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Why great companies fail

Clayton Christensen, who developed the seminal theory on disruptive technology, examines why companies fail and why theory trumps data. Plus: What's the future for HP and Charles Schwab?

The inspiration for Clayton M. Christensen's seminal theory on disruptive technology came from watching Digital Equipment's fall in 1988. How could the management team that had been rightfully lauded for its brilliance by every popular business publication have stumbled so badly?

As Digital's star fell, the business press blamed the ineptitude of the company's management. But Christensen observed that every other minicomputer company collapsed at the same time. Since no one colludes to fail, something more was at work. He concluded that the reason for the implosion of the minicomputer industry was not just the rise of the personal computer, but what the PC represented: a disruptive technology to which the minicomputer companies could not respond.

His theory of disruptive technology became the basis of "The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail" (Harvard Business School Press, 1997). Named the best business book of that year by the Financial Times/Booz Allen Hamilton Global Business Book Awards, its influence was all the more potent because it prescribed no new management rules or standard solutions, but instead confronted companies with Christensen's chilling vision of how the world works.

A company can do all the right things--listen to its customers, invest in research and development, compete aggressively--and yet fall victim to a new technology or business plan that seemed, at first, almost irrelevant.

It is usually the case that the faddish prescription was indeed sound advice in certain circumstances, but actually was poor advice in other circumstances. Whether it was Digital and the PC, Sears Roebuck confronting Wal-Mart Stores, or the makers of cable-activated earth excavators encountering hydraulics, leading companies declined and sometimes died not because of competitors' advances, but because of new players with lower-quality solutions.

Conventional wisdom holds that as companies get big and successful, they become risk averse and avoid innovation. Christensen found this was not the case.

Large companies successfully embrace innovations that are what he calls sustaining technologies, which are often responsible for performance breakthroughs. He defines a sustaining technology as any innovation that enables an industry's leaders to do something better for their existing best customers. A disruptive technology, on the other hand, is a product or service that your best customers can't use and that has substantially lower profit margins than your business can support. Companies ignore disruptive technology innovations for perfectly rational reasons, but to their ultimate peril.

Businesses get blindsided because they focus on their best, most profitable customers and ignore other potential markets or customers seeking lower-cost products. This narrow view, Christensen says, ignores the fact that every market is characterized by three distinct change trajectories:

• Performance improvement that customers can readily use (that is, it matches their own changing needs).

• Technology advances driven by sustaining technological improvements.

• New performance introduced by a disruptive technology, which typically begins at a lower level of performance, but rapidly improves until it meets the majority of customers' needs.

It is the tendency of all successful companies to match their performance to their most demanding customers, exceeding the needs of most of their customers, which creates an opening for disruptive technologies, he says.

A successful entrepreneur before returning to Harvard Business School in his early 40s, Christensen co-founded the Ceramics Process Systems Corporation, a manufacturer of products made from injection-molded powdered metals, high-performance ceramics, and ceramic-metal composites.

He bases his theory on a rigorous observation of business phenomena, a meticulous classification of the conditions that affect those phenomena, and an endless cycle of testing the theory against the observations. Too many business theorists, he says, indulge in what he calls academic malpractice, propounding theories and selecting cases to support those theories without ever subjecting them to the rigors of the real world.

Christensen delivers his message with a dry wit that would be disarming were the message itself not so devastating. He emphasizes that understanding disruptive technologies is a highly valuable way for managers to frame how the world works and to create consistently innovative businesses. Companies that align their processes and values with the actions of innovators need not repeat the past and can, indeed, seize wave after wave of new opportunities. And despite their power to bring down great companies, disruptive technologies serve the greater good, Christensen believes, noting that although established companies may suffer, customers usually benefit, as does humanity, in the broader context.

Q: Let's start way back, by talking about your observation of Digital Equipment in the late '80s. What was remarkable at the time was the speed with which it went from being on top of the world to being a disaster. How did you take a situation that seemed so extraordinary and extrapolate a more general rule for what happens to companies?
A: I didn't know the answer at the beginning. But in my first career I had founded my own company, with a group of MIT professors, before coming to Harvard to finish my doctorate, and so I had a deep respect for the brains, talent and dedication of managers. That made it hard for me to believe the attributions in the business press that stupid management was to blame. So I looked elsewhere for an explanation.

