Editor’s note: Andy Rachleff is President and CEO of Wealthfront, an SEC-registered online financial advisor. Prior to Wealthfront, Andy co-founded and was general partner of Benchmark Capital. Follow him on Twitter @arachleff.
Entrepreneurs in Silicon Valley love to talk about disruption, though few know what it really means. They mistake better products for disruptive ones. Silicon Valley was built on a culture of designing products that are “better, cheaper, faster,” but that does not mean they are disruptive.
I mistook better, cheaper, faster for disruptive when I became an entrepreneur. This was after I had spent years thinking about disruption as a venture capitalist, and even structured a Stanford Graduate School of Business class around Clay Christensen’s book, The Innovator’s Dilemma.
Christensen, a Harvard Business School professor, defined “disruption” in The Innovator’s Dilemma. In short, a disruptive product addresses a market that previously couldn’t be served — a new-market disruption — or it offers a simpler, cheaper or more convenient alternative to an existing product – a low-end disruption.
An incumbent in the market finds it almost impossible to respond to a disruptive product. In a new-market disruption, the unserved customers are unserved precisely because serving them would be unprofitable given the incumbent’s business model. In a low-end disruption, the customers lost typically are unprofitable for the incumbents, so the big companies are happy to lose them.
Thus, the innovator’s dilemma. Incumbents appropriately ignore the new product because it is uneconomic to respond, but the incumbents’ quiescence can lead to their later downfall.
Google: Disrupting online advertising. Most people correctly refer to Google as disruptive but don’t understand why. Google’s search algorithm wasn’t disruptive. It was AdWords, its advertising service. In contrast with Yahoo, which required advertisers to spend at least $5,000 to create a compelling banner ad and $10,000 for a minimum ad purchase, Google offered a self-service ad product for as little as $1.
The initial AdWords customers were startups that couldn’t afford to advertise on Yahoo. A five-word text ad offered inferior fidelity compared with a display ad, but Google enabled a whole new audience to advertise online. A classic new-market disruption. Most have forgotten that Google added significant capability to its advertising service over time and then used its much-lower-cost business model (enabled by self-service) to pursue classic Internet advertisers. Thus it evolved into a low-end disruption.
Salesforce: Disrupting CRM. Salesforce started as a new-market disruption and evolved into a low-end disruption. Its initial product had fewer features than Siebel Systems’ software, but Salesforce made it possible for companies that couldn’t afford a multi-million dollar license fee to employ sales force management software. Once it built a critical mass and further developed its product, Salesforce disrupted Siebel and other CRM companies from below.
It is far more common for a product to be only a new-market disruption or only a low-end disruption. eBay brought auctions to the non-Sotheby’s crowd. Amazon’s amazing business is simpler, cheaper and more convenient than shopping at a store.
Disruptive products don’t have to be cheaper. A low-end disruption doesn’t have to be lower priced than existing products. Christensen says a low-end disruption must be simpler, cheaper or more convenient. Uber is a great example of a disruptive service that is more convenient, but more expensive than its taxi alternative.
Low-end disruptions are usually inferior. It is also possible to offer a low-end disruption through an inferior product. In fact, almost all disruptions start out with products that are inferior to those of the incumbents. This is possible when current customers are “over served” by existing products.
Understanding disruption is hard. Disrupting is even harder.
Ubiquiti, a supplier of Wi-Fi equipment that went public about a year ago, is an example of this kind of disruption. It sells dirt-cheap access points that are designed, manufactured and distributed by third parties. Ubiquiti’s products are dirt cheap because they offer far fewer features that appeal to the most cost-sensitive audience and because the company employs very few people. Not surprisingly, Ubiquiti is taking major market share from the incumbents.
A better product isn’t necessarily disruptive. Tesla has built new cars that I think are tremendous, but the company is not disruptive. It doesn’t address consumers who can’t solve their current problems with existing cars, and its cars are not far less expensive than the incumbents’ cars.
Kayak went public a few months ago and is thought by many to be disruptive. While it’s a better service than alternative travel sites, it is not disruptive by the Christensen definition, because it is not uneconomic for the incumbents to respond (and many have).
Business models, not products, are disruptive. People sometimes say a technology is disruptive. It’s more appropriate to call the business model disruptive. In order for a company to disrupt, the revenue and cost structure of the incumbents that the company faces must keep them from responding. It’s easy for other companies to add Kayak-like technology to existing products. The business model, not the technology, usually determines whether it is uneconomic for the incumbent to pursue the disruptor.
If you apply this model of disruption to past fads, you can predict with incredible reliability which products turn into long-term successful businesses and which ones don’t.
You would think a guy who has witnessed many disruptions over a 25-year venture capital career and teaches disruption would find designing a disruptive strategy easy. I thought I’d found the formula with Wealthfront’s initial service, which was meant to be disruptive to mutual funds. In hindsight, we built a better product than the alternatives, but it wasn’t disruptive.
Contrary to conventional wisdom, startups with better products seldom succeed unless they are also disruptive. We hadn’t been growing as fast as we had wanted to, and then I happened to reread a Christensen chapter on competition to prepare for a class I was about to teach. It immediately hit me that our initial service had no chance.
We began to find success when we transitioned into a software-based financial advisor attempting a new-market disruption by serving young people who can’t afford the high minimums associated with traditional financial advisors (financial advisors can’t afford to lower their minimums to compete with us).
Understanding disruption is hard. Disrupting is even harder.