Christensen_Challenge

Meeting the Challenge

of Disruptive Change

Clayton M. Christensen

Michael Overdorf

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HBROnPoint

F R O M T H E H A R V A R D B U S I N E S S R E V I E W

A R T I C L E

Meeting the Challenge of Disruptive Changeby Clayton M. Christensen andMichael Overdorf

New sections to

guide you through

the article:

• The Idea in Brief

• The Idea at Work

• Exploring Further. . .

P R O D U C T N U M B E R 3 4 5 6

Trying to transform an

enterprise, managers can

destroy the very capabili-

ties that sustain it.

Before you respond to

drastic change, make sure

you know what your organ-

ization can and cannot do.

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T H E I D E A

Amid all the clamor about the need to res-pond quickly to changing technologies andmarkets, it’s easy for a company to miss theboat. In its rush to alter the organizationalstructure, the company not only fails to capital-ize on the new development—it undermines itscore competencies.

Before you can respond to change, you have tounderstand the nature of the change. For exam-ple, there are two basic types of innovation.Whereas sustaining innovations make a prod-uct perform better for mainstream customers,

disruptive innovations create entirely newmarkets. Managers in established companiesexcel at sustaining innovations but fare lesswell with disruptive ones. Why? As a company’score capabilities grow, its disabilities becomemore accentuated. Although they can usuallysee the disruptive change coming, the managersare too enmeshed in the can-do ethos of thecompany’s core capabilities to understand thata fundamentally different organizationalresponse is required. The skill they mustdevelop is the ability to see their organizations’capabilities and disabilities together.

Meeting the Challenge of Disruptive Change

Whe n thinking about how to respond todisruptive innovation, managers must take intoaccount the unique resources-processes-valuesframework that defines a company and shapesits capacity to change:

• Resources include people, technologies, and

cash, as well as such intangibles as product

designs, brands, and customer and supplier

relationships.

• Processes comprise the patterns of interac-

tion, coordination, and decision making

that lead to the company’s output. By

nature, they’re designed for stability and

consistency. But a process that creates the

E X A M P L E :Digital Equipment’s fall from grace was not theresult of misreading the market. Although it hadthe resources to enter the emerging personal computer market, Digital’s processes and valueswere built around minicomputers. To edge outcompetitors in that market, Digital adoptedprocesses that sought incremental improvement,which fit with a corporate value that emphasizedhigher margins in order to cover overhead costs.Consequently, smaller companies and start-ups,whose processes and values embraced disruptivechange, were the ones that capitalized on the new market.

HBR OnPoint © 2000 by Harvard Business School Publishing Corporation. All rights reserved.

capability to do one thing can create dis-

abilities in other areas.

• Values, in this context, mean the standards

by which you judge one customer or market

opportunity to be more important than

another. Two values in particular have

tremendous impact on how well a company

addresses disruptive change: how the com-

pany judges acceptable gross margins and

how big a business opportunity needs to be

before it can be interesting.

When a large, established company needs dif-

ferent resources, processes, and values in order

to respond to a disruptive innovation, it must

create new organizational space where those

capabilities can be developed. Options include:

• developing the capabilities internally. This

means pulling relevant people out of the

existing organization and drawing a bound-

ary around the new group.

• spinning off an organization with theresources needed to build a strong posi-tion in the new market. It was not until

Hewlett-Packard’s managers transferred the

ink-jet unit to a separate division that the

business became successful.

• acquiring another company that has therequisite capabilities.

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It’s no wonder that innovation

is so difficult for established

firms. They employ highly

capable people – and then set

them to work within processes

and business models that

doom them to failure. But

there are ways out of

this dilemma.

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Copyright © 2000 by the President and Fellows of Harvard College. All rights reserved. harvard business review March–April 2000

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hese are scary times for managersin big companies. Even before the Internet and globalization, their track

record for dealing with major, disruptivechange was not good. Out of hundreds of department stores, for example, only one –Dayton Hudson –became a leader in discountretailing. Not one of the minicomputer com-panies succeeded in the personal computerbusiness. Medical and business schools arestruggling – and failing – to change their cur-ricula fast enough to train the types of doc-tors and managers their markets need. Thelist could go on.

harvard business review March–April 2000 67

Meeting the Challenge ofDisruptive Change

Tby Clayton M. Christensen

and Michael Overdorf

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It’s not that managers in big companies can’t seedisruptive changes coming. Usually they can. Nordo they lack resources to confront them. Most bigcompanies have talented managers and specialists,strong product portfolios, first-rate technologicalknow-how, and deep pockets. What managers lackis a habit of thinking about their organization’s ca-pabilities as carefully as they think about individ-ual people’s capabilities.

One of the hallmarks of a great manager is theability to identify the right person for the right joband to train employees to succeed at the jobs they’regiven. But unfortunately, most managers assumethat if each person working on a project is wellmatched to the job, then the organization in whichthey work will be, too. Often that is not the case.One could put two sets of identically capable peo-ple to work in different organizations, and whatthey accomplished would be significantly different.That’s because organizations themselves –indepen-dent of the people and other resources in them –have capabilities. To succeed consistently, goodmanagers need to be skilled not just in assessingpeople but also in assessing the abilities and disabil-ities of their organization as a whole.

This article offers managers a framework to helpthem understand what their organizations are capa-ble of accomplishing. It will show them how theircompany’s disabilities become more sharply de-fined even as its core capabilities grow. It will givethem a way to recognize different kinds of changeand make appropriate organizational responses tothe opportunities that arise from each. And it willoffer some bottom-line advice that runs counter tomuch that’s assumed in our can-do business cul-ture: if an organization faces major change – a dis-ruptive innovation, perhaps – the worst possibleapproach may be to make drastic adjustments tothe existing organization. In trying to transform anenterprise, managers can destroy the very capabili-ties that sustain it.

Before rushing into the breach, managers mustunderstand precisely what types of change the ex-isting organization is capable and incapable of han-dling. To help them do that, we’ll first take a sys-tematic look at how to recognize a company’s core

capabilities on an organizational level and then ex-amine how those capabilities migrate as companiesgrow and mature.

Where Capabilities ResideOur research suggests that three factors affect whatan organization can and cannot do: its resources, itsprocesses, and its values. When thinking about whatsorts of innovations their organization will be ableto embrace, managers need to assess how each ofthese factors might affect their organization’s ca-pacity to change.

Resources. When they ask the question, “Whatcan this company do?” the place most managerslook for the answer is in its resources –both the tan-gible ones like people, equipment, technologies,and cash, and the less tangible ones like product designs, information, brands, and relationshipswith suppliers, distributors, and customers. Withoutdoubt, access to abundant, high-quality resourcesincreases an organization’s chances of coping withchange. But resource analysis doesn’t come close totelling the whole story.

Processes. The second factor that affects what acompany can and cannot do is its processes. By pro-cesses, we mean the patterns of interaction, coordi-nation, communication, and decision making em-ployees use to transform resources into productsand services of greater worth. Such examples as theprocesses that govern product development, manu-facturing, and budgeting come immediately tomind. Some processes are formal, in the sense thatthey are explicitly defined and documented. Othersare informal: they are routines or ways of workingthat evolve over time. The former tend to be morevisible, the latter less visible.

One of the dilemmas of management is that pro-cesses, by their very nature, are set up so that em-ployees perform tasks in a consistent way, time aftertime. They are meant not to change or, if they mustchange, to change through tightly controlled proce-dures. When people use a process to do the task itwas designed for, it is likely to perform efficiently.But when the same process is used to tackle a verydifferent task, it is likely to perform sluggishly. Com-panies focused on developing and winning FDA ap-proval for new drug compounds, for example, oftenprove inept at developing and winning approval formedical devices because the second task entails verydifferent ways of working. In fact, a process thatcreates the capability to execute one task concur-rently defines disabilities in executing other tasks.1

The most important capabilities and concurrentdisabilities aren’t necessarily embodied in the most

68 harvard business review March–April 2000

M eeting the Chal lenge of Disrupt ive Change

Clayton M. Christensen is a professor of business admin-istration at Harvard Business School in Boston and theauthor of The Innovator’s Dilemma: When New Tech-nologies Cause Great Firms to Fail (Harvard BusinessSchool Press, 1997).

Michael Overdorf is a Dean’s Research Fellow at Har-vard Business School.

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visible processes, like logistics, development, manu-facturing, or customer service. In fact, they are morelikely to be in the less visible, background processesthat support decisions about where to invest re-sources – those that define how market research ishabitually done, how such analysis is translated intofinancial projections, how plans and budgets are ne-gotiated internally, and so on. It is in those processesthat many organizations’ most serious disabilitiesin coping with change reside.

Values. The third factor that affects what an orga-nization can and cannot do is its values. Sometimesthe phrase “corporate values” carries an ethicalconnotation: one thinks of the principles that en-sure patient well-being for Johnson & Johnson orthat guide decisions about employee safety at Al-coa. But within our framework, “values” has abroader meaning. We define an organization’s val-ues as the standards by which employees set priori-ties that enable them to judge whether an order is attractive or unattractive, whether a customer ismore important or less important, whether an ideafor a new product is attractive or marginal, and soon. Prioritization decisions are made by employeesat every level. Among salespeople, they consist ofon-the-spot, day-to-day decisions about whichproducts to push with customers and which to de-emphasize. At the executive tiers, they often takethe form of decisions to invest, or not, in new prod-ucts, services, and processes.

The larger and more complex a company becomes,the more important it is for senior managers to trainemployees throughout the organization to make in-dependent decisions about priorities that are consis-tent with the strategic direction and the businessmodel of the company. A key metric of good manage-ment, in fact, is whether such clear, consistent val-ues have permeated the organization.

