The case for disruption is clear….

Pick up a newspaper, read the latest magazine, listen to the news and the message is consistent and clear – the 4th industrial revolution is here, and businesses must disrupt or be disrupted. Books such as Martin Ford’s “The rise of the robots” make the case. The race is on to be the first mover in each sector to create the leading businesses of tomorrow.

…or is it?

Whenever a trend becomes so universally accepted, I always worry about how everyone can be so certain as to what the outcome is going to be. If last year has taught us anything, it is surely that the world is hard to predict, and we should be wary of the herd mentality. The case for digital disruption should be approached no differently to other trends – decisions should be based on rigorous analysis. I find it hard to believe that the optimal strategy for every business is to move to adopt new technologies immediately. Could there be opportunities to maximise shareholder value by taking a different course to the herd?

Is disruption an illusion?

There are alternative views as to the pace of change and hence its implications. The analysis in “The Innovation Illusion” suggests that a pause for thought before plunging headlong into a disruptive approach could be wise. The authors, Erixon and Weigel, point out that contrary to the view that the pace of innovation is accelerating, the reality is that markets have become increasingly stable in recent times. There has only been one new company in the CAC 40 since 1970, and only two entrants to the DAX 30 in Germany in the same period. Indeed the top 100 most valuable companies in Europe are all over 40 years old. This view is supported by research by Harvard’s Shikhar Ghosch, who found that over 95% of start-ups fail to deliver their expected returns. It does appear that the case for pursuing disruption at all costs is not as clear as we might think from listening to the headlines.

Change is all around us…

However, scepticism over future innovation sits uneasily with the everyday experience which suggests technology expansion is ever faster and more widespread than the past. When we consider the media and music worlds, it is certainly the case that there has been dramatic change in the way that these products and services are supplied and consumed. Messaging services and other developments mean we are in an “always on world”.

…although the financial benefits can be hard to discern.

It is important to note that much of the innovation that captures most attention is in the consumer rather than the corporate space. Moreover, many of these new services appear to be available at low or zero cost if my daughter’s communication and media consuming behaviour is any guide. This may explain some of the reasons why we don’t see innovation showing up in productivity statistics as strongly as we might expect. People are able to connect more easily and regularly and access more information faster than before, and this improves their quality of life, but the free or low charging regimes limit the impact on GDP and productivity aggregates. This may also mean that businesses should be wary about how they respond. Disrupting a profitable business to create one with free services may not be value enhancing.

Understand the threat of disruption…

Erixon and Weigel identify a number of factors which they believe are currently inhibiting innovation:

• “Gray Capital”: the impact of the desire of pension funds and institutional investors for predictability, which acts to slow change;
• Managerialism: which describes the way corporate bureaucracy and planning processes work to ensure stability and hence work against innovation;
• Globalisation: acting to strengthen the power of incumbents both in end user markets and throughout value chains; and
• Regulation: which increasingly works to reduce market dynamism, making it hard for new firms to enter markets.

While my view is that the authors stretch some of these points a little too far, the analysis provides a guide to factors that are influencing the rate of innovation in different sectors, and slowing the overall pace of change. Companies with a strong market position in sectors in which one or more of the inhibitors are present, may well have more time before the threat of disruption materialises. Certainly all decisions need to be based on tailored industry, and possibly even geographic, market analysis.

…and disrupt when you have to.

The imperative to disrupt and especially to self-disrupt, is neither as certain nor as urgent as it might at first seem. It certainly varies by industry, and businesses should assess their industry structure and look for the presence of the inhibitors to innovation outlined above.

Companies in relatively concentrated sectors, especially ones in which regulation shapes the market, may well find they are more protected from disruption than firms in other sectors. Making the move to disrupt the market in these cases could well destroy the value that could be generated by a more gradual approach. I remember from my time working in the telecommunications sector, that in markets dominated by four or five firms, being the follower in innovation terms was usually the strategy that paid off.

By contrast, fragmented sectors such as hotels and taxis provide examples of how disruption can take hold. Although even in some of these sectors, the presence of regulatory barriers provides larger firms with some protection.

Companies in sectors that are exposed to disruption by start-ups will need to move faster and potentially disrupt themselves before others do so. By contrast in more concentrated markets, disruption by incumbents may not be the value maximising strategy, a managed approach may be more lucrative. Experience to date suggests the key task is to define the approach for dealing with legacy assets and resources – these are the potential sources of weakness compared to the cleaner business models typically developed by new entrants. As an example, think of a high street retailer with an expensive store estate and large workforce competing with an online provider.

Disruption is in vogue, and the message seems to be that there is no alternative and hesitation is not an option. This is not universally the case – decisions should be made based on rigorous analysis as it is possible that a more gradual approach may be more beneficial for many companies. It is important to do the work now to ensure the business is prepared when disruption does materialise.

@MarkGregoryEY

markgregoryeconomics.ey.com

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