Responses to Disruptive Strategic Innovation (2024)

In the mid-1990s, European airline giants such as British Airways and KLM Royal Dutch Airlines came under attack from relative newcomers such as easyJet and Ryanair. Rather than embrace the full-service, hub-and-spoke strategy of the major airlines, the upstarts introduced a low-cost, point-to-point, no-frills strategy that proved to be a hit with European consumers. Before long, they had captured a large segment of the market, and established airlines in Europe were searching for answers to the threat. Meanwhile, Merrill Lynch was searching for its own answers in response to competition from online brokers such as Charles Schwab, E*Trade and Ameritrade. Unilever was concerned about a threat in its business — the growth of low-priced, distributor-owned brands (private label) — and Barnes & Noble was considering how to respond to online distribution of books and Amazon.com. In industry after industry, once formidable competitors that had built their success on apparently unassailable strategic positions were coming under attack from relative unknowns that employed radical new strategies. As a result, established leaders in a variety of industries were asking the same question: “Should we respond to these disruptive innovations and, if so, how?” (See “Examples of Disruptive Strategic Innovations.”)

The leading companies were facing a dilemma: Their attackers utilized strategies that were both different from and in conflict with their own. Thus, if the established companies were to respond by adopting the strategies of their attackers, they would run the risk of damaging their existing business and undermining their existing strategies. However, they couldn’t simply ignore the disruptions. What, then, was an appropriate response?

Understanding the Phenomenon

Strategic innovation is a fundamentally different way of competing in an existing business.1 The way Amazon.com competes in book retailing is different from Barnes & Noble’s way. Similarly, the way Charles Schwab, easyJet and Dell Computer play the game in their industries is different from the way competitors such as Merrill Lynch, British Airways and IBM play the game in theirs.

Strategic innovation means an innovation in one’s business model that leads to a new way of playing the game. Disruptive strategic innovation is a specific type of strategic innovation —namely, a way of playing the game that is both different from and in conflict with the traditional way. Examples include Internet banking, low-cost airlines, direct insurance, online brokerage trading, online distribution of news and home delivery of grocery services.

Past research has shown that disruptive strategic innovations share certain characteristics. First, compared with traditional approaches, they emphasize different product or service attributes. Thus traditional brokers sell their services on the basis of their research and advice to customers, whereas online brokers sell on price and speed of execution. As a result, innovators become attractive to a new customer segment.

Second, disruptive strategic innovations usually start out as small and low-margin businesses. That’s why they rarely gain support or long-term commitment from established competitors. The innovations are small and are not attractive until they start growing.

Third, disruptive strategic innovations grow to capture a large share of the established market. Over time, they improve to the extent that they are able to deliver performance that is good enough in the old attributes that established competitors emphasize and superior in the new attributes. Inevitably, their growth attracts the attention of established players. As more customers (both existing and new) embrace the strategic innovation, the new business receives increasing attention from the media and established players. Soon, established companies cannot afford to ignore the new way of doing business anymore and begin to consider ways to respond.

At this stage, established companies confront an unavoidable fact: The new ways of playing the game are in conflict with the established ways. That is because the strategic innovations have different key success factors and thus require the company to develop a new combination of tailored activities as well as new supporting cultures and processes. For example, if British Airways is to compete effectively against easyJet, it must evaluate the discount end of the market and develop the activities and processes required to be successful in it. But the new activities are incompatible with the company’s existing activities because of the different trade-offs in the two ways of doing business. Thus, British Airways cannot simply start selling tickets through the Internet like easyJet, because its existing distributors — travel agents — will object.

The existence of trade-offs makes it difficult for an established company to respond to the disruptive innovation effectively. A company that tries to compete in both positions simultaneously risks degrading the value of its existing activities and will experience major inefficiencies. Any attempt to manage the innovation by utilizing the company’s old systems, processes, incentives and mind-sets will only suffocate and kill the new business.

Conflicts between the traditional and the new way of playing the game have prompted many academics to argue that, in response to disruptive innovation, an enterprise should either ignore the disruption (and stick to its core strategy) or embrace the disruption, but only in a separate division or company.2 But are those the only responses for established companies? And under what circ*mstances is each option preferable? It was with those questions in mind that we embarked on a multiyear research project to explore disruptive strategic innovation in more detail. (See “About the Research.”)

