Wednesday, February 06, 2008

Library Technology, Cable-Actuated Excavators, and the Collapse of Bethlehem Steel

Imagine that you are a senior executive in a successful company selling high-end equipment to all the major consumers in your market. Now imagine a product manager approaches you with the following suggestion:
"We aren't selling to the smaller, niche, consumers. Why don't we create a new, stripped down product so we can move into that market segment. It would take a year or so to create a new design that would be underpowered, lack significant functionality that our major accounts consider critical, and fail to conform to industry standards. Oh, and because the target market is made up of smaller players, we'd have to be satisfied with a lower profit margin."

You probably wouldn't react to favourably to this idea, now would you? But that could be a problem in the long run, according to Clayton Christensen, who first explored the idea of "disruptive technology" in his 1997 book, The Innovator's Dilemma.

When hydraulic excavators were first introduced after World War II, they were were too small to be used by the mining, general, and sewer contractors who were the major users of excavators, so the big manufacturers ignored the hydraulic technology; they were focused on supporting their primary market. So the makers of the new “backhoes” sold them into the agricultural and residential contracting markets. From 1947, when hydraulics were introduced until 1960, when the transition from cable-actuated to hydraulic excavators was complete, the power and reach of the hydraulic systems gradually improved until they were able to do the work that the mining, general, and sewer contractors needed. They still weren't as strong as, nor could they reach as far as, the cable-actuated excavators, but they were strong enough and could reach far enough. More importantly, they broke down less often, and when they broke down, it was less dangerous: “[T]hose who had experienced the life-threatening snap of a cable while hefting a heavy bucket embraced reliable hydraulics quickly, as soon as it was capable of doing the job (p. 72).” The cable-actuated excavator manufacturers were doing great the year before hydraulics were “good enough”. After that, sales of new excavators went exclusively to the hydraulics and the old guard was gone.

Christensen finds the same pattern in the steel industry: when minimills were introduced, they could be built cheaply and they used scrap steel for inputs, but they were limited to making poor quality steel, suitable only for concrete reinforcing bars. Concrete rebar is a very low-margin product, so the major steel manufacturers with their integrated mills didn't particularly care if the minimills took over that work: they were focused on high-quality steel products for major clients like the automotive industry. Over time, the minimills kept getting better at producing steel, and kept improving the quality of their output until they were producing steel that was good enough for the high-end customers. And because the minimills were born in an environment that demanded low profit margins, as they moved up-market, they were producing equivalent quality steel with lower margins than the integrated mills could manage, allowing the smaller companies to charge less and still make a higher profit. The large integrated mills lived in an ecosystem of suppliers, labour relations, and investors that required a certain level of profitability to sustain the mills. When that business model was undercut by the minimills, the big steel companies collapsed.

These examples don't match the current situation in the ILS marketplace exactly, but there are some interesting parallels, which will have to wait for another day.

No comments: