Cracking the Code: What Makes a Premium Company

premium company positioning

In this blog post, I provide a framework that helps you understand what you can do to become or continue to be a premium company.

What is a Premium Company

To get straight to the point, here’s my definition:

A premium company is a company that can consistently convince its customers to pay more than what they had initially intended for a certain product or service by virtue of its value proposition.

Let’s now dissect this definition and provide more context.

Product vs. Company

The first essential element to clarify is the difference between company, business, and product.

  • A company or firm is the organizational structure, in legal terms no not, that operates one or more businesses.
  • A business is the exchange of goods produced or services provided for money.
  • A product is one of the outputs of a business.

Avoiding product- or pricing-specific answers is essential when trying to answer what makes a premium company. They are not mutually exclusive. A premium company can offer non-premium products, and a non-premium company can offer premium products. However, what makes a premium company is its ability to deliver premium products to the market consistently.

Relative Positioning

The second important element to clarify is that “premium” is not an absolute or fixed position in the market but relative to the target customer needs. We can draw upon Clayton Christensen’s disruptive innovation framework to clarify this idea.

The framework defines a market or arena with multiple customer types: high-end, mid-end, and low-end. To avoid confusing these terms by their commonly used association with pricing, let’s call these high-needs, medium-needs, and low-needs customers instead.

High-needs customers require the product to offer various attributes and features. In addition, the features must be up to standard. To put it in terms I used in an earlier blog post titled “Attributes and Values: Business Strategy Core,” high-needs customers have many attributes that need satisfying and more than a few that need championing.

Low-needs customers require the product to meet their basic needs sufficiently and nothing more. They are willing to accept sub-standard attributes or forego them entirely.

Medium-needs customers fall in between high-needs and low-needs customers.

Collectively, we define the needs of a customer type as the required product performance.

Firms can now develop and market products catering to different customer types. Generally, the goal for the firm is to understand the customer performance expectations appropriately, then deliver a product that closely matches those expectations. We can call upon the price/value framework from an earlier blog post titled “Value and Price Dynamic” to understand the tension between Value Offered, Value Perceived, and Purchase Price.

This framework offers three possible customer segments in a market with high-, medium-, and low-needs customers. However, in relative positioning, the firm also has the option to make a deliberate choice to either exceed the customer expectations or fall short of the customer expectation. Let’s call this premium and discount positioning.

In premium positioning, the firm delivers a product that offers more or better attributes than the customer needs or expects. It also comes with a slightly higher price tag. The company must communicate to the customer the extra value offered and why it’s worth the additional money. Customers may be willing to spend more than planned if they appreciate the additional value offered.

In discount positioning, the firm delivers a product that offers fewer or worse attributes than the customer needs or expects. It also comes with a slightly lower price tag. The company must communicate to the customer why the lack of value offered is not a concern. Customers who appreciate this story will happily pay less for the product.

The Premium Company

Let’s return to the definition of a premium company. A company is a premium company when it can consistently market premium products relative to its target customer needs and consistently convince customers to pay more for those products.

Notice how I emphasize the word “consistently?” One premium product doesn’t make a premium business. And one premium business doesn’t make a premium company. The challenge of becoming and staying a premium company is that you need to consistently outperform your customer expectations, even when those expectations increase year after year.

Another critical challenge of being a premium company is thoroughly understanding your customer’s needs and wants. Based on that information, you must plan to exceed those needs and wants. And if that’s not enough, you must also be able to execute this plan. It’s tough being a premium company!

The benefit of being a premium company is that over time customers will associate premium with your brand and products and thus will automatically expect to pay a higher price than for an equivalent product of another brand.

Premium Company Margins and ROI

As a final note, I want to cover the topic of profit margins of premium companies briefly.

Following the framework of the premium company, we can say these companies can charge higher average selling prices (ASPs) and higher margins. Thus, the premium companies enjoy higher ROE and can invest in new projects more easily.

However, we must separate the premium positioning from a firm’s ability to capture the value. Whereas premium positioning allows a firm to charge higher ASPs, the margin and associate ROE highly depend on the operating model. Inefficient premium companies won’t be able to capture the appropriate margin and may not achieve the expected return on investment as a premium company.

