Escaping the Innovator’s Dilemma – Does start-up innovation impose risks or offer opportunities to corporate innovation? 21.11.2021 | by Markus Fost Learn more FOSTEC & CompanyNewsEscaping the Innovator's Dilemma - Does start-up innovation impose risks or offer opportunities to corporate innovation? Many enterprises face the so-called “Innovator’s Dilemma” at a certain point – a situation in which, even though they spot innovation potential, are unable to innovate in a way necessary to maintain their position. There are two main reasons to explain this dilemma – the need to generate revenue in a not yet developed market and decreasing innovation opportunities of existing products with a demanding customer base. As a result, new start-ups surpass established organizations by introducing innovative products and creating a new market for them. One example is the introduction of mobile banking by neo banks like N26 and the story of how the new bank gained seven million customers in less than ten years by creating a new demand for mobile banking. While disruptive technology and new market entrants are often considered a threat, the following chapters aim examining potential benefits and opportunities resulting from start-up innovation. The innovator’s dilemma and its impact on corporate innovation Innovation helps businesses to grow by increasing the product portfolio or optimizing existing processes to ultimately increase revenue and profits. Therefore, the ability to effectively innovate is often considered a key factor for long-term business success. However, innovation is not as easy as it seems and many limitations to innovation capabilities exist. One of these limitations is the Innovator’s Dilemma, which was introduced by Clayton M. Christensen in 1997 in his homonymous book “The Innovator’s Dilemma”. Christensen claims that established firms reach a point at which they will not be able to keep up with external innovation of smaller companies (Christensen C. M., 1997). Two main reasons for the failure of corporate innovation and long-term market leadership can be identified. First, the marginal product performance increase changes over time (Figure 1). Setting up an innovative and potentially disruptive product is difficult and therefore the product performance curve begins with a flat curve. Once the product is developing, more and more improvements lead to a steep slope. In the end, however, the curve becomes flat again as the innovation of the product reaches its maximum and only little adaptations can be made. The overall curve therefore is s-shaped (Christensen C. , 1992). At the end, customers demand improvements of the existing products, which corporates are not able to deliver due to reaching the limits of innovation capabilities within their products. Second, the bigger a company is, the higher are the revenues it requires to maintain its position. Low revenue generating innovations are therefore often not considered on a long-term basis, as the required revenues thresholds are not met. Since most of the existing customer group might not be ready to adapt to the innovation, the market size is limited and cannot satisfy the corporate need for revenue. Figure 1: General development of product performance over time (adapted) (Christensen C. M., 1997) Corporates cannot focus on the development of new technologies because a small customer base combined with low profitability does not match the revenue requirements resulting from the company size. In contrast to the established corporations, new and small start-ups are not limited by these revenue requirements and can therefore focus on a niche market and steadily build demand for a new product. At one point, customers might start to switch towards the innovative product due to decreasing perceived values of the existing product and potential of the innovation. Established organizations which could not focus on these innovations are ousted from the market. From this point, start-up innovation can be considered a threat to corporate success. However, some threats can also lead to opportunities. Many cases of disruptive business models and their impacts exist. One of these examples is the banking industry with new players like the German mobile Bank N26 or the British Revolut that entered the industry and introduced new ways of banking with the help of digitalization and modern technology. While the traditional view suggests that the success of these mobile banks is a pure threat to existing banks, we argue that corporations can use the created demand for innovation for their advantage by adapting to the technology based on the customer expectations that did not exist in the old product sphere. Case study – N26 and mobile banking in Germany As a more the 4000-year-old industry, banking has gone through major changes. One of the latest shifts happens towards a more mobile focused banking approach. Instead of managing capital in banking branches and with the help of clerks, people start to access their accounts with the help of mobile apps and mobile connection. The major development towards this mobile oriented banking industry might originate from small niche start-ups like N26, the most successful and popular mobile bank in Germany. In 2015, when N26 was founded within an ongoing trend of digitalization and an increasing rate of smartphone ownership in Germany (Statista, 2021), the basis for mobile banking had already existed for a while. However, banking users were hesitant to make a full switch towards new technology due to security doubts and their known habit to use bank branches and do banking with a clerk. Therefore, many banks decided against the further improvement of mobile banking besides some basic functions like account overviews. Some banks that assessed the demand for mobile banking gave up the ideas due to limited market size. Due to the nature of innovation, traditional banking had already reached a stagnating performance increase (Figure 2) and therefore further product innovation was limited. In contrast to established banks, N26 as a newly created start-up was more flexible and not bound to minimum revenues within the mobile market. Therefore, the company could (as one of multiple FinTechs) develop the mobile banking market from a small scale onwards. By the time traditional banking had reached a flat slope in improving performance, mobile banks were in a steep upwards trend. Therefore, a new user base developed, and some initial customers of existing banks saw the opportunity in mobile banking. As a result, a first shift of users happened. The initial success of N26 might be one of the reasons more established banks introduced further digitalized and mobile banking focused services to maintain their customer base and utilize ongoing trends. N26 as a pioneer further increased its customer base and in early 2021, celebrated a userbase of over seven million, thereby maintaining its position as the European market leader. Due to the ongoing Covid-19 pandemic, the user base of mobile banking applications will further increase over the next months. Figure 2: Mobile banking product performance over time Risks and benefits of start-up innovation according to technology push and market pull To better understand the impact and the potential risks and chances start-up innovation can have on established corporates, it is important to take a step back and take a broad view at the way markets work. One framework that is well suited to analyze the source and size of demand is the concept of technology push and market pull. The concept evolved in the field of marketing to determine which side of the market steers the demand for a specific product or product group. Technology