Saturday, 17 December 2016

Disruptive Innovation - Part 1 - Why it Succeeds?, How it Spreads?, S-Curve; Transport Infrastructures to Year 2000;

Blog Content - Who am I?    Category:  Self-Indulgence 
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Disruptive Innovation (DI) is a process by which a product or service takes root initially in simple applications at the bottom end of a market and then relentlessly moves up market, eventually displacing established competitors.

DI is ruthless and spares nobody: Fortune 500 lists the most successful companies in the world - of Fortune 500 firms in 1955 vs. 2015 - only 12% remain, thanks to destructive innovation.

How can DI destroy powerful, established companies? The answer really is in the way companies work tirelessly to improve and innovate existing products to increase their market share. A company with an established product range continues to improve the top-end of its market (sustaining innovation) chasing higher margins and profits. Funnily, the bottom-end  -  representing the bigger share of the market - is often left unattended.  This allows a new entrant (the disruptor) to take a foot-hold in the low margin part of the market. The successful entry of the disruptor is often made possible by some technology driven change - this process is accelerating due to the exponential growth in technological advances

Many firms now practice what is called self-disruptive innovation to ensure that new entrants face tough competition and do not grab market share from them by default. For example, even though it affects their current product range, GM and other motor companies are developing electric cars to provide tough competition to Tesla and other new entrants.

One also has to appreciate that the task of a disruptor is never easy.  A disruptor starts with little capital, frequently borrowed from friends and family; they may not be business savvy, the idea may not gain momentum and a very large number, ~ 90% of start-ups fail before making any impact (the valley of death - where start-ups go to die).  The figure below demonstrates how a disruptor might develop in time:

I have chosen to discuss the way transport has changed over the past couple of centuries as transport, energy and communications have been the most important elements in the development of the industrial revolution and still play a pivotal role in underpinning our civilization. Innovation in new energy sources from wood to coal to oil then gas is reflected in the form of disruption in transport by canals, steam, cars and planes. Of course, the technology environment also must be correct - e.g., for cars to replace steam engines, the availability of the internal combustion engine was a pre-requisite etc. 
It is interesting to note that technological innovation, transport system infrastructure and economic development are closely related.  Technological innovations create opportunities for the development of cheaper and faster modes of transport and new economic sectors leading to increased prosperity.  This is nicely summarized in the slide adapted from :
The following two slides show S-curve analysis of energy and transport infrastructures. I shall discuss S-curve in detail later in this blog, but feel that it is important to show these slides to demonstrate how new transport infrastructures grew and declined in consonance with new energy sources.   In the slides, the wavy lines are actual data, smooth lines are S-wave description of the data.  Figures are adapted from The Rise and Fall of Infrastructures by Arnulf Grubler (1990). 

An interesting observation from the first slide is that the demand of wood and coal dwindled not because the world ran out of wood and coal but because other sources of energy became available - technology based on the new sources was more advanced and efficient.  Oil as an energy source is approaching its peak demand and will be replaced in the near future by solar, wind and other renewable energy sources.

The S-curve:  Also called the Sigmoid (Sigma is the Greek letter for English S).  Pierre Verhulst (1804 - 1849) studied the population growth in Belgium and found that sigmoid curve correctly described the growth pattern.  Small populations grow slowly at first but then the growth increases exponentially (growth rate is proportional to the population size) as the resources are much greater than the demand.  This continues until the population reaches a level that stretches available resources - then the growth slows down eventually reaching a trickle.  This is what we call limits to growth. 
In biology, two species might compete for limited resources (food supply) and a competitive pattern emerges. The end result is that one species wins and replaces the other species completely - the dominance is described by a model developed by Volterra and Lotka in the 1920s.      

In transport, it is not the resource scarcity but the destructive innovation by new technology that limits the growth of the incumbent.  When a technology proves to be a better option - determined by its technological, economic and social credentials - competition will ensue resulting in a process by which the new technology replaces the old. (Fisher-Pry Model 1971 - a model similar to Volterra and Lotka model). They assumed:
1.  The process is competitive (try to win a bigger market share) aiming for the substitution of one method of satisfying a need by another.
2.  Once the new technology entry reaches a tipping-point - generally a market share of a few percent, it will proceed to complete take-over
3.  The fractional rate of substitution (fractional market share F) of the new technology is proportional to the remaining market share (1 - F) and follows an exponential trajectory.  
The next slide (adapted from Fisher and Pry's 1971 paper) shows the S-curve evolution of the substitution of an old technology by a new one in 17 different technology areas. Dimensionless normalized time is used to plot the two graphs. Also notice the y-axis log scale for the figure on the left. 

It is amazing that the Fisher Pry model works so well for a large number of disparate technologies. In the next slide, I summarize the equations involved in the model - 
The following slide is more mathematical and may be skipped without loss of continuity.

The result is an s-curve, also called the logistic function. This describes the rate at which disruptive innovation (DI) replaces an incumbent.  From the rate and early stage adoption, it is possible to predict the maximum market that the new technology will reach (the saturation value). 

We shall first look at examples from the transport sector and then muse how the substitution process actually comes about.  Analysis by Fisher and Pry shows  (see slide above) that DI in 17 technologies in very different sectors may be described very well by their model curve - what is actually happening on the ground is something we would like to understand.  

Some Historical Notes:  Until the 18th century, the transport infrastructure in the UK was poor - particularly travel and transportation of goods was very expensive and unsafe.  Few roads were suitable for wheeled vehicles - in fact in the early stages,  industrial revolution suffered due to a lack of proper transport infrastructure.  Canals and inland waterways were constructed to connect industrial centers to transport coal, wood and manufactured goods.  From the mid 19th century railways started to replace canals which reached a peak around 1890.  To replace canals, railways had to develop its own infrastructure of railroads - this was time consuming and very expensive.

