Four Market Disruptors

Does anybody remember the Diamond Rio PMP300? It  was one of a few pre-iPod digital music players, and although innovative, the device never achieved liftoff in consumer markets—confusing interfaces, minuscule memory and lousy sound are three reasons. Beyond that, Diamond Multimedia didn’t see the full picture of what digital music players could be—nor did Sony, which owned the category to that point. Steve Jobs and Apple wanted to change the world and accomplished that with the fully integrated, easy-to-use iPod.

Disruptive companies aren’t satisfied with grabbing a share of an existing market. They want to transform the status quo or build a whole new model. Jobs famously said he designed products that people didn’t know they needed but then couldn’t live without. Same thing with Xerox’s copiers, IBM’s PCs, Chobani’s yogurt, McDonald’s fast food and Starbucks’ coffee  stores.

According to Harvard Business School professor Clayton Christensen, who coined the concept of disruptive innovation, companies that fit the bill are characterized (at least initially) by “lower gross margins, smaller target markets, and simpler products and services that may not appear as attractive as existing solutions when compared against traditional performance metrics.” In other words, the products’ value isn’t immediately apparent, which can make for tough going early on.

But market disruption eventually is lucrative. Harvard Business Review reported that category creators make up just 13 percent of entries on the Fortune 100 list but are responsible for 74 percent of its incremental market cap growth. The four companies profiled here are disruptors that created new categories and spawned imitators.

Republic Wireless: Calling Wi-Fi

David Morken’s buzz cut gives him away: The Bandwidth co-founder and CEO, an Ironman and triathlon competitor, looks every inch of his Marine Corps background. He says Marine training—“keeping people on mission”—helped him aggressively build Bandwidth’s Republic Wireless division, which offers smartphone service with unlimited talk, text and data for $19 a month. With some customers saving more than $900 a month, disruptive pricing drove Republic’s marketing and growth.

“I started Bandwidth in my spare bedroom in 1999,” says Morken, who trained as a lawyer during his Marine service. “I thought at the time there was a better way for businesses to buy Internet connectivity.” It turned out there was—Bandwidth has more than 340 employees and is a $150 million business with four divisions (inetwork, Phonebooth and Broadband in addition to Republic Wireless). Republic’s innovation was to build a smartphone service that mostly works via Wi-Fi but transfers to Sprint’s cellular network when Wi-Fi is unavailable. “We’re around Wi-Fi most of the day at work and at home,” Morken says. “You don’t need cellular… 60 percent of the time; you’re on Wi-Fi,” but major carriers don’t discount for the cheaper Wi-Fi usage on your bill.

Republic does that with its $19-a-month deal. And it has additional plans, including a $5-a-month Wi-Fi-only phone service (great for parents who want their teens to have voice and text capabilities but want to limit Internet use outside the home).

In a crowded marketplace, Republic grabs attention with can-you-top-this announcements. For instance, it began offering the Motorola Moto X smartphone without a contract for $299 (you can split from Republic and keep the phone if you’re unhappy) in November 2013, when other carriers priced the device at $599. Moto X features a seamless transition between Wi-Fi and cell use.

To be really disruptive, Republic Wireless’s Wi-Fi strategy would have to evolve from tiny and questioned by some pundits to the new normal. Morken believes that’s on the horizon. “Eventually all the companies will operate this way. It’s simply a matter of when carriers make all calling and texting a hybrid experience.”

The hybrid experience isn’t seamless, though. Some calls get dropped when switching from Wi-Fi to cellular. And if phone choice is important to you—if you had to have a 5S iPhone the day it came out—then Republic, which limits phone choices (and offers no iPhones) isn’t for you.

Says Andrew Borg, a research director at the Aberdeen Group, which studies and analyzes IT companies: “Tier One carriers have been ripe for disruption and vulnerable for a long time. They’re complacent and not listening to the market.”

Republic is moving, with military discipline, to set the new standard.

SolarCity: Lease, Not Buy

Let’s consider the state of the solar industry before California-based SolarCity disrupted it. That’s certainly what the upstart company’s CEO, South Africa-born Lyndon Rive, did in 2006, when he huddled with his brother, Peter, and cousin, Elon Musk, to consider a new venture.

“The product people were buying was equipment—photovoltaic panels—which only a certain number of people can afford,” Lyndon Rive said. “People want to do the right thing, but they don’t necessarily have the capital.” Under SolarCity’s business model, the company installs, owns and maintains photovoltaic panels on the roofs of its clients—homeowners, schools and commercial enterprises. SolarCity makes money by selling the electricity that’s generated from those panels, although it charges clients a rate lower than mainstream utility companies.

