Where Does Growth Come From? | Clayton Christensen | Talks at Google

MATT: Professor Christensen is one of the most thoughtful, interesting, and committed people I have had the opportunity to work with during my time at Google. And I'm very, very excited to allow us all to share a little bit of that today. Without further ado, Professor Clayton Christensen. CLAYTON CHRISTENSEN: You're very kind, Matt. And I'm delighted that it's worth coming here and talking about some of the things I want to propose. There are three main objectives in my talk. The first is, my goodness, Google is in a wonderful place. And almost never in the history of humanity has anyone been seen to be so successful at much of what you're trying to do.

And the reason that worries me is that success is very difficult to maintain. And if you analyze business history, almost all the companies that at one time were considered unquestionably successful, 10 or 20 years later, we find them in the middle or at the bottom of the pile. And I'll talk a little bit about that later. But the scary thing about this is that it's actually good management that causes successful companies to stumble. And so the solutions you might think of are not solutions at all. Anyway, that's one of the reasons I came: simply to share the desperation that

come

s with success.

And then the second is that

growth

is actually a big problem every

where

. Not only American companies, but also Japanese and European companies are even more desperate for

growth

. In China, which has been on a roll for the last 10 years, they can't grow there. And politicians are worried that we won't be able to grow. And they have no idea

where

the growth at the level of national economies

come

s from. And if our nations are not prosperous, it will be difficult for businesses to be prosperous. That's what I want to talk about, if that's okay. And what I would like to offer you, which is my third objective today, is that I want to talk to you about theories about management.

And the word "theories" gets a lot of buzz among managers, because the word "theory" is associated with the word "theoretical," which connotes impractical. But a theory is a statement of causality. It is a statement of what causes what and why. And when we think about it in those terms, you, as technologists or managers, are voracious consumers of theory. Because every time you take an action, it is based on the belief that if you do this, you will get the result you want. And every time you put a plan into action, it is based on a set of theories that tell you that if you do these things, you will succeed.

But most people are not even aware of the theories they use. And many times, the theories you use are more destructive than productive. That is why I have spent much of my academic life trying to understand management theories. Therefore, there is no great management theory that solves all the problems of managers. But there really are theories about different dimensions of a manager's job, which are quite useful. And you will see some of them, as I will present them today. And it's like, if you came to my office, there would be a bookshelf there. And on the shelf there will be a set of theories about management.

And some of them have emerged from my own research. And alongside them are management theories that other members of our faculty have offered. And there are some spaces on the shelves that are not filled, because there are really important theories about management that no one has provided a theory for yet. So, for example, metrics and the way things are measured are very important. And yet, there is no theory about metrics. But with this as a set of building blocks, if someone can come to us with a problem, instead of giving them my opinion on how to solve the problem, what we can do is say, well, if that's the problem. , you know, so we have a theory on the shelf called disruption theory.

And I bet you that if we applied that theory like a pair of glasses and looked at this problem, we could understand what's going on. And that's what I want to do, explain to you a series of problems for which good theories could help you. And I chose these because I think you are probably facing similar problems. So if you think a lot about our economy, you'll realize that occasionally we have a recession. And when our economy goes into recession, at some point we will hit rock bottom. And then it takes some time before companies have to start hiring people again.

Because the people on board can meet the demand of receiving more orders for a while. And we've had nine recessions since World War II. And in the first six of those nine recessions, on average, it took our economy six months from the time they hit rock bottom to get to the point where they needed to hire more workers. But we had a recession in 1991, 1992, where it took our economy 15 months to get to the point where they needed to hire people again. Then we had a recession in 2001 and 2002. So it took us 15 months in that recession to get to the point where they had to hire people.

Then we had a recession in 2001 and 2002 where it took our economy 39 months, in total, to get to the point where they were hiring more people. Then, during the most recent recession, it took almost six years for our economy to get to the point where we needed to hire more people. And what seems to be happening more and more is that these rebounds appear to be financial in nature, not real. So people who have money get a lot of money much faster. But for the rest of us there are no longer jobs we can fit into. And something fundamental has gone wrong in our economy.

And what we see in the economy is also a summary of what happens in most companies. That's why I want to propose that there are four different types of innovations. And the reason I would like to focus on innovation is because every time a company makes an investment, it invests in an innovation of one kind or another. So what I want to do is describe these four types of innovations and then teach a little more about whether, why, and where they will generate growth. There are potential products, which means no one has figured out what they are yet.

Then, the second is to sustain innovations that improve those products. The third is disruptive products that make markets grow. And then the fourth is efficiency innovations where they sell them to get their money back. Let me start with possible innovations. Almost any study on innovation will say that, of all the products that a company starts developing, only about 15% to 25% of them will be financially successful. And innovation is generally considered to be a game of chance. The more projects you launch, the more successful you will be. But in the end it is a game of chance. And what we have concluded is that it is not true.

The reason we can't seem to predict in advance whether a customer will buy the products we're developing is that people at business schools like Harvard teach marketing in a perverse way. And in particular, we have decided that understanding the customer is the wrong unit of analysis. So to illustrate this, look at me for a second if you don't mind. My name is Clayton Christensen. Unfortunately I am 64 years old. Unfortunately, he used to be 6 feet 8 inches tall. And now he's 6 feet 6 inches, unfortunately. And luckily I married a wonderful wife. We have five children. The third of them, Michael, unfortunately came here to Stanford.

