When Entrepreneurs Innovate: The trade-offs of innovation
Written by Maxim Cartledge
This piece comes from an E-Lab Entrepreneurship Essay Competition winner from the 2024 competition. For more information about the Essay Competition, and to see the other winning entries, see this overview post.
“The heart and soul of the company is creativity and innovation”. These words by Robert Iger, managing director of Disney, present innovation as a key determining factor of sustainable success for a business. Entrepreneurs who innovate are able to thrive in new markets and to meet the demands of an ever-changing consumer base. This allows them to succeed to a greater extent than their rival firms. The payoffs, however, to fruitful innovation are achieved only as a reward for overcoming the significant challenges faced.
Whilst innovation can provide impressive benefits, it often demands substantial initial investment in research, development, production and marketing. The costs for this process of innovation are substantial for startups and small businesses, to whom an economy would often look to innovate and to create competition. However, even large corporations have to be careful when spending on innovation, as they too must consider the potential return of an investment against the significant expenditure it requires. One example of this is Apple, a company which is continuously innovating through its yearly iOS updates and consistent new product launches. These technological advancements require high levels of investment, with Apple spending around $29.915 billion on R&D in 2023 [source]. The fact that Apple, an exemplary firm in terms of growth, has such a large budget devoted to innovation highlights the financial importance that it presents for new and continuing businesses.
Yet even if innovation is successful, we must consider how it can lead to a reduction in the quality and quantity of a firm’s existing products. When a firm innovates, they tend to create a new, efficient product. This means that older models previously produced by the firm become obsolete. While sales for the new product may rise and revenues may increase, the reduction in sales for older products made by the same company could actually result in a minimal net increase in revenue. This problem is known as the “innovator’s dilemma” and was first proposed by Harvard professor Clayton Christensen in his 1997 publication [source]. As such, whilst large firms have a clear motivation to innovate, they are also deterred from doing so by the awareness that their older products and offerings, which may have required high costs of production, will be consequently undermined. Apple also provides good example of the innovator’s dilemma through the company’s transition from the iPod to the iPhone. When the iPod was released in 2001, it revolutionised the portable technology market by introducing a far more functional music player in comparison to older ones. As such, the iPod dominated the market; becoming one of the most sold goods in the early 2000s. However, Apple continued to innovate and, in 2007, they released the iPhone; an even more monumental piece of technology that, again, revolutionised the market. This disrupted sales for the iPod because the iPhone combined the iPod’s functionality with other features, such as telephone and internet access. In fact, the iPhone would render the iPod fairly useless, and eventually the iPod was discontinued in 2022. In this we can see the potential for innovation to disrupt the sales of goods and services even when these goods and services are produced by the same company.
At the same time, while innovation does present these drawbacks, even with its benefits, a failure to innovate can also have detrimental consequences for firms, including bankruptcy and closure. A company that fails to continuously innovate or to strive to improve their goods and services risks losing sales to rivals who do. These rivals are thus able to introduce new goods and services that provide more utility for consumers at a lower cost. The decline in demand that results from consumers moving to substitute goods can lead to a firm’s downfall. A good example of this is to be found in the case of Blockbuster: a video-rental brand founded in 1985. In the 1990s, the sales of Blockbuster boomed as a result of a cultural revolution in home cinema. At its peak, Blockbuster had over 9,000 stores globally and was a dominant force in the cinema industry [source]. As online streaming began to grow in the 2000s, however, Blockbuster struggled to adapt to the changing market and it allowed rival firms to the opportunity to capture an increasing amount of market share. Such firms include streaming services, like Netflix, which were able to offer more consumer utility and lower price. Blockbuster’s refusal to innovate prompted, if not forced, customers to move to the services offered by Netflix in order to obtain better consumer experience. The company’s lack of innovation proved tragic and Blockbuster filed for bankruptcy in 2010. This demonstrates a sharp juxtaposition between the firms that do choose to innovate and those that do not. After Netflix’s rise to prominence, it continued to embrace innovation and as such has held its position as the apex firm in the industry. For example, Netflix has begun to produce original content. Some of this content, such as Stranger Things, has proven incredibly successful for the firm and attracted customers to their exclusive content, allowing Netflix to differentiate itself from traditional content providers. This, along with other feats of innovation such as providing personalised recommendations for users, has only cemented the company’s dominance in the industry and protected it from its competitors. This stark contrast between the story of Blockbuster’s inability to adapt to a changing cinema market, and the more proactive approach of Netflix highlights the critical role of innovation as a determining factor for a company’s success and growth.
It seems clear that innovation is essential for entrepreneurship through its role in growth and competitiveness but there are many considerations that come with an entrepreneur’s decision to innovate. Innovation presents challenges through its significant financial cost and the potential of the “innovator’s dilemma” to curtail actual benefits. At the same time, firms that fail to innovate may see a decline in market share that can result in an exit from the market entirely. Entrepreneurs, and the firms that they may lead, have to consider carefully the trade-offs that come with a decision to innovate so that they can judge the best time to do so, if at all.
Original Prompt: Entrepreneurs that innovate can keep up with the latest trends and fight off competition to increase consumer demand for their products. However, innovation can be expensive and can also destroy revenues for a firm's existing products. Provide some examples of this and discuss, in more detail, the trade-offs firms and entrepreneurs face when deciding to innovate, and what happens if they fail to innovate.