Research & Thought Leadership

  • Louis Strauss

3 types of innovation to guide your investments

In order to transform your organisation into a digitally focused company with a clear future, you must adopt a new investment management mindset and framework (which we discuss in our new book, Chasing Digital).

Before you can do that, however, it’s important to understand the different types of innovation. After all, innovation drives investment, and investment drives growth.

Author Clayton Christensen identities three types of innovation you can use to describe the nature of an investment.

Although this theory of innovation is now 20 years old, it is becoming even more relevant as digital becomes increasingly central to your business strategy.

Christensen describes the three types of innovation as:

  1. Disruptive innovation,

  2. Sustaining innovation, and

  3. Efficiency-based innovation.

Below, we explain the different characteristics of each innovation type.

Disruptive innovation

Disruptive innovation converts a ‘high-end’ product, such as a mainframe computer in the 1970s or an automobile in the 1930s, into something more affordable and accessible.

It’s desirable in capital-rich economies as it generates economic growth and creates job opportunities in exchange for (often risky) investments.

Disruptive innovation tends to start with a poorly distributed and expensive product. Think of the supercomputer in the 1970s, a machine so unwieldy that the CEO of Digital Equipment Corporation, Ken Olson, infamously quipped, ‘There is no reason anyone would want a computer in their home.’

Over time, innovations in miniaturisation – along with the effects of Moore’s Law, halving the cost of computing power every 18 months – put personal computers into everyone’s hands. The outcome is Apple’s 2008 iPhone, which packed as much power as a 1985 Cray-2 supercomputer.

Because powerful computing products are now available to the masses rather than just a select few, they create new jobs beyond just service and support, such as app developers, and new businesses, which use the iPhone to connect with customers.

This is just one example of how disruptive innovation can unlock huge amounts of value not only at the company level, but also on a global scale. For these innovations to flourish, however, they need capital.

Sustaining innovation

In contrast to disruptive innovation, sustaining innovation is the process of fine-tuning your company’s business by making a good product or service better. These types of innovations are very important for maintaining or increasing margins relative to the competition.

Sustaining innovations do not create jobs, as companies fight for customers in a mature market, which in return creates little net growth. This is a result of the fact that if you buy the latest generation of a product or service, you won’t then buy the previous version that isn’t as good. There is no new market created.

As another example, take car manufacturers. Each year they update their range, introducing new features and benefits to address increasing competition and expectations from consumers.

Or, alternatively, in the finance industry, new consumer debt products provide flexibility, ease of use, loyalty point schemes or greater affordability in an effort to gain market share and address increasing expectations.

These sustaining innovations generate new products to sell, but not new buyers or new economies.

Efficiency innovation

Lastly, a speciality of Japan and China is efficiency innovation, which is doing more with less. Efficiency innovations increase free cash flow but cut jobs, often dramatically.

Toyota pioneered efficiency-based innovation by continuously seeking to improve its processes. In doing so, it created just-in-time manufacturing, which is the precursor to the lean manufacturing model employed by thousands, if not millions, of companies across the world.

Use these innovation types as guiding principles

Remember, innovation drives investment, and investment drives growth. So you need a solid understanding of innovation itself – what it is, and what it sets out to achieve strategically.

The three types of innovation identified above – efficiency-based, sustaining and disruptive innovation – should be used as guiding principles for your investment strategy. To learn more, check out Chasing Digital.

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