Clayton M. Christensen
Professor, Harvard Business School

I love working with Michael Mauboussin. He is one of the smartest people I have ever met. It is a privilege to join you here today.

As you look across the sweep of business history, there are a lot of poorly-managed companies that have stumbled and failed, and it is quite obvious why that happened. If you look at the companies who at some point were widely regarded as unassailably successful, you often find that a decade or two later, they are in the middle of the pack or even at the bottom of the heap. Why is that? Why is it that good companies seem to get killed with some regularity?

There is a second puzzle. Venture capitalists have a belief that "you just can't pick 'em." They think that success in new businesses is mostly random, so you have to place ten bets to have two successes. It didn't feel to me as though success was intrinsically random. In fact, there are patterns that allow for an entrepreneur to increase the probability of success.

Many of the principles of management that we teach are not universally true.

• We teach that you should always listen and respond to the needs of your best customers. We teach that you should focus your investments on the opportunities that offer the most attractive profit margins. It turns out that sometimes, in certain circumstances, these are the right principles to follow. When faced with disruption, however, these are the wrong principles to follow.
  
• We teach that large markets represent the best growth opportunities, and this is a widely-held belief. We teach that understanding the customer is the key to successful innovation. Based on our research, we have concluded that this is almost universally false.
  
• We teach that you should outsource those functions which are low value-added and which are not your core competencies. It turns out that this is false as often as it is true, but to understand the difference, you need to understand in what circumstances this is true and in what circumstances it is a false gospel.
  
• Finally, we teach in finance and economics that you should ignore fixed and sunk costs and make future investments based on future marginal outlays. It turns out again that there are circumstances in which this is the right thing to do and circumstances in which this is badly misleading in terms of its impact on success.

Let me start with a model of disruption. I will plot on the vertical axis the performance of a service or product. On the horizontal axis, we will plot time. In every market, there is a trajectory of improvement that customers can use - a line sloping up and to the right. There is a distribution, of course, so at the high end, there are very demanding customers who will never be satisfied with the best that is offered. At the bottom of every market, there are simple folks who can be over-served by almost nothing.

In each market, there is also a different trajectory of improvement that innovating companies can provide as they keep introducing new and improved products. The most important finding is that the industry's rate of technological improvement almost always outstrips the customers' ability to use the progress.

Some of the innovations that help companies move up the improvement trajectory are simply year-to-year incremental improvements. Others are dramatic breakthroughs. But our research indicated that the incremental and the breakthrough innovations had the same impact on the industry, in that their purpose was to sustain that trajectory of improvement as it existed in the market at the time. What we found almost invariably is that the leaders at the beginning of a cycle of sustaining industry innovation will remain on top when it's all over. If the purpose of the innovation will help the leaders in the industry make better products that they can sell for better profits to their best customers, they will figure out how to stay on top.

There is also another type of innovation that we observed that always killed the leader. We called this "disruptive innovation". We chose the word "disruptive" not because it was a sustaining, breakthrough improvement, but because it actually brought to the market a product that was worse. It was not as good as what the leaders were selling, but it was simple, convenient and affordable. It could take root in the most undemanding tier of the market, and then improve off of that foothold. Almost invariably, we found that the entrants kill the incumbents and become the new leaders.

I can explain case studies without using the words "stupid manager" once. There is no stupidity involved on either the incumbent or challenger side of the equation. The incumbents are told to always focus investments where profit margins are most attractive, and to always listen to the best customers. This is very good advice on the sustaining innovation trajectory. But this advice paralyzes companies from moving down-market.