Clayton Christensen is a Harvard Business School professor and the author of such groundbreaking works on innovation as The Innovator's Dilemma and Seeing What's Next. He sat down with Managing Automation to offer tips on how manufacturers can develop new revenue streams.
Q: Traditional manufacturers tend to be structured to encourage their work force and managers to focus on existing products and operations. That focus can discourage new business model ideas. How can top executives change that?
A: If the company isn't good at staying the course -- that is, making the critical investments required to continue to prosper -- the company will fail. So it's the right thing, not the wrong thing, to funnel investments toward keeping the core business healthy. But it does make it difficult to create new waves or new growth businesses. The only way to do that is to create new business models.
The way you balance the tension of sustaining the current business and creating new growth is to put away two buckets of money. One bucket is focused on keeping the core business healthy. The other has to be focused on creating new growth, and it has to be done while the core business is healthy. If you wait until the core business is sick, it becomes almost impossible to invest in new growth.
Q: Should the additional money go to managers handling traditional parts of the business or to teams dedicated to focusing on new ideas?
A: For new products that can be sold through the existing business model, you don't have to separate those people. They're part of the core business. But building and commercializing a new business model requires that you set up something completely different.
As a film company, Kodak had an economic model that defined the gross margins it had to earn to cover the fixed overhead inherent to the chemical film business. To make money on digital photography required a different economic model.
Therefore, in 2001, it set up an autonomous business unit to give it the freedom to create a different cost structure and make money in consumer cameras. That meant it had to strip out a lot of overhead cost -- something the unit couldn't have done if it was still part of the film business. Setting up the unit autonomously let Kodak understand what kind of volumes and different costs it needed to make money in digital cameras. They were wildly successful. Kodak's market share went from 7% to 28% in two years.
Then a new CEO came in. He saw a consumer product in digital photography, and another one in chemical film. So he folded them together to get rid of duplicate overhead costs. When Kodak contrasted the gross margins it could get in further investments in chemical film with what they could get in digital photography, all of a sudden digital photography didn't seem profitable.
So the company began to un-invest in it. Over the next two years its market share dropped to 12%. And the company is back to where it used to be. You cannot have two fundamentally different profit models within the same business unit. It's a physical and logical impossibility.
Q: At what point should traditional financial calculations, such as return on investment and profit and loss statements, be applied to an innovative process or business model?
A: Those tools of financial analysis are never appropriate to apply to an innovation, or even an acquisition. The reason is that there's a fundamental logical flaw in the analysis. It parades under different names -- net present value or discounted cash flow. But inside of each is the basic assumption that if we don't make this investment, the existing state of affairs will maintain itself into the future. That's not true if the existing business case is an accelerating decline in the core business.
Traditional tools of financial analysis systematically bias managers against innovation. A better method for doing it, first written about by Columbia University's Rita McGrath and Wharton's Ian MacMillan, is called discovery-driven planning. It's a great idea whether we're talking about sustaining investment in existing business models or creating new business models.
The idea is that rather than try to build a case by making assumptions about the future, and then converting those into financial projections, ask this question: What kind of income statement is acceptable in our situation? That is, what's an acceptable statement for a new innovation or business model? Then ask what assumptions have to prove true for these numbers to materialize. As you think that through in reverse -- essentially a reverse income statement -- you come up with what we call an assumptions checklist. You can then create a project to test the validity of those assumptions as you feel your way into the market with a new innovation.