Disruptive innovation and sustainable development

When companies work on sustainability they are rarely inclined to contemplate the structure of their current business model. Any action related to sustainable development needs to fit within their current system of activities. Changing the model to become more sustainable is usually not worth the investment in the short and medium term, and is thus not pursued. Rather, companies prefer to work on incremental changes to improve on sustainability where they can, steering well clear of the root of the problem which lies in the impact that flows from their current business model design. What is the reason that companies seem so unwilling to opt for radical change, even if it were for the better? With this blog I would like to share some thoughts.

Value networks determine which business models apply
Part of the answer is revealed through Clayton Christensen’s theory of disruptive innovation and the role value networks play. A value network comprises of interdependent value chain actors, from sourcing to marketing. This network of actors is pieced together to provide for the product or service features, which are defined by carefully listening to customer demand (which ultimately closes off the value network). The value network is thus the context within which the firm responds to customers’ needs.

All activities by each member in the value network, are geared to deliver on the requested product features as efficiently as possible. A value network knits all the different business models of all the participating value network members together. In practice the interrelations can be so strong that the composition of a value network is formed as a hierarchy which mirrors product or service architecture.

This value network is visualized by Christensen as a nested system, where each part of the value chain fits into another one like a Matryoshka doll (original can be seen in the Innovator’s Dilemma, 38-39). I’ve made a slight alteration to Christensen’s figure by drawing out one for the agricultural system, changing its shape to show how different uses, or purposes for the use of agricultural production [food, non-food, fuel] shape the hierarchy of a value network.

If you consider the value network of local food, then you are dealing with something totally different than when you’re looking at value network that belongs to conventional agriculture. It’s just not possible to take out one part of the value network you don’t like (eg. lack of scale in local food distribution), and replace it with a bit that you do like from another system (large distribution from conventional agriculture). Most companies are thus “locked” in their interdependent value network, and couldn’t change their business model to become more sustainable even if they wanted to.

Christensen describes this impossibility very well by analogy to the components of computers, where components belonging to the mainframe computers (physically) can’t fit into the architecture of the mini computer. Both technologies, even though the same in nature, belong to very different value networks. The upshot is that value networks can only keep innovating along the same line of improvement of those business models that befit their network. This is what Christensen calls sustained innovation. It could provide part of the explanation of why companies usually prefer to stick to incremental change when it comes to sustainable development.

Value system order determines how business models deliver on sustainability
Through disruptive innovation it is possible to challenge existing value networks and replace them with new networks with new business models. However, you often see that these disruptive business models are no guarantee that business will deliver on sustainability.

In order to understand why value networks, even though they can be disrupted, will rarely changes in terms of delivery on sustainability, we need to consider a second value system layer: one which expresses the overall order of values which permeate throughout the value network. Let’s call this value system order. I have taken the liberty to use the figure below to depict value system order, taken from the MIT Sloan Management Review. Again, the value system order is a nested system. Ideally the sustainable value system order consists of a well-proportioned spacing between the values of economy, society, and the environment like the one below.

 

If the value order prioritizes economy over the environment, like for instance in conventional agriculture, the order will look different, something akin to the next figure on the left. Any choice made for business model innovation in this order of values will result in this proportion of delivery on sustainability, regardless of whether we’re talking about sustained innovation, or disruptive types. If you look at the design order of a contrary example, a national park or reserve, then sustainability will look something like the figure on the right. The choice here is always for models which take lots of environment into consideration, link to society but more limitedly so, and the economics of it all is quite negligible.

The main point is that the value system order provides guidance for the designing the hierarchy that you want to implement in the actual value network that operates the value chain. Each value system order will result in a corresponding set of value system hierarchies and business models, which deliver on sustainability according with the proportion of the order.

Redesign of value system order and the value network makes or breaks sustainable development
If you look at the relation between the role the value network plays in business model innovation in combination with the value order proposition, we can now argue why existing industry finds it so difficult to deliver on sustainability. They might be willing to reconsider the value order (commiting themselves to sustainability covenants, like the World Business Council for Sustainable Development), but they soon find that they are not  ready or able to disrupt their own value network with a different network design hierarchy that will deliver on sustainability in line the with desired value order.

So what might be the alternative? Though still a budding sector, the alternative might lie in the social entrepreneurship sector. Social entrepreneurs practice innovation alchemy, where new business models are designed from an uncompromising value order perspective, but fully flexible in the design of the corresponding value network. This article in Forbes explains along these lines how social entrepreneurs are hacking capitalism. In practice you will find that social entrepreneurs are using their alchemy in an attempt to disrupt incumbent value networks, and replacing them with more sustainability oriented ones.

Regardless of the promise of social enterprise, sustainable change in any case, even from incumbent industry, will need come from the same process. This is a process where firstly a clear sustainable value order is chosen, through which new value network hierarchies are consequently designed that are able to challenge the old capitalist system. Combining both will create the type of disruptive innovation which is needed to transform an industry’s practice to a more sustainable design.

