Creative destruction
Lourdes Sosa, Assistant Professor of Strategic and International Management at London Business School, provides new insights into how incumbents react when faced with a disruptive technology
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When a disruptive technology attacks a market, incumbent firms and new entrants often react very differently in terms of research and development productivity. Take, for example, the disruption biotechnology has brought to the anticancer drug market.
Why do incumbent firms produce less innovation for every pound they invest in it? And when they do generate radical innovations, why do these innovations tend to be of lesser quality? Received wisdom suggests that this is a result of bureaucracy, the dynamics of inertia among large corporations. Incumbent firms present in a market that gets disrupted by a radical technological discontinuity, tend to be large established firms that are therefore assumed to be significantly bureaucratic. As a result, when they try to generate radical innovations within their research and development operations, they find it difficult to put their teams, assets and even culture together.
In my research I asked, what do successful entrants look like? Are they so different? If successful entrants are dramatically different but we could make a list of the organizational features that constitute their sources of competitive advantage, then we could provide the seed for a solution. The question would boil down to investigating how established firms might get access to implementing the organizational features that represent an advantage for entrants under their own corporate roofs.
Surprisingly, it turns out that successful entrants are very often as large, as old and as established as the companies that they come to replace. They are often firms that diversify from other markets as part of a corporate strategy that takes advantage of the synergies between its currently targeted markets and the disrupted one into which they expand. So the difference between winners and losers is not a question of bureaucracy and inertia. Winners and losers can often both be assumed equally bureaucratic. The important differences are to do with their capabilities, the sources of competitive advantage that they lost or can reuse and the way they are organised as corporations. And the true advice to managers should come in those details.
There is beauty in all sizes
The mirror image of the assumption that all large corporations are disadvantaged by their bureaucratic structure is to think that start-ups, those small firm counterparts, are the engines of invention in our economies thanks to their unique advantages. What I have found is that start-ups are not always the most productive organisations. Indeed, they're the least productive, even less productive than the incumbents who are trying to react to incursions into their markets.
That said, while start-ups may not be the most productive in researching radical innovations, they do carry the largest proportion of the sub-set of radical innovations with the highest risk. So, for example, in biotechnology, although start-ups are not the most productive in terms of biotechnology innovations, they are the most productive in gene therapy, a sub-set of biotechnology innovations. This seems to be a result of a combination of two reasons.
First of all, of course, start-ups tend to choose the areas of radical innovation where there are very few capabilities to reuse. In other words, common sense in business would make us expect firms to choose to compete in areas where there is less competition. As an extension, one would expect start-ups competing through a discontinuity to concentrate in a technological variant, such as gene therapy, where it is less likely that a firm existing anywhere in the economy might find it synergistic to enter and compete. This is precisely because the toughest competition for start-ups comes not only from incumbent firms reacting to the disruption, but also from those firms entering through diversification, the ones I mentioned often end up taking over the market. In that sense, by choosing to concentrate among radical innovations in the sub-set with highest risk, more new-to-the-world nature, start-ups get a plain level field against incumbents and more importantly, the large entrants that could potentially come to face them.
But there is a second reason why I am finding start-ups concentrated in the sub-set of radical innovations that are highest-risk, such as gene therapy within biotechnology. Their organizational structure procures them an advantage precisely in the case of high-risk radical innovation. It is well recognized that projects compete for resource allocation. Although we tend to discuss more frequently competition for resources in external markets, such as start-ups competing against one another to get venture capital support, competition for resources in "internal markets" is equally important. In other words, inside firms, projects also compete against one another to be granted the best resources. High-risk radical innovation, such as gene therapy, tends to suffer underinvestment when housed within a corporate roof where it competes against other radical innovations precisely due to the significant differences in risk. Therefore, for example, initial evidence shows that in the anticancer drug market, firms that house gene therapy projects only, perform better in gene therapy than firms that house gene therapy projects along with other biotechnology projects, because in the first scenario, gene therapy projects "starve." Because start-ups tend to be the only firms small enough to find it strategically optimal to house a single project type, these firms tend to be the only organizational structure that supports high-risk radical innovation.
So what do we learn?
My research suggests that there are lessons to be absorbed from both large and small firms, and that distinguishing which lesson to learn from each seems to be the crux for managers whose firms are facing disruptive technologies.
On the part of large firms, think, for example, of how Novartis moved into anticancer drug development, even though neither the firm nor its merger predecessors were in the market in the 1950s and 1960s. The firm is currently a leader in research in this market, and there is much to learn about how it decided to organize its R&D and any synergies that supported this expansion.
On the part of small firms, think again about the case of gene therapy research I described. As said, the advantage that sustains high performance in gene therapy for start-ups is the narrow competition for resource allocation that a particular type of internal structure grants to these firms. This ongoing investigation highlights more nuanced recommendations for managers. Existing wisdom emphasizes the need to organize support for both incremental and radical innovation inside a firm by setting up some form of structural and/or temporal separation. In other words, the risk most often highlighted when combining incremental and radical innovation is that the engineers and scientists themselves will begin mixing old solutions for new problems, a natural pattern found in R&D centers since the 1960s. Therefore, managers need to structurally separate teams: separate teams to work on incremental and radical innovations often housing them in different facilities. If unfeasible to assign different personnel to different teams due to the need for their particular skills, then implement temporal separation: assign teams to work full time in incremental innovation for a period of time, then switch to work full time in radical innovation for another period. In contrast to this wisdom, the case of gene therapy I described points out differences even among radical innovations, and highlights another aspect. Managers need to separate innovation streams on the basis of resource allocation as well, beyond the structural and temporal separation of research teams that we have been recommending. This points to the need for new criteria for resource allocation and budgeting commitments, and there is room to learn on this specific end from the organization of small firms.
Next steps
Clearly, better solutions to the conundrum of radical innovation will only come as the result of a long research agenda. This is an area I have looked at for a number of years and although I consider the findings promising, some of my next projects will round my perspective to more confidently offer advice to managers. The anticancer drug market is the largest market in pharmaceuticals, also one of the most science-intensive, least price-sensitive, and more profitable areas. But the market has existed since the end of the 1940s, and many of its dynamics are well established, as are the criteria to evaluate the quality of new drugs.
Beyond looking into historical research, spanning transitions such as that from vacuum tubes to transistors, I am also looking into other, contrasting markets within pharmaceuticals. In particular, psychotropic drugs, mainly antidepressants and antipsychotics, offer much to learn. Although psychotropic drug discovery is also science intensive, it is less clear how to go about measuring drug quality in this setting. Whereas in the anticancer drug market we can clearly look for efficacy and safety, in antidepressants and antipsychotics, drugs often compete in the reduction of side effects as opposed to efficacy per se. Since such a contrasting setting could shed light on how to strategize around radical innovations where not only the technology to produce them is complex, but also the understanding of consumer preferences for one feature of product quality over another is intricate, psychotropic drugs represent an area of growing interest for me.
In the end, there should be a message that collectively scholars and expert practitioners can put forth on how to strategize to more effectively face and generate radical innovation. Although if all firms in our economy get better at radical innovation, competition will intensify, this will also create the increase in quality of life that analysts have been linking to radical innovation since at least the work of Nobel Prize winner Robert Solow.
Lourdes Sosa (lsosa@london.edu) is an Assistant Professor of Strategic and International Management at London Business School.