Disruptive Innovation

I have been following Apple's introduction of the iPhone with great interest. The story actually begins with the success of the iPod - a great story of stupendous growth being driven by organic innovation, something we rarely see large companies do. Though the technology and marketing was innovative, the most critical thing that Apple got right was targetting a highly fragmented and underserved market for digital music players.

The success of the iPod helped bolster Apple increase its marketshare in computers, bolster its bottomline and made it an investor favorite. Apple, more than anyone else, probably knew that the gains could not be sustained just by introducing smaller and sometimes crippled versions of the iPod. The introduction of the iPhone gives us a great insight into where Apple is headed over the next decade or so.

Those who have read Clayton Christensen and Michael Raynor's "The Innovator's Solution" will notice many patterns that make the iPhone a disruptive innovation in the classic mould, including the targetting of non-consumption of legal digital music, the innovative approach to licensing music through iTunes, the use of proprietory (interdependent) architecture to get better performance and integration with iTunes. In fact, the last point about how Apple's proprietory and integrated architecture, which was its bane in the PC market, turns into a key strength, is also predicted in the chapter on commoditization.

The authors argue that a proprietory architecture is critical to the success of new products as customers will demand the best performance for their investment in the product. A proprietory or integrated approach will be better optimized to provide better performance than a modular one with components and software from different vendors. However, as the market matures and more entrants join the fray, the marginal improvements in performance or form factor (a la, the iPod mini, nano, micro, pico, etc) will not always lead to better price or margins. The product will eventually become a commodity, with the focus shifting to volume away from high margins.

This phenomenon will slowly shift the balance away from proprietory architectures to modular ones which are better suited for higher volumes. Fortunately for companies like Apple, this is phonomenon is cyclic in nature. As the product becomes a commodity, companies will focus on new markets which play to their strengths. Apple may have found a new market and the right product (iPhone) to do just this. For now, Apple seems to have the Midas touch and if you were thinking of investing in technology, Apple is a stock that I'd highly recommend ...