Churning Things Up

Innovations with the power to transform entire industries are the Holy Grail of business strategy. Unfortunately, the innovators don't always survive.

By Andy Grove

July 21, 2003

As a technologist with an interest in business strategy, I have long been intrigued by what happens to industries when a new technology changes the rules of the game, usually by providing an order of magnitude – “10X” – improvement in cost-effectiveness. The history of technology-based industries – communications, computing, and health sciences – is marked by such transformations.

For example, the introduction of personal computing transformed the business model of each member of the computing industry; the growth of the Internet transformed the business of every member of the communications industry; and it can be argued that the introduction of medicine based on molecular biology is likely to transform the pharmaceutical industry.

But as I've studied business history, I've found that strategic actions with profound consequences aren't caused only by technological innovations. Southwest Airlines, for example, was created when its executives helped instigate a change in the regulatory environment that would allow them to compete with the established carriers. Their strategy of low-cost, no-frills air transportation – becoming the "Greyhound of the skies" – forever changed the public's attitude about flying. The altered environment and Southwest's ability to take advantage of it by promoting cost before comfort reinforced each other, providing a change of 10X magnitude.

Whether rooted in technology or not, 10X changes wreak havoc, forcing all the players to adapt. Often the only way they can do so is by transforming their own business models in fundamental ways. Most of the firms that dominated the old order usually disappear, replaced by new players operating in new relationships under new rules.

Classical competition theory doesn't address situations like this. In fact, it implicitly assumes that the environment in which a company operates is basically a given and limits itself to suggesting ways in which a company can better its lot in this environment. In contrast, 10X changes are usually initiated by one firm whose strategic action changes the environment for all the others. But at the same time, that firm's strategic action changes its own environment. And the interaction between the firm's strategic action and the changing environment can yield dramatic outcomes.

I'd like to borrow a concept from physics to describe the difference between two types of strategic actions. If the effect of a company's strategic action changes only its own competitive position but not the environment, the action is linear. In contrast, a nonlinear strategic action sets off changes in the environment that the company as well as its competitors then have to cope with.

To see the difference, think of what happens when you stir a bowl of water vs. when you stir a bowl of cream. When you stir water, it starts swirling. The more vigorously you stir it, the faster it swirls – yet it remains water. By contrast, as you stir a bowl of cream, it gets thicker and thicker and eventually turns into butter. It becomes more and more difficult to stir, tiring you and causing you to slow down. The action affects the environment; the changed environment impacts further action.

The formation of AT&T some 100 years ago provides a classic example of a nonlinear strategic action. Picture the world of telephony in the U.S. back then. There were between five million and six million telephone lines in use, half of them operated by the company then called American Telephone & Telegraph, the other half by some 6,000 independents. It was a chaotic mix of often incompatible systems in which companies sometimes were unable to handle one another's calls (or simply refused to). That environment made the growth of telephony – and therefore the growth of AT&T – very difficult.

In 1907, AT&T's president, Theodore Vail, began pursuing an aggressive policy of consolidation and at the same time attempted to strong-arm the independents into accepting standards imposed by AT&T. The independents fought back and, taking advantage of antitrust sentiments, persuaded the federal government to file a suit objecting to AT&T's interconnection and acquisition policies.

Vail's vision was to expand telephone service throughout the U.S.; consolidation, he was convinced, was a must. Rather than abandon the vision in the face of the suit, he chose a different means of achieving it. Vail proposed offering universal service throughout the U.S. – but he argued that to provide service to underserved areas, AT&T would have to be protected from competition in high-density areas. He asked for a government umbrella. Despite an environment that was fiercely against monopolies – witness the dismembering of Standard Oil – the government agreed, and the result was a federally mandated monopoly endorsing Vail's vision.

With this deal, Theodore Vail changed his operating environment and set the stage for AT&T to become one of the most prominent corporations in the world for much of the 20th century. It was a stunning strategic action.

Not all nonlinear strategic actions turn out to be so happy for their perpetrator. One classic example involved a decision that must have seemed minor and innocuous at the time. As the story goes, when IBM entered the personal computer industry, it chose to base the IBM PC on an operating system supplied by Microsoft. As part of the deal between the two companies, IBM let Microsoft market this operating system to third parties. This must have been an easy decision from IBM's standpoint because for all practical purposes, third parties didn't exist. IBM gave away something that, in their view, cost them nothing.

However, the availability of a standard microprocessor and operating system virtually ensured the creation of third-party competition. Over time those companies grew and provided an increasingly competitive environment for IBM. The decision to license the operating system must have seemed so minor to IBM managers two decades ago that they might not even have considered it a strategic action. Yet it changed their environment profoundly, just about guaranteeing the relative decline of IBM's presence in the "IBM PC" business.

Two strategic actions in Intel's history, one linear and one nonlinear, provide another illustration. In the mid-1980s, Intel faced major technological and manufacturing competition in the memory business from half-a-dozen very large and well financed Japanese conglomerates. In a wrenching strategic shift, we gave up on memories, the original business on which the company was founded, and dedicated ourselves entirely to the pursuit of the emerging business of microprocessors. To do that we had to shrink the company and acquire new capabilities. But we were convinced that in our environment, it was the only way we could succeed. As it turned out, we were right.

With the decision to get out of memories, our corporate strategy changed in a big way. But our environment did not. The Japanese companies continued to make memory chips; we just chose not to compete. This was a linear strategic action.