Six Red Flags of Vulnerability for Tech Businesses

Disruption is a constant across technology sectors.  Whether it’s SaaS stealing share from traditional software businesses or “sharing economy” apps killing traditional services industries, disruption is everywhere.  If you are an executive in a technology business, you need to not only be thinking about what disruptions your company can spearhead, but also to be ever vigilant about where and how your company might be a target of disruption. Here are six red flags of vulnerability for any tech business.

Disruptive Innovations

There are many examples of disruption across technology sectors, with huge implications on industry revenue and market capitalizations.  The following table highlights a few examples:

Disruptors	Company Story	Industry Changes
Google	Google’s search-based advertising platform transformed the industry by making ads extremely targeted, market priced, and performance based. It achieved a market cap of over $450 billion within 16 years from startup.	Since its mid-1990s inception, internet advertising has mainly risen at the expense of print. Between 2003 and 2013, the internet’s share of global advertising rose by 17%, while newspaper’s share fell by 14%.
Salesforce   Trending The Denver Auto Show and the Rise of Smart Car Technology	Salesforce’s SaaS model transformed the ERP industry, reducing many traditional expenses and complexities of enterprise software implementations. Salesforce first targeted smaller businesses with a less expensive user friendly product that was initially ignored by incumbents SAP and Siebel.	As a result of Salesforce’s SaaS model, traditional software companies began to shift away from large upfront licensing fee options to adopt more of a “pay-as-you-go” or “pay-as-you-consume” model. Many incumbents either exited or purchased cloud services to compete.
Airbnb	Airbnb, founded in 2008, shifted demand away from the hotel industry. Its marketplace allows anyone, from private residents to commercial properties to rent out excess space. The site features rentals in 190 countries and recently acquired $2.3B in funding, with a $20B valuation.	Airbnb achieved an estimated 155 million guest stays in 2014, nearly 22% more than Hilton Worldwide, which had 127 million guest stays in 2014.

How do you know if your company is vulnerable to disruption?  In Waterstone’s experience working across tech sectors, we see certain red flags that are hallmarks that a business is ripe for disruption.  Following are six such red flags:

1. Abnormally High Margins: Are the operating profit margins in one of your businesses significantly higher than your competitors’ or those in other parallel industries? If so, you are vulnerable. You can bet that new competitors are looking at those margins and trying to figure out how to disrupt your business; more than likely some of your customers will be susceptible to a new offering at a lower price point.  Examine each major source of your profits and ask yourself, “Could a competitor have a sustainable business at 50 percent of our margins?” Amazon founder Jeff Bezos famously quipped, “Your margin is my opportunity.”Example: Famous for 60+ percent gross margins on shaving products, Gillette has been disrupted by subscription-based start-ups like Dollar Shave Club that offer very similar products at less than half the price.

2. Stale Technologies in a New Technology World: Is there an open technology movement afoot in your industry? Do you have proprietary technology, perhaps that you’ve underinvested in, that hampers your customers’ choices? Are new technologies reshaping similar industries (e.g., proprietary hardware giving way to software on commodity hardware)? If so, you are vulnerable to disruption by a new technology gaining traction.

Example: In the mid-1990s, the market for proprietary servers (with an average sale price of $80,000) rapidly collapsed with the introduction of commodity x86-based industry standard servers, priced 85% lower.  Within a few years, the average sale price for proprietary servers had been cut in half while the volume of industry standard servers grew by 10x.

3. Unserved Low-end or Niche Market Segment: This is the classic “Innovator’s Dilemma” that Clayton Christensen examined. Is there a set of customers with lower/different needs and profit margins that your company has decided against serving because they are unprofitable and would distract from your core, higher-end customers?  If so, you are vulnerable to being disrupted by a challenger who can figure out how to serve this segment’s specific needs with a lower-cost, less-comprehensive offering.Example: Salesforce initially targeted the low end of the CRM market with a simpler, lower-priced SaaS offering, while incumbants were offering unneeded complexity at higher prices, justified by other market segments.

4. Privileged Access to Supply or Customers: Do a select few companies in your industry control the supply of goods sold? If so, you should be wary of challengers seeking to upend that paradigm, either by breaking down the barriers to entry or expanding the supply in previously unthought-of ways.Example: Airbnb and Uber leveraged technology and peer-to-peer sharing to increase the supply of hotel rooms and taxis, respectively.Similarly, if your industry has gatekeepers who control distribution to customers, look out for  challengers bringing a more open model to the market.

5. High Level of Coordination Required Between Stakeholders: Does your industry rely on complex interactions between different parties or a high degree of coordination within your customers’ organizations? If so, you are vulnerable to disruption from a challenger introducing a new paradigm with a new technology, which either automates the coordination or addresses the segments that do not require coordination to the extent that existing solutions provide.Example: Credit card payments, which have long required a complex set of processes, have been challenged by simpler peer-to-peer transfers enabled by PayPal and Square, among others.

6. Extremely Fragmented Industry: Are there a lot of niche players and not one company that determines the direction of the industry? If so, you may be at risk of displacement by a larger entrant offering better products and/or pricing enabled by economies of scale, often made possible by the internet. While historically a diverse set of competitors might have evolved based on geography or a small set of similar customers, connectivity and the rise of platform technology is breaking down those barriers.Example: Smaller niche retailers were disrupted by big box stores, which were in turn disrupted by national/global e-retailers.

Be alert to these red flags.  Ensure that your planning processes specifically address these potential harbingers of vulnerability.  And, once you find a looming disruption, address it head on through focused analysis and a deliberate decision to ignore, fight, or embrace the disruption.

Eric Pelander is a partner and co-founder of Waterstone Management Group, a consulting firm that advises technology investors and senior management teams of technology-led clients on strategy and related execution initiatives. Eric’s personal work with clients has focused on growth strategy and execution, including go-to-market and services improvements. Chris Kammerer is a manager at Waterstone.

Photo credit: TopRank Marketing