Take away points:

–       incumbent firms are often locked in value networks that prevent them from innovating towards more sustainable business models

–       disruptive innovation does change value network designs, but they are no guarantee in themselves for sustainable development

–       sustainable market transformation will more likely come from companies that adopt well-balanced priorities between economy, society, and the environment, and accordingly create scalable and replicable business models that are able to disrupt an industry’s status quo

–       it is more likely that those companies will be social enterprises than existing multinational publicly listed enterprises.

Tipping points, sustainability overhaul, and business model design

When grand visions are presented on how business could develop sustainability into the mainstream, often the metaphor of Malcom Gladwell’s Tipping Point is used. The World Wildlife Fund’s (WWF) vice president of market transformation, Jason Clay, has worked out the most famous application of this theory to the domain of food and agriculture in relation biodiversity conservation. In short this work argues that there are 15 key commodities which impact biodiversity and that 70% of those key commodities are under influence of a limited group of 300-500 corporations. This fact underlies the foundation of the WWF’s theory of change for business enagement, where the WWF has selected to work on mainstreaming sustainability with the top 100 influential branding companies that control 25% of trade in key commodities. Through working with reputable brands, which have a high level of public exposure, WWF hopes to push the system to a tipping point in environmentally responsible global commodity production and trade by 2020.

In order to transform production practices for these commodities to be environmentally responsible, the WWF strategy proposes to work with product labeling backed by independent third party certification. The idea is that labeling will allow branding firms to profile themselves as responsible companies, and distinguish their value proposition from the conventional product. For farmers, the hypothesis is that environmentally responsible production practices, prescribed by certification schemes, entail lowering the use of costly pesticides and artificial fertilizers which burden the environment. In short, certification’s proposition is that the tipping point to mainstreaming sustainability will be reached by creating value for brands, and by reducing production costs for farmers.

Constraints in market transformation
This is certification’s promise, but the true effect is currently under much discussion. Research is working very hard on conducting impact evaluations on certification. Despite the fact that there is no convincing evidence yet of whether certification works or not, there are two tell-tale signs that certification alone won’t drive the system to its tipping point:

  1. certification is costly and the rate of return to producers is low. Certification entails making investments, changing management practices, and paying for auditing activities by expensive consultants. These are all costly activities. To stimulate producers to change their ways, the rewards of certification should be crystal clear, but the figures I’ve seen (unfortunately always off the record…) indicate towards a zero-to-no returns*.
  2. certification has to overcome this business model design flaw that currently contains most value capturing with the downstream corporations in the value chain. However, certification does not promote business model innovation to overcome this constraint in value distribution. To the contrary, certification schemes are designed in such a way that they can be used as a plug-in in existing business models.

Currently there is a very limited group of top tier producers for whom the value proposition of certification works through the existing business models of the top 500 companies. Consequently, these companies are competing amongst each other for sourcing from this top tier of producers, because they produce the highest quality, and are most productive.  Yet the value proposition of these existing business models is least attractive for the bulk of the producer population (generally consisting of smallholder farmers), which produces the lion’s share of the world’s food. We thus face the contradictory situation that the group which can contribute most to environmentally responsible production is excluded from the market under current business models, and that certification schemes have no power to reach out to these groups.

Business Model Design and experimentation
The WWF sustainability mainstreaming strategy is a valid one to follow. However it is confronted with operational constraints due to design flaws in the adoption of responsible practices by the agricultural population under operations of current agribusiness models.  It is evident that new agribusiness models need to be developed, which effectively integrate lower tiers of producers, and encourage them to up their game by allowing them to capture more of the value which is generated. Companies should be encouraged to purposefully experiment with business model innovations which could make certification practices work, rather than stick to their existing business models. Business model design should be employed to pivot new ideas, and validate what works and what doesn’t.

Business Model Innovation = Substantial Rewards
Just as in the oil and gas industry, where more difficult to capture oil and gas wells are becoming feasible to exploit in the wake of scarcity, it will also become rewarding to find ways of tapping into the productive resource of smallholder producers. Companies that succeed in innovating in profitable new business models that include lower tiers of producers will create a first mover advantage for themselves in the wake of the battle for agricultural commodities under a continuously growing world population.

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* In some cases producers are forced to stick to certification standards by making trade conditional on compliance, even is there are no returns. Under these conditions it is often more rewarding for producers to find creative ways of tricking the auditor into believing that they are complying to more responsible practices, rather than actually adopting them.

Acknowledgement: The farmer population pyramid and competition for the top tier farmers was shown to me by David Croft, sustainability director at Kraft Foods, during a business modeling workshop in 2011 on firm strategies and labor impact.

More on the WWF’s strategy of supporting big brands as presented by Jason Clay at this TED conference in 2010: