Opportunities for Innovation: The Three Types of Customers

Clayton Christensen gives an interesting classification of customers in his book ‘Seeing What Next’ – a classification that I think reveals opportunities for innovation for both incumbent companies and new entrants. This classification is based on how satisfied customers are with the current solutions to get their jobs done. There are essentially three customer segments:

  1. Undershot Customers: Customers who are not satisfied by the performance of the current solutions and would pay a premium for better solutions. Customers are willing to pay a premium for an ERP software that is more reliable, a car that is more reliable, a payment solution where fraud is negligible, an encyclopedia that has few errors, a language translation software that is more accurate etc.
  2. Overshot Customers: Customers who are more than satisfied by current solutions to the point that they cannot use all the features of the solution. A student who does not care whether her college maintains a top level football team, a patient who does not need to be checked and prescribed medicine by a highly qualified doctor for a common cold, a traveler who is happy with a minimum threshold of hygiene in a hospitality solution, a cable customer who does not watch the huge bundle of channels but only a few select ones predominantly etc. are typical examples of overshot customers.
  3. Non-Consumers: Customers who want to get a job done but face certain barriers while using the current solutions. A woman who wants to feel important at a wedding but could not afford the designer clothing and expensive jewellery. A customer who wants to get a small credit to pay for something but does not have the time to go apply for credit at a bank. A student who wants to learn from the best professors but finds the best schools too expensive. A small business owner who wants to open a website for his business but does not have the skills to do so. These are typical examples of non-consumers.

A. Undershot Customers: Sustaining Innovation

Prof. Christensen identifies ‘sustaining innovations’ – innovations radical or incremental that focus on improving on the existing set of parameters and focus on the existing mainstream customers of the business as an opportunity for companies having huge numbers of undershot customers. Can you make the second version of the iPhone much better than the first version? Can you make the second model of Tesla much better than the first version? Can Windows 10 offer much better performance than Windows 8? Can you reduce the delivery times of your e-commerce solution to 1 day for all users?

Undershot customers are in huge numbers when an industry is new. These customers will adopt or even pay a premium for solutions that give a simply better performance. When the industry is new and when there are huge numbers of undershot customers, you need not be the innovator. You can be successful even if you are a ‘fast follower’ or an ‘imitator’. Examples abound for success of imitators and failures of pioneers.

Godfrey Hounsfield won the 1979 Nobel Prize for inventing the first CAT scanner. But his company EMI did not emerge the winner. GE and Siemens spit the rewards. RC Cola was the first to introduce Cola in a can and was the first to introduce diet cola but lost out to the giants Coca Cola and Pepsi. Similar pioneer-losers were Xerox for office computers, de Havilland for commercial jetliners and Bowmar for Pocket Calculators.

Facebook was not the first social network. Friendster was an early leader in the space. Reid Hoffman in an interview with Pando Daily made the following comment about Friendster, “Friendster was doing 2 minute page load times, which is kind of like hanging out a sign that says ‘f**k off, go away!’”. Facebook had to cross that bar to be the leader.

However, when newer and newer versions of products/solutions (within the same core technology) are released, the following inevitably happen:

  1. The products become good enough on the main parameters which the companies sought to initially improve.
  2. The technology improvement ‘overshoots’ customer’s readiness to use the new improvements.
  3. After overshooting, the rate of performance improvement gradually decreases over subsequent versions.

B. Overshot Customers: Low-end Disruption

This overshooting can be clearly seen in the below graph that is central to Clayton Christensen’s work.

Disruption Graph

The blue sloping line represent the rate of product improvement of the solutions of incumbents and the green line represent that of new entrants (solutions to the same job-to-be-done). At the intersection with the red sloping line (the performance that customers demand), the solutions become good enough.

As the blue line moves further and further away from the red line, some customers become increasingly dissatisfied. This is because companies satisfy a job-to-be-done of some of the customers too well and these customers at this stage are not ready to pay premiums for further improvements to a solution that already does the job very well. For example, it is remarkable that more than a decade old, Windows XP still has a desktop OS market share of 17%! Windows XP does the job very well for a lot of customers who don’t see the value of upgrading to higher versions. Such customers are called Overshot customers.

This expectation of customers for more basic solutions that get their jobs done opens up opportunities for what is called Low-end Disruption. Airbnb is a classic low-end disruptive innovation with respect to the incumbent hotels. Apparently a lot of customers worry only about some threshold of safety, hygiene, location etc. They then start worrying about price. Airbnb is valued more than some of the strongest hotel brands like Hyatt and Accor. Dell was a low-end disruption to the PC Industry for years before the industry was more or less commoditized. Dow Corning introduced a low-end disruption for selling its commoditized silicone products and created a new brand for these products called Xiameter.

MinuteClinic answered a seemingly obvious question – why do we need a highly qualified and expensive doctor to treat common cold or a strep throat or a minor abrasion? And worse still why wait in long queues to finally be told what you already know – “you have a strep throat”? MinuteClinic launched the first walk-in clinic in United States in 2000 and are staffed by relatively inexpensive nurses and other paramedical people. The satisfaction rating for MinuteClinic is as high as 95%.

Some types of companies are often targets of low-end disruption. Highly integrated architecture companies are a classic target of such a type of disruption. Initially companies tend to produce all the components because only they know how different pieces fit together. For example, AT&T in the early 20th century consolidated and produced all the components because, aside from any monopoly intentions, that was the best way to guarantee the reliability of the solution. Similarly IBM had to produce all the components of a Mainframe in a closed architecture for reliability. Over time, standards are developed and other competitors figure out how the different pieces of the solutions ‘fit’ together. So you can with a few hours of practice, buy components from the internet and slap together a PC in a garage. So over time new entrants engineer low-end disruption by modular architectures. (But in such solutions, the profits move to the sub-systems: example, in the PC Industry, most profits were reaped by Intel and Microsoft).

