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This is a personal blog. Although the authors are affiliated with Coda Payments, the views expressed here are their own.

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Friday
Mar082013

Desperately seeking disruption

Like other, more famous graduates of Harvard Business School, I have been influenced by the writings of Professor Clayton Christensen and his theory of disruptive innovation, which he laid out in 2003 in his landmark book The Innovator’s Dilemma. (For those who haven't read it, TechCrunch recently published a summary of the book's key ideas.)

Christensen categorizes innovations as either sustaining or disruptive. Sustaining innovations target “demanding, high-end customers with better performance than what was previously available.” When a new generation of TVs comes out that are brighter, thinner, and larger than those that went before, they exemplify sustaining innovation. In contrast, disruptive innovations are “products and services that are not as good as currently available products, but… are simpler, more convenient, and less expensive,” making them available to new or less-demanding customers. Classic examples of disruptive innovations include low-cost airlines, online travel-booking sites, and mobile phones (which originally disrupted landline telephony and are now, in their smart incarnation, in the process of disrupting the traditional PC business). Needless to say, these are all innovations that benefitted consumers enormously, by making a certain kind of product accessible to a wider range of users than ever before.

It is important to stress that disruptive innovations, as Chistensen defines them, are actually worse than the products and services that are otherwise available to customers along at least one important dimension. Mobile money counts as disruptive because it compares unfavorably to traditional banking in a number of ways: the customer experience in a mom-and-pop shop serving as an agent will unquestionably be worse than what you get in a formal bank branch, accounts don't pay interest, and so on. But of course, these shortcomings are in part what makes the mobile money business model successful even when serving low-income consumers.

Now one of Christensen’s crucial insights is how difficult it is for established players to compete with disruptive innovations or to develop them themselves (i.e., to "disrupt themselves"). The reason is that the resources, processes, and values that firms develop over time, while optimized to support their existing businesses, often become hindrances when trying to bring disruptive innovations to market. For example, a manager in a company that specializes in high-gross-margin products will find it almost impossible to get approval to develop a low-margin offering, particularly if it threatens to siphon off customers from the higher-margin business, even if the volume potential and scale economies of that new business make it economically attractive.

Normally this is not a problem for consumers, because we don’t rely exclusively on incumbents for innovation. You can be sure that traditional travel agents would never have disrupted themselves with online booking engines; happily, however, firms like Expedia, Travelocity, and so on sprung up to seize the opportunity instead.

But high barriers to entry, including those erected by regulation, can stymie such competition. It seems obvious to me that what has short-circuited the emergence of disruptive products and services in financial services are the very high barriers to entry to firms that might have the capacity for such innovation. This includes not just startups but also established players from other industries. One of Christensen’s key insights is that an idea can be sustaining for firms in one industry and disruptive for firms in another, and you can made a good argument that while mobile money and prepaid cards are disruptive to banks, they are sustaining to the likes of Vodafone and Walmart.

This is why it is so vitally important that we open financial services to nonbanks: without them, there is no disruption. And where there is no disruption, consumers lose out.

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