September 30, 2015    4 minute read

Disruption And Destruction: How Innovation Can Both Help And Hinder Markets

   September 30, 2015    4 minute read

Disruption And Destruction: How Innovation Can Both Help And Hinder Markets

Disruption: it’s a word often used in tech circles to describe the way traditional industries are being displaced by technology. Like all terms though, it has its limitations. When we see the likes of Uber driving down the cost of taking a taxi, or Transferwise enabling cheaper transferring of funds, people frequently refer to the concept of disruptive innovation, seemingly fitting the economist Joseph Schumpeter’s theory of “creative destruction.”

However, there is a subtle distinction between disrupting and destroying. When we disrupt, we force the competition to improve the way they strategically operate their business or price their products. On the other hand, Schumpeterian thinking would point to innovation as eliminating the fundamental value of traditional businesses. In effect, this is Uber versus a conventional taxi service: over the longer term (in the absence of regulation), it is seemingly impossible for taxi firms to compete on a level playing field. Why don’t they just change their business model, you say? Well, the underlying problem here is Uber’s scalability and monopolistic hold on the tech space for taxis: were, say, Hackney Taxis to create their own app for their service, a few people would use it, but why download an app for Hackney Taxis when you could just use your Uber app across many developed countries.

Amazon is a similar example: by pricing books at a discount, it forces bookstores to follow suit, eventually forcing them out of business as delivery times become shorter and transportation costs fall. This is great for the consumer, but has a negative social impact by further increasing Amazon’s market dominance and ability to dictate prices. Of course, this is the nature of capitalism: the free market is a mechanism for a “survival of the fittest” contest of sorts. Does this unduly harm competition in the long run? In this case, quite possibly.

Before you think I oppose innovation, I must convey the wholly positive impact it can have on an industry. Disruption forces established players in a market to adapt or risk extinction: it doesn’t lead to the highly concentrated industries as specified above, but instead changes their dynamic for the better. Take financial technology innovation, or Fintech, for example. Entrepreneurs have recognised the efficiencies that can be created through cutting out middle men, setting technology as the focal point of the business model and pricing competitively, thereby lowering transaction costs for the consumer.

Valued at more than $7 billion, Lending Club had the largest IPO of all US tech companies last year, and offers Peer-to-Peer (P2P) financing solutions: while it offers a similar product to traditional high street banks, it challenges them in such a way that they must adapt to the new environment, rather than threaten to drive them out of business over a long term period. The banks may consequently lower interest rates, offer better customer service or improved rewards for customers in order to differentiate themselves from the new entrants: however, extinction, unlike traditional taxi services, is virtually unimaginable. Here, technology in the free market is working to disrupt rather than destroy, adding value rather than replacing it.

The fundamental question which must be addressed from the above examples is whether technological innovation can be characterised as “good” or “bad”, and if, in the case of the latter, government intervention may be a necessary remedy. Indeed, governments in countries such as France have banned Uber in response to union pressures, and others may soon follow suit. A blanket ban, however, is not an optimal solution to every threat which innovation poses to a traditional industry, as it sends the wrong message: governments should do everything possible, within reason, to encourage innovation. Instead, imbalances should be addressed by imposing price floors on journeys, better screening of drivers and for traditional taxi services, more payment options to offer an improved service to tech-savvy customers. Agreed, it’s difficult to pigeonhole innovation as being good or bad, and a great deal depends on a person’s opinions and views. In spite of this, the newly established Competition and Markets Authority (CMA) in the UK should investigate innovation which might be regarded as destructive more seriously. Amazon are renowned for engaging in numerous anti-competitive practices, but attempts to penalise them have been limited thus far.

The balance between what is perceived as constraining innovation and controlling it, to ensure disruption rather than destruction of markets, is a delicate one. As more economies mature, economic growth will slow, and for these countries, innovation will be the principal driver of future growth, so its importance can’t be overstated. However, innovation comes in different forms, and consumers, firms and regulators must come to recognise them.

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