Responding to Disruptive Innovation

Of the 98 established companies that completed our survey questionnaire, two-thirds had responded to a disruptive innovation in their industry by adopting it in some form — either by setting up a separate organizational unit or by using the existing organizational infrastructure. Of course, the way those established players adopted the innovation proved to be more nuanced than simply deciding whether to create a separate unit. Among the companies that did not adopt the innovation in their industry, there were also a variety of strategic responses — including, but not limited to, ignoring the disruption. Overall, we identified five key responses to disruptive strategic innovation.

Response One: Focus on and Invest in the Traditional Business

The biggest misconception about disruptive strategic innovation is that the new way of doing things will grow and eventually overtake the traditional way of playing the game. Established competitors, the thinking goes, had better face up to the innovation by embracing it somehow. That misconception probably arose from research on technological innovation showing that new disruptive technologies replaced the existing technologies completely and destroyed competitors that failed to jump from the old to the new. That may be true for disruptive technological innovations, but not for disruptive strategic innovations.

With a strategic innovation, the new way of competing grows (usually quickly) to control a certain percentage of the market but fails to overtake the traditional way completely. For example, Internet banking and Internet brokerage have grown rapidly in the last five years but have captured, at most, only 10% to 20% of the market. Similarly, budget, no-frills airlines have grown phenomenally since 1995 but have captured no more than 20% of the total market. In market after market, the new ways of playing the game grow to a respectable size but never really replace the old ways. Nor are the innovations ever expected to grow to 100% of their markets.

Appreciating that the new way is neither superior to the existing way nor destined to conquer the whole market opens up alternatives for established players. An established competitor does not necessarily have to embrace the innovation. It could respond by making its traditional way of competing even more attractive and competitive. That might sound obvious, but in most established competitors, the framing of the decision has usually been: “Should we do it or not, and if we do, how do we play two games simultaneously?” Companies rarely consider that responding to disruptive innovation can mean declining to adopt it and instead investing in its own business.

Yet that is exactly how Gillette responded in the face of the disposable-razor threat. Like any disruptive strategic innovation, disposables entered the razor market by emphasizing a different dimension of the product (price and ease of use versus Gillette’s closeness of shave) and grew quickly to capture a large market segment. How did Gillette respond? Without completely ignoring the disruption, it chose to focus its resources on its traditional business to improve its competitive standing relative to the new way of doing business. It produced disposable razors in a defensive way, but it focused its energy and resources on its main business and innovated by creating two new products, the Sensor and the Mach3. Innovation in the traditional business eventually led to the decline of the disposable-razor market from its heights in the 1970s. Even Gillette’s November 2002 decision to create a new line of disposable razors did not come at the expense of its main business.

According to our research, companies that chose not to embrace a disruptive strategic innovation did so because they wanted to remain focused on their existing businesses, often to capitalize on large investments already made. In addition, senior management was against embracing it because of important issues and challenges in the existing business. (See “Why Not Embrace Disruptive Innovation?”)

Edward Jones, one of the leading companies in the U.S. retail-brokerage industry, is another firm in the study that decided not to embrace the disruptive innovation, Internet brokerage, which invaded its market in the mid-1990s. According to chief operating officer Doug Hill, “We think online trading is for speculators and entertainment. We are not in the entertainment business; we are in the ‘peace of mind’ business.”

Instead, Edward Jones focused on improving its value proposition for its targeted customers, investing in its trademark personal, face-to-face service in its offices across the country. The company continues with its one-broker office strategy, which runs counter to that of virtually every other major U.S. securities organization. As managing partner John Bachmann has stated, “You will not buy securities over the Internet at Edward Jones. That’s going to be true as far as I can see into the future. … If you aren’t interested in a relationship and you just want a transaction, then you could go to E*Trade if you want a good price. We just aren’t in that business.”3

Jones’ conservative style of managing assets, remaining unchanged despite the rapid expansion of online trading, has helped fuel remarkable growth. The number of offices has expanded from 304 in 1980 to more than 4,000 today (more than any other U.S. brokerage firm). Edward Jones’ response highlights a key finding of our research: New ways of competing are not always destined to win the battle. In fact, depending on how they respond, established competitors can slow down or even destroy the new ways.

