Shaping For-Profit Enterprises Through Disruptive Innovation

In the last decade, the sheer size of the lower-income market has enticed multi-national companies and investors to search for ways to reach this customer base.  While some have made successful forays into this market—for example, microfinance or small unit products—there is a new set of emerging enterprises being shaped through disruptive innovation.  These innovative products and services not only create consumption, but also create entirely new markets.  Hari Nair, partner at Innosight Ventures, explains his company’s philosophy, and explains how innovations that are smaller, cheaper and simpler than the market leaders can often reshape a market.

Disruptive innovations are all around us, either creating new markets or challenging entrenched incumbent technologies or products.   Internet blogs for example have challenged mainstream media like newspapers and magazines, while Apple with its Ipod or Nintendo with its Wii game console has engaged a large group of otherwise non-consumers into purchasing music and video games.  While disruptive innovations are seen and used at all levels of the market spectrum, their focus around closely meeting consumer needs via combinations of customized functionality, specifications, and higher affordability, make it a valuable tool in creating products and services that connect with the circumstances of members of the lower-income population. Typically, with less emphasis on technology and more concentration on situational applications, they help shape meaningful solutions that offer convenience, affordability, access, and utility to lower socioeconomic groups that current alternatives may not provide.

In recent years, the lure to access the spending power of large lower-income consumers has led large corporations and venture capital to chase many markets.  We have seen companies engineering low unit price products to encourage trial and consumption, as well as the rush of social venture capital to invest in the growing microfinance sector.  While these innovations have certainly grown the market, there is a new set of emerging enterprises being shaped via disruptive innovation and new business models.  These innovations not only create consumption, but also create entirely new markets.

Great Opportunities Are Shaped

History tells us that almost all great products and services begin as something not so great.  For example, the first personal computer was sold in 1950 as a kit and did virtually nothing.  More recently, few would have thought that the web site created in 1995 by Pierre Omidyar to sell Pez dispensers and other collectibles would be one of the few remaining companies that continue to set the benchmark for e-commerce.  Remarkable success often involves some measure of insight and luck.  But more importantly, notable business successes are nearly always shaped by the skillful, patient and thoughtful decision-making of uniquely capable managers.

The traditional venture capital approach emphasizes the search for opportunities and relies on deep insights around long-term trends.  Firms usually have access or commission consulting studies and market research.  Investors construct complex models and discounted cash flow sheets to identify the best potential investments. Those predicted to have promise are funded with a clear and specific business plan in mind; funds are then allocated (sometimes in massive quantities) to achieve that pre-determined plan – with limited deviation allowed from the original investment thesis.

In contrast, we believe that success is shaped rather than predicted, so we shape our own outcomes through in-market iteration of our business ideas.  We aggressively, quickly and cheaply push initial offerings into the market.  We then let customers determine success or failure. If they buy, we quickly shift our focus to achieving profitability; if they don’t buy, we figure out why and quickly and cheaply iterate the offering until we find something that delights them.  

Spotting Opportunities Others Cannot See

The principles of disruptive innovation, as defined by Harvard Business School professor Clayton Christensen (a counselor and shareholder in Innosight Ventures), tell us that most successful companies innovate faster than customers’ lives change. They ultimately end up producing products that are too good, too expensive, and too inconvenient for large segments of customers. In the process, they unwittingly open the door to entrants that can offer simpler, more convenient and lower-cost products and services to those customers who have no need, or lack the means, to keep up with the accelerated pace of innovative change.

Our venture portfolio is targeted towards creating new markets or reshaping existing markets by delivering relatively simple, convenient, low cost innovations to a set of customers who are ignored by industry leaders.  To identify customers who will welcome disruptive innovations, we use a “jobs-to-be-done” approach. This theory holds that products are successful when they connect with a circumstance: a job that customers find themselves needing to get done. For example, we recently helped develop a low cost appliance which will help rural consumers who don’t own refrigerators keep their drinks cool and preserve their leftover food for a few days.  We believe products that make it easier for consumers to do something they are already trying to accomplish become what we call, “killer applications.”

Got Dirty Clothes?

Village Laundry Service (VLS) offers micro-franchises to carefully selected and efficiently trained entrepreneurs.  Operating under the brand name Chamak (meaning “shine” in Hindi) they offer washing, drying, and ironing to consumers who lack clean, affordable, and accessible laundry service.   Chamak offers high-quality washing services to middle-income families, students, and single workers in India at an affordable price point. These customers typically have limited access to efficient washing facilities.

VLS franchisees are enterprising low-income people who have little education and opportunity to start their own business. For a very low start-up fee (1-2% of regular franchise fees), these entrepreneurs are carefully selected and trained by the VLS Academy and provided specially engineered single-machine laundry booths. These booths operate much the same way a regular franchise does: the franchisee is responsible for the success of the business, has access to VLS-branded and marketed products and supplies, and earns based on performance. A VLS franchisee stands to minimally double his previous earnings, increase his social status, and gain valuable basic business knowledge.

