How To Survive The Cyber Revolution

Clayton Christensen on adapting your game plan

In his book The Innovator's Dilemma, Clayton M. Christensen, an associate professor at Harvard business school, took a look at how companies struggle to adapt to technological change. The book was published in 1997, but sales zoomed only in the past few months, landing the book on the Business Week best-seller list in February. The surge seemed to be at least partly tied to the emergence of the Internet as a place to do business. For instance, Edward D. Horowitz, corporate executive vice-president for advanced technologies at Citigroup, sent a copy to 200 top Citigroup execs in December. Christensen discussed The Innovator's Dilemma with BUSINESS WEEK software editor Steve Hamm.

Q: What is "the innovator's dilemma"?

A: The dilemma is that the criteria managers use to make the decisions that keep their present businesses healthy make it impossible for them to do the right thing for their future. What's best for your current business could ruin you for the long term. Managers have been trained to listen closely to customers and do things that improve their margins. Those things are mandatory to keep your present business healthy and stock price high. But they can prevent you from addressing the Internet.

Q: How do the Internet and E-commerce challenge companies to change the way they operate?

A: When the trajectory of improvements in products and services that a good company offers overshoots what customers in a tier of the market want, that opens the opportunity for a different approach--typically, simpler and cheaper ways of doing business. That's the kind of new opportunity the Internet offers. Think about, the online bookseller. The old model in bookselling was to build ever-larger stores with more inventory. But that had reached the end of the game, and still reliability and convenience were inadequate. has found a new market opportunity based on convenience and reliability, and it's changing the scale of the economics. Barnes & Noble is aggressively trying to respond. But they started late.

Another example is investment banking. The services that Goldman Sachs and Morgan Stanley Dean Witter offer are important at the high end--for the best investment-banking customers. But for other companies that want to sell stock, there are now other ways to do it--using the Net. William R. Hambrecht just announced that his new investment-banking company, OpenIPO, will use an auction concept. Hambrecht puts out a prospectus with no price. Then he conducts an online auction, gradually cutting the price until someone bids, and continuing down as more people bid, stopping when all the stock is sold. In the end, everybody gets the same price--the lowest one--but people get allocations of stock depending on how early in the process they bid.

It changes the rules of the game. Now, investment bankers price arbitrarily and sell most of the IPO shares to their friends. Hambrecht can do business his way because, thanks to the Net, the cost of communicating is so low. Under the old model, a $150,000-a-year investment banker calls on brokers, who call on the investors. Doing investment banking over the Internet will appeal to the least attractive of the customers of high-end investment banks, so it's not attractive to those banks to go after that business.

But eventually, somebody like Hambrecht can keep adding capabilities to go after more sophisticated markets--and ultimately, he can attack the high end. Meanwhile, high-end firms have a difficult time coming down.

Q: Which established companies are doing the best job of responding quickly and effectively to this "disruptive" technology?

A: Charles Schwab is far and away the most successful. Their advantage is that there's more distance between Merrill Lynch and the Internet than there is between Charles Schwab and the Internet--in cost structure. For Merrill to go after online trading is very difficult. It attacks their own main business of handling customers through brokers. Schwab, on the other hand, is finding that it's much less costly to do trading over the Net. It's more profitable to do it that way than the traditional means of addressing customers--by phone or mail.

Dell Computer is in a similar spot. They didn't have to break their direct-sales business model to succeed with the Internet. Compaq Computer is now trying to do what Dell is doing because it has become destructive to their business model. If Compaq can come up with a way to keep the two business models separate, they have a chance of succeeding at both.

Q: Should companies be reengineering their businesses around Web media and technologies?

A: I don't think everybody should change their main business models. For most companies, there are still a lot of good opportunities in their traditional businesses. An insurer, for instance, would be foolish to abandon its agents and just sell directly over the Web. It still has lots of customers who need sophisticated services and aren't comfortable doing things over the Internet. That kind of company has processes and values that are tuned to that kind of business. What it would need to do is set up a different company that can have a new low-cost structure that can be competitive with new technologies.

Digital Equipment is an example of a company that failed to respond to a major technology shift. It saw the personal computer coming, and it tried to attack the opportunity with its existing business model. But the PC was too small a business back then, and margins on it were too small for it to successfully compete for resources within the company. The mistake was that Digital didn't set up a different company to attack the PC. In the end, it compromised its mainstream business model, and it lost a step there.

There are lots of ways the Internet can be used to serve your current customers more reliably and conveniently and profitably--the way Federal Express uses it. Those aren't innovators' dilemmas. They're innovators' no-brainers.

Q: What hurdles do companies face when they set up independent Internet divisions?

A: The idea of setting up a separate company sounds simple, but it's really difficult. You need to establish a different brand and sell different products--so you don't just cannibalize an existing business. The people who are running these new organizations have to think like the disruptive innovator.

Q: Is the Internet disrupting your business?

A: I worry a lot about Harvard business school. Our business model and our products have become very expensive. They're the highest-performing products in management education. But today, online courses can't appeal to the mainstream of our customers. First, there are corporate universities such as Motorola University [for instructing employees]. They've grown in number from 400 to 1,600 in the past eight years. Our product is just too expensive for them. Then there are online [colleges] such as the University of Phoenix and others. They're improving at an alarming rate.

Even the business schools that are so good at dispensing advice need to hold a mirror up to their own faces and make sure it doesn't happen to them. We've set up Harvard Business School Publishing. It has the charter to...publish online and address new customers. We've responded. But there's a long way to go.