A key question in business (and hence in investing) is: what drives change? Why do dominant businesses get disrupted so frequently by challengers? I posit in this post that most of this disruption is a consequence of a shift in economic scarcity, mainly caused by technological advances.
Most businesses can be conceptualized as offering a product or service bundle of value to their customers. The bundle is made up of various modules that combine together to provide the customer a valuable offering. I suggest that advances in technology cause changes in the relative scarcity or abundance in the underlying economics of these modules, and it is these changes in economics that create an opening for a challenger to topple a dominant business.
Consider an example given recently by Marc Andreessen:
“And so the newspaper bundle, the idea of this slug of news and sports scores and classifieds and stock quotes that arrives once a day was a consequence of the printing plant. Of the metro area printing plant, of the distribution network for newspapers using trucks and newsstands and newspaper vending machines and the famous newspaper delivery boy. That newspaper bundle was based on the distribution technology of a time and place.
When the distribution technology changed with the internet, there was going to be the great unwind, and then the great rebundle, in the form of Google and Facebook and Twitter and all these new bundles.
I think music is a great example of that. It made sense in the LP and CD era to [bundle] eight or 10 or 12 or 15 songs on a disc and press the disc and ship it out and have it sit in storage until somebody came along and bought it.
But, when you have the ability online to download or stream individual tracks, then all of a sudden that bundle just doesn’t make sense. So it [got unbundled] into individual MP3s.
And I think now it makes sense that it’s kind of re-bundling into streaming services like Pandora and Spotify.”
In general, once the deck of economic value has been shuffled by the shift in scarcity, it can create an opening to an entrepreneur to start from scratch by targeting a key module of the old bundle that is now relatively scarce — hence valuable — and leverage the newly created abundance. The Moore’s law driven plunge in the price of communications, for instance, is enabling a lot of startups to rethink existing business bundles by exploiting the “free” distribution available on the internet, just like iTunes did to unbundle CDs and Pandora is doing to iTunes in the example.
Once the challenger has won, it is fairly easy for the winner to bundle more and more features around the core module, to increase its value and to capture incremental marketshare. Of course, this process eventually sets up the bloated bundle to become a target for the next new challenger on the block, as technology changes the point of scarcity again!
The former CEO of Netscape, Jim Barksdale’s observation: (hbr.org/2014/06/how-to-succeed-in-business-by-bundling-and-unbundling): “there’s only two ways I know of to make money: bundling and unbundling” captures this cycle of unbundling followed by bundling; but he does not really explain why should this be so? Andreessen, in a recent Tweetstorm, has provided a detailed example of this phenomenon of bundling and unbundling (twitter.com/pmarca/status/481554165454209027).
Thus the key driver of all the disruption and unbundling is technology driven changes in economic scarcity. A particularly powerful example of such a technology driver is the virtuous cycle of semiconductors and software advances feeding into each other, diagrammed below (I have previously written about this loop here: arunsplace.com/2014/09/22/the-moore-andreessen-feedback-loop).
I think it is vital for a disruptor to succeed that it be better aligned with this loop than the product it is challenging!
This is why I think the Christensen model of disruption, while insightful, is not complete. It comes in two flavors: low-end disruption and new-market disruption. Neither is fully satisfying as an adequate model of disruption – a counter-example to Christensen’s framework is the fact that the expensive, richly-featured iPhone manage to completely disrupt the cheaper, less functional feature-phone business (e.g., Nokia) — the exact opposite of what his model predicts! In my framework, by contrast, the key driver (driven by Moore’s law) was the relative abundance, and hence cheapness, of the internet. This allowed the iPhone to feature internet-enabled apps as the main attraction, rather than phone calls (in fact the initial iPhone was not all that great at making calls!). Thus the shift in scarcity/abundance created an opening for Apple to target internet connectivity as the core offering. This, I claim, is a better framework to explaining why they succeeded in disrupting the plain old cellphones despite being much more expensive; it was clearly not an attack from the bottom. (To be sure, smartphones also disrupted PCs, and that fact can be explained as an attack from the bottom as well as an unbundling of PCs due to a shift in scaricity/abundance; I chose the disruption of dumb-phones in this example since that cannot be adequately explained by one of the two frameworks).
To be sure, there can be other kinds of technology changes that are not related to semiconductors. But it is really hard to find other examples of something that can grow 40% per year for nearly 50 years! Moore’s law in likely unique in this aspect, which is why I think it has plays such a crucial part in the persistence of the disruption phenomenon, of the kind we have been experiencing in the last few decades.