Japan’s Seeds of Disruption

The phrases “disruptive innovation” and “disruptive business” are thrown around far too often and far too loosely these days. Of course, at first glance, it would seem that the same charge could be leveled against this podcast. This is a special one-on-one episode where we talk about what disruptive innovation really means.

We examine how Japan went from being the world’s engine of disruptive innovation to being the developed nation most resistant to disruption. Most important, we show you how things are starting to change. A small handful of entrepreneurs are, perhaps for the very first time in Japan, embracing the spirit of disruptive innovation. And these startups will be the key to Japan’s next economic boom.

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Show Notes for Startups

• What disruptive innovation really means
• Why well run companies can’t adopt disruptive innovations
• How Japan moved from a disruptor to a defender
• The first Japanese entrepreneurs
• How Rakuten started out by playing nice, but now wants to disrupt
• Why mobile gaming is not (at all!) disruptive
•  The social challenge inherent in embracing disruption

Links and Resources

• The Innovators Dilemma (Required Reading)
• Clayton Christensen’s Home Page 
• Rakuten
• Gree
• DeNA
• Mixi (Japanese)

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Transcript from Japan

Welcome to disrupting Japan. Straight talk from Japan’s most successful entrepreneurs. I’m Time Romero and thanks for listening.

This week due to a long holiday break and a bit of a technical malfunction I’ve got something special for you. Rather than our usual interview, it’s just going to be you and me today.

I want to take the next 20 minutes to talk about Disruptive Technologies, disruption in general and about the importance of disrupting Japan.

Now before we get too far into this I need to explain something about disruptive businesses and disruption in general. Most of the time when people use the word disruption today they are using it in a way that is annoyingly frustratingly incorrect. In the immortal words of Inigo Montoya, you keep using that word. I do not think it means what you think it means.

In the startup world, disruption has become a fashionable overused and almost meaningless word. Founders recently described their to-do apps or restaurant recommendation sites as disruptive. But, disruptive does not mean innovative. It doesn’t mean cutting edge. It doesn’t even imply that an idea is good.

So, before we move forward with today’s story about disruption in Japan we need to take a few steps back, and to look at what the term disruption really means, and to understand disruptive innovation we need to go back to the source.

The term disruptive innovation was first defined by Clayton Christiansen in 1997 in his Seminole work The Innovators Dilemma. In perhaps overly simplified terms the defining feature of a disruptive innovation is that it extends an existing market to allow a new segment of the market or a market niche access to a product or service that they didn’t have previously.

It opens up a niche that was not or could not be addressed by the existing market players. Now these market niches are usually small and low margin at first. But as technology improves and the market develops sometimes these niches have the potential to grow much larger and larger until they completely displace the old way of doing things and become the dominant force in the market.

In the Innovators Dilemma, Christiansen provides case studies from disk drive manufacturers to excavation equipment. But, a clear on topic example for us might be the introduction of digital photography. Both Kodak and Fuji film have powerful patent portfolios in this technology. But neither one wanted to address this low margin, low quality market until it got big enough. And by then it was too late. They could not catch up with the new market leaders.

People often think of automobiles as the classic example of disruptive technology. But it is important to remember that in 1900 cars had been in production for decades. There was nothing particularly disruptive about them. Until Henry Ford figured out how to produce them so cheaply and reliably enough that many workers and farmers could afford one. Then the automobile truly began to displace animals as a source of power.

It’s interesting to note that the Japanese auto and motorcycle makers disrupted the same industry in the 1970s by introducing un-glamorous small inexpensive but very high quality products, and then moving up to the more expensive models. U.S. action in the 1980s and 1990s is the only reason Harley Davidson and U.S. Auto Makers survived this disruptive innovation, and eventually got back on their feet.

The computer mainframe industry was disrupted by desktop computers and the desktop industry is being disrupted by mobile devices. Quartz watches resulted in firms that have been world leaders in chronography and mechanical timekeeping for centuries, being permanently redefined as basically makers of niche jewelry.

A disruptive innovation is one that has the potential to redefine an industry, to destroy not only the market leaders, but to destroy most of the ecosystem that has built up around them in that industry. August firms will disappear, value change will be rendered irrelevant, fortunes will be made and lost. But something more effective will take its place in the long run.

Disruptive innovation is shiva like in its mechanism of creation and destruction or perhaps, a bit closer to home, Godzilla-like.

Now, fans of modern Japanese history will spot an irony here. Japan’s post war expansion was built on the disruption of many industries, cars, motorcycles, timekeeping, transistor electronics, cameras. From the 1960s to the 1980s disruption was Japan’s secret weapon.

So, what the hell happened? How did an economy with its roots in disruption become after only 50 years the world’s developed economy most resistant to and most in need of disruption?

Well, it’s actually not that surprising. In fact, it’s what usually happens. Once a company becomes large and powerful a different dynamic takes hold. If you want to advance your career at a large organization whether you are in sales or product management, you want to be working on the biggest most important product that company has to offer.

You want to be in charge of the divisions selling hundreds of millions of dollars of product to Fortune 100 clients. You want to be the one being interviewed in trade magazines. You definitely don’t want to be stuck in some backwater division earning half a million with terrible margins and struggling to find customers.

