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Avoiding Disruption

We look at disruption as a good thing, but how can companies ride the wave?

8Jul

Disruption of existing business models, leading to the collapse of major companies and even entire industry sectors is, of course, not new. In the past the main causes of disruption were:

  • The adoption of new technologies that were relatively slow to develop and become adopted as in the case of jet propulsion in aircraft manufacturing.
  • The growth of very low cost imports (for example of clothing and footwear as in the case of the UK textile and shoe making industries), increasing steadily from the 1960’s.
  • Long term changes in consumer behaviour such as the adoption of continental type lager beers.

More recently there have been a multitude of technological innovations that are capable of very rapid development and deployment and which have the potential to cause disruption in a wide range of industries.

Nokia provides a classic case of a company being derailed in this way. Not that long ago Nokia was the world’s dominant and pace-setting mobile phone maker. Yet by 2013 it had just three per cent of the global smartphone market, and its market cap was a fifth of what it was in 2007 even after rising more than thirty per cent on the back of the sale of its handset business to Microsoft.

The company underestimated how rapid the transition to touch-screen smartphones would be. Nokia was earning more than fifty per cent of all the profits in the mobile-phone industry in 2007, and most of those profits were not coming from smartphones. Diverting a lot of resources into a high-end, low-volume business (which is what the touch-screen smartphone business was in 2007) was not something the company was prepared to do.

Today, no company, however successful, is secure from the fear of disruption and the issue should be on every board agenda. The two key questions are:

  • Which new technologies pose a threat to our business?
  • Do we have the capacity to respond in a timely way to such a threat?

Established companies are often late to spot threats to their business model. A McKinsey article discusses how they should respond when industry disruption strikes and makes, inter alia, the following points.

Incumbents can not only compete but actually lead radical industry change if they pay attention to the way their business model is shifting and act boldly in response.

Well managed companies may excel running their business in current business conditions or responding to a very immediate crisis. But disruption plays out over a very, very long period of time, and the pressures of the short term are so all encompassing that the possibility of disruption gets scant attention.

CFOs dislike a business case that’s based on preventing decline as distinct from proposing an investment that is going to add to profitable growth.

It is very difficult for long serving executives to accept the decline of a business that they have grown up in and they love and to accept that it will continue to decline without big investment and big effort. That is why, when the response does come, it is too often too late.

The top executives grew up in the era pre disruption. They’re actually the architects of the existing business model. Their conviction in the soundness of that and their beliefs about consumer behaviour are all based on past experience and have served the company well. They are likely to be blind to some big shifts that are taking place. For those who are aware of the threat of disruption, it is not easy to determine which of many digital or other trends are going to influence their business and which ones are simply hype?

Philip Beeching (Guardian, January 15th 2013) described what happened when he made a presentation to the CEO of HMV, at the time the most powerful company in the music industry. He said that there were three main threats – online retailers, downloadable music and supermarkets discounting loss leader product. The CEO stopped the meeting and was visibly angry. “I have never heard such rubbish”, he said, “I accept that supermarkets are a thorn in our side but not for the serious music, games or film buyer and as for the other two, I don’t ever see them being a real threat, downloadable music is just a fad and people will always want the atmosphere and experience of a music store rather than online shopping.”

When companies do react they face all the inertia that exists in a large organization and that makes it hard to respond in a timely way. Added to which the top team face the prospect of destroying their own jobs because a radical shift in business model will probably require new leadership to carry it through successfully.

The difficult thing about avoiding disruption is that by the time action of some kind is unavoidable the financial strength of the business will already have diminished and the capability to act will have suffered accordingly. Therefore companies need to act before they have to act.

The role of the board is key. Partly it’s because it’s quite hard at times for a board to disentangle all this talk about potential sources of disruption and threats to the business model from the question of whether the management team is doing everything they can to run the current business well?

To send a message to the market that earnings are going to dip for a time as the industry is being disrupted, is going to cause the share price to fall, and in the inevitable conflict of the board wanting to do the right thing and think long term and the management team being incentivized in the near term, the near term wins every time. What changes in incentives will encourage and enable management teams and boards to make decisions in the long term interest of a company that will help them avoid disruption?

3 Questions for the board:

  • How often do we discuss possible sources of disruption?
  • Do we include people from all parts of the business and from all age groups in these discussions?
  • How often do we invite someone from the forefront of digital technology to address the board?

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