“Doing the right thing is the wrong thing” - What sustainable investors can learn from the innovation classic "The Innovator’s Dilemma"

For some of the more entrepreneurial and innovative efforts in my career I read, many years ago, “The Innovator’s Dilemma” by Clayton Christensen. In rereading the book over the summer, it struck me that the ESG movement – which is in many ways also a disruptive start-up, or at least is about innovation – can learn many things from this classic.

The insightful yet sobering key take-aways for me are that

(i) the sustainable finance movement started out as a disruptor about 15 years ago but has now in many ways become the established incumbent

(ii) in order to stay relevant, we have to continue to disrupt, even if that means ‘cannibalizing’ the products, concepts and ideas we launched

(iii) if we don’t stay innovative and focus rigorously on achieving our stated objectives some other movement will come along and disrupt us.

This is not meant as a full summary of the book, rather a selection of those elements that I find most applicable to - and inspiring for - the further development of sustainable finance.

Principles of Disruptive Innovation

… many of what are now widely accepted principles of good management are, in fact, only situationally appropriate. There are times at which it is right not to listen to customers, right to invest in developing lower-performance products that promise lower margins, and right to aggressively pursue small, rather than substantial, markets. This book derives a set of rules, from carefully designed research and analysis of innovative successes and failures in the disk drive and other industries, that managers can use to judge when the widely accepted principle of good management should be followed and when alternative principles are appropriate.

These rules, which I call principles of disruptive innovation, show that when good companies fail, it often has been because their managers either ignored these principles or chose to fight them. (…) As in many of life’s most challenging endeavors, there is great value in coming to grips with “the way the world works,” and in managing innovative efforts in ways that accommodate such forces.

Guessing the right strategy at the outset isn’t nearly as important to success as conserving enough resources so that new initiatives get a second or third stab at getting it right.

Sustaining vs Disruptive Technologies

Most new technologies foster improved product performance. I call these sustaining technologies…. What they have in common is that they improve the performance of established products, along the dimensions of performance of established products, along the dimensions of performance that mainstream customers in major markets have historically valued.

Occasionally, however, disruptive technologies emerge: innovations that result in worse product performance, at least in the near term. They bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets. But they have other features that a few fringe (and generally new) customers value. Products based on disruptive technologies are typically cheaper, simpler, smaller and frequently, more convenient to use.

… Disruptive technologies that may underperform today, relative to what users in the market demand, may be fully performance-competitive in that same market tomorrow.

Disruptive Technologies versus Rational Investments

.. the conclusion by established companies that investing aggressively in disruptive technologies is not a rational financial decision for them to make, has three bases:

1 First, disruptive products are simpler and cheaper; they generally promise lower margins, not greater profits.

2 Second, disruptive technologies typically are first commercialized in emerging or insignificant markets.

3 And third, leading firms’ most profitable customers generally don’t want, and indeed initially can’t use, products based on disruptive technologies.

Make revisions as you gather data.

Fear of Cannibalizing

The fear of cannibalizing sales of existing products is often cited as a reason why established firms delay the introduction of new technologies. … if new technologies enable new market applications to emerge, the introduction of new technology may not be inherently cannibalistic. But when established firms wait until a new technology has become commercially mature in its new applications and launch their own version of the technology only in response to an attack on their home markets, the fear of cannibalization can become a self-fulfilling prophecy.

The Innovator’s Dilemma: Doing the Right Thing is the Wrong Thing

In many instances, leadership in sustaining innovations – about which information is known and for which plans can be made – is not competitively important. In such cases, technology followers do about as well as technology leaders. It is in disruptive innovations, where we know least about the market, that there are such strong first-mover advantages. This is the innovator’s dilemma: “Doing the right thing is the wrong thing”.

Who benefits from disruptive technologies – established firms or entrants?

Although entrants led in commercializing disruptive technologies, their development was often the work of engineers at established firms, using bootlegged resources. (…) New companies, usually including frustrated engineers from established firms, were formed to exploit the disruptive product architecture.

Despite evidence that leadership in disruptive innovation pays such huge dividends, established firms (…) often fail to take the lead.

Further relevant insights…

-         The popular slogan “stay close to your customers” appears not always to be robust advice.

 -         The dominant difference between successful ventures and failed ones, generally, is not the astuteness of their original strategy. Guessing the right strategy at the outset isn’t nearly as important to success as conserving enough resources (or having the relationships with trusting backers or investors) so that new business initiatives get a second or third stab at getting it right. Those that run out of resources or credibility before they can iterate toward a viable strategy are the ones that fail.

-         Plan for Failure: Don’t bet all your resources on being right the first time. Think of your initial efforts at commercializing a disruptive technology as learning opportunities. Make revisions as you gather data.