Disruptive ideas usually don’t see light of day at large companies. And when they do, it’s not for long.

This is because traditional financial metrics such as NPV, IRR and RoNA are used as measures of success. In addition, the allocation of capital for new ideas hinges on business cases that ask us to forecast indicators such as the target market, the market size, the payback period and aforementioned financial metrics - all factors that can’t be reliably predicted when it comes to disruptive innovation which is inherently uncertain and chaotic.

In the odd case that capital is allocated to a potentially disruptive idea, it’s usually pulled prematurely because the financial metrics or assumptions that made up the crux of our business case were faulty - which is to be expected for almost any truly disruptive idea because if you’re reliably estimating what every variable looks like from day one, you’re either a prophet, have a crystal ball or are just pursuing incremental innovation, the opportunities for which are much more visible and obvious, so too the underlying assumptions.

So what’s the alternative to facilitating disruptive innovation?

There are a number of different approaches to corporate innovation programs, including:

• Creating an independent entity with its own processes, budget and values
• Investing in or partnering with startups
• Big bang transformation (probably at a risk to the core business)
• Creating parallel processes to support disruptive innovation

The latter is the focus of this post and is representative of an alternative investment pathway for disruptive ideas at large companies.

Hold up! What’s a disruptive idea?

First up, we need to have a process for defining whether an idea is disruptive, mere incremental innovation or somewhere in between.

So, a quick refresher on McKinsey’s three horizons (or types) of innovation:

Disruptive innovation falls into the Horizon 3 bucket and was characterised by Mr. disruption theory himself, Clayton Christensen, as:

• Not being good enough for mainstream consumption
• Commercialised in small or insignificant markets
• Promising small margins, not high profits
• Being simpler and cheaper

Again, it’s clear to appreciate why large companies don’t support disruptive ideas in their infancy.

If a listed company made $1B last year and analysts are forecasting 5% growth then it needs to find an additional $50M this year or suffer a decline in share price and value.

Finding an extra $50M in small markets with products that aren’t yet good enough for the mainstream is probably not the best place to find the extra coin.

Airbnb might be a US$30B company today, but they made $200 a week in their first year. They struggled so much that they came up with their own line of topical cereal simply to pay their credit card bills.

These are the negative attributes of disruptive innovations in their infancy that prevent large companies from taking an interest until, oftentimes, it’s too late (hello Blockbuster...or, erm, goodbye I guess?).

So what other factors might define disruptive innovation that we could use to determine which investment pathway to funnel an idea into - a traditional business case or our alternative?

The disruptive innovation litmus test, first put forward in Christensen’s The Innovator’s Dilemma, proposes the following solution for new market or low-end disruptive innovations.

New Market Disruption (innovation that creates a new market, eg. iPad)

• Is there a large population of people who historically have not had the money, equipment, or skill to do this thing for themselves, and as a result have gone without it altogether or have needed to pay someone with more expertise to do it for them?• To use the product or service, do customers need to go to an inconvenient, centralized location?

Low-End Disruption (innovation is better or cheaper than what came before it, eg. Netflix)

• Are there customers at the low-end of the market who would be happy to purchase a product with less (but good enough) performance if they could get it at a lower price; and

• Can we create a business model that enables to earn attractive profits at the discount prices required to win the business of the over-served customers at the low end? Once an innovation passes the new market or low-end disruption test, there is still a third critical question to answer affirmatively;

• Is the innovation disruptive to all of the significant incumbent firms in the industry? If it appears to be sustaining to one or more significant players in the industry, then the odds will be stacked in that firm’s favor, and the entrant is unlikely to win.

The typical horizon for low-end disruptive innovations, Source: Clayton Christensen

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