SolarCity pioneered this kind of solar leasing and the option of panel installation with no upfront cost, Rive said. With consumers avoiding maintenance and depreciating equipment (panels cost 70 percent less than they did in 2008), “the choice became paying more for dirty energy or less for clean,” Rive said. (When your system generates more power than your building can immediately use, the excess flows back to the utility grid and your meter goes backward.)

That no-brainer choice has riled energy markets and led to rapid expansion beyond California. The company now serves 82,000 customers in 15 states and has 4,000 employees.

Although SolarCity’s leasing model is easy to explain and market, one enormous hurdle was securing the upfront capital necessary to get initial solar systems installed and paying off. “Since our business model is to install solar systems for free, we needed significant scale to get the business to the point where we could finance it,” Rive said. “That meant raising more than $3  billion over the last six years. There was skepticism that we could, installing 5- to 6-kilowatt systems one at a time, get to the point where we could install hundreds of megawatts at a time.”

SolarCity actually is installing large systems. On the Hawaiian island of Oahu, it is putting in a 15-megawatt solar array for the local utility that, over its life span, could reduce the island’s electricity-generating cost by $64 million and displace the use of 1.8  million gallons of oil per year.

Like many disruptors, Lyndon and Peter Rive are contemptuous of the old model they’re replacing. “We’re aiming to be the most compelling energy company of the 21st century, and we’re doing that by changing the paradigm of how energy is delivered,” says Peter Rive, co-founder and chief of both operations and technology. “The utilities saw solar as a fringe power source, but now look at the rate of deployment—we’re managing hundreds of thousands of power plants around the country.”

Brother Lyndon points out that utilities “hadn’t seen any competition in 100 years, and suddenly here’s a disruptive technology that gives consumers an alternative. They can either innovate and give better service or continue to cry wolf” about consumer-generated power. Sometimes they’ve done the latter, saying that alternative energy being added to the grid could destroy it, causing blackouts and ultimately raising utility costs. In reality, he adds, the amount of alternative energy on the grid has been steadily increasing without dire consequences.

Mainstream utilities also have fought or lobbied to weaken the so-called “net metering” laws that force the companies to buy excess energy generated by, say, solar and geothermal systems. The laws, which encourage adoption of clean energy in 40-plus states and the District of Columbia, often have caps on the amount of energy the companies are obligated to buy. Those caps have already been reached in some places such as Hawaii. Some of the laws, such as California’s, will expire soon.

Utility companies are expected to fight renewal. Alternative energy is “a long-term threat to their business models,” says Ethan Elkind, a climate policy associate at the University of California at Berkeley and Los Angeles law schools. “I find it hard to trust that utilities are doing all they can to accommodate solar.”

SolarCity shareholders don’t seem worried. The company went public in late 2012 at $8 a share but was more than $51 at press time. “It’s a very exciting time to be in solar energy,” Peter Rive says. “Back in 2002, there were high costs and high incentives. Now those incentives are going away, but costs have come down. We realized the subsidies had expiration dates, so our mission became to make solar affordable without them.”

Keurig: Brewing Success

“Brewing excellence, one cup at a time.” That’s Keurig’s marketing slogan, with emphasis on the “one cup at a time” part. It’s your coffee, when you want it, minus the measuring and mess. By putting coffee brewing on par with cracking a pop top, Keurig created a whole new beverage category.

Considering the percolator has been around since 1889—and electric coffeemakers were in American homes in the early 1970s—a revolution was overdue. Keurig, now a division of Green Mountain Coffee Roasters, patented its K-Cups (individual filter cartridges) in 1992. The consumer drops a K-Cup into a kitchen appliance, splashes in a cup of water, and presses the brew button. The drink of choice (coffee, tea or cocoa) fills your mug in seconds.

Harvard Business Review points out that a K-Cup of brew costs 50 cents, 10 times that of traditional methods, but “consumers are willing to pay for the speed and convenience.” And as Williams Capital Group analyst Marc Riddick told Bloomberg News: “K-Cups resonate well with consumers, and the product that resonates with customers is ultimately what wins.”

Green Mountain, which first invested in Keurig in 2002, wasn’t unduly worried when the K-Cup patent ran out in 2012. After all, the brand had become firmly established in 20 years. Anyone can now make a K-Cup clone, but good luck getting traction in the marketplace when Keurig means cartridge coffeemaker—the same way Crayola means crayons.

