Urlocker On Disruption

Disruption Investing Part II: A little goes a long way

Would you invest in a company with inferior and incompatible products, marginal customers and a strange business model?



Those are among the characteristics of BlackBerry maker Research in Motion back in early 1999 when its stock was trading at under $2 split-adjusted vs. a recent high of $85.

Spotting the patterns of disruptive competition can put investors ahead of the stock market because most investors are not looking for these patterns.

Let's look at another case in which we identified similar disruption patterns ahead of the market:

McDonald's vs. Starbucks, which we published in March 2007 based on anti-marketer Paul Paetz's ideas.

The results surprised me by showing a little disruption goes a long way in the stock market -- and delivers outsized returns faster than expected.

Read the full article published in The Financial Post (pdf)

Financial Post archive

This article is an excerpt from The Disruption Group's latest newsletter. Sign up for our newsletters here.

Disruption Investing: Picking the Next Apple, Not Next Vonage

I have been experimenting with a new approach to stock picking for much of the past two years and I thought I would share the results.

Using the Disruption ScoreCard (.xls file), which grades companies or projects according to how disruptive they are, I have been ranking companies.  Sometimes I publish the results here on this blog and sometimes in the Financial Post.  Results:

• Companies with high Disruptions Scores were great stocks to own: Apple (A- Disruption Score (pdf), stock up 140% in the past year) and electric car maker Zenn Motor Co. (B+ Disruption Score, stock up 250%)

• Companies with middling to low Disruption Scores were awful stocks to own: Vonage (C Disruption Score (pdf), stock down 80% since its hyped-up IPO last year, JumpTV (B- Disruption Score (pdf), down 58% from a share issue in February this year), for example

• In the rare circumstances where I could identify one company that was disrupting another, the pair-trade (long the disruptor, short the disrupted) paid off both ways, although sometimes you need to apply careful timing to maximize results. Examples include Nintendo vs. Sony, and Apple vs. satellite radio broadcasters (pdf).

To me it is quite startling that nobody else has used Clayton Christensen's principles of disruptive innovation and applied them to investing.

Read the complete column on the Disruption Score and its stock picks in the Financial Post.

Other tools to manage disruption.

VIDEO: Apple TV System Rates A- Disruption Score

Update II: March 22, 2007: Apple TV now in stores at $300. Gizmodo has a video review by Walt Mossberg of the Wall Street Journal. Walt doesn't do a great job as a video presenter, but his published reviews in the WSJ have great influence: "Part of the secret of Apple TV is that, like most of Apple's products, it doesn't try to do everything and thus become a mess of complexity."

Update I: Jan 9, 2007: Apple announced details on its Apple TV system, previously known as iTV, today at MacWorld: To sell for $299 starting in Feb., featuring a 40Gb hard drive. This is disruptive to mainstream broadcast and cable-TV companies. The iPhone is interesting as a swiss-army knife style device, but the Apple TV seems more disruptive  in our analysis because it does the simple job of showing movies on your TV in a convenient way.

We ran Apple TV through our Disruption ScoreCard, generating an A- rating, which is exceptional.

You can use the Disruption ScoreCard to rate your own projects. (More tools for managing disruption at The Disruption Group's tools page.)

These sorts of evaluations are subjective. Feel free to challenge my input assumptions to come up with your own Disruption ScoreCard.

The following were among the high-scoring inputs:

• Low-end product at $300

• Product superior to early-adopter needs (This score was a leap of faith, based on current iPod users and the fact that they have downloaded 45 million TV shows on iTunes in the past 11 months)
• Customer behavior: Fits with how people watch TV and use their iPods
• Off-shelf standard technology
• New business model relative to TV: Apple earns on hardware and downloads

The following were lower-score inputs:

• Public company: Most public companies are severely challenged to disrupt
• New channel: Unclear whether Apple will create a new channel or piggyback on existing Apple and home electronics channels
  
• Not an independent corporate structure for iTV

Download the full Apple iTV Disruption ScoreCard plus some charts showing iPod and TV trends.

** Other Views **
NY Times' David Pogue says Apple TV is a winner and that because of its simple design, it stands out vs Netgear's device and Microsoft's Xbox 360. "It’s a computer-to-TV bridge for the rest of us."

O'Reilly Mac Dev Center's Chuck Toporek says he won't buy the iTV device because it won't record shows.

