Clayton Christensen on the Prosperity Paradox

Probably my favorite business book ever is Clayton Christensen's The Innovator's Dilemma. It is not just important, a book that anyone involved in management and strategy should read, it is also wonderfully written. I don't think I can go as far as to say it's unputdownable, but it is close. The Economist lists it as one of the top 6 business books of all time.

I've seen Clayton talk once before when he gave a keynote at the internal engineering conference that Cadence had back in the early 2000s, and even though he talked for half-as-long-again as he was meant to, nobody wanted him to stop. So when I saw he was talking at the Computer History Museum recently about his new book, I signed up immediately.

The Innovator's Dilemma was his first book, but he's written several since, mostly variations on the theme: how to deal with the dilemma, how it looks in healthcare or education. Those books all have "innovator" in the title. His most recent books were different, How Will You Measure Your Life? and The Power of Everyday Missionaries: The What and How of Sharing the Gospel. Clayton is a Mormon, and as a young man, he went on his mission to South Korea. He's the tall one at the back in the photo to the right.

However, I suspect that the reason for this change of focus in his books was that he had a stroke, a heart attack, and cancer in 3 years from 2007.

The evening was split up into two parts: Clayton talked about the contents of his next book with a few slides, and then Scot Cook (the founder CEO of Intuit) interviewed him.

The Prosperity Paradox

His next book comes out in January, called The Prosperity Paradox: How Innovation Can Lift Nations out of Poverty. When Clayton was on his mission to South Korea, it was still a very poor country, not at all what it is today. Nobody could afford air-conditioning, and it was hot and humid (as you will have noticed if you have ever been to Korea or Japan in mid-summer). But, as Clayton put it, "our church had rules about how much clothing you had to keep on" so they would hope for evening breezes.

Some of the ideas in this book came from that experience. In the year he was there Korea was regarded as one of the most impoverished nations in the world. The Philippines was regarded as a basket case. South Korea is now an economic miracle. The Philippines is still a basket case. Why?

God hasn’t provided us data so we’ve had to develop theories of causality for becoming prosperous. I want to talk to you a little since our methods are a little bit different, and I’m proud of how we do it. We develop theories. Like we are used to in engineering and science. A decade ago I realized managers use theories a lot, they are statements of causality. In these terms, every time we take an action, it is predicated on a theory. If we do this, this will be the result.

Clayton's main observation is that there are three types of innovation. No, not sustaining and disruptive, like in The Innovator's Dilemma. In the context of nations, they are market creation, sustaining, and efficiency. All of these can be great for a company that takes advantage of them, but the key thing is that only the new market innovation leads to growth (of the country, not the company).

In some ways, this is a continuation of some of the work he did on innovation. Disruptive innovation is when something cheap comes along that isn't good enough for the incumbent customers. In Clayton's book, hydraulic excavators were useless for big open-cast mines, for example. But they found a great home digging utility lines to houses in housing developments, because those were previously done by hand. Eventually, hydraulic excavators drove everything except the largest excavators out of the market once the seals and pumps got good enough.

That evening, Clayton talked about the mainframe, the PC, and mobile. Each time the market got bigger because it was more affordable to a larger population who had less money.

Or cars. When cars started, for 30 years they were for the rich. Then the model T for the middle class. Then "when I was in college in the 1960s, Toyota came in at an even lower end of humanity, college students." He continued:

Some of you own a car called a Tesla…and we would all hope to have a Tesla. But the theory says they won’t create jobs or growth. A Tesla has to compete against BMW, Mercedes etc. When you go to Beijing and look to left and right, and if you walk 30 yards you will come across an electric car, the $4,000 Shifeng. Electic cars just need to be better than nothing, not like Teslas that need to be better than other luxury cars. Theory says the people who are selling Teslas will not survive. That's not my arbitrary opinion, that’s what the theory says. The bottom of the market is where new markets begin.

On the other hand, sustaining innovations make a good product better, but will little net growth. There will be an improvement in margins and market share. So for Toyota "good news, they brought a Prius, but bad news they won't buy a Camry." Most innovations around the world are sustaining innovations. But sustaining innovations don't create growth.

The 3rd type of innovation is efficiency innovations. They allow good products to become cheaper. But they don't create growth either, their purpose is to increase free cash flow.

This is responsible for our inability to create growth in the US today. Our model is that market-creating innovations create growth. The other two do not drive growth except in the company you are studying, not in broader society. But going back in time, look at, Singer sewing machines. Through the 1880s if you wanted a new piece of clothing you had to ask your wife or daughters to make it by hand, and it took about 8 hours. So most people just had one piece of clothing that had been hand-sewn. Singer figured out how to make their machine much more affordable, and reduced the cost of a piece of clothing from 8 hours to 2 hours. They kept making it cheaper. But this was a problem for Singer, because by making it affordable, so many more people wanted to buy their machines, so they had to hire more people to make them, retail operations to sell them, trainers to teach customers how to use them.

Mexico and Nigeria

Why does Venezuela not become prosperous? Is it that they don't know what to do with all that oil? But we recognized there was an answer in our theory. A nation like Venezuela or Nigeria, when they go to drill a well, they are not trying to help the nation become more prosperous, they are trying to take a well and make it cheaper, and faster, and more efficient (the bottom right of the triangle). This helped me understand why Mexico has been a basket case for so many years. I realized that car companies like Ford would go to Mexico, and under NAFTA build a plant. If someone built a better one in E Asia, they would shut down the plant in Mexico and build it up in Asia. It happened time after time in Mexico: create, shutdown, move, without creating a lot of prosperity.

These were all efficiency innovations. If Ford had gone to Mexico with market-creating innovation, a car so affordable and accessible, then it would be created in Mexico, by Mexicans, for Mexicans. Mexicans would use them and require other things: dealerships, spare parts, and cheap cars would enable other things that depend on cheap transport.

