Disruptive Storm

The Nintendo president pushed the idea that brain games and unusual controllers were "disruptive," and that they could break new ground in an industry grown accustomed to familiar types of game experiences. He pointed to the success of the unconventional DS — 6 million units sold in Japan in 14 months, compared to the 20 and 21 months needed for the Game Boy Advance and PS2 to reach those marks, respectively. But whether disruption is the strategy to raise Nintendo's home-console fortunes above the steamrolling PlayStation brand and the still-hot Xbox 360 remains to be seen.

-Iwata as reported from Stephen Totilio,

”I am here today to share some stories about Nintendo. But, I begin with a story about Pepsi because it demonstrates how thinking differently, and holding strongly to your strategy, can disrupt an entire industry and in a good way.”
 

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”For some time, we have believed the game industry is ready for disruption. Not just from Nintendo, but from all game developers. It is what we all need to expand our audience. It is what we all need to expand our imaginations.

”But the success of DS is not based on just one game; it is the story of several new kinds of software creating brand new players.

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“Let me explain how disruption is working for us. Most of you are very familiar with the American market, so let me share some information about Japan.

“When it launched in 2001, PlayStation 2 sold 6 million units in its first 21 months. Soon after, our Game Boy Advance did even better, reaching 6 million in 20 months. But Nintendo DS is selling at a much faster pace than any game system in Japanese history. We have reached sales of 6 million systems in just 14 months. And, this number would be far higher if production could keep up with demand.

“In part, the DS success is due to how we redefine better technology with unique hardware features. But more importantly, the disruption of Nintendo DS comes from how software takes advantage of the hardware.

”The second story I want to share with you involves disruption of a different sort not only taking a different approach to a new technology, but also finding a way to make it attractive to everyone and thereby expand the overall audience. The topic was constructing the Nintendo Wi-Fi Connection.

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”Some people put their money on the screen, but we decided to spend ours on the game experience. It is an investment in actual market disruption. Not simply to improve the market but disrupt it. We believe a truly new kind of game entertainment will not be realized unless there is a new way to connect a player to his game.

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”Since I first announced the virtual console concept last year at E3, other people have become very interested in digital downloads. Others will offer such a service, but it will not be the same. Because for us, this is not just a new business opportunity, for us, this is true innovation true disruption. It is part of our DNA.

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”Yes, we have already disrupted handheld and it worked. Yes, we have already disrupted Wi-Fi and it worked. We disrupted the very definition of a game and that is working, too. In a few weeks, you will better understand how to disrupt console gaming. You will play, and you will see.”

-Satoru Iwata, GDC 2006 “Disrupting Development”.

"Nintendo CEO Satoru Iwata emphasized the themes of disruption, originality, and creativity in his talk. Nintendo invited one gamer up on stage to play the tennis game, to hilarious effect. John Taylor, an analyst at Arcadia  Investments, said, 'They are staying on their own path, stubbornly, and it may just be where the market is going to be. On the tennis game, it’s clear there is a social element to this.'"

-Iwata as reported by Dean Takahashi covering E3 2006 Nintendo Press Conference.

"We took a different path, one we call the path of disruption, of really doing things differently, focusing on games and hardware that consumers could immediately pick up and play like the DS and Wii. (We developed) software targeted to new users, not only the core 15- to 25-year-old type of consumers but consumers older and younger as well as focusing on the female demographic…”

”Whenever we launch hardware we immediately start working on the next iteration. That is the way we keep our selves fresh and we keep ourselves from being disrupted much like we've done to our competitors. And so it is incumbent upon us to find the next great improvement to our system and we're constantly in search of that.”

-Reggie Fils-Aime, San Francisco Chronicle Interview.

”Nintendo's counterpunch is disruption. We've determined that the videogame market is ripe for revival—and we're looking to make it happen by reaching out to the millions of players still on the sidelines, including those over the age of 35…

”And we've pulled the wraps off a new game interface for our upcoming console, code-named Revolution, that will break down the barriers of complexity that bar newcomers from test driving our products, while featuring the most advanced gaming experience ever. We're expanding our market by disrupting it.”

”In short, the sensible path seems clear: disrupt before you're disrupted.”

-Reggie Fils-Aime, February 13, 2006 “Mario’s Grown Up, You Ready to Play”, Brandweek article.

I have been waiting for a while for our esteemed analysts to begin writing about Nintendo’s disruption. Since they have dropped the ball entirely this generation, let us, friend, go through Christensen ourselves and understand why this generation will be called “The Generation of Disruption”.


What is Disruption?

Business professor Clayton Christensen asked, “Why do well managed companies fail?” His book, The Innovator’s Dilemma, deals with that question and discovers the answer is disruption. Well managed companies fail because the very management practices that have allowed them to become industry leaders also makes it extremely difficult for them to develop the disruptive technologies that ultimately steal away their markets. Well-managed companies are excellent at developing the sustaining technologies that improve the performance of their products in the ways that matter to their customers. This is because their management practices are biased toward:

-Listening to customers.
-Investing aggressively in technologies that give those customers what they say they want.
-Seeking higher margins.
-Targeting larger markets rather than smaller ones.


This is Clayton Christensen. When he speaks, Reggie, Iwata, and countless presidents from numerous industries stop and listen.

Disruptive technologies, however, are very different from sustaining technologies as they change the value proposition in the market. When a disruptive product appears, it almost always offers lower performance in terms of the attributes that mainstream customers care about. (For you hardcore gamers, this means ‘crummy products for non-consumers’). While the Wii may be inferior in graphics and horsepower, it contains attributes that fringe customers value such as cheaper, smaller, simpler, and frequently more convenient to use. Due to the experience and investment, the developers of disruptive products will always take over the older markets. This is because they are able to deliver sufficient performance on the old attributers, and they add some new ones.

The Innovator’s Dilemma describes the process how a disruptive product supplants older markets and the powerful forces within well-managed companies that make them unlikely to develop these technologies themselves. Professor Christensen offers a framework of four Principles of Disruptive Technology to explain why the management practices that are the most productive for exploiting existing technologies are antiproductive when it comes to developing disruptive ones. Christensen gives advice to managers of how to develop disruptive products in how to take over old markets.

“To help frame for you what we're doing from a strategic standpoint, let me spend a little talking about two current business thoughts out there in the market place. And how it corresponds to what we're doing from a Nintendo perspective.

”The first is a first the concept of "Blue Ocean Strategies." I don't know how many of you might have taken a look at this book. I've read it and I'm a big fan of the thinking. Really what it talks about is how, from a company perspective, you ought to focus on expanding your market boundaries versus singularly being focused on your competition. The thought being, if all you do is focus on your competition, imagine it's like sharks in the water, dealing with blood in the water, constantly going at each other. Take a wider view, look at broader opportunities out there in your marketplace.

”What's important about that is if you do it successfully, you're able to create new demand -- demand that never existed in that way before. Part of this is thinking about what can be versus what is. Thinking about broader horizons, broader opportunities.

”The second book is "The Innovator's Dilemma." I actually had the opportunity to meet the author of this. The thinking is similar, slightly different bend. What this focuses on is the concept of disruptive technologies. There's a lot of examples in history that touch on this. The thought being that if you are a market leader, you focus on doing what you are doing a little bit better.

”And then out of nowhere, some one comes with a disruptive technology and impacts your marketplace. A great example is one of our competitors. You look at how Sony was so focused on creating a better Discman, a better disc-playing portable device, MP3 players came out of nowhere and impacted their marketplace. And then, out of nowhere, came Apple with IPod and ITunes and further disrupted their marketplace.

What this talks about is creating new definitions of performance, new definition and what the consumers wants and delivering on that in new and provocative ways. These disruptive technologies typically appeal to new customers, people entering the category for the first time, but done successfully really blow open a marketplace and bring all types of consumers -- new, existing -- into the marketplace.”
 