Notes on Disruptive Innovation: Intellectual History and Future Paths

My notes on HBS Working Paper 17-057 (PDF) titled Disruptive Innovation: Intellectual History and Future Paths by Christensen C., Altman E., McDonald R., and Palmer J. It complements my previous blog posts like Business Theory of Disruptive Innovation, Jobs To Be Done: Business Raison d’Etre, and Managing the Six Phases of Transient Competitive Advantage

3 principal components of disruptive innovation:

  1. The pace of technological progress outstrips growth in market demand for higher-performing technologies, causing incumbents to overserve the market and, as a result, creating a gap in lower market
  2. There is a strategically important distinction between different types of innovation
    • Sustaining innovations: improve product along existing dimensions of performance (make a good product great)
    • Disruptive innovations: usually cheaper but better at other dimensions (create a new product)
  3. Established profit models constrain investment in new innovations because they are typically less profitable

Anomalies uncovered in further research

  1. At first, the idea is that incumbents don’t invest in disruptive innovation. But that’s not true: investment ranges from little to freely flowing
    • Opportunity framing vs. threat framing: threat framing usually leads to greater resource allocation
    • However, despite investments, inertial forces prevented from adoption
  2. A small subset of incumbent leaders successfully dealt with disruptive innovations
    • autonomous business unit separate from parent company free to enact own business mode
  3. Different types of disruptive innovation:
    • Low-end disruptions: enter the low-end of the market, solidify market share and position in the value network, then move up-market
    • New-market disruptions: compete against non-consumptions
  4. For disruption to occur, industries must be structured so that producing higher-performing products and services results in higher profitability for firms, giving them an incentive to go upmarket.
  5. Specific industries have an “extendable core” that allows firms to produce at first simple products at low cost, but eventually can make more sophisticated things at lower cost

Causal Pathway for Disruptive Innovation theory

  1. Insidious resource allocation process within the organization that favors “sure” investments
  2. Customers ultimately provide the firm with the resources it needs to survive
    • Sustaining innovation serves and is valued by existing customers
  3. As performance improves, there is a more significant overlap between different market segments
    • Disrupters invade contested up-market to increase economies of scale
    • Incumbents retreat to uncontested up-market to protect profitability

Research with Intel on investment in disruptive innovation.


  • If the innovation was sustaining and Intel was an incumbent in the target market, the venture would succeed.
  • If the innovation was sustaining and Intel was an entrant in the target market, the venture would fail.
  • If the innovation was disruptive and an autonomous business unit was formed to pursue it, the venture would succeed.
  • If the innovation was disruptive and an integrated business unit was formed to pursue it, the venture would fail.

Using business plans to classify the ventures and survival to proxy performance, the theory correctly predicted the outcomes of 45 of the 48 businesses (94 percent accuracy rate) (Raynor, 2011)

Refining Performance Trajectories

  • The variance in the speed of disruption across different industries
  • The variance in speed of disruption within the same industry over time

Responding to Disruptive Innovation

Incumbent Response Strategies

  • Separate organizational unit tasked with developing or commercializing the new innovation
  • Aggressively invest in existing capabilities to extend current performance improvement trajectories to slow or delay the onset of disruption
  • Boldly retreat by proactively repositioning to profitable new niches
  • Organizational ambidexterity to manage conflicts arising from pursuing different types of innovations simultaneously
  • Redefine the organization’s identity to convince customers to value their products not on functional dimensions but on characteristics like nostalgia, authenticity, etc
  • Partner with or license startup technology once it advances beyond a certain threshold or acquire it altogether
  • High brand status can help incumbents re-emerge after experiencing a decline due to disruption

Hybrid offerings

  • Combine the new technology with the existing one to ensure a smoother transition
  • Improve existing technology while learning the uncertain technology
  • The performance difference between using new technology to enhance existing products and deliver to an existing customer base (sustaining) versus using hybrid technology to target new customers or applications (disruptive)
  • Hybrid may be of particular use to enter a market to support both legacy and new use
  • Business model hybrids?

