How to Lead Disruptive Innovation in an Uncertain World

A major challenge companies face today is how to innovate and grow in a rapidly changing and uncertain environment. CFOs can take a leadership role in facing this challenge. Continuing research in the Strategic Risk Management Lab at DePaul University’s Kellstadt Graduate School of Business studies how companies successfully develop and execute innovation strategies to create long-term sustainable value. This article discusses how disruptive innovation theory can help companies to achieve sustainable and profitable growth.

In this article, Mark L. Frigo is joined by Scott D. Anthony, clinical professor at the Tuck School of Business at Dartmouth, where his research and teaching focuses on the adaptive challenges of disruptive change. Scott’s next book—his ninth—is slated to be published by Harvard Business Review Press in 2025. The book’s provisional title is Anomalies Wanted: How Disruptive Innovators Change the World.

Anthony previously spent more than 20 years at Innosight, a growth strategy consultancy founded by Harvard Business School professor Clayton Christensen. He has held board roles at public and private companies, given keynote addresses on six continents, and worked with CEOs at numerous global organizations. Thinkers50 named him the world’s ninth most influential thinker in 2023 and the world’s leading innovative thinker in 2017. (Note: Thinkers50 is the first-ever global ranking of management thinkers. It has been published every two years since its inception in 2001. In the intervening decades, the scope of the Thinkers50 has broadened to include a range of activities that support its mission of identifying and sharing the best management thinking in the world.)

Part 1: What is Disruptive Innovation?

In his 2004 Strategic Finance article —“Using Disruptive Innovation Theory to Guide Investment Decisions”—Scott D. Anthony discussed how CFOs should:

• continually monitor whether their company has overshot a customer segment;
• continuously scan for threats emerging from outside their core market; and
• use the disruptive innovation model to help identify high-potential acquisition targets.

The ideas in the 2004 article are even more important and powerful today as companies face high-speed change and uncertainty. In this section, we discuss how disruptive innovation theory has evolved in the last 20 years and how it can help CFOs with investment decisions today.

Mark L. Frigo: Scott, since 2004, how has disruptive innovation theory evolved? How are companies using it today? Can you describe an example?

Scott D. Anthony: There are three primary ways in which disruptive innovation theory has evolved:

• First, there is a more robust set of tools to help people use it to spot early warning signs of change and to manage specific disruptive initiatives.

• Second, there is a greater understanding of circumstances where the theory faces limitations, most notably in more complex environments. The research base for the development of the original disruptive innovation theory was relatively straightforward products like rigid disk drives and accounting software. The rise of platform business models creates new circumstances the original theory didn’t anticipate.

• Third and finally, the advance of digital technologies means that disruptive change is significantly more pervasive than it was in 2004. What used to apply to a small group of companies now applies quite generally.

The primary use I’ve seen in the field is for companies trying to make sense of changes in their environment and then develop dynamic strategies to turn potential disruptive threats into growth opportunities. A good example is the Australian arm of King & Wood Mallesons, a global law firm. About five years ago, after systematically evaluating changes in the market, the leadership team determined that emerging technologies like machine learning posed a significant risk of disruption. That analysis led the organization to invest early to become a tech-driven law firm. Disruptive innovation theory helped leadership make a decision before data were clear, helping KWM to get ahead of change. (For more on this, read the Harvard Business Review article Persuade Your Company to Change Before It’s Too Late.)

Part 2: Guiding Strategic Investment Decisions

In our October 2020 Strategic Finance article Strategic Life-Cycle Analysis: The Role of the CFO, Bart Madden and I discuss how companies can guide investment decisions based on their position on the life-cycle framework: Early-Stage Growth, High Growth, Slowing Mature Business, Mature Business, and Distressed Business, as shown in Figure 1:

From “Strategic Valuation in the New Economy,” October 2021

The article discusses how companies like Intuitive Surgical (ISGR) were transformed by making strategic investments to drive their innovation strategy, including reinvestments in R&D, M&A, intangibles, and IP. Intuitive Surgical developed advanced expertise in systems, instruments, staples, energy, and vision, enabling it to create the future of robotic surgery, including the pioneering da Vinci robotic surgical systems.

Another related article in the series, Strategic Valuation in the New Economy (Strategic Finance, October 2021) discusses the importance of investments in intangible assets in driving valuation of companies. It is a qualitative and analytical process to develop and validate assumptions in traditional quantitative valuation cash flow models. It’s driven by a three-step process:

1. Strategy analysis using the lens of the Return Driven Strategy (RDS) framework;
2. Intangible assets analysis using RDS; and
3. Strategic life-cycle analysis.

The process poses key questions from the RDS framework (as described in the book Driven: Business Strategy, Human Actions and the Creation of Wealth by Mark L. Frigo and Joel Litman), including how disruptive innovation should target value-creating customer needs. The company might ask itself:

• What are the otherwise unmet customer needs our offerings fulfill?
• For how long will the customer needs exist?
• How are those needs changing?
• How valuable and valued are these needs to our customers?

These questions will help the company determine its profit margins and pricing power, which are key assumptions in traditional quantitative valuation models.