-Reggie Fis-Aime, “Nintendo Summit” November 2005.

Principles of Disruptive Technology
1) Customers, Not Managers, are in Control of Resource Allocation

This means that big companies have well-developed systems for killing ideas their profitable customers (both consumers and investors) do not want. Because of this, these companies find it extremely difficult to invest in products customers do not want… until they want them. And by then, it is too late.

EXAMPLE: See Nintendo selling Brain Age and Wii Sports to non-gamers. Now, Sony and Microsoft want to sell to these people, but it is too late. Sony and Microsoft were focused on their current customers, not on non-gamers.

2) Small Markets Don’t Solve the Growth Needs of Large Companies

Successful companies need to grow in order to retain their share prices and provide internal opportunities for employees. As companies get larger, they must increase the revenue just to maintain the same growth rate. Thus, as a company grows larger it is more difficult for them to enter newer, smaller markets that are destined to become the large markets of the future. To maintain their growth rates, they focus on the large markets.

EXAMPLE: Often, people say today, “Wii is not truly successful.” “Why is that?” I ask. “Well, the ‘blue ocean customers’ are not that profitable. They may buy today, but how often and will only choose the lower price. But hardcore gamers will always buy the big games and, as a result, bring greater revenue.” The person, thinking himself the smartest person in the room for coming up with this point, did not realize that chasing higher revenue markets is destiny for that company to collapse for the disruptor will move upstream and steal that revenue.

3) Markets That Don’t Exist Cannot Be Analyzed

Market research and good planning followed by execution according to plan are hallmarks of good management. But companies whose investment processes demand quantification of market size and financial returns before they can enter a market get paralyzed when faced with disruptive technologies because they demand data on markets that don’t yet exist.

EXAMPLE: Every analyst missed the DS and Wii explosions because they could not analyze markets that did not exist. Nintendo, in their corporate briefing to investors, would literally say “we do not know how much it will sell” and still say this in regards to the Wii.

4) Technology Supply May Not Equal Market Demand

Although disruptive products initially can only be used in small markets, they eventually become competitive in mainstream markets. This is because technological progress exceeds the rate of improvement that mainstream customers want or can absorb. As a result, the products that are currently in the mainstream eventually will overshoot the performance that mainstream markets demand, while the disruptive products that under-perform relative to customer expectations in the mainstream market today may become directly competitive tomorrow. Once two or more products are offering adequate performance, customers will find other criteria for choosing. These criteria tend to move toward reliability, convenience, and price, all of which are areas in which the newer disruptive products often have advantages.

EXAMPLE: Microsoft and Sony, relying on sustaining technologies, overshot the market. The technological progress for graphics exceeded the market’s demand. With consoles costing from $400 to $600 and relying on features (better graphics and horsepower) the market didn’t really want, this opened the way for a disruptor.


Disruption is a Slow Process

Unlike the Blue Ocean Strategy which can *pop* to visible and open success, Disruption Strategy takes years and is always misinterpreted and invisible to mainstream customers.

In my previous article, “Birdmen and the Casual Fallacy”, it talked about how the Industry was misinterpreting the beginning disruption (of greater ‘low use’ user growth) to mean a ‘Casual Boom’ was underway. Casual gaming was always there, it is just that game consoles have overshot most of the market and left it open for a disruptor to seize. Over time, the disruptor will climb up the tiers of users to keep pushing out the incumbent companies in their entrenched markets.

The ‘low quality use’ we can describe as the so-called ‘casual gamers’. The ‘most demanding use’ can be described as the so-called ‘hardcore gamer’. Over time, the disruptive product will rise up the tiers. Incumbent companies either retreat up the tiers (to their more profitable users) or they stay and fight for a lower tier. The incumbent company will always lose because the disruptor has a more profitable business model. The incumbent’s investors will demand why money and time is being wasted on a market that is not that profitable. Since the disruptor is more profitable, the incumbent will always lose the war of attrition and retreat upmarket. In other words, Sony and Microsoft can fight all day for ‘non-gamers’ and ‘casuals’ against Nintendo but they will lose and retreat upmarket. Why? It is because Nintendo is far more profitable and will outlast them in those tiers.

Click to enlarge chart.

This chart shows how the different destinies of sustaining products versus disruptive products. With sustaining innovations (that has been the nature of 'generations' since the NES), the incumbent nearly always win. The reason why an incumbent would lose with sustaining innovations is if the incumbent was just plain stupid or if the challenger was so huge, so vast, that it could overpower the incumbent in technology, in product, and in everything else. The latter is what occurred when Sony entered the market and, perhaps, what might have happened with Microsoft entering the game.

So why do disruptors nearly always win? Who is the master of the market? Is it technology? Is it brand? Is it marketing? Is it demographics? Is it innovation? Is it invention? Who is the master toward that these companies must bend their knees and kneel?

"It is the customers," someone replies.

True. But how are the customers the master?

"It is the customers' wishes."

No! No! No! That is not it at all!

"But what else could it be?"

It is the customers' behavior. Most people cannot express what they want. Often, when they express what they want, they behave in an entirely different way. This is true for all Human behavior be it in consumer markets, romance, or anything else.

Consumer behavior defines the functionality that users can or cannot absorb. This is the red line on that graph. Technological progress is only good when it helps consumers. When it surpasses the red line, of consumer behavior, it has overshot the market. Then the market is ripe for a disruptor to appear. And this disruptor will bring new values to the market while being sufficient in the old values.

Voice technology is a cool technology. But remember, the master of the market is Human behavior. Will current voice technology eliminate keyboard typing? The keyboard is obviously technologically dated. The answer is 'no'. A normal person, used to typing, is not going to give that up for current voice technology that is more error prone. It does not let the user kick ass. Until voice technology is less error prone, people will continue to use keyboards. However, places where keyboards are difficult to use such as mobile devices have a great future for voice technology despite its errors. As voice technology sells on the mobile systems, it becomes better and more sophisticated. Eventually, it rises through the tiers until it ultimately replaces keyboards. This would be how voice technology could disrupt typing.

Netflix disrupted Blockbuster because Netflix's mail service matched consumers' behavior better. The telephone disrupted telegrams because that matched consumers' behavior better. The Wii disrupts because it also matches consumers' behavior better.



Click to enlarge chart.

The above chart illustrates disruption's concept of upstreaming. Three strategies are displayed for the disruptor in changing the nature of competition (remember, disruptions start with non-consumers first). The first strategy is to push upmarket toward higher-end customers. The second strategy is to stay with the new-market customers. The third strategy is to change the market's demand for functionality.

Which strategy is Nintendo doing? Well, they are obviously not staying with the new-market customers or else we would have seen Wii Sports 2 or Nintencats by now. The strategy of changing the market's demand for functionality also seems unlikely because upper tier users, the hardcore, will prefer long epic games of graphical value over short games even if they use motion control. So the only strategy left is for Nintendo to move upstream. The epic, huge, hardcore games will eventually emerge with motion controls that will attract more and more of the upmarket. While the DS stylus was used only for mini-games and non-games at the beginning, it eventually was used as the only control scheme for the system's Zelda.

Click to enlarge chart.

Here is another chart that shows the bare basics of market disruption. As you can see, the capability of original technology rises faster than the market wants. In the same way, the capability of disruptive technology rises faster than the requirements of the new market. But do you see that?

"See what?"

The capability of the disruptive technology eventually crosses lines with the requirements of the original market. This means the original market will eventually find the disruptive product acceptable.

"You're saying PS3 and Xbox 360 are the first red line and the first blue is the traditional gamers. That means Wii is the second red line and the second blue line is the 'new market'."

Precisely.