And I have all kinds of other characteristics and attributes, as you can see. But none of my characteristics or attributes have yet led me to buy the "New York Times" today. There could be a correlation between the propensity to buy the "New York Times." But my features don't make me buy it. Our characteristics and attributes also do not lead us to buy any product or service. And yet, almost all of the work we do to evaluate market potential looks at the characteristics or attributes of potential customers. And we decided that a better way to think about it is that, damn, things happen to us every day.

Jobs arise in our lives. And when these jobs come up, we need to find some way to get them done. And some of the jobs are simple, gradual things that happen regularly. Others are dramatic and important deal-breakers. But whenever we have a job to do, we have to find something and incorporate it into our lives in order to get the job done. And what we decided is that understanding the job is the fundamental key to developing products that we can make predictably and find customers to buy from. So, to illustrate this point, several years ago, as the idea for the work to be done was emerging from our research, McDonald's was trying to decide how they could improve sales of their milkshakes.

And as some of you may know, McDonald's is a very sophisticated marketing company. And they have bulk data on every dimension of what they're doing. And then when you walk in, on the menu, behind that is a profile of the demographic profile of the quintessential customer who likes to buy that product when they come. And so what they've done is have these groups of people who are the quintessential smoothie customers, for example. And it turns out that I fit that profile perfectly. So they would bring people like me into conference rooms and ask them: could you help us improve the shake so they could buy more?

Customers would provide very clear guidance on how to improve it. They would then improve the product in those dimensions. And it had no impact or sales on the product. So what we decided is that that is not the right way to approach it. Rather, there has to be a job somewhere that people need to do and for which they go to McDonald's to get a milkshake. And we need to understand what the job is. Then one day, one of our colleagues was at a restaurant for 18 hours and took very careful notes about what time did they buy these shakes?

What was he wearing? Was he alone or with other people? Did you buy anything else or just the shake? Did they eat it at the restaurant or did they get in the car and drive away with it? And it turned out that about 50% of customers bought the shake before 8:30 in the morning. It was the only thing they bought. They were always alone. And they always got in the car and drove off with him. So we decided we had to understand, what was this job? So we came back the next day and positioned ourselves outside the restaurant so we could confront these people as they walked out with their milkshake.

And in language they could understand, we asked them: I have a problem with your behavior here. What job were you trying to do that made you come here to hire this smoothie? And because they had a hard time answering, we would try to help them by asking them, well, look, think about the last time you were in the same situation, needing to do the same job, but you didn't come here to hire a smoothie. What did you hire to do the job? And it turned out that everyone had the same job to do. And they had a long and boring trip to work.

And my goodness, one hand had to be on the wheel. But someone gave me another hand. And there's nothing inside to drive. And I just need to do something while I'm driving. And I'm not hungry yet, but I know I will be hungry at 10 o'clock. So I also need something that just works and stays there until 10 o'clock. So when I have this problem to do, what else do I contract? And one guy said, he'd never thought about it in these terms. But last Friday I hired a banana to do the job. Take my word for it.

Never hire bananas. They're gone in less than a minute. I'm hungry at 7:30. Another guy said, promise not to tell my wife, please. But I hire a lot of donuts to do this job. But they don't really do the job well. I promised my wife that I'm going to lose money. But I add it. And they fall apart all over my clothes. And my fingers get sticky. And I put it on the steering wheel. And another guy said, yeah, sometimes I make bagels. But damn, the bagels are so dry and flavorless. I have to drive the car with my knees while I put the cream cheese on it.

And then if the phone rings, I have three problems and two hands. And one guy said, I hired a Snickers bar to do the job. But I felt so guilty that I never listened to Snickers again. But let me tell you, every time I have this job and I come here to rent McDonald's milkshakes, it's so slimy that it takes me 23 minutes to slurp it through that thin straw. Who knows what the ingredients are. I don't mind. All I know is that it's been in my stomach all morning. And it fits perfectly in my cup holder.

And it turns out that the shake

does

the job better than any of the competitors. And the competitors are not Burger King shakes. But it's bananas, donuts, bagels, Snickers bars, coffee and a few other things. And then it turned out that in the afternoon he was hired for a very different job. And that's when someone is a parent, he just needs to have a nice, quiet time to talk about whatever his kid is thinking. And they hire the shakes to do this job. And it

does

that job very well. But it is a very different job than the morning job.

And it turns out that it is not unusual that almost always, said Peter Drucker, the customer rarely buys what the company thinks it is selling him. And that is whyI said at the beginning that understanding the work is essential to developing successful products. The customer is the wrong unit of analysis. Because the client sees the need to carry out different jobs over the course of a day, a week or a month. So there's some work out there near here that needs to be done. And people find themselves needing to do this work at different frequencies. And that is to say, I need to get this from here to there as quickly as possible with perfect certainty.

How many of you have discovered that you needed to do this work over the last year? Almost every. It turns out that Julius Caesar had this job to do. But when he had the job, he was able to hire a rider and cart to do the job. Queen Victoria had exactly the same job to do. But she could hire the telegraph and the railroad to get the job done. And Winston Churchill could charter a plane to do it. And now, our leaders can hire DHL. But the work itself has not fundamentally changed over these centuries. And that is a characteristic of most jobs: they are very stable over time.

But the technology we might hire to do the job changes at an alarming rate at times. So if you think about the business we're in, I'm in the DHL business and I'm competing against FedEx, my life is very unpredictable. But if I think that the work to be done is the main business, then life is very stable. And it makes it much easier for us to predict what the next technology will be. Let me describe to you... Sorry. I need to tell you a couple of things about myself. I'm stumbling around because I've had a couple rounds of chemo for the cancers I've had.

And one of the side effects is that I can't feel my feet. So when I look at you, I don't know if my feet are there or here. And then I had a stroke. A clot came from somewhere and lodged right there in my brain. And he formulated the part of my speech where we formulated. It killed the part of my brain where speech is formulated. This happened about four years ago. And just like that, I lost the ability to speak. And I've been trying to learn to talk again. And there is a program called Rosetta Stone for English.

Turns out it's very good. But, as you see, in my language, sometimes I have a hard time finding the word. And that's because I lost it. And I'm learning to speak from the other side of my brain. And I noticed that I notice that I talk to the floor a lot. And the reason is that if I look at the floor, I can focus on what the next sentence should be. And if I look at you, you distract me. So it's not that I've suddenly become shy. So I apologize for that. Still, there is an architecture for every job to be done.

So, the fundamental basis is that there is a job that I need to know, given the situation in which I find myself. And that's a big reason why understanding the customer is the wrong unit of analysis. Because the situation I find myself in has a huge impact on the nature of the work. And each job has a functional, emotional and social dimension. And the combination of those three depends on the application of the situation they are in. If we understand what the job is, then we can ask the next question. So what are the purchasing and usage experiences we need to provide to get the job done perfectly?

And if we understand what those experiences are, then we will know what to integrate and how to integrate it so we can provide the experiences necessary to get the job done. And if we understand that, then it tells us what type of brand we should apply to that product. So that when they need to get the job done, that brand comes to mind. So, to summarize why it's important: the reason we need to understand the opportunity in terms of the job and not the customer. We need to understand what work the client needs to do. We need to understand how customers will choose us.

And we also need to be able to say what we can do that other people can't, and that's how we integrate. And finally, how will everyone know which product works best? There's a job that comes up in people's lives that happened to our son Mike when he came here to start Stanford. And after a couple of days here, he called Christine and me. And he said: Mom and dad, I found our apartment. And I need to furnish my apartment tomorrow. And then there's a job that Mike needed to do. I mean, I need to furnish my apartment tomorrow.

When you discover that you have that job to do, does a brand come to mind that says, This is what I can do to do this job perfectly? AUDIENCE: Ikea. CLAYTON CHRISTENSEN: Ikea. How many of you said the word Ikea in your mind when I told you what the job entailed? Look around. It is not interesting? And that's what we mean by a brand with purpose. We need to organize our product around a job that does it so perfectly that anyone around the world who needs that job done thinks of Ikea. And Ikea has no competitors.

There are other retailers that sell furniture. But there is no one in the world who is organized around that work to be done. As a result, they are tremendously profitable. And you think about this for a minute. Its owner is the third richest man in the world. The quality of the furniture they buy is marginal. And they sell it to the lowest segment of humanity, to college graduates. And clearly, they can get a premium. Your customers are happy to pay a premium price for your products. And the reason is, if you hire a product to do the job and it doesn't work well, then you have to retire it or throw it away or give it away or repair it and go out and find something that will do the job well.

And if that doesn't work, then you'll have to try it and talk to your friends. And when you find yourself buying a product and discover that it doesn't work well, it is very expensive to find something that does it well. And that's why it can be so profitable if you organize yourself around a job to be done. Because customers will be happy to pay a premium price for your product, because the alternative of something that doesn't work well is very expensive. So that is the first type of innovation. And we call them potential products because we don't know their potential unless we understand the work that needs to be done.

We call the second type of innovation sustainable products that improve good products. And so, the day after launching a new product where we discovered that there is a job to be done (we have a product to do the job well), we immediately start improving those products. And we call those products sustaining innovations. And they are important. When we look around the world as we walk, almost all the innovations we see are sustainable products. They help companies maintain healthy margins. They are the mechanism to gain market share. And those of you who work on AdWords and its other products are committed to maintaining innovation.

They are critical. But because they replace old products with new ones, they do not generate growth. Let's imagine I'm working for Toyota. And I convince you to buy the Prius, the hybrid car. Then you won't buy a Camry. If I sell you this year's best product, you won't buy last year's best product. And so, by their very nature, sustainable innovations, although important, are replicative in nature. And most of what we consider innovation is of this type. That is the second type of innovations. We call the third type of innovation disruption. And they create growth. Let me describe... this is going to be a complicated slide before we're done.

So I apologize in advance. But you will see these three concentric circles. And what they are intended to represent is that, in reality, you can describe the history of any company in terms of these three circles. The innermost circle represents customers who have more money and better access to a product or service. And then as you move toward larger circles, they represent larger populations of people who have progressively less money. Industries almost always start in the center, because the first products and services are so expensive and complicated that only people who have many of them can buy and use them.

With this in mind, I want to describe what disruption is and why it creates growth. So I will put the performance of the product or service over time on the vertical axis. In every market there are two trajectories. The first is that in every market there is an improvement trajectory that customers can use in their lives. And we don't think about it much, but our lives don't change much. And that's why this is so flat. Then, in each market, there is a different trajectory of improvement that innovative companies offer as they continue to introduce better and better products.

And the most important finding here is that this trajectory of technological progress almost always exceeds customers' ability to use the product. And what it means is that a technology that isn't very good at first is actually prone to overtaking what those same customers can use at a later time. And there aren't many gray hairs in the room. But if you talk to someone who was in their teens or 20s in the 1980s, at that time we were trying to figure out how to use, learning to type on those first personal computers. About every 30 seconds, you had to stop and let the Intel 286 chip catch up to you.

Because the world's fastest microprocessor couldn't even keep up with our fingers on the left side. But if you take your computer apart now and just look at the microprocessor there, we use only about 15% of the capacity of that processor. Intel has far exceeded what most customers in mainstream applications can use. Now, some of the innovations that help improve good products are incremental innovations. Others are dramatic and revolutionary innovations. But we used a word for them that we call sustainable innovations, which was on the last slide, because they're really important. Almost always, the established companies that are leaders on the left side of the diagram are still at the top of the industry when these battles to sustain innovation end.

And if you want to start a new business and you want it to be successful and you think you can beat the incumbents by making better products that you could sell for better profits to the customers' better competitors, they will kill you. And the evidence is actually very strong. It doesn't matter how big or powerful you are. If you think you can beat the incumbents in their market, they will kill you. And we could spend a lot of time on that. But there is another type of innovation that we call disruptive innovations. And disruptive innovations transform products that, in the middle, were too complicated and expensive.

Now, disruption makes it much more affordable and accessible for many more people to use those products or services. And almost always, the companies that enter usually win in the event of disruption. And that's exactly what Google did, right? Because advertising, finding clients and disseminating things... you had to have a lot of money to play that game. And then, its technologies and services made it possible for anyone to find what they needed, whether they were a buyer or a seller. And you changed the world by making it affordable and accessible. And none of the incumbents you defeated exist today, because the entrants usually win.

And let me describe why. So, living in Boston as we have for the last three decades, in the 1970s and 1980s there was a company called Digital Equipment Corporation. And at that time, digital was widely viewed as Google is now. It was the most admired company in the world. And when you read explanations about why they were so successful, the success was always attributed to the brilliance of their management team. Then around 1988, Digital Equipment just fell off the cliff and started to fall apart very quickly. When explanations were later read as to why they had stumbled so much, it was always attributed to the ineptitude of the management team.

And the same people ran the company. And for a while, I framed the problem as, Oh my God, I wonder how smart people can get so stupid so quickly. And that's really the explanation most people cite when a company stumbles. That somehow, a company where the management team acting together at one time was out of reach at another time. But the real reason the manager's stupid hypothesis just didn't seem right is that all the companies that made the same kind of computers were called minicomputers. They were about the size of this pulpit. All the companies that did that were killed in unison.

It wasn't just digital equipment. But it was Data General, Prime, Wang, Nixdorf, Hewlett Packard, Honeywell. And one would expect these people to occasionally collude to fix prices. But conspiring to collapse was an exaggeration. And trying to understand why they would do that was the puzzle we had. So when we understood it a little better, we realized that this minicomputer was a rather complicated product that had to be sold directly to the customer. and the sales processIt involved a lot of training, support, service and software. And you had to have a cost like that in the business to get in the game.

And that meant Digital Equipment had to generate 45% gross margins on computers that sold for $250,000. And that's how they made their money. Now, in his company, as in all companies, there were people coming in during the 1980s all the time with ideas for new products that they could develop. Some of them involved making better products than had ever been made before. In fact, these minicomputers would be so good that they could reach the market levels where people historically had to buy mainframe computers. You looked at those business models. They could generate gross margins of 60%. And you could sell the products for double the money.

So while management was trying to decide if that's what they should do, other people came in and said, ladies and gentlemen, you don't understand. Just look out the window. Everyone is buying personal computers, as was the case in the 1970s and '80s. But when management looked, they could actually see that everyone was making personal computers. But there were a couple of other things that bothered them a lot. The first: remember how bad those first personal computers were? Apple sold the Apple II as a children's toy. None of Digital's clients were even able to use a personal computer during the first 10 years they were in charge.

And then they didn't get any signals from their customers that the personal computer was important. Because it really wasn't like that for them. And then when we looked at the details of the business, it seemed much worse. Because these little computers only generated gross margins of 40%. And they were quickly heading to 20%. And those measly percentages could only be earned on computers that sold for $2,000. So the question management had to address was: Oh my God, guys, let's sit here. I wonder if we should make better products that we can sell to make better profits to our best customers.

