The key to disruptive innovation is to identify unserved or overserved markets and find ways to service them. An unserved market is one in which a large population lacks the skills or finance to participate; an overserved market is one in which the trajectory of product improvement, driven by the most demanding customers, has left the mainstream of the market open to a cheaper but good-enough innovation. The mainstream product, through continuous sustaining innovation, seeks to take more revenues from the most demanding, least-satisfied tier of customers who are willing to pay more for a better product. Meanwhile a disruptive product that appears later does not appeal to the great majority of the mainstream customers. The disruptive product costs less than the mainstream product and so is attractive to the most overserved users of the mainstream product. Its creator is initially satisfied with making lower levels of profitable income from the lowest tiers of the incumbent's user base.
Over time the disruptor is incentivised to improve the performance of its product to attract more and more customers away from the mainstream product. The incumbent is not motivated to defend these marginally profitable customers by providing a competing product because its limited resources are fully focused on serving its higher-margin customers and developing new products to satisfy its most demanding customers. Once it recognises the threat that the disruptor poses, the only defence that the incumbent has is to create a disruptive innovation of its own, sacrificing its low-end customer base. However, if that response is created within the existing business it will inevitably fail because the mechanisms the mainstream business uses to allocate resources will not favour the new innovation. Many disruptive innovations start in unserved markets, where the incumbents do not see any need to respond, and subsequently move into the overserved market where they start to remove the less-profitable customers from the incumbent. In fact, to be disruptive a product relying on new innovation must be capable of improving so that it gradually takes more and more of the incumbent's market.
The disruptor will again be motivated by increased profitability and growth, to create the improvements and innovations needed in their technology to sell to, what will be for them, the much more profitable customers. The industry incumbents cannot incorporate the disruptive business model within their own business. The incumbents are motivated to flee rather than fight. This presupposes that they have an attractive growth area to flee into. The reason that incumbents cannot adopt such business models are that their resources, processes and values prevent an innovation being proposed as an attractive use of the shareholders' money. In other words, the economics of the disruption are deeply unattractive to the incumbent. To be disruptive the technology must also be unattractive to the incumbents' main customers, otherwise it is just a threat to be dealt with. V-STP is a disruptive innovation because the combination of resources cannot be used by custodians to automate corporate actions internally. This is because many parts of the corporate actions process (more than 60% in the case of withholding tax) are fundamentally manual. Equally V-STP is unattractive to a custodian's customers (i) because they lack the resources to deal with the issue effectively and (ii) that's why they employ their custodian. The difference in this case is that the disruption is being offered as a competitive advantage to custodians in the market.
Its inventor, GlobeTax, can't use V-STP directly because it doesn't compete with custodians, they are its customers. So, what is a complex, manual and difficult area for custodians becomes a clear differentiator for them, if they are able to adopt the innovation to put them a step ahead of their in-market competition. If a new business attacks an incumbent's main market then the incumbent is motivated to defend its territory. A disruption has to attack either the overserved - those who don't need all of the features of the incumbent's service that are designed for the more demanding end of its market - or service the unserved, those who cannot afford the incumbent's services. Once the disruptor has established a foothold it can then go on to improve developing the expertise to make the best use of the new technology. As the new technology continues to improve it eventually invades the territory of the incumbent, which by now lacks the resources and expertise in the new technology to compete.
Christensen uses the example of Sony to illustrate this point. While the television manufacturers set about trying to develop the transistor to the point where it could be used in their large sets, Sony used the transistor for what it was good for at the time and created a small, low-cost low-power radio. This radio's performance was in turn far inferior to the large household valve radio sets of the day - its sound reproduction was tinny and it could only power an earpiece, not a loudspeaker. However, the new radio created a new market of teenagers for whom the alternative was not listening to music at all, and who were now able to listen to their own choice of music with their friends wherever they chose. Sony went on to create more and more new products, eventually moving into low-cost portable black-and-white TV sets while the mainstream TV manufacturers like RCA and Rediffusion were developing large colour sets that still required the capabilities of the vacuum tube. As the technology developed still further Sony and others were able to use the transistor to meet the demands of the market for colour televisions. RCA and Rediffusion were gradually displaced from the TV market partly because they lacked the skills in the new technology to create competitive transistorised products. The exponential rate of increase in processing power of microchips, a prediction known as Moore's law that the industry has followed now for over 40 years, is the basis of a sequence of disruptive developments - the mainframe computer, the minicomputer, the desktop PC, the hand-held computer, the datacentre, distributed computing and so on.
The development of hand-held electronics, including the personal digital assistant (PDA) or high-functionality mobile phone, has been the result of the continuing development of many different technologies which have been combined to create new and exciting products. The iPod is a good example - the battery, screen, processor, touch-sensitive controls, the iTunes music management system and digital copy protection all combined with Apple's funky magic to create a ground-breaking innovation that has had as big an impact as Sony's original transistor radio. Much of this would have seemed irrelevant to the financial services industry even as little as two years ago. However it is already clear that mobile banking at the retail level is set to roll-out into the markets over the next 18 months. The iPhone and many other hand-held devices already have good enough Internet connections to provide access to on-line banking sites for customers. What is less clear is what innovations will flow through to back office processing from these technologies. Parallel developments in various technologies including memory, disk drives, batteries, display technologies and so on have allowed the continual introduction of new and innovative electronic products. Peer-to-peer technologies combined with open source may perform a similar feat in the financial industry.
Progressive developments of technologies have the tendency to make industry pundits look extremely foolish. They successfully predict the use of the developing trajectory to make sustaining innovations while invariably completely missing the opportunities where the innovation has finally become good enough to form the basis of a product that creates a whole new market.
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