Making the leap into developed markets
Costas Markides examines whether disruptive innovation at the Bottom of the Pyramid will come to disrupt Western markets.
Disruptive innovation is credited as the strategy that led to Japan’s dramatic economic development after the Second World War. Japanese companies such as Nippon Steel, Toyota, Sony, Canon and Matsushita started out by offering inferior but cheaper products to those of their Western competitors. This allowed them to capture the low-end (and less profitable) segment of the market, something that Western incumbents were happy to give away. However, Japanese firms succeeded in improving the performance of their products and began to slowly move upmarket, into segments that allowed them more profitability. Over time, they managed to capture most of these segments and in the process pushed their Western competitors to the very top of the market or completely out of it.
A similar disruption process is thought to be brewing at the moment at the Bottom of the Pyramid (BoP), especially in China and India. Perhaps the best known example is the Nano, a cheap car developed by Tata Motors in India and introduced in 2009 at a retail price of (about) US$2,500. Its initial success in India is thought to be just the prelude to what’s to follow — a full scale attack on Western markets. Other often mentioned examples include: the Tata Swach, an eco-friendly portable water supply system; the ChotuKool, a portable and cheap refrigerator that requires no electricity, introduced in India by Godrej & Boyce; the G-Wiz electric car, manufactured by Mahindra Reva Electric Vehicles as a cheap and green car for urban commuting in the West; the LePhone, China’s answer to the iPhone (at half the price) which was introduced by Lenovo and has received strong support from top domestic service and content suppliers; and Galanz’s small but affordable microwaves, perfectly suited for the cramped apartments of major European cities.
There are many more similar examples. Numerous and less well-known companies and entrepreneurs located in BoP countries are currently serving billions of local consumers with cheap products without any real competition from global competitors who find these markets unprofitable and unattractive. But once the local entrepreneurs establish themselves in their local markets, they should make the great leap into developed markets. They will start with the low-end segments and slowly make their way upmarket. The fear, therefore, is that history is about to repeat itself: the disruption process that catapulted Japanese firms to industry prominence 40 years ago is about to play out again with BoP firms at the forefront.
But how serious is this threat and what are the factors that contribute to a successful disruptive strategy?
The disruption process
Just because a BoP product “underperforms existing technologies” or “serves a less profitable customer” or “is really cheap” or “targets non-consumption” does not mean it is disruptive. For it to be disruptive, it has to meet two conditions:
First, it must start out as inferior in the performance that Western customers expect, but superior in price. This implies that when it starts out, mainstream customers will ignore it, but other customers (usually non-consumers or BoP consumers) will be attracted to it because of its low price. But of course this is not what really makes it disruptive to Western firms. For it to truly become disruptive, it must start like this but must evolve to become “good enough” in performance (and so attract mainstream Western customers) while at the same time remaining superior in price. It’s not enough to be just “good enough” in performance or to be just cheaper. It must be “good enough” in performance and superior in price.
It is important to appreciate that there is a dynamic element here. It is not how a product starts out that makes it disruptive. Rather, it is how it develops and how incumbents respond to it that makes it disruptive. This has the important implication that you can never tell ex-ante whether a product will be disruptive or not. You can only tell after the fact. All you can do at the start is to assess the chances (or probability or potential) of a product evolving to become disruptive. And to do that, we must first answer two questions:
Will the BoP innovators continue to have a (significant) price advantage over Western firms?
Will they succeed in closing the performance gap so that Western mainstream customers come to see their products as “good enough”?
Applying this logic to the best known example of BoP innovation — the Tata Nano — we can immediately see that whether the Nano will come to disrupt the Western car industry is not a sure thing at all. First, the Nano has to improve in quality and performance to a level where Western mainstream customers will look at it and say “it’s a good enough car for me.” Will it succeed in doing this? And what determines if it will succeed or not?
Second, and equally important, the Nano has to improve in this manner to become “good enough” in performance while at the same time maintaining its price advantage over Western cars. Will it succeed in achieving this even as it makes expensive investments to improve its quality and performance? And what factors determine if it will do this successfully?