If times are hard and you need to cut back on something you are certainly not going to cut back your main revenue generators. Now, whether you are talking about powerful companies or powerful countries the same dynamic comes into play. Smart, well-informed people making rational decisions are unable to act on disruptive innovation. Even when they know it’s coming. And that is the heart of the Innovator’s Dilemma. That’s why it’s a dilemma in the first place.

I want to point out again that labeling something as disruptive is not a value judgement. It doesn’t mean it’s good or profitable or cutting edge. In some ways it’s most a statement about the fortunes the innovation will destroy rather than the fortunes the innovations will build.

Facebook was not disruptive, but Uber is. Tesla is not really disruptive, but Toyota in the 1960s was. And self-driving vehicles will be in the future. In warfare drones are not, at least not yet disruptive, but terrorism is.

One thing you will notice is that disruptive innovation almost always has to come from the position of market weakness rather than market strength. It needs to come from the bottom up. And Japan, because of both its hierarchal nature of society and the importance of consensus and decision making has a particularly hard time with bottom-up change, and yet for the Japanese economy to thrive or even to continue to grow sustainably at all there needs to be a mechanism for disruptive innovations to take root and flourish. There needs to be a way of disrupting Japan.

And the good news is that it’s already starting to happen. But we are getting ahead of our story. For now, let’s step back quite a few years into the roots of Japanese business and entrepreneurship. Now, several of my American founder friends are in the habit of pointing out that ever business no matter how large or powerful was once founded by someone.

And in the strictest sense I suppose that’s true. But in Japan very, very few of these firms were actually founded by an entrepreneur at least in the modern sense of the word. Most of today’s large Japanese firms while they certainly have a founder grew and run under government charter or at least guidance.

For hundreds of years and until very, very recently the Japanese government largely decided which industries were important, how many firms should compete in each one and the government endeavored to keep competition from shall we say getting out of hand here in Japan.

Loose cartels and industry associations fine tune pricing and product availability and tight vertically integrated supply chains and distribution networks prevented both foreign and domestic startups from disrupting the flow of things. So, while Japanese industry made its fortunes disrupting markets all over the world they put in place a system at home to protect domestic markets from disruption.

Naturally the post war era saw few true entrepreneurial companies, Honda and Sony being the most famous. Now these two firms were not among the governments chosen firms. And they had to fight for their market share both at home and abroad. And while both Honda and Sony were masters of the disruption gave overseas they were careful to play by the rules in Japan.

Honda and Sony were first tolerated in Japan and after success overseas they became quite respected here. But, they never really achieved the reputation domestically that they did internationally. Both Honda and Sony were great companies founded by larger than life entrepreneur. But they knew how the game was played. And they made no attempt at disrupting Japan.

Now, let’s jump forward to the dot com boom of the late 1990s. Here we saw a lot of new startups founded by modern entrepreneur, but very little actual disruption. One of the most successful companies to come out of that time was Rakuten for hose of you overseas who might not be familiar with it. Rakuten is by far the largest e-commerce shopping site in Japan.

Rakuten was not originally a disruptive company. In the late 1990s there was a large open green field of e-commerce. NEC didn’t want it. Fujitsu didn’t know what to do with it. Mikitani said “mine”. He elbowed the smaller more poorly funded competition out of the way and the man built an empire.

Mikitani is a savvy business man and an insider. So, Rakuten never tried to disrupt an industry the way that say Amazon disrupted the American publishing industry. Amazon rolled out a set of free tools aimed at self-published authors, who traditional publishers usually ignore. And as more and more of these independent authors began using these tools more successful authors began to take notice. And they also began to notice how little the traditional publishers were actually doing for them and began to migrate to Amazon’s tools.

Now, in America the publishing industry is changing. Many of the publishers, the distributors and the bookstores are not going to survive the next 10 years. That is not happening in Japan. Although, as an interesting side note one of the reasons the Japanese publishing industry has not yet been disrupted in the same way as the U.S. is that the publishers here are very aware of what happened to the industry in the U.S. And they are taking some counter measures.

Some firms are experimenting with e-book publishing, on-demand, low volume print runs. I think it would be fascinating and wonderful if the Japanese publishing industry which includes some of the oldest and most conservative companies in Japan turns out to be one of the first to embrace disruptive innovation. It’s too early to tell, but it’s worth keeping an eye on them.

Now, getting back to Rakuten. What is particularly interesting about them is that they are now trying to disrupt Japan. In their lobbying efforts to allow over-the-counter drugs to be sold online. Their goal is not just to increase their own profits, but it would fundamentally alter the distribution channels of pharmaceutical companies and potentially allow a much wider variety of products to reach the market.

The mid-2000s saw a new generation of successful Japanese startups. But these like Mixi, DeNA and Gree tended to be focused on the new field of mobile gaming. Again, these were companies that became the dominant player in a new industry. They were not companies based on disruptive innovation. They did not have the potential to undermine the core of any existing industry. They did not have the desire to destroy an entire ecosystem of companies in an existing value chain.