You went looking for an explanation for Digital's rapid fall from grace and came up with a theory that appears to apply equally well to disk drives, excavation equipment and consumer retail. How did you go about it?
Let me go back, if you wouldn't mind, and give you a "theory of how theory is built."

If you ask the average guy on the street to name five companies that have truly transformed themselves over the last 20 years, Hewlett-Packard would be on everybody's list. In the first stage of insight-building, all that researchers can do is observe phenomena. Second, they classify the phenomena in a way that helps them simplify the apparent complexities of the world so they can ignore the meaningless differences and draw connections between the things that really seem to matter. Third, based on the classification system, they propose a theory. The theory is a statement of what causes what and why, and under what circumstances.

Next, they use the theory to go back and say, "Now if this theory is right, when I go back into the world and look at more phenomena, under this particular circumstance, this is what I ought to see, and under that circumstance, that is what I ought to see."

If the theory accurately predicts what they see, it confirms that it's a good theory. If they see something that the theory didn't lead them to believe, that's what Thomas Kuhn calls an anomaly. The anomaly requires a revised theory--and you just keep going through the cycle, making a better theory. Ultimately, when you come up with a classification scheme that is collectively exhaustive and mutually exclusive, then the theory can become what Kuhn called a paradigm.

In the study of management, unfortunately, many writers have been so anxious to articulate a theory in the form of, "If you do this, this will result," that they never go through this careful effort.

You mean they don't take the time to observe the phenomena and derive a classification.
Right. Often they have a point of view based upon intuition and experience. They then offer a cadence of two-paragraph examples carefully selected to "prove" their theory, and then they write "one size fits all" books. The message is, "If you'd do what these companies did, you'd be successful too."

One reason there are so many short-lived management fads is that their prescriptions were derived and advocated in precisely this way. So managers read about a fad and try it, find that it doesn't work, abandon the effort, and move on to the next thing. In reality, it is usually the case that the faddish prescription was indeed sound advice in certain circumstances, but actually was poor advice in other circumstances.

Year after year, people write books about managing innovation or about leadership, for example, without ever going through the pain of saying, "This kind of leadership will cause this result in these circumstances and a very different result in those circumstances." This is academic malpractice of the worst kind. I've concluded that getting the categories right is an absolutely crucial step to building useful management theory, and unfortunately too few writers do this. You've got to engage in serious scholarship and then figure out how to write it in a way that lots of people can understand.

I was lucky enough to build on the work of a number of people who had already run laps around this theory-building track. The original classification scheme, years ago, distinguished radical from incremental change. The theory said that established firms managed incremental change well but would be expected to founder when their industry encountered a radical change.

Then Rebecca Henderson, who teaches at MIT, studied the photolithographic aligner industry, where the leader had failed in each of three product generations. She observed that when the architecture of the product changed, the leaders failed. As long as the technological changes involved were at the component level rather than the architecture level, the leaders did fine.

She proposed a classification scheme and theory that asserted, "In modular change, the leader will succeed. But in architectural change, the leader will fail, because organizations are structured and people have learned to interact in patterns defined by the product architecture." This is a simplification of her profound work.

From that theory you progressed to your concept of disruptive vs. sustaining innovations?
Right. So I used Rebecca's theory and studied the disk-drive industry to see if her theory held up in another circumstance. If you want to make better theory, you've got to use the best that's available and look through the lens of another discipline to see if you can uncover more anomalies. By looking at the phenomena of failure from the perspective of sales, marketing, finance, general management and the equity markets, I was able to see things that Rebecca hadn't. I owe her a huge debt.

When I was writing my doctoral thesis about disk drives, I could see that this related to the computer industry and Digital Equipment's demise. But it wasn't yet clear how robust this classification scheme of disruptive vs. sustaining was for other industries.