In this section, we discuss how disruptive innovation can be used along with the strategic life-cycle analysis by considering where the company is on the life-cycle framework.

Frigo: Scott, please describe how CFOs can use disruptive innovation to guide investment decisions based on the position of the company on the life-cycle framework, especially for companies in the Slowing Mature Business and Mature Business phases. Can you describe an example?

Anthony: I would say three things here:

1. First, it is always important for CFOs to have a good handle on how much growth headroom they have in their existing business. Even seemingly mature businesses can have lots of room for growth. Take, for example, The Coca-Cola Company. Coke has significant room for growth in Africa and Asia. Even though its category looks mature, there remains significant growth headroom within certain geographies.

2. Second, the more mature an industry, the greater the chances that companies have fallen prey to what Harvard Business School professor and the “father” of disruptive innovation Clayton Christensen called “overshooting.” Overshooting happens when a company continues to innovate along a dimension that used to matter to customers, but no longer drives meaningful market differentiation. That appears to be at least one explanation for Intel’s recent struggles. Its obsessive focus on the clock speed of its processors led to it underinvesting in special-purpose chips for mobile phones and artificial intelligence (AI).

3. Third, disruptive innovation theory suggests there are opportunities among two types of customers: overshot customers who welcome cheaper, more convenient solutions, and customers who can’t easily solve a problem on their own, so have no choice other than to engage experts or go to centralized locations. Microsoft’s recent growth resets significantly on appealing to both customer segments. Its move to the cloud enables cheaper, more customizable solutions. Its market-leading investment in generative AI enables non-experts to do things quickly and easily. Microsoft has done a wonderful job turning what could be threats into opportunities.

Part 3: M&A Investment Targets and Disruptive Innovation

In this section, we discuss how disruptive innovation can be useful in M&A investments.

Frigo: In your 2004 Strategic Finance article, you mentioned identifying M&A targets as a way CFOs can improve their return on innovation investment. Please describe examples of companies that have achieved successful M&A from your recent experience.

Anthony: One example that I really like is Adobe. When Shantanu Narayen took over as CEO in 2007, the company seemed to be at maturity, with few places left to bring core software packages like PageMaker, Photoshop, its PDF reader, and so on. Adobe used M&A as a key lever to reframe its business from providing software to support professionals in the creative industry to an end-to-end marketing services and analytics company.

Adobe has made more than 20 acquisitions since 2007, including acquiring Omniture, a leading marketing services company, in 2009. That acquisition was notably made in the depth of the global financial crisis, allowing Adobe to acquire a critical asset at a reasonable price. Adobe’s stock has increased by more than 1,110% under Narayen’s leadership.

Part 4: Warning Signs of Disruptive Change and Risk Management

In this section, we discuss how disruptive innovation can be useful in risk management at companies. Research in the Strategic Risk Management Lab at DePaul University finds that risk management often suffers from “blind spots” when companies fail to take a strategic approach to risk assessment and risk management.

The January 2020 Strategic Finance article The CFO and Strategic Risk Management discusses how a strategic risk assessment process from COSO can be used to identify strategic risks—including the customer risk that can arise when a company’s offerings don’t align to customers’ unmet needs. Here we discuss how disruptive innovation can help companies assess and avoid these risks.

Frigo: Scott, from your experience, what early warning signs of disruptive change should CFOs and management teams monitor?

Anthony: My 2017 book, Dual Transformation: How to Reposition Today's Business While Creating the Future, coauthored by Clark Gilbert and Mark Johnson, suggested six warning signs:

1. First, look for signs of decreasing customer loyalty. That often indicates overshooting, which can drive disruption.

2. Second, assess the degree to which venture capitalists (VC) are active in and around the space. Any individual startup is more likely than not to fail, but enough VC investment increases the possibility of a disruptive breakthrough.

3. Third, evaluate where people are entering the industry. Disruption tends to start in the low-end or industry fringes, which makes it easy to miss if you aren’t watching.

4. Fourth, look to see the degree to which customers are changing their habits. Changing habits indicate changing preferences, which indicate potential shifts in the industry’s basis of competition.

5. Fifth, look at whether new entrants are following different business models. It’s easy enough to copy a technology, but it’s very hard to copy a distinct way to create, capture, and deliver value. When an entrant pieces together a disruptive business model, it indicates the potential for big shifts.

6. Finally, look at the impact on the income statement. This is tricky, because often the early days of disruption feel good to an incumbent. They might be losing customers at the low-end, but those are their worst customers. So, if they’re in a growing category, their revenues and margins might still be increasing. What I tell people to look for is any kind of sign of revenue slowing. Once that happens, even if profitability looks good, it can be very hard to restart growth.

I generally guide executives to track and measure the best quantitative indicators they can along each of these six factors, even if it means looking at rough proxies. It’s important to do qualitative analysis as well. For example, when KWM was doing the work described above, it interviewed customers to learn more about how they made purchasing decisions. They learned that even in segments that looked “safe,” there had been several “near misses” where customers actively considered going with an alternative technology solution. That qualitative analysis gave the executive team greater confidence that the forces of disruption were at work.

