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The Innovator's PrescriptionA Disruptive Solution for Health Care
By Clayton M. Christensen Jerome H. Grossman Jason Hwang
McGraw-HillCopyright © 2009 Clayton M. Christensen, Jerome Grossman and Jason Hwang
All right reserved.
Chapter OneThe Role of Disruptive Technology and Business Model Innovation in Making Products and Services Affordable and Accessible
In the 15 years since we first introduced the term "disruptive technology" into the lexicon of business management, there has probably been as much confusion about it as there has been clarity because the terms "disruption" and "technology" carry many prior connotations in the English language. Disruption connotes something "upsetting" and "radically different," among other things. And to many, "technology" connotes revolutionary ways of doing things that are comprehensible only to Ph.D. scientists and computer nerds. As a result of these other connotations of the words we chose, many who have only casually read our research have assumed that the concept of disruptive innovation refers to a radically new technology that tips an industry upside down.
But we have tried to give the term a very specific meaning: "disruption" is an innovation that makes things simpler and more affordable, and "technology" is a way of combining inputs of materials, components, information, labor, and energy into outputs of greater value. Hence, every company—from Intel to Wal-Mart—employs technology as it seeks to deliver value to its customers. Some executives believe that technology can solve the challenges of growth and cost that confront their firms or industries. Yet this is rarely the case. Indeed, widely heralded technologies often fall short of the expectation that they will transform an industry. Anyone who has been inside a modern hospital, for example, has noted the myriad sophisticated technologies at work today, yet health care only seems to get more expensive and inaccessible. The reason is that the purpose of most technologies—even radical breakthroughs—is to sustain the functioning of the current system. Only disruptive innovations have the potential to make health care affordable and accessible.
In this chapter we first review the concept of disruptive innovation and its constituent elements. We then zero in on the concept of a business model, showing that it is composed of four elements—a value proposition, and the resources, processes and profit formula required to deliver that value proposition to targeted customers. Because business model innovation is the crucial ingredient in harnessing a disruptive technology in order to transform an industry, we then describe three different classes of business models around which the health-care industry will be organized in the future. Along the way, we offer illustrations from other industries showing that when innovators stop short of business model innovation, hoping that a new technology will achieve transformative results without a corresponding disruptive business model and without embedding it in a new disruptive value network or ecosystem, fundamental change rarely occurs. In other words, disruptive technologies and business model innovations are both necessary conditions for disruption of an industry to occur. We close the chapter by explaining the process by which existing companies and their leaders can create new business models that match the degree of disruption needed.
In the subsequent five chapters we will build upon the foundation we lay out in this one. Chapter 2 explores the technological enablers of disruption in health care. Chapters 3 and 4 show how the business models of hospitals and physicians' practices must change in order to harness the power of disruption to make health care affordable and conveniently accessible, while Chapter 5 addresses the type of business model innovation necessary to transform the management of chronic disease. Finally, Chapter 6 explores which companies and industry executives are and are not in a position to lead these disruptive innovations—and what they need to do to get the job done.
THE DISRUPTIVE INNOVATION THEORY
The disruptive innovation theory explains the process by which complicated, expensive products and services are transformed into simple, affordable ones. It also shows why it is so difficult for the leading companies or institutions in an industry to succeed at disruption. Historically, it is almost always new companies or totally independent business units of existing firms that succeed in disrupting an industry.
The theory's basic constructs are depicted in Figure 1.1, which charts the performance of a service or product over time. First, focusing on the graph in the back plane of this three-dimensional diagram, there are two types of improvement trajectories in every market. The solid line denotes the pace of improvement in products and services that companies provide to their customers as they introduce newer and better products over time. Meanwhile, the dotted lines depict the rate of performance improvement that customers are able to utilize. There are multiple dotted lines to represent the different tiers of customers within any given market, with the dotted line at the top representing the most demanding customers and the dotted line at the bottom representing customers who are satisfied with very little.
As these intersecting trajectories of the solid and dotted lines suggest, customers' needs in a given market application tend to be relatively stable over time. But companies typically improve their products at a much faster pace so that products that at one point weren't good enough ultimately pack together more features and functions than customers need. A useful way of visualizing this is to note how car companies give customers new and improved engines every year, but customers simply cannot use all of this improvement because of speed limits, traffic jams, and police officers.
Innovations that drive companies up the trajectory of performance improvement, with success measured along dimensions historically valued by their customers, are said to be sustaining innovations. Some of these improvements are dramatic breakthroughs, while others are routine and incremental. However, the competitive purpose of all sustaining innovations is to maintain the existing trajectory of performance improvement in the established market. Airplanes that fly farther, computers that process faster, cellular phone batteries that last longer, and televisions with larger screens and clearer images are all sustaining innovations. We have found in our research that in almost every case the companies that win the battles of sustaining innovation are the incumbent leaders in the industry. And it seems not to matter how technologically challenging the innovation is. As long as these innovations help the leaders make better products which they can sell for higher profits to their best customers, they figure out a way to get it done.
The initial products and services in the original "plane of competition" at the back of Figure 1.1 are typically complicated and expensive so that the only customers who can buy and use the products, or the only providers of these services, are those with a lot of money and a lot of skill. In the computer industry, for example, mainframe computers made by companies like IBM comprised that original plane of competition from the 1950s through the 1970s. These machines cost millions of dollars to purchase and millions more to operate, and the operators were highly trained professionals. In those days, when someone needed to compute, she had to take a big stack of punched cards to the corporate mainframe center and give it to the computer expert, who then ran the job for her. The mainframe manufacturers focused their innovative energies on making bigger and better mainframes. These companies were very good, and very successful, at what they did. The same was true for much of the history of automobiles, telecommunications, printing, commercial and investment banking, beef processing, photography, steel making, and many, many other industries. The initial products and services were complicated and expensive.
Occasionally, however, a different type of innovation emerges in an industry—a disruptive innovation. A disruptive innovation is not a breakthrough improvement. Instead of sustaining the traditional trajectory of improvement in the original plane of competition, the disruptor brings to market a product or service that is actually not as good as those that the leading companies have been selling in their market. Because it is not as good as what customers in the original market or plane of competition of Figure 1.1 are already using, a disruptive product does not appeal to them. However, though they don't perform as well as the original products or services, disruptive innovations are simpler and more affordable. This allows them to take root in a simple, undemanding application, targeting customers who were previously nonconsumers because they had lacked the money or skill to buy and use the products sold in the original plane of competition. By competing on the basis of simplicity, affordability, and accessibility, these disruptions are able to establish a base of customers in an entirely different plane of competition, as depicted in the front of Figure 1.1. In contrast to traditional customers, these new users tend to be quite happy to have a product with limited capability or performance because it is infinitely better than their only alternative, which is nothing at all.
The personal computer is a classic example of a disruptive innovation. The first personal computers (PCs), like the Apple IIe, were toys for children and hobbyists, and the first adult applications were simple things like typing documents and building spreadsheets. Any complex computational problem still had to be served by the back plane of competition, where experts with mainframe computers ran the jobs for us. However, the performance of these simple PCs just kept getting better and better. As they became good enough, customers whose needs historically had required the more expensive mainframe and minicomputers were drawn one by one, application by application, from the back into the front plane of competition.
None of the customers of mainframe or minicomputer companies like Control Data Corporation (CDC) and Digital Equipment Corporation (DEC) could even use a personal computer during the first 10 years that PCs were made; PCs just weren't good enough for the problems they needed to solve. When CDC and DEC listened to what their best customers needed, there was no signal that a personal computer was important—because it wasn't to them. And when they looked at the financials, the personal computer market looked bleak. The $800 in gross margin that could be earned from selling a personal computer paled in comparison to the $125,000 in margin per unit that DEC could earn when it sold a minicomputer, or to the $800,000 in margin that Control Data could earn when it sold a mainframe.
Eventually, every one of the makers of mainframe and minicomputers was killed by the personal computer. But they weren't killed simply because the margins and volumes were different. The PC simply got better at doing more things. And it wasn't because the technology was difficult; in fact, given their industry expertise, companies like DEC could build some of the best PCs in the world. But it never made business sense for them to pursue the personal computer market. Even when PCs were becoming good enough to do much of what mainframes and minicomputers could do, the business model at companies like DEC could only prioritize even bigger and faster mainframes or minicomputers.