Click to enlarge chart.

This chart is like the previous one but in action. While it is self-explanatory, I want to direct your eyes to 'D'. 'D' is pointing basically to the 'New Proposition'. However, the 'New Proposition' starts only once the disruptive product crosses the dotted red line (which is performance that customers can absorb and utilize).  Once Wii crosses that dotted red line, then it begins to absorb the traditional market. Whether Wii has begun to do this now or is about to is another debate entirely. But rest assured, this is the destiny of the Wii.


Click to enlarge chart.

This is the chart for those who say, "Nintendo is aiming at a new market. They do not care to compete." It is true that Nintendo does not compete. But it is also true that Nintendo wants to gobble up the established market (traditional games). Disruptions start in a new market (a 'Blue Ocean') and then it grows like filling air in a balloon. But... what is this!? The New Market begins to run over the established market! How could this be!? Reader, I demand an explanation!

"How should I know? I am the reader, and you are the author. You are supposed to give the answer, and I am supposed to read it."

Is that how it works? Well then. You be the author for the moment. What is the answer? How can the new market run over the established market?

"It is because New Market is growing while established market is shrinking or in a standstill."

Very good! If Nintendo was correct about gamer drift, then Wii will keep growing while Xbox 360 and PS3 cannibalize one another in a stagnant market. Eventually, the growth will begin to displace the games. A few at first. Then more. Who would have thought DS would be THE system for RPGs, adventure and other games? No one said that when 'non-games' such as Brain Age and Nintendogs were selling the system. Of course, DS will never get ALL the games and neither will Wii. But there will be displacement.

But before we talk more about disruption in the game market, let us look at other industries to see the onslaught of disruption. Let us examine the wreckage of this... this disruptive storm... The foot prints of the past will give us the pattern of the future.


Behold the Disruptors!

 
Steel Mini-mills

Yes, even steel can be disrupted. The disruption of integrated steel mills by steel minimills demonstrates how low-end disruptors harness what is called asymmetries of motivation.

Minimills first took hold in the steel industry in the mid-1960s. Minimills could be described as melting steel in electric ovens while integrated mills used blast furnaces. Minimills were very efficient. They had a 20 percent cost advantage over integrated mills. But the quality of the steel they produced was inferior. The rebar market at the bottom rung of the industry (rebar is small steel bars made from scrap and used to create reinforced concrete) was the only market that would accept the minimills' steel.

As the minimills entered the rebar market, the integrated mills were happy to exit it. Their gross margins in the rebar business were a mere 7 percent, and rebar accounted for only 4 percent of the industry's tonnage. So the integrated mills decided to focus on higher-profit steel products. The minimills made boatloads of money until they finally drove the last of the integrated mills out of the market—and then the price of rebar dropped 20 percent, because rebar had essentially become a commodity market. The minimills' reward for victory was that none of them could make money.

To make attractive money again, the minimills had to figure out how to make better-quality steel in larger shapes—not only angle iron but also thicker bars and rods. Profit margins in this market tier were 12 percent, almost double those of the rebar market; the overall market was also twice as large. So the minimills invested in equipment to make the larger pieces and worked to improve the quality and consistency of their steel. As the minimills began making inroads with better and bigger steel, the integrated mills were happy to exit this market tier to concentrate on more profitable products. When the last integrated mill left the market, the price of angle iron collapsed. Once again, the minimills had to move up to the next tier of the industry in order to survive. And so on.

At each stage of the minimills' climb up-market, an asymmetry of motivation was at work. For the minimills, the need to enter a more profitable market provided the motivation to solve the technological hurdles preventing them from producing higher-quality steel. The integrated mills were happy to leave these markets because the lower tiers in their product mix were always less profitable than products targeting higher-end customers. Eventually, of course, the integrated mills ran out of markets to flee to.

DISRUPTIVE LESSON #1: One’s junk market is another company’s “Blue Ocean” opportunity.

Big Steel abandoned the rebar market happily as there was little profit in it. It became the minimills’ big opportunity. Sony and other companies look to abandon the low tiered ‘casual market’ as there is little profit in it. But it has become Nintendo’s ‘Blue Ocean’.


DISRUPTION LESSON #2: Taking unfavorable markets leads to the more favorable markets.

This means, my friends, that taking the ‘undesirable’ low tier market, Nintendo has created a disruptive foothold to travel upward into the more favorable markets just as the mini-mills did.





Sony Transistor

In what is called a new-market disruption, attackers take root in a new "plane" of competition or a new context of use outside of an existing market. Consumers historically locked out of a market because they lacked the skills or wealth welcome a relatively simple product that allows them to get done what they had always wanted to get done. These markets typically start out small and ill defined. They don't meet the growth needs of large companies. And the incumbent feels no pain at first. Because it creates new consumption, the disruptor's growth doesn't affect the incumbent's core business. But as the innovation improves, it begins to pull customers away from the incumbent. And the incumbent doesn't have the ability to play in this new game.

Transistors were a disruptive innovation. Mainstream suppliers of tabletop radios, which were made with vacuum tubes, couldn't figure out how to use transistors because they couldn't initially handle the power requirements of these components. Still, some saw the opportunity.

In the early 1950s, Akio Morita, the chairman of Sony, took up residence in an inexpensive New York City hotel in order to negotiate a license to AT&T’s patented transistor technology, which its scientists had invented in 1947. Morita found AT&T to be a less-than-willing negotiator and had to visit the company repeatedly badgering AT&T to grant the license. Finally AT&T relented. After the meeting ended in which the licensing documents were signed, an AT&T official asked Morita what Sony planned to do with the license. “We will build small radios,” Morita replied. “Why would anyone care about smaller radios?” the official queried. “We’ll see,” was Morita’s answer. Several months later Sony introduced to the U.S. market the first portable transistor radio. According to the dominant metrics of radio performance in the mainstream market, these early transistor radios were really bad, offering far lower fidelity and much more static than the vacuum tube-based tabletop radios that were the dominant design of the time. But rather than work in his labs until his transistor radios were performance-competitive in the major market (which is what most of the leading electronics companies did with transistor technology), Morita instead found a market that valued that attributes of the technology as it existed at the time- the portable personal radio.
 
In 1955, Sony introduced the pocket radio. It was a static-laced product with horrible fidelity. But it enabled teenagers to do something that they couldn't before—listen to rock'n'roll out of their parents' earshot. Had Sony targeted consumers in established markets, the pocket radio would have bombed. But for teenagers, the alternative to a Sony pocket radio was no radio at all. By competing against nonconsumption, Sony set a very low technical hurdle for itself: The product just had to be better than nothing in order to find delighted consumers.

Not surprisingly, none of the leading makers of tabletop radios became a leading producer of portable radios, and all were subsequently driven from the radio market.


Click to enlarge chart.

The above chart is excellent in illustrating the upstreaming Sony did with transistors. Remember that transistors were not refined yet for upmarkets such as television sets (however, television makers did know about transistors and were waiting for the technology to develop further before springing on it). Sony did not wait. Sony used the transistor, even in its early state, to aim at non-consumers and lower tier markets. At first, it was hearing aids. Then, it was pocket radios. On and on Sony marched upward until Sony began making televisions.

RCA was the market leader of televisions. It, naturally, saw no threat from Sony... until it was too late. The transistor created a new value to the market. While Sony went up the tiers, the traditional market MIGRATED over once it became good enough.

"Are you saying that hardcore gamers who love PS3 and Xbox 360 are going to migrate to Wii?" Sure, once the games become 'good enough' for them. Some already have started to migrate over with the release of games such as Mario Galaxy. Soon, the Wii will become very attractive to the hardcore just as the DS did.

DISRUPTIVE LESSON #3: If companies wait for disruptive technology to be perfected, they get wiped out by companies who do not wait.

Motion sensing in the Wii is by far not perfect. But it is good enough for the market who loves Wii Sports. While the technology rotted in Sony labs, Nintendo applied it to the market and created a sensation.

DISRUPTIVE LESSON #4: Competitors will not feel the new-market disruption and will not worry about it until it is too late.

Nintendo’s ‘new market’ disruption is said to just be about ‘casual gamers’ and not to impede into the core markets. Ho ho ho! To the contrary, this gives Nintendo the position to infiltrate the more core markets. This will become more visible as time passes.


Apple iPod

”What!?” says a sly reader. “How can you put the iPod as a disruptor? It did not disrupt from the bottom to top, it disrupted from the top to bottom!” Alas, I cannot slip anything past my readers. You are correct that iPod did disrupt from the top-bottom (however, mp3s went bottom-top).

It is possible to disrupt from the top-bottom but unlikely. FedEx could do it as the US Mail Service had a practical monopoly. I suspect a top down disruption will occur in U.S. Education.
 
Wang’s word-processing system followed a similar top-down trajectory. Wang Laboratories introduced its microprocessor-based word-processing system in 1976, a quarter-century after the company’s founding. Although rudimentary word-processing applications had been in existence for some years, at the time most business documents were still typed on typewriters, and even minor revisions required laborious cycles of marking up and then retyping pages. Wang’s system, which combined desktop workstations with a central data server, offered superior performance on almost every measure of document production, including revision speed, output quality, reprint capability, and the ability to support collaborative composition. Who would pay so much for such a high end word processor? Why, places such as law and consulting firms who need such programs to boost productivity. Wang then began making cheaper versions of its word processor until it got wiped out by the usual bottom-to-top disruption from Micropro’s Wordstar and Microsoft Word.

So why did the iPod succeed over cheaper mp3 players? “Marketing and packaging,” snivels a cynic. Call it what you will, but the iPod adopted a different philosophy than its competitors. Apple, like Nintendo, places the customer experience first. Apple focused on how people would use the portable mp3 players as opposed to the technology itself (which led to the innovative click wheel). The iPod disrupted because it aligned itself with the behavior of the customer as opposed to the behavior of the technology.

Microsoft marketing made a video mocking themselves on their cluttered packaging. As internal teams shared it with one another, somehow it ended up on YouTube (and got taken down). However, Google was able to put it up on their servers. The video itself illustrates philosophical differences in the approaches of Apple and companies such as Microsoft.


iTunes was another major factor in the iPod disruption. Sony did not want to cannibalize its traditional music business. Apple, a computer maker who had no music business, had no problems creating a digital download service.

Soon the traditional radio industry faced a major threat from top-down disruption of satellite radio. XM and Sirius offered satellite radio with clear performance benefits over familiar through-the-ether version. First, no commercials. Second, a far larger menu of programming choices. Third, you can listen to the same station anywhere you want. The signal doesn’t fade as you move further from a land-based transmitter. Fourth, the quality of the digital audio is higher than what you get over the airwaves.

While there was a subscription that had to be paid for the service, technology advanced which drove down the costs for receivers from car radios to portable tuners to home systems. The number of subscribers for both XM and Sirius shot up in 2004. Howard Stern even moved his program to the new medium. All analysts predicted that satellite radio, upsurging in sales, would do a top-to-down disruption on radio.

Apparently analysts eat the same food as the game console analysts do as the future ended up something completely opposite. Satellite radio got completely disrupted by the iPod. Again, the the top-to-down disruption was destroyed by the down-to-top disruptor. Satellite radio has slower sales while iPod sales kept increasing in 2007.

Why did iPod disrupt Satellite Radio? The subscription model was disliked by customers. More important, the iPod offered users more control over their music. Satellite Radio offered control only by genre. 70% of new cars in 2007 came equipped with iPod connectors while major airlines followed suit. The victor is quite clear.

LESSON #5: Bottom-to-Top Disruptions Will Wipe Out Top-To-Bottom Disruptions

Heed this lesson well, analysts, when you all slavishly predict Playstation 3 to undergo a top-to-down disruption. Historically, top-to-down disruptions lose to the typical down-to-top disruptor. Don’t forget what happened to Wang’s word processor or Satellite Radio.



Honda Motorcycles

After World War II of reconstruction in Japan, Honda appeared as a supplier of small, rugged, motorized bicycles that were used by distributors and retailers in congested urban areas to make small deliveries to local customers. This experience allowed Honda to develop expertise in making small efficient engines for these bikes. Honda sales for bikes went from 1,200 in 1949 to 285,000 in 1959.

Very naturally, Honda’s executives looked to exploiting the company’s low labor costs to export motorbikes to North America. However, North America did not have any equivalent to the Japanese ‘delivery’ bike. Honda’s research discovered that in North America, motorcycles were used primarily for over-the-road distance driving in which size, power, and speed were the most highly valued product attributes. So Honda engineers designed a fast, powerful motorcycle specifically for the American market, and in 1959 Honda dispatched three employees to Los Angeles to begin marketing efforts. To save living expenses, the three shared an apartment, and each brought with him a Supercub bike to provide cheap transportation around the city.

Honda’s products offered no advantage to prospective customers other than cost, and most motorcycle dealers refused to accept the unproven product line. Honda persevered and was able to find some dealers and sold a few hundred units. The results were horrible. Honda’s understanding of engine design turned out not to be transferable to highway applications, in which bikes were driven at high speeds for extended periods. The engines sprung oil leaks and the clutches wore out. Honda’s expenses in air-freighting the warranty replacement motorcycles between Japan and Los Angeles nearly sunk the company.

With everything falling apart around them, the Honda executive in charge of the North American venture, Kilhachiro Kawashima, decided to vent frustration one Saturday by taking his Supercub into the hills east of Los Angeles. It helped. He felt better after zipping around in the dirt. A few weeks later he sought relief dirt-biking again. Eventually he invited his two colleagues to join him on their Supercubs. Their neighbors and others who saw them zipping around the hills began inquiring where they could buy those cute little bikes, and the trio obliged by special-ordering Supercub models for them from Japan. This private use of what became known as off-road dirt bikes continued for a couple of years. At one point a Sears buyer tried to order Supercubs for the company’s outdoor power equipment departments, but Honda ignored the opportunity, preferring to focus on selling large, powerful, over-the-road cycles, a strategy that continued to be unsuccessful.

As more and more people clamored for their own little Honda Supercubs to join their dirt-biking friends, the potential for a very different market dawned on Honda’s U.S. team: Maybe there was an undeveloped off-the-road recreational motorbike market in North America for which- quite by accident- the company’s little 50cc Supercub was nicely suited. Although it took much arguing and arm-twisting, the Los Angeles team ultimately convinced corporate management in Japan that while the company’s large bike strategy was doomed to failure, another quite different opportunity to create a totally new market segment merited pursuit.

Honda’s 50cc motorbike was a disruptive product in the North American market. The small bikes had a very different value network than the established network in which Harley-Davidson, BMW, and other traditional motorcycle makers had competed.

Let us break with this history to ask a question. Reader, can you imagine how the motorcycle market’s reaction was with Honda’s little bike?

”I imagine,” said the reader, “they considered the small bikes as ‘bikes for casual riders’. Obviously, those bike riders were not hardcore like the Harley-Davidson and BMW. They probably laughed at the small bikes.”

And do you think they imagined those small Honda bikes as a fad?

”Oh, very much so!”

What should be noted is that Honda’s low-cost manufacturing base for reliable motorbikes, Honda turned its sights upmarket and introduced between 1970 and 1988 a series of bikes with progressively more powerful engines.

”This would cause upmarket companies like Harley-Davidson to respond.”