Alternatively, maybe we should make worse products that none of our customers would buy and that would ruin our margins. What should we do? And it is a very, very difficult problem. And we call it the innovator's dilemma. Because doing the right thing is the wrong thing. And doing the wrong thing is the right thing. Can you think of where else you've seen this happen? When someone comes in with a simple product chasing customers who historically couldn't get access to it and then it just grew and killed the leaders? AUDIENCE: Mora. CLAYTON CHRISTENSEN: BlackBerry. Yeah, they just ended up sitting with a laptop.

And then Apple broke into BlackBerry. And now, Samsung and Huawei are in the process of revolutionizing Apple. It's a good one. Where else have you seen it? AUDIENCE: Drives. CLAYTON CHRISTENSEN: Drives. The big ones disturbed by the small ones. And then the flash disrupted the drives. And almost all of them are now out of business. That's a good example. It seems like you guys make a lot of money. And I saw Lexus outside left and right in the parking lot. But that was not how Toyota entered the United States, with the Lexus. Toyota came along with a rusty little subcompact in the 1960s called the Corona.

And it was much more affordable and accessible for the rebar of humanity, the people we call college students, to be able to own a car. And that's why they came here to make it affordable. And on the back end, General Motors and Ford made big cars for important people. And people would see Toyota come in. And Toyota went from Corona to Tercel, Corolla, Camry, Avalon, 4-Runner, Sequoia and then to Lexus. And as Toyota came in there looking for new customers, they said, "We should go find those bastards." And then they would design a Pinto or a Chevette and try to sell subcompacts in the market.

But then their finance people would weigh the money they could make on subcompacts against the profitability they could make by making bigger SUVs and trucks for even bigger people. It made absolutely no sense to defend the lower end of the business, when they had the opportunity to improve good products. Who is killing Toyota? By the way, they don't feel like they're being killed. AUDIENCE: It's probably... CLAYTON CHRISTENSEN: Yeah, the Koreans are just killing them on the low end. And Toyota is doing the right thing. Because why would they ever try to defend the lower end of their business when they have the privilege of competing against Mercedes in the upper end?

And then come the Chinese manufacturers. And seriously, we don't need to worry about them. And one of the reasons why this is so difficult is that what is emerging in this dimension, in the third dimension, is that it competes against non-consumption. Because the products are so expensive and expensive that there are no customers behind them. They are potential clients, but if you make it affordable and accessible. And so, looking at their world, they seem to be doing well. And that is why, almost always, you have to have a new company with new people who look in another direction.

Because you are competing against non-consumption by making it affordable and accessible. And that is why growth comes in this dimension. And we almost always find... AUDIENCE: Eh. So, I guess, do you have examples of companies that have successfully leveraged this notion of disruption and where they themselves, within their own company, have that disruption happen? CLAYTON CHRISTENSEN: Yeah, that's a great question. It turns out that there really are a few who have done that, where they were the leaders and then became leaders of the new wave without being killed in the old one. But only a few.

And in each case they succeeded: they created a completely independent business unit and allowed it to create a different profit formula and develop different processes. As a good example, IBM has just dominated the mainframe business. But there were eight companies that made mainframe computers. The other seven died when the minicomputer entered underneath. But IBM was successful in establishing itself... they manufactured their mainframes in Poughkeepsie, New York. And they made their minicomputers in Rochester, Minnesota. And there were nine companies that made minicomputers. Only one of them, IBM, was successful. And they did it by setting up a different business unit in Florida and having them figure out how to make products with 25% gross margins, instead of 40% or 60%.

Hewlett-Packard did it once when the laser printer was discontinued by an inkjet printer. And they set up inkjet separately in Vancouver and had their own sales force. And they did very well. But both companies are now in serious trouble. Because they have not continued with that of launching disruptive innovations and keeping them separate. So we have had three types of innovations, potential innovations, which we understand by understanding the work to be done; Sustained innovations improve good products; Innovations in efficiency help us do more with less. The role they play in growth is that they keep us competitive, but they reduce employment.

But they do create free cash flow. And that is why Wal-Mart is an efficient innovation. Toyota's production system is an innovation in efficiency. And again, they are important. Because if we don't become more efficient, otherwise we would get killed sooner rather than later. So this is a view of where the growth is coming from. So the first step is to understand the job and develop a product that does it well. And essentially, what that does is it puts us in the center of the market. And then disruptive innovations make products better and more accessible. So they create growth.

Sustained innovations improve good products. And efficiency innovations allow us to do more with less. And that is a manager's view of where growth comes from. Now, why are we not able to maintain growth? And I put the problem in the hands of the finance people who are taught finance at places like Harvard. So there are two elements that are quite important. One is a doctrine that they teach in finance and that we call abundance and scarcity. Now, what that means is that, if I have received an order from you, in order to deliver to you what I tell you I will offer, I have to order the necessary supplies.

