Friday, October 7, 2011

Disruptive innovation, buy vs. build, the most pernicious lie in business, and how to know if you're fooling yourself

If a man has good corn or wood, or boards, or pigs, to sell, or can make better chairs or knives, crucibles or church organs, than anybody else, you will find a broad hard-beaten road to his house, though it be in the woods. 
—Ralph Waldo Emerson, big fat liar

No matter what the dictionary says, you can't describe a company as disruptive without giving weight to Christensen's description of innovation. It's perhaps overly simplistic to divide innovation into two categories--disruptive and sustaining--but the strikingly different characteristics of companies pursuing these strategies makes the partition a natural one.

Sustaining innovation means finding ways to do things better. Lowering the cost of manufacturing a widget by 10%, making a widget 20% more durable while only spending 10% more, reorganizing a department so ten people can do the work of twelve, creating an integrated supply chain to deliver goods to your stores in smaller quantities and less time. That sort of thing. Sustaining innovation often results in products that exceed customer needs at a given price point. The proliferating options in Microsoft Office show a sustaining innovation cycle that has exceeded most of the market's need.

Disruptive innovation means creating a product or service that is radically cheaper but much less functional (and this needs to appeal to a customer set that was previously underserved, so disruptive innovation often creates entirely new markets) and then using sustaining innovation to improve it until it meets mainstream customer needs (but is still radically cheaper.)

Before Google, there was targeted advertising. Very targeted. Hog Farmers Digest (now National Hog Farmer) was aimed at hog farmers. If you were a hog farmer, you read it; if you weren't, you didn't. It was a pretty effective buy: not a lot of wasted impressions. But creating an entire magazine for a very specific market is a difficult business proposition. The fixed cost of putting a book together limits how small its audience can be and so how targeted its ads can be.

Google's disruptive innovation was being able to create content for next to nothing. They can create a page that addresses a market segment as small as a single person for nominal marginal cost. Even though the content was lower quality than that it was competing with--the lack of human writers and editors means that any specific page is much less useful than a well-written and thought-out page would be--it turned out it was good enough. And because advertisers could be so specific in their buy, they could spend much less money. This opened up an entirely new market: advertisers that don't have multi-million dollar budgets.

Existing publishers could not compete: they could not lower their cost per page to anywhere near Google's. If they tried, they would lose quality and the loss of quality would mean losing their existing customers. This is the beauty of disruptive innovation: it is almost impossible for incumbents to respond. Disruptive innovations are disruptive because business logic precludes old-line companies from shrinking their business to address the disruptors.

It's incredibly difficult and expensive to challenge incumbents with nothing but a better product. Sustaining innovations are easy to copy and well-managed incumbents are always on the lookout for challengers and willing to learn from them. But when a disruptor comes along, they are trapped.


What kind of innovation are we peddling in adtech? Article after article calls our companies disruptive, but do we really fit the Christensen mold? A disruption scenario would look like this:
  • the existing industry would supply a product of higher quality/functionality than the majority of potential customers actually needs and at a very high price;
  • the disruptive companies would find a way to bring in a product of lower quality/functionality at a much lower price;
  • customers that did not need and could not afford the old product would emerge as customers of the disruptive product, allowing the new companies the wherewithal to quickly mature their technology until it was competitive in the old product's market.
Does this sound like ad tech to you? It doesn't to me. The current ad-world is not supplying services at a higher quality than its customers need and there seems to be advertising inventory at every price point. If you can't supply advertising at a radically lower price point to customers who were previously underserved at a quality level that the incumbents are not interested in touching, you aren't really in a position to be disruptive. Almost all of adtech now is sustaining innovation: building a better mousetrap.

We clearly have a better solution than what existed, no argument. But the big lie of business, the pernicious fallacy that has deluded countless entrepreneurs, is that if you build a better mousetrap the world will beat a path to your door. It doesn't work that way.


What is going on in adtech right now is clearly innovative. But because it's not disruptive in the Christensen sense, it means we're going to have to earn our money. We need to move fast to build scale.

There have been scores of M&A discussions in adtech this Summer and only a few have resulted in deals. One of the things I heard as an excuse over and over (from buyers, from sellers, from bankers, from founders, after a few drinks) is that the buyer said "we don't need to pay up for this, we could build it internally."

Build versus buy is an interesting discussion to have before you buy anything, especially something with the revenue multiple adtech VCs are looking for. Cold hard fact is, there's almost nothing out there in adtech that someone else couldn't build from scratch. The CTO would certainly tell the CEO that building would be cheaper than buying a company, and be right.

