Clayton Christensen: Disruptive innovation

good afternoon so welcome to the Clarendon management lecture I am thrilled to in to welcome Clayton Christenson to Oxford when I was named Dean a few years ago Clayton came up to me within a day or so and said that he had a fabulous experience at Oxford and he was hoping that he could come back someday and I am delighted that today is that day where the first of a visit here at s business school and the ability to talk to all of you about his theories of management now I don't really need to introduce

Clayton very much because that's why you're all here you know enough about him but he's not a slouch let's put it that way um so sumacum la from briam Young um then went on to this place actually um a road scholar here at Oxford Queens um then went to another interesting place Harvard Business School he was a an MBA student there and graduated with high distinction and then he took the kind of low-end job of working at the White House um along the way then went back and got his def or his Doctorate excuse me

I'm us terms doctorate DBA at at Harvard uh worked for BCG started up a couple of firms um wrote nine nine books something like that um including one that's been noted as one of the six best business books of forever um um in addition to all that he does remarkable work in his community and his church um and I can tell you as a colleague of his he's a remarkable colleague as well so uh Triple Threat you know scholar academic educator gentleman everything I am thrilled to introduce Clayton Christensen welcome well I'm just honored that

you take the time to come uh seeing so many of you here causes me to believe that it was just a boring day at Oxford and this is all that you could find that would be partially interesting but I um it's been a great opportunity for me to think through the uh today tomorrow and Wednesday and what I might offer that is new uh and yet wouldn't waste your time so um what I want to lay out today in one way or another is what I think might be the beginnings of a new theory of

growth uh whose roots are at a microeconomic level not the perspective of um what an economist might view from the top down and uh what I'm hoping is that the model might be useful enough that that it could help us explain why some of our economies have stagnated and then also understand what can enable a a nation in poverty to become prosperous so um I don't know if these will work or not but uh if they're of interest to you um and some of you are interested in similar things I would love to have a

chance to talk this over through you um so what I'm going to do for those of you who haven't suffered through um a reti repetition of what the the theory of disruption is I'd like to just diag lay this out for you U and then we'll come back to that for the rest of the time together where this came from was as Peter mentioned I founded several F firms but uh one of them has become quite successful and I did that before I became an academic and I brought with me a set of questions as

I reflected on my own experience a primary one was what causes successful companies to lose their growth and ultimately fail and this is the model that emerged and what I'm going to do is describe the model in the context of a case about the steel industry um so for those of you who've not yet made a lot of Steel in your lives there are two ways to make it most of the world's steel historically has been made in massive integrated steel companies it would take about1 billion dollar to build an integrated Steel company today the

other way to do it is in what we call a mini Mill mini Mills melt scrap in electric furnaces and we could put easily eight electric furnaces in this room because you can make steel of Any Given quality in one of these mini Mills they don't have to scale up the downstream processing steps and that's why they call these things mini Mills the most important dimension of a mini Mill is that in fact you can make steel of any quality for 20% lower cost in a mini mill than you can make it in an integr

ated Mill so just think about this for a minute imagine that you were the CEO of an integrated Steel company somewhere in the world you're making Commodities here is a technology mini Mills that would reduce the full cost of making steel by 20% don't you think you'd adopt this new technology it's broadly available and yet not a single integrated Steel company anywhere in the world has yet successfully built and operated one of these mini Mills and this is my sense for why something that makes consummate sense is actually impossible for smart people to do so

the steel market like every Market is uh comprised by tears at the bottom of the market is concrete reinforcing bar or rebar almost all of us could make rebar if we wanted to at the high end of the market is sheet steel that's used to make uh appliances and cars it's actually very hard to make that stuff and at the beginning of this story the integrated steel companies made the full range of these products mini Mills became technologically viable in the late 1960s and because they were melting scrap in these electric furnaces the quality that

they could produce was uniformly bad in fact the only Market that would buy what the mini Mills made was the concrete reinforcing bar Market because there are almost no specs for rebar anyway and then once once you buried it inside of cement you couldn't verify if it had met spec or not and so rebar was a perfect market for crummy products as the mini Mills mini Mills attacked the rebar Market the reaction of the integrated Mills over there was they were just relieved to get out of the rebar business it truly was in American English

a doggy dog commodity their gross margins were only 7% it just didn't made no sense to defend a crummy TW 7% margin business when in the tier above them the integrated steel companies could generate uh 12% gross margins so an interesting thing happened as the integr as the mini Mills were expanding their capacity to make rebar and the the integrated steel companies got out is they got out of rebar and added up the remaining numbers their profitability improved by getting out mini Mills because they had a 20% cost Advantage they rolled tons of money by

getting in so they're quite happy one with another but that disappeared in 1979 that was the year when the mini Mills finally succeeded in driving the last high cost integrated player out of rebar you look at what happened to the price of rebar in 1979 the price of rebar collapsed by 20% it just turns out that there's a subtle fact about strategy that nobody had thought about before and that is a lowcost strategy only works as long as you have a high-cost competitor in your market and as soon as they had fled up market then

it was just low cost Mini fighting against lowcost mini Mill in a commodity business very quickly competition drove prices of rebar down to the point where nobody could make money so what are these poor mini Mills going to do well they try to become efficient making rebar but that's just a recipe for survival and then one of them looked up market and announced oh my gosh if we could just make bigger and better steel we'd make money again because the margins there are nearly double and so they stretched their ability from rebar into making thicker

bar and Rod and angle iron as they attacked that tier of the Remar of the market the reaction of the integrated Mills was they were just relieved to get out of that business because it was such a doggy dog commodity and why would they ever want to defend a crummy 12% margin business when they could make 18% in structural steel so the very same thing happened is the integrated steel companies lopped off the lowest profit part of the product line and added the remaining numbers their profitability improved by getting out and the mini Mills by

getting in had a 20% cost Advantage again and everything was ha hunky dory on both sides until 1984 that was the year when the mini Mills finally succeeded and drove the the last high- cost integrated player out of angle iron bar and Rod if you look at what happened to the price of those products in 1984 their prices collapsed by 20% and the reward to the mini Mills for their Victory is they couldn't make any money so what are these poor suckers going to do one of them looked up and said my gosh if we

could just even bigger and better St deal we'd make money again and as they attacked the smallest end of the structural steam B business the reaction to the integrated Mills was man were they happy to get out of that business because it was such a doggy dog commodity and why would they have I told this story before why would anybody ever want to uh defend a crummy 18% business when their margins in and sheet steel were so dramatically better so the very same thing happened is the integrated Mills lopped off the lowest profit part of

their product line and added the remaining numbers up their profitability improved by getting out and the mini Mills as they had a 20% cost Advantage their profitability improved by getting in to the the piece that the integrated Mills got out of and things were just fine with this Arrangement until 1996 that was the year when the mini Mills finally succeeded in driving the last high cost integrated player out of she uh structural steel what happened to those products in that year prices collapsed by 20% and so what's poor newor and the mini Mills going to

do they've got to get into sheet as they hit the commodity ends the reaction in the integrated Mills was boy they were happy to get out of that commodity stuff because their margins are so much better in specialty Steals and so so here we are today the mini Mills account for about 65% of North America's steel production all but one of the integrated steel companies has gone bankrupt now you notice I was able to tell the whole story without using the words stupid manager once because there's no stupidity involved on either side of the equation

every time the integrated steel companies got out of what was less uh profitable their profitability improved and every time these guys went at one stage up Market their profitability improved and the causal mechanism behind this phenomena that we call the innovator's Dilemma is the pursuit of profit so if you are a little boy and you want to kill a big giant what does it tell you you ought to do well if you think you can buil the beat the giant by by making better products that you could sell for better profits to the Giants best

customers they'll get you but if you define a business or an approach where you come in at the bottom of them then in pursuit of profit the giant is motivated to flee ra rather than fight you and if we had several days we could go through industry by industry of how this has happened before uh and is going on today uh just as a simple example um looking at the way you guys uh the clothing that you have you may not have heard of this company called Toyota as you guys drive lexuses and things but