Disruption ScoreCards and related columns on Apple (A), Vonage (C), JumpTV (B-) as published in the Financial Post.

Archive of On Disruption columns from The Financial Post.

**Other Views**

Inventor and author Shelly Palmer looks at how the broadcast industry is being disrupted in his book "Televison Disrupted" Palmer also writes a blog and a hosts a series of online videos on new media.

Apple's iPhone Likely a Hit, But Not Disruptive

Apple's new iPhone has high appeal to a segment of the market and looks like it will be successful.

Early reports show several indicators of pent-up demand and cult-like followings even before the product is released in June.
Why?

• Apple is the master of design in creating simple, powerful devices with high appeal
• Apple markets better than any tech consumer company
• Apple has no entrenched base of cell-phone customers or channels to worry about offending, marginalizing or competing against

But is the iPhone a disruptive force in the industry? By disruptive I mean, will it displace current suppliers like Nokia, Motorola or even a niche-player like RIM's BlackBerry? Will it win in the market by changing the basis of competition?  Will iPhone change the game for cell-phone users? 

Or is adding a phone to an iPod an incremental function for a disruptive product? By that, I mean is it just a brand extension that enhances the value and helps take a product mainstream, similar to the addition of an mp3 player and a phone on recent BlackBerry models?

Using the Disruption ScoreCard (located on The Disruption Group's  tools page) here are some of the assumptions I used for the iPhone:

• New customers: C
• Product inferior to mainstream: C (ie iPhone is not perceived as inferior)
• Product superior to early adoptor needs: A
• New business model: A+ (I assume that iTunes makes this a new cell phone business model)
• Investment required large: C (Apple has invested two years R&D and mega-bucks)

I don't know if the Disruption ScoreCard is the best framework for analyzing the iPhone or other high-end products because it has a clear bias towards new markets and low-cost entries.  (Afterthought: Maybe there is room to consider the iPhone as inferior relative to conventional phones in that it lacks a keyboard, which would be a sore point with mobile email-junkies, as some readers have pointed out.)

However, a key issue comes through: The iPhone has a different user interface; It is sleek; It is cool; It is well integrated; But it does not appear to do something new for a new set of customers. And doing something new, (especially something new that mainstream suppliers consider unimportant or wrong) is a key ingredient of many successful market disruptors. 

My personal experience (or bias) sees little value in Swiss Army knife kind of multifunction products that do many things adequately but do not specialize in doing one thing extremely well. That razor-like focus, at the expense of ignoring other functions, is what helped make the iPod and the BlackBerry very successful, high-margin products with long-lasting competitive advantage.

The net result of the Disruption ScoreCard was a "B-" rating for iPhone: Some work ahead to get disruptive.  Download the iPhone Disruption ScoreCard and test your own assumptions in the spreadsheet.

This lack of full-on disruption doesn't suggest that iPhone won't make inroads in the market. And it clearly adds some value to people who are considering buying an iPod or a cellphone. But it suggests a limited lifespan and a product that is less likely to be a disruptive breakthrough than say, the Apple Mac or the iPod.

My take is that the iPhone caters to a segment that wants status and high-design and is willing to trade up for it, to use the language of Michael Silverstein of Boston Consulting Group.  While the $500-price point seems impossible to current cell-phone suppliers, ultra high-end pricing of other so-called commoditized products (coffee, beer, laundry machines) shows that historic price-demand assumptions can be dead wrong.

**Forecast Confession**

Six years ago, I mistakenly thought the iPod would flop: Too expensive; Incompatible with PCs; Me-too product.  My mistake was in undervaluing two important iPod attributes 1)The mega-size of the iPod allowed it to solve a new problem for customers (How do I carry ALL my music with me?) and 2) I underestimated the capabilities of iTunes in that it made it easy and convenient for people to legitimately download music.  Those two attributes far outweighed the shortcomings of the early iPods.

**Other Thoughts**
Apple's iPhone has 50% gross margins and a great business model says Alex at EightySevenFour.

RoughlyDrafted says Apple will disrupt the entire wireless industry just as it did the music industry.

More juice from Apple: Apple TV rated an 'A' on our Disruption ScoreCard posted last September when the first details of the product, then known as iTV, were released. Why? It's a low-cost device that fits with how consumers already behave.

Bruce Tognazzini, a 14-year Apple veteran, has a detailed analysis of the iPhone's user interface: Not exactly new and revolutionary, but advanced enough to put the rest of the cell phone industry to shame.

Bloomberg news columnist Matthew Lynn says iPhone will be a flop: Apple is late, Apple is not a team-player with telcos, and the product is a defensive attempt to protect iPod, he says. "Consumers are interested in new things, not reheated versions of old things."

Eager to get an iPhone right away and without dropping $500? Try printing off this fold-and-clip paper version.  And this one with full-color fish screensaver (pdf).

The Wall Street Journal reported on the online debate of whether iPhone will be a hit, including reference to a list of seven iPhone shortcomings compiled on her blog by Motorola Chief Technology Officer Padmasree Warrior.

Arik Hasseldahl at Sci-Tech Today says he learned his lesson from overstating the shortcomings of the iPod back in 2001, when it suffered a long list of complaints (incompatitble with PCs, poor battery life, expensive, etc.) "We now know that the first iPod was just that: the first. Apple learned from what worked and what didn't and made adjustments." 

Stock view: Needham's Charlie Wolfe says buy Apple based on a forecast 7% cellphone market share by 2016. But Eric Savitz at Barron's shows the risk side as well from Bernstein.

 

Is Steve Jobs Disrupting Again with Apple's Showtime? Run the Disruption ScoreCard to Decide

Consumer electronics and media pundits are lining up to predict what Apple CEO Steve Jobs has in mind for his next big thing, presumably a marriage of TV and PCs. Apple is hosting media and technology people Tuesday in San Francisco with the tagline, "It's showtime."

"A more intriguing possibility discussed by former Apple engineers and on rumor sites like AppleInsider.com is that Apple may use wireless technologies like WiFi and ultra-wideband to stream digital content from a Macintosh to the TV."

Om Malik speculates the deal could be:

• Showtime, its movie download/streaming service
• New devices/iPods optimized for video
• New Macbook Pros
• All of the above
• Jobs decides to buy Sun, then eclipse it ;-)

Clearly there are also some implied questions: Will Apple unveil a 'cool' device and will Apple disrupt another market the way it did with the iPod and earlier with the Mac?

I wouldn't actually know anything about cool. And I have no idea how to create a culture or a repeatable pattern of creating cool devices. Steven Jobs is a serial disruptor/genius. But for most companies, trying to create something cool is a good way to neglect business fundamentals and to kill a company.

Think about Microsoft TV, which was ranked one of Microsoft's top 10 blunders... because it was a feat of engineering but it didn't fit with what users actually do when they watch TV.  Same for the Media Center PC.

But I do have a sense of some of the right questions to ask Tuesday to assess whether Apple's new  product is potentially disruptive, culled from our Disruption ScoreCard:

• Is Apple pursuing marginal customers otherwise ignored by the mainstream?
• Do competitors underestimate the product as a 'toy' or deficient?
• Are customers overjoyed by what it does?
• Does it solve a problem that customers are already trying to solve but can't do conveniently or easily themselves?
• Simple purpose? Easy to use?
• Performance improving?
• New business model?

You can use the Disruption ScoreCard to rate Apple's innovation. (More tools for managing disruption.)

** Other Views **
Wired has some speculative pictures of future iPods.

Apple's 1984 Macintosh TV commercial still resonates with a disruptive marketing campaign to showcase a disruptive innovation, the first easy-to-use computer.

 Harvard Prof. Clayton Christensen takes a harsh view of Apple in this BusinessWeek interview, warning the company will head back to obscurity unless it changes its integrated approach: "If they don't open up the architecture and begin trying to be the iTunes inside all MP3 players, they're going to have to keep coming up with the next cool thing...I think it will allow them to survive for a little bit longer (in the PC market.)

Full archive of On Disruption columns published in the Financial Post.

Remember Apple's Newton?  It was a $350-million flop in the PDA market, and a highlight from the wilderness years (for investors at least) from 1987-1997. Some insights on why Newton failed.

Author Andy Hertzfeld, one of the early Mac designers, explains Why the Mac was a success.

Disruption TV: JumpTV Scores B-

JumpTV is an Internet-based subscription TV service far from the mainstream, unless you are an immigrant from Turkey, Iraq, Romania or any of the 60+ countries from which JumpTV carries original programming.

The service is aimed at people far from home, eager to see home-country TV, with more than 200 channels to choose from. Individual channels range from roughly $5.95 per month individually to packages of up to 17 channels for $25.