push Over the course of time different new technologies are developed. However, corporations can decide whether they are willing to introduce these technologies to the market by creating innovative products or services or remaining withing their existing product offerings. Since the market is not aware of potential innovations, the demand for these products evolves from the introduction of the product. The whole process (Figure 3) of innovation and demand increase therefore begins with a new existing technology which pushes the industry towards innovation. As a result, the process is best described as technology push. Figure 3: The technology push dynamic Market pull Another factor that can lead to innovation is the market pull. In contrast to the technology push were new technologies and the industry initiate innovative developments, in the market pull dynamic, customers are responsible for new product development. By creating demand for a product that does not exist or a solution to for an existing problem, the market compels the industry to create new products and services so satisfy the demand. The industry then uses new technologies to innovate and solve the customer demand. Figure 4: The market pull dynamic Start-up influenced market pull While technology push and market pull are commonly frameworks in marketing, a further adaption of the dynamics by introducing an additional party into the system could be assumed – start-ups. In the traditional technology push/market pull framework, no differentiation between the innovating companies is made. However, looking at the dynamics through the Innovator’s Dilemma lens, it becomes apparent that huge differences exist regarding innovation capabilities and flexibility. Consequently, it makes sense to separate the existing industry from start-ups in this conceptualization. To recall the previously mentioned facts: Start-ups have a higher flexibility to innovate due to the Innovator’s Dilemma that limits corporates. Technology push creates demand for a product by creation of innovation based on new technology development. Market pull creates demand for a product by unsatisfied needs of customers and forces the industry to create new products. Bringing the factors together allows a new view of the demand dynamic and thereby demonstrates the risks and potential chances for corporates (Figure 5). Since corporates are limited in their innovation capability by the innovator’s dilemma, start-ups are the ones that can more easily utilize new technologies to innovate into a market that does not yet exist. By doing so, the start-ups slowly create a market for their innovations and reach a point where the demand becomes so high that it influences the customer group and the demand of the established corporations. This is the crucial point for the corporations as from this point onwards innovation stands in direct competition to their products. Two scenarios evolve – one is a threat to the corporations while the other one offers a chance. The threat is that customers shift their demand fully to the innovation whereas corporations cannot supply the required products. This is the classical scenario mentioned by Christensen, in which successful corporations get surpassed by new start-ups due to the innovator’s dilemma (Christensen C. M., 1997). However, another possible scenario might arise. By forming demand for an innovative product, start-ups enable existing corporations to utilize technology themselves and follow the innovational path that was initiated by the start-ups. Thinking back, one of the reasons for the Innovator’s Dilemma, was the market size for innovations. By giving start-ups a head start towards the innovation corporations get the chance to enter not a new, but a pre-developed and therefore bigger market, which better suits their revenue generation needs. Figure 5: Market Pull and the influence of start-up innovation Coming back to the example of mobile banking in Germany and the launch of N26, it is now possible to set the framework into perspective (Figure 6). Traditional banks tend to have been locked in the Innovator’s Dilemma with a small niche market for mobile banking and a customer base demanding improvement in traditional banking. However, with the market entry of N26, the technology was utilized by a young and flexible start-up to create a niche product. The user base constantly evolved, popularizing the concept of mobile banking not only in the N26 customer group, but also in the traditional banking customer group. By doing so, a general demand for digitalized and mobile-based banking services evolved. Therefore, over the last years different established banks further digitalized their services and are now offering mobile banking services similar to N26 or other mobile banking focused banks. Figure 6: Market Pull dynamic in mobile banking (Illustrated on N26) From the perspective of the innovation limitations, the launch of N26 might have helped companies to overcome the Innovator’s Dilemma by creating a market for mobile banking, in which established banks could then follow more easily. Conclusion and key takeaways On first sight, start-up innovation might indeed help established corporations to overcome the innovator’s dilemma by giving them the chance to follow into the newly developed market once it becomes profitable enough. However, this view is very one dimensional as it does not consider other aspects of the innovation development. First, critically reflecting on the development shows, that even though the established banks were able to follow the innovation different drawbacks occurred. N26 and other neo banks were able to create a userbase for themselves, thereby reducing the number of potential clients and the number of actual clients of the established banks. Further, the shift towards mobile banking does not create a new market but cannibalizes parts of the existing customer base. Second, the drawbacks are not always as narrow as in the mentioned case of mobile banking in Germany. As Christensen claims in his book, failure to adapt to the innovation by new players and the resulting demand, can lead to failure of the most successful and well-managed businesses. One example of this failure is KODAK, which was a world leader for analog photography but had to declare bankruptcy in 2012 after failing to adapt to the demand for digital cameras (Forbes, 2012). Third, to be able to utilize ongoing innovation and make the shift towards the new market, corporates need to prepare their organization for change, by monitoring ongoing industry trends and allowing company internal innovation. The last point is especially difficult to implement as it requires a careful equilibrium between risk of failure, chance of success and capital requirements. Summed up, while in theory start-up innovation can help established corporations to overcome the Innovator’s Dilemma, in practice it is connected to high risks that need careful consideration in and case. It is therefore not possible to approve the made hypothesis. (Disruptive) Business Model Development Your request to FOSTEC & Company Contact one of our experts Markus Fost, MBA, is an expert in e-commerce, online business models and digital transformation, with broad experience in the fields of strategy, organisation, corporate finance and operational restructuring.Learn moreMarkus FostManaging PartnerMarkus Fost, MBA, is an expert in e-commerce, online business models and digital transformation, with broad experience in the fields of strategy, organisation, corporate finance and operational restructuring.markus.fost@fostec.comPhone: +49 (0) 711 995857-10Mobile: +49 (0) 170 8057143Fax: +49 (0) 711 995857-99LinkedInXINGLearn more