These are obviously hypothetical questions but we can begin to understand the factors that determine the answers to these questions 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 per cent of the market by the early 1980s. Yet, it quickly faltered and ceased being a major threat to Gillette by the early 1990s.
Other low-cost disruptions that were not particularly successful in disrupting incumbents include low-cost watches, cheap consumer electronics and generic pharmaceutical drugs. 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 (that now account more than 60 per cent of the supermarket shelf in Europe and the US) as well as online bookselling, online travel agents and online trading of financial instruments. Why did some low-cost disruptions succeed while others failed? It turns out that there are some pretty predictable factors that explain the difference in success rates.
Will they maintain their price advantage?
For disruptors to have a chance of winning against incumbents, they must invest in improving the performance of their products while still maintaining their significant cost (and price) advantage over the incumbents’ products. Whether they will succeed in maintaining this advantage depends on the source of their cost advantage and how sustainable this is. After all, incumbents are not stupid. They will try to respond to a low-cost attack by reducing their costs as well. Whether they will succeed in doing this depends on the source of the cost advantage that the disruptors enjoy.
If the source of the cost advantage is low labour costs or a re-engineered product that requires fewer or cheaper components, the incumbents can find a way of neutralising these advantages. For example, if the source of the cost advantage is low labour costs, Western incumbents could simply transfer their manufacturing process to India or China and so enjoy the same labour costs as their attackers. If it is a re-engineered product, Western firms could undertake a similar re-engineering process with their own products. To see this, consider the case of the Swiss watch industry when it came under attack from cheap Japanese watches in the 1970s.
In the early 1960s, the Swiss dominated the global watch industry. This dominance all but evaporated in the 1970s when companies such as Seiko (from Japan) and Timex (from the US) introduced cheap watches that used quartz technology and provided added functionality and features (such as the alarm function, date indication, etc). The Swiss share of global world production declined from 48 per cent in 1965 to 15 per cent by 1980. In response, the Swiss company SMH introduced the Swatch. Not only did the new watch introduce style as a competitive dimension but more importantly, it was sold at a price that was close enough to the average Seiko price. The Swatch was not cheaper than Seiko but the tremendous price advantage that Seiko enjoyed was cut to a few dollars. Since its launch in 1983, Swatch has become the world’s most popular time piece with more than 100 million sold in over 30 countries.
How did the Swiss manage to cut the price of the Swatch to such low levels without moving manufacturing offshore? They achieved this by eliminating many of the product attributes that they thought were unnecessary (thus cutting costs) while enhancing certain other product features like style and design (thus building differentiation). They also found ways to cut other costs (in manufacturing and in materials used) and to build differentiation in other ways (for example, through the Swatch Club). The end result was a watch that all but eliminated the disruptors’ price advantage (while offering a new differentiation benefit — style — as well). As a result, the Swiss have regained most of their lost market share.
A cost advantage is very difficult to sustain, especially if the incumbents go about the business of cutting their costs in an aggressive and committed way. For example, Bic had an initial cost advantage over Gillette. Yet, Gillette succeeded in producing its own line of cheap, disposable razors that thwarted Bic’s onslaught. Similarly, generic drugs use low prices to attack branded drugs that come off patent. But there is no secret to their low-cost strategy and there’s little that can prevent big pharmaceutical companies from doing the same. Novartis, GSK, Merck and Sanofi-Aventis are all examples of incumbents doing very well in producing and selling generic drugs. A similar pattern can be seen in a number of industries that were attacked by low-cost disruptors (such as the banking industry, the supermarket industry and the cosmetics industry), a fact that reinforces the point that a cost advantage is difficult to sustain for too long.
Is anything sustainable?
This raises the question: “Is any source of cost advantage sustainable?” The truth is that nothing can be sustainable forever but there is one source of cost advantage that is more sustainable than others. This is the business model of the disruptors. Specifically, a cost advantage that comes on the back of a business model that is not only different but also conflicts with the business model of the established firms is more sustainable than other cost advantages. This explains the success of low-cost airlines over traditional airlines, as well as the enormous inroads that mini-mills have achieved against integrated steel mills.