Toyota didn't come into our markets with lexuses in fact they came in with Rusty little Sub Compact in the 1960s called Coronas and uh they made it finally so cheap to buy a car that the rebar of humanity people we call college students today canona car and then Toyota went from a Corona to Tel Corolla Camry Avalon forerunners Sequoia and then Alexis and General Motors and Ford who are making big cars for big people in the equivalent of integrated steel companies they could see Toyota coming up after them through the 60s 7s 80s and 990s

and every once in a while General Motors would say you know we ought to go get those buggers and so they designed a subc compact to their own that they called a coron uh a a Chevy a Chevy a shebat yeah or a pinto and it made no sense to defend the least profitable end of their business when the Americans could make even bigger cars for even bigger people and uh Toyota just came underneath them and essentially killed Detroit who's killing Toyota they don't feel as if they're being killed incidentally Kia and yend the Koreans

have stolen the bottom of the market from Toyota not because Toyota's asleep at the switch but why would they ever want to defend a crummy the lowest profit part of their product line when they have the privilege of competing in luxury cars against Mercedes and then uh right after Korea uh Chevy um from China Shere shereé yeah is doing it next I had a stroke a couple of years ago and sometimes I just can't think of the words instantaneously so thanks for helping me out anyway so this is the model of disruption and it explains

not not everything but a lot of what goes on in our world now what I like to do is given that context that people in the pursuit of profit need to go up I want to describe three types of Innovations and then try to knit lit knit them together in a way that at least has helped me explain why our economies are stagnant now in America you see this because I live there every day in our economy since World War II we have had nine recessions in the first sex the first six of those nine

from the time where on our economy hit bottom till when they had rebounded to achieve the prior economic Peak on average of 6 months just like CL work but we had a recession in 1991 92 is where it took our economy 15 months to achieve the prior Peak and then in 2001 and two we had another recession it took us 39 months to hit the prior Peak and now we've been working at getting out for 67 months and we still haven't hit the prior Peak and so there's something nothing fundamentally wrong with our economy and

I will assert the very same problem is at work with yours and and in Japan as well so the first type of disruption or of of innovation that's Salient to this I'll call disruptive innovation and it looks at it from a different perspective than the one I described before I'll describe here uh three concentric circles and they're meant to represent populations of people where in the center these are the customers in an industry who have the most money and skill and then these larger pop uh circles represent larger populations of people who have less money

and less skill now almost always in an industry it's begins at the center because the first manifestations of new technology are indeed complicated and expensive so in the case of computing this first manifestation was what we call the Mainframe computer it filled a whole room it cost about two bil $2 million to own it and operate it and it took years of training to operate it and so only the largest universities and the largest corporations could have one and therefore it was a limited size of the market only the wealthy could have access the personal

computer was a disruptive technology and I call it disruptive because it transforms what was a complicated expensive product into something that is so affordable and simple that even a poor fool like Clayton Christensen could own a computer and if you remember those early personal computers were very limited at the beginning and when we had a complicated problem we had to take it to to the center where people who operated the the Mainframe helped us but my gosh that personal computer just got better and better and better and better and so that more and more you

can do more and more things on that personal computer and you just didn't need the Mainframe nearly as much until ultimately that just disappeared and that personal computer was pretty much all that we needed notice the economics were so different these guys $2 million gross margins of $1.2 million per machine the personal computer they cost $2,000 not $2 million and that meant that the gross margins were only $7 $700 per machine as a result the people that made the mainframe computers just like the integrated steel companies made better and better and better mainframe computers they

didn't go after this low-end product because it just made no sense to go after that when the margins up here were so attractive then the next one substance was the smartphone the cost is 200 rather than 2,000 and gross margins per unit are $80 and so the very same thing is at work at the beginning you could just use the simplest problems with that that with that machine and so we had to do the complicated ones on our personal computer but oh my gosh this technology just gets better and better and better so that more

and more we can do our problems on this little device and ultimately we're just not needing the personal computer nearly as much as it was historically the case and true to form the people who make these products the personal computers like Dell ulet Packard Lenovo ausc they're not making these products because it makes very little sense to make something that doesn't make sense so this is the first uh type of Technology I'll call it disruptive innovation and what they these Innovations do is they make they transform complicated products into simple products that are much more

affordable now I'm going to put those there here the impact that disruptive Innovations have is that they create jobs because so many more people can own and use these computers they're more people are buying them that means you have to hire people to make them and distribute them and sell them and service them if you could go back into our history or yours I'm quite certain that the data will show that nearly 100% of all all of the net jobs that have created in our economies in the last 100 years were created by disruptive Innovations