And yet, and yet. And yet the companies that are prowling for bargains still can't get advertising right. They clearly have a ton of tech talent in their core businesses, and the ability to hire more. They have the money to hire and manage and build adtech solutions. But they don't. Why not?

When I was at Omnicom, back in the 90s, investing in the early interactive agencies--clearly not disruptive businesses--the old-guard ad agencies that then made up the bulk of Omnicom's business talked big about building their own interactive units. But they never could. They also refused to pay the valuations the i-agencies commanded. They were on the sidelines while their clients hired hotshot young startups to build their websites, and some of the startups got pretty big in the process.

There were several reasons for this. Primarily, the old guard couldn't hire good people: no one who understood the web back then would go work for an agency whose primary business was making 30 second films for TV. Why would anyone who was any good go be a second-class citizen at a firm that was paying nothing but a salary and had no career path in interactive? Why wouldn't they go instead to Razorfish and get stock options and be a hero to their management everyday? They would, of course, and they did. And almost all the true stars of that era spent time in one of the independent agencies.

As then as now. Why would any competent adtech engineer go work for AOL or Yahoo or Twitter or any of the other big old companies where stock options issued today will in all probability never be worth anything? There are plenty of good jobs at exciting startups where there's the possibility of making actual money*. More importantly, why go to one of those big companies and be a second-class citizen, the "ad guy," when at a startup you're essential to their product?**

Companies can do very well at their core mission. But when their core mission is media or software or infrastructure or professional services, it's going to be really hard for them to get a foothold in the quickly changing adtech world. This never seems to be taken into account in build versus buy analyses: they can't build, and even if they could, they won't. And if they do, it will suck. Trust me, I've been there. And if you don't trust me, just take a look around.

But remember that the era of the independent i-agencies only lasted some six or seven years. At some point the number of people that could do the work more than competently was enough that even old-line agencies could hire them. At that point the i-agencies were like every other agency: they competed head-to-head with the old guard. Many of the biggest remained independent until acquired for great prices. But these were the ones who earned it. Unlike a disruptive business where nothing but guts, an innovative spirit and a huge dose of luck are necessary, competing head-to-head means competing: blood, sweat and tears.

We need to keep building, ignore the distractions and focus on winning clients, not just raising money, so that when it comes time to compete head-to-head, we will win. That's as it should be, of course, and I think many of our industry leaders have what it takes. But if you're starting an adtech company and you want to win, you have to know that you're in it for the long-term. It's a marathon, not a sprint, the cliche goes, and it's true.


Meh, you say. I'm disruptive, I am going to go viral, achieve imminent world domination and sell to Google for $5 billion in two years. Neumann's an idiot.

Maybe. But disruptive businesses have certain characteristics. Ask yourself these questions.

1. Am I creating a new market, bringing in a set of customers for whom there was previously no value proposition?

Disruptive businesses bring out a product or service that is so far off the industry price/quality line that customers who would never have used the industry's products start to. This gives the disruptor the foothold it needs to start improving quality until it threatens the incumbents. Google AdWords is an excellent example of this.

Who are the unserved markets in advertising? Are there any? I think there are, and I think that if you don't see any, you need to think about what advertising is more broadly.

2. What is price in my market?

If you're in ad-tech, what does price even mean to your end-customers (the advertisers***)? Is it just lower CPMs? There have always been low CPMs out there. Is it higher ROI? That's probably closer to the mark. The best answer I have heard is that it is lower risk: the ability to more accurately predict ROI.

You have to credibly answer this question and then be radically better along this dimension if you are disruptive. I think there are many answers here, and your answer will depend on your answer to question one, above.

3. What is quality in my market?

In disk drives (Christensen's first case study), this is an easy question: quality is how much data can be stored. The disruptors built lower-quality disk drives at lower prices, then used the march of progress to threaten the old-line disk makers. The old-line disk makers' customers wanted more storage, not less, so they did not see this market and could not address it with the existing customer bases. But key to the disruptors long-term value was the ability to improve quality quickly. If they could not, they would not have been able to displace the old guard.

What is quality in adtech? Conversion? Click-through? Pinpoint targeting? And if you know what quality is to your market, can you then improve quickly along that metric so you serve not only the new market you've created, but the giant market that already exists?

Quality. I've been thinking about this question for ten years and don't have a definitive answer. Do you?