Platform Businesses


  • Platform businesses are built around modular architectures; the primary competitive advantage is interaction with one another and building upon the others’ products
  • Platform and network-based business strategies are emerging more rapidly, especially in IT- and cloud-enabled business models
  • When products are not yet good enough to satisfy customer performance requirements, firms rely on highly internally interdependent and integrated product architectures to maximize performance. Firms cannot afford to adopt modular architectures because standard interfaces compromise performance
  • When performance is satisfied, the basis of competition shifts to other product dimensions such as convenience, customization, price, and flexibility
  • When the shift to less integrated happens, modular architectures enable simpler and more efficient interfaces between products. Disruptive entrant incorporating modularity strategy can be highly effective

Disruption through incumbent transitions to platform business

  • When in an industry’s lifecycle, it’s effective for the incumbent to transition to modular/platform
    • If differentiation is performance-based, platform business is sub-optimal
    • If the industry over-serves and competition basis shifts to convenience, the platform may prove viable

Disruption through complementor ecosystem and network effect

  • A strong link between the management of complementor ecosystems for disruptive innovation
  • The competitive success of platform strategy hinges on the ability to create and harness network effects
  • A pricing strategy can disrupt the incumbent. E.g., offer free products to gain adoption
  • To build network effects, a firm may adopt strategies that rely on revenue sharing or royalties rather than sales revenues
  • Coopetition as a form of defense against disruption

Financial Metrics

  • Disruption is not a technology problem; it is a business model problem (and tightly related to the profit model)
  • Two problems with Profit Model
    • A measure of success -> drives investment decisions, especially when compensation is tied to financial success
    • Shows short-term success -> drives investment decisions, avoiding the long-term return perspective
  • New startups without defined profit formula as a success metric gauge success in different ways
  • The use of financial metrics may unconsciously create bias against disruptive innovations
    • Implications of marginal cost thinking and sunk cost fallacy
    • Valuation metrics don’t work if you underestimate the true benefits of innovation
    • Ratio-based metrics = manage by metrics (balance sheet management)

Updates to My Blog Post

I have updated my blog post titled “Managing the Six Phases of Transient Competitive Advantage” to include the Management Priority in each of the six phases:

Phase 1: The management is focused on its vision and aims to deeply understand the job to be done.

Phase 2: The management is focused on its vision and aims to find the right customers for its new product or service.

Phase 3: The management is focused on the operations as it aims to establish the right business and profit model to repeatedly deliver to the customer needs.

Phase 4: The management is focused on the operations as it aims to maximize the market opportunity.

Phase 5: The management is focused on finance as it aims to maximize the profit & loss statement.

Phase 6: The management is focused on finance as it aims to maximize the balance sheet statement.

Managing the Six Phases of Transient Competitive Advantage

The traditional goal of corporate strategy is to obtain a sustainable competitive advantage. However, this paradigm is outdated in the fast-moving globalized world we live in today. Instead, firms should consider their business models flowing from one transient competitive advantage into another.

What is a sustained competitive advantage?

A sustained competitive advantage includes everything that allows a firm to meet its customers’ needs better than competitors or substitutes. It consists of any attributes of the product sold, or service offered that the customer values highly, the perceived value of your brand, the business operating and profit model, etc.

By definition, a sustained competitive advantage is sufficiently strong, unique, and inimitable. That allows the firm to indefinitely fend off competitors vying for the same customers, discourage new entrants from entering the market, and prevent customers from considering any available substitutes.

The sustained competitive advantage is often described as an economic moat, similar to the deep and wide trench around a castle. In this parallel, the castle is your business, and the size of your moat determines how well your firm can protect its business.

In the past, firms would search for this sustained competitive advantage by deeply analyzing a target market, its customers, and the existing supply chain. Once a potential competitive advantage was uncovered, the firm would go to market and do everything possible to turn the advantage into a sustained advantage.

What is a transient competitive advantage?

In a globalized world, barriers to entry have lowered significantly. So, your position in the market with a competitive advantage is exposed to many more players than before. A threat can now be mounted from any country, not just known players in your vicinity.