And some of the inputs will be expensive and scarce, like platinum. And you have to be very careful with the use of platinum. And others are abundant and cheap, like sand. And I can waste sand. That's why we have to take care of what is expensive. And we can waste what is abundant. And you'll see that in finance, historically, we needed to carefully manage the use of capital, because capital was expensive and scarce. But now it is abundant and cheap. And the world has really changed for us. The second thing that finance gave us is that they decided that we should measure our success using ratios instead of whole numbers.

Now, when I studied finance in the 1970s, we were taught finance using whole numbers, like millions of dollars or tons of cash. But starting in the mid-1980s, shortly after Dan developed the spreadsheet, the analysts who picked it up began to worry because, as analysts, they wanted to be able to compare Cisco to Sun Microsystems. And they are different companies. And then, if I compare them with whole numbers, I don't make much sense. But they realized that if they measured success using ratios, then they could compare two companies that were not comparable. So if they want to compare you to Microsoft in whole numbers, it doesn't make sense.

But in fractions, it commodifies everything around the denominator. So fractions... I went back to my fifth grade math. A ratio is a fraction. It has the numerator and a denominator. So if I want to grow, there are metrics that we use. And one is return on net assets or RONA. And another is the internal rate of return, IRR. And these are fractions. So if I'm the manager and I want RONA to go up, sure, it could be more profitable if I were more innovative and put profits in the numerator of the index. But gosh, if that's hard, the denominator is assets.

And I just have to outsource everything to get assets out of the denominator. But either way, improving the numerator or decreasing the denominator, RONA goes up. And it turns out that it is easier to outsource than to make more profits. And so, in the pursuit of RONA, we outsource more and more. And then the internal rate of return is a ratio. The numerator is the profit. The denominator is: how quickly do I get my money out after depositing it? And either way, the internal rate of return improves by making the numerator or the denominator. And because it's harder to make a profit than investing only in things that pay off in the short term, more and more companies are investing only in projects that pay off in the short term, because that's how they increase IRR.

So what is happening to us as a nation, and I think you guys are temporarily doing a good job, is that we are losing our growth because of what finance taught us to do. So imagine I'm doing really good work on efficiency innovations. And that creates free cash flow. And we have so much cash that we have to ask analysts to tell us where we should put our money. Then analysts will analyze that disruptive story. And they say we should use our money to create disruptive companies. But the problem is that if we invest in disruptive companies, they pay off in five to ten years.

And then the internal rate of return will plummet. And if we start creating disruptive companies, we will have to put assets back on their balance sheets. On the other hand, if we use our money to make another round of efficiency innovations, they will pay off within six months to three years. There is no risk. The market is there. Create free cash flow. So if you don't mind just this once, what I'd like to do is use our money to make another round of efficiency innovations. And I do that. And the problem is that we have more free cash flow.

And we have to figure out what we do with all this stuff. So can we look at the analyst, let's say, just take another deeper look at disruptive innovations? And so he does it. And he said he, the problems are the same. If we invest to create disruptive products, they will pay off in five to ten years and the IRRs will go down. And RONA falls because it needs assets. So if you don't mind, I'd like to use our money once again to make another round of efficiency innovations. And the problem is that it creates more capital.

What are we going to do with all this capital? My God! And then, I do it again and again and again. And that is what has happened in our economies in Japan and Europe and, increasingly, in North America. Because we have chosen to measure success with these ratios, our analysts take that free cash flow and use it to create more free cash flow. And if you want to know what is going to happen to the United States, just look at Japan. Because in the '60s, '70s, and most of the '80s, the Japanese economy was growing at unprecedented rates.

And the reason they were growing was because they had companies in that economy that continued to invest.in disruptive innovations. So Toyota made affordable cars for humanity. Honda made affordable motorcycles for humanity. Sony made a 10-transistor pocket radio that allowed teenagers to listen to rock and roll. And the reason you have printers in your offices and homes is because Canon disrupted Xerox. But because they made things affordable and accessible, billions of people around the world were able to own and use things that had historically been out of reach. And that forced these companies to manufacture more products.

And that meant they had to hire more people to manufacture them, distribute them, sell them and service them. And for 30 years they had no economic recessions. They didn't have unemployment because they persecuted people who competed against non-consumption. And in the late 1980s, analysts in Japan began measuring their success as gross margins and net present values ​​and internal rates of return. And since 1990, in Japan, they have not yet generated a single disruptive innovation. And their economics just went “ppt.” It has been stagnant for 25 years. And they have capital everywhere. And the cost of capital is almost $0. And yet, they can't grow because of the metrics they've chosen.

And that's what worries me a lot about the United States. Increasingly, financial analysts force us to use our capital to create capital. And the cost of capital is almost $0. And yet, most companies are not organized to invest for growth. And you guys are doing a good job temporarily. Anyway, those are just some of the ideas we have about where growth comes from and how to deal with it. AUDIENCE: So for a company like Google, what metrics would you suggest to get out of this vicious cycle? CLAYTON CHRISTENSEN: Well, there is no metric that any analyst has developed or is motivated to develop.

Then there are analysts, like Moody's and S&P, any indicator they have is very short-term. They have their metrics about this year and next. But that's all. And we don't have a metric that allows an analyst to say that this company, 10 years from now, will be in very good shape. Because these are the products they have in the pipeline. And then you have to develop your own. It turns out that God didn't tell us to use those metrics. Someone decided to use those metrics. But it was not God who told us. So we should tell those, whoever told us the metrics, screw you guys.