Green Mountain began a partnership with the largest coffee retailer—Starbucks, once a key competitor—in 2011. More than 850 million Starbucks K-Cups were sold in the first two years. When closing the deal, Howard Schultz, Starbucks’ chairman and CEO, observed that the premium single-cup category had grown nine times faster than the regular coffee market in the preceding year and had achieved a 25 percent grocery coffee share.

Brian P. Kelley, Green Mountain’s president and CEO, embraces the disruptive label, and sees “significant, untapped potential to continue to change consumer behavior.” Green Mountain didn’t just blunder into single-serving coffee. Launched at a Vermont café in 1981, it had grown into a high-end specialty roaster with products in supermarkets and restaurants by the early 2000s.

The company’s market research showed that customers wanted an easy way to make Green Mountain at home or at the office. And in 2002, Green Mountain sought to tap that market and grow with the Keurig acquisition (the purchase was completed in 2006) for a competitive advantage.

As Peter Skarzynski and Jorge Rufat-Latre noted in the Strategy and Leadership journal, a key to Green Mountain’s success was launching its branded K-Cups not in retail but in the workplace. Future customers could test the product at work “and become familiar with its benefits before spending $150 to buy the system for the home,” they said. Green Mountain nosed out other workplace beverage competitors by forging K-Cup alliances with Celestial Seasonings, Newman’s Own Organics, J.M. Smucker (owner of the Folgers brand) and Conair (Mr. Coffee), among others, and by buying rival coffee companies such as Diedrich and Van Houtte. The try-it-at-work first approach hit a home run.

Perhaps surprisingly, Keurig’s coffeemakers as well as its K-Cups are pricey. That’s a departure from the model embraced by companies such as HP, selling its printers cheap but mining gold in ink sales. Green Mountain, with coffeemakers that can cost $200, makes large profits on both sides of the equation.

Green Mountain’s net income was more than $350 million in fiscal 2012. And 2013 looked even better; in the third quarter, the company’s profits—assisted by lower coffee prices—were up 59 percent compared to the same period in 2012. K-Cup volumes? Well, they increased 21 percent from the same period in 2012.

Red Bull: High-Energy Marketing

After essentially launching the energy drink product category, Red Bull ingeniously marketed it as a thrill-ride-by-association on its website and in ads that mostly appear in social media and elsewhere on the Web.

Energy drinks were nonexistent in the West until an Austrian entrepreneur named Dietrich Mateschitz encountered Thai “tonic drinks” in 1982 and co-founded Red Bull in 1984. By 2004, energy drinks were a $2 billion market, with Red Bull owning 50 percent, followed by imitators Monster and Lost. Soft-drink sales were stagnant, but energy drinks grew 75 percent annually that year. The category grew another 60 percent from 2008 to 2012. U.S. sales of energy drinks and shots totaled $12.5 billion in 2012.

Today Red Bull (which had global revenue of $6.5 billion in 2012 and is sold in 165 countries) and Monster duke it out in the marketplace. Since 1987, more than 30 billion cans of Red Bull have been consumed worldwide, and the company employs 8,300 people.

Energy drinks are designed to do just what the name implies—give you “wings” to get through the day, and that explains Red Bull’s website. Instead of being a testimonial to how cool the product is—the usual approach with soft drinks—it’s a destination for content on adventure, music, surfing, snowboarding and skateboarding, and motorsports. “Red Bull is a publishing empire that also happens to sell a beverage,” Mashable says. Its universe “is extreme sports and adrenaline-junky stunts.”

And it goes well beyond the Web. Red Bull Media House, established in 2007, recently launched the full-length documentary film McConkey (about free-skiing and ski-BASE jumping pioneer Shane McConkey) with theatrical runs in New York and Los Angeles. Red Bull Media House produces content in multiple formats, owns an environmentally themed print magazine, TV production house and a record label, sponsors contests, and  more.

Red Bull’s marketing appeals by promising excitement for the consumer: If these competitors get energy from a silver-and-blue can, you can, too. Figuring out what marketing approaches work was and is something of a seat-of-the-pants operation. Mateschitz’s philosophy is that marketing requires “only a clear mind and bright eyes. Perkiness is the only prerequisite. Everything else you can learn quickly.”

The energy drink in the skinny can probably wouldn’t even exist if Mateschitz had listened to traditional marketers, who told him energy drinks had no future. The company encourages free thinkers and mixing business with play (it’s probably OK to compete in video games at your desk).

Red Bull’s formula may not be taught in business school, but there’s no arguing with success: The company both created and dominated its category. That’s disruptive, and it’s darned hard to do—especially in a field as crowded and entrenched as soft drinks.

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