We've also taken a look at how this theory has helped us look at how the World Bank tries to help nations grow: develop a plan, get money from Washington, go to Nigeria, build some schools or whatever. They get something started but then after 2 years, they couldn't keep it going in a sustainable way. If there wasn't a job waiting for the children then the schools shut down. We call that "push" innovation.

What we need to create is "pull" innovation. A student who helped me write one of my books decided to create a company called Indomie. People in Africa didn't eat noodles. He brought the company into Nigeria and figured out how to operate it. Farmers weren't good at keeping the recipe consistent so he had to buy the farms that fed the factories. Then he needed engineers to maintain the equipment and had to hire them and train them as mechanical engineers. Shipping these noodles in a developing country, roughly 20% of them "disappeared' by the time they got to the destination, so they needed to own and operate their own trucks. Then, in the port, people were so dishonest, that they ended up building the largest port in all of Africa.

If you just try and make better roads, schools, and ports by pushing, it doesn't create real growth. You have to create something economically real and pull the population. This difference between pull and push is critical.

If you have dishonest people, then if you are American, you wait for people to become honest and follow the rules. But the way you get honesty is to have companies that want to deal with other companies that are honest, and little by little, honesty gets pulled out. But if you wait for it to happen, you'll wait a long time.

Q&A

 Scott Cook was introduced with some numbers:

• 25: Number of VCs he pitched Quicken to in 1984.
• 0: Number of VCs who invested.
• 2: Number of months it took Quickbooks to become the market leader.

Q: Is the theory applicable to all developing countries?

In China, I have a sense that the types of markets that were drivers were making things affordable and accessible like low-end car manufacturers and AC manufacturers. These have been the main engines of economic growth. In Russia, next door, they are engaging with large corporations around the world with efficiency innovations. But there is almost no investment for market creating growth. Russia has invested to maximize free cash flow.

However, there are some very impoverished nations that are very behind. I worry about the nations in which the religions are not dealing with each other in the right way. it's hard to change those kinds of cultures in some nations.

But the short answer to your question is "I don't know".

Q: So let's pick some. You are hired as supremo advisor, what do you do going forward. First, the Philippines:

For the Philippines, the question is where there is non-consumption of anything in that nation, where people want it but its not accessible. That's an opportunity for growth. Most of then they will be consumer items and not industrial products. That's where I'd look first.

Q: Xi of China.

I'd keep trying to drive growth in the markets where there is a lot of non-consumption and create a situation where they’ll pull it into their lives. For education, they need it so badly but you can’t create growth pushing education into the market. There need to be companies that need educated people to create pull, and they will pull it into the market. There has to be a job to be done, and then education can fulfill it.

Q: Last question from me [Scott], many countries have pursued lots of policies to help themselves grow. This is a lightning round. Thumbs up or thumbs down:

• The World Bank—Down
• World Trade Organization—Down
• Direct Aid—Halfway
• Philanthropy—Halfway
• Fair Trade—Up

Q: As you observe companies in last 10-15 years do you see where they amplify your DEC/PC type theories? Or have you changed?

Companies in the path that grew, they really did follow the rules. If you want to create new waves of growth, you have to separate out a separate organization and not try and do it from the core. Rules are clear, there are no exceptions. But what have we done with technology? IBM caught the new wave of disruption, maineframe; minicomputer, PC. Looked as if they had been followed the theory, and they kept their prosperity. Then they got a CEO who stopped following the theory, shut down laptop, shutdown smartphone. It was similar at HP. They caught the minicomputer, PC, and were very successful. Then the next CEO wouldn’t set up the separate organization and so flow of capital shut down. So there's no HP in this room. Same now with Dell.

I have developed a sense of what are the anomaloies and see why they didn’t work out the way the theory said. But so far the theory has been something to follow.

Q: Why not look to public transportation instead of auto for growth?

I think that's the "jobs to be done" theory. Public transportation doesn't have a job to do, a job that consumers have. You can't do it by pushing.

Q: What about refugees?

The theory would say we have to go to the bottom of the pyramid and make Honduras, or wherever, an exciting place. Pull not push.

Summary

There wasn't really a summary at the end, but the strong message that I took away was that only market-creating innovations create growth for countries, and they always start at the bottom of the market, where they are competing with non-use. Even in The Innovator's Dilemma, which was looking at industries, not countries, you saw a lot of that. For example, when 1.8" disk drives came out, the laptop manufacturers weren't interested. But somebody at Apple had an idea: we could put your entire music library in your pocket on a 1.8" disk drive. As opposed to non-use, not having your music library in your pocket.

However, non-market-creating innovations can be good for an individual company but don't affect growth at the country level. "Great, you bought a Tesla. But boo, you didn't buy a BMW."

By the way, a fact you might not know: the biggest US exporter of cars is...BMW. It exports 75% of the SUVs built in South Carolina, for example.

You can pre-order Clayton's new book The Prosperity Paradox: How Innovation Can Lift Nations out of Poverty, and presumably, buy it wherever books are sold from mid-January.

Best Business Books of All Time

I mentioned above that The Innovator's Dilemma was one of The Economist's 6 best business books of all time. Here is the whole list (from 2011, but I can't think of any business book I've seen in the last few years that I think should make the cut):

• My Years with General Motors, Alfred Sloan, 1964
• The Organisation Man, William Whyte, 1956
• Management: Tasks, Responsibilities, Practices (Drucker series), Peter Drucker, 1973
• In Search of Excellence: Lessons from America's Best-run Companies, Tom Peters & Robert Waterman, 1982
• The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits, C.K. Prahalad, 2004
• The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail, Professor Clayton Christensen, 1997

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