They did. Harley attempted to compete head-on with Honda and to capitalize on the expanding low-end market by producing a line of small-engine (150 to 300 cc) bikes acquired from the Italian motorcycle maker Aeromecchania. Harley attempted to sell the bikes through its North American dealer network. Although Honda’s manufacturing prowess clearly disadvantaged Harley in this effort, a primary cause of Harley’s failure to establish a strong presence in the small-bike value network was the opposition of its dealer network. Their profit margins were far greater on high-end bikes, and many of them felt the small machines compromised Harley-Davidson’s image with their core customers. Meanwhile, Honda was inaccurate with its estimating of how large the potential North American motorcycle market was as in understanding WHAT it was. In 1959, Honda captured 5 percent of the market. By 1975, the market had grown 16 percent per year to 5,000,000 annual units- units that came largely from an application that Honda could not have foreseen.

”What are you saying?”

I am saying that Honda used the disruptive product to find a Blue Ocean (of outdoor motorbikes) and then moved upmarket to ultimately blow all established motorcycle manufacturers out of the market except for Harley-Davidson and BMW which barely survived. Harley-Davidson, who had all the advantages of brand, being a market leader in North America, was unsuccessful in attacking downmarket due to Honda’s superior business model. Also, Harley’s profits were coming from its upmarket. By attempting to go downmarket, it threatened their upmarket image. Harley had to retreat upmarket.

”So, you are saying that if Microsoft and Sony attempt to outdo Nintendo in the downmarket, not only will Nintendo’s superior business model win, but it will damage Sony and Microsoft’s upmarket?”

Correct. No one bought the Playstation 3 or Xbox 360 to play Peggle or other downmarket games. For quite some time, upmarket gamers are screaming at Nintendo for ‘destroying’ gaming. How do you think they will respond when Microsoft and Sony attempt to replicate Nintendo’s success in the downmarket?

”They will not be happy.”

Even companies that do not require profit for their game division, such as Microsoft, will struggle as their entire game division is dependent on the upmarket. Now imagine how Xbox Live and other Xbox 360 features will be if Microsoft goes downmarket.

”Oh my, Xbox 360 gamers will definitely NOT be happy.”

This is an additional reason for Microsoft to abandon the downmarket and remain upmarket. I believe Microsoft will attempt to fight for the downmarket while Sony will flee to the upmarket. But I doubt Microsoft will be fighting for the downmarket for too long before they retreat.


DISRUPTIVE LESSON #6: Combating the disruptor for the low tiers ends up destroying the brand for the high tiers.

Harley could not make little bikes or else it would end up destroying its brand. It will be difficult for Microsoft or even Sony to combat Nintendo on the low tiers without destroying their carefully crafted upmarket brand.

 
I love this picture. The man, wearing a button-less sweater, plays with his computer on the kitchen table while the wife (in the kitchen where she belongs) smiles in approval at him. Rest assured, this ad was aimed at MEN!

Apple II

Another “fad” that was for “casual users” was the Apple II computer. In the late 1970s and early 1980s, the Apple II was far too basic to meet the needs of corporate users who required complex minicomputers to run financial and engineering applications. As the personal computer improved, the disruption pulled new users into the computer market by the millions. The PC allowed people to compute conveniently for themselves rather than rely on computer specialists. Disruption led to the demise of the previously high-flying minicomputer manufacturers, such as Digital Equipment Corporation, who were unable to change their internal processes to compete with PC manufacturers.

DISRUPTIVE LESSON #7: Market leaders must change their internal processes or see their fortune become folly.

It is not about Sony responding by putting out a Wii-mote type product. Sony, if it wishes to regain any relevance, must alter its internal processes or risk being railroaded not just by Nintendo’s Wii disruption but multiple disruptions that are to come.


Wal-Mart

Did you know Wal-Mart is a disruptor? “Evil!” says a reader. Now hold on a minute.

Discount retailers made money in a very different way than traditional department and variety stores. The profit equation in retailing depends on two vital inputs: gross margin of inventory and the number of times inventory ‘turns’ in a year. Department and variety stores had gross margins on their items of about 40 percent and turned their inventory over about three times in a year, giving them a return on inventory investment of about 120 percent (40 times three). On the other hand, discount retailers’ products were cheaper, with gross margins closer to 20 percent, but their inventory turned over about six times a year. Their return on inventory investment was about 120 percent. The discount retailers were as profitable, if not more so, then the department store retailers.

This low-cost, high-turn business model just did not make sense for down-town department stores, which lost increasing amounts of their business to places such as Wal-Mart.

DISRUPTIVE LESSON #8: Disruption is about a superior business model devouring other businesses.

Christensen admits he made a mistake in his first book by describing it as ‘disruptive technology’ as then everyone began focusing on ‘new’ technology. Remember, if there is no change in the business model, there is no disruption. For example, Nintendo’s Wii is disruptive due to the different business model it has from its competitors NOT because of the Wii-mote by itself. WiiWare also is disruptive to Xbox Live Arcade and PSN.

1.8 Disk Drive

This isn’t so much about a disruptor as it is about a revealing story Christensen tells in Innovator’s Dilemma. I have transcribed the story word for word from The Innovator’s Dilemma, pages 98 and 99.
***
In August 1994, I [Professor Christensen] was visiting the CEO of one of the largest disk drive companies and asked him what his firm was doing about the 1.8-inch drive. This clearly touched a hot button. He pointed to a shelf in his office where a sample 1.8-inch drive was perched. “You see that?” he demanded. “That’s the fourth generation of 1.8-inch drives we’ve developed- each one with more capacity than the last. But we haven’t sold any. We want to be ready when the market is there, but there just isn’t a market for them yet.”

I countered by reminding him that Disk /Trend Report, a highly regarded market research publication that was the source of much of the data used in my study, had measured the 1993 market at $40 million, was projecting 1994 sales to be $80 million, and forecast 1995 volume at $140 million.

”I know that’s what they think,” he responded. “But they’re wrong. There isn’t a market. We’ve had that drive in our catalog for 18 months. Everyone knows we’ve got it, but nobody wants it. The market just isn’t there. We just got way ahead of the market.” I had no other basis for pressing my point with this manager, who is one of the most astute managers I’ve ever met. Our conversation moved to other issues.

About a month later I was leading a case discussion in the Harvard MBA program’s technology and operations management course about the development of a new engine at Honda. One of the students in the class had previously worked in Honda’s research and development organization, so I asked him to take a few minutes to tell the class what it was like working there. It turned out that he had been working on dashboard mapping and navigation systems. I couldn’t resist interrupting his talk by asking, “How do you store all that data for the maps?”

Said the student: “We found a little 1.8-inch disk drive and put it in there. It’s really neat-almost a solid-state device, with very few moving parts. Really rugged.”

”Who do you buy them from?” I pressed.

”It’s kind of funny,” he replied. “You can’t buy them from any of the big disk drive companies. We get them from a little startup company somewhere in Colorado-I can’t remember the name.”

I have since reflected on why the head of this company would insist so stubbornly that there was no market for 1.8-inch drives, even while there was, and why my student would say the big drive makers didn’t sell these drives, even though they were trying. The answer lies in the northeast-southeast problem, and in the role that the hundreds of well-trained decision makers in a good company play in funneling resources and energy into those projects they perceive will bring the company the greatest growth and profit. The CEO had decided that the company was going to catch this next disruptive wave early and had shepherded the project through to a successful, economical design. But among the employees, there was nothing about an $80 million, low-end market that solved the growth and profit problems of a multibillion dollar company- especially when capable competitors were doing all they could to steal away the customers providing those billions.
***

DISRUPTIVE LESSON #9: Disruption begins not in next generation of products but in aiming at non-consumers.