And that brings us back to today. Japanese industry has been very good at incremental sustaining innovations. Capitalism has been strong enough here for decades so that any market vacuum left by the larger firms whether it’s e-commerce or mobile gaming is quickly filled by small innovative ones that then grow as the new market grows. But frankly, that’s not good enough.

Japan cannot rely on new technology emerging to provide space for new companies to fill. And then play nice once they grow to a certain size. It may sound like a workable system at first glance, but in today’s world of open economic borders all preventing domestic disruption really achieves is insuring that industry will be disrupted by foreign competitors.

Japan needs truly disruptive businesses. Large Japanese companies for the most part cannot make changes. Progress needs to be forced upon them by smaller more nimble domestic firms or larger better funded foreign firms.

In a way, Japanese traditional hierarchal structures, the emphasis placed on maintaining harmony and the importance of consensus decision-making. The vertically integrated supply chains and distribution channels make the Innovator’s Dilemma so extreme here. But they also make the Japanese market somewhat of an entrepreneur paradise.

Despite all the claims to the contrary most startups including those that appear on this show are not disruptive. Most still dream of finding an open niche or creating a valuable complimentary technology that will be acquired by a large industry player in a few years. And there is nothing wrong with that of course. It’s just good business really. It’s a lot easier to play nice and make alliances than to disrupt an industry and to start taking food out of the mouths of powerful, well-connected companies.

Disruption is painful for the industries being disrupted. And the startups that are causing that disruption often find an entire ecosystems and powerful politicians working to shut them down.

Your mobile game is not disruptive. Neither is your restaurant review site or your food pic sharing app, and that’s fine. Most great companies are not disruptive and most disruptive startups don’t work out in the end. If you are really being disruptive somebody wants you dead.

Who in their right mind especially here in Japan would sign up for that? Well, here is how the current generation of Japanese founders differs from their predecessors. While most are still hoping to discover some uncontested economic niche in which they can grow large enough to IPO. Many of today’s founders want to disrupt things.

There are founders who point to large established Japanese firms and say — privately of course. Public harmony must be maintained — but they will tell you “Yeah. Those guys can’t do what we do. We are going to take away their business. We are going to drink their milkshake. Maybe they will buy us in 5 years, but if they don’t we are going to buy them in 10, or they are going to be out of business in 20.” And as strange as it sounds this gives me hope.

Even if large Japanese companies can’t change themselves there is still a way forward. Disruptive Innovation can come from within Japan rather than being forced upon it from outside. Now, even if Japan finds a way to accept disruptive innovations there is one interesting challenge that remains for it. And one, I hope she finds uniquely Japanese solution for.

Today, America unquestionably does economical disruption better than anyone else. Disruption is practically a cult in startup circles. And as I mentioned before Americans frequently equate disruption with progress. There is however a dark side to the American cult of disruption that occasionally reveals itself in a sort of Ayn Randian, bare-knuckled, winner-take-all cruelty. And that’s unfortunate.

The greatest challenge for Japan is to find a way of embracing economic disruption while maintaining the social engagement and cohesiveness that has been the hallmark of Japanese society for the last 120 years.

And when you think about it economic disruption and social prosperity are not necessarily in conflict. Wanting to tear down your business competition is not the same as wanting people to suffer. A passionate desire to succeed is in no way mutually exclusive with wanting to make sure that those who lose the game are taken care of.

However it works out it will mean big changes of course. A lot of the older hierarchies would fall. Being more senior would no longer guarantee you deference or promotion. Working for a large company would no longer carry more prestige than working for a small one. But those changes are already happening.

The best model for Japan might be found in some of the large companies that have been able to solve the Innovator’s Dilemma, to co-op disruptive technology and to continue to dominant their industries. Microsoft did it with the World Wide Web and is positioning itself to do it again with Cloud Computing and mobile devices. Intel did it when they moved out of memories, but might have missed their chance with low performance mobile chips. IBM and Apple have both done it a number of times. And in those cases the corporate culture and harmony actually improved after the transition.

And who knows, the giant Japanese companies might even find a way to turn it around themselves. To their credit a lot of major firms are launching programs aimed at embracing outside technology and even disruptive innovation.

Mark Twain once said history does not repeat itself, but it rhymes. In the 1950s, Japan Inc. found the blueprint of what would become their phenomenal worldwide reputation for quality, efficiency and sustaining innovation in the work of W. Edwards Deming. Perhaps, just perhaps the work of Clayton Christiansen will provide Japan a blueprint she needs for a future of positive disruptive innovation.

Well, that wraps up our little one-to-one chat, and this special episode of Disrupting Japan. If you enjoyed it and want to hear more of these one-to-one episodes please let me know. Let me know what you think at [email protected]. And of course you can find links to all of the books, sites and companies that we talked about in the show on the show notes at the site.

And if you want to talk to me about disruptive innovation drop by disruptingjapan.com and leave a comment.

And listen, on a personal note I want to thank everyone for all of the positive feedback you have given. I am delighted to hear from listeners who find the show enjoyable and useful. If you like what we are doing don’t hesitate to get in touch. Or even better tell others about Disrupting Japan when you talk about startups in Japan.

I am Tim Romero and thanks for listening to Disrupting Japan.