The power of disruptive innovation

Disruptive innovation is often cited as the force that is reviving the world´s economy. The regulators that oppose it face an unenviable task in differentiating positive disruptors and those simply seeking to evade regulation

Feature image
Airbnb has repeatedly been accused by regulators of evading regulations and breaking the law

Sporadic fires and overturned cars dotted the streets of Paris earlier this year, when taxi drivers made known their frustrations at a certain newcomer in their industry. In the French capital, a war was waged between the old and new, with heavy losses for both sides to follow. Led by long-time drivers, whose livelihoods had taken a hit in light of recent developments, access to airports, rail stations and key intersections was cut off, and many feared for their safety as the protest devolved into violence and chaos.

“This is France? I’m safer in Baghdad”

Visiting celebrity Courtney Love was among those caught up in the pandemonium, and called on President François Hollande to act after her car was ambushed and her driver held hostage. “This is France? I’m safer in Baghdad”, were her words. Meanwhile, police clad in riot gear were called to the scene, and were at one point forced to dispense tear gas in the hopes of quieting the raucous crowds. 70 cars were damaged, seven police officials injured and 10 people arrested, all because of the disruptive influence of US firm Uber.

The ride-sharing app, popularised across the Atlantic and better known to Parisians under the UberPop banner, has eroded market share for traditional taxi firms and, in doing so, has come up against fierce industry opposition since its arrival on French soil. Before the app was suspended in July, the service boasted 500,000 regular users and even more supporters, whose voices have been instrumental in stifling the crackdown.

Nonetheless, the French Government last year ruled the service illegal on the grounds that it failed to comply with local licensing laws, and Interior Minister Bernard Cazeneuve said that anyone caught using the app would be “systematically seized” by authorities. The so-called Thévenoud Law, introduced to stop the app in its tracks, stipulates that any driver found ferrying paying passengers must have the appropriate license and insurance coverage, as well as 250 hours of professional training under their belt.

Bad boys:

Many disruptors are criticised and praised in equal measure

• Founded 1994
• $89bn revenue 2014
Amazon has severely hampered independent bookshops and music stores. The company’s creative tax structure, which sees it technically based in Luxembourg, has been criticised, as has its treatment of warehouse staff

• Founded 1995
• $46m profit 2014
Offering open auctions, eBay has been criticised for facilitating the trade of forgeries and counterfeit or stolen items. More specifically, tactics such as shill bidding and aggressive reselling have also received negative press

• Founded 2008
• Over 1.2 million listings
As rooms are offered by unregulated, private individuals, there are concerns about the safety of Airbnb bookings. Some listings are effectively run like businesses, using the platform simply to avoid taxes and regulation

• Founded 2009
• Over 8 million users
By defining drivers as contractors, Uber avoids the costs of licensing, training, and running local bases, allowing it to significantly undercut traditional taxi services. Critics argue this also makes the service less safe for customers

Opposition all round
“Regulation almost always favours existing industry players. Existing players have the resources and expertise to influence policymakers and regulators against the disruption of their business model. Existing players, because of their size, pay more taxes than newcomers and employ more people. They’ve also had time to develop strong relationships with policymakers and regulators. In many cases, they’ve used their influence to set up barriers to new entrants. The taxicab industry’s support of the medallion system is a good example”, observed Steve King, Partner at Emergent Research, on the subject of Uber. “We’ve looked at a lot of industries that attempted to stop disruptive companies by pressuring regulators and policymakers, and this approach almost always fails. However, it is a way to delay the expansion of a new disruptive competitor.”

French authorities have charged over 300 drivers for working illegally, for which Uber has footed the bill. The service has succeeded time-and-again in frustrating the industry, which claims that Uber’s drivers have been allowed to skirt licensing laws and undercut the competition. The government, meanwhile, has struggled to limit the company’s horizons, and Uber announced only months after the crackdown that it was to expand its UberPop service to Nantes, Strasbourg and Marseille, with further growth in the pipeline.

“We are faced with permanent provocation [from Uber] to which there can only be one response: total firmness in the systematic seizure of offending vehicles”, noted the head of French taxi company G7 Serge Metz, speaking on French television. “We are truly sorry to have to hold clients and drivers hostage. We’re not doing this lightly.” As can be seen here, there is some level of dissatisfaction with the steps taken to restrict Uber, and competitors have been known to take matters into their own hands, forcing a regulatory crackdown.

In Germany, the Frankfurt District Court has banned UberPop on the basis that it violates transport laws, a decision which Uber deemed “a fundamental infringement of our ability under European law to establish and provide a service”. Policymakers in France, Germany, South Korea, Spain and the Netherlands have all taken pains to make life difficult for the cut-price taxi service.