Furthermore, the rapid increase in information flow and the digital world also exposes these potential disruptive threats to investment markets. Capital has increased visibility on attractive opportunities and can deploy resources to go after them if necessary.

The transitive competitive advantage distinguishes itself in that it is, by definition, not indefinite but limited in time. This significantly affects how a firm should approach ensuring its long-term success.

With a traditional sustained competitive advantage, the assumption is that a competitive advantage can be sustained indefinitely. So, the firm is primarily concerned with reinvesting in the economic moat around its castle to protect its business. The best firms can dig the deepest and largest trenches and, therefore, can protect their business indefinitely.

With a transient competitive advantage, the assumption is that no competitive edge can sustain forever. Therefore, the firm is no longer focused on protecting the existing economic moat at all costs but on the continuous transformation process.

The focus on transformation shifts the firm’s priority from protecting the economic moat to managing the rise and demise of competitive advantages.

How should a transient competitive advantage be managed?

We outline six distinct phases of the transient competitive advantage paradigm. We differentiate the phases from the perspective of McGrath’s “Transient Waves,Damodaran’s “Corporate Lifecycle,Christensen’s “Innovation Cycle,” and Ulrich’s “MOE Organization.”

Phase 1 – Launch of Disruptive Start-Up Team

The first phase of the transient advantage wave begins with identifying a new business opportunity and the decision to mobilize resources to capture it.

In this phase, the team is small. It operates like a start-up, focusing on developing a product that gets a well-defined job done better than anything else currently available. The identified opportunity can take many shapes, including:

  • Addressing a market need for which demand far exceeds supply
  • Low-end disruption in a market where an existing product or service overserves a significant portion of the customers, and therefore there is an opportunity to better serve the customer with a lower-cost business model.
  • New market disruption addresses under-served customers with a more suited product or service offering.

The management is focused on its vision and aims to deeply understand the job to be done.

The team leader is a visionary who can tell a compelling and plausible business story with potential upside for huge profits. The leader must connect the dots between the business opportunity, how the product addresses this opportunity, and what business model can capture the value created. The strength of the story will draw employees and investors to the vision.

The visionary is surrounded by RD innovators and out-of-the-box thinkers who are comfortable with experimentation and iteration and have a fundamental belief in the positive outcome of the project. The RD innovator’s priority is to turn the business idea into a feasible prototype that can be brought to market.

At this point in the business lifecycle, the revenue growth is non-existent, the operational cash flow is negative, and the reinvestment needs are high. Since the business is not generating any surplus cash, there can be no dividends returned to the shareholder. Also, there is no money to pay interest on the debt. Therefore, financing should be done exclusively with equity.

Phase 2 – Ramp Up of Disruptive Young Growth Team

The second phase of the transient advantage wave takes the working prototype to market. It aims to scale the business by turning the business opportunity into a revenue stream.

In this phase, the team remains small. Still, it adds market-oriented capabilities such as marketing and sales and operational-oriented capabilities such as supply chain management.

The management is focused on its vision and aims to find the right customers for its new product or service.

The team leader is a pragmatist (not a purist) who stays consistent in words and action with the business story that launched the business. The leader’s primary focus is to ensure the team remains focused on developing a disruptive product that “gets the job done” and finds customers who “need to get that job done.” At the same time, make the compromises required to ensure market viability.

A common mistake is that the business team pivots too quickly away from the business idea to address the initial customers’ needs. Especially when the team is part of an already established organization with an existing customer base. Another common mistake is to see the narrow, pure vision as the only yardstick of success which may prevent the business from taking off in the first place. The business leader must manage the friction between the “pure vision” original team members (developers) and “pragmatic” new team members (marketing, sales, supply chain).

At this point in the business lifecycle, revenue grows exponentially, starting from a low base. While the (re)investment rate remains high, the business should aim to achieve at least the operational breakeven point. Since profitability remains near zero, there is still no surplus cash to return to shareholders or money to pay interest on the debt. Therefore, financing should still be done exclusively with equity.

