market can lead to organizational rigidity – Trying Harder Can Be Part of the Problem! • Identifying these opportunities requires different lenses: • Reconsidering technologies viewed as “inferior” in your core market • Targeting “overshot” where the primary alternative is non-consumption • Developing these opportunities requires different tools: • A different development, review, and funding process than the core business • A venture process that is patient for growth, not for proof of concept • A willingness to look outside of core business—venture autonomy, talent, partnerships, and acquisitions • Disruption can provide competitive advantage is the search for growth

26. Managing Uncertaintyin New Venture Creation Clark Gilbert Harvard Business School

27. HBS Definition of Entrepreneurship Without Regard to Resources Currently Controlled Pursuit of Opportunity Managing Uncertainty • Identify Critical Risks • Design Experiments • Stage Investment

28. 1) Identify Key Sources of Risk • Technical • Operating • Market • Distribution /Pricing • Team • Environmental Which is the most important risk to understand and remove? Deal Killers, Path Dependencies, Costs, Investor Needs, Greatest Uncertainty Total Venture Risk

29. Business Models: Fishbone Diagrams Driver 1 Driver 1 Driver 2 Driver 3 Driver 3 revenues Driver 2 Driver 3 profits Driver 1 Using the tool 1. Draw the key drivers of revenue and costs 2. Identify key drivers and assumptions 3. Test sensitivity to changes in key drivers 4. Analyze how reasonable key assumptions are 5. Use the tool to surface key assumptions, logical inconsistencies, critical sources of uncertainty and important questions to ask Driver 2 costs Driver 2 Driver 3

30. 2) Types of Experiments • Partial experiments • buy information on “deal killer” source of uncertainty • good when you know you don’t know something, risk of failure is high • case examples • customer research before introduce product (Parenting, Tally Up) • hire as consultant before hiring full time (Tally Up) • background check on job candidate • Holistic experiments • test entire model on small scale • good to reveal ignorance-I.e., things you didn’t know you didn’t • good to tests interaction between variables • case examples • introduce product in trial before full launch (Onset vs. Knight Ridder) • develop prototype with development partner (Tally Up’s beta version, E Ink) • projection and reflection (ONSET ask VCs evaluate whole plan)

31. Experiments can be expensive (Knight Ridder, E Ink, Segway) They can take too long What if you finally get it right, only to find out that the market has moved or someone else has beat you to the punch? They can perpetuate “Given the pace of our expansion, I don’t think we made mistakes fast enough and we didn’t learn from them often enough. The problem wasn’t just turning them on, sometimes it’s turning them off.” -Bob Ingle, Executive Editor, San Jose Mercury News 2) Risks of Experiments

32. Value greatest when: Significant cost of failure Significant probability of failure Cost of the experiment is a small percentage of the total investment The experiment yields fairly accurate results You can increase the value when: Minimize both costs and timing You impose variance on key questions, but control for other variables (Onset) Have key milestones and ways of measuring progress Change behavior as a resultenter vs. exit, product adaptation, adaptation subsequent roll-out 2) The Value of Experiments

33. 3) Staging Investment Lock-in on Early Assumptions Discovery of New Market and Business Model

34. Only spend significant sums of money after big risks have been reduced. Examples R&R doesn’t place manufacturing order until after K-Mart order is received Knight Ridder waits on registration until execution and sales risk are reduced 3) Staging Investment

35. 3) Staged Investments and Value of Information SUCCESS Payoff - Investment INVEST NOW PS (1-PS) - Investment FAILURE SUCCESS Payoff- Investment - Cost of Test GOOD RESULTS INVEST PS|G 1 PG (1-PS|G) -Investment- Cost of Test RUN AN EXPERIMENT FAILURE 1 (1-PG) ABANDON - Cost of Test 1 BADRESULTS ABANDON

36. Funding to Milestonesaka “Old-Fashioned Venture Capital” TechnologyWorks A Customer Buys Idea isFeasible P(success) = 80% Req’d IRR = 30% Valuation P(success) = 50% Req’d IRR = 50% P(success) = 40% Req’d IRR = 70% P(success) = 30% Req’d IRR = 100% Risk (ß) Capital Seed Funding R&DCapital Go-to-MarketCapital ExpansionCapital Source: Lou Mazzucchelli, Ridgewood Capital

37. The “Fully Funded” Folly TechnologyWorks A Customer Buys Idea isFeasible Valuation Risk (ß) Capital Fully Fund IPO (……….pray……………….) Source: Lou Mazzucchelli, Ridgewood Capital

38. Implications • Risk is inversely related to value • Entrepreneurial managers don’t take risk, the manage risk • New ventures will: • Develop in an highly iterative and staged process • Employ a series of risk reducing experiments • Business models will change multiple times • Reviewing of new ventures requires that board members can: • Considered plans that will change considerably • Demand results, but on different metrics—opportunity recognition and milestone achievement • Identify risks, stage investment, and value risk reducing experiments • Embrace outside perspectives • Creating the right context for reviewing new ventures is key—simply having powerful ideas and opportunities is not enough