But consistent, broadly understood values also de-fine what an organization cannot do. A company’svalues reflect its cost structure or its business modelbecause those define the rules its employees mustfollow for the company to prosper. If, for example, acompany’s overhead costs require it to achieve grossprofit margins of 40%, then a value or decision rulewill have evolved that encourages middle managersto kill ideas that promise gross margins below 40%.Such an organization would be incapable of com-mercializing projects targeting low-margin mar-kets – such as those in e-commerce – even thoughanother organization’s values, driven by a very dif-ferent cost structure, might facilitate the success ofthe same project.

Different companies, of course, embody differentvalues. But we want to focus on two sets of values

in particular that tend to evolve in most compa-nies in very predictable ways.The inexorable evolu-tion of these two values is what makes companiesprogressively less capable of addressing disruptivechange successfully.

As in the previous example, the first value dictatesthe way the company judges acceptable gross mar-

gins. As companies add features and functions totheir products and services, trying to capture moreattractive customers in premium tiers of their mar-kets, they often add overhead cost. As a result, grossmargins that were once attractive become unattrac-tive. For instance, Toyota entered the North Ameri-can market with the Corona model, which targetedthe lower end of the market. As that segment be-came crowded with look-alike models from Honda,Mazda, and Nissan, competition drove down profitmargins. To improve its margins, Toyota then de-veloped more sophisticated cars targeted at highertiers. The process of developing cars like the Camryand the Lexus added costs to Toyota’s operation. Itsubsequently decided to exit the lower end of themarket; the margins had become unacceptable because the company’s cost structure, and conse-quently its values, had changed.

In a departure from that pattern, Toyota recentlyintroduced the Echo model, hoping to rejoin the entry-level tier with a $10,000 car. It is one thing forToyota’s senior management to decide to launch thisnew model. It’s another for the many people in theToyota system – including its dealers – to agree thatselling more cars at lower margins is a better way toboost profits and equity values than selling moreCamrys, Avalons, and Lexuses. Only time will tellwhether Toyota can manage this down-marketmove. To be successful with the Echo, Toyota’s man-agement will have to swim against a very strong cur-rent –the current of its own corporate values.

The second value relates to how big a business opportunity has to be before it can be interesting. Because a company’s stock price represents the discounted present value of its projected earningsstream, most managers feel compelled not just tomaintain growth but to maintain a constant rate ofgrowth. For a $40 million company to grow 25%,for instance, it needs to find $10 million in newbusiness the next year. But a $40 billion companyneeds to find $10 billion in new business the nextyear to grow at that same rate. It follows that an op-portunity that excites a small company isn’t big



Often, it seems, financial analysts have abetter intuition about the value of resourcesthan they do about the value of processes.

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enough to be interesting to a large company. One ofthe bittersweet results of success, in fact, is that ascompanies become large, they lose the ability to en-ter small, emerging markets. This disability is notcaused by a change in the resources within the com-panies – their resources typically are vast. Rather,it’s caused by an evolution in values.

The problem is magnified when companies sud-denly become much bigger through mergers or ac-quisitions. Executives and Wall Street financierswho engineer megamergers between already-hugepharmaceutical companies, for example, need totake this effect into account. Although their mergedresearch organizations might have more resources



One of the bittersweet results of success is that as companies become large, they lose sightof small, emerging markets.

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to throw at new product development, their com-mercial organizations will probably have lost theirappetites for all but the biggest blockbuster drugs.This constitutes a very real disability in managinginnovation. The same problem crops up in high-techindustries as well. In many ways, Hewlett-Packard’srecent decision to split itself into two companies isrooted in its recognition of this problem.

The Migration of CapabilitiesIn the start-up stages of an organization, much ofwhat gets done is attributable to resources –people,in particular. The addition or departure of a fewkey people can profoundly influence its success.Over time, however, the locus of the organization’scapabilities shifts toward its processes and values.As people address recurrent tasks, processes be-come defined. And as the business model takesshape and it becomes clear which types of businessneed to be accorded highest priority, values coa-lesce. In fact, one reason that many soaring youngcompanies flame out after an IPO based on a singlehot product is that their initial success is groundedin resources – often the founding engineers – andthey fail to develop processes that can create a se-quence of hot products.

Avid Technology, a producer of digital-editingsystems for television, is an apt case in point. Avid’swell-received technology removed tedium from thevideo-editing process. On the back of its star prod-uct, Avid’s stock rose from $16 a share at its 1993IPO to $49 in mid-1995. However, the strains of be-ing a one-trick pony soon emerged as Avid faced a saturated market, rising inventories and receiv-ables, increased competition, and shareholder law-suits. Customers loved the product, but Avid’s lackof effective processes for consistently developingnew products and for controlling quality, delivery,and service ultimately tripped the company andsent its stock back down.

