China has slashed extreme poverty from some 66% in 1990 to under 2% today. Clayton Christensen, a professor at Harvard Business School, an expert on innovation and one of the authors of The Prosperity Paradox, says China’s prosperity comes from its market-creating innovations that have made products and services affordable and accessible. Christensen believes that other nations can replicate such success. In a conversation with Knowledge@Wharton, Christensen discusses what he calls the three types of innovation and why only one drives strong economic growth.
An edited transcript of the conversation follows.
Knowledge@Wharton: What inspired you to write The Prosperity Paradox?
Clayton Christensen: I was asked by the Mormon Church that I’m a member of to serve as a missionary in Korea in the early 1970s. Korea, at the time, was a desperately poor country. But over the next 30 years, Korea transformed itself from being impoverished to being very prosperous. I wanted to study that. Is there a process by which prosperity emerges, and can other nations manage this process as well? It took about 20 years for us to figure that out. The book is the result of that very long effort over many, many years.
Knowledge@Wharton: How was China able to reduce extreme poverty from more than 66% in 1990 to less than 2% today. Can other countries replicate that?
Christensen: We think that it is replicable. That is the exciting thing about the message of the book: That it does happen to some nations and not others. There really is a process by which that happens. The key element of the argument is innovation. Innovation is probably what I’m known for in my research in business. But it turns out that there are three types of innovation. One of those three types is the key to why China became prosperous, and right next door, Russia did not, and why Korea and Taiwan became prosperous, and the Philippines did not.
The first type of innovation is efficiency innovation. This helps companies make good products cheaper. They’re important in our economy because they help maximize free cash flow. But efficiency innovations don’t create growth. Because you’re always trying to make things more efficiently, it maximizes free cash flow but it causes you to minimize growth and job creation. In America today, much of the investment in growth is misguided because if focuses on efficiency innovations. Such innovations don’t create growth; they eliminate growth.
“Efficiency innovations don’t create growth. They eliminate growth.”
The second type is sustaining innovation. In this, you try to make good products better. Almost all the innovations that we see around us are sustaining innovations. This type of innovation also doesn’t create net growth for a corporation or for the economy. Imagine that I am working for Toyota. If I convince you to buy the Prius from me, you won’t buy a Camry. If I sell you this year’s product, you won’t buy next year’s product or last year’s product. So, sustaining innovations allow us to make good products better, but they don’t create any new growth.
It’s the third type of innovation that creates net growth for a corporation and for a country. We call these market-creating innovations. They transform products that historically were so complicated and expensive that only the rich had access to them. A market-creating innovation transforms them into products that are affordable and accessible so that many more people can own and use them.
I’ll give you a couple of examples. America is a very prosperous nation today. But prosperity hasn’t always been the case in America. If you go back to the 1850s, America was more impoverished than Bangladesh is today. The process by which we transformed ourselves is through market-creating innovations. The Singer sewing machine is a great example of this. Prior to that, if you needed to have a new piece of clothing, our mothers had to do it by hand. It took them about a day to make a piece of clothing — trousers or pants, or shirts, and only the rich could have more than one pair of clothing. When Isaac Singer developed his foot-operated sewing machine, thousands and tens of thousands of customers — and ultimately millions of customers — could own and use the sewing machine. The company had to hire more people to make the machines, it hired more people to sell them, and then more people to distribute and service the machines and to teach people how to use them. More than two million people became owners of these sewing machines, first in America, and then around the world, because Singer made these machines affordable and accessible.
Similarly, Henry Ford made cars that, at the beginning, were available only to the wealthy. By making cars affordable and accessible, millions of people could own them. But it wasn’t that Henry Ford had to only make the car. He had to find somebody to provide the steel. He had to create a network of dealerships that could sell and service the car. For every person that Henry Ford sold a car to, he had to hire in his system eight more people to do all the things that were inherent in this market-creating innovation. So, there is a causal mechanism. First, you make a product or service affordable and accessible, and then you set up a system to service those people who now are enabled by this affordable product or service.
Knowledge@Wharton: When a new innovator comes along, is it possible to identify up-front whether the innovation is going to be market-creating, or one of the first two kinds? Or is this something we can only learn in retrospect?
“Sustaining innovations allow us to make good products better, but they don’t create any new growth.”
Christensen: You can see it happen as it unfolds. There’s another concept in the book that’s called “jobs to be done.” When you go outside in the morning, you look around the neighborhood, and you realize, “Darn it, there’s a job that I have to do today.” Some of these jobs are small, incremental jobs that occur over and over again. Others are big problems, or big solutions, that cause you to do a lot of things differently. Whenever we have a job to do, we look around and try to find something that we could buy or use and pull into our lives in order to get these jobs done. In order to understand that there is an opportunity for an efficiency innovation or a sustaining innovation or a market-creating innovation, you only have to watch what people are trying to pull into their lives in order to get it done. You only have to watch what people are trying to do. It gives you the opportunity — the ideas — around which you can create new products.
