Essay

So sorry, I just interrupted you.

An essay by Thomas Ramge

Disruption is Silicon Valley’s management mantra. It is also portrayed as a battle of how a digital David slays the analogue Goliath. Throughout history, paradigm shifts in technology have often triggered upheavals in economic power structures.  But this time, the Goliaths of the analogue world are prepared. The race between disruption and transformation is far from over, in spite of Silicon Valley’s overconfident chest-beating.

Disruption is a clever theory and it creates an empowering feeling. That is what makes the disruptors so strong.

Disrupt... disrupt... disrupt... The singer’s deep voice does not sound particularly aggressive. The beat is not fast, either. The track resonates. Typical deep house. There is something meditative about it. Disrupt... disrupt... disrupt... The sound collage transports  the  concept  into  the subconscious. Which is where it belongs. In Silicon Valley at least.

The voice comes from the loudspeakers at Disrupt, the world’s most important digital con- ference. It is staged annually by the TechCrunch website in both San Francisco and New York. It also makes guest appearances in Berlin and London. What else could it possibly be called, besides Disrupt? Digitization sweeps all before it when we’re talking value creation. And the Disrupt conference is the Super Bowl of the players in the digital revolution, an annual get-together that attracts widespread attention. It is where investors with the fattest war chests find entrepreneurs with the best ideas.

But representatives of the old industries with a digital transformation agenda are increasingly mingling with visitors to Disrupt. They are curious to see what the army of startup Davids is working on, to learn which ideas are being presented  by these young people who are radiating the self- confidence of football stars at the top of their game. Could these ideas pose a threat to the old business models that have worked fine for decades?

The representatives of big companies at Disrupt have also read Clayton M. Christensen’s cult book on economics that highlights the dilemma of the innovators. They have understood that the term “innovators” does not refer to the young attackers, but to those like themselves, who represent the establishment.

Their companies were successful in launching an innovation onto the market some time ago but now, with a technological paradigm shift unfolding, they are threatened with the disruption of their business model. It is similar to what happened generations ago when coachbuilders were confronted with automotive engineers like Gottlieb Daimler and Henry Ford.

Christensen provides the theoretical underpinnings of the Disrupt conference. He systematically extends Joseph Schumpeter’s model of creative destruction. Schumpeter was an Austrian economist and he described the rise and fall of business enterprises as a necessary development process. Christensen refines this and gets to the heart of the dilemma of established companies. His point is simply that Goliaths become prisoners of their own success. If they change their business model, they create problems for their regular customers. But customers, of course, are the primary source of the company’s profits. What’s more, the chances of succeeding with a radical new idea are pretty low. Which idea will succeed is also impossible to predict. Making an informed risk assessment and calling your own business model into question practically never makes sense for successful companies. Management acts rationally when it puts its faith in constant improvement. Creative destruction is an option only for founders who have a lot to win, and nothing to lose.

Disrupt... disrupt... disrupt... It makes sense for representatives of the old world to drop at conferences like TechCrunch’s Disrupt. They want to assess the potential of creatively destructive business models. But if they stop at analysis, they will miss out on something essential. They also have to listen to the track with the deep voice.

Disruption is more than theory. “Disrupt is the mantra of Silicon Valley,” writes Christoph Keese from Germany’s Axel Springer media empire. “Disrupt is the key word and central battle cry.” Together  with other top executives, Keese spent six months in California gathering inspiration for the digital transformation at Springer.Keese also attended the Disrupt conference. “It’s a code for an attitude to life,” he says. “A kind of brainwashing. A profession of faith for a successful inventor culture that knows it can achieve anything when it thinks radically enough. It is a stimulant for an avant-garde which works day and night, and must convince itself of its own meaning just to withstand the physical  stress.”

Disruption has probably become the most popular word in northern California since the word “peace” was ubiquitous in the sixties. Those who have elevated Christensen’s model to its status  as a manual for radical thinking in the context of value creation are often brilliant minds. And they have access to vast sums of venture capital. That alone makes them a threat to the establishment. Disruption is buried deep in the subconscious of many startup entrepreneurs. It is the beat driving them on, and the one that has captivated most of their employees. And the staff are often stakeholders in the company.

This is not good news for anyone in a large organization engaged in a defensive battle.

Above all, digital disruption means a change in market structures and platforms with the help of so-called network effects.

Anything that can be digitized will be digitized. This is another Silicon Valley mantra. The drivers of digital change often use it like a threat. The Goliaths that have grown to size in the old world built of atoms have heard the message often enough. And the Goliaths are now taking it seriously. But confusion still reigns as to what digitization means for value creation right across the  board.

Many Goliaths scrutinize how products, channels of communications and sales are digitized. Many use data streams to control the flow of goods more efficiently and to optimize processes both internally and externally. The word has also spread that data can boost knowledge about the customer and consequently the customer’s value. That is all true and important, but it underestimates an important element. Digital disruption changes market structures ranging from pipelines to platforms. What does that mean?