The only one of these companies that didn't fail was IBM, which for a time became a leader in personal computers by setting up a completely independent business unit in Florida and giving it the freedom to create a unique business model and compete against the other IBM business units.
The Kodak camera, Bell telephone, Sony transistor radio, Ford Model T (and more recently Toyota automobiles), Xerox photocopiers, Southwest Airlines' affordable flights, Cisco routers, Fidelity mutual funds, Google advertising, and hundreds of other innovations, all did or are doing the same thing. They used disruption to transform markets that had been dominated by complicated, expensive services and products into simple and affordable ones.
In each of these cases, the companies that had successfully sold their products or services, often dominating industries for decades, almost always died after being disrupted. Despite their stellar record of success in developing sustaining innovations, the incumbent leaders in an industry just could not find a way to maintain their industry leadership when confronted with disruptive innovations. The reason, again, is not that they lack resources such as money or technological expertise. Rather, they lack the motivation to focus sufficient resources on the disruption.
During the years in which a commitment to succeed with a new innovation needs to be made, disruptions are unattractive to industry leaders because their best customers can't use them and they are financially less attractive to incumbents than sustaining innovations. In a company's resource allocation process, proposals to invest in disruptive innovations almost always get trumped by next-generation sustaining innovations simply because innovations that can be sold to a firm's best customers for higher prices invariably appear more attractive than disruptive innovations that promise lower margins and can't be used by those customers. In the end, it takes disruptive innovations to change the landscape of an industry dramatically.
An industry whose products or services are still so complicated and expensive that only people with a lot of money and expertise can own and use them is an industry that has not yet been disrupted. This is the situation in legal services, higher education, and, yes, health care. The overarching theme of this book, however, is that these processes of disruption are beginning to appear in health care. One by one, disorders that could be treated only through the judgment and skill of experienced physicians in expensive hospitals are becoming diagnosable and treatable by less expensive caregivers working in more accessible and affordable venues of care. True to form, most of these innovations are being brought into the industry by new entrants, and they are being ignored or opposed by the leading caregiving institutions for perfectly rational reasons.
WHAT IS A BUSINESS MODEL AND HOW IS IT BUILT?
We mention above that of all the companies that made mainframe computers, IBM was the only one to become a leading maker of minicomputers; and of all the companies that made minicomputers, IBM was the only one that became a leading maker of personal computers. The reason is that IBM was the only company that invested to create new business models whose capabilities were tailored to the nature of competition in these disruptive markets. The others, if they attempted at all to participate in these emerging market segments, did so by trying to commercialize the disruptive products from within their existing business model.
So what is a business model? It is an interdependent system composed of four components, as illustrated in Figure 1.2. The starting point in the creation of any successful business model is its value proposition—a product or service that can help targeted customers do more effectively, conveniently, and affordably a job that they've been trying to do. Managers then typically need to put in place a set of resources—including people, products, intellectual property, supplies, equipment, facilities, cash, and so on-required to deliver that value proposition to the targeted customers. In repeatedly working toward that goal, processes coalesce. Processes are habitual ways of working together that emerge as employees address recurrent tasks repeatedly and successfully. These processes define how resources are combined to deliver the value proposition. A profit formula then materializes. This defines the required price, markups, gross and net profit margins, asset turns, and volumes necessary to cover profitably the costs of the resources and processes that are required to deliver the value proposition.
Over time, however, the business model that has emerged begins to determine the sorts of value propositions the organization can and cannot deliver. While the starting point in the creation of a business model is the value proposition, once a business model has coalesced to deliver that value proposition, the causality of events begins to work in reverse, and the only value propositions that the organization can successfully take to market are those that fit the existing resources, processes, and profit formula. In other words, the available business model is often the constraint to the realization of a disruptive technology's full potential.
Excerpted from The Innovator's Prescription by Clayton M. Christensen Jerome H. Grossman Jason Hwang Copyright © 2009 by Clayton M. Christensen, Jerome Grossman and Jason Hwang. Excerpted by permission of McGraw-Hill. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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