What Christensen is saying is that the big CEO was thinking of disks as in ‘generations’. He had the new generation of disks ready to go but no one was buying it. The problem was that the CEO was relying on the standard customers. It was non-consumers who begin the next disruptive wave. Honda’s Research group was not a regular consumer of disk drives, which put them as a non-consumer, so they weren’t receiving the usual disk catalog. The start up company aimed for the non-consumer and won while the big company missed the boat… again.

 
Google

If there are Seven Wonders of the Web, Google would take the first spot. Microsoft is scared of Google because Google is attempting to disrupt Microsoft. The following is from a reporter who actually focuses in disruption:

“Microsoft says it has no fear about losing sales of its office applications to Google because they aren't up to corporate standards.
 

"’The simple argument that 'this is good enough for 90 percent of what we do' has fallen on its face over and over and over again,’ Microsoft's Antoine Leblond told Reuters in an interview on Tuesday. ‘When it comes to mission critical things and key pieces of how people run their businesses, the threshold is higher.’

”Microsoft is right.

”But being right could take Microsoft Office to a point of future irrelevance. Disruptive innovations typically are inferior to incumbent products on mainstream attributes. And disruptive innovations typically appeal to marginal customers initially.

”Think about how the entire minicomputer industry dismissed early PCs as inferior. Or how the cellular phone industry dismissed the BlackBerry and the wireless email market as insignificant in 1999. Or how once-dominant department stores like Sears crumbled by dismissing low-end discount stores for 40 years.

“What was BlockBuster’s reaction in 1998 when Netflix launched a snail-mail based video rental service?

“I recently studied a handful of young employees at a high-end global consulting firm and -- surprise -- they were using Google applications like docs and spreadsheets to get their jobs done instead of MS Office.”

-Michael Urlocker from ‘The Disruption Group’.

Selling what people ‘want’ is not disruption in the slightest. Disruption never comes up in market research as people do not know what they really NEED.

Prior to the NES being released in America, the President of Nintendo, Arakawa, spent money on extensive market research. The results all showed the same: no one wanted console video games when computers could do that and more. At one focus group test, kids played Super Mario Brothers among other games and called it horrible. Any other business would never have released the NES after that. Historical revisionists like to claim that someone would eventually have come up with the NES and that Nintendo was just lucky to be in the right place at the right time. To the contrary, it was because of the way how Japanese did business that allowed the NES. American businesses would not go against market research focus tests and would have to respond to quarterly profits from investors (NOA was running at major losses for quite some time when NES was launched). This is why during the 80s that Japan not only took over the video game business, they also began to take over cars, VCRs, TVs, and generally every sort of electronic appliance. The point is that Arakawa could throw away all the extensive papers of ‘market research’ and go with how he saw how children behaved.

People never ask for a disruptive product. But when it arrives, they cannot live without it. One relatively new ‘disruptive’ product would be Roomba the robot.

Roomba is a robot that vacuums by itself. While it is not cheaper than a regular vacuum cleaner, it is cheaper than a maid. No one wanted the Roomba robots until they were released. Now, people will not depart without them. Roomba isn’t a better vacuum cleaner. Some might say that it is a vacuum cleaner for ‘casuals’ and a ‘fad’. While it takes longer for Roomba to clean a room than a regular vacuum cleaner, Roomba can vacuum while the owner is at work or at sleep and can start itself on a schedule automatically. Roomba also cleans under all the furniture, including beds and couches, which, to be honest, most people do not clean well if at all. When done cleaning, Roomba lets out a triumphant note and returns to its dock. Should Roomba be caught under something or cannot move (such as being stuck on rug tassles), it lets out a mournful noise so the owner can find it.

Technological evolution is not progress. Disruption is progress. The original vacuum cleaner, for example, was a disruptive product. It was not *better* for those who would take out their rugs and beat the dirt out. But to the non-consumers it sold, it spread and eventually people could not live without them.

Among the numerous ‘market aberrations’ that were ‘fads’ for ‘casual users’ include the telephone (that disrupted telegrams), the railroad (that disrupted river boats), automobiles (that disrupted horses), refrigeration (that disrupted the ‘ice boxes’), television (that disrupted radios), digital photography (that disrupted chemical photography), DVDs (that disrupted laser disc and VHS), integrated circuits (that disrupted discrete components) and steamships (that disrupted sailing ships).

Fans of Sid Meir’s Civilization already understand disruption. They know that a more powerful bowman is not going to change the course to history to their side. However, the invention of gunpowder would for the musket disrupted crossbows, longbows, and knights).

And, if the reader happens to be a game journalist, he or she should realize that desktop publishing disrupted traditional publishing.

Anthropologists have speculated the response hunter-gatherer societies had to the introduction of agriculture. We now know what they said: “Planting crops is for a casual people. Real people hunt and forage! This planting is just a fad. Its growing popularity is simply a temporary aberration that will soon collapse.” The same thing was said about the Industrial Revolution.

What is that? A reader interrupts this text to say, “You are going to extremes. How dare you suggest disruption is the engine of civilization!”

Perhaps. But I want to drive home the concept that progress is not a linear line of increased technological sophistication. Every stock you wished you owned was from a company creating disruptive products.  Historically, both of market perspective and general history, inventions that change the market are never well liked by the mainstream at first. Your elegant lifestyle, after all, is held up by disruptive product pillars that are being built, one on top of another, for centuries.


How to Think Disruptively

Market disruption is something that seems obvious in retrospect but was considered ‘insane’ back when the product was introduced. The acceptance of the mainstream from the ‘insane product’ to considering it the ‘obvious product’ is the revolution. While Wii dominating the sales charts would have been considered laughable years ago, today, it is considered ‘normal’ and commentators see it as the landscape itself. “The Wii? What is there to say? It is dominating as usual” is the common end of analyst reports now.

In order to think disruptively, I want you to pretend you are Iwata or Reggie and the year is 2004. How do you disrupt the game industry? Answer the questions in the below chart thinking you are them.

Then, you have to identify potential disruption in the market. You would probably diagnose the Blue Ocean market with the below chart:

When one reads any speech made by Reggie or Iwata in the years before the Wii launched, the content of their speeches were answers to possible disruption.

 
Malstrom Issues a Test

”What!” cries the reader. “There is a test?”

Yes. The purpose of this small little article is to teach about disruption. Now, it is time to quiz you.

”I remember everything you said.”

Oh, no. Unlike school, I do not wish to teach content but CONTEXT. Let us see if you can think in a disruptive context.

”What is the quiz?”

It is one issue, really. With Blu-Ray winning over HD-DVD, new questions have arisen about digital distribution. I want you to look at digital distribution in a disruptive context. Explain how the market would unfold.

”How do I do that?”

If digital distribution is a disruptive technology, how would it manifest itself into the marketplace? And what impact would Blu-Ray have on digital distribution?

*Jeopardy Theme*

OK. Reader A, tell me your answer.

”It is quite simple. Digital distribution has no future because market research shows that people want to buy things on disk. Blu-Ray and its HD movies are so much data that they cannot be put on digital distribution… at least not for a long time. Therefore, the success of Blu-Ray means digital distribution is defeated, at least for a decade. Sony is a genius.”

Sorry, but you get an F.

”What! Why!?”

Disruption relies on certain rules which you violated. One, market research never reveals disruption until it is too late. One cannot analyze markets if they do not exist yet. Also, Blu-Ray can never ‘defeat’ a disruptor. The only thing that can ‘defeat’ a disruptor would be another disruptor. When HP noticed Dell disrupting its computer sales due to cheaper computers, HP combated this by disrupting with cheaper computers as well. This stopped Dell from devouring HP’s market. Blu-Ray is a ‘sustaining’ advance. It is better than DVD in many ways. But since it is just ‘sustaining’ and never ‘disruptive’, it cannot stop a disruptor simply because it is ‘better’.