Railways: Starting in 1825, the UK was the first country to develop the railroad infrastructure.  The rapid growth in railways was possible due to the simultaneous development in technology (steam engine), energy source (coal) and market forces (industrial revolution).  Other countries were not far behind - I shall discuss mainly the analysis of UK and USA railway infrastructures using the logistic curve (Fisher Pry model).
The following two slides show this analysis:

USA has the world's largest rail network - by 1930 when rail networks length was near saturation, USA had 480,000 km network. The global network was 1.256 million km. Interesting to note that time for the railways infrastructure to grow from 10% to 90% of its final saturation value is 57 years for both UK and USA - in fact it is roughly the same for most countries (Russia is an exception and expanded in ~40 years).  Also most countries reached a saturation value in about 1930.
Road Transport:  Automobiles:  Railways had to develop its own infrastructure - in contrast, cars had a vast network of roads, albeit not very good quality, in place - developed for horse driven vehicles.  DI by automobiles happened in two phases. Firstly cars replaced horses as the main means of local transport without seriously affecting the railways.   Starting in about 1910, in the UK and other developed countries, cars rapidly replaced horses with almost total substitution by 1930 (see slide below).  In the second phase of DI, starting after WWII cars substituted railways for long distance travel and transport of cargo etc.  The substitution process was slower than in the first phase and completed around 1980. In the slides below, the two phases may be seen on the global car ownership data.

Road infrastructure expanded in all countries in response to expansion of automobiles.  The first slide shows how the USA unpaved (rural) and paved road infrastructure grew in the past 100 years or so.  The next slide shows similar dates for the UK. (Road length in thousands of miles)

Understanding the origin of the S-Curve: Substitution of older transport infrastructures like canals and horses by railways and roads follows a symmetric S-curve with a takeover time - time for adoption from 10% to 90% of the social system - and is rather similar in different regions of the world. 
Businesses flourish by innovating new products to satisfy human needs of faster, efficient, comfortable, greater capability in range and reduced costs; but they operate in a complex environment that is a mixture of social, economic, and technological activity. A disruptive technology increases its market share by providing a superior product but still has to be accepted by members of the society - the adoption of the new technology follows an evolutionary pattern characterized by the S-curve.  Members of a social system have to make a decision about adopting or rejecting an innovation - they need information that has to diffuse through to them.  The quality and the rate of diffusion of the information determine the rate of adoption.    

Empirically, the rate of adoption is quantitatively given by the slope of the S-curve at any point and  may be represented as in the slide:

Members of a social system may have vastly different expectations, value systems, communication networks etc., but they are sharing information and learning experience through interaction with other members in the society. This sets up a diffusion process that is more efficient for some members but may be not so for others.  The diffusion of knowledge and experience about the innovation from the early adopters to the general population has a time spread and contributes to the time evolution of the S-curve. 

The next stage is the use of the knowledge by members to arrive at the decision to adopt the innovation.  The relative advantage of an innovation, as perceived by members of a social system, is positively related to its rate of adoption. Rodgers (1995) has summarized the factors that affect adoption of innovations and I reproduce the relevant information from his book

DI  in transport (1830 - 2000):  Until the arrival of the steam engine and railways, horses and canals were the primary means of transport for people and goods. This was slow, uncomfortable and dangerous.  Railways infrastructure, which had to start from scratch in about 1830, increased along an S-curve trajectory  - the network length reaching over 1.3 million km (0.8 million miles) worldwide, saturating at the end of the 1930s. Railways permitted long distance travel at much higher speeds in conditions of relative comfort, and safety and was readily adopted globally.
Railways had a catastrophic impact on the quality of roads in the 19th century.  Horse driven transport could not compete with railways; in England and Wales the number of turnpike trusts (private enterprises for maintaining and constructing long distance principal road network) fell from 3800 in 1830 to 20 in 1886!   

Cars used an extensive road structure, although not of great quality, which were developed for horse drawn vehicles. Initially cars replaced horses in providing transport links to and from railways and transporting goods and services in rural and urban areas.  The adoption of cars in their complementary role to railways was rather rapid  - takeover time of ~12 years in the USA. Horses disappeared as significant means of transport by 1930.
A second phase of DI by car happened in the 1930s when closed body structures permitted long distance travel.  Cars started to compete with railways as the main means of moving passengers and goods. Cars were also more convenient for personal transport, short journeys and were responsible for a decline in railway infrastructure.

Many technological innovations have occurred in automobiles during the 20th century - automatic transmission (1930s), power steering (1951), air conditioning (1953), disc brakes(~1960), radial tyres (1968), electronic ignition(1972) and their adoption follows a standard S-curve evolutionary trajectory (S.T. Jutila and J.M. Jutila 1986). 

Final Word:  In this first part, I have discussed DI in transport with case study of railways and automobiles.  This brings us to the end of the 20th century.  I have deliberately missed the impact of air transport from our discussion as this would have made the blog too complex.  
In the second part, I shall look at the future of transport up to about 2050.  The disruptive innovation for surface transport of first the introduction of electric vehicles (EV) progressing to the adoption of autonomous vehicles (AV) is inevitable as all the hallmarks for a DI are present in the transport system. The current system suffers from congestion, noise, pollution, inefficiency of use of infrastructure, safety and much more. with the inexorable increase in urban populations through out the world, a new paradigm in personal transport and transport in general is inevitable - conditions are just right for a DI in surface transport
In comparison to the 19th and 20th centuries, the diffusion process is so much faster now due to efficient communication channels in our society.  This will make DI much more rapid and it will be interesting to see how private enterprise deals with the new situation.

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