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HARVARD BUSINESS REVIEW

As hockey great Wayne Cretzky used to say, the key to winning is getting firstto where the puck is going next. The same could be said about succeeding in business, and a new theory of profitability could help you do just that.

to Where the

by Clayton M.Christensen, Michael Raynor, and MattVerlinden

NOVEMBER 2001

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Skate to Where the Money Will Be

When IBM decided to outsource its operating system and processor chips in the early 1980s, it was, or appeared to be, at the top of its game. It owned 70% of the entire mainfranie market, controlled 95% of its profits, and had long dominated the industry. Yet disaster famously ensued, as Intel and Microsoft subsequently captured the lion's share of the computer industry's profits, and Big Blue entered a decade of decline. It's easy to look back and ask, "What were they thinking?" but, in truth, IBM's decision fit well with prevailing orthodoxies, particularly with the idea that companies should outsource all but their core competencies-that is, sell off or outsource any function that another company could do better or cheaper than it could. Indeed, at the time, many observers hailed IBM's move as a masterstroke of strategy, forward-looking and astute. Of course it turned out not to be, but what lessons should we draw from IBM's spectacular mistake? They're far from clear. It's easy to say, "Don't outsource the thing that's going to make lots of money next," but existing models of industry competitiveness offer very little help in predicting where, in an industry's value chain, future profitability will be most attractive. Executives and investors all wish they could be like Wayne Gretzky, with his uncanny ability to sense where the puck is about to go. But many companies discover that once they get to the place where the money is, there's very little of it left to go around. Over the past six years, we've been studying the evolution of industry value chains, and we've seen a recurring pattern that goes a long way toward explaining why companies so often make strategic errors in choosing where to focus their efforts and resources. Understanding the pattern helps answer some of the enduring questions that IBM's leaders, and thousands of others before and since, grappled with: Where will attractive profits be earned in the value chain of the future? Under what circumstances will integrated corporations wield powerful competitive advantages? What changes in circumstances will shift competitive advantage to specialized, nonintegrated companies? What causes an industry to fragment? How can a dominant, integrated player determine what to outsource and what to hold on to as its industry begins to break into pieces? How can new entrants figure out where to target their efforts to maximize profitability? The pattern we observed arises out of a key tenet of the concept of "disruptive technologies"-that the pace of technological progress generated by established players inevitably outstrips customers' ability to absorb it, creating opportunity for up-starts to displace incumbents. This model has long been used to predict how an industry will change as customers' needs are exceeded. (See the sidebar "The Disruptive Technologies Model.") Building on that ground, this new theory provides a useful gauge for measuring not only where competition will arise under those circumstances but also where, in an industry's shifting value chain, the money will be made in the future. The implications of our theory will surprise many readers because, if we're right, the money will not be made where most companies are headed, as they busily outsource exactly the things they should be holding on to and hold on to precisely the things they should unload. But we'll get to that later...

A Tight Fit

Companies compete differently at different stages of a product's evolution. In the early days, when a product's functionahty does not yet meet the needs of key