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Clay Christensen warns CIOs that smart managers are doomed to fail

Disruptive innovation theorist Clay Christensen warns CIOs to be skeptical of time-honored business tenets.

Business thinker Clayton Christensen spoke softly to CIOs at last week's annual meeting of the Society for Information...

Management (SIM), and he also carried a big stick. But will CIOs heed the warning?

Christensen is this century's preeminent expert on the theory of disruptive innovation -- the concept that a simple technology starting at the bottom of a market with no competitors can in time move up-market to displace industry leaders. Fueled by growth and unimpeded by serious competition, the new technology eventually improves, outstripping the ability of its original low-end customers to use it and sucking customers away from the industry giants who originally paid it no mind. Sony did this to RCA Corp. Toyota did this to Detroit. The mini steel mills did it to all but one of North America's integrated steel mills.

The theory has taken hold. Christensen's 1997 flagship book, The Innovator's Dilemma, was named by The Economist as one of the six most important books about business ever written. Thinkers50, a biennial ranking of the world's most influential management, ranked Christensen as the world's top business thinker for two years running. In fact, he had just gotten back from the awards ceremony in London that morning at the SIM conference.

Christensen, 61, has a piercing dry wit and affected but endearing habit of badmouthing Harvard Business School, his employer. Still recovering from a stroke suffered in 2010, he begins his talks with a customary request: If he appears to be searching for a word, as sometimes happens, the audience should shout it out to him. Listeners should also be aware that his habit of fixing his gaze on a spot on the floor is a coping mechanism that helps his stroked brain stay focused and not a sudden case of shyness. He needn't have bothered to smooth the way. The audience of CIOs was enthralled.

When disruption happens, those principles of good management make it impossible for smart people to do what needs to be done to sustain growth in the industry.
Clayton Christensen

In a lecture that went well over the allotted hour, Christensen took his listeners through the nuances of disruptive innovation. For example, it only works when the innovation is competing against nonconsumption (the something new is better than nothing) or when the industry giant is motivated, usually by profit, to cede the market to the disruptor. Solar power, not as reliable as electricity over the grid, is fighting an uphill battle in his view, despite government subsidies because, for most people, it is neither better than nothing nor better than the established products.

CIOs, of course, are acutely familiar with the power of disruptive innovation to vanquish industry stalwarts and make an Amazon out of, for example, a puny online bookseller. What might not have occurred to all the left-brain smarties in the room, however, is Christensen's contention that the more management-savvy the entrenched business is, the more likely it is to fail when faced with a new paradigm. Digital Equipment Corp., toppled by the PC, could hardly be blamed for not making crummy computers because it needed to focus on making excellent and profitable products for its most demanding customers. Listening to the customer and focusing on areas of greatest profit are time-honored business tenets.

"When disruption happens, those principles of good management make it impossible for smart people to do what needs to be done to sustain growth in the industry," Christensen said.

Logic trips them up! (OK, maybe greed too.) Even when an industry leader understands the value of the new technology, as RCA (R.I.P.) did with transistors, smart management tends to respond incorrectly and actually hastens the established business along the path to oblivion. RCA, for example, invested a fortune in perfecting transistor technology to meet its high standards, only to be pushed out of the market before perfection was achieved. "It's sad," Christensen said.

There is more than one way to disrupt the market. In addition to disruptive market-creating innovations, which succeed by offering products or services to a class of customer that previously didn't exist, there are sustaining innovations. These succeed by replacing good products with better ones (Prius for a Camry). Efficiency innovations, on the other hand, succeed by offering the same product at a lower price (Geico). Each plays a different role in the economy. Market-creating innovation requires capital and creates jobs. Sustaining innovation is "replacetive" in nature and, while making the economy more vibrant, does not generate a lot of jobs. Efficiency innovation eliminates jobs but frees up capital for other things. It's kind of a neat system, Christensen noted.

"As long as the market-creating innovations are creating more jobs than the efficiency innovations are taking out," he said, "and as long as the efficiency innovations are creating enough capital to fund the market-creating innovations, it is like a perpetual motion machine."

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But since the 1990s, this nifty machine -- the envy of the global economy -- has been under assault from the "Church of New Finance," his name for the doctrine taught at places like the Harvard Business School, he said, that measure profitability by how efficiently a company uses capital. What the new ratios offer is two ways to achieve good results. Return on Net Assets (RONA) comes out just fine by either increasing the numerator or decreasing the denominator. "Either way RONA goes up," Christensen said. The same holds true for internal rate of return, the ratio that basically expresses how quickly one can get money out of an investment. Innovation is hard. Since those market-creating innovations that generate jobs often take five to 10 years to pay off, wouldn't it make more sense to invest mostly in efficiency innovations?

The end result of pursuing that strategy, however, is that profits accumulate but job growth declines. "That is why we are not getting out of the recession and why we are not creating jobs," Christensen said. And the doctrine makes no sense, he added, giving the audience a glimpse of the passion bordering on rage that fuels his pursuits. A scarce commodity when these measures took hold, capital is abundant today. The cost of capital is zero. America is awash in cash. Instead of hoarding capital, companies should be pouring it into innovations that create jobs. And yet, the management tenets of the Church of New Finance -- which protect capital at all costs -- "make it impossible for smart people to do what needs to be done to sustain growth in the industry," he said.

Sound familiar? He offered CIOs an alternate view of reality: "Focus on investing in making good people better people and more capable, because that is what is scarce."

Let us know what you think about the story; email Linda Tucci, executive editor, or reach her on Twitter at @ltucci.

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