Another target of low-end disruption are bundled solutions. Bundled solutions cater to more than one job-to-be-done. The fact that they are very susceptible to low-end disruption must be a little obvious because there will exist a group of customers who will not want that ‘bundle’ but instead would want a solution for a particular job. The traditional college is for example a bundled solution – rather an extraordinary bundle of solutions. The college has a bundle of compulsory courses, compulsory credit fulfillment requirements, a career placement office, sports teams, libraries, research labs, recreation facilities, well cut lawns etc. Note that the bundle in the first place would have existed to guarantee reliability and the bundle would have grown as the incumbent business adds bells and whistles to differentiate. But all of the above mentioned components of the ‘college bundle’ go into the cost structure of the college. This may open opportunities for low-end disruption.

C. Non-Consumers: New Market Disruption

Non-consumers are those who want to get a job done but face barriers while using incumbent solutions. Common types of barriers are wealth (something is not affordable), time, access and skill (something is too complex to use). As Prof. Christensen’s work proves, new entrants so very often topple large incumbents by not building better solutions than these incumbents for undershot customers but by focusing on these non-consumers. Such disruptions are called ‘New market disruptions’.

Want to build the next big financial giant? Build a solution for the borrower who cannot repay properly. Build a solution for the rural poor in India who is considered ‘non-bankable’ by the incumbent banks and cannot even open a bank account. Want to build a great university? Build a solution for someone who cannot afford as much as a text book. Want to build a fashion empire? Build a solution such that the even middle class get to wear designer clothing.

What is the logic behind the above advice? This is because a non-consumer has severe constraints. Building a solution for that non-consumer by definition overcomes such severe constraints (often with the help of technology). What then the follows is a three stage process that topples big incumbents:

  1. New Entrants hide behind ‘asymmetric motivations’. The big incumbents see these newly converted customers as too unprofitable a market or too niche a market. They do not go with the same motivation behind these non-consumers as the new entrants.
  2. New Entrants slowly move upmarket. The new entrants slowly improve their solutions. In the quest for growth and profitability, they often have no choice but to move upmarket. When they build good enough solutions for the customers above the tier of the initial target non-consumers, the constraints which the new entrants have solved become a deciding factor. Here is where the Innovator’s dilemma begins for the Incumbents. They have to ‘fight’ for these low margin customers who are again few in number or flee to upper markets. They often choose ‘flight’.
  3. New Entrants wield ‘asymmetric skills’. The incumbents at some point begin to respond. But alas, they have allowed enough time for the new entrants to build ‘asymmetric skills’ – technology capabilities and process capabilities that cannot be quickly replicated by the incumbents. At this point, the new entrants take over the market.

So, the advice for both incumbents and startup entrepreneurs is axiomatic from the above. As long as there are non-consumers, incumbents face the danger of disruption and new entrants have the opportunities to disrupt. When a new technology enabler arrives (internet, cloud computing, 3D printing, internet of things etc.), then it opens opportunities for new entrants to build new business models to cater to these non-consumers.

Rent-a-Runway built an e-commerce solution that caters to a clearly large group of non-consumers: the middle class who want to look important during special occasions like weddings but cannot justify spending a lot of money on a single dress for once-in-a-lifetime occasion. Why buy them when you can rent them instead and at much cheaper rates than is available at brick and mortar renting shops and with a much larger collection. Customers are able to afford these indulgences and the designers are also able to showcase their creations to a wider audience!

The ‘David’ Wikipedia slayed the ‘Goliath’ Britannica in just a few years’ time. At its peak, Britannica sold 120,000 copies every year. But the non-consumers numbered in hundreds of millions. Enabled by the internet and with a unique unbeatable business model, Wikipedia has made a much larger and an almost equally accurate encyclopedia available to anyone with an internet connection.

Khan Academy started as a website with a collection of 10 minute Youtube lectures by a single instructor Salman Khan on various topics. Today it is a go to library for many students who receive high quality and sub-standard education alike and is used by increasingly many number of schools. It may well replace the ‘lecturing’ job of a teacher entirely.

Tata Swach negated an extreme constraint in water purification, the need for running water – a luxury that hundreds of millions in rural India cannot afford. With a unique solution involving nanotechnology it has the potential to reduce or eliminate many water borne diseases at a fraction of the cost of the traditional water purifiers. And as the solution becomes better and better may very well replace these incumbent purifiers.

Examples like Tata Swach raise the hopes that the emerging markets which have customers with greater constraints are fertile grounds for new market disruptions that may later proliferate to the developed markets.

For example, Eko, an Indian startup offers branchless banking services to the common man by leveraging the small retail shops (in India called ‘Kirana stores’), telecom connectivity and existing banking infrastructure. A low cost mobile phone acts as the transaction device. The customer (earlier non-consumer) can open a bank account, deposit and withdraw cash, send cash to any part of the world etc. all by using his inexpensive mobile phone. And it removes the wealth barrier (extremely affordable) and the skill barrier (you just need numerical literacy to use the solution) with this solution.

Therefore, taking cognizance of the undershot customers, overshot customers and non-consumers around a solution reveals opportunities for innovations and enables both incumbents and new entrants to build just the right solutions and position them to the right type of customer.

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