By contrast, at highly successful firms such asMcKinsey & Company, the processes and valueshave become so powerful that it almost doesn’tmatter which people get assigned to which projectteams. Hundreds of MBAs join the firm every year,and almost as many leave. But the company is ableto crank out high-quality work year after year be-cause its core capabilities are rooted in its processesand values rather than in its resources.

When a company’s processes and values are beingformed in its early and middle years, the foundertypically has a profound impact. The founder usu-ally has strong opinions about how employeesshould do their work and what the organization’s

priorities need to be. If the founder’s judgments areflawed, of course, the company will likely fail. Butif they’re sound, employees will experience forthemselves the validity of the founder’s problem-solving and decision-making methods. Thus pro-cesses become defined. Likewise, if the company be-comes financially successful by allocating resourcesaccording to criteria that reflect the founder’s priori-ties, the company’s values coalesce around thosecriteria.

As successful companies mature, employeesgradually come to assume that the processes andpriorities they’ve used so successfully so often arethe right way to do their work. Once that happensand employees begin to follow processes and decidepriorities by assumption rather than by consciouschoice, those processes and values come to consti-tute the organization’s culture.2 As companies growfrom a few employees to hundreds and thousands of them, the challenge of getting all employees to agree on what needs to be done and how can bedaunting for even the best managers. Culture is apowerful management tool in those situations. Itenables employees to act autonomously but causesthem to act consistently.

Hence, the factors that define an organization’scapabilities and disabilities evolve over time – theystart in resources; then move to visible, articulatedprocesses and values; and migrate finally to culture.As long as the organization continues to face thesame sorts of problems that its processes and valueswere designed to address, managing the organiza-tion can be straightforward. But because those fac-tors also define what an organization cannot do,they constitute disabilities when the problems fac-ing the company change fundamentally. When theorganization’s capabilities reside primarily in itspeople, changing capabilities to address the newproblems is relatively simple. But when the capa-bilities have come to reside in processes and values,and especially when they have become embeddedin culture, change can be extraordinarily difficult.(See the sidebar “Digital’s Dilemma.”)

Sustaining VersusDisruptive InnovationSuccessful companies, no matter what the sourceof their capabilities, are pretty good at respondingto evolutionary changes in their markets – what inThe Innovator’s Dilemma (Harvard Business School,1997), Clayton Christensen referred to as sustain-ing innovation. Where they run into trouble is inhandling or initiating revolutionary changes in theirmarkets, or dealing with disruptive innovation.



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Sustaining technologies are innovations thatmake a product or service perform better in waysthat customers in the mainstream market alreadyvalue. Compaq’s early adoption of Intel’s 32-bit 386microprocessor instead of the 16-bit 286 chip was a sustaining innovation. So was Merrill Lynch’s in-troduction of its Cash Management Account, whichallowed customers to write checks against their eq-uity accounts. Those were breakthrough innova-tions that sustained the best customers of thesecompanies by providing something better than hadpreviously been available.

Disruptive innovations create an entirely newmarket through the introduction of a new kind ofproduct or service, one that’s actually worse, ini-tially, as judged by the performance metrics thatmainstream customers value. Charles Schwab’s ini-tial entry as a bare-bones discount broker was a dis-ruptive innovation relative to the offerings of full-service brokers like Merrill Lynch. Merrill Lynch’sbest customers wanted more than Schwab-like ser-vices. Early personal computers were a disruptive

innovation relative to mainframes and minicom-puters. PCs were not powerful enough to run thecomputing applications that existed at the time theywere introduced. These innovations were disrup-tive in that they didn’t address the next-generationneeds of leading customers in existing markets.They had other attributes, of course, that enablednew market applications to emerge – and the dis-ruptive innovations improved so rapidly that theyultimately could address the needs of customers inthe mainstream of the market as well.

Sustaining innovations are nearly always devel-oped and introduced by established industry lead-ers. But those same companies never introduce – orcope well with – disruptive innovations. Why? Ourresources-processes-values framework holds theanswer. Industry leaders are organized to developand introduce sustaining technologies. Month aftermonth, year after year, they launch new and im-proved products to gain an edge over the competi-tion. They do so by developing processes for eval-uating the technological potential of sustaining

A lot of business thinkers have analyzed Digital EquipmentCorporation’s abrupt fall from grace. Most have concludedthat Digital simply read the market very badly. But if we lookat the company’s fate through the lens of our framework,a different picture emerges.

Digital was a spectacularly successful maker of mini-computers from the s through the s. One mighthave been tempted to assert, when personal computers firstappeared in the market around , that Digital’s corecapability was in building computers. But if that were thecase, why did the company stumble?