Isaac Singer was surrounded by people who paid very high prices for clothing and [he spotted an opportunity in that]. If you look around us now, smartphones are everywhere. If you watch what people are doing, it’s not that they are trying to get photographs for posterity. But rather, they are trying to communicate better with people. All the devices in your hands exist because people were earlier writing letters and that was complicated, expensive and time consuming. Now we can communicate with each other in ways that are affordable, accessible and efficient.
Knowledge@Wharton: Why do market-creating innovations do more to foster prosperity than attempts to fix poverty? Could you explain the difference in the long-term effects?
Christensen: Market-creating innovations create growth because they have to create the infrastructure. Let me give you example of a product in Nigeria called Tolaram’s Indomie Noodles. This was started by a family that came from Indonesia to Nigeria. In Asia, noodles are an inexpensive and simple way to get a meal. But in Africa, noodles were viewed as worms. There wasn’t a market for noodles in Africa. This family constructed a noodles factory in Nigeria and they developed a recipe that was tailored to products that are common to Nigeria. But they found that every batch of flour that they bought from the farmers in their area was different and therefore every product that they shipped was different in some significant way.
In order to control the quality and consistency of the flour, they had to buy a farm. Then they found that there were no dealers to sell their product. So they had to create a system of dealerships. Then they found that they didn’t have people who knew math and English. So they had to create jobs to teach this. They also had to build their own roads and bridges around their factories in order to ship their products. And in order to control corruption at the ports, they had to build their own port. And so, in order to sell their noodles, they had to build an entire infrastructure.
Knowledge@Wharton: Why has this approach of building prosperity through market-creating innovations been overlooked in the past? What do you see as the main barriers to its adoption today?
Christensen: I think the core reason why market-creating innovations haven’t been the key to better growth is that managers need to have a different way to frame the problem. By framing it this way — market-creating innovations — it doesn’t cause people to demand different behavior as much as these are things that people are trying to do anyway. But by making it affordable and accessible, many more people have access to it. It’s a simple concept that allows us to do more. [Empowering] people to do what they’re already trying to do — that’s the key to innovation in every industry.
“Market-creating innovations create growth because they have to create the infrastructure.”
I have an example of the challenge. Companies like Shell, Gulf, BP and others go to Africa and drill oil and then they ship it to the Western nations. And every time they put an oil well into the ground, they engage in efficiency innovations so that they need to employ fewer people. Their purpose is to drive down costs. That’s why these companies don’t create growth or jobs — because that’s not their purpose. Their purpose is to eliminate jobs. This helped us understand why, when we compare China with Russia, their outcomes are very different. Most of the innovation that’s driving China’s growth has been around products. Products that were earlier complicated and expensive have now become affordable and accessible, like the Haier refrigerator, for instance. In contrast, Russia has focused its economy on efficiency innovations. Oil is a big one. Gas is a big one. But their innovations are eliminating jobs. And so, you see Russia is struggling to grow, and China is awash in growth opportunities.
Knowledge@Wharton: Where do you see the most promising market-creating innovations today in the U.S. as well as in other countries?
Christensen: I’ll go out on a limb and anticipate something that might happen, and that is in electric cars. The U.S. firm Tesla makes really nice cars and they sell those cars for $80,000 to $100,000. Tesla competes head-on with BMW and Mercedes and other large corporations. We call this a sustaining innovation. They try to make good products better, but they don’t create growth. That’s not their purpose.
In China, you can see electric cars everywhere. These cars are priced at $4,000. They are made out of plastic and they are very narrow so they can easily squeeze in and out of the markets where their owners sell their day-to-day supplies. While Tesla sells a few hundred electric cars, in China they’re selling hundreds of thousands of electric cars. There will be a booming market for electric cars in the world, but those cars won’t come from Tesla. They will come from China where they’re making them affordable and accessible.
Knowledge@Wharton: Towards the end of the book, you write that the Prosperity Paradox should become the Prosperity Process. How can this happen, and who should make it happen?
Christensen: The challenge in every corporation, and every university, is the process by which resources are allocated. Most corporations’ research allocation processes allocate capital to products or services that maximize the net present value of sustaining and efficiency innovations. Even if executives want to create new opportunities around the world, their resource allocation process doesn’t allow them to do it. So, managing the resource allocation process, the mechanism by which they prioritize market-creating innovations rather than efficiency innovations, is key. You have to manage that process year after year with these criteria in mind in order to be successful.