Suppose you have decided that the job market is tough, and you want to start your own business. There is a lot of information on what investors are looking for and how to approach them for funding, including two iconoclastic views from Guy Kawasaki and Collin Timms in this issue of Ethix.
But there remains the challenge of what kind of products and services to offer in the proposed business. It helps if the focus of the business is something for which you have the skill and passion, since starting a business is hard and you need to like what you do. Another consideration is the need in the market (including both the product or service and the cost). This requires a market study. But which product or service (we will use product to talk about both product and service from now on) should you offer?
Generally, books and articles on starting a business begin this way: “Suppose you want to build a business from this new product idea. What steps are required to begin the business?” What about the person who wants to start a business but is looking for a product idea?
I found an interesting source of ideas for new businesses in a lecture by Clayton Christensen, who was the presenter this past spring at the annual Technology Alliance luncheon in Seattle. Christensen is the author of The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (1997). Since his original book, Christensen has written four other books and given many lectures applying his basic theory to health care, automobiles, steel, and education, focusing on why disruptive technology creates problems for large firms. I believe an opportunity for small companies lies in this problem area for large companies.
I will briefly sketch his idea here, but any budding entrepreneur (or large company player) would find it worthwhile to either read one of his books or at least watch a replay of his Technology Alliance talk.
The Innovators’ Dilemma
New technologies, when first introduced, tend to be costly and complex. Think about the first large mainframe computers, or the first MRI machines. These tools, developed at great cost, are sold to high-end customers and require significant expertise to operate. This may have been the reason early IBM chairman Thomas Watson declared, “I think there is a world market for maybe five computers” in 1943. But the requirement for this same capability that is both accessible by users with less expertise, drives further development to low cost, easy to use products.
Unfortunately, companies pioneering the first high-cost, complex product development are usually unable to make the transition to the lower cost, accessible product. Examples include the big computer companies (such as IBM) that could not continue as leaders in the PC market. Similarly, the mobile device makers are different again from the PC sellers (with the interesting exception of Apple). Or the makers of complex medical devices are often not the ones who make the smaller, portable devices that can be used by every health clinic rather than a few high-end hospitals. Christensen illustrates his premise in such diverse areas as automotive, steel, and education in addition to information technology and medical products.
He goes on to develop reasons why it is difficult for the maker of the more expensive product to become the dominant supplier of the lower cost, more widely accessible product. Imagine yourself inside a large corporation with multiple billion-dollar divisions. You have an idea for a new product and you prepare the business case and take it to the senior management. Here are some objections you will hear:
1. The kind of revenue you are anticipating from this product won’t even show up on our balance sheet; we are looking for billion-dollar ideas, and even if you are successful, the revenue would measure in the millions.
2. Your idea will take away revenue from our more profitable, high-margin products.
3. We are set up to sell to large corporations; your product would require managing resellers or direct sales people, and we don’t know how to do that.
4. Our overhead cost structure would not allow this new product idea to be profitable even if we could solve the other issues.
5. Your product fits in a market space where we have no experience.
This is representative of some of the areas of objection that Christensen cites, and is very consistent with the experiences I have had as a part of a large corporation. Christensen said in his presentation, “The new ideas need an institution with a different kind of business model. Ideas within a company are always in a battle for funding. Those ideas promising better profits from better products at better prices always trump ideas for cheaper products at lower prices with lower margins.”
On the other hand, a new company built around cheaper products at lower prices with lower margins provides an opportunity for the startup. From that vantage point, with lower cost structure, a market worth millions looks quite attractive.
Finding the Opportunity
Though not the only cause, the rapid changes we have experienced in information technology over the past 50 years have led to many opportunities to create new, lower-priced products, opening the door for the entrepreneur. All of the companies creating apps for cell phones, for example, have found their opportunity exploiting this change. Telecommunications, faster chips, cheaper memory, and GPS have come together to create a market that didn’t exist a decade ago for these apps, and which is a difficult area for the “big guys” to penetrate for all of the reasons given above.
The big opportunity seems to be the low-end products where technology creates an opening that is tougher for the large company to exploit. Christensen tells the story of how Toyota started with a small car while the big companies ignored that part of the market. They didn’t start with a Lexus. But they ate the market from the bottom up. The micro mills did the same in the steel industry starting at the lower cost, low-margin rebar. Eventually they worked up the ladder in product cost and complexity, putting all of the big U.S. steel mills out of business. Exploiting technology and using a company infrastructure with lower costs was key in both cases. Interestingly, as Christensen says, this loss for the big company is not simply a problem of ignorant management, but a subtle, very difficult challenge for any big company.
This opportunity from the bottom would seem to exist in almost any area. Here is one more example demonstrating the same principle in a completely different field. I was talking with a stock broker who started his business with a great deal of effort through cold calling. Anyone with a few retirement dollars, and who wanted someone with expertise to take care of his money, would be welcomed as a client. But as the business grew, he found that very high-net-worth clients wanted personal attention, and he could no longer afford the time to handle small clients. A young entrepreneur came along with a different model, depending much more on technology to manage many small accounts, and the first money manager gladly provided some accounts to his portfolio because they no longer fit his model. Another entrepreneur developed a business from the bottom.
Entrepreneurs often assume they cannot take on a big company with a new offering. And if they started at the top, with the areas of highest profits for the big company, they would likely be “crushed” as Clayton Christensen says. But the opportunity is there from the bottom, taking over products that are simply not a part of the highly profitable portfolio of the bigger company. The problem for the bigger company is that, starting at the bottom, they may allow a competitor to develop, eventually defeating the bigger company. Steel, autos, computing, even wealth management provide examples of this, and bigger companies must beware of “the innovator’s dilemma.”
But while this is a huge challenge for the big company, it is a great opportunity for the entrepreneur. This is a great place to look for new product offerings for that new company.
Al Erisman is executive editor of Ethix, which he co-founded in 1998. He spent 32 years at The Boeing Company, the last 11 as director of technology. He was selected as a senior technical fellow of The Boeing Company in 1990,
and received his Ph.D. in applied mathematics from Iowa State University.