Clearly, Digital had the resources to succeed in personalcomputers. Its engineers routinely designed computersthat were far more sophisticated than PCs. The companyhad plenty of cash, a great brand, good technology, andso on. But it did not have the processes to succeed in thepersonal computer business. Minicomputer companiesdesigned most of the key components of their computersinternally and then integrated those components intoproprietary configurations. Designing a new productplatform took two to three years. Digital manufacturedmost of its own components and assembled them in abatch mode. It sold directly to corporate engineeringorganizations. Those processes worked extremely wellin the minicomputer business.

PC makers,by contrast,outsourced most components fromthe best suppliers around the globe.New computer designs,made up of modular components,had to be completed in six to months.The computers were manufactured in high-volume assembly lines and sold through retailers to consumersand businesses.None of these processes existed within Digital.In other words,although the people working at the companyhad the ability to design,build,and sell personal computersprofitably, they were working in an organization that wasincapable of doing so because its processes had been designedand had evolved to do other tasks well.

Similarly,because of its overhead costs,Digital had to adopta set of values that dictated,“If it generates % gross marginsor more, it’s good business. If it generates less than % mar-gins, it’s not worth doing.”Management had to ensure that allemployees gave priority to projects according to these criteriaor the company couldn’t make money.Because PCs generatedlower margins, they did not fit with Digital’s values.Thecompany’s criteria for setting priorities always placed higher-performance minicomputers ahead of personal computers in the resource-allocation process.

Digital could have created a different organization thatwould have honed the different processes and values requiredto succeed in PCs – as IBM did. But Digital’s mainstreamorganization simply was incapable of succeeding at the job.

Digital’s Dilemma



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innovations and for assessing their customers’ needsfor alternatives. Investment in sustaining technol-ogy also fits in with the values of leading companiesin that they promise higher margins from betterproducts sold to leading-edge customers.

Disruptive innovations occur so intermittentlythat no company has a routine process for handlingthem. Furthermore, because disruptive productsnearly always promise lower profit margins perunit sold and are not attractive to the company’sbest customers, they’re inconsistent with the es-tablished company’s values. Merrill Lynch had theresources – the people, money, and technology – re-quired to succeed at the sustaining innovations(Cash Management Account) and the disruptive in-novations (bare-bones discount brokering) that ithas confronted in recent history. But its processesand values supported only the sustaining innova-tion: they became disabilities when the companyneeded to understand and confront the discountand on-line brokerage businesses.

The reason, therefore, that large companies oftensurrender emerging growth markets is that smaller,disruptive companies are actually more capable ofpursuing them. Start-ups lack resources, but thatdoesn’t matter. Their values can embrace smallmarkets, and their cost structures can accommo-date low margins. Their market research and re-source allocation processes allow managers to pro-ceed intuitively; every decision need not be backedby careful research and analysis. All these advan-tages add up to the ability to embrace and even ini-tiate disruptive change. But how can a large com-pany develop those capabilities?

Creating Capabilities to Cope with ChangeDespite beliefs spawned by popular change-man-agement and reengineering programs, processes arenot nearly as flexible or adaptable as resources are –and values are even less so. So whether addressingsustaining or disruptive innovations, when an orga-nization needs new processes and values – becauseit needs new capabilities – managers must create anew organizational space where those capabilitiescan be developed. There are three possible ways todo that. Managers can " create new organizational structures within

corporate boundaries in which new processescan be developed,

" spin out an independent organization fromthe existing organization and develop withinit the new processes and values required tosolve the new problem,

" acquire a different organization whose processesand values closely match the requirements ofthe new task. Creating New Capabilities Internally. When a

company’s capabilities reside in its processes, andwhen new challenges require new processes – thatis, when they require different people or groups in a company to interact differently and at a differentpace than they habitually have done – managersneed to pull the relevant people out of the existingorganization and draw a new boundary around anew group. Often, organizational boundaries werefirst drawn to facilitate the operation of existingprocesses, and they impede the creation of new pro-cesses. New team boundaries facilitate new patternsof working together that ultimately can coalesceas new processes. In Revolutionizing Product De-velopment (The Free Press, 1992), Steven Wheel-wright and Kim Clark referred to these structuresas “heavyweight teams.”

These teams are entirely dedicated to the newchallenge, team members are physically located to-gether, and each member is charged with assumingpersonal responsibility for the success of the entireproject. At Chrysler, for example, the boundaries ofthe groups within its product development orga-nization historically had been defined by compo-nents – power train, electrical systems, and so on.But to accelerate auto development, Chrysler neededto focus not on components but on automobileplatforms – the minivan, small car, Jeep, and truck,for example – so it created heavyweight teams. Al-though these organizational units aren’t as good atfocusing on component design, they facilitated thedefinition of new processes that were much fasterand more efficient in integrating various subsys-tems into new car designs. Companies as diverse as Medtronic for its cardiac pacemakers, IBM for its disk drives, and Eli Lilly for its new blockbusterdrug Zyprexa have used heavyweight teams as vehicles for creating new processes so they coulddevelop better products faster.