Response Two: Ignore the Innovation — It’s Not Your Business

Our research uncovered a second aspect of disruptive strategic innovation that can easily lead established companies astray: Compared with the traditional way of doing business in an industry, the new way targets different customers, offers different value propositions and requires different skills and competences. In fact, the new way is often so divergent from the established players’ way of playing the game, it might be viewed as a totally different business. For example, is online brokerage similar to traditional brokerage or a totally different industry? By adopting a disruptive innovation that only appears to be in its business, an established competitor is effectively diversifying in an unrelated market. That could lead to disaster.

That’s why Hartford Life chose not to get into direct selling of life and health insurance by phone or Internet. According to the company, direct sales methods are appropriate primarily for simple products for the low-end segment of the market. “Since our product and distribution does not focus on this market, we do not see direct sales as a current threat, nor do we see it as a sales opportunity,” says one senior executive. “We target the top 5% of affluent Americans, people with a net worth in excess of $2 million. These customers have complex financial problems and need professional advisers to identify problems and solutions. The life-insurance agent or broker, working with the client’s attorney or accountant, is often used to provide this consultation as part of the selling process. People with lower income levels do not have such complex financial issues and may be more approachable through direct sales methods. Since this is not our target market, we have spent few resources on evaluating or implementing direct-marketing strategies. The affluent market is large and growing fast enough to fuel our growth for the foreseeable future.”

That example reinforces the point that even though an innovation may be part of the established competitor’s industry, it may not be part of its market. This implies that before deciding to adopt a disruptive innovation, an established company must assess carefully whether the new way is related to its existing way.

Assessing relatedness is a thorny issue for many established companies. Traditional measures of relatedness provide an incomplete and potentially inaccurate picture of the scope of exploiting interrelationships between two businesses. Recent academic research has shown that companies need to go beyond cosmetic similarities and assess relatedness at the competency level rather than the industry level.4 Specifically, they should assess what kind of skills, competences and assets they currently have and what they need in the new business. The skills and competences that count are those that are difficult for competitors to imitate or substitute. Only if the traditional and the new business share enough of these difficult-to-imitate assets and competences should the two businesses be considered related.

The mistake that established competitors make is to assume that because a disruptive innovation creates a new market in their industry, it must be an easy market to enter and a quick way to achieve growth. That may not be what awaits them should they enter the new market. A more appropriate response is to ignore the innovation — it may look appealing but it is not their business.

The second response is both similar to and different from the first. In response one, established competitors recognize the innovation as a threat to their business. As a result, they invest to make their business more attractive to customers relative to the disruptive innovation. In response two, the established competitors do not see the innovation as a threat. They continue to play the game in their business as if the disruption did not even occur.

Response Three: Attack Back — Disrupt the Disruption

Established competitors play one game — emphasizing certain product attributes and targeting certain customers. Disruptive innovators attack them by playing a second game. They build their success by emphasizing new, nontraditional product or service attributes that, by definition, become attractive to new customers. Over time, the innovators also become good enough at delivering the attributes that traditional customers value and thus begin to attract the customers that originally had remained loyal to the established companies. How should the established competitors respond? Why not develop a third game, attacking the innovators by emphasizing still different product attributes?

In the early 1960s, for example, the Swiss dominated the global watch industry, selling watches on the basis of Swiss craftsmanship and the accuracy of their mechanical movements. The dominance all but evaporated in the 1970s when companies such as Seiko and Timex introduced cheap watches that used quartz technology and provided added functionality and features. As with every disruptive innovation, the innovators did not attack by trying to become better at providing the product attributes that the established competitors (the Swiss) were emphasizing (quality of the movement and accuracy). Instead, they focused on different product attributes — price, features and functionality. Swiss share of global world production declined from 48% in 1965 to 15% by 1980.

The response of the established Swiss watch industry should be a lesson to all companies facing similar strategic disruptions. Instead of adopting the new way of playing the game, the Swiss responded by introducing the Swatch. The new watch did not pretend to be better than Seiko or Timex in price or performance. Instead, it emphasized a totally different product attribute — style. Instead of responding to the disruptive game by embracing it, the Swiss chose to disrupt it. Since its launch in 1983, Swatch has become the world’s most popular watch, with 100 million sold in more than 30 countries.

