Lesson 3.5 · 5 of 5 · The quality of a business
When new technology replaces the leader: Nokia, BlackBerry and Kodak
A market leader can fall fast when new technology changes what customers buy: Nokia and BlackBerry after touchscreen phones, Kodak after digital photography. The warning signs appeared in margins first and only later in sales. The innovator’s dilemma explains why even well-run companies sometimes miss the shift.
Terms in this lesson
- Economic moat
- What protects the company from competitors, year after year.
- Gross margin
- What is left of sales after the direct cost of the products.
- Operating margin
- How much operating profit is left from every $100 of sales.
Nokia: from 40% of the market to selling its phone business
Apple unveiled the iPhone on 9 January 2007, and it went on sale in the US on 29 June 2007, at $499 or $599. That year Nokia had net sales of €51.1bn, operating profit of €8.0bn and an estimated 38% share of the world mobile phone market.
Columns showing the Nokia group’s operating margin for 2007-2012: 15.6%, 9.8%, 2.9%, 4.9%, -2.8% and -7.6%. The margin drops sharply from 2008, recovers a little in 2010 and turns negative in 2011 and 2012.
2008 and 2009 were also the years of the financial crisis, which hit sales across the industry. But Nokia’s margin never recovered. On 11 February 2011 Nokia announced it would adopt Windows Phone, Microsoft’s system, as its main smartphone strategy. In 2012 it had net sales of €30.2bn and an operating loss of €2.3bn. On 3 September 2013 it announced the sale of its phone business to Microsoft for €5.44bn: €3.79bn for the business and €1.65bn for patent licences. The deal closed on 25 April 2014. In July 2015 Microsoft booked an impairment charge of about $7.6bn on the assets it had bought and announced up to 7,800 job cuts, mostly in its phone business.
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Create a free accountBlackBerry: rising sales, falling margins
Columns showing revenue at Research In Motion / BlackBerry, in billions of dollars, for financial years 2008-2016, ending in late February or early March: 6.0, 11.1, 15.0, 19.9, 18.4, 11.1, 6.8, 3.3 and 2.2. The peak is in financial year 2011, which ended in February 2011.
At Research In Motion, the company behind BlackBerry, revenue more than tripled between financial years 2008 and 2011, to $19.9bn. Looked at on their own, sales showed no problem at all. The gross margin told a different story: 51.3% in financial year 2008, 46.1% in 2009, 44.0% in 2010 and 44.3% in 2011. On 28 September 2016 BlackBerry announced it would stop developing its own phones and hand that work to partners.
Kodak: it invented the digital camera and still went bankrupt
Real case
The first digital camera was built at Kodak
In December 1975 Kodak engineer Steven Sasson took the first picture with a digital camera.
The image was 100 × 100 pixels, black and white, and took 23 seconds to record onto a cassette tape. After a few demonstrations, Kodak’s managers saw no market for it. Yet Kodak did not ignore digital: in 2000 it had sales of $14.0bn and net earnings of $1.4bn, and digital products and services made up 21% of sales. Its digital camera sales had grown by 26%, on more than 70% higher unit volumes: prices were falling. In 2011 sales were $6.0bn and the net loss $764m, its fourth annual loss in a row. On 19 January 2012 Kodak filed for Chapter 11 bankruptcy protection. It emerged on 3 September 2013 as an imaging technology company serving businesses.
From Kodak’s Form 10-K annual reports.
The innovator’s dilemma: why leaders miss the shift
Definition
What is the innovator’s dilemma?
The very things a leader does well can make it miss a technology that starts out worse and cheaper.
Clayton Christensen, a professor at Harvard Business School, set it out in his book “The Innovator’s Dilemma” (1997). A disruptive innovation starts with simple uses at the bottom of a market, or creates a new market. At first it is worse at what the leader’s best customers value, so the leader, which listens to them and invests where margins are highest, leaves it alone. Then the new technology improves and moves up towards the leader’s customers. The leader is not badly run: it does exactly what looks right.
- Starts lowA simpler, cheaper product for customers the leader does not want.
- Gets betterYear by year it becomes “good enough” for more and more customers.
- Moves upIt takes the leader’s customers, while the leader keeps investing in the older, more profitable product.
Kodak fits well: the first digital camera took far worse pictures than film, but it improved until it replaced it. For Nokia and BlackBerry the story is different. The iPhone was not a simpler, cheaper version: it cost $499 or $599 and was better at what customers were starting to value. The Christensen Institute calls each new version of the iPhone a “sustaining” innovation and gives smartphones, used instead of laptops, as an example of disruption that creates a new market. In 2015 Christensen and his co-authors wrote that the theory is widely misunderstood, and gave Uber as an example: often hailed as a “disrupter”, it does not fit the pattern.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: Apple, press releases of 9 January 2007 (iPhone unveiled, prices of $499 and $599) and 28 June 2007 (on sale from 29 June); Nokia, 2007 results (Form 6-K, SEC: net sales €51,058m, operating profit €7,985m, estimated market share 38% in 2007 and 40% in Q4), Form 20-F annual report for 2012 (net sales and operating profit 2008-2012), announcements of 11 February 2011, 3 September 2013 and 25 April 2014 (Form 6-K, SEC); Microsoft, announcement of 8 July 2015 (Form 8-K, SEC); Research In Motion / BlackBerry, Form 40-F annual reports filed with the SEC (revenue and gross profit for financial years 2008-2016; negative gross profit of -$43m in 2014); BlackBerry, results release of 28 September 2016 (Form 6-K, SEC: ending internal hardware development); IEEE Spectrum, on Steven Sasson’s 1975 camera; Kodak, Form 10-K for 2000 (sales $13,994m, net earnings $1,407m, digital products and services 21% of sales, digital camera sales +26% on more than 70% higher unit volumes), Form 10-K for 2011 (sales $6,022m, net loss $764m), Form 8-K of 19 January 2012 and press release of 3 September 2013; Clayton M. Christensen, “The Innovator’s Dilemma” (Harvard Business School Press, 1997); Christensen Institute, “Disruptive Innovation” (each new version of the iPhone a sustaining innovation; smartphones instead of laptops); Christensen, Raynor and McDonald, “What Is Disruptive Innovation?”, Harvard Business Review, December 2015 (published summary: the theory is widely misunderstood, Uber does not fit the pattern).