In most industries, we think traditionally in terms of chains, or networks. In practice, this means that innovative companies develop a good product and then either manufacture it themselves or get it produced by a partner of their own choice. The company selects its suppliers along with its sales partners and, of course, it is also perfectly free to build up its own distribution channels, in some cases even direct to the customer. In contrast, the disruptive founders from Silicon Valley think along the lines of the market structure, which has dominated the IT industry for four decades. Their aim is to create platforms that no one can do without. They have a number of historical role models.

– The IBM mainframe computers with their monopoly position in the 1970s. Basically, these were platforms for the first independent suppliers of business software like SAP.

– Makers of games consoles since the 1980s. Right from the start, they dictated the conditions for the game designers.

– Microsoft in the 1990s. With Windows, Bill Gates created possibly the most successful digital platform of all time. Thanks to monopoly-driven profits, it made him the richest man in the world.

ANYTHING THAT CAN BE DIGITIZED WILL BE DIGITIZED.

The construction and functioning of platform markets in their pure form can be studied in the app stores of Apple and Google. The way economic power is distributed between them can also be seen. The Android and iOS app stores combined command around 95 percent of the world market. So they constitute a duopoly.

Any app developer aiming for success first has to comply with the rules of the platform operator, either Google or Apple. First of all, he has to meet specifications  regarding  technology  and  content to be included in the app stores’ listing. And he has to accept the margins that the duopolists charge for each sale. The bargaining power of the designer vis-à-vis the platform operator is rather low. There is just no other place he can go if he wants to do business on a large scale.

It is obvious how the power is distributed. The platform operator possesses all the contact and payment data of the end customer. As the intermediary for all apps, the operator also gets an excellent idea of the requirements and shopping habits of every individual and can use this knowledge for his own product development or for his own marketing. Only Google and Apple command an overview of the total market for apps.

App stores are platform markets par excellence. Yet the same principles kick in with Amazon and eBay with their marketplaces for professional and semi-professional traders. And with Uber and Airbnb as brokers for taxi journeys or private accommodations. Also, Booking.com, and HRS.de or Lieferheld.de in Germany, have provider-independent websites for booking hotels or ordering from restaurants.

In the mid-1990s “cut out the middleman” was the internet’s message to all those who wanted to establish direct contact with their customers. Twenty years later, we see that this is still possible, in theory. But in fact, new and extremely  powerful middlemen have established themselves: those platforms, which derive their power to a great extent from so-called network effects.

Network effects are to digitization what economies of scale were to mass production. Technically speaking, they transform platforms into systems with positive feedback. With every new agent on the platform, be it customer or supplier, there is increased benefit for all participants. Once a critical mass of users has been reached, the growth in their numbers is no longer a linear-type progression like in traditional markets. It becomes exponential. With the really successful platforms, saturation effects only occur when they have conquered a dominant position in the market.

The standard work in economics on the subject is Information Rules – A Strategic Guide to Network Economy. It was written in 1998 by Carl Shapiro and Hal R. Varian. Today, Varian is Google’s chief economist. Boiled down to a single sentence, the book’s core message is that success breeds success.

This logical progression of increased benefit through more market participants is alien to traditional branches making physical products and using the classical pipeline structure, which starts with invention, and goes on to development, manufacturing, marketing, and then sales. It is true that customers benefit from economies of scale in production.

But apart from the lower unit price achieved through mass production, anyone who buys a packet of cookies does not gain additional benefit when another customer also buys a packet. Where finite resources are involved, the opposite effect comes into play. If too many new customers suddenly discover their love for a particular French wine, the wine gets uncomfortably expensive for the ones who discovered it first.

We are living in an age of vanity about the present. Disruption is going on much less often than claimed.

The German-Austrian trend researcher Matthias Horx has coined the word, Gegenwartseitelkeit. Literally translated, it means “vanity about the present,” and it describes a kind of pride one feels from living in the here and now. What Horx means is that we are all a bit smug and like to fancy our- selves as living at a very special time in history.

In a period where there is a lot going on, the world  is changing for  the  better,  and where  new technologies are bringing new benefits, the way electricity and antibiotics did in the old days. It’s a very human trait. After all, nobody wants to live in times where there’s hardly anything happening.

Horx says this perception is vain and therefore we systematically overestimate the amount of progress that is actually taking place. This distorts reality, and one of the ways this distortion finds expression is in the overuse of the term “disruption.” No, the 28th car-sharing app is not disruptive, no matter how often the startup’s business plan claims that it is. Incidentally, the operators of the biggest car-sharing enterprises are Goliaths as well.

THE INTELLIGENT GOLIATHS CONNECT THE BEST OF BOTH WORLDS, THE KNOWLEDGE FROM EXPERIENCE AND A READINESS FOR CHANGE.

To put all the things that are referred to as disruptive into a historical perspective, the American economist Robert J. Gordon recommends the toilet test. To take the test, choose which of the two options is most appealing to you.