Other companies currently disrupting their disruptors include Sony (in mobile phones), Apple Computer (in personal computers) and British Airways. For example, after its airline market was attacked by easyJet and Ryanair, British Airways responded by emphasizing comfort and luxury in its service offering — witness the introduction of seats that become flat beds, and the luxurious executive lounges in airports around the world. Similarly, both Apple and Sony are responding to the invasion of cheap products in their businesses by emphasizing style and design as the attributes of their products — the Apple iMac is a classic example.

Response Four: Adopt the Innovation by Playing Both Games at Once

A fourth alternative is simply to adopt the disruptive innovation. The decision must be based on a detailed cost-benefit analysis.5 But even when an established company has resigned itself to the fact that a disruptive innovation is here to stay and that it had better find a way of adopting it, doing so can be problematic. The question arises, “How do we adopt it?” Unlike entrepreneurial startup companies such as The Body Shop or Dell Computer — entrants that occupied no other strategic position — established companies already have a way of playing the game. If an established company decides to adopt the strategic innovation, it must find ways of playing two different and conflicting games simultaneously.

Despite the challenge, 68 of the 98 companies we surveyed decided to embrace the disruptive innovation in their industries. The study showed that managerial perceptions about the dangers of playing two games varied considerably, with some companies viewing the potential conflicts as serious risks to their existing businesses and others being relatively unconcerned. (See “Conflicts in Playing Two Games.”) Not surprisingly, those companies that viewed the potential conflicts as serious risks decided not to embrace the innovation. Those that embraced the innovation viewed the size and importance of the conflicts facing them as manageable.

The majority (62%) of those that decided to adopt the disruptive innovation entered the new business by establishing a separate unit — most doing so from the start, with the rest spinning out the new venture later, under the wing of the parent company. The remaining companies chose to compete in the new business solely through their existing organizational structure and divisions.

Sixty-eight percent of the companies that established a separate unit used a different name for the new organization, and 83% of those put a new CEO or division manager in charge. In most cases, that person moved from an existing position within the organization.

The products or services that the companies offered in the new businesses were, on average, different from those in the established businesses along dimensions such as targeted customer segment, level of personal service provided, price and overall characteristics. To offer the new products and services to customers, a majority of the new units (79%) shared back-office activities with the parent companies.

Clearly, embracing the disruptive innovation through a separate organizational unit was popular. Graham Picken, creator of the United Kingdom’s most successful telephone bank in the late 1980s (First Direct, a subsidiary of Midland Bank), offers insight: “The question is not whether conflicts exist between the traditional retail-banking business and direct banking. They do exist and are important. The key question is how well the company manages these conflicts, which will ultimately determine its success in competing in the two different businesses. First Direct was formed as a stand-alone company and had the freedom to set up its own processes, organizational structure, incentive and control mechanisms, and create its own distinct culture.” The new bank, Picken says, was set up to be what is known as a “greenfield” operation, to offer a new value proposition to a newly identified customer segment by distancing itself from the Midland Bank. One indication of Midland’s desire to create an organization disassociated from traditional banking was keeping the word bank out of the new unit’s name. Simply separating the new unit is not enough. The new business must have autonomy to run its operations as it sees fit. We found that the higher the degree of decision-making autonomy given to the new units, the more effective the company was in playing two games simultaneously. For example, when Royal Bank of Scotland formed Direct Line Insurance to introduce direct telephone insurance in the United Kingdom in 1985, it gave founder Peter Woods total operational autonomy. “I was given the freedom and power to build a new, independent company,” he says. “I was able to hire new people from outside the bank and set up Direct Line Insurance as a separate business.”

In addition to decision-making autonomy, the new units in the study had their own budgetary and investment policies and procedures. They also developed their own cultures and values. However, their reward mechanisms were kept similar to those in the established businesses.