”But the better product will sell the most!”

Fool! A disruptive value is different than a sustaining value. The two do not compete in traditional terms. Digital distribution may not be as ‘nice’ as Blu-Ray but it has values Blu-Ray does not: mobile anywhere with an internet connection, easier to transport, can make more than one copy, and so on. YouTube is wiping the floor with Blu-Ray and YouTube’s video quality is worse than VHS.

”You are only giving me an F because I am not giving the answer you like. You just want to see an answer that fits your opinion.”

Not true. The purpose of this quiz is for you to think in disruptive terms. Now, you may disagree about the future of a disruptive product. But how can you disagree with disruption when you still don’t understand it? I just want you to understand. Creating informed readers is my purpose, not mindless automatons. Review the examples of disruption above and try again later.

Now, Reader B, how did you do?

”Well, Malstrom, this is what I wrote. Digital distribution will come sooner or later. We should remember the VHS was replaced by DVD not because it simply was a better quality of video. It was because DVD helped consumers in other ways. DVDs did not have to be rewound. Finding a scene on the DVD was much easier than on a VHS. VHS wore out much faster. It is logical to assume that digital distribution of video would apply similar to that of music. CDs became disrupted by MP3. It is not because MP3 was a better quality than CD. It is because MP3 had many other value elements that put it superior to CD. MP3s could be placed anywhere, were very mobile, could transfer them over the Internet, and one could create giant song lists. Blu-Ray’s impact is little. Soon, people find a way to transfer Blu-Ray type data via digital distribution and the age of the disc will end.”

Hmm. All right. Not bad. I will give you a C+ for this.

”What! I thought it was perfect. I should get A+.”

You get big marks on your attention to history and realizing that the winning format is not necessarily ‘better’ than the one it is disrupting. The major flaw in your answer is when you talked about Blu-Ray and in how the video disc would end.

”I don’t understand.”

You are saying digital distribution will ‘eventually’ win simply based on technology reasons. That is not disruption. Disruption is about new business models. A disruptive product will be aimed at non-consumers first and then ramp up through the tiers and gobble up the mainstream product. Your flaw is in saying Blu-Ray would be disrupted.

”Wouldn’t it?”

It would be the very last thing disrupted. HD movies would be the very top tier. Disruption starts at the lowest tier and moves up. It does not start at the top tier.

”That explains why people who look for digital distribution of movies first are saying digital distribution is just propaganda from the tech world. They do not see disruption occurring at the top tier so they assume it is not happening at all.”

Correct. Now, Reader C, tell me your answer.

”Of course, Malstrom. Digital distribution of video will occur first in places no one expects. It will occur first to people who don’t really buy disc movies. I suspect digital video will become more and more popularized due to the explosion of video devices coming out (such as phones playing video). Based on these early users, a business model will be molded. It could be paid from online or it could be done through advertising or even subscription. We are seeing digital distribution such as YouTube become insanely popular. Porn magazines and porn disc movies are already being disrupted by digital distribution of porn. If there was no Blu-Ray or HD-DVD and DVD stayed as it was, the disruption of video would take place much sooner. What Blu-Ray has done, far from stopping the disruption revolution of video, is flee upmarket. Blu-Ray is obviously a higher tier than DVD. Success of Blu-Ray simply is delaying the inevitable disruption of the entire market. Movie companies are paranoid that disruption will destroy them just as it destroyed the recording industry (not the musicians, the record labels). They were lucky when High Definition came along so they use that to move the tier up, to flee upmarket. Blu-Ray is a last desperate attempt for movie studios to keep control of their content before digital disruption totally destroys them.”

Excellent, Reader C! Most excellent! You get an A.

”Why does he get an A!?” the other two readers protested.

Reader C gets an A because he correctly said that video disruption would occur with non-consumers first. It would prove profitable there first before it moved to higher tiers. He also correctly analyzed Blu-Ray’s impact. Blu-Ray is the video companies fleeing upmarket as the disruptive storm brews below them. They are not stopping the disruption or fighting it. They are scared and are on the run.

Analysts Miss the Market Paradox

One thing everyone can agree on is that this generation’s market results have been going against the conventional wisdom. A low powered console outselling the previous market leader? Such a suggestion was seen as absurd before the Wii launched, but, today, it is the truth.

With the market behaving opposite to conventional wisdom, it puzzles me that our esteemed analysts do not ask an obvious question. They rely on conventional wisdom’s belief that the high definition consoles will come down in price and will move downmarket. In this view, the Wii will become obsolete and forgotten within three years.

"Consumers may hope for improved graphics, and my guess is that Nintendo will comply. In two or three years, commodity prices for graphics processors and CPUs may decline to the point that a High Definition Wii could be introduced. If so, Nintendo will likely introduce one,"

-Michael Pachter, analyst for Wedbush Morgan, in an email to GamePro.

”The statement comes as several industry pundits suggest that Wii's success will gradually fade given the console's dated graphics technology. The long-standing argument is that both core and casual gamers will grow wary of Wii's novelty once Xbox 360 and PS3 graphics hit their full stride.”
 

-Blake Snow, Gamepro.

”A considerable part of the Xbox 360's revenue model is Xbox Live and aftermarket online and/or casual game sales. Drop the 360 price into Wii territory and get your marketing team going toe-to-toe with Nintendo on the casual-online front and you just might redraw the battle lines. Nintendo may have found a new niche, but it remains a pretty monolithic one. The Xbox 360 (uniquely) has the economic and creative potential to mix and match hardcore and casual demographics. Figuring out how to market that message is Microsoft's game to lose.”

-Matt Peckham, ‘Game On’ blog.

“..the way we're thinking about this cycle from a high level is, the Wii at that lower price-point had a lot of momentum early in the cycle, but as Sony and Microsoft come down the price curve those two should accelerate, and there's a lot of firepower left in their arsenal...”

-Farrell, Brian. Morgan Stanley Technology Conference

But the Xbox 360 and PS3 have already had price cuts. Why has this not changed the market? The analysts and company managers do not say; they merely march to conventional wisdom like automatons.

It is clear that they think PS3 and 360 will become cheaper and absorb the downmarket where the Wii is enjoying. My question for these gentlemen is amazingly simple: If the PS3 and 360 are thought to move downmarket, how come no one suggests that Wii could move upmarket?

After all, the DS started out with mini-games and casual games like Brain Age and Nintendogs to move up to beefier titles. Is it so hard to believe the Wii will do something similar? Is it so difficult to believe that Nintendo will undergo the Christenson disruption as stated in all their speeches?

How can everyone state that the PS3 and Xbox 360 will be able to move down to grab Wii’s market but do not suggest that Wii could move upmarket? “It is because Wii is not a powerful machine, Malstrom!” Then why is every generation’s market leader always the inferior machine? Oh snap!


Disruptions Occurred Before in Gaming

Disruptions, as seen as the Christensen kind, are no stranger to gaming. Look at all the generations of gaming. Can you tell where the disruptions are? There have been three major disruptions total in the games industry (not including the PC sphere).

In order for a disruption to occur, a new business model must appear. If there is no new business model, there is no disruption. Period. Disruption is not a new controller or influential new games.

A Disruption must have…

-Disruptive Technology as opposed to Sustaining Technology. The difference is that sustaining technology is the same value of the past but better. Better graphics is a common sustaining technology. Disruptive technology provides a new value that makes the product easier to use (very important). Wii’s motion controls would be a disruptive technology as it made gaming more accessible.

-A new business model. A new business model means selling the product in new, different ways, and gaining customers and revenue in different ways. Bigger advertising budgets are not disruptive. Viral marketing, when everyone else is doing television ads, would be disruptive. This new business model always focuses on creating crummy products for non-customers (which mainstream customers laugh at).