For Uber, it seems that behind every small victory is another setback, with the latest having come in June, courtesy of the Labour Commissioner in California. The ruling focused on a particular driver, named Barbara Berwick, finding that she was an employee and not a contractor. This is significant, as Uber claims that its drivers fit into the latter category. In deciding that the opposite is the case, the ruling suggests that the firm is in fact a transport operator. This is disturbing not just for Uber, but for the wider sharing economy in general, whose success depends on the ability to maintain independent contractor status. The decision could have wide-reaching consequences for a sector without the requisite infrastructure or finances to fulfil legal obligations to workers designated as employees.

A warm reception on the user front and a frosty one from industry peers seems to be the standard cocktail facing firms for whom disruptive innovation is both their biggest asset and biggest challenge. Established industry protocols and practices do not come into being easily, nor do they change without a fight once in place. This is particularly the case when the change amounts to a complete industry overhaul, often to the detriment of the old guard.


“Disruptive innovation as a theory of change is meant to serve both as a chronicle of the past, and as a model for the future” – Jill Lepore, Professor of American History, Harvard University

“By doing what they must do to keep their margins strong and their stock price healthy, every company paves the way for its own disruption” – Clayton Christensen, Author of The Innovator’s Dilemma

“Everywhere, the rate of change is so fast that large US companies are in constant danger of disruption from two guys in a garage in Silicon Valley, or anyone, anywhere, empowered by exponential technology” – Peter Diamandis, US engineer and entrepreneur

“A moment of disruption is where the conversation about disruption often begins, even though determining that moment is entirely hindsight” – Steven Sinofsky Investor and former president of Microsoft’s Windows Division

Up in the air
Airbnb, another major player in the sharing economy, has been targeted time and again by regulators on the grounds that its business model is built on evading regulations and breaking the law. Beginning with three air mattresses on a San Francisco apartment floor, the short-term rental site has amassed over 1.2 million listings across more than 190 countries. At the same time, regulators have stepped up their attempts to restrict and constrain further growth.

In Santa Monica, authorities have imposed stringent regulations on Airbnb and copycat sites, which stipulate that hosts must register for a business license, live alongside their guests, and pay a 14 percent hotel tax in order to operate legally. These rules could wipe out 80 percent of local listings. The aim is to “restore the residential fabric of our neighbourhoods”, according to Santa Monica Mayor Kevin McKeown, in an interview with NPR.

Santa Monica is not alone in challenging Airbnb’s legality. New York, San Francisco and other areas in California have all taken steps to tidy up the grey area in which the sharing economy thrives, though the sector continues to flourish. According to ING, more than 150 million consumers in Europe will offer to share their property and possessions for a price this year, as growth in the sharing economy continues in spite of challenges. At five percent, European participation is far short of that in the US, at nine percent, though 32 percent of the 15,000-person sample said they planned to take part in the coming year.

“In one sense, it has been with us forever, but over the last decade, it has grown from a means of transaction between friends and family to become a global movement of businesses which are increasingly being valued in the billions”, noted a PwC industry analysis of the sharing economy. Already thought to raise global revenues by $15bn, the professional services network is of the opinion that the figure may actually get as high as $335bn within ten years.

Airbnb was last valued at $25.5bn, greater even than industry stalwarts Marriott and Starwood, whereas investors valued Uber at $40bn at the tail end of last year, putting it ahead of Twitter and $8bn away from Yahoo. However, while investors have profited a great deal from the sharing economy, the honeymoon period is wearing off, and in its place has come wave-upon-wave of criticism, mostly from regulators and affected industries.

The sharing economy may be positive for users and recipients, in that it makes use of underutilised resources, but those at the sharp end of the transformation have been quick to point out that the sector relies on skirting regulations that exist, they claim, to protect jobs and customers. Effectively, hotels can’t match Airbnb’s prices as they have to pay taxes that Airbnb hosts don’t, while taxi companies need to spend money training drivers and maintaining licences so can’t cut fares as low as Uber. As far as these points are concerned, disruptive innovation can distort the playing field, and the benefits reward only a few, rather than the whole, at least until regulators get a tighter handle on the way in which internet companies stack up against traditional firms.

Essentially, decisions made by market leaders now will have a significant bearing on the regulatory response to future introductions. Disruptive innovation, as in the case of Airbnb and Uber, can be beneficial to the economy and society at large, though it’s important disruptors control the pace of radical developments, so as not to inflict pains on established industry lines and practices.

Riots that arose as the result of anger over Uber in Paris
Riots that arose as the result of anger over Uber in Paris

Disruptive innovation 
Coined by Harvard professor and best-selling author Clayton Christensen in the mid 1990s, the idea of disruptive innovation has quickly found its way into everyday discourse, and the principle is often flaunted by startups and aspiring entrepreneurs as a sort of end goal. The term “describes a process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up-market, eventually displacing established competitors”, as defined by Christensen himself.

When disruptive innovation hits, as in the advent of the personal computer, which rendered mainframes and minicomputers obsolete, the competition can be slow to recognise the threat until long-time customers jump ship. iTunes and music downloads, eBay and online sales, RyanAir and cheap flights; each of these innovations has overturned age-old industry practices and brought much in the way of change. For affected businesses, there will undoubtedly be casualties, though what’s important is that a balance is struck between the losses on one side and the efficiency gains on the other.

“Disruptive innovation is the extreme form of creative destruction, which economist Joseph Schumpeter described as the essential fact about capitalism. So, if you believe capitalism in any of its various forms is positive – which we do – then disruptive innovation is positive”, said King. “Another point in disruptive innovation’s favour is [the fact that] most of the major breakthrough products and services in today’s world are due to disruptive innovation.”

As opposed to established companies, disruptive innovators tend not to breach the uppermost tiers of the market, and, as in the case of crowdfunding, seek instead to introduce a particular product or service to a new bracket of consumer. Where established firms seek to thrive on higher margins, disruptive forces opt instead to capitalise on the neglected lower end of the market. It’s here that the lion’s share of innovation occurs.

As the digital age has taken hold, disruptive innovation has grown increasingly common, evidenced by shorter CEO tenures and greater investment in R&D, and businesses have largely embraced disruption as a dynamic force for change. In a report, entitled Organising for Digital Disruption, James McQuivey of Forrester Research argued that we “consistently underestimate the power and speed of digital disruption because we don’t realise that the economics of digital business actually accelerate disruption”.

False economy
As we enter the digital age, and into a fruitful new era for disruptive innovation, it’s not only companies that need to adapt to the transformation, but regulators also. The one group works towards unearthing unseen opportunities, while the other focuses on minimising the fallout. Having said that, it’s important that disruptive innovation is true to its name, disrupting age-old practices for good ends, and not merely for regulatory evasion. It’s no coincidence, in this respect, that a great many disruptions occur in tightly regulated industries, with some new entrants aiming to escape this regulatory burden under the pretence of innovation.

Evolved industries:

Some industries, more than others, have witnessed significant disruption

Data storage
Analogue data storage was limited in speed and capacity. The introduction of writeable CDs and portable drives revolutionised the industry, though it also paved the way for the illegal mass circulation of copyrighted material

Digital photography reduced the skill level needed to take passable photos, and made advanced editing possible for the masses. This watered down the specialist services of professional photographers and developers

Mobile phones
Smartphones put internet-enabled devices with cameras into people’s pockets. This had severe effects for directory enquiry firms, the sale of portable cameras and printed maps, and payphone operators, among others

Wonga, for example, which was among the first of a new breed of financial services and is today the UK’s largest payday lender, escaped the scrutiny of its more traditional rivals, only to feel the full force of a regulatory crackdown later in its lifetime. The company’s business is to extend a lifeline to cash-strapped people who have been refused credit by banks, and it was making over £1m profit per week in 2012. That same year, the firm handed out over 3.5 million loans worth a total of £1bn, up from 2.5 million the previous year. In the opening quarter of 2013, Wonga unveiled plans to expand to both the US and Spain.

Flaunted at the time as an innovative alternative to bank lending, and in a period where many were struggling to access traditional avenues of finance, the firm recently came undone thanks to a regulatory crackdown. Branded by trade union Unite as ‘vulture capitalism’, the whirlwind media storm that enveloped the sector sparked regulators into action, and resulted last year in the firm’s first annual loss. The new laws, designed to keep a lid on irresponsible lending, have already hit Wonga’s customer numbers hard, as regulators made it clear that they saw the firm’s form of disruption as no more than a clever attempt to escape regulation. The fear for firms such as Uber and Airbnb is that they’ll suffer much the same fate.

In the case of Airbnb, the ability to share living spaces for profit is an innovation that promises to make good use of an underutilised resource, and deliver benefits to both parties involved. Few would dispute the value of such a system in principle; it’s when such platforms facilitate exchanges closer to those of hotelier and client that their status as positive innovations is called into question.

“The downside of disruptive innovation is that it’s disruptive. Existing companies are damaged or destroyed, workers are dislocated, and cities and even nations can be negatively impacted – at least in the short run”, observed King. “The term Luddite comes from the British workers who lost their jobs due to disruptive innovation in the early 1800s. The disruption was real and many people lost their jobs, but I doubt many today think we’d be better off without steam engines.”

Certainly, there are instances where regulation designed to protect free trade and the population has succeeded in protecting established monopolies. However, there are companies on the other side whose ambition it is to exploit loopholes and make a quick profit. Neither side is necessarily in the wrong; what’s important is that each recognises the role of the other in spurring growth and in protecting consumers against reckless practices. Disruptive innovation is a positive, necessary force; it’s only when more nefarious pursuits are wrongly labelled as such that real problems arise.