Phase 3 – Exploitation of Sustained High Growth Team

The third phase of the transient advantage wave aims to scale up and expand the business operations to capture profits by exploiting the fast-growing business

In this phase, the business is considered more than viable and success hinges on the team’s ability to turn revenue into profitability. The team shifts the focus from entrepreneurship and innovation to business management, operational excellence, and sustained RD development. In addition, the organizational focus shifts from focusing on the product alignment with the initial business idea to expanding the offering into a portfolio developed to address the growing or changing customer needs.

The management is focused on the operations as it aims to establish the right business and profit model to repeatedly deliver to the customer needs.

The team leader is a builder who can deliver the financial numbers in alignment with the original business story. They accomplish that by setting up a scalable organization with the capacity to build business processes that allow repeated success in the market.

The organization grows rapidly in size and capabilities, including but not limited to a variety of operational, finance, and human resource management. This is often associated with severe growing pains and a challenge to maintain a thriving company culture.

At this point in the business lifecycle, revenue growth remains high while operational costs are growing slower due to the benefits of scale. As a result, the business profitability is growing and should have a low but growing operating cash flow. The (re)investment needs remain high; therefore, there is still no surplus cash available for the shareholder. Since there is a positive cash flow, there’s room for small debt financing as long as it doesn’t waste the money needed for reinvestment. So, equity financing is still the primary choice.

Phase 4 – Exploitation of Sustained Mature Growth Platform

The fourth phase of the transient advantage wave focuses on leveraging a solidified position in the market and associated profitability to transform the business team into a business platform.

In this phase, the business has a double focus: internal and external. The external focus remains entirely on addressing the customer needs by continuously updating and refining the portfolio offering with new and better products. Since the customer knows and trusts your business and products, their willingness to pay is at its highest point. The internal focus is new to the business team. It addresses the need to find appropriate purposes for the increasing cash surplus generated from operations by transforming into a business platform.

Due to the double needs, two leaders are now required: a platform leader and a business leader.

The management is focused on the operations as it aims to maximize the market opportunity.

The business leader is an opportunist who keeps the business story in check with the numbers and quickly captures any new opportunities that extend from the existing business and may include M&A. Furthermore, the business leader aids the transformation from a business team focused on generating profits to a business platform that can support different business teams with capabilities and financing.

The platform leader focuses on repurposing the surplus cash to establish a business platform to fund new waves of transient advantage.

The organization continues to grow in size and diversity in capabilities. By now, the business should have several idiosyncratic internal processes that are inimitable competitive advantages. “The way we work” is a crucial differentiating feature within the broader market. The unique, idiosyncratic qualities are fundamental to the transformation from a business team into a business platform

At this point in the business cycle, revenue growth is slowing but still above the market average. However, thanks to a finetuned operating engine, profitability and operating cash flow are high and growing. At the same time, the reinvestment needs are less. Thus, there is a surplus of cash. The cash surplus can be used to transform the business team into a business platform or return to the shareholder. In the case of the former, the business platform can invest surplus cash in beginning a new wave of transient advantage. Debt financing is generally cheaper than equity financing, and there’s more than sufficient cash to pay interest on debt, so business operations should be financed primarily by debt.

Phase 5 – Reconfiguration of Efficient Mature Stable Platform

In the fifth phase of the transient advantage wave, the business platform reconfigures the organization to allocate internal resources where they are most needed.

In this phase, the business is no longer growing. Furthermore, there is increasing tough competition trying to steal your market share. Thus, it is important to reconfigure the organization to make resources available for new business opportunities. The platform and business leaders continue to manage the internal and external focus, respectively.

The management is focused on finance as it aims to maximize the profit & loss statement.

The platform leader focuses on absorbing the idiosyncratic capabilities and repurposing the surplus cash to establish a business platform that will fund new waves of transient advantage.

The business leader is a defender who adjusts the business story to reflect the mature nature of the business. They shift focus from finding new markets to defending existing market share, which is necessary to ensure further profits are extracted from the business and transferred to the platform.

The organization shifts its focus from sustaining development to efficiency optimizations where the same is done with increasingly fewer resources. The organization reduces headcount and outsources capabilities that are not essential to the business’s survival. The RD developer is replaced with an RD optimizer focusing on reducing product costs.