Again by making it affordable and accessible now they use Capital when you're growing you just need to put assets on the balance sheet in order to finance that growth so that's the first type the second type we call sustaining Innovations and sustaining Innovations on the prior slide were making better mainframe computers or better personal computers um their purpose is to make good products better and these are very important for our economy because they kept the mar the market efficient and productive but on average they don't create jobs and the reason is when we buy a

new product we don't buy the old product product when Toyota successfully sells a Prius the hybrid car they don't sell a Camry and so by their very nature dis uh sustaining Innovations which make good products better don't create a lot of new jobs in the economy and because of their very nature of their replace of in character uh they don't use a lot of capital either so important but that was the role that they played and then the third type of effic of of innovation we're calling an efficiency Innovation efficiency Innovations allow you to set

sell the same products to the same customers but cheaper and so Walmart is an efficiency Innovation they allow you to produce the same products to the same customers about 15% lower cost now when Walmart builds a a a store in a community they have to hire people to work in their store but if you look at the region almost always the number of people in retailing is reduced because they're so much more efficient in getting it from here to there now what if I go back to the Mainframe minicomputer discussion when the integrated steel companies

were going up Market they were investing in in sustaining Innovations very aggressively to make better products that they could sell for better profits to their best customers the mini Mill was an efficiency Innovation they requ they could make a a ton of Steel with many fewer people than was required um in a integrated Steel company and so the impact of efficiency inovations has is that they eliminate jobs but importantly they free capital and what I mean by that is for example before Toyota came into North America it took the American car companies about 60 days

to to assemble a car and as it went through this uh Turtle uh Pace there had to be a lot of work in process inventory in that factory and that required a lot of capital to keep that on the balance sheet when Toyota figured out what the Toyota production system was about they reduced the cost or the time required to assemble a car from 60 days to 2 days and because they did it so quickly you just didn't have to have all of that um work in process inventory on your balance sheet and so all

of that c Capital that had been imprison proned on the balance sheet was freed up to you be used for other things and so you you could use that Capital than to invest in new disruptive Innovations and so it's almost like this works as a perpetual motion machine as long as efficiency Innovations are creating enough Capital that we can launch disruptive Innovations and as as long as disruptive Innovations create more jobs than efficiency Innovations eliminate it just keeps going and I would believe my sense is that over the last 150 years in North America our

machine worked in this way but then I mention to you something has gone wrong and this is my sense for what that in fact has gone wrong and that is that rather than working at it as a circle it's laid out in a straight line and the problem with the straight line is it has a beginning and an end what that where that came from was a couple of Concepts the first one was a marvelous Economist named uh George Gilder who just had this Axiom that I describ so whenever you're making a product you have

inputs um if some of those inputs are abundant and cheap you don't have to account for them you can waste it if you want to so sand for example is abundant and cheap and you you can waste it if you need it but other inputs might be costly and scarce and if that's the case then you got to be careful and you have to really husband the use of that product and only deploy it in applications where it will be leveraged in a maximal way um and you have to measure how efficiently you're using this

scarce resource now so that's kind of the Paradigm that that Gilder gave to us now what has happened is that within our midst there is a new Seminary that has emerged in our midst and I call it a seminary of new finance and uh this is actually a Beau beautiful cathedral in ruik um and I call it a seminary because the the the the students in the Seminary believe in the doctrines that are being taught in this Seminary as deeply as people who are religious people like I am believe in the the doctrines of our

churches and uh the people who teach in this Seminary are uh business professors oddly and and uh Partners in equity firms and and so on and uh this this uh Seminary emerged through the 1940s 50s and 60s in an era where Capital was scarce and very costly and that meant that if you're going to be good you got to be very careful and deploy Capital only in those applications where it's going to generate the highest return and you got to be careful and measure carefully this deployment of capital so that over time you only deploy

it where um it is most productively deployed in order to do this the theologians had to give us ways to measure goodness or profitability now prior before this this managers have always needed to measure profitability in some way or another but before these guys came on this this this scene they measured profitability with crude measures like tons of cash and now these theologians gave us sophisticated ways of measuring things and interestingly they are all ratios and the great thing about measuring things by ratios is it gives options to managers so each ratio has a numerator

and a denominator and I can go after both of those in different ways to get the number up so so so for example return on net assets is a ratio and sure I could make more profit and put it to in the numerator of the ratio but what the heck I could just Outsource stuff and get assets off the balance sheet to reduce the denominator in the ratio either way the measure of profitability goes up and so thank goodness these theologians gave us Commandments and uh interesting they they are all ratios so I talked about

uh Rona which is a common ratio Eva and rce are similar ratios uh this is an interesting One internal rate of turn it's a ratio where you've got profit in the numerator if you want to take that root the denominator in ESS essentially is time and if I want to get internal rate of return to go up then all I have to do is invest only in things that pay off in the short term and so uh they G gave us these sophisticated measures of um measuring this uh scarce and costly input that we call

