Why incumbents struggle with change 

 

Kodak provides us with a useful case study of why dealing with technological transformations is so difficult for incumbents.  In the world of conventional cameras, Kodak dominated the film business.  More importantly, Kodak did something that lots of other incumbents do as well – it used its laboratories to develop the technology of the future.  Kodak actually developed the first megapixel digital camera sensor in 1975. But, then it did what most dominant incumbents do – instead of seizing the opportunity to dominate the nascent digital photography industry, it saw that industry as a threat to its legacy film business.  At the time, Kodak’s film business was still successful and growing, albeit slowly. Going digital would have meant spending a lot of money developing new technologies that ultimately were just going to take market share away from Kodak’s own film products. Spending money to cannibalize existing sales seemed neither profitable in the short run nor likely to please stockholders.  It is a decision repeated again and again by companies leading industries facing what, at the time, feel like very nascent and incomplete efforts to forge a new way.

 

By choosing to continue to bet on the business it already dominated over the infant technology its labs had developed, Kodak just did what most incumbents do.  Even if it recognized that it was at risk of allowing others to dominate digital photography, it saw that business as a niche market of the larger photography business.   By the time Kodak realized the mistake it had made, it was too late. The company was not alone; a number of other historically successful companies, including Agfa, Contax, Minolta, and Polaroid, also disappeared with the rise of digital imaging.

 

The shift from film to digital was more than just a transition to a new way of doing the same thing.  The key insight that Kodak missed was that going digital opened the door to doing things with photos that film simply didn’t enable – it allowed them to be shared instantly and across digital networks.  Going digital also allowed photography to migrate to new devices like cell phones that greatly expanded the definition of a camera.  Soon the same capabilities followed for video.  Thus Kodak failed to understand that instead of eating into a photography market of static size, digital would drastically expand the overall market. 

 

The inability to see the opportunity represented by change is certainly not limited to Kodak.   It is something we see over and over again.  A very recent example is the pattern of growth of the car sharing service “Uber.”  Yes, Uber is taking market share away from taxis.  But, far more importantly, Uber is dramatically increasing the overall number of rides taken in taxis plus Uber combined in the cities where it operates.  Why?  Because it has leveraged digital technologies and a new business model to greatly enhance the overall ride for hire experience. 

 

In energy, we are witnessing the same experience.  Big oil companies like BP, Shell and Chevron were early funders of and participants in the wind and solar businesses.  There was a long period of time when any of these giants could have acquired the entire wind or solar industry for a month’s free cash flow.  Compared to their legacy businesses, these upstarts looked very much like early digital photography did to Kodak – it was a business they thought they knew, thought would remain a niche market and thought they could wait to buy into because their legacy businesses continued to throw off so much cash.  Today, that picture looks very different.  Wind and solar are here to stay and continue to grow rapidly.  Big oil, on the other hand is suddenly going through all kinds of austerity measures, cutting back expenses and waking up to the reality that it can no longer afford to buy those once tiny upstart businesses they internally funded only a decade ago.

 

Kodak experienced what professor Clayton Christensen describes as the “innovator’s dilemma.”  As innovation management professor Christian Sandström notes, it might seem hard to imagine a company pouring millions into R&D yet failing to recognize the technology revolution their own research could spur. But it is very hard to get industry-leading firms to make large bets on new technologies when they can get larger near-term returns by continuing to do business as usual.

 

Sandström notes that the inclination to protect existing technologies and markets is reinforced when, at the critical time of adoption, the new technology is typically still both expensive and not fully developed. Exponential improvements and costs savings for successful new technologies, however, can happen very quickly.  “Timing such a shift is not an easy task, …but, failing to do so has often led to corporate extinction.”

 

Hewlett Packard was, in the 1990’s, a leader in light-emitting diodes (LEDs). An HP scientist developed the technology enabling red LEDs to become mainstays in automotive and traffic lighting.  The company fully understood the market for these early LED applications but saw the bigger market for general lighting as being still decades away. As a result, the LED group was de-emphasized and then was sold to Philips, which is now turning LEDs into a core component of its general lighting market (although it too is struggling at the hands of newer LED intervenors).

 

Many of the large European utilities have fared even worse.  As Germany aggressively developed its wind and solar industries, most of these utilities clung to their legacy coal, nuclear and gas generation businesses.  They failed to recognize that a buildup of the new energy technologies would drive down wholesale energy prices and make conventional baseload generation – built to operate on a 24 by 7 basis and amortized the same way – much less attractive when relegated to peak or standby capacity.  Today, a number of these utilities have taken many billion dollar writedowns of their legacy businesses and others are trying to spin off or sell these business as they struggle to now develop businesses that will grow in the new European energy paradigm.  But doing so today, when the Company’s stock is trading at a heavy discount and cash is suddenly scarce, is far far harder than it would have been to aggressively invest in these nascent businesses when a) they were cheap and b) their acquirors/investors were valuable and flush with cash. 

 

Obviously, the financial world and its focus on short-term earnings and growth compounds the difficulty of acting aggressively when no one else is.  This conspiracy of market forces and incumbent inertia is what gives those of us who form, guide and invest in entrepreneurial companies a significant opportunity to dominate new businesses in a way that seems completely disproportionate to our skills and capabilities when we first set out to do so.  But teaming with us, learning from us, and putting yourself in a position to move just a bit faster than the other legacy players is a big part of what separates survivors from dinosaurs.