Creating Capabilities Through a Spinout Organi-zation. When the mainstream organization’s valueswould render it incapable of allocating resources toan innovation project, the company should spin itout as a new venture. Large organizations cannot beexpected to allocate the critical financial and hu-man resources needed to build a strong position insmall, emerging markets. And it is very difficult fora company whose cost structure is tailored to com-pete in high-end markets to be profitable in low-endmarkets as well. Spinouts are very much in vogueamong managers in old-line companies strugglingwith the question of how to address the Internet.



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But that’s not always appropriate. When a disrup-tive innovation requires a different cost structurein order to be profitable and competitive, or whenthe current size of the opportunity is insignificantrelative to the growth needs of the mainstream or-ganization, then – and only then – is a spinout orga-nization required.

Hewlett-Packard’s laser-printer division in Boise,Idaho, was hugely successful, enjoying high mar-gins and a reputation for superior product quality.Unfortunately, its ink-jet project, which representeda disruptive innovation, languished inside themainstream HP printer business. Although the pro-cesses for developing the two types of printerswere basically the same, there was a difference invalues. To thrive in the ink-jet market, HP neededto be comfortable with lower gross margins and asmaller market than its laser printers commanded,and it needed to be willing to embrace relativelylower performance standards. It was not until HP’smanagers decided to transfer the unit to a separatedivision in Vancouver, British Columbia, with thegoal of competing head-to-head with its own laserbusiness, that the ink-jet business finally becamesuccessful.

How separate does such an effort need to be? Anew physical location isn’t always necessary. Theprimary requirement is that the project not beforced to compete for resources with projects in themainstream organization. As we have seen, proj-ects that are inconsistent with a company’s main-stream values will naturally be accorded lowest pri-ority. Whether the independent organization isphysically separate is less important than its inde-pendence from the normal decision-making criteria

in the resource allocation process. The sidebar “Fit-ting the Tool to the Task” goes into more detailabout what kind of innovation challenge is bestmet by which organizational structure.

Managers think that developing a new operationnecessarily means abandoning the old one, andthey’re loathe to do that since it works perfectlywell for what it was designed to do. But when dis-ruptive change appears on the horizon, managersneed to assemble the capabilities to confront thatchange before it affects the mainstream business.They actually need to run two businesses in tan-dem –one whose processes are tuned to the existingbusiness model and another that is geared towardthe new model. Merrill Lynch, for example, has ac-

complished an impressive global expansion of itsinstitutional financial services through careful exe-cution of its existing planning, acquisition, andpartnership processes. Now, however, faced withthe on-line world, the company is required to plan,acquire, and form partnerships more rapidly. Doesthat mean Merrill Lynch should change the pro-cesses that have worked so well in its traditional investment-banking business? Doing so would bedisastrous, if we consider the question through thelens of our framework. Instead, Merrill should re-tain the old processes when working with the exist-ing business (there are probably a few billion dollarsstill to be made under the old business model!) andcreate additional processes to deal with the newclass of problems.

One word of warning: in our studies of this chal-lenge, we have never seen a company succeed in addressing a change that disrupts its mainstreamvalues without the personal, attentive oversight ofthe CEO – precisely because of the power of valuesin shaping the normal resource allocation process.Only the CEO can ensure that the new organizationgets the required resources and is free to create pro-cesses and values that are appropriate to the newchallenge. CEOs who view spinouts as a tool to getdisruptive threats off their personal agendas are al-most certain to meet with failure. We have seen noexceptions to this rule.

Creating Capabilities Through Acquisitions. Justas innovating managers need to make separate as-sessments of the capabilities and disabilities thatreside in their company’s resources, processes, andvalues, so must they do the same with acquisitionswhen seeking to buy capabilities. Companies thatsuccessfully gain new capabilities through acquisi-tions are those that know where those capabilitiesreside in the acquisition and assimilate them ac-cordingly. Acquiring managers begin by asking,“What created the value that I just paid so dearlyfor? Did I justify the price because of the acquisi-tion’s resources? Or was a substantial portion of itsworth created by processes and values?”

If the capabilities being purchased are embeddedin an acquired company’s processes and values,then the last thing the acquiring manager should dois integrate the acquisition into the parent organi-zation. Integration will vaporize the processes andvalues of the acquired firm. Once the acquisition’smanagers are forced to adopt the buyer’s way of do-ing business, its capabilities will disappear. A betterstrategy is to let the business stand alone and to in-fuse the parent’s resources into the acquired com-pany’s processes and values. This approach trulyconstitutes the acquisition of new capabilities.



Once an acquisition’s managers are forcedto adopt the buyer’s way of doing business,its capabilities will disappear.

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Suppose that an organization needs to react to orinitiate an innovation. The matrix illustrated belowcan help managers understand what kind of teamshould work on the project and what organizationalstructure that team needs to work within. The verticalaxis asks the manager to measure the extent to whichthe organization’s existing processes are suited togetting the new job done effectively. The horizontalaxis asks managers to assess whether the organiza-tion’s values will permit the company to allocate theresources the new initiative needs.

In region A, the project is a good fit with the com-pany’s processes and values, so no new capabilities are called for.A functional or a lightweight team cantackle the project within the existing organizationalstructure.A functional team works on function-specific issues, then passes the project on to the nextfunction.A lightweight team is cross-functional, butteam members stay under the control of their respec-tive functional managers.

In region B, the project is a good fit with the com-pany’s values but not with its processes. It presents theorganization with new types of problems and thereforerequires new types of interactions and coordinationamong groups and individuals. The team, like theteam in region A, is working on a sustaining ratherthan a disruptive innova-tion.In this case,a heavy-weight team is a goodbet,but the project can beexecuted within themainstream company.A heavyweight team –whose members worksolely on the project andare expected to behavelike general managers,shouldering responsibil-ity for the project’s suc-cess –is designed so thatnew processes and newways of working togethercan emerge.

In region C, the man-ager faces a disruptivechange that doesn’t fitthe organization’s exist-


Fitting the Tool to the Task


ing processes or values.To ensure success, the managershould create a spinout organization and commissiona heavyweight development team to tackle the chal-lenge. The spinout will allow the project to be gov-erned by different values –a different cost structure,for example, with lower profit margins. The heavy-weight team (as in region B) will ensure that new processes can emerge.

Similarly, in region D, when a manager faces a dis-ruptive change that fits the organization’s currentprocesses but doesn’t fit its values, the key to successalmost always lies in commissioning a heavyweightdevelopment team to work in a spinout. Developmentmay occasionally happen successfully in-house, butsuccessful commercialization will require a spinout.

Unfortunately, most companies employ a one-size-fits-all organizing strategy, using lightweight orfunctional teams for programs of every size and character. But such teams are tools for exploiting established capabilities.And among those few com-panies that have accepted the heavyweight gospel,many have attempted to organize all of their develop-ment teams in a heavyweight fashion. Ideally, eachcompany should tailor the team structure andorganizational location to the process and valuesrequired by each project.

Fit

wit

h O

rgan

izat

ion’

s Pr

oce

sses Poor

Good

Good(sustaining innovation)

Poor(disruptive innovation)

Fit with Organization’s Values

A

C

D

Use a heavyweight team within the existing organization.

Use a heavyweight team in a separate spinout organization.

Use a lightweight or functional team within the existing organization.

Development may occur in-house through a heavyweight team, but commercialization almost always requires a spinout.

B

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If, however, the acquired company’s resourceswere the reason for its success and the primary ra-tionale for the acquisition, then integrating it intothe parent can make a lot of sense. Essentially, thatmeans plugging the acquired people, products, tech-nology, and customers into the parent’s processes asa way of leveraging the parent’s existing capabilities.

The perils of the ongoing DaimlerChrysler mergercan be better understood in this light. Chrysler hadfew resources that could be considered unique. Its recent success in the market was rooted in its pro-cesses – particularly in its processes for designingproducts and integrating the efforts of its subsystemsuppliers. What is the best way for Daimler to lever-age Chrysler’s capabilities? Wall Street is pressuringmanagement to consolidate the two organizationsto cut costs. But if the two companies are integrated,the very processes that made Chrysler such an at-tractive acquisition will likely be compromised.

The situation is reminiscent of IBM’s 1984 acqui-sition of the telecommunications company Rolm.There wasn’t anything in Rolm’s pool of resourcesthat IBM didn’t already have. Rather, it was Rolm’sprocesses for developing and finding new marketsfor PBX products that mattered. Initially, IBM recog-nized the value in preserving the informal and un-conventional culture of the Rolm organization,which stood in stark contrast to IBM’s methodicalstyle. However, in 1987 IBM terminated Rolm’ssubsidiary status and decided to fully integrate thecompany into its own corporate structure. IBM’smanagers soon learned the folly of that decision.When they tried to push Rolm’s resources –its prod-ucts and its customers – through the processes thathad been honed in the large-computer business, theRolm business stumbled badly. And it was impossi-ble for a computer company whose values had beenwhetted on profit margins of 18% to get excitedabout products with much lower profit margins.IBM’s integration of Rolm destroyed the very sourceof the deal’s original worth. DaimlerChrysler, bow-ing to the investment community’s drumbeat for ef-ficiency savings, now stands on the edge of the sameprecipice. Often, it seems, financial analysts have abetter intuition about the value of resources thanthey do about the value of processes.

By contrast, Cisco Systems’ acquisitions processhas worked well because, we would argue, it haskept resources, processes, and values in the rightperspective. Between 1993 and 1997, it primarilyacquired small companies that were less than twoyears old, early-stage organizations whose marketvalue was built primarily upon their resources, par-ticularly their engineers and products. Cisco pluggedthose resources into its own effective development,

logistics, manufacturing, and marketing processesand threw away whatever nascent processes andvalues came with the acquisitions because thoseweren’t what it had paid for. On a couple of occa-sions when the company acquired a larger, moremature organization – notably its 1996 acquisitionof StrataCom –Cisco did not integrate. Rather, it letStrataCom stand alone and infused Cisco’s substan-tial resources into StrataCom’s organization to helpit grow more rapidly.3

Managers whose organizations are confrontingchange must first determine whether they have theresources required to succeed. They then need toask a separate question: Does the organization havethe processes and values it needs to succeed in thisnew situation? Asking this second question is notas instinctive for most managers because the pro-cesses by which work is done and the values bywhich employees make their decisions have servedthem well in the past. What we hope this frame-work introduces into managers’ thinking is the ideathat the very capabilities that make their organiza-tions effective also define their disabilities. In thatregard, a little time spent soul-searching for honestanswers to the following questions will pay offhandsomely: Are the processes by which work ha-bitually gets done in the organization appropriatefor this new problem? And will the values of the or-ganization cause this initiative to get high priorityor to languish?

If the answers to those questions are no, it’s okay.Understanding a problem is the most crucial step insolving it. Wishful thinking about these issues canset teams that need to innovate on a course fraughtwith roadblocks, second-guessing, and frustration.The reason that innovation often seems to be so dif-ficult for established companies is that they employhighly capable people and then set them to workwithin organizational structures whose processesand values weren’t designed for the task at hand. En-suring that capable people are ensconced in capableorganizations is a major responsibility of manage-ment in a transformational age such as ours.

1. See Dorothy Leonard-Barton, “Core Capabilities and Core Rigidities: AParadox in Managing New Product Development,” Strategic Manage-ment Journal (summer, 1992).

2. Our description of the development of an organization’s culture drawsheavily from Edgar Schein’s research, as first laid out in his book Organi-zational Culture and Leadership ( Jossey-Bass Publishers, 1985).

3. See Charles A. Holloway, Stephen C. Wheelwright, and Nicole Tem-pest, “Cisco Systems, Inc.: Post-Acquisition Manufacturing Integration,”a case published jointly by the Stanford and Harvard business schools,1998.

Product no. 3456 To place an order, call 1-800-988-0886.



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ARTICLES

“Disruptive Technologies: Catching theWave” by Joseph L. Bower and Clayton M.Christensen (Harvard Business Review, Janu-ary–February 1995, Product no. 3510) The authors introduce the concepts of sus-taining and disruptive technologies andexplain how perfectly reasonable decisions infavor of current customer needs can causesmart managers to let disruptive technologiesslip through their fingers. This article illus-trates why small start-ups can ride the waveof major change—right past established com-panies with vast resources. To capitalize ondisruptive technologies, companies must pro-tect them from organizational processes andincentives that are geared to serving main-stream customers.

“Tough-Minded Ways to Get Innovative” byAndrall E. Pearson (Harvard Business Review,

What distinguishes outstanding competitorsfrom the rest? In a complementary piece tothe discussion of disruptive change, Pearsonoffers some enduring principles to help sparkinnovation. Among them: innovation beginsat the top; and new ideas need a champion, asponsor, a mix of creative types and opera-tors, and a separate system to propel them totop management early and fast. Pearson alsoaddresses how to think about corporate strat-egy and structure, where to look for goodideas, and what to do when you find them.

“The Discipline of Innovation” by Peter F.Drucker (Harvard Business Review, Novem-ber–December 1998, Product no. 3480)Innovation is the responsibility of every exec-utive, and it begins with a conscious searchfor opportunities. Drucker argues that suc-cessful entrepreneurs share not so much acommon personality as a commitment to thesystematic practice of innovation. Offering awealth of interesting examples, he maintainsthat the systematic search for innovationopportunities should focus on seven areas:unexpected occurrences, incongruities,process needs, industry and market changes,demographic changes, changes in perception,and new knowledge.

BOOK

The Innovator’s Dilemma: When NewTechnologies Cause Great Firms to Fail byClayton M. Christensen (Harvard BusinessSchool Press, 1997, Product no. 5851) This book elaborates on the concept of dis-ruptive technology and offers a framework forresponding profitably. Christensen exploresthe puzzle of why logical management deci-sions that are critical to success are often thevery reasons a company loses its position ofmarket leadership. By staying too close to itscurrent customers, a company developsprocesses and incentive systems that aregeared only toward satisfying those cus-tomers. As a result, the company has greatorganizational difficulty recognizing andresponding to the disruptive technology—whose potential, at least at first, is with newmarkets and customers.

Meeting the Challenge of Disruptive ChangeE X P L O R I N G F U R T H E R . . .

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617-783-7500 • Fax: 617-783-7555

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May–June 1988, Product no. 1636)

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