Capital so what impact has this had on our economies so we got this going and then out of efficiency Innovations comes capital and I have to decide what should I do with this Capital well darn it if I use that Capital to invest in disruptive Innovations the problem with disruptive Innovations is it pays off in 5 to 10 years and it uses Capital so I have to put Capital onto the balance sheet what that means is if we go after this internal rate of return goes off the cliff and return on net assets goes off

the cliff on the other hand guys what if we just took this capital and spend it again into another round of efficiency Capital the great thing about this is it turn pays pays off in one to two years and it creates more capital and if we have more Capital then we have more options to invest and so this comes out and then as an analyst uh because I studied this stuff in this Seminary I look at this and say darn it the problem with disruptive innovation is it pays off in 5 to 10 years and

it's going to use Capital darn it on the other hand if we just run it right back into efficiency Innovations it's going to pay off in a year or two and it's going to give us even more Capital that we can invest and then I go through the logic and realize what makes sense is to keep investing in efficiency Innovations and more and more and occasionally a little bit of capital goes up into disruption but in America in the last 20 years the number of disruptive innovations that our economy has produced is about a third

the number of disruptive innovations that emerged in our economy in the 50s 60s and 70s and uh and so we are creating taking a lot more jobs essentially out relative to the number that we're creating with disruptive innovation and that's what's wrong with our economy and if you ever want to know what the future is for Britain or America just look at Japan because in Japan uh through the 19 in the 1950s 60s and 70s remember how Japan was just a juggernaut was growing at unprecedented rates well what was happen happening was that they were

doing disruption over and over again and so uh I'll talk about some of these in a minute but they made motorcycles affordable that even grandmothers could have a mo motorcycle Toyota did it for um students Sony made a television and radio so affordable that any person could have it Canon made copying so affordable that we could have a a printer in every office and these innovations that em were emanated from Toyota allowed billions of people around the world to own things and use them that previously were impossible for them to have access to it and

so their economy was growing at 6 to 10% per year and if you could walk you had a job their unemployment rate during this those three decades was less than 2% and then in the 1980s they began to hire people who were graduates of the Seminary just like we did in America and as they assessed the the return on Capital that came from that versus this they just stopped and uh in since 1990 Japan's economy has generated only one disruptive innovation that's the Nintendo Wii but it's the only one and so what they're doing is

as what we're doing is just investing over and over again to create more and more capital and the result is we are a wash in capital we truly are a wash in capital and the cost of capital is zero it literally is zero there's a company we still create a few of these in America there's one in the Silicon Valley called Square they just finished their most recent private round the cost of that Equity is negative the investors paid Square to take their money and uh the head of our Federal Reserve banki spends every day

standing on the beach with a fire hose open full bore and he's trying to fill the ocean with capital and I think that the bank of England is essentially trying to do the same thing but our world has changed um when cost of capital or when the cost of uh commodity is cheap and it is abundant you don't need to take account for it anymore and so if we had some time we've got some ideas for how to solve this problem but I want to go over that to finish the other elements of the theory

but I just want to have you think about this that if in fact the cost of capital is zero then the the me trying to measure and optimize the cost of capital when capital capital is zero is irrelevant and we teach in finance that we should calculate net present value what value is that if the cost of capital is zero and what uh um George Gilder would say is we're at a time a time when we could actually just waste capital and what is scarce are investments in making our good people to become more capable

people and probably 10 years down the road we will come to discover that that's the kind of thing that we need to husband because they are so scarce and so costly um anyway so that's one piece of the system now um I had a former student who uh returned to Japan took a position in their industry of international trade and Industry and this poor man was sentenced to develop a plan for the resurrection of Japan's economy and you know this is a big puzzle because through the 60s 7s and much of the 80s Japan's economy

was growing like Gang Busters and then start 1990 it just flat flat uh flatlined and he said uh he worked on the problem for about two years and he called me one day and he said clay there's no hope for Japan and I'm a very optimistic guy as you can tell and and I said look I'm certain there's something Japan can do why don't you just come back to Harvard and we'll spend a day and solve Japan's problem and uh what he pointed out to after he talked with me for about an hour he convinced