An essential part of reconfiguration is to ensure that, while resource allocation is dynamic, the organizational platform structure and support provide a stable environment for people to thrive. If people fear that reconfiguration equates to job insecurity, there may be significant organizational resistance to free up resources.

At this point in the business cycle, revenues are stable but not growing beyond the market average. Due to increased competition, profitability is under pressure. It requires the organization to become more efficient to ensure positive operational cashflows. At the same time, (re)investment needs are low, so there’s surplus cash that should, in its entirety, either be returned to the shareholder or reinvested via the business platform. There is no need to risk equity to finance the continued operation of the business, so debt financing is preferred.

Phase 6 – Disengagement from Efficient Declining Assets

The sixth and final phase of the transient advantage wave focuses on healthy disengagement from the business by either liquidating or absorbing the assets into the platform.

In this phase, the business has run its course and is no longer of value to the shareholders or the business platform. Healthy disengagement is as vital as continuous innovation.

The management is focused on finance as it aims to maximize the balance sheet statement.

The platform leader focuses on absorbing the remaining valuable assets and capabilities and repurposing the surplus cash to fund new waves of transient advantage.

The business leader is a liquidator who dismantles the business and sells the assets of no further use to the business platform. They can maximize the cash received for the sold-off assets by ensuring timely disposal. They can avoid bad press and, if possible, reduce the business operations so that the platform is well-compensated to maintain legacy support.

The organization is dismantled with only critical roles remaining if there’s a need to maintain legacy support. People transfer within the business platform into new positions. In the end, the business is discontinued entirely.

At this point in the business cycle, revenue continues to decline until the business is discontinued. Due to the reducing revenues and increased competition, profitability declines faster than revenue. Thus, there is a declining operating cash flow. There are no reinvestment needs, and as assets are converted into cash, there’s a negative reinvestment rate. The surplus cash is either transferred to the business platform or returned to the shareholder. Any outstanding debt is retired in an orderly manner.

Table1: Six Phases of Transient Competitive Advantage

Phase 1Phase 2Phase 3Phase 4Phase 5Phase 6
McGrath's “Transient Wave”LaunchRamp UpExploitExploitReconfigureDisengage
Damodaran's “Corporate Lifecycle”StartupYoung GrowthHigh GrowthMature GrowthMature StableDecline
Helmer's "7 Powers"Counter-positioning
Cornered Resource
Scale Economies
Network Effects
Switching Costs
Scale Economies
Network Effects
Switching Costs
Christensen's “Innovation Cycle”DisruptiveDisruptiveSustainingSustainingEfficiencyEfficiency
Ulrich's “MOE Organization”TeamTeamTeamPlatformPlatformAssets
Business LeaderVisionaryPragmatistBuilderOpportunistDefenderLiquidator
Business CapabilitiesEntrepreneur
RD Innovator
+ Marketing
+ Sales
+ Supply chain
- Entrepreneur
- RD innovator
+ business manager
+ RD developer
+ Op manager
+ Finance manager
+ M&A - RD developer
+ RD optimizer
- Marketing
- Sales
- Supply chain
- RD Optimizer
Business PriorityBusiness ideaCreate revenue streamAchieve profitabilityMaximize profitabilityDefend market positionScale down business
Management FocusVision: Understand the job to be done
Vision: Find the right customers
Operation: Build the business operations
Operation: Maximize the market opportunityFinance: Manage the P&LFinance: Manage the balance sheet
Product focusDevelop productScale productExpand portfolioMaintain portfolioReduce portfolioLiquidate assets
KPI PriorityProductProductCustomerCustomerPlatform Platform
Revenue growthNoneExponential from a low baseHighAbove market but slowingStagnating to market averageDeclining
Operating cash flowNegative BreakevenLow but growingHigh and still growingHigh but stagnatingDeclining
Reinvestment needsHighHighHighAverageLowNegative
ProfitabilityNegativeBreakevenGrowingHigh and growingHigh Declining
FinancingEquityEquityEquity and low debtEquity but mostly debtDebtRetiring debt