Here is the metric by which we want to be analyzed. It's a great question. Yeah? AUDIENCE: So you started talking about how it takes a long time for the workforce to come back and it's because people are investing in things that give them more capital efficiency. And one of what I think is the biggest investment that you see here at Google is artificial intelligence. So if you look at humanity as a job to be done, before the Industrial Revolution you had to build or make things. And human muscles were a good way to do it. And in this decade that we're looking at, the work to be done is that people need to think about things and solve problems.

And human brains are pretty good at that. But now comes AI. It's cheaper. It is more scalable. What will be the jobs that humans will be able to do after this AI revolution? CLAYTON CHRISTENSEN: Yeah, that's a great question. These are just a couple of things that concern me in that initiative. So we might think, by analogy, that a driverless car as a technology is a complicated problem. If we focus on the California highway as an application for a driverless car, it is a very complicated application. And there are all kinds of legal issues that are fair... and the technology has to be quite sophisticated.

And maybe that will happen. Maybe not so. But we don't think about, if we change this, what are all the other things that need to change to allow this technology to develop? And so our theory says that where you have to look is on a farm. And John Deere has cordless tractors that go up and down. And the application is very simple. And almost always, when you try to make it affordable and accessible, you start with very simple applications and then little by little you keep doing it. But competing with non-consumption is really critical. So AI... what worries me is that, although we think it will allow us to be better thinkers at a lower cost, I worry that its applications are actually quite complicated.

And we don't think about that, what are all the other things that have to happen for our piece to achieve that? And then, it could be something big. But I bet that in the process, we will realize that we should look for simple applications. And that usually forces us to hire more people. But it's good. Because if we call it efficient innovation or disruptive innovation, there are big differences in terms of the result. Thank you. AUDIENCE: I just want to say, thank you for coming. Actually, reading his book was one of the reasons I did my MBA and ended up here.

CLAYTON CHRISTENSEN: Oh, gosh. AUDIENCE: So you had a pretty tangible effect on my life. But... CLAYTON CHRISTENSEN: Oh, you're nice. AUDIENCE: I want to see if you could help me clarify the way we talk about disruption in regards to the technology itself. And we have a couple of technologies at Google that could be considered, which are often called disruptive technologies, artificial intelligence, machine learning, that are largely being built internally in the organization. It is helping to improve what we do as a company and could be seen as sustainable innovation. And then we have autonomous cars, which are being treated (built in X, external) much more in line with the disruptive model.

So, is it technology that is disrupting? Or is it the application of technology? Is it the market effect that makes it disruptive? What is it harmful for? CLAYTON CHRISTENSEN: Yeah, that's a great question. It's actually very important that you say what you just said. Because in many ways I made a mistake by calling disruptive phenomena disruptive. Because there are so many connotations of the word disruptive in the English language. That's why there are a lot of people who call anything that is a dramatic improvement or a breakthrough... we call it disruptive. And that is not true.

Therefore, almost always, disruption is built within the company's business model, not through the development of the best technology. Because typically, you can take a technology and deploy it on a highway in California or a cornfield in Iowa. And how you deploy it determines how disruptive it is. And that's really important. And people say I'm a Jewish business mom because I'm always worried about everything. But I worry about you. Because I think you're very good at developing potentially disruptive innovations. But I don't think you care enough about the business models you have to build and then turn your technology into an application that competes against non-consumption.

And I think that's a very important concept. And I don't think I'm totally wrong about that. AUDIENCE: So I also want to start by praising your book. I think it is the best book I have ever read. And it's hard to think of anything else that has impacted my thinking so much. But... CLAYTON CHRISTENSEN: You're nice. You have low standards, but... AUDIENCE: Do you think so? Well, here comes the but. So I've been wondering this for a while. But how do you explain certain products that have transformed industries and toppled incumbents but do not fit into the framework of low-level disruption?

So off the top of my head, Uber, iPhone, Tesla, they all started from the top end of the market and work their way down from there. CLAYTON CHRISTENSEN: Yes. Well, let's look at them one by one, because they are all very good examples. So the theory would say that Tesla is a sustainable innovation, right? Therefore, they are at the top end of the market. And they are implementing it in a very demanding application, which is the California highway. And what the theory says is that they could develop the best product in the world. But if they go after the best clients of the leaders there, these guys will take advantage of everything they can.

And they will do everything possible to knock them out. Or they will acquire them. So in many ways you could think of disruption as a theory of competitive response. If I do this, what will the competitors do? And when Toyota came with the simple product, the theory predicts that Detroit will simply ignore them. And then what happened is that yes, Tesla is the best and has the best product. But Porsche has spent a billion dollars. And now they have a completely electric car. And you can smell BMW all around it. And then the theory could be wrong.

But the theory would say that these other guys will either kill Tesla or acquire them. And that's what it would be. But just as a $100,000 Porsche hasn't transformed the world, an electric car at that price really won't. And that's what the theory says. And Christine and I were in Beijing four weeks ago, walking down the street. And here's this electric car that was as wide as me. And if I had a passenger I had to fold it up and put it in the trunk. And it cost $2,500. And from there I believe transformative technology will come. Apple... there are a couple of answers to that.