-Disruptions create new markets and then ride those new markets upstream to take products away from the former market.

-Disruptions rely on new markets that have been ‘overshot’ by traditional market leaders.

-Disruptors do not directly compete.

The Pong Disruption

The lore of Pong is well known to everyone so I will get to the core of the issue. Nolan Bushnell imagined video games being side by side with pool tables and pinball machines. Using Computer Space, he managed to get a small pinball company to generate 1,500 machines. As everyone knows, Computer Space failed.

Bushnell’s response to the failure was appropriate for a disruptor. He knew that making a better, more complicated product was not the answer. He made a simpler and easier game. (“He stole Pong!” someone from the back shouts. When will you people realize that genius applies to generating new business models, not to product ideas?)

Bushnell placed the new Pong in Andy Capp’s tavern to test the product. The product was extremely successful as it broke down with too many quarters being put in. Smelling a hit, Bushnell went to Bally’s Midway (the popular pinball maker) for help in constructing the Pong machines. Bally’s Midway showed him the door.

Why did Bally’s Midway turn down Bushnell? It is because, by traditional standards, Pong was not a better product than pinball. Pinball was far more exquisite, more complicated, and Pong seemed like a crummy product compared to a pinball machine. But Pong was a digital video game, the first most people would see, and would be defined as a disruptive technology. Pong brought new values to it that pinball could never match even if the pinball machines were far superior.

Pong was a sensation, as we all knew. Pong generated new players all over as well as taking some traditional pinball players. Pong created the video game arcades which would disrupt pinball machines. While Pong was a crummy product, its superior profit model attracted more work and technology which created better products. Soon, video game arcades were doing things pinball machines never could. And it was then that pinball machines became relegated to a niche (keep in mind pinball was a popular pastime whose popularity surged during America’s ‘Great Depression’).

 

 In 1973, after six thousand Pong machines were sold, Bally’s Midway approached Bushnell for the rights to the game. Bushnell agreed and nine thousand more Pongs were sold. Bally knew which way the wind was shifting.

But Pong’s disruption did not end there. A home version of Pong was made. Now, the Odyssey had done the same (and failed). Bushnell found similar failure as the Toy Fairs he went to had no one interested in the product. It was Sears who wanted the home version of Pong and offered to sell it through their sporting goods department (which Bushnell would never have thought to approach). By selling Pong as a ‘sporting good’ rather than a ‘toy’ or ‘electronic device’, this gave a strange twist to the product. Due to Pong’s popularity, there were many copycat Pong games out there. The home version of Pong would disrupt these arcade Pongs.

This would start a long standing disruption in the game industry of home versions disrupting arcade versions. The home version was never better, most times it was often worse, but it was ‘good enough’. Arcades couldn’t fight it as home versions were more profitable. So arcades had to keep moving upmarket. The graphics got better, the games got bloodier, but the home versions would keep disrupting the arcades. All the way into the nineties did the arcades generally last, even going 3d, until they could no longer move upmarket anymore and were wiped out. Even Japanese arcades, who used to be healthy, are being cannibalized by the Wii.

Pong disrupted pinball and then the arcades in which it thrived.

Why Atari 2600 wasn’t a disruption:

The ability for consoles to play different games was an obvious major change, it warrants the definition of a sustaining technology as opposed to a disruptive technology. There was no new business model attached to the Atari 2600. It simply expanded on the success of Pong and games got more complicated and ‘better’.

Was the personal computer revolution a gaming disruption?

Yes, but it is the rare top-down disruption. Top-down disruptions rarely work because they are so easy to blow from the bottom. The way how top-down disruption worked is not because ‘superior technology always wins’ but because the company at the downmarket is completely inept. At this time period, Atari WAS completely inept and was being cannibalized by the PC market. The Crash of 1983 sealed Atari’s fate.




The NES Disruption

It became conventional wisdom that all home consoles would crash and gaming would forever remain on personal computers. Atari became a black hole that swallowed the entire home console market. Video games were declared a fad that had passed. Retailers would never accept them anymore since they got burned during the crash.

However, that was in America. In Japan, the Famicom sold to great success. Nintendo was doing to Japan what Atari had already done in America (similar to the Pong disruption).

In America, a new generation of kids was growing up who were probably too young for the Atari era. They could not transport themselves to the arcades. And they were too small to play computer games (using text only operating systems were tricky for kids back then). Also, the computer games tended to be elaborate RPGs, strategy games, and adventure games which were too much for kids.

The NES was disruptive as it found a new market its competitors were not going after: kids. The Game Industry thought the NES was a joke. Trip Hawkins, head of Electronic Arts, swore that the NES, like the Atari, would crash and games would appear on computers again. Computers were moving into 16-bit while the NES was an 8-bit machine using a processor from the 1970s.

The definition of a disruptive product is: a crummy product for non-consumers. Sure enough, the NES was a crummy product for non-consumers… these being kids. Kids didn’t care that the NES had worse graphics than the computers. NES brought values that computers did not have which included no loading, easier to play games, and playing in front of a television.

Nintendo relied on different techniques to get its product out. They put in R.O.B. to market the NES as a toy as opposed to a game system. Later, they would make the ‘World of Nintendo’ store-within-a-store. There was Nintendo Power which became the most popular kids’ magazine in America. There were the cartoon shows, the cereal, the toys, and, of course, The Wizard. As the NES grew in popularity, it began to cannibalize lower tiered computer games. Within time, a sizable schism resulted that has remained between console gaming and PC gaming in terms of how PC games would have to use the unique capabilities of the computer (such as hard drive, keyboard and mouse) or risk the games being moved to consoles (as is increasingly occurring).



While the Gameboy was an evolution of the Game and Watch, it would be appropriate to describe the Gameboy as the initial disruptor since Game and Watch wasn’t as widespread outside Japan. The Gameboy fit the disruptor description well. It was definitely a crummy product for non-consumers. It was, in every way, inferior to the NES. However, it brought values to it that the NES did not have: it was portable.

“But Malstrom!” you say. “Are you saying that the Gameboy was disrupting the NES, that Nintendo was disrupting itself? Are you insane?”

The correct action for a disruptor is to follow-up previous disruption with another disruptive product to cannibalize their business. Had console gaming remained forever in the 8-bit generation, it is obvious that Gameboy would have disrupted consoles as its mobile technology improved. Instead, console gaming moved upmarket and handhelds have always been a couple of generations behind.

While competitor consoles are the obvious reason for Nintendo moving upmarket (to 16-bit, to 64-bit, and so on), the bigger problem is Gameboy cannibalizing the console market. In the future, this will become a problem for Sony with their handheld. The point is that the handheld business forced Nintendo to keep moving its console to the upmarket (or else risk it becoming gobbled up by the improving Gameboy). Nintendo’s solution was innovative: the DS turned Gameboy into a product that does not resemble a portable console for there are two screens and a touch pad (which cannot easily be put on consoles). This would later allow Nintendo to create a disruptive console without risk of its handheld equivalent eating it up.

Was Sega a disruptor? They came out with many peripherals!

No. Sega relied on sustaining technologies. Sega had almost the exact same business model that Nintendo did.

Was Sony Playstation a disruptor? They had ‘mature’ marketing!

No. Sony, also, relied on sustaining technologies and directly competed with Sega and Nintendo. Marketing on MTV or elsewhere for Sony knew they were aiming at the same audience. Sony was carefully watching the 16-bit war between Nintendo and Sega. They knew that Sega did well because it marketed itself to teenagers (as the NES generation grew up). Sony took it to the next step.

Was the CD a disruptor? It took Final Fantasy VII! OMG!

No. CDs are a sustaining technology in the game business. CDs, like game carts, used the same exa