Business Theory of Disruptive Innovation

The theory of disruptive innovation, introduced by Joseph L. Bower and Clayton M. Christensen in 1995 , deals with the question how an organization can drive growth through innovation. The theory of disruptive innovation builds on the jobs to be done and aims to help organizations focus on innovation-driven growth

While the theory extends much further than described in this post, I find it particularly helpful when evaluating new opportunities. Although the theory will help you understand how to appropriately allocate the organization’s resources, I feel the topic fits the Opportunity question as outlined in the Strategic Blueprint Structure better.

innovation in business
Innovation in business

Consumption vs Non-Consumption

A first important topic in the theory of disruption of innovation is recognizing there are different type of consumers and non-consumers. Whereas traditional businesses think of a market as the amount of people buying a specific product or service, it’s more useful to think of your market as everyone who needs to get a certain job done. From that perspective, you can separate four types of people

  • Consumers: people who are using your product or service to get the job done
  • Non-consumers (A): people who are not able to use your product or service, but would like to if they had the means to acquire or hire
  • Non-consumers (B): people who refuse to use your product or service because it does not meet their needs or desires
  • Non-consumers (C): people who have no idea your product or service exists and are currently using a different product to get the job done

Note that while we recognize a distinct difference between the groups, they do share certain characteristics. For example, the group of consumers, non-consumers (A), and non-consumers (B) have in common that they all know about your product. They are either a customer already, or feel your offer either over-serves or under-serves them. Similarly, the group of all non-consumers share the fact they’re not using your offer, however they all have a different reason.

The theory of disruptive innovation states that organizations benefit most when they compete against non-consumption. This seems logical as the group of non-consumers would typically be much larger than the group of consumers. However, in day-to-day operations we often get caught up in trying to sell more or newer to those people who are already buying our solutions.

The terms under- and over-served will return later in the post but for clarity purposes let’s define them as follows:

Under-served customers are people for whom the product offer does not meet the desired performance while over-served customers are people for whom the product provides too much performance. Product or service performance, in this context, is measured against the set of specific attributes and values a customer is willing to pay for. You can read more about this topic here: Attributes and Values: Business Strategy Core.

Sustaining and Efficiency Innovation

In his theory of disruptive innovation, Clayton Christensen distinguishes three type of innovation in business: sustaining, efficiency and disruptive innovation. The fundamental difference between both types of innovation is easily understood. Simply put, sustaining innovation is making a good product better while efficiency innovation is making the same product using fewer resources.

Product Development Sustaining InnovationEfficiency InnovationDisruptive Innovation
Capital Required+++++++++
Free Cash Flow++++
Jobs Created+++++++++

The key difference between the different types of innovation lies in the capital requirements and its uses, and its impact on the free cash flow.

Product Development (“Empowering Innovation”)

When a new product is developed for a certain job to be done, it demands a lot of capital. In fact, often starting the business requires much more capital than is available to the founders of the business. That’s why we would get a bank loan or venture capital firms to invest in our business. Both the bank and the investor help us obtain the capital required to start the business. Christensen refers to this phase as “empowering innovation” because it creates jobs for people who build, distribute, sell and service these products.

Sustaining Innovation

Once a product is in the market and establishes itself as a profitable business, a big driver to engage in sustaining innovation is the rivalry that takes place in the marketplace. Different firms will try and compete for the same customers by improving their offer vis-à-vis your offer. While significant re-investment in the business is of course necessary to survive in the marketplace, the amount of capital necessary for the re-investment is not that large. You can usually rely on the same people who made the product to also improve its attributes and performance. You can often use the same facilities and factories although maintenance and upgrading may be needed. Your inventories will not drastically expand either since people who buy the new product are not also buying the old product.

Efficiency Innovation

At a certain point, the sustaining innovation will reach a point of diminishing returns. The product improvements are not significant enough to convince customer to buy the new product. This will hamper the revenue growth potential and it is at this moment the financial folks will step in. The focus shifts from re-investing to improve the product, to re-investing to improve the gross, operating and net margins. The idea is that by improving the margins the business generates more free cash flow, which then can be reinvested in new projects or opportunities. The financial folks have plenty of efficiency measures at their disposal to determine what’s the best way to improve margins, but usually it boils down to either outsourcing operations to a business with lower operating costs.

