What is a value network? What is the significance of value networks for innovation?
Value networks are the sum of producers and markets for the components of a product. They represent the value of each piece.
Read more about value networks and understand what a value network means for innovation.
Explaining Failure in the Face of Innovation
In order to explain why dominant companies often fail in the face of technological change, most experts offer two theories:
- The Organizational Structure Framework: Companies’ organizations, managements, or cultures can’t adapt to radical innovations that require different communication patterns and workflows.
- The Capabilities Viewpoint: Companies develop certain skills and knowledge from producing their existing products, and they stumble when a radically new technology requires a different set of skills and knowledge.
Although these theories help explain many firms’ failures, they don’t address what happened in the disk drive industry, where established firms adopted radically new technologies for various sustaining innovations, but they failed when faced with relatively simple innovations like the 8-inch drive. As we saw in Chapter 1, a major factor determining whether a company adapted to disruptive technologies was whether its customers were interested in the new technology.
A third theory—the theory of value networks—explains how customer input is part of a larger system that determines how companies respond to customer input, set and pursue goals, and react to industry changes, such as disruptive innovations.
What is a value network? Just about every product requires specific component parts—for example, a mainframe computer needs circuit boards, a central processing unit, and disk drives, among other things. Component parts, then, require their own component parts: Disk drives need disks, a motor, and a spindle. While some companies produce their own component parts, most buy them from various suppliers.
This creates a nested network of producers and markets. So, what is a value network? Each nested network represents a unique value network, because the chain of supply and the products being manufactured determine each component’s value.
There are two metrics that factor into a product’s value in the value networks. Let’s look at them in terms of a disk drive in a network producing laptops versus a network producing mainframes:
- Performance attributes: These are the traits that customers value in a product. For laptop manufacturers, the most valued attributes for disk drives are small size, durability, and low power needs. By contrast, mainframe makers value speed, megabyte capacity, and reliability.
- Cost structure: This is determined by a product’s overhead costs, production volume, and price point, and it dictates the gross profit margins manufacturers need to meet. Laptops entail high production volume in low-cost factory settings and distribution to retailers, thus laptop makers need only 15-20 percent gross profit margins to cover overhead. By contrast, mainframes require low-volume, custom manufacturing; direct sales, requiring a sales team; and ongoing tech support for customers, which means mainframe makers need 50-60 percent gross profit margins to cover overhead.
Value networks provide the context for an organization’s decisions and actions, including how it approaches innovations. If an innovation affects a product’s attributes or cost in a way that is highly valued within the value network, then the company is more inclined to pursue it.
The value networks framework illustrates why established firms are reluctant to allocate limited resources—including time, money, and personnel—to disruptive innovations, which have low value in both metrics:
- Disruptive innovations don’t have attributes that appeal to existing customers in the value networks.
- Disruptive innovations promise low profits because they are initially marketable only to small, emerging markets.
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