One thing that’s critical in all of this is there is very rarely a blindingly obvious “red alert” sign until it’s too late to act. The trick is using a good theory to amplify weak signals to make bold decisions before you need to.

Frigo: The concept of needing both qualitative and quantitative analysis is a good strategy. This is very consistent with the strategic valuation approach described above. This is also consistent with the strategic risk assessment process as described above, which takes both a qualitative and quantitative approach for risk assessment and risk management. The interviewing of customers by KWM is consistent with Tenet 9 of the Return Driven Strategy framework “Engage Employees and Others (including Customers)” to better understand and target customer needs.

Part 5: Teaching Disruptive Innovation in Business Schools

In this section, we discuss how business schools and executive education programs are presenting disruptive innovation.

Frigo: Scott, you teach a course at Dartmouth on Leading Disruptive Change as well as executive education programs at Dartmouth. What are the key skills learned in your courses?

Anthony: There is a well-developed technical prescription for how to respond to disruptive change. What I mean by technical is strategies, structures, systems, policies, and so on. I try to provide a quick overview of this technical toolkit and then point students to relevant literature if they want to go deeper. It isn’t the focus of my teaching, because for the most part, it is not the hard part of the problem anymore. The hard part of the problem is the human part.

It's well known that humans have a range of biases and blind spots that make it hard to make good decisions through uncertainty. Given the uncertainty that accompanies disruptive change, it’s very important to understand and learn how to deal with those biases. A simple example is confirmation bias. We generally pay more attention to things that fit how we think about the world. For a market leader, then, it’s easy to dismiss disruptive signals as the natural churn of the market.

Another human problem is the deep psychological barriers people have toward change. People love change that’s good for them. Who returns money when they win the lottery, after all? But disruptive change can rearrange internal power dynamics and require people to develop completely new skills. That can be really scary for people! If you don’t have space to understand and explore those challenges, sophisticated defense mechanisms kick in and change efforts stall. I recognize that talking about human biases and frailties can feel “squishy,” but fields such as behavioral economics and systems psychodynamics offer ways to bring more discipline to these topics. This serves as the foundation for my teaching, where I seek to give students the capabilities to stand calm in chaos, identify hidden individual and institutional barriers to change, align groups around an uncertain path forward, and turn ambiguity into opportunity.

Part 6: Disruptive Innovation and Artificial Intelligence (AI)

In this section, we discuss how companies can consider using AI to drive innovation.

Frigo: Scott, you teach a course at Dartmouth on AI and decision making as well as in executive education programs at Dartmouth. What are the key skills learned in this course? How are companies leveraging AI in innovation? Can you describe an example? Is there data available for an AI model to evaluate firms that are more likely to be disrupted? What variables would one want to quantify?

Anthony: Great questions. And we can be sure that any specific answer I give now will become outdated quickly given the emergent nature of artificial intelligence. As such, I care less about teaching students a specific skill. Rather, what I want them to leave class with is really confidence and curiosity. Confidence that the right investment in time can help them to develop fluency with AI. Curiosity to play around with and learn as the technology continues to develop. Play is how we develop as children, and I think adults need to spend a lot more time playing, given the increasing pace of change in the world. Leaders need to give their teams the equipment to play and create some—but not too many—guardrails to contain that play, while still encouraging risk taking and avoiding punishing what might feel like failure. It is play, after all, and the only failure is failure to play! Then executives need to get in there and play as well.

In terms of how companies are leveraging AI in innovation, right now we are in a period of pretty radical experimentation. Some are using AI to aid with concept creation and development, others with specific modeling and simulation tasks, and still others with generating internal alignment. What’s clear to me is that AI can greatly accelerate and augment certain tasks. For example, I remember doing consulting work a decade ago and laboriously working over weeks to create a visual representation of an idea. A good enough version of this can be done in seconds. It’s also clear to me that having a human in the loop is critical to sanity check work generated by AI and leverage their wisdom to push the frontier as much as possible.

I haven’t seen an AI model that predicts the degree to which firms are at risk of being disrupted. I would ground one in the early warning signs I described previously and the research Howard Yu at IMD has done to develop a Future Readiness Indicator.

I’ve personally enjoyed playing with AI a lot. Just the other week I was curious about speeding up analysis of the stock performance of 90 different companies. I worked with OpenAI’s ChatGPT to develop a short Python program that not only simplified the task, but helped me create a tool I could use to answer other similar questions. It’s amazing what you learn when you play!

Frigo: As a fellow business school professor, I highly endorse the philosophy of play and fun as an integral part of business education and practice.

Creating Value with Disruptive Innovation

CFOs and finance organizations can use the ideas and concepts in this article to drive innovation and growth in their companies. Here is an action plan for CFOs to consider:

• Use disruptive innovation to guide your strategic investment decisions
• Use disruptive to target the right M&A targets
• Align disruptive innovation warning signs and risk management
• Develop disruptive innovation skills in the finance organization

CFOs can use this approach to take a leadership role in creating long-term sustainable value in a rapidly changing and uncertain environment.