I ran a Disruption ScoreCard  (more tools for managing disruption) on JumpTV and assigned the following categories with high grades:

• New customers: A (The niche immigrant market they are pursuing is underserved by cable and satellite;)
• Product inferior relative to mainstream TV: A (Streaming foreign programming on a PC vs mainstream broadcasts on cable or satellite;)
• Product superior to early adopter needs: A (Most of the channels are not available anywhere else except in the originating country.)
• New business model: A (Low-cost infrastructure. No fiber to the home etc.)

Analyzing the financials, available on a recent prospectus and financials, I was tough in assigning  grades for the following categories:

• Impatient for profits: C  (Losing money at an accelerating rate in recent quarters.)
• Investor profile: D (Looks like it may attract a hot money crowd in the IPO.)
• Plan to learn: C (Management says it priority is to build the infrastructure and sign up new channels, then aim for subscribers.)

Net result was a summary grade of B- (Some work ahead to get disruptive.) This is higher than the C grade Vonage earned, chiefly because of all the A's JumpTV scored for its unique market and original business model.

Here is the full Disruption Scorecard. Download jtv_disruption_scorecard_v2.xls
These sorts of evaluations are subjective. Feel free to challenge my input assumptions to come up with your own ScoreCard.

As an aside, the JumpTV management team includes Kaleil Isaza Tuzman and Tom Herman, stars of the 2001 documentary movie Startup.com, the story of an internet company that went bust. Here's a three-minute preview of the film, which attracted  good reviews, but not for management.

 ** Other Views/ Late Addition **

Financial Post: JumpTV leaps into a costly niche (pdf)

Full archive of On Disruption columns published in the Financial Post.

Telecom Consultant Mark Goldberg warns that IPTV, as envisioned by telephone companies, looks unlikely to be successful.  Partly the problem is technical, due to the bandwidth requirements for multi-channel HDTV, he says. As a result, Verizon plans to spend $20B on new infrastructure. "That is a brute force way to fight off the converged communications portfolio of cable. It is certainly one approach: replace the entire access infrastructure. There is another way. Change the rules of the game...Telcos need to disrupt the broadcast model because the alternative means fighting the battle using the cable industry's rules."

Mediangler says JumpTV's approach to the market is not new, but "that the money this time round is not necessarily in the technology. It is after all a cultural revolution...Other niche services are growing around the home - for example builder and contractor channels and VegTV for veggies."

New York Times announced the birth of the slivercast earlier this year, referring to JumpTV as a prime example.

PaidContent.org was doubtful of JumpTV when it wrote it up in January: "While there is certainly some business sense in this, the plans sounds gimmicky, if you ask me... B-grade channels at best."

JumpTV publishes its own blogs to build market awareness and a sense of community for different regions, including Africa, Middle East, Europe, etc.

Vonage IPO: All that's left is the crying

Vonage's IPO bombed: now down 25%. Worst in two years. 

Now here's an extra slap for investors: Vonage customers who want to renege on their share purchase can do so, safe in the knowledge that the company will pick up the bill.

David Jackson, an ex-Wall Streeter and founder of the Seeking Alpha Network, says the lesson for companies is to never sell stock to your customers.

My take is that the whole process of the IPO was formulated earlier in the year when VoIP looked like the hot flavor of the month. The Preliminary Prospectus was filed in February.   But with the actual IPO in May, it seems the company and its investors failed to consider their risks were changing, that VoIP was looking more like a commoditization play than an innovation.

In my experience, the stock market and news sources offer a lot of free feedback that is invaluable in understanding investments and risk, if you look for it. Skype's free SkypeOut announcement was one of these free indicators on the trend to devalue Vonage service, and as TechCrunch put it, to see calling fees disappear.

Why do investors and companies fail to see risk? Likely because there was such an illusion of instant profits... a mania even.

Ouch!
 

Other Angles:
Andy Kessler's blog is full of comments prior to the IPO from supportive Vonage customers/investors who criticized him for highlighting the risks of the IPO and missing "the next Google".

The last paragraph in today's New York Times' report on Vonage quotes an analyst speculating that the company is now takeover bait.

Full archive of On Disruption columns published in the Financial Post.

Updated With 'Bullet to Head' - Vonage Disruption Score: C

Update April 6, 2007: Vonage fights for its life as judge rules it can't add new customers because of a patent violation. Stock down 80% since IPO last May... Temporary injunction subsequently granted. Vonage's lawyer says: "It's the difference of cutting off oxygen as opposed to the bullet in the head."

Original Post May 29 2006: Vonage's first two days of trading after the IPO didn't work out so well. This got me thinking, is Vonage a great growth company that is being misunderstood by investors?  Is it the next great market disruptor?

Compared to mainstream telephone companies, Vonage looks disruptive in some ways:

• New business model
• New features
• Low priced service loaded with features
• High subscriber growth

But, using  a Disruption ScoreCard (more tools for managing disruption from The Disruption Group's site) Vonage looks like it falls short. Why? It isn't really creating a new market.  It seems to have a dotcom business model (high growth now, worry about profits later) and it isn't standing on its own in terms of unique attributes.

We may be all wrong, but our Disruption Scorecard tool gave Vonage a C.  Maybe we are being too harsh here. Download the file to see our assumptions and to try your own assumptions.

We welcome your comments on the Disruption Scorecard tool and the criteria as well as the grades we assigned to Vonage.

Download Vonage_Disruption_Scorecard_v1.31.xls

** Other Information **

Read the full article 'Vonage Destructive'(pdf) published in the Financial Post May 29, 2006.

Full archive of On Disruption columns published in the Financial Post.

BCE exec Lib Gibson considers Vonage a disruptor.  Gibson has a lot of experience on the subject and is profiled as a voice of disruption in Clayton Christensen's Strategy & Innovation newsletter.  Her discussion is insightful because it looks at the market perception of "good enough" telecom service, which has moved down from 5-9s reliability.

VoIP expert Rich Tehrani has an interesting take on Vonage... discussing its attractiveness as a takeover target by foreign telco seeking to break into the U.S. market. That would be disruptive.

Broadband expert Om Malik points out, scrubbing the prospectus, that Vonage's estimate of 2% customer churn per month may actually be higher.

New Disruption Scorecard

Several managers and execs have offered feedback on v1.1 of the Disruption Scorecard.  Thanks for the input, and as a result we have revised the Disruption Scorecard to include a few new tests for profitability and growth rates.  The scoring is also a bit tougher. (Aim high, we say.)

Disruption ScoreCard  (Also more tools for managing disruption at The Disruption Group website.)

We have also added areas for you to customize the tool to your needs, such as input weightings, grade thresholds and output messages.

Grading a project or business is a subjective process, but we have tried to identify the major components of successful market disruptors while keeping to a quick process.

The Disruption Scorecard is best used as a starting point for discussions on market disruption. It should stimulate questions and thinking on the subject. Not all successful disruptors score straight-A's, but we think that if you can score well on more of the criteria, you will have a greater chance of success.

Feedback is welcome on this new version and the criteria used. We will post some example Scorecard results shortly. 

Feel free to download and post your own calculations of Disruption Scores for your projects or companies.

** New Version 2.1 **
Disruption Scorecard v2.1 includes some further refinements to incorporate low-end disruption as well as the earlier focus on new-market disruption. Some criteria related to the profile of investors is also included.

Skype Disruption Score: B+

I ran Skype through the Disruption ScoreCard  (more tools for managing disruption), which generated a score of B+.

This is a bit less generous than the  view of disruption expert Chris Carter or a detailed academic study by the University of Lausanne (see download below.) 

I am not sure if my assumptions as inputs were fair and accurate (I left a few blank because I was unsure), but here they are:    

• New Market: C  <--- Gartner etc have studied it
• New customers: B
• Product inferior relative to mainstream: A
• Superior to early adopter needs: A
• Off-shelf technology: A
• Integrated product: C <--- Skype doesn't control the telco interface
• Performance improving: B
• New business model: A+
• Discovering the market: ?
• New channel: A
• Plan to learn: ?
• Independent corporate structure: C  <--- part of Ebay

I welcome comments on whether my subjective inputs are fair or ways to improve the ScoreCard tool. 

The Skype analysis suggests a tweak in the next rev:  I awarded Skype an A+ for a different business model, but the ScoreCard leaves out the question of whether Skype is pushing for quick profitability, an important element of disruption.

Version 1.1 of the ScoreCard can be downloaded below or from the 'Tools for Managers' section of this website.

Download Skype_Disruption_Scorecard_v1.1.xls (27.5K)

Download lausanne_may_05skype.pdf

** Late Addition/Other views **

VoIP Blogger Andy Abramson highlights tech flaws in Skype which leave it vulnerable.. to a Microsoft takeover(!)