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Public funding schemes for innovation: lessons from disruptive innovation theory

The concept of disruptive innovation is by many regarded as one of the most important theories of innovation in the last decade. While the theory’s implications for management practices have received extensive attention, its link to innovation policy remains largely unexplored. Although more research is needed, I argue that disruptive innovation and its implications for management practices already provide some findings of relevance to policymakers. This highlights not only the potential rewards of further research, but also the potential benefits of disseminating current knowledge about disruptive innovation among innovation policymakers.

by Thor Haugness
Innovation advisor at Infosector AS, Norway

March 28th, 2012

Disruptive innovation

The term “disruptive innovation” was first used by Clayton Christensen in his highly influential book “The Innovator’s Dilemma” (Christensen 1997). It commonly refers to an innovation that helps create a new market and value network, and eventually goes on to disrupt an existing market and value network (Christensen, 1997). The theory has been widely recognized for its explanatory power of why most successful companies at one point in time, a decade or two later are either bankrupt or marginalized. In recent years, research has uncovered various processes by which new innovations disrupts markets. This has given rise to the conceptualization of various types of disruptive innovation such as “low-end disruption”, “high-end disruption” and “new-market disruption”. The following sections will give some brief examples on how this research can be of relevance to designers and evaluators of public funding schemes for innovation.

Difficulties of estimating market size and financial returns

Most funding schemes require applicants to estimate market size and likely financial returns. Applicants for funding who do not manage to provide such quantitative estimates - in a convincing way - thus have a higher chance of being rejected. Theory on disruptive innovation indicates that a strict enforcement of this evaluation criterion could cause funding schemes to discriminate against promising innovation projects with disruptive potential. The reason is that disruptive innovations are uncertain on these issues compared to more sustaining/incremental innovations. This is particularly the case for new-market disruptions where the innovation is targeting a new market of previous non-consumers. In these cases, the market size and demand are highly uncertain prior to commercialization.

According to Christensen, these kinds of projects are usually initiated based on “gut-feelings” rather than on thorough quantitative estimations of market size and expected financial returns. He argues that these “shortcomings” causes top-level managers to favour sustaining innovation projects at the expense of high risk projects with disruptive potential. Similarly, I believe funding schemes could be biased towards rejecting promising innovation projects with disruptive potential if the requirements of having thorough estimations of market size and financial returns are strictly and unconditionally enforced by application evaluators. Thus, I believe it is important that evaluators have knowledge of these characteristics of disruptive innovation and are able to assess, on an individual basis, the relevance of such criteria when evaluating project applications.

Low-end disruption - initially inferior product

Similarly, the theoretical concept of “low-end disruption” may also provide some useful input for evaluators. According to Christensen, the process of low-end disruption starts with an innovation that is initially inferior to its competitors judged by the performance criteria that mainstream customers value. In their infancy these innovations start out by serving the low-end of the market, often competing on price or convenience at the expense of performance. The innovation then starts to improve on mainstream performance criteria to the point where the mainstream customers are satisfied. At this point it starts to out-compete the inattentive market leaders in the mainstream market and a disruption unfolds.

The well-documented process of low-end disruption raises awareness of the potential bias in judging an innovation’s long term commercial potential on the first prototype. In order to fully assess the commercial potential and the market size of a product/technology, the possibilities for further improvements and their effects on demand should, to the best of efforts, be taken into account. Evaluators with knowledge about the characteristics of low-end disruptions, would be better equipped to recognize innovation projects with such potential. Rather than discriminating against such projects based on the seemingly low commercial potential of the first prototype, basic knowledge of low-end disruption could enable evaluators to help bring forward such initiatives.

Disruptive innovation and R&D challenges

Many innovations commonly classified as disruptive are often not high-tech products demanding research or overcoming technological challenges in the development phase. In fact, many of Christensen’s primary examples of disruptive innovations are businessmodel-, market-, or process innovations. These types of non-technological innovations have now been widely recognized as a key driver of growth and competitive advantage. With regard to public funding schemes, the main question is whether there are adequate funding opportunities available for innovation projects not entailing classical R&D challenges. It is beyond the scope of this blog to review EU funding opportunities in this regard. However, my general impression is that most funding schemes uses R&D challenges/technological risk as an criteria in the evaluation process (at least in Norway).

The last decade’s literature on disruptive innovation clearly highlights the great economic potential and disruptive effects of non-technological innovations. Thus, it is important that policymakers pay adequate attention to this development when designing funding schemes and other public services. My impression is that many of today’s funding schemes are based on a somewhat outdated linear model of innovation by focusing on innovation projects which include, or result from, research activities. If this is the case, we could have gap in the European and national funding systems for other types of innovations, some with potential disruptive effects.

Conclusion

There is clearly a lack of research exploring the links between disruptive innovation theory and innovation policy. Nevertheless, I believe that recent research about the characteristics of disruptive innovation has produced knowledge that could be of benefit to policymakers when designing innovation policy. According to Christensen, disruptive innovation illustrates that classical management practices, taught at business schools worldwide, cause managers to favour sustaining innovation and disregard high-risk innovation projects with disruptive potential. Similarly, I believe that criteria commonly used in funding schemes also favour sustaining innovation projects.

Given the increased recognition of the importance of disruptive innovation for long term growth and survival, it is paramount that we assess ways in which to prompt such innovation through policy measures. A small first step in the right direction, I believe, is to diffuse basic knowledge of disruptive innovation theory among policymakers and evaluators in funding schemes. As argued, such knowledge could help identify promising innovation projects with disruptive potential and avoid possible discrimination of such projects as a result of using evaluation criteria favouring sustaining innovation.