Overall, the research results suggest that although it is difficult to manage two strategic positions simultaneously, the task is not impossible. Using questionnaire data, we conducted regression analyses to examine whether separating the new business is beneficial to the company, finding that, on average, it is. But it also appeared that how the new unit is managed (in terms of autonomy, processes and incentives) has more to do with its eventual success than the decision to keep it separate. The study suggests that the higher the degree of decision-making autonomy given to a new unit and the greater the synergies between it and the parent company, the more effective the company is at playing two games simultaneously.

Response Five: Embrace the Innovation Completely and Scale It Up

The final option available to established companies is to abandon their existing ways of playing the game and embrace the disruptive strategic innovation wholeheartedly. In that case, the goal is not only to imitate the innovation but also to scale it up and grow it into a mass market.

Consider, for example, the case of online brokerage. What few people know is that the first online broker was not Charles Schwab or E*Trade. Rather, it was two Chicago companies, Howe Barnes Investments and Security APL, which launched a joint venture called Net Investor in January 1995 to offer Internet-based stock trading. Six years later, the venture was dwarfed by the success of Charles Schwab. So although Charles Schwab did not discover online brokerage, it can be credited with scaling it up into a mass market.

The key point for established competitors to remember is that innovation involves two essentially different activities — coming up with a new technological, strategic or product idea and then creating a market out of it. For an innovation to be successful, both activities have to be effectively coupled, but there is no need for the same organization to do both. One company may come up with a new and disruptive way of playing the game and another may take the idea and run with it.

In fact, the skills and capabilities needed for scaling up are essentially different from those needed to discover the new idea. In this regard, established companies have a competitive advantage over the pioneers — they have the skills and competences to embrace a disruptive innovation introduced by another company and grow it into a mass market.

Established companies are, typically, slow movers, and they ought to be. Assembling the required skills and capabilities to take ideas and grow them into big markets is a formidable undertaking. Most of the investments involve substantial sunk costs not to be undertaken lightly. Established companies are better able to make the serious investments in production needed to generate high-quality products economically. Further, only big-name, established competitors are credible enough to send a clear signal that the market is about to develop in new and profitable ways. They can reach out to the many potential consumers who are ready to purchase the new product or service — but are unwilling to shoulder the risk of choosing between many alternatives — and create consensus to support a dominant design. Finally, established companies are best at creating the kind of organization required to serve such a large and rapidly growing market.

The idea that established competitors have the option of embracing somebody else’s disruptive innovation and growing it into a mass market is neither new nor novel.6 What is amazing is how few established competitors consider it. Many of the managers we interviewed at established companies talked about the strategy but refrained from using it. Yet history suggests that those companies that pursue the option successfully create the basis for tremendous growth for years to come.

When To Do What

Which of the five responses to disruptive strategic innovation is right for a specific company? The answer depends on the company’s position in its industry, its competences, the rate at which the disruption is growing, the nature of the innovator that introduced the disruption and so on. However, past research has identified two factors that influence how companies should respond to major disruptions in their businesses: motivation to respond and ability to respond.7

In the case of disruptive strategic innovation, the ability of an established company to respond is determined by factors including the company’s portfolio of skills, its resources and the time it has at its disposal. But most important is the nature and size of the conflicts between the traditional business and the new business: The higher the degree of conflict, the lower the ability to respond. Similarly, the company’s motivation to respond is determined by factors such as the rate at which the innovation is growing and how threatening it is to the main business. Here the most important factor is how strategically related the new business is to the existing one: The more strategically related the new business is, the more motivated the company will be to respond.

If the two factors are plotted on a matrix, certain implications emerge. (See “How To Respond to Disruptive Strategic Innovations.”) When the company’s motivation to respond is low — either because the disruptive strategic innovation is not growing fast or is not threatening to the traditional business — the established company should ignore it and focus on its own business no matter what its ability to respond. However, if the company’s motivation to respond is high, but its ability to adopt the innovation is low because of major conflicts, it should either attempt to destroy the innovation or embrace it completely, abandoning its traditional business. If the company’s motivation to respond is high and its ability to adopt the innovation is also high because of the absence of major conflicts, it should imitate the innovation, incorporating it into the traditional business.

Every organization needs to determine its own specific response according to the unique circ*mstances facing it. The recommendations here are applicable only on average. But appreciating that the new ways of competing are not inherently superior to the existing ways and that established companies have many options for responding is half the battle.