“Efficiency innovations pay off really quickly. Empowering innovations take five or more years to pay off. So, they invest in efficiency innovations, and more capital comes out.”

Clayton Christensen, 2013 (source)

Clayton Christensen is very specific in his criticism of efficiency innovation. While jokingly referring to the “invention of the spreadsheet” as the root cause of the demise of economies, fundamentally the criticism is that companies get used to the short-term profits of efficiency innovation. In addition, instead of using those profits to invest in innovation businesses choose to re-invest further in the efficiency optimization practices in order to realize even more profit. The efficiency cycle repeats itself, until there’s no more efficiency to squeeze.

Disruptive Innovation

Disruptive innovation is similar to empowering innovation in the sense that disruptive innovation also ends with a new product or service offered on the market. However, the disruptive innovation theory distinguishes two types of innovation as particularly powerful: low-end disruptive innovation and new market disruptive innovation.

Low-End Disruptive Innovation

low-end disruptive innovation
Low-end disruptive innovation

Low-end disruptive innovation begins with offering low-cost products to over-served customers using a lower cost business model than established players. As the product improves over time through sustaining innovation, the product will eventually over-serve the initial customers. However, you’ll find that up-market there are now under-served customers with greater performance demands you can serve with the lower-cost business model.

A couple of clarifications are necessary.

The term “performance” refers to the specific offering level of the set of attributes or values offered by your product or service. The performance evaluation of a product is entirely dependent on the customer needs and desires. The better the value offered by your product matches the performance demanded from the customer, the less likely the customer will switch to a different solution.

The term “over-served” indicates that the performance demanded by the customer is lower than the value that is offered by the product. Thus, the customer is paying for things they don’t really need, and the customer may prefer a lower quality but cheaper solution.

Generally, fueled by rivalry and associated drive for sustaining innovation, the performance offered by the market increases at a much faster pace than the performance demands by the customer base. This causes companies to look for market segments that are willing to pay more for higher product performance. This is called going “up-market”.

Not only are the customers in this segment willing to pay more, generally the profit margins are also higher in the up-market segments. So, companies find it natural to dispose of their lower-margin business and prefer the higher-margin new customers. However, the more up-market you go, the more you find yourself catering to a niche market with niche demands.

The disruption takes place every time the low-cost business model enters a new market. The disrupting company is able to take on the incumbents thanks to the cost advantages inherent to its low-cost business model. It can repeat this every time it moves up-market as incumbents are usually slow to adapt to new business models.

Notice how the low-end disruption model appears cyclical in nature. As the low-cost business models improve the product performance and moves up-market it will eventually over-served certain customers. Those over-served customers will eventually be looking for cheaper alternatives. New low-cost disruptive businesses can then take their piece of the market.

New Market Disruptive Innovation

new market disruptive innovation
New market disruptive innovation

New market disruptive innovation focuses on under-served or non-served customers (non-consumption). Typically, this requires a low-cost business model combined with a new value chain as non-consumption performance demands are different from existing customers.

The term “performance” refers to the specific offering level of the set of attributes or values offered by your product or service. The performance evaluation of a product is entirely dependent on the customer needs and desires. The better the value offered by your product matches the performance demanded from the customer, the less likely the customer will switch to a different solution.

The term “under-served” indicates that the performance demanded by the customer is higher than the value that is offered by the product.

Often, this under-served market is interpreted as a low-end market segment with cheap customers. This is wrong. The customers in this segment are misunderstood as cheap because they are not willing to pay for the attributes offered by the company, regardless how low the price is. Their willingness to pay is low because they don’t value those specific attributes. They value different attributes; attributes which the company isn’t offering.

For an existing business to venture in new market disruption, it’s often required to establish an entirely new team separate from the current team. Everything is different: the customers, their needs, the profit-formula, the value and supply chain, the volumes, and so on.