The business model is driven by flexibility as the rollaway kiosk with self-contained water supply allows VLS to position its kiosks in expected high demand locations and the flexibility to move to other corners if demand does not materialize as quickly as expected.  Meanwhile, the franchisee, previously an ironer, earning INR200 (US$4) per day dramatically improves his income; VLS allows him to more than double his income by expanding his “share of pocket” from existing customers and attracting new ones.

C.K. Prahalad, renowned author of The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits, wrote: “Large-scale and wide-spread entrepreneurship is at the heart of the solution to poverty.”  He suggests that in order to succeed both monetarily and socially, companies need to offer the enterprising poor empowerment, choice, and self-esteem.

VLS provides incentives to all involved parties to perform, and it is self propagating. Franchisees must perform (keep the rig utilized with target volume of wash per day) in order to make better livelihoods, so they will strive to thrive. They are more likely to train themselves to excel in their craft, to care enough to ensure quality, to work harder with longer hours, and to grow their business. The most successful franchisee will open additional booths, thus expanding and transforming his/her family’s socio-economic status.  VLS is incentivized to fuel this behavior as it creates natural reach and scale, while building its brand and reach, while driving the business to profitability. 

Value of Being Parsimonious

We use a distinctive and systematic process for making good things happen with very little money.  Conventional wisdom says that it takes millions of dollars to produce compelling prototypes and initial revenues, but all of our ventures are structured to achieve success with modest investment: US$250,000 or less to achieve initial revenues and US$1m or less to achieve profitability.

We begin by assuming we’re partially right and partially wrong in everything we do. We take an “emergent” approach to building our ventures; that approach emphasizes retaining flexibility and gathering feedback from the marketplace as we figure out what’s right and what’s wrong about our strategy. We continually structure “quick and dirty” tests to help us obtain new, proprietary sources of information. And we don’t keep the strategy static – we continually shape and mold our businesses and strategy to meet the realities of the marketplace.  But we don’t hesitate to shut down things that the market tells us very clearly simply won’t fly.

Importantly, our multi-geographic presence allows us to achieve very low factor costs – most of our hardware and software is developed through close third-party partnerships in India and Singapore. We ensure we have different schools of experiences within the team to help each venture iterate through the uncertain early stages.

Razor Rave:  Grooming on the Go

Single serve products (sachets) have found success in India as its population desires quality brand names but is unable or unwilling to pay for regular bulk packages. At any given neighborhood mom-and-pop store, known locally as a kirana, hundreds of brightly-colored single-use packets of detergent, shampoo and lotions hang from hooks.

Razor Rave’s micro-franchise booths provide single serving premium shaves, facials, face-powdering, cologne sprays, and other male beauty services. Delivering instant, convenient, and affordable feel-good boosts for young men on the go, Razor Rave targets a growing market of image-conscious professionals and students. Previously, these young men were unable to consume these products and services due to high prices, substandard quality, or lack of knowledge.

Barbers form Razor Rave’s main entrepreneur franchisee base. The barber entrepreneurs that take up Razor Rave franchises have previously worked for a fixed salary, though the value they create far outweighs what they are paid. The franchise allows them not only to earn based on their output, but also to provide customers a more holistic experience with the use of a wider range of male beauty products and services.

A Replicable Model for Success

Our repeatable process emphasizes modest investments that grow with market-based proof.  We form perspectives on possible opportunities through observation and discussion; our local team explores dozens of ideas every year, before eventually assembling about 10 business plans and taking 5-7 new ideas to market for initial testing; ventures are refined and iterated with the help of targeted field experiments (learning pilots) with “foothold” customers (intital consumers for the product or service) with key unmet jobs-to-be-done.  As we see confirmation of widespread market demand, we focus on quickly achieving breakeven profitability and locking-in forms of long-term advantage.

We do well by doing good.  The discarded customers we embrace include the socially disadvantaged, so our business model naturally leads to social good, allowing us to link financial and social investors in new and unique ways for mutual benefit.  Financial investors benefit from our social motives through cheaper access to capital, receptive foothold customers and new segments, general goodwill generated and knowing their money is earning “double-bottom line” returns.  Social investors benefit from the financial disciplines that both make ventures economically sustainable and create access to massive pools of talent and capital

Our current portfolio includes five ventures with revenues and seven others that have passed through initial marketplace testing; we have several other business plans ready to enter the initial testing phase.
Through 2015, we expect to launch 30-35 new ventures and produce at least half of them that have significant value to potential buyers.  We have also set a goal of impacting 100,000 under-privileged lives by creating a significant transformation in their household income levels.

Hari Nair is a Partner at Innosight Ventures, a venture capital firm inspired by the theories of Disruptive Innovation of Professor Clayton Christensen of Harvard Business School.   Innosight Ventures has offices in Singapore, Mumbai, and Baltimore.  Hari’s primary focus is on India and emerging markets.