Option 1: You have a laptop dating from 2002 or a personal computer with the Windows XP operating system and the usual programs. Your internet access also dates back to 2002. But your toilet is right there in your apartment.

Option 2: You have the iPad connected to the internet wherever you go. Naturally, you also have a state-of-the-art smartphone, armed with Facebook, Twitter and all the social media apps we are familiar with today. But your toilet is way outside in the yard.

When Gordon asks the audience to make their choice, the majority chooses option one, the one with the convenient indoor toilet. This confirms his basic proposition. At present, technological progress is anything but disruptive. When our technophile age is interpreted by social psychology, it would seem the inflationary use of the term disruption is a warning that technology brings much less added value than is claimed.

So Gordon has devised an analytical alternative concept to Disrupt’s deep house soundtrack beamed at the subconscious. That is very helpful for all those in the higher echelons of management who have to make strategic decisions in the context of the megatrend of digitization. This stance of skepticism about  technology, combined with the diagnosis of our contemporary vanity, makes it possible to categorize the phenomenon of disruption in a far more relaxed way. We look at the phenomenon from the point of view of an alert Goliath who does not want to be knocked out by a David. What emerges when the two extreme positions are synthesized is the realization that, yes, disruption takes place. But  it happens less frequently than is claimed.

THE IPHONE HAS BEEN A MAGNIFICENT DOORMAN FOR THE MOBILE INTERNET. BUT WHOSE BUSINESS MODEL HASIT DISRUPTED?

We have already noted that anything that can be digitized gets digitized. Digitally organized markets are dominated by platforms. Network effects play into the hands of the innovators. That is all very true. But it says little about which companies will benefit the most in the long term from digital trans- formation, and whether the path to success in most industries will follow the route of disruptive innovation or the evolution of clever business models in the wake of a shrewd digital transformation strategy.

It is not only that disruption happens less frequently than is claimed. From an etymological perspective, the word is nearly always used incorrectly. The fact is, the majority of the great disruptors of the last fifteen years have not ruptured or disrupted old business models but have simply employed new technologies to create new markets with and for consumers. Before Facebook, there was no platform that organized private communication as a social network. With its algorithmic innovation of page ranking, Google has ousted other search machines. Today, Google’s search term marketing, still by far its most important revenue model, works wonderfully well and has made its founders rich. It continues to be a large slice of the world’s total advertising cake. The iPhone has been a magnificent doorman for the mobile internet, opening up the world of highly solvent consumers. But whose business model has it disrupted?

The fact that Nokia was incapable of developing decent smartphones has nothing to do with disruption. It was bad innovation management for an important product category. For the big players of the pre-digital world, it is here that they can draw perhaps the most important lesson to be learned about handling technological leaps in development. It’s not about disruption. It’s about good management.

Clayton M. Christensen’s ideas about the rise and fall of big organization are only sacrosanct at a very lofty level. Presumably, no big company will be successful forever. But where medium-term time scales are concerned, the theory of the “Innovator’s Dilemma”, which sounds so plausible, is currently coming under heavy fire from academia. (see also related content: A framework for the far future) The popular horse versus carriage comparison is a nice tale but it’s a lame comparison in nearly all industries, especially in business-to-business markets. One example: the industrial “internet of things” is more thing than internet.

Here, too, there will naturally be powerful digital platforms but it is up to the manufacturers and operators of the physical goods and infrastructures to fight for the command of these platforms.

They start off in an excellent position since it is their machines and goods that accumulate the data which will control the internet of things. If they are clever enough to use the data, no digital pure player will have an easy job of siphoning them off and constructing its own platforms that the data suppliers would then be dependent on.

The intelligent Goliaths tread the path of digital transformation in three phases. At the moment, they are systematically collecting knowledge on the subject. Then, they put the changes brought about by technological upheavals in the context of their existing business models. Finally, they connect the best of both worlds, the knowledge from experience and a readiness for change.

In order for the attempt at intelligent further development to succeed, there is a need for a new attitude in management that takes on board a lot of the things that startups demonstrate.

MODERN LEADERSHIP IN BIG ENTERPRISES MEANS: BECOME MORE AMBITIOUS AND AGGRESSIVE AGAIN.

In order for the attempt at intelligent further development to succeed, there is a need for a new attitude in management that takes on board a lot of the things that startups demonstrate.

Modern leadership in big enterprises must: 1) Become more experimental. Embrace a culture that allows errors. 2) Grant innovative brains the freedom they need. Understand that uncertainty of outcome and aiming for results are not contradictory but two sides of the same coin. And 3) become ambitious and aggressive again.

The last point is the most important. The fear of disrupting one’s own market may be exaggerated due to vanity about the present. But the fear has a very positive side effect. It gives a new boost of energy to large companies that have become fat and sluggish.

Transform... transform... transform... That mantra may not sound like a deep-house track for a trendy digital economy conference. It is not a message to the subconscious, but an appeal to the reason inherent in large organizations.

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