Christensen uses the disk drive industry as an example and explains: “When the best firms subsequently failed, it was for the same reasons--they listened responsively to their customers and invested aggressively in the technology, products, and manufacturing capabilities that satisfied their customers' next-generation needs. This is one of the innovator's dilemmas: Blindly following the maxim that good managers should keep close to their customers can sometimes be a fatal mistake.”
The pursuit of ever increasing profits causes companies to increase their prices and innovate to bigger and better. As a result, they alienate and/or under-serve smaller customers along the way, opening the door to new competitors who serve those neglected customers with simple and inexpensive technologies. After winning the customer’s loyalty, the new entrants innovate their way up to larger customer segments along the way taking market share.
Last year US companies reported record earnings, up 37% in the fourth quarter. Most of those gains have been made through productivity improvements as a result of the “jobless recovery.” First quarter earnings for 2011 were a modest 11% because of inflationary pressure coming from oil, commodities and transportation.
Similar to the disk drive manufacturers highlighted in Clayton’s book, big companies who performed extremely well last year will be under pressure this year to maintain profits. The challenge this year is that cost are rising and companies have little room to absorb it. As a result, they are passing these costs to customers, which we have already begun to see.
Although confidence is slowly improving, consumers haven’t recovered fully from the recession. Wages have not kept pace with inflation. And according to a study by McKinsey, consumers have also learned to appreciate and enjoy lower cost products. When taking all this into consideration, we have a perfect storm gathering for new competition to enter at the low-end of the market.
What industries and companies are most likely to be squeezed? Let’s first start with who probably won’t: Industries with very little transportation and manufacturing needs; like the service sector; and media. Retail banking, financial information and professional services also come off the list. Business in industries that are somewhat shielded from inflation pressure, and/or can easily pass it along to consumers, like Healthcare and Utilities, also are likely to not feel the pressure.
Using that same logic companies in industries that rely heavily on transportation and commodities are top targets. Airlines, grocery chains, and manufacturing expect to see new low cost competitors with unique business models. Companies with high gross margins will also be especially rip for picking.
Where will the competition come from? Hopefully, new, innovative US companies but the best bet is probably China. They’ll use their low cost producer advantage, along with the fact that China controls more than 90% of the rare earth elements. Those minerals are used in your IPAD, IPhone and electric motors...given that fact, let’s add hi-tech to the list.
The good news is that time is right for disruptive innovation. New companies should mean job growth, as long as the credit markets continue to improve. And if you’re in an industry mentioned above, hopefully, innovation is top of the list of company priorities.
Coming out of the recession we are, most likely, very attuned to our biggest customers. But as Christensen warns us, to stay competitive we need to avoid being held “captive” by them. Perhaps while we are on the look out for new competitors, we might also want to keep an eye out for new customers.
