An icon of innovation — Harvard Business School professor Clayton Christensen — died in January. In 1997, he wrote a book, “The Innovator’s Dilemma,” which changed management thinking for an entire generation. The book’s thesis was that the factors that helped the best companies succeed were also the reasons some of those same companies later failed.
At the time, this was revolutionary, because it challenged a company to be willing to shift away from making a product or selling a service that was currently profitable, particularly those products with the highest margins and what the customer wanted at that time. Instead, Christensen asserted that it was important for companies to begin thinking about new products and different customers still on a distant horizon.
What had been taught for generations at the nation’s top business schools as gospel, he wrote, could allow the dominant player in a market to be blindsided by a small, fast-moving, innovative company that was able to enter a market nimbly with disruptive products and services and grab large chunks of market share.
One of his classic examples was the steel mill industry. I will not try to fully explain (you need to read his book), but the essence is that the big “integrated steel mill companies,” making specialty products, were eventually put out of business by the “mini-mill” companies, which started with ordinary rebar with low margins, but over time, as they got more efficient, they moved up the food chain and grabbed market share, eventually putting the big guys out of business. What is astounding, Christensen says, is that not one big, integrated mill adopted the technology that was right in front of their eyes. They couldn’t change. Where is Bethlehem Steel today?
The landscape is littered with similar stories. Toyota first came to America with a rusty compact called a Corona. Then they moved up the food chain and several iterations later, they made the Lexus. The stories of RCA, Kodak, Zenith, GM, IBM are all told around the basic challenge of the innovator’s dilemma.
His death coincided with a New Yorker article, by Nathan Heller, that detailed the current state of venture capital. Heller looked back at the whaling industry in the 1850s, when pools of money backed a captain and his boat in their effort to capture whales and sell the oil. Historically, 80 percent of those ships either were unprofitable or sunk at sea.
In 2018, venture capital fundraising topped $56 billion, and they were all chasing the same elusive unicorn. Here is the innovator’s dilemma — lots of ships, not enough whales. If you have that much money, you risk propping up losing ideas, keeping them alive, hoping either to take them public or sell them to someone else (the greater fool theory may have a place here). The Ewing Marion Kauffman Foundation has a sobering statistic: “The average venture capital fund in the previous two decades has scarcely broken even.” But don’t cry Argentina, the venture capitalists themselves made money on their fees.
The result of this “propping up” is that you and I get goods and services at deep discounts, far less than the true cost, and along the way, some older industries get crushed. Talk to any taxicab driver who bought a medallion 10 years ago. Venture has the power to distort certain economic realities by subsidizing the losses until the competition suffocates. Most of those taxicab drivers were immigrants, hoping to get a toehold in the American dream. Heller shines a light on whether this economic power is used wisely.
Venture money can change the world for the best at times, but you can also count on their reversion to the mean (the “dumb as rocks” investment thesis), and so we get Movie Pass. That company went to the famous “Widget School of Investing,” where the plan is to only lose a nickel on each item, but make it up on volume. Movie Pass blew through over $200 million, and then the screen went dark.
One of the key reasons the whaling industry died is that the ocean ran out of whales. The industry overfished the sea, almost to extinction. Whales or unicorns, Christensen called it out 23 years ago. Maybe it is time to read his book again?
Rule No. 647
Where is Moby Dick
when you need him?