me that there indeed was no hope for Japan and he pointed out as just I've described to you that Japan disrupted America and they disrupted America faster they than they disrupted uh Western Europe because you guys have all kinds of ways to keep people out um ours are are more are easier to get into um but those companies started at the bottom in the industries that I've described and by 1990 they were making the best products in their categories in the the world the problem with hitting the high end of the market is there's no

place to go and the margins are beautiful but the volume there is limited and what happened to Japan is they stopped investing in disruption is that Korea Taiwan Singapore and Hong Kong started with simple products and by making them affordable and simple in a whole new section of the ntion the Global economies enabled more people to have access to more interesting things and as they started to grow these guys leveled off and America got even in worse shape now those guys are clearly close to the top and then China comes next they start with simple

things now they're growing like Gang Busters but you could already feel that it's becoming mature and then India comes next and when we laid all this out um we started to want understand why this happens why is it that disruption itself seems to be an engine of prosperity but also raised the question why did these waves of disruption all come from China or from Asia and why hasn't Mexico disrupted America in fact why hasn't Any Nation in Latin America or the Middle East or Africa become gone from poverty to prosperity in such a short time

as these guys have why haven't them they been able to disrupt the rest of us and it's a puzzle I'm not sure that I know the answers but let me just describe a little bit of what we see so Toyota do you know where they started this is their first product a three a three-wheeled delivery truck that they could use in the uh congested Pathways in urban cities as Japan's economy was trying to get out of World War II and they started with domestic capital this wasn't outside Capital that came in but they mustered enough

Capital to get going the customers were Japanese drivers and the distribution system were Japanese as well that's how they started in other words through disruption made it possible for a larger population of people now to have a car in some way or another uh whereas historically they didn't have access to it and then the next step was they started to to fuel disruption in America by making it so affordable and accessible now that college students can do it and this is the first one that they introduced in 1962 it cost less than $2,000 and by

creating this in America they had to have more um more customers more Distributors and so on and then after they did that then their focus became much more focused on sustaining Innovations that's the first uh an early Camry and then the last one is Alexis which I've never ridden in um in Korea Kia started out here domestically domestic customers domestic Capital domestic distribution uh so affordable that almost anybody could have one this was the first uh passenger car again for domestic U Market entirely and this one that came in ' 86 was the first one

that they sold in the world markets and now this is what they sell today but again the the first step was with the domestic customers and domestic Capital um this is how Tia Kia got into the bus business I was a a a missionary for the Mormon Church in Korea in the early 70s when it was the the poorest nation in Asia and this was a this was a a bus you just sat in the back and uh hopefully they you got off when they hit the a pothole and this is what they do now

um think about where where Honda came from their first product again was what they called a cub essentially a motor a bicycle with a motor uh domestic customers domestic Capital uh domestic dealers and then they came just as Toyota did to do disrup in America and uh new customers new dealers but in our nation and uh you notice these are different kind of motorcycles than normally we have thought about and they they had a marvelous advertising campaign called you meet the nicest people on a Honda because you didn't meet a lot nice a lot of

nice people on Harley's but then after they created this new market then they also started to focus on sustaining Innovation and just like Toyota when it hit this this um transition growth started to stop because they're focusing not on the things that create this kind of growth here so I don't know if you get a sense of what's going on that in every case they have to create within themselves innovations that helped them allow more people to have access things that previously wasn't possible and then they go up from there this is how it happened

in Taiwan this is an interaction I'll describe quickly between a company called ausc and their customer Dell at the beginning of the story ASC which is a Taiwanese uh T car uh circuit bar guard company uh came to um deell with an interesting value proposition you know we've been doing a good job with these come to think of it that motherboard making uh circuit boards isn't your core competence Dell it's ours and if you let us do it we could do it for 20% lower cost and Dell's analyst looked at it and realized gez they

could and if we had them do the motherboard not only could the cost drop by 20% but we could get all of the the circuit board manufacturing assets off the balance sheet because it's very Capital intensive so they shoveled that over Del's profitability was improved and their revenues were unaffected ausc revenues and profits both improved then they came back a little bit later with an interesting value proposition you know the motherboard is really the guts of the machine come to think of it you don't need to assemble all the rest of the junk because assembly

isn't your core competence it's ours and if you let us do it we do it for 20% lower cost and Dell's analysts looked at it and realized gosh they could and if we gave them assembly we could get all of the other manufacturing assets off the balance sheet and we still get 20% lower costs so they shoveled that over D's revenues were unaffected but profitability improved and sustc revenues and profitability improved by getting into what Dell got out of and then Dell was visited by a suc people a couple of years later with an interesting