Business models are difficult to imitate. But what makes the task even more difficult for incumbents is the fact that the disruptors’ business models often conflict with their own business model. For example, by selling its tickets through the internet just like its low-cost competitors, British Airways risks alienating its existing distributors (the travel agents). Similarly, if Unilever moves aggressively into private label, it risks damaging its existing brands and diluting the organisation’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 paying a huge straddling cost and degrading the value of its existing activities. The task is obviously not impossible, but it is certainly difficult. This is the logic that led Harvard Business School’s Michael Porter 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.
Incumbents will find it difficult to neutralise the cost advantage of a disruptor that is based on that disruptor’s different business model. Because of the inherent conflicts between their traditional business model and the disruptor’s business model, they will think twice before attempting to imitate the disrupting business model. And even when they do adopt it — in a separate subsidiary as advised by academics — the evidence shows that they are likely to fail.
For example, in 1993 Continental Airlines 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 the airline Southwest had pioneered. Unfortunately for Continental, the strategy adopted by its Lite subsidiary was almost a replica of the Southwest strategy. As a result, it failed to make any inroads and Continental shut the unit down in 1994. European airline companies like BA (with its GO subsidiary) and KLM (with its Buzz subsidiary) had exactly the same experience as Continental: they entered the new market using the same business model as the (European) disruptors — in this case easyJet and Ryanair — and ended up selling or shutting down their operations within a few years of entry. The same pattern emerged in the newspaper industry. For example, in 2005 the Swiss newspaper company Edipresse entered the huge new market created by advertiser-funded free daily newspapers that were distributed through major cities’ public transportation systems during the peak morning commute. It did so by developing its own free newspaper (called Le Matin Bleu) and started distributing it in Geneva and Lausanne using the same business model as the original disruptor, Sweden-based Metro International. Inevitably, the venture failed and was shut down in 2009.
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 the evidence shows that most incumbents do not do a good job at it. All 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. The question is: how many of the BoP disruptors are actually utilising such a business model? And the answer is: very few. The Tata Nano is not based on a different business model to the established businessmodel in the car business. Neither is the Tata Swach or the ChotuKool or the G-Wiz car or the LePhone or any of the BoP innovations that one reads in the press these days. This suggests that committed Western incumbents should be able to find ways to neutralise their attackers’ cost advantage. This, in turn, raises serious doubts whether many of the BoP products would actually be successful in disrupting Western markets.
Will they succeed in closing the performance gap?
Not only do the disruptors have to maintain their price advantage over incumbents but they must also find ways to improve the performance of their products so that mainstream consumers begin to look at these products as “good enough”. The first point to appreciate is that the disruptors do not have to reach the same level of performance as the incumbents. The gap they have to close is not between the performance of their products and that of the incumbents. Rather, it is the gap between the performance of their products and what Western consumers would consider as “good enough”. This implies that they can remain inferior to the incumbents’ products and still win out.
What determines if they will be successful in closing this gap? Obviously a lot depends on how big this gap is, but there are two major factors that will influence their success rate: what disruptors do and what incumbents do.
What disruptors do to close the performance gap is an obvious factor that will determine their success. The evidence shows that disruptors have a number of options in how they go about doing this. They could develop the necessary technology or knowledge by acquiring Western firms (e.g. Tata’s acquisition of Rover or Lenovo’s acquisition of IBM’s PC division); they could licence the necessary technology (e.g. China International Marine Containers Group entering into a licensing agreement with Graaff Transportsysteme); they could enter into partnerships and alliances with Western firms (e.g. Huawei and 3Com and Cisco with ZTE); they could hire Western talent (e.g. Pearl River Piano Group); or they can invest heavily in their own R&D (e.g. Zhongxing). The list of possible options seems endless.
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, the incumbents must carry on innovating their products so that Western consumers continue to see a big gap between what the BoP product can offer them and what is available from the incumbents.
There are two major ways of doing this. The first is by focusing on the product’s existing value proposition (such as performance) and raising that to higher levels. Doing so will keep raising the bar on what is “good enough” and make life more difficult for BoP disruptors. The best way to see how this works out is to compare an industry that failed to do so against one that did it.
One group of companies that lost enormous market share to disruptors (i.e. private label) is the FMCG companies. Research has shown that some products (such as wine, cheese, syrup, rice and pasta) are more susceptible to the private label threat than others (such as deep-frozen food, coffee, yogurt and chocolate). The difference is all down to innovation. Specifically, private label products tend to do well when: the incumbents charge “excessive” price premiums not justified by quality; the incumbents have stopped innovating in these products (as measured by per cent of new products introduced in the last five years); and the incumbents have cut advertising investment in these products. All this suggests that it doesn’t matter how big the performance gap is — if you stop innovating in your product, the disruptors will inevitably catch up.
Compare how the FMCG players responded to the low-cost disruption in their markets with how Gillette responded to a similar threat. After seeing a quarter of the market being won over by Bic (in less than ten years), Gillette set about to change people’s perceptions on what to expect from its razor. Through a series of innovative product introductions (such as the Sensor, the Mach 3 and the Fusion), Gillette redefined what “performance” meant in this market. It also innovated in the disposable space — for example, in 1994 it introduced the Custom Plus line that was a disposable with a lubricating strip. In late 2002, Gillette announced the introduction of a new line of disposable razors with proprietary technology. By successfully raising the bar in this market, Gillette managed to convince consumers that they should expect more from their razors and that Bic was not really “good enough” for them. In the process, it succeeded in maintaining its leadership position in refillables while capturing a 45 per cent market share in disposables.
Improving the product’s existing value proposition (as Gillette did) is the first way to change consumers’ expectations of what is “good enough”. A second way is to shift the basis of competition altogether, away from what the disruptors are trying to catch up with (i.e. performance) to another product benefit. For example, SMH was able to shift customer attention away from performance to style and design, an area where the disruptor (Seiko) was not even considering. Nintendo also succeeded in doing this in its response to Sony and Microsoft’s entry in the home games console market.
Throughout the early years of the games console industry, consoles were viewed as toys, primarily targeted at young teenage boys with non-violent titles such as Super Mario, Donkey Kong, Zelda (all Nintendo) and Sega’s Sonic the Hedgehog. Nintendo dominated this market with its 16 and 32-bit cartridges and with its popular Super NES console, introduced in 1991. This dominance came to an abrupt end in 1994 with the entry of Sony’s Playstation into the market. With superior graphics, CD-quality sound playing techno tracks, and a full range of games titles, the Playstation broke out of the toy niche. Games were targeted at young adults who had larger disposable incomes to purchase new titles. The games themselves were darker, more sophisticated and more violent. Microsoft pushed the evolution of the market further in this direction with the introduction of its Xbox in May 2001.
The three-way battle focused the manufacturers on a continual and seemingly unending battle for technological advancement and superiority of hardware. Consoles had to have faster processing speeds and higher definition graphics. The games became more and more complex, requiring gamers to invest time learning how to play. An entire allied industry sprang up with websites and magazines that offered gamers tips on strategies to win as well as how to actually use the games controllers with their combinations of buttons and joysticks. Gamers themselves were seduced into immersing themselves ever deeper into these increasingly sophisticated fantasy worlds.
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 even 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 learnt quickly and played by all members of the family, including the very youngest and the very oldest.
The strategy seems to have paid off. 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 US. It has also been crowned the fastest selling console in history in the UK after one million units were sold in just eight months. Nintendo, the dominant giant brought to its knees, has now re-emerged as a dominant player in the video games industry. The disruptors are still searching for an appropriate response.
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 BoP disruptive innovations succeed in disrupting Western markets depends to a large extent on how aggressively (and how successfully) Western incumbents respond to them. The more successful the incumbents are in changing consumers’ expectations of what is “good enough” in their markets, the less successful the disruptors will be in disrupting them.
What determines if the incumbents respond aggressively?
