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Innovator’s Business Model

image A few weeks back, I wrote a quick overview of Clayton Christensen’s explanation for how new technologies/products can “disrupt” existing products and technologies. In a nutshell, Christensen explains that new “disruptive innovations” succeed not because they win in a head-to-head comparison with existing products (i.e. laptops versus desktops), but because they have three things:

  1. Good enough performance in one area for a certain segment of users (i.e. laptops were generally good enough to run simple productivity applications)
  2. Very strong performance on an unrelated feature which eventually will become very important for more than one small niche (i.e. laptops were portable, desktops were not, and that became very important as consumers everywhere started demanding laptops)
  3. Have the potential to improve by leveraging their industry learning curve to the point where they can compete head-to-head with an existing product (i.e. laptops now can be as fast if not faster than most desktops)

But, while most people think of Christensen’s findings as applied to product and technology shifts, this model of how innovations overtake one another can be just as easily applied to business models.

A great example of this lies in the semiconductor industry. For years, the dominant business model for semiconductor companies was the Integrated Device Manufacturer (IDM) model – a business model whereby semiconductor companies both designed and manufactured their own product. The primary benefit of this was tighter integration of design and manufacturing. Semiconductor manufacturing is highly sophisticated, requiring all sorts of specialized processes and chemicals and equipment, and there are a great deal of intricacies between one’s designs and one’s manufacturing process. Having both design and manufacturing under one roof allowed IDMs to create better products more quickly as they were able to exploit the interplays between design and manufacturing and more readily correct problems as they arose. IDMs were also able to tweak their manufacturing processes to push specific features, letting IDMs differentiate their products from their peers.

image But, a new semiconductor model emerged in the early 1990s – the fabless model. Unlike the IDM model, fabless companies don’t own their own semiconductor factories (called fabs – hence the name “fabless”) and outsource their manufacturing to either IDMs with spare manufacturing capacity or dedicated contract manufacturers called foundries (the two largest of which are based in Taiwan).

At first, the industry scoffed at the fabless model. After all, these companies could not tightly link their designs to manufacturing, had to rely on the spare capacity of IDMs (who would readily take it away if they needed it) or on foundries in Taiwan, China, and Singapore which lagged the leading IDMs in manufacturing capability by several years.

But, the key to Christensen’s disruptive innovation model is not that the “new” is necessarily better than the “old,” but that it is good enough on one dimension and great on other, more important dimensions. So, while fabless companies were at first unable to keep up in terms of bleeding edge manufacturing technology with the dominant IDMs, the fabless model had a significant cost advantage (due to fabless companies not needing to build and operate expensive fabs) and strategic advantage, as their management could focus their resources and attention on building the best designs rather than also worrying about running a smooth manufacturing setup.

The result? Fabless companies like Xilinx, NVIDIA, Qualcomm, and Broadcom took the semiconductor industry by storm, growing rapidly and bringing their allies, the foundries, along with them to achieve technological parity with the leading IDMs. This model has been so successful that, today, much of the semiconductor space is either fabless or pursuing a fab-lite model (where they outsource significant volumes to foundries, while holding on to a few fabs only for certain products), and TSMC, the world’s largest foundry, is considered to be on par in manufacturing technology with the last few leading IDMs (i.e. Intel and Samsung). This gap has been closed so impressively, in fact, that former IDM-technology leaders like Texas Instruments and Fujitsu have now decided to rely on TSMC for their most advanced manufacturing technology.

To use Christensen’s logic: the fabless model was “good enough” on manufacturing technology for a niche of semiconductor companies, but great in terms of cost. This cost advantage helped the fabless companies and their allies, the foundries, to quickly move up the learning curve and advance in technological capability to the point where they disrupted the old IDM business model.

This type of disruptive business model innovation is not limited to imagethe semiconductor industry. A couple of weeks ago The Economist ran a great series of articles on the mobile phone “ecosystem” in emerging markets. The entire time while I was reading it, I was struck by the numerous ways in which the rise of the mobile phone in emerging markets was creating disruptive business models. One in particular caught my eye as something which was very similar to the fabless semiconductor model story: the so-called “Indian model” of managing a mobile phone network.

Traditional Western/Japanese mobile phone carriers like AT&T and Verizon set up very expensive networks using equipment that they purchase from telecommunications equipment providers like Nokia-Siemens, Alcatel-Lucent, and Ericsson. (In theory,) the carriers are able to invest heavily in their own networks to roll out new services and new coverage because they own their own networks and because they are able to charge customers, on average, ~$50/month. These investments (in theory) produce better networks and services which reinforce their ability to charge premium dollar on a per customer basis.

In emerging markets, this is much harder to pull off since customers don’t have enough money to pay $50/month. The “Indian model”, which began in emerging countries like India, is a way for carriers in  low-cost countries to adapt to the cost constraints imposed by the inability of customers to pay high $50/month bills, and is generally thought to consist of two pieces. The first involves having multiple carriers share large swaths of network infrastructure, something which many Western carriers shied away from due to intellectual property fears and questions of who would pay for maintenance/traffic/etc. Another plank of the “Indian model” is to outsource network management to equipment providers (Ericsson helped to pioneer this model, in much the same way that the foundries helped the first fabless companies take off) — again, something traditional carrier shied away from given the lack of control a firm would have over its own infrastructure and services.

Just as in the fabless semiconductor company case, this low-cost network management business model has many risks, but it has enabled carriers in India, Africa, and Latin America to focus on getting and retaining customers, rather than building expensive networks. The result? We’re starting to see some Western carriers adopt “Indian model” style innovations. One of the most prominent examples of this is Sprint’s deal to outsource its day-to-day network operations to Ericsson! Is this a sign that the “Indian model” might disrupt the traditional carrier model? Only time will tell, but I wouldn’t be surprised.

(Image credit) (Image credit – Foundry market share) (Image credit – mobile users via Economist)

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