But what allowed them to survive when they reached the top end of the cordless phone market is that they came to revolutionize the handheld industry. And they have destroyed the laptop. And that is why they have achieved it. If they had stayed and simply tried to compete against BlackBerry (they had the benefit for a while), BlackBerry had an architecture that was terribly interdependent. And then, you couldn't develop applications for it. And then Apple came up with... internally, it's interdependent. But there was a standard port, so applications could be developed. And that blew BlackBerry out of the water.

But of course, the Android operating system, Huawei and Samsung are simply killing Apple. Because they are being disruptive in the conventional way. So on average I think we can understand why it's happening. But sometimes it takes a few years instead of a few months. AUDIENCE: So what about Uber? CLAYTON CHRISTENSEN: Yes. AUDIENCE: The traditional operator is not going to acquire Uber. CLAYTON CHRISTENSEN: That's right. And he taught me a lot about the theory with Uber. So it is true. Well, first they came and broke up the black sedans. And that is unequivocal. But then they went down and are making a better product than taxis at about the same price.

And they have taken them out of the water. They didn't enter from below. And what we realized is that there is a correlation between reaching the end of the market and being successful as a disruptor. But the reason why that is correlative and not causal is that if you look at Uber's business model, taxi is asset-intensive. They own the car and the medallion. And its costs are intensive in fixed costs. And they just had to have these taxis on the road 24/7 in order to make money. And Uber's business model is that they have no assets. And your costs are all variable, not fixed.

And taxis can't actually get there from here. And so, in our thinking, we've decided that we don't want to say that they always start at the low end. But they have to develop a business model where incumbents simply can't get there from here. And that's what makes it disruptive. So I learned a lot from that. AUDIENCE: Thank you. CLAYTON CHRISTENSEN: You're welcome. Thank you. MATT: Okay, I'm going to read one of Dory. What did you notice in your own life or the world around you that inspired you to write "How Will You Measure Your Life?" And how can companies and institutions help their employees better measure their lives?

CLAYTON CHRISTENSEN: Wow. Thanks for your question. We will arrive at 3 o'clock. So can I answer this one? And for you, can we talk later? I'm sorry to do that to you. AUDIENCE: Yes, it sounds good. CLAYTON CHRISTENSEN: So the reason we wrote this book about measuring your life is simply because I described here how the metrics they were using caused them to spend their time and energy developing; They didn't intend to do what they actually did. And what I realized is that the reason they invested so much in things that made them fail was not because they were stupid.

But the process of allocating resources (the metrics) caused them to allocate their money in a direction they had no intention of going. Anyway, where I worked at Harvard Business School, the core competency of Harvard Business School is that we are very good at getting donations for our students. That's why, every five years, we invite all of our alumni to return. And we remind you to please bring your wallets. And we are very good at this. Since Christine and I have lived in Boston since I graduated, we have attended all of these 5, 10, and 15 year reunions. And I remember when we returned for our fifth meeting.

Oh my God! Most of my friends had married people much prettier than my friends. They had well-behaved children. And their jobs were going well. And everything we imagined to be true was unfolding as we thought. But then, I realized that by the tenth meeting, my goodness, a lot of people I expectedsee they did not appear. And when I asked mutual friends, where is so-and-so? More often than I ever imagined, the answer was that he's in the middle of a terrible divorce and he just doesn't want to talk about it. And by the fifteenth meeting, there were even fewer people.

And when he asked about them, most of the time it wasn't like that, it's either that he's in a terrible divorce or that his spouse remarried and now they're raising his kids on the other side of the country. And they just don't want to talk to anyone about how wrong life was. And then at meetings 20 and 25, it was really scary. And it was the same problem. I can tell you with absolute certainty that none of my classmates when we graduated from Harvard planned to go out and raise children who hated each other and divorced once, twice, or three times.

Our intention was to create homes where there was happiness. And it was a source of happiness for the rest of our lives. But that's what we intend to do. And the way we spent our time and energy was quite the opposite. And the reason is exactly the same. They are the metrics. So those of us who are driven to achieve, that includes at least 100% of us, when we have that need for achievement, then when we have an extra 30 minutes of time or an ounce of energy, we instinctively expend our energy . time and energy in any activity that gives us the most immediate and tangible evidence of achievement.

And our careers provide it. So every day at work I ship a product, finish a project, get promoted, get paid, and close another deal. And every day I receive immediate, tangible proof of my achievements at work. And then when I walk in the front door, there's not much evidence of achievement when you look at your kids. On a daily basis they misbehave every day. The place is filled with things every day. And it's really not until 20 years later that you're able to look at your children and put your hands on your hips and say, Oh my goodness, we created a wonderful young man or woman.

But on a day-to-day basis, there is no evidence of that. And as a result of that, we invest our time and energy in our careers and we don't invest enough in our children and our spouses, even though we plan for that to be the source of energy. And that's why I decided to write that book, "How Will You Measure Your Life?" Anyway...