Of course, whether the incumbents respond (or how aggressively they do so) depends on many factors. For example, if the incumbents are faced with a mature product where the potential for additional innovation is limited, there is little scope in encouraging them to invest more in innovation. Perhaps FMCG companies stopped investing in products such as cheese, rice and pasta not because they wanted to but because there was little room to innovate in these products. Similarly, if a product is already over-engineered, there is little scope in encouraging incumbents to continue improving its performance. For example, is the Gillette five-blade razor an improved product that consumers want or is it simply an over-engineered product that will fall prey to a simpler, “inferior” product? Only time will tell.
Past research has unearthed some of the factors that determine how aggressively incumbents are likely to respond. These factors can be grouped into three broad categories: awareness, motivation and ability. The more aware incumbents are of a disruptive innovation and the more motivated and able they are to respond to it, the more aggressively they will. Any factor that influences the firm’s awareness of the disruption or its motivation and ability to respond will influence how aggressively the firm responds.
Of the many factors that influence these three variables, two stand out: degree of conflicts between the disruptor’s business model and the incumbent’s business model; and the level of threat that the disruption poses to the incumbent’s main business. The degree of conflicts influences the firm’s ability to respond: the higher the conflicts, the lower the ability to respond. The level of threat influences the firm’s motivation to respond: the more threatening the disruption, the more motivated the incumbent will be to respond.
Simply because incumbents respond aggressively to a disruptive innovation does not necessarily mean that their efforts will be successful. In fact, the evidence shows that the attitudes and mindsets that incumbents bring into the battle are key to their success. Specifically, we know that incumbents that look at the disruptive innovation as a threat to their business are likely to fail in their response. Those that are more likely to succeed are those that approach the disruption as both a threat and an opportunity. This allows them to respond with the appropriate level of urgency, while at the same time maintaining a long-enough perspective to make the necessary investments.
In summary then, we can see that whether BoP innovators will succeed in disrupting Western markets will depend a lot on how the incumbents respond. How they respond, in turn, depends on too many factors to even begin listing here. But we can at least start to get a better idea on whether Western firms will respond aggressively enough or whether they will have much success with their responses, by thinking through the following questions:
- How threatening is the disruption to the incumbent’s main business?
- How conflicting is the disruption to the incumbent’s business model?
- How are the incumbents viewing the disruption?
Answering these questions will not give us a definite answer. But it will allow us to assess the probability that the incumbents will be successful in stopping BoP disruptive innovations from disrupting their markets in the West.
The incumbents’ response is key
Whether BoP innovations end up disrupting Western markets depends on whether they succeed in improving their products to a level where Western consumers begin to look at them as “good enough” while sustaining their significant cost advantage (reflected in a much lower price) over the incumbents. As discussed, if history is any guide, the two primary factors that will determine this outcome are: whether their cost advantage is derived from a business model which is not only different but also conflicts with the business model of the incumbents; and how aggressively and successfully the incumbents respond to the disruptors.
If these two factors are plotted on a matrix, certain implications follow (see Figure 1). If the disruptors’ cost advantage is derived from their innovative business model (e.g. airline companies) and incumbents do not respond aggressively enough (for whatever reason), then the disruptors will have great success in disrupting Western markets. If, on the other hand, the disruptors’ advantage is not based on an innovative business model (e.g. Bic) and incumbents respond aggressively (e.g. Gillette) then the disruptive innovation is unlikely to capture much market in the West.
The other two scenarios depicted in the matrix are more difficult to call. If the disruptors’ cost advantage is derived from their innovative business model and the incumbents respond aggressively, the outcome will be determined by how successful the incumbents are in executing their strategy and how committed they are in their response. The most likely outcome is that the disruptors will make some inroads in Western markets but the incumbents will be able to limit the damage. Similarly, if the disruptors’ cost advantage is not derived from an innovative business model and the incumbents fail to respond aggressively, then a lot will depend on how successful each group of firms in executing their respective strategies. The most likely outcome is that disruptors will gain some market share but incumbents will begin to take note (and respond) once the disruptors have grown to a certain size.
All this suggests that the outcome of the impeding battle will depend more on how the Western firms respond than on the disruptiveness of the innovations coming from the BoP. For the Western firms, knowing that their fate is in their hands is half the battle won.
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