If you do, if you think you really have a disruptive business model, call me, I'm looking to back people like you.

* If this is you, email me.
** Soldiers don't get promoted if they haven't seen battle. If you want a career path, always take the job in the middle of the action, even if it pays worse.
*** And are the advertisers really your customers? Why aren't the 'consumers'?


Anonymous said...

This is a really great piece. Thanks for sharing your thoughts.

Matt Straz said...

Jerry this is truly an amazing post. I can see why John Ebbert lead off with it today on AdExchanger. Wow.

I posted recently about how agencies do not make for good software / ad tech companies. Perhaps some similar themes though not as deep as your piece:

Scott Hoffman said...

Jerry - love the thinking on this - and you are so right - there are many, many, many, many, many "me 2" companies! Did you see the piece in Digiday? It is the manifestation of many companies thinking they are disruptive, selling the investment community that they are/will be, and most falling way short!

Yossi Barazani said...

I read it a few times!

We are building the first ad-free network, and I'd appreciate to get your perspective.

Thanks, Yossi Barazani

Nene Kalu said...

Jerry, you write very well and your post bring up many questions.

Concerning your actual argument, the underlying assumption is that disruptive businesses create value (more money, more useful products, new markets) for their respective industries.

Your post challenges the notion that adtech companies are truly disruptive. Instead, they are simply building fancier mousetraps and sustaining innovation, as you call it.

On the contrary, I think that adtech is full of disruptive technologies -- RTB, private exchanges, retargeting, data management, etc. How many new products must be introduced for you to consider the adtech industry disruptive? I guess I don't understand why sustaining innovation in the form of improving upon the technologies I've listed is somehow inferior or less valuable than disruption. You don't explain that in this post.

Nene Kalu said...

Excuse the typo, meant *brings up many questions.

Jerry Neumann said...


In this context 'disruptive' is what Christensen describes in his book. The book is required reading--at least the first 100 pages are--so I don't feel the need to completely recap it. If you'd rather not read it, Mark Suster has a great summary (

I'm not a great writer, so it may not have been as clear as I'd like, but I do try to explain what the difference is and why it matters.

Disruptive: incumbents can't compete on your terms.
Sustaining: incumbents will copy your innovation and compete with you directly.

Sustaining innovation is, by far, the bulk of innovation. But building a new business on sustaining innovation is a much harder, and longer-term challenge. That was my point, not that sustaining innovation is not useful: of course it is.


Nene Kalu said...

You are a great writer, I just instantly look for assumptions in any argument.

I will check out Suster's commentary.

I understand the difference between disruptive and sustaining more clearly now. Sustaining innovation is a much harder proposition than what? Disruption is pretty tough too -- or at least generating the disruptive idea is hard. And working long nights with a lean team is difficult still.

dherman76 said...

Jerry - as always, you nailed it.

Sachin said...

Great post Jerry. I am big Christensen fan and I have been thinking about what can be considered disruptive in the AdTech world for a while and love your thoughts. I think of quality as better ROI or more scale at the same ROI.

One area I feel needs more disruption (or maybe its sustaining innovation) is building on Google's disruption of opening up the market to advertisers with sub million dollar budgets - the SMB market. Darren recently blogged/ posted about SMB agencies serving successfully advertisers with $7500 budgets/month . Would you think of that as a sustaining innovation since it builds on Google's disruption, or a disruptive one?

Jerry Neumann said...

Sachin --

I think it's arguable whether Google is really serving the SMB market anymore. They might sell ads, but they don't help make them effective. If competing along this axis can become the primary mode of competing, then yes, I'd agree.


Jerry Neumann said...


Thanks. I don't think anyone's ever mistaken me for a good writer before.

Sustaining innovation is a much harder prospect in terms of standalone success, is what I meant, not that one of the other is more work. In that there are only 168 hours in a week and the typical entrepreneur works all of them--sustaining or disruptive--the concept of 'more' work doesn't even really make sense.

Sachin said...

Thank you for your perspective again!

Jonathan Wolf said...

I enjoyed this very much.
Along your lines, youtube was truly disruptive and so was adsense: both also meet your lower quality requirement to start with, and then have steadily improved.
I agree that most of adtech is about incremental improvements. There is a lot of hype about RTB, but fundamentally it is a next generation adserving technology removing paper IOs, and allowing easier purchasing of user-level segments.
I'm obviously a little biased, but I think an example of a disruptive business would be one that allows display to have the same performance as search.