Wednesday, November 21, 2012

Are All Reverse Innovations Disruptive?

Vijay Govindrajan is one of management's top thinkers today. One of his more recent insights lies within a concept that he has called "Reverse Innovation" in which innovation is driven from developing countries to the developed ones in contrast to the typical, and perhaps more intuitive, globalization model that drives innovation the other way around. The traditional flow of innovations in our economy has been from the developed to the developing nations. Vijay calls this phenomenon "glocalization" in which companies take successful products that they have created for customers in their Western markets and modify them, most often by stripping off many of their features, for distribution all around the world at lower price points. And while glocalization has proved effective in reaching the top segments of the market in developing nations – buyers with needs and resources similar to those in the developed world, it has not proved to be an effective market penetration strategy. The reason – most growth opportunities in emerging markets are not at the top but in the middle market and below, where the gaps between customers’ needs and those of their developed-world counterparts are enormous. While success in ripe developing markets might be reason enough to embrace reverse innovation, there is more good news. Because the global economy is richly interconnected, innovations developed for emerging economies can be extended to the developed world. Such "extensions" generally occur in two phases - first in under served, niche areas of the developed markets and then "disruptively" in the mainstream markets.

Hence the question - Are all Reverse Innovations Disruptive?

I found the answer to that question in a recent article titled "How Disruptive Will Innovations from Emerging Markets Be?"  in the MIT Sloan Management Review. In his informative article, the author Constantinos C. Markides eloquently describes the two conditions that any "reverse" innovation must satisfy to become disruptive. First, it must start out as inferior in terms of the performance that existing customers expect, but superior in price. Second, for the innovation to truly become disruptive, it must evolve to become “good enough” in performance (attracting mainstream customers from the earlier generation of incumbent products) while at the same time remaining superior in price. In other words, it must become “good enough” in performance and superior in price. So essentially, as the author summarizes, one must answer the following two questions:
  1. Will the emerging-market innovators continue to have a significant price advantage over competitors from more developed countries?
  2. Will the emerging-market innovators succeed in closing the performance gap so that customers in more advanced economies come to see their products as “good enough”?
There are many success stories that illustrate the disruptive nature of reverse innovations. Disruptive innovation has been credited as the strategy that led to Japan’s dramatic economic development after World War II. Japanese companies such as Nippon Steel, Toyota, Sony and Canon began by offering inexpensive products that were initially inferior in quality to those of their Western competitors. This allowed the Japanese companies to capture the low-end segment of the market. As the performance of their products improved, they began to move upmarket, into segments that allowed them more profitability. Eventually, they captured most of these segments and pushed their Western competitors to the very top of the market or completely out of it.

What many people do not realize is that there are many stories where reverse innovations have failed to be disruptive. In the razor business, Bic emerged as a huge, low-cost disruption to Gillette in the 1970s and quickly succeeded in capturing 25% of the disposable razor market by the early 1980s. Yet Gillette countered with its own line of inexpensive disposable razors, and Bic ceased being a major threat to Gillette in razors by the early 1990s.

So why do some reverse innovations disrupt industries while others don't? Once again, the answer lies in how well the reverse innovation stands up to the two fundamental questions posed by the author above.

As the author explains in his article, the first indicator of success lies in the source of the "low cost" advantage of the reverse innovation. If the source of the cost advantage is low labor costs or a reengineered product that requires fewer or cheaper components, incumbents can find a way of neutralizing these advantages. However, there is one source of cost advantage that is more sustainable than others. This is the business model of the disruptors. A cost advantage that comes on the back of a business model that is not only different from but also conflicts with the business model of the established companies is more sustainable than other cost advantages. This explains, for example, the success of low-cost airlines over traditional airlines.

The second indicator of success is the reverse innovator's ability to close the "Performance Gap" between their innovation and the mainstream product/service. As the author explains, reverse innovators have a number of options in how they go about closing the performance gap. However, less obvious is the proposition that whether the reverse innovator's products come to be seen as “good enough” depends not only on what they do, but also on what incumbents do to influence consumers’ expectations of what is “good enough.” As an example, consider how Nintendo dealt with the onslaught of gaming consoles in its bread and butter market space. Nintendo’s response to all of this was a classic strategy of shifting the basis of competition and changing consumers’ perceptions of what is “good enough” in this market. Rather than follow Sony and Microsoft down the performance trajectory, Nintendo introduced the Wii on the basis of family entertainment, a benefit that the disruptors were not paying attention to. Nintendo’s strategy was essentially to expand the market by developing consoles that would support simple, real-life games that could be learned quickly and played by all members of the family, including the very youngest and the very oldest. By 2007, the launch of the Wii led to household penetration of consoles rising for the first time in 25 years. The console outsold the PS3 three-to-one in the Japanese market and five-to-one in the United States.

The Bottom Line
Reverse innovation is a powerful force for good in developing countries. Not only does it benefit the innovator but it serves to uplift the lives of all those to whom mainstream products were simply inaccessible or impractical. Longer term, many (but not all) reverse innovations have the potential to disrupt mainstream markets and incumbents. Success, however, depends on two critical factors – 1. basing the cost advantage on a sustainable and "hard-to-imitate" source (such as a business model) AND 2. becoming "good enough" in the eyes of the "mainstream market." Conversely, incumbents must constantly be on the look out for reverse innovations that have the potential to be disruptive and proactively undermine them by redefining "good enough" and/or changing the rules of the game.


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