value proposition that is you know having to deal with all of these component suppliers and working out all the logistics headaches and shipping the stupid computers to your dumb customers Logistics isn't your core competence Dell it's ours and if you let us do it we could do it for 20% lower cost Dill zos looked at it and realized gez they could and if we gave them the supply chain not only could it could they do it by 20% lower cost but we could get all the current assets off the balance sheet and so they shoveled

that over Dell's revenues were unaffected but their profitability now really improved especially return on net assets cuz they got no assets and ass sistex revenues improved by getting into what Dell got out of and have I told you this story before so the very same thing happened and uh and now ausc is the third largest manufacturer of computers in the world and Dell just puts their name on stuff that these guys make and you notice I was able to H tell the whole story without using the words stupid managers once because there's no stupidity involved

these guys get their profitability by getting out these guys get their profitability by getting in and it's the pursuit of profit that cause this to happen but this is the mechanism by which uh taiwan's economy became prosperous is they did this over and over and over again primarily in consumer electronics in one way or another I'm on a board called TCS in India we started just do doing a simple coding and then step by step added more and more and more to the it processes of our customers and so really it's not clear Who's got

what brand and uh parts of India have just become extraordinarily prosperous very quickly by this method of disruption um last one and then for open for comments there's a company in India called godge that is there kind of their equivalent of whirlpool and uh the vast majority of the population in India can't afford refrigeration and to just try to make a a a fridge cheaper is is a problem because there's still a lot of uh complication and moving parts and so these guys actually read the theory of disruption and decided that there was another way

to make a fridge and that is they use uh an effect called the Peltier effect and essentially you get a wire of bismuth and connect it to a wire of copper and if you send the electrons through One Direction it it makes it hot if you send it in the othered other direction it absorbs heat and so they bit these these plastic little boxes that are insulated and in the the lid they have these wires that use the Peltier effect and they send it in this direction and it can generate it can reduce the cost

inside the box to about 4° c not cold enough to make ice but cold enough to support whatever you need in the home and they can sell it for about 25 or I'm sorry $35 a piece and what's happening just in this industry is that many more people can now own and use a refrigerator and because there's so many people who are buying them they have to hire a lot of people to make them and then you have to have retailers to sell them these are just the result of that and then have to have

new ways of Distributing these products actually their um post office sell these things now because the they're getting disrupted in the post offices as we are here and that then enables more people to start new businesses this is somebody who now can sell out of his uh shop uh cold things that previously weren't possible before and that means that more people can do more things and so uh Against All Odds uh 20 years ago India has become really pocket by pocket and now in much more pervasive ways a prosperous Nation through disruption now let me

come back to Mexico unfortunately what's happening in Mexico and I don't know all the answers is that in America we use our capital build factories in Mexico on a sustaining basis these products make our car companies make better pro profits in the way they're structured to make profits we do the same thing in in clothing or M um beauty products or we'll use it for efficiency Innovations to make products at lower cost to then be brought back into America but none of those creates disruptive products and what they need to do in fact is use

domestic Capital with domestic customers and domestic distribution to create new businesses in Mexico and uh and I've got some thoughts about why that doesn't happen but I do think that somehow in the midst of all of that is kind of a a model and that is there have been lots of explanations about why um poverty persists and what actions might or might not be levered to solve that problem and there's a lot of logic in a lot of these the law of law the rule of law investment in infrastructure that I that the World Bank

will do for us uh foreign de direct investment NGO and made uh but every one of those as an explanation just doesn't is correlative but not causal I think and there are counter there are an anomalies to these explanations and somehow I just have a sense that disruption might be an element of a theory of of uh prosperity that hasn't yet been explored in the way that it should so one of the reasons I asked the dean to give me a desk to work at for a bit is um those of you who have interest

in this and and tools to ma to mathematically model what we're looking at I'd be really interested and uh any of the rest of you who can see um anomalies from the theory would be very helpful but anyway this is what I wanted to share with you today is that I think that there are microeconomic re causes of our macroeconomic prosperity or or uh stagnation and uh it's something that you would only see if you're watching how companies actually do their work as opposed to analyzing it from the the level of uh government policy um

questions or comments or criticisms or cannonballs you want to throw at me for the next few minutes