Innovators Dilemma: Disruptive Opportunities for Start-ups

I spent the last week at Algonquin Park and had the chance to finish reading The Innovators Dilemma. I would recommend this book to start-up founders before anything else. It introduces a type of opportunity that gives small companies advantages over big market leaders, by taking recent innovations and creating new markets.

Four Types of Business Opportunities

There are four main types of opportunities you can pursue when creating a software start-up:

1) New technology in a new market, you create a new innovative product in a previously unserved market. Example: Overture (acquired by Yahoo) creating the pay-per-click technology to create the search engine advertising market.

2) New technology in an established market, this most likely starts with, “this product sucks… I could make something better.” You take advantage of recent advancements to build a product that improves on the existing solutions. Example: Last.FM creating a social music application that gradually learns your tastes in music, a significant improvement over the existing online radios.

3) Applying a proven technology to a new market, you see an opportunity to take an existing product and tailor it to a new market. Example: 37Signals Highrise, CRM applied to smaller businesses like web design firms.

4) Applying a proven technology in an established market this is where a start-up tries to compete head-to-head with market leaders. There’s generally a lot of money at stake so there will be a lot of entrants. Example: Cuil building a search engine with a fast indexing technology to compete against Google and Yahoo.

Disruptive Opportunities

Disruptive opportunities generally fit into the first too categories. Although, it’s not just an improvement over existing technology. It’s an innovation that causes a significant shift in the market (see Wikipedia entry).

For example, Mint created an online finance application that took aim at Quickens desktop software. Mints founder, Aaron Patzer took recent improvements to web applications and combined it with an innovative monetization system that allowed him to launch an effective competitor to the cluttered desktop alternatives.

If Aaron took the usual approach and created the desktop software it would of just been another new product, trying to compete in an established industry. Instead he created a disruptive innovation, an online financial application with an automated system that helps people save money, and helped create a new market (plus its free).

Whats stopping the big competitiors from copying you and using their market access?

Big companies have a history of failing to adopt disruptive technology, the author gives a few reasons why:

1) By adopting the technology they cannibalize their current customers by offering a product thats usually at a lower price point.

2) Big companies are not organized to build out disruptive technologies because the markets for them are too small to begin with to make it worth the companies time.

3) They can’t gauge how big the market is because there is no current market to base the research off of, making it hard to sell to the executives making the decision.

These are things that start-ups can take advantage of and makes disruptive technology can be much more effective then the other types of opportunities

Why are disruptive opportunities better for start-ups?

It’s easier to answer this in context with the types of opportunities mentioned above:

1) Being first to market tends to be difficult because the companies end up spending a large amount of money laying the ground work, for example building awareness and facing unknown difficulties.

A good example of this happening right now is the Enterprise 2.0 market. Jevon Macdonald wrote a great post on the lack of an established market for Enterprise 2.0.

“There is no Enterprise 2.0 market. Enterprise 2.0 budgets do not exist, except where some early adoptors create them, and there is no Enterprise 2.0 sales cycle.” – Jevon Macdonald, Firestoker.

The businesses in that market have to either invest in building awareness through media, wait until the market develops, or building off of existing markets. For start-ups that can be very costly unless they can ensure a return.

If you building a “new market” disruptive technology you can benefit in the long run from being the leader and championing the technology. It allows you to have first-mover advantages that gives you a competitive edge when other competitors enter the market.

2) Just creating a better product then your competitors can also very difficult. A big company has the resources, brand and access to existing customers that would require much more then just a slightly better product to effectively compete.

In the tech world I see that most new companies seem to fall into this area. Just spend a few weeks watching Techcrunch and you can see just how many people are creating me-too companies.

These founders see the big companies making money and want a piece. They end up modeling their business around the leading companies and offer little differentiation. To make it worse their business models rely on low-margin advertising.

If you take a different approach by bringing a disruptive technology to an existing market (called “low-end disruption”) you can target the customers that were left behind by the current market leaders. Those leaders usually have a high-performance and expensive product thats out of reach by certain segments.

Once start-ups have some market share they can improve the technology until it’s capable of being valuable to the larger mainstream market.

3) Applying a proven technology to a new market usually has the lowest barrier to entry mainly because it involves little innovation. This is a trap I fell into myself when I created Contrastream. The product was essentially a derivative of an existing product Digg (but not nearly as bad as most Digg-clones) that I applied to a new market, indie music.

The problem with this approach is that it’s difficult to gauge whether there is actually a need for the product in the new market.

It’s a common trap to have built a new technology and see all the ways it could benefit peoples lives. But that does not mean there is a need for it. If you are relying on the theory that “great products spread online by themselves” you better hope that people are aware of something lacking in their lives and are looking for a way to satisfy that need.

For online marketing to be effective its essential that people are already searching for a solution. You can’t spend a ton of money on advertising just to make people aware that their need exists.

Of course, some products have a viral nature, like being invited to Facebook or emailing Youtube videos to your friends. But viral marketing is not something that can be created, only assisted.

4) Bringing a proven technology to a well-developed market is an area left to the ambitious entrepreneurs.

You will be facing some tough competition by companies with years of experience in the market. When markets reach a certain point its generally very hard for a small company to compete. This is because those big companies are spending all their time not only fending off the other big competitors but also securing their position in the market.

Approaching a Disruptive Opportunity

The idea behind Innovators Dilemma is to find a smaller market that can benefit from a new disruptive technology. Build the product, get some market share, make improvements and reiterate until it’s ready for a mainstream market.

Early on the technology tends to be more expensive or under-developed to be ready for a mainstream market, for example Flash solid-state hard drives are too expensive for the average consumer but the price continues to drop.

The key is becoming the expert in that technology and the company that pushes it forward until it’s matured. By the time the bigger companies see the potential in the technology they will already be way behind.